DECISION
1. This case is
an appeal against a closure notice issued on 13 November 2011 and concerns the
tax treatment of interest income arising to the Appellant (“Euroceanica”) for
the accounting periods comprising the calendar years 2006, 2007, 2008 and 2009
amounting to $4,094,648. The interest in question arose from cash collateral
deposited by Euroceanica with two Italian banks as part of its loan
arrangements with those banks for the financing of its shipping fleet. The
question for the Tribunal is whether that interest fell for UK tax purposes to be treated as within the favourable tonnage tax regime, or within the normal, and
less favourable, corporation tax regime in the UK.
Agreed Facts.
2. Euroceanica
was a tonnage tax company in a tonnage tax group (both terms as defined by
paragraph 2(1) Schedule 22 Finance Act 2000. (“Schedule 22”)). Between May
2005 and December 2006 it entered into a number of loans with two Italian banks
– Sanpaolo IMI SpA (“Sanpaolo”) and Unicredit Banca d’Impresa (“Unicredit”).
All of the relevant loans have now been repaid or refinanced.
3. The loans
from Sanpaolo were used to finance the purchase of seven “Euro” vessels which
were operated by Euroceanica as part of its tonnage tax business (the “Euro
Fleet”). There was an initial short term facility for the purchase of three
vessels, followed by long term (12 year) loans replacing that facility, and 12
year loans for the four other vessels. The Unicredit loan was a short term
loan (12 months) used to finance indirectly the purchase of five “Crystal” vessels which were owned and operated by a 100% subsidiary of Euroceanica,
Crystal Pool (UK) Limited (“Crystal”), as part of its own tonnage tax
business. The Unicredit loan was on lent interest free by Euroceanica to Crystal and used by that company to finance the purchase of the Crystal vessels. (the
“Crystal Fleet”).
The Sanpaolo Loans
4. We were
given illustrative details of the terms of the Sanpaolo loans (both the short
term facility and the 12 year loans) and a copy of the documents for the Sanpaolo
short term advance facility (dated 10 May 2005) and for the loan to purchase
the Euro Atlantica (dated 23 June 2005). In particular we noted that the short
term Sanpaolo loan granted a charge to the lender over a bank account into
which Euroceanica was obliged to deposit a certain sum (initially set at $31.8m
but reduced to $25m in September 2005, clause 2(e) of the loan document). The
amount borrowed was $53m reducing in September 2005 to $47.6m. This is one of the
Sanpaolo deposits in respect of which the disputed interest income arises. In
the case of the seven long-term loans we noted that Euroceanica was required
(Article 19, paragraph 1(b)) to maintain in its own name with Sanpaolo’s London branch liquid assets which might be accessed at short notice. This took the form of
a cash deposit which is also a deposit in respect of which disputed interest
arises. The total of the long-term borrowing for all seven vessels was $132m, and
the deposits were in total $14.5m for the first five years then $7.25m
thereafter. We were also informed that Euroceanica granted a mortgage over the
vessels to Sanpaolo, and the bank required charterers of the vessels to channel
freights directly to Sanpaolo as part of the security for the loans.
5. Euroceanica
also entered into a floating to fixed interest rate swap with Sanpaolo from 8
July 2005 with a termination date of 29 July 2017 to hedge its interest rate
exposure on the $27.2m loan entered into for the purchase of the Euro Atlantica
(which was one of the Sanpaolo loans).
The Unicredit Loan
6. We were
also given illustrative details of the Unicredit loan. The terms of the Unicredit
loan, which was for €90m obliged the borrower to pledge a sum of $20m in a
specified Unicredit bank account. This is the Unicredit deposit in respect of
which the disputed interest income arises. We were provided with a copy of the
Unicredit Bridging loan documents dated 22 December 2006. Clause 5 of this
agreement relates to the cash deposit. The Unicredit loan was in euros, all of
the other loans were in dollars, the group’s functional currency.
7. Crystal
purchased the Crystal Fleet at the end of December 2006 but from the date of
purchase until about 1 March 2007 it chartered this fleet out on bareboat
charter to companies within the same group as the sellers of the Crystal Fleet.
From March 2007 the Crystal Fleet was chartered out by Crystal on time or
voyage charter through the Crystal management company, Crystal Pool Limited
which was purchased, also from the sellers of the Crystal Fleet, in or around
February 2007.
8. In mid-2010
Euroceanica attempted to refinance both the Sanpaolo and the Unicredit loans
and during 2010, as a result of Euroceanica failing to make the payments due on
the Sanpaolo loan, Sanpaolo called on the deposits held to remedy Euroceanica’s
failure to pay.
9. The total
amount of disputed interest arising for the four relevant periods in respect of
both the Sanpaolo and Unicredit loans is $4,094,648.
The Law
10. The relevant legislation is
Schedule 22 Finance Act 2000 (“Tonnage Tax”), related regulations and parts of
the legislation relating to loan relationships. Schedule 22 provides a rather
convoluted and interlinking set of definitions to determine, among other
things, a company’s tonnage tax profits. The arguments of both parties rest to
some extent on the interpretation and interaction of these rules and therefore
it is necessary to set out the relevant parts in some detail here.
