Revenue And Customs v Lloyds TSB Equipment Leasing (No 1) Ltd

By a decision released on 12 January 2012, the First-tier Tribunal (Tax) (Judges Edward Sadler and Adrian Shipwright, ‘the FTT’) allowed an appeal by Lloyds Equipment Leasing (No 1) Limited (‘LEL’) against an amendment made on 24 April 2009 by The Commissioners for Her Majesty’s Revenue and Customs (‘HMRC’) to LEL’s corporation tax self-assessment return for the year ended 30 September 2006: see [2012] UKFTT 47 (TC). The subject of the amendment had been LEL’s claim for writing-down capital allowances at the rate of 25% in respect of expenditure incurred by LEL on the purchase of two merchant vessels, the Arctic Voyager and the Arctic Discoverer, of which it is the owner and lessor. The vessels had been designed and built for the purpose of shipping liquefied natural gas (‘LNG’) from northern Norway to Spain and the USA as part of a project (‘the Snøhvit project’) for the exploitation of natural gas fields under the Barents Sea by a consortium of energy companies.

LEL is a wholly-owned subsidiary of Lloyds Banking Group. It is resident in the UK and carries on the trade of finance leasing. It claimed the disputed allowances in the computation for tax purposes of the profits of its trade. LEL contracted to purchase the vessels in September 2002 and they were delivered to it during its accounting period for the year ended 30 September 2006. LEL’s total expenditure on the purchase of the vessels was £198,226,884, with the bulk of its expenditure incurred in the year ended 30 September 2006 (£33,351,994), but it had also made instalment payments in each of its four preceding accounting years. The effect of HMRC’s amendment was (i) to deny LEL’s claim for capital allowances in the return for the year ended 30 September 2006, and (ii) to recover in full the capital allowances LEL had claimed in the preceding four years. The further effect was to require LEL to pay additional corporation tax of £6,278,877, as well as certain penalties, for the year ended 30 September 2006; and to deny LEL the right to claim writing down allowances in respect of the balance of its expenditure on the vessels over subsequent accounting periods.

Four issues were argued before the FTT on LEL’s appeal, of which the FTT decided issues 1, 2 and 4 in favour of LEL (which was sufficient for it to succeed), and issue 3 against LEL. Issue 3 was an argument by LEL that issue 4 did not arise for consideration at all.

By a decision released on 14 August 2013, the Upper Tribunal (Newey J and Mr Howard M. Nowlan, ‘the UT’) dismissed HMRC’s appeal against the decision of the FTT: see [2013] UKUT 0368 (TCC). Of the same four issues argued before the FTT, the UT upheld the FTT on issues 1, 2 and 3. On issue 4, Newey J would also have upheld the FTT’s decision, whereas Judge Nowlan would not. As, however, Newey J had a casting vote, the FTT’s decision on issue 4 was also upheld.

HMRC, with the permission of the UT, now appeal to this court. Whilst they originally sought to appeal only on issues 1 and 4, they abandoned issue 1 shortly before the hearing and their appeal became confined to issue 4. By a respondent’s notice, LEL appealed against the decision of the UT to uphold the FTT’s rejection of its argument under issue 3.

I shall first summarise the facts and then deal successively with issues 3 and 4.

I take these from the meticulously full decision of the FTT, running to 432 paragraphs occupying 95 single-spaced pages. My account does not attempt to be similarly comprehensive: the interested reader is referred to the FTT’s decision for the detail.

The Snøhvit project is a joint venture set up to extract, process and deliver to market LNG from the gas fields in the Barents Sea off the north-west coast of Norway. There were originally seven partners (‘the Snøhvit Sellers’) in the consortium, of which the lead member was Statoil SA, although since the relevant transactions were entered into the Snøhvit Sellers now consist only of Statoil. The Sellers required a fleet of dedicated, purpose-built vessels to ship the LNG to its long-term customers. Because of the location of the gas field in the high north, the vessels required were ‘winterised’ ones with design features capable of coping with the severe weather features they would encounter. The vessels were required to meet high standards.

