BMBF No 24 Limited v Inland Revenue

This is an appeal from the order made on 26 November 2002 by Mr Justice Etherton on an appeal by BMBF (No 24) Limited under section 56A of the Taxes Management Act 1970 against the decision of the special commissioners (Mr Theodore Wallace and Dr Nuala Brice) dated 12 December 2001 on an appeal by the taxpayer against the rejection by the Commissioners of Inland Revenue of a claim for writing-down allowances under section 24 of the Capital Allowances Act 1990. The appeal raises questions of some general importance as to the effect of section 42 of the Act in the context of finance leasing arrangements of plant and machinery to be used by non-residents for the purposes of a trade carried on outside the United Kingdom. Permission to appeal was granted by this Court on 27 February 2003.

BMBF (No 24) Limited ("BMBF 24") is a special purpose vehicle wholly owned by Barclays Mercantile Business Finance Limited, a subsidiary of Barclays Bank plc. Caterpillar Inc ("CI") is the manufacturer of heavy plant and earth-moving equipment at factories in Illinois, United States of America. Caterpillar International Leasing LLC ("CIL"), a limited liability company incorporated in Delaware, is a wholly owned subsidiary of CI. CIL is registered in the United Kingdom as an overseas company and is resident in the United Kingdom for tax purposes.

In late 1995 CI, CIL and BMBF 24 entered into arrangements the purpose of which was to enable CI to raise funds on the security of plant and machinery ("the equipment") on favourable terms by taking advantage of the availability of writing-down allowances under United Kingdom tax legislation. In broad terms the arrangements involved the acquisition of the equipment by BMBF 24, the grant of a finance lease by BMBF 24 to CIL and the grant of an operating lease by CIL to CI. The intended effect of the arrangements was that the availability of writing-down allowances to BMBF 24 would enable that company to offer more favourable rental terms under the finance lease than it would otherwise have done; so enabling CI to obtain finance on advantageous terms.

The equipment – which comprised cranes and hoists, factory furniture, production machinery and storage, handling and distribution equipment – was in use by CI for the purposes of its business in the United States. Although the equipment was capable of being removed from CI’s premises in Illinois, it was not intended that it should be; and, in fact, it was not removed. In November 1995 the equipment was inspected and appraised by an independent valuer, Mentor Valuations Inc of Chicago. On 14 December 1995 CI transferred title to the equipment to CIL. On 15 December 1995 Mentor issued a formal valuation letter, valuing the equipment at US$255 million.

On 18 December 1995 CI, CIL, BMBF 24 and others entered into the following transactions:

The Capital Allowances Act 1990 ("CAA") consolidates earlier statutory provisions relating to capital allowances. Part II of the Act, in which both section 24 and 42 appear, is directed to allowances and charges in respect of plant and machinery. Section 24 CAA contains the basic rules in relation to writing-down allowances. Subsections (1) and (2) are in these terms, so far as material:

Section 42 CAA restricts the application of section 24 in the cases to which it applies. Subsection (1) is in these terms, so far as material:

Section 42(3) CAA provides that no balancing allowances or writing-down allowances shall be available in respect of expenditure falling within section 42(1) if the circumstances are such "that the machinery or plant in question is used otherwise than for a qualifying purpose" and the case falls within one or other (or more than one) of the following five paragraphs – that is to say, paragraphs (a) to (e) of section 42(3).

It is pertinent to note that (conceptually, at least) the words "for a qualifying purpose" in the phrase "machinery or plant in question . . . used otherwise than for a qualifying purpose" in section 42(3) CAA are wider in scope than the words "for a qualifying purpose by virtue of section 39(6) to (9)" which appear in section 42(1). The effect of the words in section 42(1) is to exclude from the reach of section 42 ships, aircraft and transport containers which are used for a qualifying purpose by virtue of the special provisions in section 39(6) to (9). Plant and machinery (not being ships, aircraft and containers) – and ships, aircraft and containers (not being used for a qualifying purpose by virtue of those special provisions in section 39) – is or are within the reach of section 42; and, if used for a purpose which is not a qualifying purpose within the more general provisions in section 39(1) to (5), is or are within section 42(3). In those cases, provided that the case also falls within one or more of paragraphs (a) to (e) of section 42(3), no writing-down allowances are available in respect of capital expenditure which would otherwise attract those allowances by virtue of the provisions in section 24(1) and (2) CAA.

It is common ground that paragraphs (a) to (e) of section 42(3) CAA describe features which would commonly be found in equipment finance leases; and which are, in fact, found in the headlease in the present case. For example, an equipment finance lease will commonly contain provision for a termination payment (paragraph (b)) and for escalating rental payments (paragraph (c)). In the present context it, is, I think, sufficient to set out paragraphs (c) to (e):

In cases which, by virtue of section 42(1), fall within section 42 CAA but which are not within section 42(3) – because, for example, none of paragraphs (a) to (e) of section 42(3) are in point – the amount of the writing-down allowances to be made to the person who has incurred capital expenditure within section 24(1) is reduced to 10% of the qualifying expenditure. That is the effect of section 42(2) CAA, which is in these terms, so far as material:

In broad terms, therefore, the position with respect to expenditure on plant or machinery for leasing, where the plant or machinery is "used for the purposes of being leased to" a non-resident who does not use it exclusively for earning profits chargeable to tax in the United Kingdom, may be summarised as follows: (i) if the "leasing" is either short-term leasing or the leasing of a ship, aircraft or transport container which is used for a qualifying purpose by virtue of the special provisions in section 39(6) to (9) ("permitted leasing" – see section 50(3) CAA), the right to 25% writing-down allowances under section 24 CAA is not affected; (ii) if the "leasing" is not permitted leasing, the writing-down allowances are either reduced to 10% or withdrawn altogether; and (iii) the allowances are withdrawn altogether if the circumstances are such that the machinery or plant is used otherwise than for a qualifying purpose within the general provisions of section 39(1) to (5) and the lease is a finance lease – that is to say a lease in respect of which one or more of the features described in paragraphs (a) to (e) of section 42(3) CAA are present.

