The Upper Tribunal (Tax And Chancery Chamber) (“UT”) has published its decision in HMRC v Blackrock LLC5.
The appeal was made by HMRC after the First-tier Tribunal (Tax Chamber) (“FTT”) had previously found in Blackrock’s favour on two issues; transfer pricing and allowable purpose. Frontier’s Simon Gaysford was an expert witness for HMRC on the transfer pricing aspects of the case.
This case concerned the structure used by the BlackRock group of companies (“the BlackRock Group”) to acquire the North American investment management business of Barclays Global Investors (“BGI US”) from Barclays Bank plc in December 2009. The ultimate issue in the appeal was whether the Respondent, BlackRock Holdco 5, LLC (“LLC5”), which was created and used as part of the acquisition structure, was entitled to non-trading loan relationship debits in respect of the interest and other expenses payable on $4 billion worth of loan notes. The loan notes (“the Loans”) were issued in return for the loan LLC5 received from its parent, BlackRock Holdco 4, LLC (“LLC4”) and were a form of intra-group financing. HMRC contended that these intra-group loans would not have happened at arm’s length, with an independent lender.
The FTT’s decision was released on 3 November 2020 and found that an independent lender acting at arm’s length would have made loans to LLC5 in the same amount and on the same terms as to interest as were actually made by LLC4 but that, critically, this would have depended on certain covenants having been provided by other parts of the group. Such group convents were not part of the actual transaction but had to be hypothesised in a transaction with an independent lender in order to assess whether such a hypothetical transaction could have taken place at arm’s length. HMRC had contended, based on Simon Gaysford’s expert evidence, that such group covenants, even if they would have been agreed at arm’s length (which was in dispute), would then have changed the economic characteristics of the transaction to such a significant degree that the whole transaction (the loans plus the covenants) could not then have been judged to pass the arm’s length test.
The UT concluded that the “hypothetical transaction must be sufficiently comparable with the actual transaction for the purpose of testing it” and that the test of sufficiently comparable rests on an assessment of the “economically relevant characteristics”.
“Importing third-party covenants into a hypothetical transaction that did not exist in the actual transaction changes the nature of the provision which is to be compared. By permitting the introduction of third-party covenants, the FTT essentially compared a different transaction to the actual one. It enabled the FTT to reach the conclusion that the same Loans and terms including interest rates as between LLC4 and LLC5 would have occurred at arm’s length. However, we do not consider that new third-party covenants that were not present in the actual transaction and which materially affect the economically relevant characteristics of the transaction can be so imposed to provide a comparable arm’s length transaction.” [Paragraph 59]
“We accept that there is nothing in the legislation or the TPG that expressly rules out third-party involvement in the hypothetical transaction. But we consider that the focus of the legislation is clear and that is on the “provision…made or imposed as between any two persons”, which in this case is the Loans, and the only substantive changes that are tested by the “arm’s length provision” are to the terms of the Loans themselves, such as the interest rate. Third-party covenants that were not given as part of or in support of the actual transaction cannot be considered to be part of the hypothetical transaction as this materially changes the surrounding circumstances and alters the economically relevant characteristics of the transactions in question.”
“In conclusion, the FTT erred in law in permitting new third-party covenants absent from the actual transaction to be taken into account when considering whether an independent lender would make a $4 billion loan to LLC5. The FTT decided that such an independent lender would not have made a $4 billion loan to LLC5 without such covenants being in place and that important finding should itself have determined that there was no comparable arm’s length transaction. Having decided that, the FTT would have been bound to conclude that no “provision would have been made as between independent enterprises” (s.151(2)).
“Therefore, we are satisfied that the FTT erred in law in a material manner and its decision should be set aside based upon this first ground of appeal.” [Paragraphs 75-77]
This is an important development in transfer pricing cases and confirms, once again, that the economics of transactions – both actual and hypothesised - play a central role in how the courts will decide, especially when the law itself may be unclear.
Blackrock may now decide to appeal this case further.
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