BlackRock HoldCo 5, LLC v Commissioners for His Majesty's Revenue and Customs, [2024] EWCA Civ 330

The structure for the acquisition by the BlackRock group of the U.S. target (“BGI”) entailed a BlackRock LLC (“LLC4”) lending US$4 billion to a wholly-owned LLC (“LLC5”) as well as injecting substantial equity into LLC5, with LLC5 using most of those proceeds to subscribe for preferred shares of the transaction Buyco (“LLC6” – which acquired all the shares of BGI). LLC6 was wholly-owned by LLC5 save for the common shares of LLC5 held directly by LLC4. The LLCs (and, thus, the loan) were disregarded for US tax purposes; however, LLC5 was resident in the UK by virtue of being managed and controlled there, so that the loan interest generated losses for UK tax purposes which it transferred to other UK group members.

The UK transfer-pricing legislation (which was explicitly stipulated “to be read in such manner as best secures consistency” with the OECD’s Transfer Pricing Guidelines) required that the profits and loss of LLC5 be computed as if the transaction which would have been made between two independent enterprises (the “arm’s length provision”) had been made, instead of the “actual provision” between LLC5 and LLC4.

In rejecting the position of HMRC (and the finding in the Upper Tribunal) that the LLC5 interest deductions should be denied under these transfer-pricing rules on the basis that the loan transaction between the two enterprises (LLC4 and LLC5) was not one which would have been made by arm’s-length enterprises (i.e., LLC4 lacked covenants of LLC5 and BGI to ensure the flow of dividends to LLC5 from LLC6 to service the loan), Falk LJ first noted that “[i]n the real transaction, LLC4 had no need of any [such] covenants … because, quite independently of its ownership of LLC5, it had control of LLC6 and its subsidiaries, including BGI US (the ‘LLC6 sub-group’)” (para. 59). She further noted that the OECD guidelines required that, in comparing the actual transaction to the hypothetical transaction that two independent enterprises would have entered into, “the OECD guidelines contemplate that adjustments may be made to ensure that material differences between ‘economically relevant characteristics’ are eliminated” (para. 67). Falk LJ found (at para. 84) that in this light:

The appropriate comparison is not between the non-existence of covenants in the actual transaction and the covenants that a third-party lender would require, but between the actual risks in the real world and the risks in the hypothetical transaction. In the hypothetical transaction there are risks that third parties (specifically, the LLC6 sub-group) may take actions that prejudice the performance of the Loans. Those risks do not exist for the parties to the actual transaction. The covenants in the hypothetical transaction effectively bring the risks into line with each other, so that the transactions are comparable.

However, although the interest deduction was not to be denied under the above transfer-pricing rules, it was denied under the UK “unallowable purpose” rule, i.e., in general, the main purpose of the loan was securing a tax advantage.

The structure for the acquisition by the BlackRock group of the U.S. target (“BGI”) entailed a BlackRock LLC (“LLC4”) lending US$4 billion to a wholly-owned LLC (“LLC5”) as well as injecting substantial equity into LLC5, with LLC5 using most of those proceeds to subscribe for preferred shares of the transaction Buyco (“LLC6” – which acquired all the shares of BGI). LLC6 was wholly-owned by LLC5 save for the common shares of LLC5 held directly by LLC4. The LLCs (and, thus, the loan) were disregarded for US tax purposes; however, LLC5 was factually a UK resident, so that the loan interest generated losses for UK tax purposes which LLC5 transferred to other UK group members.

The UK transfer-pricing legislation (which was explicitly stipulated “to be read in such manner as best secures consistency” with the OECD’s Transfer Pricing Guidelines) required that the profits and loss of LLC5 be computed as if the transaction which would have been made between two independent enterprises had been made, instead of the actual transaction between LLC5 and LLC4.

In rejecting the HMRC position that the LLC5 interest deductions should be denied under these transfer-pricing rules on the basis that the loan transaction between the two enterprises (LLC4 and LLC5) was not one which would have been made by arm’s-length enterprises (i.e., LLC4 lacked covenants of LLC5 and BGI to ensure the flow of dividends to LLC5 to service the loan), Falk LJ first noted that in the actual transaction, LLC4 had no need of such covenants given its control of LLC6 and its subsidiaries (the “LLC6 sub-group”). She further noted that the OECD guidelines required that, in comparing the actual transaction to the hypothetical transaction between two independent enterprises, “the OECD guidelines contemplate that adjustments may be made to ensure that material differences between ‘economically relevant characteristics’ are eliminated” (para. 67). She found (at para. 84) that in this light:

The appropriate comparison is not between the non-existence of covenants in the actual transaction and the covenants that a third-party lender would require, but between the actual risks in the real world and the risks in the hypothetical transaction. In the hypothetical transaction there are risks that third parties (specifically, the LLC6 sub-group) may take actions that prejudice the performance of the Loans. Those risks do not exist for the parties to the actual transaction. The covenants in the hypothetical transaction effectively bring the risks into line with each other, so that the transactions are comparable.

However, although the interest deduction was not to be denied under the above transfer-pricing rules, it was denied under the UK “unallowable purpose” rule, i.e., in general, the main purpose of the loan was securing a tax advantage.