Ruling indicates Upper Tribunal’s “narrow approach” towards windfarm capital allowances

The decision (46-page / 596KB PDF) clarifies the correct test for deciding whether the expenditure occurred in a project qualifies for being “on the provision of” plant and machinery. The tribunal’s view was that “on” and “provision” should be interpreted strictly and narrowly and qualifying expenditure should cover costs on the actual making or construction of the plant, its actual installation or actual transport of it.

This means, expenditure such as the cost of ensuring safe and effective installation, project management, or environmental impact studies in relation to a project, would not qualify for capital allowances following the ruling. This decision could have extensive implications for other taxpayers and businesses in the energy and infrastructure sectors, as it may reduce a taxpayer’s claim for capital allowances relief on a project.

The UT ruling, which overturned the decision by the First-tier Tribunal (FTT), also affirms the powers that the FTT holds to adjust tax returns in circumstances where closure notices do not accurately amend the correct part of the return.

The Orsted case

In this case, the appellant companies, Gunfleet Sands Limited and others, formed part of a wider corporate group headed by Danish energy company Orsted.

The UT considered whether expenditure that the appellant companies incurred on various environmental impact, technical and engineering studies and project management costs when setting up the windfarms (the “disputed expenditure”) would be considered “qualifying expenditure” for the purpose of section 11 of the Capital Allowances Act 2001 (CAA 2001), which provides that capital allowances are available for expenditure “on the provision of plant and machinery”. The disputed expenditure was worth around £48 million. The central issue was whether that expenditure was “on the provision of” plant and machinery.

The FTT had considered that the crucial question was whether the expenditure was directly related to the design of the plant or its installation. It drew a distinction between design which was “necessary”, meaning without which the plant would be operationally useless, and “unnecessary design”, which went to optimisation. In relation to expenditure related to installation, necessity referred to those costs incurred to ensure that the installation was “safe and effective”.

The FTT and UT referred to these as the “necessary/unnecessary design” test and the “safe and effective installation” test. In applying the necessary/unnecessary design test, the FTT also drew a distinction between studies which changed the design, which qualified for the allowance, and studies which simply confirmed the design, which did not qualify.

Both parties appealed the FTT’s decision on the basis that it had identified the wrong test. The taxpayers argued that the FTT’s necessity test was too strict, and HMRC said it was too generous.

The UT’s decision on qualifying expenditure

The tribunal concluded that “on the provision of plant” may cover installation and transport costs and other similar expenditure, but does not cover design costs.

Preferring HMRC’s view, the UT held that the necessity test used by the FTT was unfounded, and that a strict and narrow approach should be taken. It clarified that “on” does not mean “in connection with” or “directly related to” but rather signals a closer connection. The term “provision” focussed on the cost of “doing, making or constructing.”

The UT also ruled that the “safe and effective installation” test adopted by the FTT was not the right test, as the cost of ensuring safe and effective installation is not the actual installation activity itself. Although advice on how and when to install might be necessary, it said, it is not expenditure “on the provision of” the plant itself.

Drawing upon comments in an earlier case, the UT found it helpful to note that the analogous term used in relation to relief in the Capital Allowances Act for buildings and structures was “construction”. If it was accepted that parliament did not intend to have a different code for buildings and structures on one hand, and plant and machinery on the other, the reasonable conclusion was that the two formulations were intended to cover the same type of expenditure. Thus, the UT observed that it serves as a useful guide to test whether expenditure makes sense in the context of the term “construction.”

Applying this, the UT concluded that expenditure on design costs and on studies gathering data to input into design did not qualify. While the design process is a precursor to construction, it would be odd to refer to the intellectual activity of designing a building as the physical process of constructing it.

Accordingly, the UT found that none of the disputed expenditure was allowable. None was for the provision of plant because the expenditure was not “on the actual making or construction of the plant, its actual installation or actual transport of it. Nor were they expenditure of a similar nature.”

What constitutes an individual piece of plant

The UT decision also considered another important question: whether each wind turbine and connector cable constituted an individual piece of plant, or whether the turbines and cables could be considered collectively.

The FTT had found the test to be whether, taking into account the nature and function of the individual components of a composite item, the components are directed towards a single purpose. It found that each windfarm, such as the collection of turbines and cables, could be a single item of plant, stating that “their function is to generate electricity, ramp up the voltage of that electricity, and then feed it into the National Grid.”

They also found that the “generation assets”, for example, the wind turbines and connector cables, comprised a single item of plant as their purpose was directed to the single purpose of generating electricity.

In considering the issue on appeal, the UT held that rather than considering the tests in the various authorities as “hard and fast rules”, the focus should be on ascertaining the facts and circumstances.

This was because the real point of difference between the parties here came down to the level at which the purpose or function test is applied. As HMRC pointed out, while the FTT found each windfarm to have a single function, the way they put this actually showed that each constituent part also had a separate purpose: wind turbines generate, cables transport, substations step-up or transform, and export cables export.

The UT found that this demonstrated the “unrealistic aspiration” of trying to encapsulate something that the case law acknowledges is a matter of fact, degree and impression, in a single unifying test. It therefore concluded that the FTT was wrong to consider that the test was a “hard and fast rule” applicable in all circumstances.

However, it did confirm that it was open to the FTT to reach the conclusion it did that the generation assets at each windfarm were plant. It was wrong though for it to have found each windfarm to have been plant as neither side had put forward this argument.

Notably the UT observed that as the matter was one of fact and degree, this did not mean it was “a free for all” as, as with all questions of fact, there was an outer limit, being that an error would be made if the decision was one that “no reasonable Commissioners could find.”

Written by Steph Bashford of Pinsent Masons