Statoil led the tender process to select a counterparty for the provision of the vessels. That process commenced in January 2001. Some 55 companies were invited to participate in a pre-qualification process. Statoil also sought an owner and operator of the vessels which would hire them to the Snøhvit Sellers on a long-term time charter on commercial terms that they specified. Those terms were to reflect, over the time charter period, a return of the capital cost of the vessels and a finance charge on such cost, plus the expenses (or an estimate) of operating the vessels. It was a further requirement of the Snøhvit Sellers that, as the vessels would operate only within the Atlantic Basin, the commercial and technical management of the vessels in the course of their operation should be located in the European time zone.

The mandate to own and operate the vessels was, after a tender process, awarded to Kawasaki Kisen Kaisha Limited (‘K-Line’). K-Line already had a subsidiary company incorporated in England and Wales, K-Line (Europe) Limited (‘K-Euro’). K-Euro had an established shipping trade and K-Line intended that, however the vessels might be financed, K-Euro would be the company by which it met the requirements of the Snøhvit Sellers for the commercial and technical management of the vessels.

In the summer of 2001, Statoil recommended to the Snøhvit management committee the award of the contract for the vessels to K-Line, as was later approved by the Norwegian parliament. On 19 December 2001, there took place what the FTT called ‘the preliminary stage’, which included the following: (a) the entry by K-Line into a shipbuilding contract with Mitsui Engineering & Shipbuilding Co, Ltd in respect of the first vessel, the Arctic Discoverer; (b) a shipbuilding contract with Kawasaki Heavy Industries, Ltd in respect of the second vessel, the Arctic Voyager; (c) two time charterparties with Statoil, on behalf of the Snøhvit Sellers; and (d) a Memorandum of Understanding (‘MOU’) with Statoil. This preliminary stage did not include any financing in respect of the vessels: the MOU recorded the parties’ intentions to seek such financing. K-Line reserved the right to introduce other parties as co-owners and to re-structure the ownership rights and arrangements.

K-Line had, during the course of the tender process, sought indicative pricing for the vessels: it needed to do so in order for a time charter day rate to be calculated. K-Line met several institutions in order to discuss financing. The forms of financing it discussed with such institutions were debt financing, lease financing and securitisation of the project cash flows. One of the prospective lessor banks was Lloyds TSB Leasing Ltd (‘Lloyds Leasing’). On 16 April 2002, heads of terms for the financing of the vessels were entered into with Lloyds Leasing by what the FTT called Northern LNG and the Snøhvit Sponsors. Each of Northern LNG Transport Co, I, Ltd and Northern LNG Transport Co, II, Ltd (severally or together, ‘Northern LNG’) became in due course the lessee of one of the two vessels from LEL. They are Cayman Island joint venture companies, whose shares were owned in different proportions (the difference is not material) by K-Line, Statoil, Mitsui and Iino Kaiun Kaisha (‘the Snøhvit Sponsors’).

The following key transactions were entered into on 19 September 2002:

K-Euro’s business was expanded from 2002 onwards, in particular by the establishment of a bulk and gas carrier division. K-Euro took on charter, or undertook the management of, a number of LNG and bulk carriers.

With effect from 1 January 2006, K-Euro’s business was reorganised, in a way involving the following steps:

The effect of this was that whilst K-Euro retained its interest in the vessels under the bareboat and time charters, it contracted out the management of the vessels to K LNG and also transferred all other parts of its business to other fellow subsidiaries. In addition, the hire payable by K-Euro under the bareboat charters was, for a specified period, reduced. As a further part of this re-organisation, but not until October 2006, K-Euro’s share capital was re-organised so that its shareholders (and their respective interests) corresponded with those of Northern LNG, and its shareholders contributed further share capital. The reason for this re-organisation was because it was expected that, contrary to original expectations, K-Euro would make a substantial loss in operating the vessels and because certain of the security arrangements with respect to the lease structure through which K-Euro held its interest in the vessels were proving to be a commercial restraint upon the management and development of K-Euro’s other business interests.