In a case where the person ("the owner") who has incurred the capital expenditure in acquiring the plant or machinery – in consequence of which the plant or machinery belongs, or has belonged, to him for the purposes of section 24(1) CAA – and the non-resident person who uses the plant or machinery to earn profits which are not taxable in the United Kingdom (the "non-resident" – see section 50(3)) are, respectively, lessor and lessee under the same lease, the application of section 42 CAA presents little difficulty in principle. In such a case, there is only one lease in relation to which there can be inquiry whether features described in paragraphs (a) to (e) of section 42(3) are, or are not, present. That inquiry may, itself, raise questions of difficulty – as the history of this case illustrates – but there is no difficulty in identifying which is the relevant lease for the purposes of that inquiry. That difficulty arises where – as in the present case – the owner and the non-resident are not each party to the same lease; that is to say where – as in the present case – there is a headlease granted by the owner to a resident headlessee/sublessor and a sub-lease granted by the sublessor to the non-resident. In such a case the question arises whether the "lease" – for the purposes of the inquiry whether the features described in paragraphs (a) to (e) of section 42(3) are, or are not, present – is the headlease or the sublease. Or, to put the point in more general terms, whether the relevant lease is the lease granted by the owner (by whom the allowances will be claimed) or the lease granted to the non-resident (whose existence has led to the need for an inquiry under section 42(3) CAA).

The judge identified the issues which had been before the special commissioners – and which were before him – in paragraph 25 of the written judgment which he handed down on 26 November 2002:

The judge, in a full and careful judgment, decided issue (1) in favour of BMBF 24; that is to say, reversing the special commissioners on this point, he held that the equipment did belong to BMBF 24 in the tax year 1995/96. But, again reversing the special commissioners on the point, he reached the conclusion, in answer to issue (2), that "‘the lease’ referred to in section 42(3)(a) to (e) is the lease by the owner of the machinery or plant, and so, in a chain of leases, the headlease". As he recognised, at paragraph 104 of his judgment, his conclusion on issue (2) was sufficient to dispose of the appeal before him, since it was common ground that the headlease to CIL "comprises machinery or plant used otherwise than for a qualifying purpose" and satisfied one or more of the provisions of paragraphs (a) to (e) of section 42(3) CAA. Nevertheless "in deference . . . to the extensive arguments of both sides on other issues of general importance to those engaged in the business of finance leasing" (as the judge put it) he addressed issues (3) to (5). He upheld the special commissioners on issues (3), (4) and (5); with the consequence, as he pointed out at paragraph 154 of his judgment, that even if he were wrong in his conclusion that the relevant lease was the lease by the owner of the machinery or plant, the special commissioners were nonetheless correct in holding that the features described in paragraphs (d) and (e) of section 42(3) CAA were present in relation to the sub-lease, so that (on that basis also) BMBF 24 was not entitled to writing-down allowances for the tax year 1995/96. The judge rehearsed, in outline, the arguments advanced on issue (6); but reached the conclusion that it was unnecessary, and would be inappropriate, for him to decide that issue. He was conscious that each party had contentions which they sought to advance in relation to the decision and reasoning of Mr Justice Park in Barclays Mercantile Business Finance Ltd v Mawson (HMIT) [2002] EWHC Ch 1525 was wrong; and that the judgment of this Court on an appeal from that decision was pending.

BMBF 24 appeals to this Court on issues (2), (4) and (5). If this appeal is to succeed the appellant needs to persuade the Court that the judge was wrong on each of those issues. By a respondents’ notice the Revenue cross-appealed on issues (1) and (3); but the cross-appeal on those issues has not been pursued. The Revenue sought, also, to uphold the order of 26 November 2002 on the basis that it was correct on issue (6) – an issue which, as I have said, the judge did not find it necessary to decide – but it has now recognised that, in the face of the judgments of this Court in the Mawson case [2002] EWCA Civ 1853, reported at [2003] STC 66, it cannot succeed on that issue here. Leave to appeal to the House of Lords has been granted in the Mawson case. The Revenue reserves its right to seek leave to argue issue (6) in the House of Lords in this present appeal, should there be an appeal to the House from the order which we make. In its skeleton argument, filed for the purposes of this appeal, the Revenue sought to introduce a further argument under issue (2) - which it described as "Issue (2A)". It contended, in the alternative to its primary argument, that the proper application of the Ramsay principle – recognised by the House of Lords in Ramsay (WT) Ltd v Inland Revenue Commissioners [1982] AC 300 and recently restated in MacNiven (HMIT) v Westmoreland Investments Limited [2001] UKHL 6, [2001] 2 WLR 377 – requires that "the headlease and the sub-lease by the conjoined means of which [BMBF 24] leased the equipment to CI on the terms of the headlease" must be treated as the relevant lease for the purposes of section 42(3) CAA. But we were told, shortly before the hearing of this appeal, that the House of Lords would be invited to reconsider, in the context of the Mawson appeal, its restatement of the Ramsay principle in MacNiven; and that, in those circumstances, the Revenue "would not press Issue 2A" before this Court. The Revenue reserves its right to seek leave to argue issue (2A) in the House of Lords, should there be an appeal from the order which we make.

