Court of Appeal rules on 'just and reasonable' UK tax apportionment

The case, which involved oil company Total, concerned the way in which profits relating to oil extraction were allocated for the purposes of the 'supplementary charge', following an overnight increase in the rate from 20% to 32% in March 2011. The supplementary charge is a tax charge which applies, in addition to corporation tax, to companies carrying on oil-related activities, including oil extraction.

"The Court of Appeal judgment will be welcomed by other energy companies who have similar ongoing disputes with HM Revenue and Customs (HMRC) regarding the supplementary charge", said Jake Landman, a tax disputes expert at Pinsent Masons, the law firm behind Out-Law.

Companies which had an accounting period which straddled 24 March 2011 had to calculate the supplementary charge as if they had two different accounting periods – one ending before 24 March 2011 where the rate was 20% and the other beginning on that date when the rate was 32%. The legislation provided that profits should be apportioned to the two deemed accounting periods in proportion to the number of days in those periods. However, if time apportionment "would work unjustly or unreasonably in the company’s case", the legislation provided that the company could elect for its profits to be "apportioned on another basis that is just and reasonable".

Two companies in the Total Oil group, known as Maersk Oil at the time, suffered losses in production in respect of some of their oil fields from 24 March 2011, in some cases as a result of storm damage, in others as result of 'shut ins' for routine maintenance. They also incurred increased capital expenditure in the later part of their accounting periods.

The companies elected to apportion their profits between the two deemed accounting periods by allocating income, expenditure and allowances to the periods according to when they arose. This resulted in all their relevant profits for the 2011 accounting period being allocated to the period before 24 March rather than that from 24 March and the capital allowances being allocated to the later period.

HMRC rejected the companies’ calculations arguing that the basis on which profits had been apportioned was not 'just and reasonable'. HMRC objected, in particular, to all the capital allowances being allocated to the later period, rather than being time-apportioned.

The First-tier Tribunal (FTT) ruled that the companies' apportionment method was just and reasonable. The FTT judge said: "If the taxpayer’s approach is just and reasonable, the fact that HMRC’s approach might be said to be better, or more just and reasonable, is not relevant."

However, the Upper Tribunal said that the companies' apportionment method, and in particular allocating the capital allowances to the later period, went beyond what was necessary. The Upper Tribunal also said that opting for an alternative basis of apportionment was not permissible for factors which affect companies in the industry generally, such as 'shut ins' for maintenance during the summer months.

Giving the leading judgment of the Court of Appeal, Lord Justice Newey said: "It seems to me, however, that any company which earned profits at a significantly faster rate in the earlier period than the later period, and so stands to be materially prejudiced by time apportionment, can avail itself of section 7(5) [the provision allowing an alternative basis of apportionment]. It matters not, in my view, whether the differential profitability arose from the exceptional or the routine."

"The FTT thought that section 7(5) applies to all companies 'whose profits are not smoothly spread throughout the year, but whose profits differ greatly from one part of the year to the other, and who could be disadvantaged by … a change of tax rate part way through an accounting period'. I agree", Lord Justice Newey said.

On the capital allowances point, the Court of Appeal said that the FTT was "amply entitled" to consider that the companies’ approach to capital allowances did not prevent their basis of apportionment from being just and reasonable.

"Had the companies happened to have accounting periods ending on 23 March 2011, their capital expenditure in the remainder of 2011 would undoubtedly have served to reduce the adjusted ring fence profits subject to the 32% rate of supplementary charge: there would have been no question of any of the capital expenditure being relevant to determining the companies’ profits for the period up to 23 March 2011 or, therefore, of the capital allowances increasing the extent to which their adjusted ring fence profits bore the supplementary charge at 32% rather than 20%," Lord Justice Newey said in his judgment. "I do not see why a basis of apportionment which produces the same results and reflects the companies’ entitlement to 100% allowances when capital expenditure is incurred should on that account be other than 'just and reasonable'."