The Arctic Discoverer was delivered to LEL in February 2006; the Arctic Voyager in July 2006. The leasing arrangements in respect of each vessel took effect upon their respective delivery. K-Euro changed its name on 3 February 2006 to Polar LNG Shipping (UK) Ltd, but I shall stick to its original name.

I can now approach the issues but must first introduce the legislation.

Section 123 of the Capital Allowances Act 2001 (‘the 2001 Act’), upon which the appeal turns, is in Chapter 11, ‘Overseas Leasing’. That chapter is driven by a policy directed at limiting the extent to which the benefit of 25% UK writing-down allowances on the acquisition of capital assets can flow through to non-UK residents. Such benefit will typically do so if the obtaining of the writing-down allowance enables the asset to be leased to a non-UK resident at a lower rate than would otherwise apply.

With this policy in mind, section 109 of the 2001 Act limits the extent of the available writing-down allowance to 10% in cases to which it applies. It applies to expenditure on the provision of plant or machinery ‘used for overseas leasing which is not protected leasing, …’. ‘Protected leasing’ is defined in section 105 and means (a) short-term leasing, as defined in section 121 (not in point here), or:

It is section 110 that explains the circumstances in which neither a 25% nor a 10% capital allowance is available in respect of expenditure on plant or machinery, but no allowance at all is available. This will be the case where the expenditure is incurred on plant or machinery for leasing, the plant or machinery is used for overseas leasing which is not ‘protected leasing’, it is used otherwise than for a ‘qualifying purpose’ and it is a lease within any of the items there listed. If LEL is not entitled to 25% capital allowances under section 123, the effect of section 110 is that it is not entitled to any allowances.

Section 123, headed ‘Ships and aircraft’, provides as follows:

Sub-section (4) is an anti-avoidance provision. Subject to issue 4, there is no dispute that in principle LEL is entitled to the 25% writing-down allowances it claimed in respect of its purchase costs of the vessels. In particular, subject as aforesaid, there is no dispute that the vessels were used for a ‘qualifying purpose’ within the meaning of section 123(1), namely by being let on charter in the course of trade within such meaning. Putting it generally, the question raised by section 123(4), under issue 4, is whether ‘the main object, or one of the main objects’ of any of the transactions in question, ‘was to obtain a writing-down allowance …’. If it was, the claim to the allowance fails because the ships will, ex hypothesi, not have been used for a ‘qualifying purpose’ and so will not satisfy section 123 at all. The FTT found in favour of LEL on this point, and the UT, albeit divided, upheld that decision.

Issue 3, however, raises a preliminary issue as to whether sub-section (4) applies to the present case at all. I turn to that issue.

LEL’s point is that section 123(4) is, according to its express terms, directed only at a case in which the, or a, main object of any transaction or transactions falling within its sub-paragraphs (a), (b) and (c) is ‘to obtain a writing-down allowance determined without regard to section 109 (writing-down allowances at 10%) …’. Thus the, or a, main object at which it is said to be directed is only one in which the aim is to achieve a 25% rather than a 10% allowance. There is no suggestion by HMRC that that was an object of any of the transactions in this case: it is agreed that, if obtaining a writing-down allowance was one of LEL’s main objects (which LEL disputes), it was to obtain a 25% allowance rather than no allowance. As section 123(4) makes no comparable reference to section 110 (no allowances), it is said that the main object that HMRC attribute to LEL is not within the grasp of section 123(4) at all and so the subsection has no application.

LEL’s proposition is beguilingly simple, if intuitively unattractive. It fell on stony ground with both tribunals below. Its consideration requires an explanation of the legislative antecedents to section 123(4).

