Tax Case - The Real World

RICHARD CURTIS reports Barclays Mercantile Business Finance Ltd v Mawson (Inspector of Taxes).

The Ramsay doctrine, when applied to a series of transactions that were ostensibly a finance lease, dictated that this was an example of 'financial engineering', rather than expenditure incurred in a trade. The expenditure was not therefore eligible for capital allowances.

The background

The general plan with a finance lease is to enable a business to have the use of an asset for a rental charge, rather than having to buy the asset itself. The lessor has legal ownership of the asset, but the risks and rewards of ownership rest with the lessee. As this is basically a loan of money with the asset as security, the lessor, commonly a finance company, will effectively be looking for a return of interest on the loan. As it will be carrying on a trade of leasing such assets it will be entitled to capital allowances under section 24, Capital Allowances Act 1990 and this tax relief will be reflected in lower rental charges that the lessee business must pay. Sometimes, the business will already own the asset, which it sells to the lessor (usually to release capital for further investment in its business) and then leases it back. This commonly used commercial transaction, familiar to many, was the basis of a disagreement over entitlement to capital allowances between the Inland Revenue and Barclays Mercantile Business Finance Limited which was the appellant company in this case. Rather like a play, the case report lists the dramatis personae and then sets out the events as they unfolded and the effects upon the characters.

The events

The Irish Gas Board had built a natural gas pipeline from Scotland to the Irish Republic at a cost, net of a European Community grant, of £91 million. In 1992, Barclays de Zoette Wedd Ltd started to advise the Gas Board about financing opportunities and on 31 December 1993 the following transactions took place.

• Barclays Bank lent £91 million to the appellant company which then purchased the pipeline from the Gas Board for £91 million.
• It leased the pipeline back to the Gas Board. There is not space to go into great detail, but the rents payable were calculated, over the main 'primary' 31 year period of the lease, to repay the £91 million to the company plus a 'worthwhile margin'. But this would only be the case if capital allowances on the pipeline were available to the company. Also, as is usual in such cases, the finance lease had conditions written into it that the terms could be varied (or ultimately terminated) depending upon changes in the levels of United Kingdom corporation tax and entitlement to capital allowances.
• The Gas Board then subleased the pipeline to a subsidiary company (BGE(UK) Ltd) on terms which, for all intents and purposes, largely mirrored its own lease with the appellant company. (N.B. There had to be a lease to a United Kingdom company because, otherwise, section 42, Capital Allowances Act 1990, would prevent a claim to capital allowances. At the time of these transactions, the Revenue took the view that one could 'look through' a series of leases to determine whether allowances were due. Generally this would prevent allowances being available if assets were leased to a United Kingdom company, which then subleased them to a non-resident company. The Revenue has now changed its view on the interpretation of section 42, but sportingly did not argue this point.)
• The Gas Board and BGE (UK) Ltd made a transportation agreement under which the Gas Board would make payments to BGE (UK) Ltd for transporting its gas. There was a complex formula for calculating these payments, but they would always be sufficient to cover the lease payments due from BGE (UK) Ltd to the Gas Board.
• An 'assumption agreement' was made whereby, instead of BGE(UK) Ltd paying the Gas Board who would then pay the company, BGE (UK) Ltd would pay the company directly.
• Barclays Bank gave a guarantee to the company that it would receive the finance lease payments from BGE (UK) Ltd.
• The Gas Board was obliged to deposit the £91 million that it had received from the sale of the pipeline with Deepstream Investments Ltd, a Jersey company owned by a charitable trust, but managed by a company in the Barclays Group.
• Deepstream immediately deposited the £91 million with Barclays Finance Company (Isle of Man) Ltd.
• Barclays Finance Company (Isle of Man) Ltd placed the £91 million on deposit with the group treasury of Barclays Bank.

So, although there was no doubt that the payments had been made using the CHAPS system, the £91 million had started out from and, via a circular route, returned to Barclays Bank. Without going into detail, payments would return in the opposite direction as the lease rental payments, etc. became due for payment.

The Revenue had refused the company's claim to capital allowances in respect of the pipeline. Having lost its appeal before the Special Commissioners, the company appealed to the High Court.

Judgment in the High Court

Having analysed the payments made between the parties, Mr Justice Park noted that the payments returning to the appellant company would not be sufficient to cover its repayment obligations to Barclays for the loan of the £91 million. Where was the balance to come from? Answer: from the tax savings that would arise from its capital allowances claim. This would lead either to a tax reduction for the company or (more likely) to a payment from another group company in return for the surrender of the loss relief arising from such a claim. It was stressed that 'this in itself is entirely normal, and not some sort of abuse of the tax system'.

