Tax ruling has implications for oil and gas support services

Jake Landman of Pinsent Masons was commenting after the UK Supreme Court rejected (15-page / 255KB PDF) an appeal raised by Dolphin Drilling Ltd (Dolphin) against a 2024 ruling by the Court of Appeal in England and Wales in which the court held that Dolphin was liable to pay additional corporation tax of £6.7 million in relation to its hire of the Borgsten Dolphin (Borgsten) rig. Dolphin had claimed the arrangements were not subject to a cap on the deduction of leasing costs.

The Borgsten had been converted to provide various support services, including accommodation for offshore workers. Dolphin leased the Borgsten from a sister company in Singapore to fulfil a contract it had entered into with Total E&P UK Ltd (Total).

Total operates a separate drilling platform, the Dunbar. The Dunbar “has a drilling derrick but lacks facilities which are essential for active drilling operations” and so it required the support of a tender support vessel (TSV), which provides tender assisted drilling (TAD) services. To fulfil its contract with Total for the provision of TAD services, Dolphin moved the Borgsten into position next to the Dunbar and connected it to the Total platform.

When submitting tax returns, Dolphin assessed that the Borgsten did not constitute a “relevant asset” under the 2010 Corporation Tax Act (CTA).

Under the CTA, profits from oil contractor activities are ‘ring-fenced’ and must be treated separately from other income or gains, with the amount allowable as a deduction for the costs of  leasing a ‘relevant asset’ restricted by a hire cap. Relevant assets are defined as moveable structures used for drilling for oil or providing accommodation for offshore workers. However, an asset is carved out from this definition if it is reasonable to suppose that the accommodation use is incidental to another use.

HM Revenue and Customs (HMRC) argued that tax deductions claimed by Dolphin within the ring fence for the hire of the rig should be capped as it was in fact a “relevant asset.” To successfully challenge the HMRC assessment, Dolphin had to demonstrate that the accommodation use of the Borgsten was “incidental”.

Dolphin was initially successful in its dispute with HMRC. The first-tier tax tribunal (FTT) found “incidental” to mean “secondary” or “subordinate” and considered the accommodation services to be a secondary function of the Borgsten. It held that whilst the requirement to provide accommodation had some importance, when viewed in context, it had less importance than other uses of the Borgsten. The upper tribunal upheld these findings when HMRC appealed, but the Court of Appeal overturned the decision on subsequent appeal.

The Court of Appeal noted that where there is no statutory definition, the ordinary meaning of the word, as it would be used, should be considered. Using this process, the court endorsed HMRC’s argument that for a use to be “incidental” to another, there must be a link between them. The court said that it was not certain that it would go so far as to suggest that a use is only incidental if it is “to further some other purposes,” as suggested in previous cases. Instead, it accepted that the relevant question is to consider whether a use – as accommodation, in this case – was an independent use or arose out of other uses.

Dolphin challenged the Court of Appeal judgment, raising two grounds of appeal before the UK Supreme Court.

First, it argued that the FTT had been correct in its interpretation of the legislation because the history of the legislation shows that the hire cap was confined to drilling rigs and accommodation vessels. It said HMRC’s proposed interpretation would capture all support vessels, because they can be expected to have surplus accommodation that could be used to supply accommodation.

Second, Dolphin said that even if the Court of Appeal’s interpretation is correct, the Borgsten fell outside of it because the Borgsten would not have been used but for the TAD services and therefore the use of the Borgsten to accommodate offshore workers was a consequence of its use to provide the TAD services.

The Supreme Court dismissed Dolphin’s appeal.

The Supreme Court evaluated pre-legislative material to help it determine how the relevant provisions of the CTA concerning the meaning of ‘relevant assets’ should be interpreted.

Dolphin had argued that those materials indicated that the target of the legislation was those vessels whose sole function was a mobile offshore hotel. The Supreme Court disagreed. It considered the provision is predicated on the assumption that a vessel has more than one use.

The Supreme Court also assessed what is meant by the words ‘incidental to another use’ to determine whether use of the Borgsten for accommodation purposes was incidental to the other support functions it performed under the terms of Dolphin’s contract with Total.

The Supreme Court did not disturb the facts found by the FTT that the Borgsten had a primary use of supplying drilling services and a secondary use of providing accommodation. However, the court found that the provision of accommodation was not incidental to the use for drilling services, because it was a separate service, contracted for specifically. Lord Hodge, giving the unanimous judgment of the Supreme Court,  summarised: “Use A of an asset, which is important or even essential, can be secondary or subordinate to another use of the asset, use B. But if use A does not arise out of use B, it is an independent use and it is not incidental to use B.”

Lord Hodge added: “I reject the argument that because the Borgsten was connected to the Dunbar in order to provide TAD services, that made its provision of accommodation to the Total personnel incidental to the provision of the TAD services. In essence the submission is: but for the connection of the Borgsten to the Dunbar it would not have provided the accommodation services. That is not the test: use A must be incidental to use B of the Borgsten.”

“Similarly, the arguments that (i) but for the provision of the TAD services there would have been no drilling campaign and no need for the provision of accommodation and (ii) all the services provided by the Borgsten were to facilitate Total’s drilling activity, founder on the same rock,” he said.

The Supreme Court suggested that there may be other cases where “use of accommodation on a TSV which is trivial or casual may not be more than incidental to the provision of TAD services or some other use”. However, it considered that the facts did not support such a conclusion in this case. This is because, Lord Hodge said, “Total stipulated for the use of extensive accommodation on the Borgsten and extra accommodation on the Borgsten was created for and paid for by Total”.

The words ‘incidental to’ feature in other tax legislation in the UK. The Supreme Court said its findings on how the words ‘incidental to another use’ were to be interpreted in this case are to be confined to the specific context that arose and is not determinative of how similar wording in other legislation should be read. It cited examples in corporation tax law where ‘incidental’ is given very specific meaning that would not be consistent with the interpretation it reached in this case, as well as others where it would, to underscore its point about the importance of context to such legal interpretation.

Jake Landman said: “Advisers and taxpayers had been wondering the extent to which this case might have wider implications on the meaning of incidental in other tax contexts, such as deductibility of expenditure. The Supreme Court has now made it clear that the meaning of incidental must be decided in the statutory context in which it is found. However, the comments of Lord Hodge may well find their way into discussions of interpretation of this phrase in other contexts.”

“From the perspective of oil and gas companies who use support vessels, this decision makes it clear that the contractual provisions between the parties in making provision of services and accommodation are key to establishing whether the hire cap applies. Consideration should be given to their existing arrangements in light of this decision,” he said.