Tribunal sets out guidance on public benefit test for use of rooftops as telecoms sites
Out-Law Legal Update | 04 Feb 2020 | 2:18 pm | 8 min. read
In this case the investment involved constructing properties in an enterprise zone. HM Revenue & Customs (HMRC) was unsuccessful in arguing that none of the allowances claimed were available, with the tribunal deciding that an apportionment was necessary. However, the tribunal said HMRC had to stand by industry guidance given in the 1990s which boosted the available allowances.
The recent UK Upper Tribunal (UT) decision in Cobalt Data Centre 2 LLP and Cobalt Data Centre 3 LLP v HMRC concerned enterprise zone allowances (EZAs), a form of capital allowances. The case considers 'golden contracts', the extent to which expenditure qualifies for allowances and the meaning of carrying on business with a view to profit. It is also a rare example of a taxpayer winning a judicial review application after HMRC tried to resile from taxpayer guidance.
In April 2011 two LLPs (the LLPs) acquired an assignment of rights under a 2006 construction contract providing for construction works to be undertaken at an enterprise zone in North Tyneside. One of the conditions for EZAs to be available was that the expenditure had to be incurred while the site was within an enterprise zone or incurred 'under' a contract entered into within 10 years of the site being first included in an enterprise zone.
The contract acquired by the LLPs was created in 2006, the day before the enterprise zone at the site expired and was designed to ensure that EZAs could be claimed on future construction work on the site (a so called 'golden contract'). The contract required the contractor to build one of six different buildings on the site as specified by the developer. Just before the LLPs acquired their rights under the contract, it was amended to provide for the construction of data centres and the developer paid advances of c.£97m to the contractor to fund the construction.
In aggregate the LLPs paid £263m for the assignment of the golden contract and claimed EZAs on that amount. HMRC refused the claim, on the basis that:
The LLPs contested all HMRC's arguments and argued, by way of judicial review (JR), that HMRC could not resile from guidance it had given to the industry saying it would not argue that part of the purchase price was provided for rental guarantees.
Collective investment structures need to be treated as tax transparent so that allowances flow through to investors and can be offset against personal income tax liabilities. In this case it was even more important because EZAs are not available for expenditure incurred on or after 1 April 2011 for corporation tax purposes and 6 April 2011 for income tax purposes. The expenditure was incurred on 4 April 2011, so if HMRC could show that the LLPs were not carrying on a “trade, profession or business with a view to profit” the 1 April deadline would apply and EZAs would not be available.
HMRC argued that the LLPs were at best indifferent as to whether a profit was made because their motive was to obtain the EZAs. HMRC highlighted that the LLPs did not negotiate the price for the contract and paid more than it was worth, the headline rent assumed for the data centres was never realistically achievable and the LLPs did not do the due diligence which would be done by someone whose purpose was to make a profit.
The UT found that the principal purpose of the LLPs was to obtain the benefit of EZAs for their members, it was their subsidiary purpose to carry on business with a view to profit and the test does not require the carrying on of a business mainly with a view to profit. The UT found that key individuals genuinely believed that a profit was reasonably achievable and that it was their genuinely held intention that the LLPs were carrying on business with a view to profit.
The UT did not agree with the LLPs that the 'change orders' requiring the developer to build data centres rather than other types of building were made pursuant to the original provisions of the contract. However, they did not agree with HMRC that the contract had been rescinded rather than varied or that the changes created a separate new contract.
The judges said that the question of whether the contract was varied or rescinded depended on the intention of the parties and they were satisfied that the parties intended to vary the contract and not to rescind it, not least because the parties knew this was crucial for the EZAs to be available.
For expenditure to qualify for EZAs it had to be paid 'for' the relevant interest i.e. the developer's right under the golden contract to have the buildings constructed. HMRC argued that not all the price was paid 'for' the relevant interest and an apportionment was necessary. The LLPs argued that there could only be an apportionment if there was an artificial effect on pricing such that an anti avoidance provision applied.
The UT concluded that apportionment is contained within the concept of consideration being paid 'for' a relevant interest. It therefore rejected the LLPs' claim that the entire price was paid for the relevant interest.
The LLPs paid around £263m for the assignment of the contract, 30% funded by subscription from LLP members and the remainder by bank loans, subject to complex security arrangements including sums required to be deposited by the developer and contractor into restricted bank accounts. The developer also agreed to pay yearly sums to ensure the LLPs had sufficient funds to meet their interest expenses before the data centres were let (expenses support arrangements) and to top up the rents once they were let if the rental income was less than envisaged (rental support arrangements). The developer was also required to pay an arranger's fee of c.£10m to the scheme promoters and there were arrangements to support the repayment of the bank loan (capital repayment support arrangements).
