Barclays Mercantile Business Finance Ltd v Mawson (Inspector of Taxes)
| Jurisdiction | UK Non-devolved |
| Judgment Date | 25 November 2004 |
| Neutral Citation | [2004] UKHL 51 |
| Court | House of Lords |
| Date | 25 November 2004 |
[2004] UKHL 51
HOUSE OF LORDS
ORDERED TO REPORT
The Committee (Lord Nicholls of Birkenhead, Lord Steyn, Lord Hoffmann, Lord Hope of Craighead and Lord Walker of Gestingthorpe) have met and considered the cause Barclays Mercantile Business Finance Limited (Respondents) v. Mawson (Her Majesty's Inspector of Taxes) (Appellant). We have heard counsel on behalf of the appellants and respondents.
The following is the opinion of the Committee to which all its members have contributed.
Capital allowances
The issue in this appeal is whether Barclays Mercantile Business Finance Ltd ("BMBF") is entitled to capital allowances in consequence of having paid about £91m for a gas pipeline under the Irish Sea.
A trader computing his profits or losses will ordinarily make some deduction for depreciation in the value of the machinery or plant which he uses. Otherwise the computation will take no account of the need for the eventual replacement of wasting assets and the true profits will be overstated. But the computation required by Schedule D (whether for the purpose of income or corporation tax) has always excluded such a deduction. Parliament therefore makes separate provision for depreciation by means of capital allowances against what would otherwise be taxable income. In addition, generous initial or first-year allowances, exceeding actual depreciation, are sometimes provided as a positive incentive to investment in new plant.
This appeal is concerned with the form of capital allowance called a "writing-down allowance", which, as its name suggests, is intended to be a substitute for deducting depreciation in the computation of profits. The conditions upon which it is allowed are contained in section 24(1) of the Capital Allowances Act 1990:
"(1) Subject to the provisions of this Part, where—
(a) a person carrying on a trade has incurred capital expenditure on the provision of machinery or plant wholly and exclusively for the purposes of the trade, and
(b) in consequence of his incurring that expenditure, the machinery or plant belongs or has belonged to him,
allowances and charges shall be made to and on him in accordance with the following provisions of this section."
BMBF
BMBF is a member of the Barclays group which carries on the trade of finance leasing or providing "asset based finance". It is the UK market leader in this field. The essence of its business is to provide capital for the purchase of an asset for use by its customer in return for a series of periodic payments secured upon the asset itself. The transaction normally takes the form of a purchase of the asset by BMBF, either from a third party or (by way of "sale and lease back") from the customer himself, followed by the grant to the customer of a lease at a rent calculated to secure BMBF an appropriate return. BMBF has the security of being owner of the asset and entitled in the event of default to sell it and recover the sums outstanding.
There is no dispute that BMBF, as purchaser of an asset, is ordinarily entitled to a capital allowance under section 24(1). It carries on the trade of leasing and has acquired the asset wholly and exclusively by way of provision for the purposes of that trade. In consequence of its purchase from the third party or the customer, BMBF becomes owner of the asset and remains owner during the subsistence of the lease. Depreciation of the asset is a depreciation in the value of BMBF's capital assets.
The pipeline
Bord Gáis Éireann ("BGE") is an Irish statutory corporation responsible for the supply, transmission and distribution of natural gas in the Republic of Ireland. Between 1991 and 1993 BGE employed contractors to build a high-pressure pipeline for the transport of natural gas from Moffat in Scotland to Ballough in the Republic. The pipeline consisted of three parts: a 30 inch onshore pipeline 80km long from a compressor station at Moffat to another compressor station at Brighouse Bay on the Scottish coast; a 24 inch undersea pipeline 208 km long from Brighouse Bay to Loughshinny on the Irish coast, not far north of Dublin; and a 30 inch onshore pipeline, 8km in length, from Loughshinny to Ballough. This was an infrastructure project of national importance, intended to meet the need for natural gas in the Republic as its own natural gas fields (off the south coast of Ireland) came to be exhausted. The pipeline was completed by the end of 1993, although there was a lengthy period of commissioning before it was fully in service. The cost was met, as to part, by a 35% EEC grant. The rest appears to have been provided by a consortium of banks.
