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Lloyds Bank Leasing: the ‘main objects’ test

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The recent decision of the First-tier Tribunal in Lloyds Bank Leasing (No 1) Ltd v HMRC [2015] UKFTT 401 is the latest instalment of a long running judicial saga which examines whether the obtaining of capital allowances was one of the main objects of a transaction. The tribunal denied capital allowances because a main object of at least some of the transactions was to obtain allowances, even though there was a paramount commercial purpose. The discussion on what constitutes a ‘main object’, and the approach of the tribunal to the evidence, is likely to be useful in other disputes.

The case of Lloyds Bank Leasing (No. 1) Ltd v HMRC [2015] UKFTT 401 (reported in Tax Journal, 4 September 2015) is interesting for two key reasons. First, it gives a detailed analysis of what is meant by ‘a main object’. This is a phrase which occurs in various targeted anti-avoidance provisions and so is likely to be referred to in many current and future disputes with HMRC. Second, the case is remarkable for the journey it has taken through the courts so far – and the journey may well not yet be over.
 

The facts and relevant legislation

 
The underlying transactions were clearly commercial. The parties to a joint venture set up to extract liquefied natural gas (LNG) from gas fields off the coast of Norway required a fleet of specialised vessels to ship the LNG to customers. After a tender process, the mandate to own and operate the vessels was awarded to a Japanese company, K-Line, in late 2001.
 
K-Line then entered into detailed structuring and financing discussions. In April 2002, Lloyds TSB Leasing Ltd entered into heads of terms for the financing of the vessels; in due course, Lloyds Bank Leasing (No. 1) Ltd (referred to as ‘LEL’, due to its former name) became the purchaser of the vessels and claimed capital allowances on the use of the ships for the purposes of its business of finance leasing.
 
The general position is that a finance lessor is entitled to capital allowances (at the time, at a rate of 25%) under CAA 2001 s11. However, where plant or machinery is used for ‘overseas leasing’, allowances are restricted to 10% or nil, unless the leasing is ‘protected leasing’, which requires the ship to be used for a ‘qualifying purpose’ as defined by CAA 2001 s 123. It was clear that the ships were to be used for overseas leasing, since the end users were non-UK companies, where profits were not subject to UK tax. 
 
The crucial questions were therefore:
 
  • whether the ships were used for a qualifying purpose, as defined by s 123(1); and
  • if so, whether capital allowances were denied by virtue of the anti-avoidance rule in s 123(4).
Section 123(1) requires the management of the ship to be undertaken by a UK resident who is engaged in the shipping trade, and who bears the expenses incurred in respect of the ship. The vessels were let on bareboat charters to a K-Line UK subsidiary, K-Euro, and it was agreed that this satisfied s 123(1), subject to the anti-avoidance rule in s 123(4).
 

The anti-avoidance rule

 
CAA 2001 s 123(4) is as follows:
 
‘Subsections (1) and (2) do not apply if the main object, or one of the main objects:
a) of the letting of the ship … on charter;
b) of a series of transactions of which the letting of the ship … on charter was one; or
c) of any of the transactions in such series,
was to obtain a writing-down allowance … in respect of expenditure incurred by any person on the provision of the ship.’
 
The test is therefore whether any transaction within the overall arrangements had a main object of obtaining a writing-down allowance. ‘Object’ in this context is synonymous with ‘purpose’; however, the test appears wider than that in the loan relationships legislation (CTA 2009 s 441) since it requires an examination of the subjective intention of all of the parties to the series of transactions. In particular, HMRC argued that one of the main purposes for the insertion of K-Euro into the structure (by the grant of bareboat charters and novation of time charters) was to secure writing-down allowances.
 

From the FTT to the Court of Appeal – and back again

 
LEL claimed allowances in respect of the instalments paid in each year to 2005, and then claimed in respect of the balance of the price in 2006. HMRC challenged the claim at that point, and sought to recover the earlier amounts claimed by way of a balancing charge.
 
LEL’s appeal came to the FTT in 2011, and was heard by Judges Sadler and Shipwright. There were four issues before the FTT: 
 
  • Issues 1 and 2 related to the question of whether the use made of the ships by K-Euro was a qualifying purpose; they were decided in the taxpayer’s favour. 
  • Issue 3 was a technical argument on whether s 123(4) was relevant; this was decided in HMRC’s favour.
  • Issue 4 was the key anti-avoidance argument.
The FTT concluded that the objective of obtaining capital allowances was not a main objective of the transactions and that the commercial objective was ‘paramount’. The taxpayer therefore won at the FTT, and an appeal was made to the Upper Tribunal where the case was heard by Newey J and Judge Nowlan. Newey J agreed with the FTT, but Judge Nowlan did not: he considered that although the FTT had identified the right test, it had not applied that test correctly by evaluating the object of obtaining the allowances. Newey J had the casting vote, so the case was decided in the taxpayer’s favour and was appealed by HMRC to the Court of Appeal.
 