The starting point is the Finance Act 1980, enacted when first-year allowances of 100% on expenditure on the provision of plant and machinery were available. Section 64(1), however, denied any such allowance unless the plant or machinery was to be used for a ‘qualifying purpose’ and section 64(2) defined when it would be so used. Section 64(5) provided that, without prejudice to subsection (2), a ship is used for a ‘qualifying purpose’ when let on charter in the course of a trade which consists of or includes operating ships if the conditions in sub-paragraphs (a) and (b) are satisfied. Section 64(5) is, in its essentials, the forerunner of section 123(1) and (3) of the 2001 Act.

The Finance Act 1982 amended section 64(5) by providing that it was subject to the new subsection 6A. Section 64(6A) provided that section 64(5) did not apply if the main object, or one of the main objects, of one or more of various transactions, ‘was to obtain a first-year allowance in respect of expenditure incurred on the provision of the ship …’. This was the forerunner of section 123(4) of the 2001 Act. It was, however, still only directed at, and concerned with, the obtaining of 100% first-year allowances.

I should refer also to section 70 of the Finance Act 1982, headed ‘Allowances for assets leased outside the United Kingdom’, and of which section 70(2) was the forerunner of section 109 of the 2001 Act. Section 70(2) provided that, in cases to which it applied, the relevant allowances legislation:

The Finance Act 1984 provided for the removal of first-year allowances with effect from 31 March 1986. The consequence was that, by the Finance Act 1986, section 64(1) of the Finance Act 1980 was repealed and section 64(6A) was amended so as to provide, materially:

The Capital Allowances Act 1990 consolidated the earlier provisions. Section 39(6) is the forerunner of section 123(1) and (3) of the 2001 Act; and section 39(8) is the forerunner of section 123(4). Section 39(8) provides, materially:

Section 42, ‘Assets leased outside the United Kingdom’, is the successor to section 70 of the Finance Act 1982. Section 41(1) provides, materially, that section 42 applies to expenditure on the provision of machinery or plant for leasing where the machinery or plant is used for the purpose of being leased to a person not resident in the United Kingdom and where the leasing is neither short-term leasing nor the leasing of a ship which is used for a qualifying purpose by virtue of section 39(6) to (9). Section 42(2) provides, materially:

There is no need to explain the various references in section 42(2), other than that to ‘subsection (3) below’. Section 42(2) is the successor to section 70(2) of the Finance Act 1982 and the forerunner of section 109 of the 2001 Act, and provides for the circumstances in which only a 10% writing-down allowance is available; and section 42(3) is the successor to section 70(4) of the Finance Act 1982 and the forerunner of section 110 of the 2001 Act, and provides for circumstances in which no writing-down allowances at all are available.

The final legislative change was the enactment of the 2001 Act, described as ‘An Act to restate, with minor changes, certain enactments relating to capital allowances’. In the 2001 Act, section 42(2) of the 1990 Act became section 109; and section 42(3) became section 110. There is, however, a difference in the drafting style of sections 109 and 110 as compared with that of their predecessors, in that section 109 is not expressed to be ‘subject to section 110’.

Mr Peacock’s submission was simple. It is that the key words in section 123(4) – ‘without regard to section 109 (writing-down allowances at 10%)’ – are there for a purpose, they cannot be ignored, they must be given their ordinary meaning and that meaning is that the only type of ‘main object’ at which section 123(4) is directed is one aimed at obtaining a 25% allowance rather than a 10% allowance. If the ‘main object’ is to obtain a 25% allowance rather than no allowance, such object is not caught by section 123(4) and so section 123(4) cannot stand in the way of a claim to a 25% capital allowance in respect of a ship used for a ‘qualifying purpose’ satisfying section 123(1). It is common ground that if a 25% allowance was not available in this case, no 10% allowance could have been available: the only alternative was no allowance.