The sale and lease back
On 31 December 1993 BGE sold the pipeline to BMBF for £91.292m and was granted a lease back. The judge rounded the purchase price down to £91m and we shall do the same. The sale was given effect by two acquisition agreements executed between BGE and BMBF providing for the sale of part of the pipeline in two sections: (i) the section on Irish soil or in Irish territorial waters (the price being £25.018m plus VAT) and (ii) the section running in international waters (or in Manx territorial waters) and three turbine compressor units at the compressor station at Brighouse Bay on the Scottish coast (the purchase price being £38.363m plus VAT for the pipeline in Manx waters and the compressors and £27.911m with no VAT for the pipeline in international waters between the Isle of Man and Ireland). These prices were based on an apportionment of the actual cost of the pipeline and compressors, with various adjustments, the most important being the deduction of apportioned amounts of the EEC grant. The aggregate assets acquired by BMBF under the acquisition agreements are referred to below as "the plant".
The lease to BGE was for (i) a pre-primary period (covering the initial commissioning of the plant) from 31 December 1993 to 30 September 1995 and (ii) a primary period of 31 years from 1 October 1995. Thereafter the lease could be renewed for a succession of one-year periods. The basic rent was specified in an "initial cash flow", a computer printout annexed to a lengthy financial schedule forming part of the lease. The rent (which was chargeable to corporation tax in the hands of BMBF) was to be about £2.86m in 1995 and about £6.01m in 1996, escalating by 5% annually in each later year. But Part 3 of the financial schedule provided for the rents to be adjusted (by the mechanism of one or more revised cash flows) if any of the assumptions in Part 2 of the schedule (which centred on corporation tax matters, and in particular rates of corporation tax and the availability of writing-down allowances) proved incorrect, either initially or as a result of changes during the course of the lease. In the event of default, BMBF became entitled to termination payments intended to put it in the same financial position as if the lease had continued and there were quite elaborate provisions for re-delivery of the plant to BMBF and its sale to enable the termination payments to be recovered.
BGE did not intend to operate the pipeline itself. It incorporated a wholly-owned UK subsidiary called BGE (UK) Ltd ("BGE (UK)") on 17 June 1993. It is resident and carries on a substantial business in the United Kingdom. On the same day as the lease to BGE was executed, it granted a sub-lease to BGE (UK) for the "Sub Lease Period", an expression which appears (after a lengthy paperchase through a thicket of definitions) to correspond exactly to the period of the lease. (No one has ever taken the point that the sub-lease might have taken effect as an assignment.) In general the terms of the sub-lease followed those of the lease, but there was an important difference as regards rent. The sub-lease provided for the same escalating rental payments as in the initial cash flow, but without any provision for adjustments.
At the same time BMBF, BGE and BGE (UK) entered into an Assumption Agreement by which BGE (UK) assumed direct liability to BMBF to pay the rent due under the head lease. BMBF agreed to accept these payments in discharge of BGE's liability and BGE agreed to treat them as discharging BGE(UK)'s liability under the sublease. The only complication arose from the absence of any provision for adjustment of the rent under the sublease. Park J described what he understood would be the position if the rent under the headlease was adjusted ([2002] STC 1068, 1089-90, para 18):
"If corporation tax rates changed, the head lease rent payable to BMBF would change but the sublease rent payable by BGE (UK) would remain the same. If I have understood correctly how it would work, if the head lease rent went up BGE (UK) would still pay the full amount of the sublease rent to BMBF, and the balance of the (now) increased head lease rent would be paid by BGE to BMBF; if the head lease rent went down BGE (UK) would pay part of the sublease rent to BMBF (that part being equal to the (now) reduced head lease rent) and would pay the balance of the sublease rent to BGE."
It has not been suggested that the judge's understanding was incorrect.
As the most important part of BGE (UK)'s business was to be to transport BGE's gas through the pipeline to Ireland, BGE (UK) and BGE entered into a transportation agreement and an ancillary licence agreement. BGE (UK) undertook the obligation to transport natural gas through the pipeline in consideration of annual payments calculated by various formulae. The details are very complicated and are not relevant, except that it is common ground that (as provisions for 5% annual escalations suggest) the payments were intended to ensure...
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