| Major leasing case in UK |
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| The UK High Court have refused capital allowances to a UK leasing company in respect of a sale and lease back transaction on a £91m gas pipeline. The deal involved Bord Gáis Éireann. |
Bord Gáis Éireann had built a gas pipeline connecting the UK with Ireland. It cost £91m net of EU grants. Its purpose was to link Ireland to European gas sources. After the pipeline had been built and financed Bord Gáis Éireann (BGE) entered into a sale and lease back agreement with a leasing subsidiary of Barclays Bank. The lease back was done to a UK subsidiary of BGE which carried on a trade of transporting gas through the pipeline in the UK.
That subsidiary’s obligations under the lease and various other obligations of the BGE group in relation to the transaction were covered by a bank guarantee which was in turn supported by a deposit by BGE of the £91m it had received on the sale of the pipeline. The guarantee, and the deposit, (indirectly) involved companies within the Barclays group. The consequence was that whereas the £91m left the Barclay group on the purchase of the pipeline, it promptly returned to a part of the group by way of a security deposit.
Capital allowances denied
It was accepted by the Inland Revenue that the Barclays leasing company was carrying on a trade of leasing. However they refused capital allowances to the company in relation to the expenditure it had incurred in acquiring the pipeline. They denied the capital allowances on a number of grounds. They contested that the company had incurred expenditure on the provision of the pipeline; they denied that the leasing was carried on in the course of the undoubted leasing trade of the company; and indeed they denied that any expenditure was incurred by the leasing company.
The Revenue case was upheld by the Special Commissioners in the UK. These are the equivalent of the Irish Appeal Commissioners. Barclays appealed to the UK High Court and lost. This decision must look odd when viewed from Ireland and from the background of the approach of Irish courts.
Commercial approach by judge
The approach of UK courts and Irish courts to a taxation matter are likely to differ in one important respect. The UK courts are quite likely to apply what is sometimes called the ‘Ramsay approach’. In the McGrath case the Irish Supreme Court rejected that approach.
The Ramsay approach started out in life as a decision that pre-ordained transactions with little or no commercial purpose should be treated for tax purposes as a nullity, with the beginning position and the end position of the pre-ordained chain being examined, rather than any concentration on the steps taken in between.
It moved on from that through a series of developments to being a flexible approach whereby the UK courts could change the rules of interpretation at any time it suited them, always to defeat a claim by a taxpayer.
More recently the UK House of Lords backed away from this approach, which had been rejected and criticised in other jurisdictions throughout the world. They decided that it had been ‘misunderstood’ and that it amounted to no more than giving legal words in a taxing statute their strict legal meaning, and giving to commercial concepts their ordinary commercial meaning. This restatement of the Ramsay approach occurred in the Westmoreland case a year ago. The judge in the Barclays case applied that approach.
The judge decided that expenditure on the provision of plant, was a commercial concept rather than a legal concept. That conclusion seemed to lead him to a commercial analysis of the transactions, rather than a commercial analysis of the wording of the legislation.
He noted that BGE appeared to have in the short term secured no funds that were freely available to them, as a result of their sale of the pipeline. From the moment they received the purchase proceeds, they were predestined to return to the Barclays group as a security deposit. Therefore one of the common features of a sale and lease back, which is to provide the vendor/lessee company with new finance, did not arise in this case.
That was a perfectly true observation and it is certainly an unusual feature of a sale and lease back. However a security deposit of a substantial nature, albeit usually less than the full sales proceeds, is not uncommon.
This factor greatly influenced the judge who concluded from it that he was not dealing with an ordinary sale or lease back transaction or finance lease. He concluded that a finance lease was a lease that provided finance to the lessee, which did not happen in this case in the short term. He therefore held that the undoubted expenditure by the Barclays leasing company was not on the provision of plant for the purpose of its trade but simply on the provision of a complex series of agreements that yielded it rights to various cash flows.
The judge did not appear to attach importance to the fact that the leasing company did become the owner of the network. Neither did he seem to attach importance to the fact that the rights which they acquired to various cash flows arose to them as owners of the pipeline and by reason of owning the pipeline and not otherwise. In that respect, amongst many others, the judgement seems rather strange.
The judge said ‘I consider that it was the money flows which mattered, and it was on the rights to the money flows that, as a commercial matter, Barclays Leasing really expended the £91m which it had borrowed’.
One might wonder what the judge imagines any leasing company expends its money on when it purchases an item of plant earmarked for leasing to a specific customer. Are there any leasing transactions which would not be adequately described by the comment just quoted?
Leasing must have risk?
The judge expressed concern at other aspects such as the fact that the £91m value placed on the pipeline in the transaction might or might not have been the open market value of the pipeline (the judge had no evidence in front of him one way or the other).
He was also surprised that no risk whatever of failure on the lease payments existed by reason of the 100 p.c. security deposit. The judge said ‘I accept that finance lessors always wish to limit the credit risk to which they are exposed. But there can be cases where the credit risk is so comprehensively eliminated that it becomes apparent, if one steps back and thinks about it, that the lessor had not really laid out its money on a leasing transaction at all’.
The judge went on to additionally decide that although the leasing company undoubtedly carried on a trade of leasing, this particular transaction was not a transaction in the course of that trade. The judge decided that the tax avoidance elements of the transaction (essentially the sale of the right to capital allowances) so outweighed any commercial aspect (eg the lessee’s need to raise finance) that the transaction was not a trading transaction.
That decision is surprising in that it takes account of the motivations of the lessee, in determining whether or not the lessor was carrying on a trade. One would not have thought that the lessee’s motivations were relevant to what the lessor was doing.
The judge emphasised that his decision on the case was not based on any finding that there was objectionable tax avoidance involved. He explicitly rejected any such description of the arrangements.
If the case is heard before Higher Courts in the UK on appeal, it will undoubtedly be a case to watch notwithstanding the differences between the approach of the UK courts and the Irish courts. |
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| Article appeared in the October 2002 issue.
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