At the hearing of this appeal, therefore, the issues before this Court were: (2) whether the relevant lease for the purposes of the inquiry under paragraphs (d) and (e) of section 42(3) CAA was the headlease (as the Revenue contends) or the sublease (as BMBF 24 contends); and, if the sublease, then (4) whether there was provision for extending or renewing that lease (or for the grant of a new lease) so that the equipment could be leased for a period in excess of 13 years (section 42(3)(d) CAA) and (5) whether the lessor or a person connected with him would or might become entitled to receive a pre-determined amount referable to a value of the plant or machinery at or after the expiry of the lease (section 42(3)(e) CAA). After hearing full argument from both parties on issue (2) we indicated that we did not find it necessary to hear argument on issues (4) and (5).

Before turning to a more detailed examination of the provisions now found in Chapter V (Leased Assets) of Part II (Machinery and Plant) of the Capital Allowances Act 1990 it is convenient to have in mind the process by which writing-down allowances have been introduced in successive legislation. This section of the judgment draws heavily upon an agreed note helpfully provided to the Court by all counsel after the conclusion of oral argument.

The computation of profits in accordance with generally accepted accounting practice will take account of the fact that plant and machinery acquired by a person carrying on a trade will depreciate over time. A measure of that depreciation will be reflected in accounts prepared to show a true and fair view of the trader’s affairs. But, absent express provision in the taxing legislation, no deduction in respect of depreciation can be made in the computation of profits for tax purposes – see section 159 of the Income Tax Act 1842 and, now, sections 74 and 817 of the Income and Corporation Taxes Act 1988.

Provision for a deduction in respect of depreciation – or "wear and tear" – was first made by section 12 of the Customs and Inland Revenue Act 1878. That section required the Commissioners, in assessing the profits of a trade, to allow "such deduction as they may think just and reasonable as representing the diminished value by reason of wear and tear during the year of any machinery or plant used for the purposes of the concern, and belonging to the person or company by whom the concern is carried on". That became rule 6(1) of the rules applicable to Cases I and II of Schedule D – see section 1 of, and the First Schedule to, the Income Tax Act 1918. The provision removed the tax disincentive to the acquisition of capital assets for use in trade; but it provided no positive tax incentive to invest in such assets.

A positive tax incentive to invest was first provided by provisions in Part II of the Income Tax Act 1945. Section 15 provided for an initial, or first year, allowance equal to one fifth (20%) of the capital expenditure incurred on the provision of machinery or plant for the purposes of the trade. Section 16(2) of the 1945 Act provided for a writing-down allowance in subsequent years equal to five/fourths of the amount that would otherwise have been allowed under rule 6(1) in respect of "wear and tear".

That regime – which may, perhaps, be described as providing for an "up-lifted wear and tear allowance" – was continued, on consolidation, in Chapter II (Machinery and Plant) of Part X (Reliefs for Certain Capital Expenditure) of the Income Tax Act 1952. But, under the provisions enacted in 1952, annual allowances on account of wear and tear were computed by reference to the capital expenditure incurred in the provision of the machinery or plant by the person to whom the allowance was to be made - see sections 280 to 282 of the 1952 Act. More precisely, the annual allowance was to be five-fourths of the percentage of the reducing balance year on year (section 281(1) of the 1952 Act) unless the person to whom the allowance was to be paid elected for an alternative "straight-line" method of calculation (section 282 of that Act).

Relevant percentages, for the purpose of sections 281 and 282 of the 1952 Act, were determined by the Commissioners as appropriate in relation to machinery and plant of the class in question. The object was to select a percentage which, if applied year on year to a reducing balance (section 281(3) of the 1952 Act) or on a straight line basis (section 282(3) of that Act) would have the effect of amortising 90% of the acquisition cost over the anticipated normal working life of machinery or plant. That may be seen as reflecting generally accepted accounting principles; and as a measure of the appropriate commercial amount of depreciation. The incentive was provided by the 25% uplift which was given by fixing the annual allowance at five-fourths of what would be the appropriate commercial amount. Save that the description "annual allowance" was replaced by the new term, "writing-down allowance", the regime remained substantially unchanged on the 1968 consolidation – see sections 19 to 21 in Chapter II of Part I of the Capital Allowances Act 1968.

The position altered with the enactment of the provisions in Chapter I of Part III (New System of Allowances and Charges in respect of Trade (etc.) Machinery and Plant) of the Finance Act 1971. Sections 41 and 42 provided for first year allowances of up to 100% of the capital expenditure on the provision of machinery or plant for the purposes of a trade; although the normal first year allowance was 60% of that expenditure – see section 42(1) of the 1971 Act. Section 44(1) continued the principle of annual writing-down allowances. But section 44(2), read in conjunction with section 44(4) (qualifying expenditure) and 44(5) (disposal value) altered the basis of computation by fixing the amount of those allowances at 25% of the reducing balance. That may be seen as severing the link with the "wear and tear" basis previously applicable.

