HMRC bound by industry guidance, says Upper Tribunal

"It is refreshing to see the Upper Tribunal making HMRC stand by guidance given to taxpayers. Other recent decisions including the Court of Appeal decision in the Aozora case have made it very difficult to rely on HMRC manuals which later turn out to be wrong," said Steven Porter, a tax disputes expert at Pinsent Masons, the law firm behind Out-Law.

The case concerned two limited liability partnerships (the LLPs) which claimed enterprise zone allowances (EZAs) related to expenditure incurred in the construction of two data centres in North Tyneside. In correspondence with the Enterprise Zone Property Unit Trust Association (EZPUTA), HMRC said it would not seek to argue that part of the purchase price was paid for rental support arrangements so as not to qualify for enterprise zone allowances, provided the rentals underpinning the transaction were at a reasonable level.

The Upper Tribunal rejected HMRC's arguments that it had no power to confirm that the allowances would be available when the legislation provided that they were not or that the fact that the guidance was wrong as a matter of law, was a good proportionate reason for HMRC to resile from it.

The Tribunal pointed out that EZPUTA had approached HMRC for confirmation as to how the law would be applied in an area where its application was open to debate and that EZPUTA and HMRC had a shared interest in a publication of HMRC's view of the law.

"From HMRC's perspective, publication of that view might be expected to enable the EZAs to provide a stimulus to investment with appropriate safeguards to the exchequer and, from EZPUTA's perspective, investors would be provided with comfort as to the circumstances in which allowances would be available. 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 Upper Tribunal said.

The judicial review challenge was heard by the Upper Tribunal at the same time as an appeal by the LLPs against refusals by HMRC of other aspects of their EZA claims.

In April 2011 the LLPs had acquired an assignment of rights under a 2006 construction contract providing for construction works to be undertaken at an enterprise zone. They had paid in aggregate around £260 million, 30% of which was funded by subscription from members of the LLPs and the remainder from bank loans, subject to complex security arrangements including sums required to be deposited by the developer and contractor. The developer also agreed to pay yearly sums to ensure the LLPs had sufficient funds to meet their interest and other expenses before the data centres were let and to top up the rents once they were let if the rental income was less than envisaged. The developer was also required to pay an arranger's fee to the promoters of the scheme.

At that time qualifying expenditure on industrial buildings within an enterprise zone qualified for a 100% capital allowance. For the allowances to be available the expenditure had to be incurred while the site was within an enterprise zone or the expenditure had to be incurred 'under' a contract entered into in the period ending 10 years after the site was first included in an enterprise zone.

The so called 'golden contract' acquired by the LLPs was entered into in 2006, the day before the enterprise zone at the site expired and was designed to ensure that EZAs could still be claimed on future construction work on the site. Just before the LLPs acquired their rights under the golden contract, the contract was amended to provide for the building of data centres, rather than other types of building and just before the LLPs acquired the contracts, the developer made substantial advance payments to the contractor.

The Upper Tribunal rejected HMRC's arguments that the payments made by the developer were not made 'under' the golden contract or that the changes to the contract were so substantial as to amount to a rescission of the contract. The Upper Tribunal said that the question of whether the contract was varied or rescinded depended on the intention of the parties and it was satisfied that the parties intended to vary the contract and not to rescind it, because the golden contract was crucial to the allowances being available.

However, the Upper Tribunal rejected the LLPs claim that the entire price paid by the LLPs for the assignment of the contracts was paid "for the relevant interest" and so qualified for allowances.

Even though the judges had decided that as a result of the judicial review application, the LLPs had a legitimate expectation that allowances would be available in respect of the rental support arrangements, they decided that they would anyway have regarded them as ancillary to the relevant interest, rather than a separate asset and therefore qualifying for allowances. The judges said the arrangements were "economically equivalent to a warranty by the developer" that the data centres would generate rental income of a certain amount.

In contrast, the Upper Tribunal said that the 'expenses support arrangements', which were rights to have the bank loan cash collateralised, to have 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, all had value and were not ancillary to the relevant interest. "There is a difference, in our view, between a right to payments designed to guarantee the value of the asset being acquired, and a right to payments designed to assist the purchaser in servicing lending obtained by it in order to acquire the asset," the Upper Tribunal said.

However, the Upper Tribunal found that HMRC's representations as to their practice extended to arrangements similar to the expenses support arrangements in this case and so the judicial review finding meant that the LLPs were entitled to allowances on these amounts.

The judges said that allowances were not available in respect of the capital repayment support arrangements, designed to assist the LLPs with repaying the capital borrowed from the bank or the arranger's fee. The Upper Tribunal ordered that the price be apportioned between the relevant interest, the expenses support arrangements, the capital repayment support arrangements and the arranger's fee so that the amounts not qualifying for allowances could be determined.

"Rental guarantee arrangements were needed to make collective investment schemes involving enterprise zone properties attractive to investors as enterprise zones were areas which were less attractive to investors. It is therefore good news for the many investors in such schemes that the Upper Tribunal has confirmed that allowances should not be denied to the extent that part of the price could be attributable to the guarantee," Steven Porter said.