Mr Justice Park then moved on to look at the elements of the 'Ramsay authorities' that he considered of relevance to this case.

The Ramsay principle (W T Ramsay Ltd v Commissioners of Inland Revenue [1981] STC 174) comes into play when there is a series of transactions with a 'close nexus' between them, i.e. they were pre-ordained and the overall nature of the transactions is different from that which would appear to be the result if looking only at one particular document. He stressed that the words 'real' and 'really' regularly appeared in judgments relating to the Ramsay principle.

Mr Justice Park then moved on to the case of Westmoreland Investments Ltd v MacNiven [2001] STC 237 (which also mentioned that 'the obligation to pay interest ... was a genuine one which existed in the real world'). In that case, Lord Hoffmann distinguished between commercial concepts, where the Ramsay principle would apply, and legal or juristic concepts, where, because they have no broader commercial meaning, it would not.

Also mentioned was Lord Nicholls' statement in Westmoreland that 'courts have regard to the underlying purpose that the statutory language is seeking to achieve'. Having referred to that, Mr Justice Park agreed with the Revenue that it was not necessary to prove that the scheme was 'a complicated, convoluted tax avoidance transaction', but the fact that it was not such a transaction did not mean that the Revenue would lose the case.

General observations

Turning to the present circumstances, Mr Justice Park noted that in the view of the appellant company, although the scheme was large and complicated, it was still 'standard commercial finance leasing'. However, he did not agree.

'I think that there is a danger that pure specialists in asset-based financing structures may become carried away by the details of a structure which they are devising, to the extent that they tend to lose sight of the overall picture.'

It did not automatically follow that, just because a lessor is in the finance leasing business, capital allowances will be available in respect of every transaction that it is involved with. Mr Justice Park referred to specialist evidence on the nature of finance leasing to the effect that in every scenario, the lessee received finance that was utilised, one way or another' in its business. After the transactions in this case, the lessee - the Gas Board - was still able to use the pipeline as before; its original loans for the construction of it were still in existence and the £91 million that it had received for its sale was not available in any other way to finance transactions or activities in its business. The transactions were 'not remotely characteristic of finance leasing as … described'.

The Revenue's three lines of argument were then considered by Mr Justice Park.

Expenditure on the pipeline

To fall within section 24, the expenditure had to be incurred on the provision of machinery or plant. This was a commercial concept and the section had been widely drawn to account for the various ways in which assets could be purchased or made. Mr Justice Park asked himself 'on what did the company really incur its expenditure of £91 million? In reply, he considered that the expenditure was actually incurred to create 'money flows' that would occur annually over the lease period and which would recoup the company's £91 million outlay plus a profit. He agreed with the Revenue's contention that this was 'financial engineering'. He also noted that the Gas Board's ability to meet its lease obligations depended only to a small extent on its business performance. Furthermore, not only was the value of £91 million attributed to the pipeline simply the cost of it to the Gas Board, rather than a market value, the plan would have worked whether the price had been £9.1, £91 or £191 million. In fact, the pipeline was actually surplus to the scheme, he likened it to 'a fifth wheel on a coach'.

In consequence of this, Mr Justice Park concluded that the appeal must be dismissed.

Some consideration was given to the Revenue's other arguments. Mr Justice Park appeared to have thought that the argument that the company did not incur any expenditure at all was rather flimsy. However, he did agree with the Revenue's contention that the expenditure was not incurred for the purposes of its trade. He drew the distinction between a trading transaction that had a fiscal advantage - which would not be 'denatured' as a result - and a transaction where the greater part was only explicable on fiscal grounds and which had only 'elements of trading'. The latter case would not be enough to 'cast the cloak of trade over the whole structure' and, if the appeal had not already failed, it would have on this ground.

Finally, Mr Justice Park mentioned that the decision of the Commissioners in Delta Finance Newco Ltd (Taxation, 22 August 2002, page 582) had been brought to his attention and that whilst there were similarities there were also differences, However, on the basis that an appeal in that case might come before the court in the future he forbore from making any further comments.

Commentary

This case is a useful lesson in the application of the Ramsay doctrine and the report in Simon's Tax Cases [2002] STC 1068 does make interesting reading. In a nutshell, I think the lesson is that once a tax planning exercise has been mapped out, one should take a few steps back and have a look at how the various parts are put together. Does it look like a map of the real world? Do transactions move from one 'country' to another with real commercial benefits to the parties involved or is one, like some sixteenth century explorer, starting to venture away from the known, 'real', world into uncharted territory. If so, then a look at one of those old, yellowing, maps can still be instructive - such areas were often inscribed 'here be dragons'!

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