The provisions subsequently re-enacted as section 42 of CAA 1990 were introduced by section 70 of the Finance Act 1982. The effect of those provisions was to withdraw first year allowances, as well as writing-down allowances, in cases which fell within section 70(4) of that Act – subsequently re-enacted as 42(3) CAA 1990 – and to reduce the 25% rate to 10% in other cases within section 70(1).

First year allowances under section 41 of the 1971 Act were progressively withdrawn by section 58 of, and schedule 12 to, the Finance Act 1984. They were reintroduced, on a selective basis, by section 22 of CAA 1990. Sections 44(1) and (2) of the 1971 Act were re-enacted as sections 24(1) and (2) of the 1990 Act. They are now found in sections 11(4), 55(1) and (2) and 56(1) of the Capital Allowances Act 2001.

In cases where the machinery or plant had a short useful economic life, the fixed 25% rate applied to a reducing balance, for which section 44 of the 1971 Act provided, was unrealistic. This was recognised in the Finance Act 1985, which provided, at section 57, that a trader might elect to treat the machinery or plant as a "short-life asset". The effect was to accelerate (through a separate pool regime) the benefit of 25% writing-down allowances on machinery or plant with a predicted life of no more than four years. Election was not available in respect of machinery or plant leased outside the United Kingdom in circumstances where section 70 of the 1982 Act restricted the writing-down allowance to 10% - see paragraph 11 of schedule 15 to the 1985 Act. The provisions were re-enacted as Chapter IV (Short-life Assets) of CAA 1990.

Save in a case where the anticipated normal working life of machinery or plant was less than eleven years, the fixed 25% rate for which section 44 of the 1971 Act provided would exceed five-fourths of the relevant percentage, determined under section 281(3) of the 1952 Act. To put the point another way, in cases where the machinery or plant would normally be written off over (say) ten years or more, the 25% writing down allowance introduced in 1971 was more generous than the previous allowances. In cases where the useful economic life of the asset exceeds twenty years, the 25% writing-down allowance may be seen as over-generous. This class of case has been addressed, since the enactment of CAA 1990, by section 84 of, and schedule 14 to, the Finance Act 1997. Schedule 14 of the 1997 Act contains provisions which have effect as Chapter IVA of CAA 1990. They restrict the rate at which expenditure on long-life assets (that is to say, machinery or plant which, as new, could reasonably be expected to have a useful economic life of at least twenty-five years) to 6% - section 38F(1) CAA. Section 42(2) CAA is amended (with effect from 26 November 1996) to exclude expenditure to which Chapter IVA of the 1990 Act applies. The provisions are now found in section 102 of the Capital Allowances Act 2001.

The pattern of development in respect of writing down allowances may be summarised as follows:

It is appropriate, therefore, as it seems to me, to approach the question posed by this appeal –"which is the relevant lease?" – on the basis that the overall purpose of the statutory scheme of which section 42 CAA forms part is to provide a fiscal incentive to the acquisition by purchase of machinery or plant to be used by a trader for the purposes of his trade; but that there is some degree of fine-tuning so as to avoid, on the one hand, cases where the scheme will provide no incentive and, on the other hand, (since 1996) cases where the incentive will be over generous. Against that background, it can be seen that cases within section 42 CAA – that is to say, cases where the machinery or plant are leased to a non-resident who does not use it exclusively for earning profits taxable in the United Kingdom – are cases in which the legislature intends no fiscal incentive. Further, although it may be said that the treatment of cases within section 42(2) is fiscally neutral, cases within section 42(3) are those which the legislature intends the fiscal disincentive to remain unalleviated. In cases within section 42(3) CAA the owner is taxed on profits which, applying generally accepted accounting principles, he has not earned.

Section 42(1) CAA applies the provisions of subsections (2) and (3) of that section to expenditure "on the provision of machinery or plant for leasing" where two conditions are satisfied. Those conditions are (i) that the machinery or plant is at any time in the requisite period "used for the purpose of being leased" to a non-resident who does not use it exclusively for earning taxable profits (the ‘non-resident’ condition) and (ii) that "the leasing" is neither short term leasing nor the leasing of a ship, aircraft or transport container which is used for a qualifying purpose by virtue of section 39(6) to (9) (the ‘permitted leasing’ condition).

It is clear - and, I think, accepted - that the first reference to leasing in section 42(1) must be a reference to leasing by the person who has incurred the expenditure in respect of which allowances would (but for the later provisions in section 42) fall to be made under section 24 CAA – read, where appropriate, in conjunction with section 61 CAA. It is also clear that the reference to "beingleased", in the non-resident condition, must be a reference to the lease to the non-resident; so that, in a case where there is a chain of leases, section 42 will be engaged (subject to the permitted leasing condition) where one of the sub-leases in the chain is to a non-resident who does not use the machinery and plant exclusively for earning taxable profits. But the parties do not agree whether, in such a case, the subsequent references to "leasing" (that is to say, the references in the permitted leasing condition) are to the headlease or to the relevant sublease (that is to say, the sublease to the non-resident).

