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Court of Appeal in England drills down on term ‘incidental’ in tax cases

A recent English Court of Appeal decision provides food for thought surrounding the use of “incidental” in tax legislation, an expert has said.

The case hinged on the interpretation of the word “incidental,” which is not defined within tax legislation but, the Court of Appeal has suggested that it, refers to something that is not the main purpose of an action or agreement but is nevertheless connected to it.

Tax disputes expert Jake Landman of Pinsent Masons said: “In approaching the term ‘incidental’ in the way that it did in this context, the court has provided food for thought not only in terms of ring-fence corporation tax provisions, but also potentially for other tax questions which involve the term. For example, in the content of determining whether a payment is wholly and exclusively for the purposes of a trade there can be other benefits which are not the object of the payment where they are merely incidental. In addition, when considering whether the main purpose of something was to secure a tax advantage some Tribunals have assessed whether securing this could instead be described as incidental.”

The case (21 pages/ 316 KB) centred around tax deduction claims by Dolphin Drilling in 2014 and 2015, linked to the hire of the Borgsten Dolphin rig. The rig had been converted to provide various services. This included accommodation for offshore workers from an associated company based in Singapore to fulfil contractual obligations to a third party.

When submitting its tax returns, Dolphin Drilling determined 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 under lease of 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 Drilling within the ring fence for the hire of the rig should be capped as it was in fact a “relevant asset.” In order to challenge the HMRC assessment, Dolphin Drilling had to argue successfully that the accommodation use of the Borgsten was “incidental”.

The court was required to consider whether it was reasonable to suppose that the use of the Borgsten as accommodation was more than “incidental” to another use of the rig. The first-tier tax tribunal sided with Dolphin Drilling on the basis that it found “incidental” to mean “secondary” or “subordinate,” considering the accommodation services to be a secondary function of the Borgsten. It was 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 before the Court of Appeal overturned the decision to side with HMRC, with Dolphin Drilling now liable for additional corporation tax of £6.7 million over two years.

In reaching its decision, 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 approved 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.

“It is perhaps important to remember the court was not attempting to provide the meaning of the world incidental in isolation. It was doing so in the context of the phrase ‘incidental to another use’,” Landman said.

We await confirmation as to whether Dolphin Drilling intends to seek permission to appeal the decision to the UK Supreme Court.

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