The Court of Appeal (Rimer LJ) agreed with Judge Nowlan: ‘I have come to the conclusion that, putting it at its lowest, there is a very real concern that the FTT misdirected itself in its approach to the s 123(4) enquiry and that its decision is too unsafe to be allowed to stand.’ The case was therefore remitted to the FTT to reconsider its conclusions; however, as both of the original judges had retired, a new panel had to be found. The appeal has now been reheard by Judges Colin Bishopp and Rachel Short.
 
The question which the FTT was asked to address was agreed to be: ‘In the light of the Court of Appeal’s judgment, the evidence before the FTT and the findings of fact in the FTT’s first decision, was it the main object or one of the main objects of any transaction or series of transactions which includes the letting of the vessels on charter to obtain writing-down allowances at 25%?’
 
And so, four years after the first FTT hearing, and nine years after the relevant accounting period, the case arrived back at the FTT. Note, however, that the new panel did not rehear the evidence. The parties agreed that the original FTT decision set out the extensive evidence accurately and in detail; and the new panel had a transcript and all of the documents available. It is, however, not clear why the Court of Appeal itself did not simply remake a finding of fact on the ‘main object’ question. Presumably, it did not want to re-examine all of the detailed evidence and so referred the task back to the FTT.
 

The test of a main object

 
The difficult question, as the FTT said, was ‘the identification of the dividing line between an object which, though not paramount, is a main object and an object which, even if it is rather more than the icing on the cake, is nevertheless a subsidiary rather than main object’.
 
In the case of IRC v Brebner [1967] 2 AC 18, the courts held that a taxpayer had the right to choose between different ways of carrying out a commercial transaction, without there being a ‘necessary consequence’ that this choice had a main object of avoidance of tax. In the more recent case of Versteegh Ltd v HMRC [2013] UKFTT 642 (TC), in part of the FTT’s judgment which was not challenged in the Upper Tribunal, it was held that the fact that tax consequences inform a transaction does not necessarily mean that obtaining an advantage was a main object.
 
However, in IRC v Trustees of the Sema Group Pension Scheme [2002] STC 276 (in a passage later approved by the Court of Appeal), Lightman J said: ‘Obviously if the tax advantage is mere “icing on the cake” it will not constitute a main object ... The question where it is [a main object] is a question of fact … in every case.’ And in A H Field (Holdings) Ltd v HMRC [2012] UKFTT 104 (TC), Judge Short said: ‘There are cases where tax, while not the only component, is a substantial component of the decision and therefore cannot be ignored.’
 
The FTT carefully considered the discussions and negotiations which led to the structuring of the transactions. K-Euro, the UK subsidiary of K-Line, took advice about s 123 and the conditions which it would have to satisfy if it were to benefit from writing-down allowances. Judge Nowlan, in the Upper Tribunal, was of the view that ‘tax and financial advice were being sought for structural, and not due diligence reasons’. In the Court of Appeal, Rimer LJ approved Judge Nowlan’s view, and said: ‘Even if each of the transactions was entered into for a genuine commercial purpose, it may still be the case that a main object of structuring them in the way they were was to obtain the capital allowances.’
 
The FTT concluded that it was not possible to agree that the availability of the allowances was no more than a subsidiary consideration, ‘however much headroom one allows above the icing on the cake’. On the contrary, the original FTT’s findings of fact could lead only to the conclusion that the agreements were structured as they were not only for commercial reasons, but also in order to satisfy s 123(1); and consequently that the securing of the allowances was a main object of at least some of the transactions.
 

Conclusion

 
Here is a tax case in which it was agreed that the transactions had a ‘paramount’ commercial purpose, and yet the FTT (at its second attempt) held that a main object of ‘at least some of the transactions’ was to obtain capital allowances, and so those allowances would be denied.
 
The discussion on what constitutes a ‘main object’, and the approach of the FTT to the evidence, is likely to be useful in other disputes. However, a large proportion of current disputes relate not to capital allowances but to loan relationships, where the test is whether one of the main purposes for which the debtor is a party to the loan relationship is a tax avoidance purpose. Here it is clear that it is only the purposes of the debtor which can be examined (although a tax avoidance purpose includes the purpose of obtaining an advantage for another party), and only his purposes for being a party to the loan relationship – not any other transactions which may have been entered into. This case may, therefore, not take HMRC quite as far as it would like in challenging transactions where a special purpose company has been inserted into a financing transaction.
 
It remains to be seen whether LEL will take this case further, although in practice (assuming that the leasing arrangements had a standard tax variation clause) the decision is likely to be that of K-Line, who will ultimately bear the costs of the loss of capital allowances in this case.
 
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