The Revenue contends that linguistic consistency requires that the "leasing" referred to in the permitted leasing condition is the same "leasing" as that first referred to in section 42(1); that is to say, to leasing by the owner (or headlessor). As it is put, at paragraph A14(16) of the Revenue’s skeleton argument, "That the repeated use of the same word in the same sub-section should have the same meaning is in the Revenue’s submission self-evident". BMBF 24 contends that the "leasing" referred to in the permitted leasing condition may be either the leasing by the owner (or headlessor) or the leasing to the non-resident sublessee. As it is put at paragraph 102 of the BMBF 24’s skeleton argument. " . . . if either the lease entered into by the finance lessor or the lease to the non-resident person is "short term leasing" or the leasing of a "ship" [etc] within s.39(6)-(9) then s.42 does not apply."

The argument that the "leasing" referred to in the permitted leasing condition in section 42(1) CAA includes the leasing to the non-resident sublessee finds support in the provisions of section 48(1) to (3) of that Act:

The judge recognised the force in that submission. But he did not accept it; for the reasons set out at paragraph 83 of his written judgment. He said this

For my part I do not find that reasoning persuasive. It is not clear to me what the judge had in mind when he referred to "the imprecision of the draftsman in the expressions which he has used in s.48(1) to (3)". Although he was correct to point out that the statutory antecedents of section 48 CAA are not the same as those of section 42, he appears to have overlooked the fact that section 48 and the second element in the permitted leasing condition of section 42(1) ("nor the leasing of a ship, aircraft or transport container which is used for a qualifying purpose by virtue of section 39(6) to (9)") do have a common origin. Both were introduced by section 57 of, and schedule 16 to, the Finance Act 1986 – see paragraphs 5(1) and 10 of schedule 16, and (for the origin of the expression "permitted leasing") paragraph 7(1)(d) of that schedule. It is, I think, plain that section 48 CAA is directed, specifically, to leasing of the kind to which reference is made in the permitted leasing condition of section 42(1). And it is important to keep in mind that "non-resident" means, for the purposes of section 48 CAA, "such a person as is referred to in section 42(1)(a) and (b)" – see section 50(3). The expression "used for leasing to a non-resident" has the same meaning, in the context of section 48 CAA, as the phrase "used for the purpose of being leased to a person who . . . is not resident in the United Kingdom . . . " in the context of section 42(1).

I have no doubt that the judge was correct to think that section 48 CAA was directed, primarily, to the situation where the owner has granted a lease to a non-resident. Indeed, I have no doubt that that is the situation to which, primarily, section 42(1) is directed. But where the sections have to be given meaning in a context where "the first use by the owner of machinery or plant is a lease to a UK resident and, at the same time and as part of the same preconceived scheme, the property is leased to a non-resident" it is necessary to ask whether, if the lease to the non-resident is "permitted leasing", Parliament intended that section 42 CAA should operate so as to deny (or reduce) the writing down allowances to which the owner would otherwise be entitled under section 24 CAA. I cannot see why the relevant provisions lead to the conclusion that Parliament did so intend. Section 42 has no application where there is a lease by the owner to a non-resident if the lease is permitted leasing. The section has no application to a finance lease to a UK resident if there is no onward lease to a non-resident. Why (in the absence of clear words) should Parliament be taken to have intended that the section would apply to reduce or deny the writing down allowances available to the owner who has granted a finance lease to a UK resident where the onward leasing to the non-resident is permitted leasing – that is to say, where the onward lease is a lease which, if entered into between the owner and the non-resident lessee, would not have given rise to a reduction or denial of allowances under section 42 CAA? I think that BMBF 24 is correct to submit that, for the purposes of what I have described as the permitted leasing condition of section 42(1) CAA, it is enough that the lease to the non-resident is permitted leasing.

It does not follow that, in a case where there is a chain of leases, "thelease" to which reference is made in each of the five paragraphs of section 42(3) CAA is the sublease to the non-resident user. The effect of section 42(1) – in a multi-lease case - is that the availability of writing down allowances to the person who has incurred expenditure on the provision of machinery or plant for leasing is not affected by a lease to a non-resident if the leasing to the non-resident is permitted leasing. But, if the lease to the non-resident user is not permitted leasing, then the restrictions on the availability of writing-down allowances to the person who has incurred the expenditure – imposed by section 42 CAA – are applicable. The question, then, is whether it is section 42(2) or 42(3) that is in point. And, as it seems to me, there is no reason to suppose that Parliament intended that that question should be answered exclusively by reference to the lease to the non-resident and without regard to the lease granted by the owner. All that can be said, at this stage, is that (other than in cases where the leasing is permitted leasing) Parliament intended to restrict the availability of writing down allowances in cases where machinery or plant (expenditure on the provision of which for leasing would otherwise qualify under section 24 CAA) is used for the purpose of being leased to a non-resident. The question whether, in cases within section 42, the restriction has the effect that no allowances are available, or that reduced allowances are available, turns on whether the case falls within section 42(2) or section 42(3). More precisely, the question turns on the effect of section 42(3), to which section 42(2) is made subject.