The FTT regarded the position for which LEL was contending as absurd. It noted that Mr Peacock was unable to identify any ground of logic or policy to limit the application of the ‘main objects’ anti-avoidance provision in section 123(4):

The FTT considered that the archaeology of the legislation ultimately enshrined in section 123 provided the answer to LEL’s submission. The FTT referred to sections 39 and 42 of the Capital Allowances Act 1990, which had consolidated the earlier provisions. I have summarised their essential provisions above, and there noted that a key provision of section 42(2) was that it was expressed to be ‘subject to’ section 42(3) (those subsections being the forebears of sections 109 and 110 of the 2001 Act). The FTT’s reasoning continued:

In other words, since the FTT did not regard the 2001 Act as intended to achieve a material change in the law, it considered that its legislative antecedents justified reading section 109 as if, like section 42(2) of the 1990 Act in relation to section 42(3), it was to be read as being ‘subject to section 110’. On that interpretation, there was no justification for reading section 123(4) as focused exclusively on section 109. The more natural sense was that if section 109 was anyway incapable of being in play, the reference to it would include a reference to section 110.

The FTT’s alternative, rather simpler, conclusion was that, taking the language of section 123(4) at face value, the words ‘determined without regard to section 109’ anyway provided no help to LEL. The words ‘without regard to’ mean ‘without taking into account’ or ‘without heed to’. If no account is to be taken of the position under section 109, it matters not whether section 109 could or could not apply: it is immaterial. As the FTT put it:

The UT agreed with the FTT’s conclusion. The UT said:

I respectfully agree with the conclusion of both tribunals below on this issue. I should say that I do not regard section 123(4) as a cleverly drafted piece of legislation. To make the availability of a capital allowance dependent on what is ultimately the subjective intention of a party to a transaction is a recipe for dispute and litigation, no better illustrated than by what has happened in this case, namely a seven-day hearing before the FTT, a four-day hearing before the UT and a day and half’s hearing before this court. Neither LEL nor HMRC can be criticised for wanting to litigate the point, but that our tax legislation should be written like this appears to me to be unsatisfactory. So far as concerns the particular point on which issue 3 depends, Mr Peacock urged that we must give effect to the key words in section 123(4), and in principle I agree. That, however, requires the court to determine what the words mean. The essence of his submission was that they mean, and mean only, that the relevant intention is to obtain a 25% writing-down allowance rather than a 10% writing-down allowance.

If that is a fair interpretation of the words, LEL might have an arguable point. In my view, however, it is not. Their ordinary meaning is not one requiring a comparative determination of the relevant intention. The question posed by section 123(4) is whether the main object (or one of the main objects) ‘was to obtain a writing-down allowance determined without regard to section 109 (writing-down allowances at 10%)’. It is, I consider, an odd piece of drafting but in my view the inquiry raised by the chosen words is most naturally to be divined as being whether the main object was to obtain a writing-down allowance determined without reference to section 109: in other words, whether the intention was focused on obtaining a writing-down allowance in the determination of which section 109 played no part. That is this case. If (which is disputed) the main object (or one of its main objects) was to obtain a writing-down allowance, it did not intend the allowance to be determined by reference to or with ‘regard to’ section 109. That, in my view, is all there is to it.

If I am wrong in that approach, I would anyway also agree with the first way in which the FTT was disposed to rule against LEL on this issue: namely, (i) that section 123(4) was not intended to make any substantive change to the prior law, and (ii) that its antecedents justified an interpretation of section 109 as if were expressed to be ‘subject to’ section 110. On that basis, even if (which I doubt) the key words in section 123(4) justify the attribution to them of a more positive reference to section 109 than I consider they do, the reference is anyway to be read as if it were a reference to section 109 ‘subject to’ section 110. In other words, in a case in which the only writing-down allowances potentially available are 25% and 0%, there is no warrant for an interpretation of section 123(4) that confines the main object to one directed at obtaining a 25% allowance rather than a 10% allowance,

For these reasons, I would dismiss LEL’s appeal on issue 3.

The issue here is whether the UT was correct to uphold the decision of the FTT that, by reference to the critical language of section 123(4), it was not the main object, or one of the main objects, of the letting of the vessels on charter, or of any series of transactions which included such letting, to obtain the 25% writing-down allowance claimed by LEL.

