Tax Avoidance
Please, Re-Lease Me …!
PETE MILLER of Ernst & Young reviews the decision of the House of Lords in Barclays Mercantile Business Finance v Mawson.
Tax Avoidance
Please, Re-Lease Me …!
PETE MILLER of Ernst & Young reviews the decision of the House of Lords in Barclays Mercantile Business Finance v Mawson.
IN THIS CASE, Barclays Mercantile Business Finance (BMBF) finally succeeded in its contention that expenditure had been incurred on a gas pipeline and that this did qualify for capital allowances.
The transactions
In 1993, BMBF, part of the Barclays banking group, entered into a series of arrangements with the Irish Gas Board, Bord Gáis Éireann (BGE), and its wholly-owned UK subsidiary, BGE (UK) Ltd. The transactions fell into two discrete series. The first was a sale and leaseback arrangement, the second effectively comprised the financing and security arrangements.
Under the sale and lease back arrangements, BGE sold part of a pipeline to BMBF for £91 million. BMBF leased the pipeline back for 30 years to BGE, which in turn sub-leased the pipeline to BGE (UK). The result was that BMBF was able to claim capital allowances in respect of the pipeline, as plant, under CAA 1990, s 24 (now CAA 2001, s 11). This requires a person to have incurred capital expenditure on the provision of machinery or plant, which consequently belongs to that person, wholly and exclusively for the purposes of its trade. Here, BMBF had bought the pipeline, which therefore belonged to BMBF, for the purpose of its asset-leasing trade.
The security arrangements were complex and will not be described in detail. Briefly, however, they were as follows.
* BGE(UK) and BGE entered into a 'Transportation Agreement' whereby BGE (UK) delivered gas under a take-or-pay contract to BGE. From the proceeds of this contract, BGE(UK) would then be able to meet its rental obligations under the sub-lease and make a profit. It was agreed that BMBF would invoice BGE(UK) directly for the head lease rentals and that the payments were guaranteed by Barclays Bank.
* The £91 million received by BGE for selling the pipeline to BMBF was deposited with Barclays Isle of Man via a Jersey trust and used as security for the head lease rentals due from BGE. The return on this investment sourced the take-or-pay contract which indirectly met the finance lease payments. Barclays Isle of Man then placed the £91 million on deposit with Barclays Bank. Deeds of indemnity were also executed by BMBF in favour of Barclays Bank. The result of these transactions was that there was negligible risk to BMBF and almost no financial risk to its parent, Barclays Bank, from the lease back arrangements.
* There were some cash payments to BGE as part of the scheme. These were the excess of investment income over the amounts required to pay the rentals.
It is also worth noting that BZW, also part of the Barclays group, were the advisers to BGE, and that the deal had originally been intended to be a much larger transaction carried out with Abbey National as the lessor.
The hearings
The Inland Revenue rejected BMBF's claim to capital allowances and the Special Commissioners agreed, reported as ABC Limited v M [2002] STC (SCD) 78.
The Revenue's position was that the entire scheme of 'financial engineering' (a term the Special Commissioners noted was probably not meant as a compliment to BMBF by counsel for the Revenue!) was intended merely to allow BMBF to claim capital allowances in the UK, and that the payment of £91 million to BGE produced no commercial benefit, as BGE 'was never able to get its hands on the money', except for 'perhaps a millisecond'. The transaction should be looked at as a whole. The company contended that the purchase and lease back by BMBF should be looked at in isolation, and that the security arrangements were a separate matter, of which BMBF was largely ignorant.
The Commissioners agreed with the Revenue that s 24 refers to commercial concepts (following, inter alia, Westmoreland Investments Limited v MacNiven [2001] STC 237) and that it is necessary to look at the transactions as a whole, following Overseas Containers (Finance) Ltd v Stoker [1989] STC 364. The Commissioners also agreed that it was irrelevant that BMBF was unaware of the detail of the security arrangements. BMBF was part of the larger Barclays group of companies, as were most of the other parties to the arrangements, and Moodie v CIR [1993] STC 188 was authority for the proposition that ignorance of tax planning arrangements was no defence against a Ramsay challenge.
The Commissioners explicitly found that the sequence of transactions was 'pre-ordained and designed … to be a composite whole', with the intention that the UK Exchequer effectively funded the capital allowances for BMBF and hence, indirectly, for BGE through reduced rental payments. While it was accepted that finance leasing is largely economic because of the capital allowances available to the lessor, the Special Commissioners held that commercially-driven finance leasing is designed to give the lessee the benefit of the capital received from the initial sale, which was not the case here.
The Special Commissioners found that BMBF had incurred expenditure, but not on plant or machinery, as required by s 24, so the capital allowances were not available to BMBF.
In the High Court, Mr Justice Park dismissed the company's appeal. He agreed with the Special Commissioners that the scheme was preordained and a composite whole and said that, in the context of the Ramsay doctrine, 'when it is necessary to consider whether an expression in a taxing statute applies … the court must consider the question with an eye to reality rather than artificiality'. He paraphrased Lord Hoffmann, in Westmoreland, by saying that 'statutory terms which are used in a "commercial" sense should be interpreted so as to have their commercial meaning'.
He summarised the Revenue's arguments as follows.
1. BMBF did not really incur any expenditure (i.e. because of the circularity).
2. If it did incur expenditure, it was not on the provision of the pipeline — as found by the Special Commissioners.
3. If expenditure was incurred on the pipeline, it was not wholly and exclusively for the purposes of BMBF's leasing trade, this form of transaction being outside BMBF's normal trade.