Section 42(3) CAA is in point where each of three conditions is satisfied: (i) the expenditure (in respect of which allowances would otherwise be available) is expenditure within section 42(1); (ii) the circumstances are such that the machinery or plant (on the provision of which the expenditure has been incurred) is used "otherwise than for a qualifying purpose"; and (iii) one or more of the features described in paragraphs (a) to (e) are present. If condition (i) is met, but either of conditions (ii) or (iii) are not met, then section 42(3) is not applicable. In such a case, the provisions of section 42(2) apply so as to reduce the amount of the writing-down allowances from 25% to 10%.

It was submitted on behalf of BMBF 24 that, if the relevant lease for the purposes of section 42(3) CAA is the headlease (as the Revenue contends), the condition which I have identified as cumulative condition (ii) in section 42(3) CAA ("the second cumulative condition") is nothing more than a repetition of the "permitted leasing" condition of section 42(1). So, it is said, the Revenue’s contention would lead to the conclusion that, if the expenditure falls within section 42(1) – the first cumulative condition in section 42(3) – the second cumulative condition is otiose: it is inevitable, in such a case, that the machinery or plant is used otherwise than for a qualifying purpose. Parliament cannot have intended that the second cumulative condition should be otiose. Accordingly, the Revenue’s contention that the relevant lease for the purposes of section 42(3) CAA is the headlease must be rejected. I do not accept the premise upon which that submission is based.

It is important to keep in mind that – whatever may be the effect of section 42 CAA in a case where there is a chain of leases – the section was intended to have effect in cases where there is a single lease; that is to say a lease by a UK resident owner to a non-resident user. In such a case there can be no argument that it is that single lease which is the relevant lease for the purposes of section 42(3): there is no other candidate. In such a case, the role of the second cumulative condition in section 42(3) CAA can, perhaps, best be seen by looking back to its statutory predecessor, section 70(4) of the Finance Act 1982, in which the relevant provisions were first introduced.

Section 70(4) of the 1982 Act was in these terms, so far as material:

The meaning given to "qualifying purpose" by section 64 of the Finance Act 1980 appears from subsection (2) of that section, read with subsections (5) to (7). Section 64(2) of the 1980 Act was in these terms:

The purpose and effect of the words in section 70(4) of the 1982 Act – "if the circumstances are as mentioned in subsection (3)(b) above" – are not in doubt. First year allowances, balancing allowances and writing-down allowances were not wholly withdrawn – if, under the provisions of section 70(1), they otherwise would be - if the case fell within one or other of the four paragraphs of section 64(2) of the 1980 Act which I have just set out ("the general provisions" defining qualifying purpose), or within one or other of sections 64(5) to (7) of that Act (the "special ship, etc, conditions"). That reflected the decision not to withdraw first year allowances in such cases, to which effect had been given by section 64(1) of the Finance Act 1980. But, although such cases were excluded from section 70(4) of the 1982 Act, they were not excluded from the reduction of the applicable rate (from 25% to 10%) effected by section 70(2) of that Act.

It is, I think, reasonably clear that, if the case fell within paragraph (b), (c) or (d) of section 64(2) of the 1980 Act, it would have been excluded from the reach of section 70 of the 1982 Act by section 70(1). But that did not deprive the "qualifying purpose" exclusion in section 70(4) of any effect. It was in point in a case which fell within paragraph (a) of section 64(2) of the 1980 Act; and, as enacted, it was in point in cases which (not being within paragraphs (b), (c) and (d) of section 64(2)) fell within section 64(5) to (7) – the special ship, etc provisions.

As I have said, section 70(1) of the 1982 Act contained no provision comparable to the final words of section 42(1) CAA 1990 ("nor the leasing of a ship, aircraft or transport container which is used for a qualifying purpose by virtue of section 39(6) to (9)"). Those final words (which exclude from the scope of section 42 CAA 1990 cases within the special ship, etc, provisions) were first introduced, with respect to new expenditure (that is to say, expenditure incurred on or after 1 April 1986), by section 57 of, and paragraph 5(1) of schedule 16 to, the Finance Act 1986. Paragraph 5(3) and (4) of schedule 16 to the 1986 Act replaced the reference to section 70(3)(b), formerly in section 70(4) of the 1982 Act, with the words "such that the machinery or plant in question is used otherwise than for a qualifying purpose, within the meaning of section 64 of the Finance Act 1980". It is clear, therefore, that Parliament decided, when enacting the 1986 Act, that cases within the special ship, etc, provisions should be treated, in the context of section 70 of the 1982 Act (Allowances for assets leased outside the United Kingdom), in a manner which differed from the treatment of machinery or plant used for a qualifying purpose by virtue of section 64(2)(a) of the 1980 Act. Between 1986 and 1990 the latter fell (at least prima facie) within section 70(2) of the 1982 Act and attracted writing-down allowances at the rate of 10%; the former (together with cases within section 64(2)(b), (c) and (d) of the 1980 Act) were excluded from section 70 of the 1982 Act altogether, and continued to attract allowances at the 25% rate.