Before coming to the FTT’s reasoning, it is material to refer to two matters. The first is its findings of fact under the heading ‘The lease financing of the Vessels’. I need to set these out in full.

The second matter to refer to is the decision of Vinelott J in Barclays Mercantile Industrial Finance Limited v. Melluish (Inspector of Taxes) [1990] STC 314, to which Mr Peacock QC, for LEL, had referred the FTT and upon which the FTT plainly placed reliance. Melluish concerned paragraph 3(1)(c) to Schedule 8 to the Finance Act 1971, which denied a first-year capital allowance on the purchase of plant in circumstances in which:

The Special Commissioners ruled in favour of the finance lessor’s claim for first-year allowance in respect of expenditure incurred in purchasing films pursuant to a sale and leaseback financing transaction, and their decision was upheld by Vinelott J on appeal, who said, at [1990] STC 314, 343:

It was common ground before this court that the inquiry as to whether there were circumstances of the type to which paragraph 3(1)(c) were directed (‘sole or main benefit’) were not comparable to the different inquiry (‘the main object, or one of the, main objects’) required by section 123(4). Nevertheless, the FTT, having referred to Melluish in its summary of Mr Peacock’s submissions in relation to issue 4 said:

It is central to HMRC’s criticism of the FTT’s decision on issue 4 that, whilst that statement may have been a correct summary of the decision in Melluish in relation to the provisions of paragraph 3(1)(c), it was an incorrect summary of the different inquiry required by section 123(4). Yet the FTT’s statement can perhaps be read as if it was there accepting that, also for the purposes of section 123(4), Melluish showed that if the obtaining of the disputed allowances is a significant factor in rendering the relevant transaction ‘commercially viable, obtaining the allowances is not a main purpose of the transaction’. Moreover, as I shall explain, the FTT returned to Melluish in the course of its discussion as to the answer to the section 123(4) inquiry with which it was faced. Melluish was, in my view, of no assistance in answering that inquiry; and a critical question is the extent to which, if at all, the FTT was influenced in its ultimate decision by its reference to the approach identified by Vinelott J in Melluish.

I make clear that there is no doubt that, at [370], the FTT had earlier correctly summarised the effect of section 123(4), and, therefore, the question they had to determine. At [386], however, which was the second paragraph of their discussion of the rival arguments, they expressly adopted the submission of Mr Peacock for LEL that section 123(4) ‘cannot have been intended to emasculate the incentives available through the capital allowances legislation by reason of section 123(1) …’. I would respectfully question the soundness of that observation, which perhaps carries with it what I would regard as an unwarranted suggestion that the ordinary interpretation and application of the inquiry mandated by section 123(4) must in some manner be diluted, whereas it would appear to me that, difficult though its determination may be in any particular case, the inquiry required by section 123(4) is clear. The FTT continued:

As it seems to me, the alternative situations that the FTT was describing in the third, fourth and fifth sentences of [387] covered respectively: (i) a case in which the obtaining of the allowance was a main object; (ii) a case in which it may, or may not, have been a main object; and (iii) a case in which it will not be a main object. In [388], the FTT then explained that in any particular case there may be a hierarchy of objectives motivating the transaction, including the obtaining of a capital allowance, and that the inquiry must then be as to which of them are ‘main’ and which are not. I would not disagree with that approach.

The FTT then expressed its view, in [390], that, in determining the objectives of the transactions, and ranking them, the key factor was their commercial basis or justification, or the commercial purposes which were served for the parties in entering into the transactions. Before, however, considering the commercial purpose of the transactions, the FTT reverted to Melluish and it did so since it regarded that decision as supporting its view that a ‘key factor’ was the commercial basis of, or purpose served by, the transactions. The FTT devoted [391] to a summary of the issue in Melluish and said that paragraph 3(1)(c) of the applicable schedule in that case showed that ‘the taxpayer finance lessor had to satisfy a “main object” test similar to that faced by [LEL] in this case’. With respect, I consider that the FTT was wrong to regard the ‘main object’ test in paragraph 3(1)(c) as similar to the ‘main object’ inquiry in section 123(4). The former inquiry was whether ‘the sole or main benefit which … might have been expected to accrue to the parties or any of them was the obtaining of [a first-year allowance]’, (my emphasis), whereas the section 123(4) inquiry is as to whether ‘the …, or one of the main objects’ of the chartering of the ship, or of a series of transactions including such chartering, was to obtain the writing-down allowance’ (again, my emphasis). The FTT explained Melluish by saying:

The FTT turned to consider the transactions in the present case, in respect of which it recorded LEL’s acceptance that the letting of the vessels on charter was one of the series of transactions that were carried out. The transactions were entered into in September 2002, but the FTT noted that they were in contemplation at the ‘preliminary stage’, that is on 19 December 2001. The MOU recorded not just that K-Line would seek a UK finance lease by which to finance the purchase of the vessels or some other form of financing, but that the vessels would be operated by a company carrying on business as a ship operator in the UK, for which purpose Northern LNG would grant a bareboat charter and the time charter would be novated.

This showed in the FTT’s view that, contrary to the Commissioners’ case, K-Euro was not inserted into the structure in September 2002 once K-Line understood what was needed in order for capital allowances to be available, but that the structure implemented in September 2002 gave effect to what the parties had intended at the preliminary stage; and this was so even though K-Euro was not a party to the MOU, nor was it there identified as the ship operating company.

The FTT directed itself, in [396], that the objects of the transactions with which they were concerned should be ascertained at the time the documents effecting them were entered into: the relevance of later events was only that they might shed light on the parties’ purposes or aims at that earlier time. The FTT considered, in [397], that December 2001 was the key point at which to ascertain the objects of the relevant transactions.

At [401], and taking what it called ‘the broader picture’, the FTT said it was clear that K-Line’s broad objective of letting the vessels on charter was to achieve its particular commercial aim, namely that of pursuing the group’s strategy of expanding its gas and bulk carrier business into the Atlantic Basin. It found that the broad objective of letting the vessels on charter ‘was entirely to achieve a particular commercial aim’. The K-Line group also identified K-Euro as the entity within the group that would comprise its regional centre and would so develop its Atlantic Basin business. As the FTT said:

The FTT, at [404], summarised how the K-Line group recognised that if K-Euro were to achieve its ambitions, it would have to increase its capability very significantly, and the FTT had earlier described how it did so. The FTT said this development was largely carried out after September 2002, but the decisions to pursue that course, and the initial steps, were taken before September 2002, no doubt in part to convince the Snøvhit Sellers before the intentions of December 2001 became ‘legal certainty’ in September 2002 that K-Euro would be in a position to operate the vessels when they were delivered.

At [405] the FTT recorded Mr Ewart QC’s submission, for HMRC, that, once K-Line was advised of the need for K-Euro to be a ‘bona fide commercial UK shipping company’ if the lease financing were to secure capital allowances, it set about creating a business that would pass the test. The submission was, therefore, that its one real, predominant motive was to do what was necessary to secure the allowances. The FTT rejected that submission, saying that it:

The FTT considered HMRC’s argument that the 2006 reorganisation of K-Euro raised a question as to whether in reality K-Euro had a genuine commercial role justifying its participation in the leasing structure. The end result of such reorganisation was to leave it with the status of a ‘mere husk of a company with a single part-time employee whose role was limited to company and regulatory compliance matters.’ The FTT rejected the argument. They repeated that the point at which the ‘objects of transactions’ were to be judged was when they were entered into. There was no evidence that at that time any of the parties expected that such a reorganisation would be required. The principal reason for the 2006 reorganisation was the unexpected increase in the manning costs of the vessels, which it became apparent would leave K-Euro with substantial losses once it took delivery of the vessels. The FTT said that ‘[t]here is nothing to suggest that the remedial action was in any way welcomed by K-Line or K-Euro: it was an act of expediency required to deal with a serious commercial threat.’

