The Upper Tribunal (UT) decision in the Lloyds TSB case reiterates that an appellate tribunal or court will interfere with a factual decision of the First-tier Tribunal (FTT) only in very limited circumstances. Notwithstanding various criticisms of the FTT’s decision in favour of the taxpayer (on which the UT judges were partially agreed), the presiding member exercised his casting vote so as to dismiss HMRC’s appeal. Apart from serving as a reminder of the critical importance to any litigant of prevailing at the FTT level, the case demonstrates a certain inflexibility in the tax appeals process, as well as the difficulties confronting the FTT in applying motive tests incorporated within targeted anti-avoidance legislation.
The decision of the Upper Tribunal in HMRC v Lloyds TSB Equipment Leasing (No. 1) Ltd [2013] UKUT 0368 (TCC) is, if nothing else, one of the most eye-catching this year.
The decision
Briefly, a Japanese shipping company, ‘K-Line’, won a tender in 2001 to acquire two ships and to time charter them to certain non-UK oil companies, including Statoil. K-Line then entered into contracts with shipbuilders for the construction of the vessels and time charterparties of the ships to Statoil for a minimum of 20 years. In the following year, the shipbuilding contracts were novated by K-Line to Lloyds TSB Equipment Leasing (‘Lloyds TSB’), which had been identified as the provider of lease finance. In turn, Lloyds TSB granted a 30-year finance lease of each vessel to a Cayman joint venture company. The Cayman company granted a 20-year lease (a bareboat charter) to K-Euro, the key UK resident ship operating subsidiary of K-Line; and K-Line’s role under the time charters to Statoil was novated to K-Euro (with the result that K-Euro would be the time charterer of the vessels for the purpose of CAA 2001 s 123). However, by the time the vessels were delivered in 2006, K-Euro’s business had been reorganised to such an extent that its only remaining activities were those contemplated by this particular leasing transaction.
Lloyds TSB contended that it was entitled to capital allowances (at the prevailing standard rate of 25%) – notwithstanding that the end users were non-UK residents – by virtue of the ‘protected leasing’ provision in CAA 2001 s 123. This required each ship to be let on charter in the course of a ship-operating trade by a UK resident (K-Euro) responsible for navigating and managing the ship. However, the allowances would not be available if the main object, or one of the main objects, of the letting of the ship on charter – or of any or all of the transactions in a series which included the ship charter – was to obtain allowances on the relevant expenditure (CAA 2001 s 123(4)).
In allowing the taxpayer’s appeal, the FTT concluded that even though the parties did have an objective that allowances should be obtained, this was not a main objective of the transactions. Rather, each transaction in the series (including those to which K-Euro was party) had a commercial purpose, to which the objective of securing the allowances was ‘subservient’. The FTT’s decision was upheld by the UT, albeit only by virtue of the presiding member’s casting vote.
Immediate observations
A number of points are immediately striking. As so often in tax appeals (beyond the FTT or, previously, the Commissioners), the longstanding decision in Edwards v Bairstow [1956] AC 14 looms large. The decision of the FTT in favour of Lloyds TSB on the ‘main object’ test in CAA 2001 s 123 could be overturned only if the FTT had failed to apply the correct legal test or had reached a decision (on the facts) that no reasonable tribunal could have reached.
It is, therefore, noteworthy how far apart the FTT and the dissenting judge in the UT were. The FTT, having of course considered all the evidence, including various witness statements, had relatively little difficulty in concluding that it was not one of the main objects of the relevant leasing transactions to obtain the allowances. The UT dissenting judge, on the other hand, not only disagreed with that conclusion on the basis of the evidence before the FTT, but took the view that it was a conclusion that could not reasonably have been arrived at (having regard, amongst other things, to the significance and timing of the tax advice obtained and the financial significance of securing the allowances).
It is difficult not to have at least a bit of sympathy for the presiding member of the UT, who exercised his casting vote in favour of the taxpayer. He was particularly conscious of the constraints imposed by the Edwards v Bairstow principle. It is understandable that he might not have been convinced that the FTT had made an error of law, bearing in mind that the correct statutory test was quoted or referred to by the FTT on a number of occasions. He also accepted that it was far from clear that he would have reached the same decision on the facts as the FTT – but this did not mean that the FTT’s decision was unreasonable.
What went wrong at the FTT?