That position established by the amendments made in 1986 was preserved on consolidation in 1990. The general provisions defining qualifying purpose, formerly found in paragraphs (a) to (d) of section 64(2) of the 1980 Act, were re-enacted as section 39(2) to (5) of CAA 1990. The special ship, etc, provisions, formerly found in section 64 (5) to (7) of the 1980 Act were re-enacted as section 39(6) to (9) CAA 1990. There can be no doubt, therefore, that the second cumulative condition in section 42(3) CAA (that is to say, the words "if the circumstances are such that the machinery or plant in question is used otherwise that for a qualifying purpose") was intended to exclude from the scope of section 42(3) cases within section 39 which were not already excluded from section 42 altogether by section 42(1). Nor can there be any doubt that Parliament thought that there were such cases; nor that it was right to think so. The effect of the second cumulative condition is to take out of section 42(3) CAA cases within section 39(2).

BMBF 24 sought support for its contention that the second cumulative condition in section 42(3) CAA added nothing to the permitted leasing condition in section 42(1) by reference to the provisions of sections 46(1) and (2). Section 46 is in these terms, so far as material:

I confess to finding the reasoning in those paragraphs of the skeleton difficult to follow. Section 46 CAA 1990 was introduced by Part II of schedule 16 to the Finance Act 1986 – see paragraph 8 of that schedule. It must be read in the context of the changes effected by the 1986 Act – which included the addition of the "permitted leasing" condition in section 70(1) of the 1982 Act (re-enacted in 1990 as section 42(1) CAA) – and in conjunction with section 70(5) of the 1982 Act as amended by paragraph 5(5) of schedule 16 to the 1986 Act (re-enacted as section 42(4) CAA). Section 42(4) CAA is in these terms:

When these provisions are read together, the position is clear enough. Paragraph 8 of schedule 16 to the 1986 Act (re-enacted in section 46 CAA) provided for recovery of excess relief where, subsequently during the requisite period, the right to normal (25%) writing-down allowances was lost by virtue of section 70(1) of the 1982 Act as amended by paragraph 5(1) of the 1986 Act (re-enacted as section 42(1) CAA) – that is to say, where the right to normal allowances was lost because the machinery or plant was, subsequently during the requisite period, leased to a non-resident otherwise than by permitted leasing. Section 70(5) of the 1982 Act as amended by paragraph 5(5) of schedule 16 to the 1986 Act (re-enacted as section 42(4) CAA) provided, additionally, for recovery of excess relief where the right to a reduced (10%) allowance was lost, subsequently during the requisite period, by virtue of section 70(4) of the 1982 Act (re-enacted as section 42(3) CAA) – that is to say, where the right to reduced allowances had been lost because, during the requisite period, the machinery or plant had ceased to be used for a qualifying purpose. Far from supporting the case advanced by BMBF 24 under this head, a proper analysis of the provisions shows that the Revenue’s contention is correct. The legislature did intend the second cumulative condition in section 42(3) CAA to have a role which was independent and distinct from the permitted leasing condition in section 42(1).

It is submitted on behalf of BMBF 24 that, nevertheless, there can be no case in which machinery leased under a finance lease could be used for a qualifying purpose within section 39(2) CAA. The point is put at paragraph 108 of the skeleton argument prepared on its behalf: "The only "buyer" in a s.42 situation is the finance lessor (here No.24) and the only use that could be qualifying would be use by him – any use by a lessee or sublessee from him could not qualify since ex hypothesi such a person is not a "buyer". This serves to exclude section 39(2) . . ." The flaw in that submission, as it seems to me, is that it fails to identify correctly the cases which do fall within section 39(2). The section is in these terms, so far as material:

It might, perhaps, be said that between 1986 and 1993, the second cumulative condition could not have been applicable in a single lease case. In a single lease case, neither section 70 of the 1982 Act, nor section 42 CAA 1990 as originally enacted, were engaged unless the lessee under the lease from the owner was not resident in the United Kingdom and did not use the machinery or plant for the purposes of a trade carried on there or for earning profits chargeable to tax; and, in such a case, the lessee would never, himself, have been in a position to claim a first-year allowance. But, whether or not there would have been force in that point if raised between 1986 and 1993, its force was lost when section 42(1)(b) CAA in its present form was substituted by section 116(2) of the Finance Act 1993. In respect of leases entered into on or after 16 March 1993 (which is the instant case) section 42 CAA is engaged where the lessee does not use the machinery or plant exclusively for earning profits chargeable to United Kingdom tax. It is possible, therefore, to envisage circumstances in which, in a single lease case, the lessee from the owner might be a person who, if he had purchased the machinery or plant himself, would have been in a position to claim a first-year allowance or to treat his expenditure as qualifying expenditure.

The position, therefore, is that where machinery or plant acquired by the owner for leasing is leased by the owner to a non-resident who does not use that machinery or plant exclusively for earning profits chargeable to United Kingdom tax (a single lease case) writing down allowances at the 25% rate are withdrawn unless the leasing is permitted leasing – that is to say, short-term leasing or the leasing of a ship, aircraft or transport container which is used for a qualifying purpose by virtue of section 39(6) to (9) CAA (see section 42(1) and the definition of "permitted leasing" in section 50(3) CAA). Where, in such a case, the machinery or plant is leased to a lessee who uses it for the purposes of a trade, otherwise than for leasing, in circumstances in which, if he had bought the machinery or plant himself (instead of leasing it) he could have claimed a first-year allowance or treated his expenditure as qualifying expenditure then, whether or not the lease is a finance lease, the owner can claim writing-down allowances at the 10% rate (see section 42(2) read with sections 42(3) and 39(2) CAA). So, also, where the lease is not a finance lease – that is to say, is not a lease in respect of which one or more of paragraphs (a) to (e) of section 42(3) are satisfied. In a single lease case it is only where the lease is a finance lease and the machinery or plant is not used for a qualifying purpose within section 39(2) CAA that writing-down allowances are withdrawn altogether.