The FTT concluded its reasoning on the section 123(4) issue as follows:

As I have said, the UT (to whose decision neither counsel made any reference in the oral argument to this court) was divided on whether the FTT had misdirected itself in its approach to the inquiry of whether or not the, or a, main object of the relevant transactions was to obtain the writing-down allowance. Newey J was satisfied that the FTT had applied the correct legal test and that it could not be said that there was no evidence to support its conclusions. Whilst Judge Nowlan agreed that the FTT had directed itself correctly as to the legal test in [370], he was of the view that:

The extended arguments before us involved a minute dissection of the FTT’s decision. The thrust of Mr Peacock’s submission was that there was no doubt that the FTT had correctly directed itself as to the required inquiry under section 123(4) and equally no doubt that it found as a fact, as it was entitled to, that the obtaining of the capital allowances was not a main object for the purposes of the subsection. Mr Ewart advanced a wide-ranging series of submissions as to why the FTT had fallen into error, although by the time of his reply he confined himself to three propositions, namely that the FTT’s error lay in (i) being influenced by Melluish into considering that, provided all elements of the transactions had a genuine commercial purpose, any object of also obtaining the capital allowances could not be a main object for the purposes of section 123(4); (ii) being also influenced by their erroneous assessment that section 123(4) could not have been intended to ‘emasculate’ the obtaining of the incentives available through the capital allowances legislation; and (iii) their failure to consider the section 123(4) inquiry by reference to the intentions of all the parties to the transactions.

I have come to the conclusion that, putting it at its lowest, there is a very real concern that the FTT misdirected itself in its approach to the section 123(4) inquiry and that its decision is too unsafe to be allowed to stand. The most striking feature of the FTT’s decision is that whilst it is, on its face, as painstakingly meticulous and comprehensive as they come, when the decision comes down to an assessment of whether or not the obtaining of the capital allowances was a section 123(4) ‘main object’, it is virtually unreasoned. The FTT opened its crucial [427] by asserting that the objective of obtaining capital allowances was not a main objective. It does not, however, then explain why it made that assessment save by explaining that the commercial objectives of the transactions were paramount, with each transaction in the relevant series having a commercial purpose. The thrust of [427] was that the achieving of each of those commercial purposes was the primary objective, and that obtaining the capital allowances was, in terms of priority, subservient to or of lesser importance than achieving such commercial purposes. The FTT also said in [427] that ‘[t]he capital allowances were a route to reduced cost of funds for the financing of transactions already decided upon.’ If, however, that was intended to suggest (and it may be that it was not) that the leasing arrangements that would enable the obtaining of the capital allowances were decided upon before it was realised that such allowances would be obtainable, that is inconsistent with the course of events that the FTT had explained in [218] to [230], which I have earlier set out.

The apparent deficiency in [427] is, in my judgment, that although the FTT was no doubt entitled to find that each transaction in the relevant series served a genuine commercial purpose, it does not follow that the obtaining of the capital allowances was incapable of also being a main object of the transactions, even if it was not the main object of the transactions. The FTT does not explain why it was not such a main object. In my view, the likely explanation for this omission is, as Judge Nowlan concluded, that the FTT was wrongly influenced by Melluish into the assessment that, provided all the transactions were entered into for genuine commercial reasons, the obtaining of the capital allowances was necessarily an immaterial, subservient consideration. In my view, however, that does not follow. Even if each of the transactions was entered into for a genuine commercial purpose, it may still be the case that a main object of structuring them in the way they were was to obtain the capital allowances; and the FTT’s findings in [218] to [230] might be said to provide a factual basis for a finding that it was.

For these reasons, I have come to the conclusion that the FTT’s decision on issue 4 cannot be allowed to stand. I would allow HMRC’s appeal, set the decision of the FTT aside and remit LEL’s appeal to the same FTT (that is to say, the same two judges) for a re-consideration of issue 4. If the parties consider that we should make any further directions for the purposes of such remission, they are at liberty to make any suggestions they consider appropriate.

I agree.

I also agree.