HMRC argued that although the developer had paid £97m to fund the construction, allowances were being claimed on a substantially higher figure. The purchase price for the assignment of the rights under the contract also funded a raft of other things including the rental and expenses support arrangements, the payment of the arranger's fee to the promoter and a profit element for the developer.
The UT concluded that under the contractual arrangements the LLPs acquired rights and benefits in addition to the assignment of the developer's interest. However, they rejected HMRC's argument that because of a circularity of funds, none of the price was paid for the relevant interest.
In correspondence with the Enterprise Zone Property Unit Trust Association (EZPUTA) in the 1990s, HMRC said it would not seek to argue that part of the purchase price on EZ collective investment structures was paid for rental support arrangements so as not to qualify for EZAs, provided the rentals were at a reasonable level. The rental support arrangements mentioned in the correspondence also covered the type of arrangement referred to in the Cobalt case as 'expense support arrangements' but not the capital repayment support arrangements. The LLPs argued in the JR claim that they had a legitimate expectation that HMRC would stick by its guidance – which seemed to have been applied consistently between 1994 and 2011.
HMRC's arguments included the assertion it had no power to confirm that EZAs would be available if the legislation provided that they were not and if the guidance was wrong as a matter of law this was a proportionate reason for HMRC to resile from it.
The UT pointed out that EZPUTA had approached HMRC for confirmation on how the law would be applied in an area where its application was open to debate and EZPUTA and HMRC had a shared interest in the publication of HMRC's view of the law. In those circumstances, "it would be unjust and disproportionate for HMRC to be permitted to disavow their guidance even if, with the benefit of hindsight, it did not set out an accurate statement of the law," the UT said.
It is refreshing to see the UT making HMRC stand by guidance given to taxpayers. In a recent judicial review case concerning Aozora, the Court of Appeal decided that the company could not rely on an incorrect statement in HMRC's manual. The Court said Aozora had to show a "high degree of unfairness" in order to override the public interest in HMRC collecting taxes properly due. It said the company's reliance on the manual was "weak" because the representation was merely HMRC's opinion about the construction of a relatively straightforward legal provision and Aozora had sought and obtained specialist advice on its meaning.
Although Aozora was not discussed in the Cobalt case, this decision can be seen as consistent with Aozora, as the guidance in Cobalt was industry guidance, deliberately issued to be relied upon and which had been applied by HMRC for number of years. However, the Cobalt guidance has some similarities with the HMRC manual guidance in Samarkand, which set out the approach HMRC would take to film partnerships. In Samarkand, the Court of Appeal said the guidance did not bind HMRC as HMRC had reasonable grounds for suspecting tax avoidance. So although the Cobalt decision assists those hoping to rely on HMRC guidance, the position remains far from clear.
Even if they had not decided the JR claim in the LLPs' favour, the UT concluded that the rental support arrangements were ancillary to the relevant interest, and thus qualified for EZAs, rather than a separate asset. The UT considered they were equivalent to a warranty from the developer guaranteeing the data centres would generate a certain level of rental income. In contrast, it said the 'expenses support arrangements' (i.e. rights to have the bank loan cash collateralised, interest on the bank loan repaid, and the right to a guarantee for repayment of the bank loan in return for a long-term interest-free subordinated loan, convertible into capital), were not ancillary to the relevant interest. The UT considered these arrangements were to assist the LLPs in servicing their lending, rather than arrangements to guarantee the value of the asset being acquired. However, as the UT found in favour of the LLPs on the JR, they were entitled to allowances on these amounts.
The UT decided that allowances were not available in respect of the arranger's fees or the capital repayment support arrangements which were designed to assist the LLPs with repaying the capital borrowed from the bank, as these could not be considered part of the relevant interest. It ordered that apportionment evidence be adduced so that the amounts not qualifying for allowances could be determined. There is therefore some way to go before the investors (who include a number of celebrities) will know how much tax relief they will get. An appeal by HMRC also looks likely.
This update is based on an article by Catherine Robins and Sam Wardleworth of Pinsent Masons which was published in Tax Journal on 17 January 2020.
Tribunal sets out guidance on public benefit test for use of rooftops as telecoms sites