It remains necessary to consider how effect is given to the second cumulative condition in section 42(3) CAA in a multi-lease case. The question in such a case is whether the use, in the context of the expression "used otherwise than for a qualifying purpose", is use by the lessee under the lease from the owner (the headlease) or use by the non-resident - that is to say, use by the person within paragraphs (a) and (b) of section 42(1) to whom the machinery and plant has been leased under a sublease. The answer, I think, is reasonably clear. The relevant use is use by the non-resident lessee under the sub-lease. In such a case it is the non-resident lessee who is "the lessee" for the purposes of section 39(2) CAA.

To hold that, in a multi-lease case, the relevant use, in the context of the expression "used otherwise than for a qualifying purpose", is use by the lessee under the lease from the owner (the headlease) would be inconsistent with the view which I have expressed earlier in this judgment as to the relevant lease for the purposes of the "permitted leasing" condition in section 42(1) CAA. The reasoning which led me to that view in that context requires me to ask, in the present context, whether, if the use by the non-resident is use for a "qualifying purpose", Parliament intended that section 42(3) CAA should operate so as to deny the 10% writing down allowances to which the owner would otherwise be entitled under section 42(2) CAA. I cannot see why that question should receive an affirmative answer. As I have said, writing-down allowances at the 10% rate are available to the owner in a case where there is a lease by the owner to a non-resident lessee if the non-resident lessee can bring himself within section 39(2) CAA – that is to say, if he is using the machinery or plant for the purposes of a trade, otherwise than for leasing, in circumstances in which, if he had bought the machinery or plant himself (instead of leasing it) he could have claimed a first-year allowance or treated his expenditure as qualifying expenditure. That is the position whether or not the lease by the owner to the non-resident is a finance lease. Why (in the absence of clear words) should Parliament be taken to have intended that section 42(3) would apply to deny the 10% writing down allowances available to the owner who has granted a lease to a UK resident (whether or not a finance lease) where the use by the non-resident under the onward lease is use for a qualifying purpose within section 39(2) – that is to say, where the use by the non-resident under the onward lease is use which, if the non-resident held under a lease from the owner, would not have given rise to a denial of 10% writing-down allowances under section 42 CAA. The better view is that Parliament did not intend that section 42(3) CAA should deny the owner 10% writing-down allowances in such a case.

With that lengthy, but I think necessary, analysis of the concepts of ‘permitted leasing’ (in section 42(1) CAA) and ‘qualifying purpose’ (in section 42(3)), I can now return to the question at the heart of this appeal: in a multi-lease case, which is the relevant lease for the purposes of the third cumulative condition in section 42(3) - that is to say, the condition that one or more of the features described in paragraphs (a) to (e) are present in, or in respect of, "the lease"?

The judge addressed that question at paragraphs 54 to 104 of his judgment. He first identified what he thought to be the statutory purpose of section 42 CAA. At paragraph 61 he set out what was common ground:

The judge then set out the rival contentions as to the way in which Parliament had sought to achieve that purpose. The Revenue’s contention, which the judge accepted, appears at paragraph 62 of his judgment:

At paragraph 68 of his judgment the judge set out part of a statement (reported in Hansard for 28 June 1982) in which the minister (Mr Ridley) had explained the thinking which had led the government to propose what was to become section 70 of the Finance Act 1982 - providing for the reduction of capital allowances from 25% to 10% where the machinery or plant was used for the purpose of being leased to a non-resident - and the perceived potential for unacceptable exploitation of the proposals which the government intended to address. The judge found no assistance in that statement on the question which was the relevant lease for the purposes of paragraphs (a) to (e) in section 42(3). As he said, at paragraph 70 of his judgment:

At paragraph 71 of his judgment, the judge explained the basis upon which he was to approach the textual analysis of section 42 CAA:

After submitting section 42 CAA to textual analysis, the judge expressed his conclusion at paragraph 103 of his judgment:

I have explained why I think the judge was wrong to take the view which he did as to the scope of the permitted leasing condition in section 42(1) CAA; and why I agree with his view as to the independent role of the second cumulative condition in section 42(3). It will be clear, also, from an earlier section of this judgment that I agree with the judge’s identification of the statutory purpose underlying the treatment of writing-down allowances in cases where the machinery or plant has been leased to a non-resident who does not use it exclusively for earning profits taxable in the United Kingdom. In such cases Parliament intended there to be no fiscal incentive to an owner. The treatment of cases within section 42(2) is fiscally neutral – in the broad sense that rentals are matched by 10% allowances. But cases within section 42(3) are those which the legislature intends to discourage by fiscal disincentive.

Although I differ from the judge as to the scope of the permitted leasing condition in section 42(1) CAA, I have no doubt that he was correct to hold that the relevant lease, for the purposes of the third cumulative condition in section 42(3), is the lease from the owner (the headlease). The reasoning which leads me to that conclusion may be summarised as follows:

I would dismiss this appeal on the grounds that BMBF 24 fails on issue (2). In those circumstances issues (4) and (5) do not arise.

I agree.

I also agree.