The second point was the Revenue's main argument. The judge said that normal finance leasing involves the lessor providing up-front finance to the lessee for use as the lessee sees fit. But here there was no effective up-front finance: BGE had owned the pipeline and continued to have unfettered rights to use it, but it had no extra cash as a result. The only benefits it received were the relatively small payments that were said to represent BGE's share of the capital allowances. Quoting Lord Nicholls in Westmoreland, he said that this transaction is not in accordance with 'the purpose and spirit of the legislation'. Mr Justice Park found that 'the expenditure was really incurred on the creation or provision of a complex network of agreements'. Not only were the transactions effectively independent of the value of the pipeline, but this was a case where 'the credit risk … is so comprehensively eliminated that it becomes apparent … that the lessor has not really laid out its money on a leasing transaction at all'.
With regards to the Revenue's first point above, he was not 'prepared positively to conclude that BMBF did not incur the expenditure'. This was partly because payments were actually made and also because the scheme was not inevitably circular (for example, it could have proceeded with Abbey National). On the third point, Mr Justice Park agreed with the Revenue, saying: 'the transaction was not one which was mainly trading, but with fiscal elements. Rather it was one which was heavily dominated by fiscal elements'. The lease of the pipeline to BGE 'was not … what the transaction was really about'.
The Court of Appeal comprehensively disagreed with the earlier decisions. The Revenue relied on the same arguments as in the High Court, while the company's arguments were as below.
1. Ramsay does not permit BMBF's expenditure to be recharacterised as being 'on the provision of a complex network of agreements'.
2. The concept of incurring expenditure on machinery and plant in s 24 is a legal concept, not a commercial one.
3. Finance leasing does not inherently require there to be some financial benefit to the lessee or any risk to the lessor.
4. Parliament's underlying purpose was not, as stated by Mr Justice Park in the High Court, 'to enable capital allowances to be used so as to provide to lessees at attractive rates finance for them to be able to use and to develop their business activities'.
5. The judge was wrong to conclude that the expenditure was not incurred wholly and exclusively for the purposes of the company's trade.
Detailed judgments were given by Lord Justice Peter Gibson (who also gave the leading Court of Appeal decision in Westmoreland) and Lord Justice Carnwath.
Lord Justice Gibson first noted that, in his view, the Special Commissioners had not properly understood the evidence before them. Some of their comments were factually incorrect and they had not taken into account the evidence from officers of BMBF, Barclays and BGE(UK). The unrefuted evidence from these witnesses was that the leasing operation was an ordinary lease finance arrangement and served the commercial purposes of the parties, in contrast to the Special Commissioners' findings. There was no evidence that the transactions were entered into solely to generate capital allowances or that the payments to BGE were its share of these. Those payments represented the income from the funds on deposit, over and above what was required to make the appropriate lease payments.
He said that the transactions were not entirely risk free to BMBF, which was investing 'a very substantial sum … on acquiring a new unproved pipeline … let on an unusually long lease to a UK corporation owned by a foreign state, the rents under the lease … to be paid by a new company starting up'. Also, the terms were originally negotiated with another party, not Barclays, 'into whose shoes BMBF stepped'. Finally, the other parties to the transactions entered into them on 'ordinary commercial terms'. He concluded: 'To my mind the commerciality of the transaction is plain'. Lord Justice Carnwath agreed, saying that the 'apparently credible evidence that [BMBF] had a distinct business purpose for this transaction' does not easily permit the application of the Ramsay approach.
Lord Justice Gibson then looked at s 24 and said that there is nothing there to prevent a person claiming capital allowances on an asset acquired for use in a leasing trade, contrary to the view of Mr Justice Park, that the legislation 'was enacted so that capital allowances could be used to provide lessees with finance at attractive rates to use and develop their business activities'. Both judges agreed that there was no requirement in s 24 that the lessee should receive up-front finance.
Nor was the asset a 'fifth wheel', unnecessary to the transaction except as the source of the capital allowances. Indeed, the asset is key in providing security to the purchaser/lessor. Lord Justice Carnwath noted that all finance leasing was predicated on the availability of capital allowances to the lessor, and that this could hardly be a ground of objection to the transaction.
On the Ramsay issue, Lord Justice Gibson distinguished this case from Ensign Tankers (Leasing) Limited v Stokes [1992] STC 226: 'In our case there is nothing comparable to the artificial self-cancelling loans found in that case … Each step taken was properly commercial and on arm's length terms'.
Both judges agreed that, as in Westmoreland, the fact that the purchase monies ended up with Barclays is irrelevant to the operation of s 24.
Lord Justice Gibson dismissed arguments about the artificiality of the transactions as there was no evidence for this. On Westmoreland, he admitted he found 'Lord Hoffmann's dichotomy of [legal and commercial] concepts a difficult one to apply'. Lord Justice Carnwath admitted the same difficulty. But by analogy with the fact that 'payment' was held to be a legal term in Westmoreland, both judges decided that 'incurred … expenditure' in s 24 was also a legal term. Even if it were a commercial term, there was no clear step that was artificially inserted into the scheme to which the Ramsay doctrine could be applied, and certainly not the payment by BMBF to BGE, as suggested by counsel for the Revenue.
The judges allowed the company's appeal.
Judgment in the House of Lords
In the House of Lords the case was heard by five judges with great experience in Ramsay cases: Lords Hoffmann, Nicholls and Hope all sat in Westmoreland