Irrespective of whether the FTT did ultimately apply the correct legal test and then reach a rational decision on the facts, there were some curious features of its approach. It indicated that the ‘main object’ test in s 123(4) should be given a fairly narrow construction because the basic thrust of s 123(1) was to provide an incentive for investment in ships (and aircraft) through the capital allowance system. This was, incidentally, against the background that the ‘protected leasing’ provision had been on the statute book for decades and that, prior to this particular litigation, there may have been relatively few instances of HMRC arguing the ‘motive’ point. The UT disagreed on the basis that the general purpose of the overseas leasing code was to restrict or deny capital allowances in respect of assets leased to non-residents: the ‘main object’ test was a pre-condition to the application of a saving from that general principle and so should not be construed narrowly.
It was probably unhelpful to characterise the tax advice sought on the arrangements as constituting mere ‘due diligence’, given that the advice did appear to inform the structuring of the transactions.
Most significantly, an analogy was drawn with the construction of the ‘sole or main benefit’ test that was the subject of the decision in Barclays Mercantile Industrial Finance Ltd v Melluish [1990] STC 314. This was particularly surprising – not least when it is borne in mind that the FTT heard the Lloyds TSB case at a time when HMRC was very deliberately consulting on a proposal to replace the modern day version of the ‘sole of main benefit’ test in CAA 2001 s 215 with a ‘main purpose’ test bearing much closer similarity to the test in s 123(4). As the UT (unanimously) stated in the Lloyds TSB case, s 123(4) can apply even where the relevant transaction had a commercial objective at least as important as obtaining writing-down allowances. In contrast, a transaction producing a commercial benefit at least equal in magnitude to the availability of allowances would not fall foul of a ‘sole or main benefit’ test.
It is undoubtedly striking that the FTT, having accepted that obtaining the allowances was an objective, and that the range of objectives for the various transactions (including the acknowledged tax objective) should be compared in relative terms (or ‘in some sort of priority or hierarchy’), seems ultimately to have relied simply on its finding that the commercial objective was paramount (as if the key statutory test related purely to the main object, rather than ‘one of the main objects’, of the transactions).
Are there any broader lessons to be learned?
As always, the key lesson (in this instance, for HMRC) is not to lose at the FTT level. However, there are a couple of more fundamental points. First, it is understood that a significant number of similar disputes are unlikely to be determined until the Lloyds TSB litigation has been completed. What are the parties to those other transactions supposed to make of all of this? Cases of this nature are of course extremely fact-dependent and it would seem that a certain amount of further litigation was always going to be inevitable. However, fortified by the dissenting judgment in the UT, it is hard to believe that HMRC will be deterred from pursuing even the most similar of cases on the ‘main object’ issue, even if the taxpayer ultimately prevails in the Lloyds TSB appeals process. Thus, whilst there is a very good justification for the Edwards v Bairstow principle (the first instance tribunal is best placed to assimilate and evaluate all the evidence; it would be inappropriate for an appeal tribunal to conduct a re-trial or provide what Lord Radcliffe referred to as a ‘second opinion’), it is nevertheless tempting to think that there are some circumstances in which the UT should have the authority to remit a case back to the FTT (and perhaps even a differently constituted FTT) for further consideration of specific issues identified by the UT, even where it has not been demonstrated conclusively that the FTT has erred in law or reached an unreasonable decision.
More generally as to ‘main object’ or ‘main purpose’ tests, there seems to have been general acceptance of the FTT’s theoretical approach that the various objectives motivating the relevant transactions should be ranked ‘in some sort of priority’ and then ‘some basis applied to separate those which are … “main” from those which are not’. The difficulty is that there was precious little explanation of how this analysis is to be carried out or of what ‘basis’ might be used. The dissenting judge in the UT considered it quite clear that the tax objective of the transactions was a major object (certainly more than icing on the cake). Yet it presumably goes without saying that the mere fact that tax advice might be ‘structural’, or might be directed at the steps required to satisfy particular statutory conditions, will not always be sufficient to justify this conclusion; and indeed that the financial significance of obtaining the allowances was not, taken in isolation, fatal to the taxpayer’s claim. The case does therefore serve as a further illustration of the uncertainty to which these subjective anti-avoidance rules inevitably give rise, the difficulties facing the FTT in applying such rules and the understandable reluctance of the tribunals (and courts) to attempt to lay down any sort of prescriptive approach to evaluating and weighing up different purposes or objectives.
