“Spent” golden contract means enterprise zone allowances disallowed

Tax experts Steven Porter and Sam Wardleworth of Pinsent Masons said that while the recent ruling of the Court of Appeal was based on the specific facts of one case, it is relevant to other investors who have claims to now historic EZAs.

EZAs were valuable deductions from corporation tax or income tax for expenditure incurred in specified zones intended to encourage development and regeneration where there might otherwise not have been. The intention was for the regeneration to happen quickly, hence the allowances were time limited.

The case before the Court of Appeal concerned the construction of data centres in the Tyne Riverside enterprise zone. The taxpayers had paid sums to a developer to acquire rights under contracts relating to the data centres. EZAs were only available if the expenditure was incurred within a specified time limit, that being either 10 years after the site was first included in the zone or, if the expenditure is incurred under a contract entered into within those 10 years, within 20 years of the site first being included in the zone.

The central question in this case was whether the expenditure for which the EZAs was claimed was incurred under a contract, referred to as the golden contract, that had been entered into on the day before the first 10 year window expired. If the expenditure was incurred under that contract the EZAs would have been allowable in full, provided they met all the other conditions. HMRC argued that the expenditure was not incurred under that contract because the arrangements made between the parties after that point amounted to a new contract.

The Court of Appeal fundamentally agreed with HMRC, concluding that no EZAs were allowable. The Court conducted detailed contractual analysis into the agreements and actions of the parties and considered case law on contractual interpretation going back to a case from 1897 concerning the construction of Blackfriars bridge in London.

Before answering the central question, the Court of Appeal had to consider other questions before it.

The initial question was whether the golden contract was a contract at all or just an option. The Court of Appeal, like the Upper Tax Tribunal before it, dismissed that argument quickly, concluding that it was a contract of the type that could give rise to EZAs provided the other conditions were met.

The much bigger and more complex question related to various contractual issues arising after the initial contract was entered into. The contract contemplated six different “works options” across three sites A – C. Specific values were attributed to each of the works options. Under the golden contract, the developer could issue a “notice to proceed”, identifying a specific works option to a contractor. There was also a clause in the contract that allowed variations to be made, for example to add or substitute works. There were two variation agreements and three “change orders”.

Ultimately three data centres were built at the Tyne Riverside enterprise zone – all within the 20 years of designation as an enterprise zone.

The first data centre, which was not the subject of this appeal, was built pursuant to the first change order. The Court of Appeal focused on the fact that the golden contract only allowed for the developer to proceed with one works option. It concluded that the variation agreements, which attempted to enable the developer to issue notices to proceed on more than one works option, could not achieve that end because the contract was already “spent”. The golden contract was spent because a notice to proceed had already been issued in relation to what became the first data centre. What followed from that conclusion was that the second and third data centres were considered to have been built under separate arrangements between the parties.

Steven Porter said: “There was considerable discussion about the extent of the variation that was purportedly made to the contract, with Lord Justice Lewison saying that he agreed with HMRC’s position that the contractor constructed a ‘materially different building on a wholly different site and at a substantially different price’. This is in very stark contrast to the Upper Tribunal, which had concluded that at least some of the variations were not significant.”

“However, the Court of Appeal’s decision is based in the fact that the golden contract did not allow for more than one works option to be chosen and completed. It is frustrating for others dealing with similar enquiries that this case does not really establish any principles that could be applied more generally. It seems likely, therefore, that further litigation on the interpretation of golden contracts and arrangements under them will follow,” he said

According to Porter and Wardleworth, while EZAs are now a historic allowance, the decision is still relevant for taxpayers. They said there are a number of other taxpayers in similar but not identical circumstances with regards to claims to EZAs and that they will be watching this case and any potential appeal to the Supreme Court closely.

They also said that allowances of a similar nature could be made available under the new investment zones that the UK government has proposed, though it is not yet known whether these will come with an element of time limitation. However, the future of the investment zones policy is uncertain. It has been reported that UK chancellor Jeremy Hunt will scrap the investment zone proposals in his forthcoming autumn statement. If the plans survive, Porter and Wardleworth said policymakers would be advised to take the considerable difficulty of applying time limitation rules into account when designing any new rules for new allowances.

Sam Wardleworth said: “The Court of Appeal has paid substantial attention to the detailed contractual arrangements between the parties in this case. Ultimately, the tax treatment, while relevant to the intention of the parties, will follow the contractual reality. While we believe that the Court of Appeal has applied existing jurisprudence on contractual interpretation rather than forging new ground, the case draws attention to the importance of those principles.”

“Any taxpayer seeking to argue that expenditure has been incurred under a contract will need to establish the facts very clearly. It would be very much to a taxpayer’s advantage to consider how their contracts and any variations to them will be interpreted by a court or tribunal when they are being entered into or varied,” he said.