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On 15 April, the Supreme Court handed down its decision in the case of Orsted West of Duddon Sands (UK) Limited and others v Commissioners for HMRC. The effect of the decision was to deny the availability of capital allowances on the cost of certain surveys and studies which had been required in order to proceed with substantial offshore wind projects. The result is, therefore, that there is no tax relief available on such costs.
Background
Orsted undertook four offshore projects through individual project companies. The capital expenditure was extensive, in excess of £2 billion for all projects. Initial costs included surveys and studies, the costs of which was c. £49 million. A number of these studies were essential in order to produce environmental impact assessments, which themselves are required to apply for consents without which the projects could not be undertaken.
The First Tier Tribunal had held that most of the expenditure in dispute did qualify for capital allowances, the Upper Tier Tribunal allowed HMRC's appeal and held that none of the expenditure qualified for such allowances. The Court of Appeal then allowed Orsted's appeal, following which it was further appealed to the Supreme Court.
The decision of the Supreme Court concerned the meaning of section 11(4) of the Capital Allowances Act 2001 whereby expenditure qualifies when it is "…on the provision of plant or machinery".
Supreme Court Decision
The Supreme Court was heavily informed by the precedents in Inland Revenue Commissioners v Barclay, Curle [1969] and Ben-Odeco Ltd v Powlson [1978]. These cases provided the basis for a narrow interpretation of the term "on the provision". Essentially, the expenditure would need to be on an item or activity that formed part of the plant and would be sufficiently close to its provision, rather than being "related to" or "connected to" the plant. In the former case, the expenditure in dispute was the excavation cost required to construct a dry dock and the latter case concerned interest on a loan to acquire plant. The former was allowed as the resulting dock in its entirety constituted plant. The latter was disallowed as being too remote from the plant itself.
The Supreme Court's decision was that the expenditure on surveys, studies and designs did not qualify for capital allowances. Certain costs, such as those incurred on transport and physical installation were allowed as these were direct inputs into the provision of plant. Expenditure "on" the provision of plant and machinery required a close and direct link to the plant itself.
Implications
Costs of studies, surveys and designs are an essential part of energy projects. Indeed, they are formally required in order to ultimately obtain necessary consents. The effect of this case is that such costs do not benefit from any form of relief, thereby impacting on the financial modelling of all such projects. Whereas these costs are inherent to all projects, some projects, such as offshore wind, would be more heavily impacted due to the sheer number and complexity of the studies involved.
This implication on renewables projects was highlighted by the Supreme Court in its judgment. However, the court noted that a broadening in the interpretation of statute was not appropriate to decide what should be considered deductible and what would not, implying that it is a matter of policy to decide what expenditure should be deductible if this sector is to be incentivised.
Practical takeaways
Given the commercial and regulatory necessity of these costs, it should be expected that HMRC and Government will give a clear indication as to what should be deductible, probably initially through guidance and then through legislation.
In the meantime, businesses developing energy projects will need to consider the following:
- Recording and differentiating costs (including, if possible, labour costs) between physical (eg. transport, site preparation and installation) and non-physical preparatory work and material
- Considering the impact of the decision with regard to the pooling of expenditure for accounting periods which have not yet been reported
- Having cost elements broken down in more granular form for development service agreements so as to clearly differentiate between the different preparatory works.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
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