The unallowable purpose rule in the legislation governing the tax treatment of derivative contracts was considered for the first time by the Special Commissioners in Prudential Plc v Revenue & Customs [2007] UKSPC SPC00636. The rule denies tax relief where a transaction is entered into for an unallowable purpose.

The Special Commissioners held that, in the absence of a clear commercial purpose for entering into a currency swap transaction, Prudential Plc (Prudential), would be treated, seemingly by default, as having the gaining of a tax advantage as a main purpose for entering into the transaction. This constitutes an unallowable purpose and so Prudential was denied tax deductions.

The legislation under consideration has been superseded. However, the current tax law that governs currency swaps and other derivative contracts includes an unallowable purpose test which is substantially the same. Similar tests also feature, in a tax avoidance context, in the UK legislation applying to the taxation of a variety of transactions. Therefore, this decision has a potentially wide application.