11. The charge on tonnage tax
profits is a nominal charge, based on the tonnage of each ship falling within
the scope of the legislation. For this reason the tonnage tax regime is
recognised as a relief from corporation tax. In the only other reported case
on the Tonnage Tax legislation, (Western Ferries (Clyde) Limited v HMRC [2011] UKFTT 541 (TC)) the Tribunal said:
170. The statutory tonnage
tax regime does not, in any real sense, impose a fiscal liability on the
taxpayer. Rather, it exempts certain of his profits from liability to
mainstream corporation tax, and substitutes a regime which appears to impose
minimal liability; putting it another way it relieves the taxpayer of a
substantial fiscal liability. Generally, exemptions tend to be construed
restrictively rather than broadly. Exceptions to an exemption tend to be
construed broadly otherwise the scope of the exemption may be unintentionally
expanded.
And this is how we approach the legislation.
The Legislation
12. Paragraph 3(1) sets out the
general approach of the Tonnage Tax legislation:
“In the case of a tonnage tax company, its tonnage tax
profits are brought into charge to corporation tax in place of its relevant
shipping profits….”.
Paragraph 16 defines a company
which can utilise the tonnage tax regime:
“(1) For the purposes of
this Schedule a company is a "qualifying company" if—
(a) it is within the
charge to corporation tax,
(b) it operates qualifying
ships, …
….”
Paragraph 18 explains when a
company is operating a qualifying ship:
“(1) A company is regarded
for the purposes of this Schedule as operating any ship owned by, or chartered
to, the company, subject to the following provisions.
…
(3) A company is not
regarded as the operator of a ship that has been chartered out by it on
bareboat charter terms, except as provided by the following provisions.
…
(5) A company is not
regarded as ceasing to operate a ship that has been chartered out by it on
bareboat charter terms if—
(a) the
ship is chartered out because of short-term over- capacity, and
(b) the
term of the charter does not exceed three years.
…”
Paragraph 19(1) explains what
activities a ship must carry on for it to be a “qualifying ship” within the
tonnage tax regime, and these are the “activities in operating qualifying
ships” which count as “core activities” in Part VI (see below). The only
relevant one for this case is in paragraph (b): “the carriage by sea of
cargo”
Part VI of Schedule 22 defines “Relevant
Shipping Profits” and is the core of the parties’ disagreement. We
therefore set the relevant paragraphs out in full.
“PART VI
INTRODUCTION
44--(1) For the purposes of this Schedule
the relevant shipping profits of a tonnage tax company are--
(a) its relevant shipping income
(as defined below), and
(b) so much of its chargeable gains
as is effectively excluded from the charge to tax by the provisions of Part
VIII of this Schedule.
(2) The "relevant shipping income" of a
tonnage tax company means--
(a) its income from tonnage tax
activities (see paragraphs 45 to 48), and
(b) any income that is relevant
shipping income under--
paragraph 49 (distributions of overseas shipping
companies), or
paragraph 50 (certain interest etc),
but subject to paragraph 51 (general exclusion of
investment income).
TONNAGE TAX
ACTIVITIES
45--(1)
References in this Schedule to the "tonnage tax activities" of a
tonnage tax company are to--
(a) its core qualifying activities
(see paragraph 46),
(b) its qualifying secondary
activities to the extent that they do not exceed the permitted level (see
paragraph 47), and
(c) its qualifying incidental
activities (see paragraph 48).
(2) Sub-paragraph (1) has effect subject to paragraph
51(2) (exclusion of activities giving rise to investment income).
CORE QUALIFYING
ACTIVITIES
46--(1) A
tonnage tax company's "core qualifying activities" are--
(a) its activities in operating
qualifying ships, and
(b) other ship-related activities
that are a necessary and integral part of the business of operating its
qualifying ships.
(2) A company's activities in operating qualifying ships
means the activities mentioned in paragraph 19(1)(a) to (d) by virtue of which
the ship is a qualifying ship.
QUALIFYING
SECONDARY ACTIVITIES
47--(1) The
Inland Revenue may make provision by regulations as to--
(a) the descriptions of activity
that are to be regarded as qualifying secondary activities, and
(b) the permitted level in relation
to any such activity or description of activity.
(2) The regulations may set the permitted level or
provide for its determination by reference to such factors as may be specified
in the regulations.”
The regulations so far as
relevant are:
TONNAGE TAX REGULATIONS 2000 (SI 2000/2303)
3—(1) The
descriptions of activity to be regarded as qualifying secondary activities
shall be determined in accordance with the following paragraphs.
(2) A tonnage tax
company's qualifying secondary activities means its ship-related activities,
other than commercial activities which form part of the operation of a port
carried on for profit, that—
(a) have a substantial connection with the company's core
qualifying activities or, where the company is a member of a tonnage tax group,
the core qualifying activities of another qualifying company in that group,
(b) fall within the descriptions in paragraph (3) or (4), and
(c) in the case of paragraph (3) are carried on at any level
and in the case of paragraph (4) are carried on at the permitted level.
(3) The descriptions in
this paragraph are—
…..
(k) activities
carried on by the company in relation to a qualifying ship operated by another
qualifying company in the same tonnage tax group, which would be core
qualifying activities of the first-mentioned company if carried on in relation
to a qualifying ship operated by that company.
QUALIFYING
INCIDENTAL ACTIVITIES
48--(1) A
company's incidental activities means its ship-related activities that--
(a) are incidental to its core
qualifying activities, and
(b) are not qualifying secondary
activities.
(2) If the turnover in an accounting period of the
company from its incidental activities (taken together) does not exceed 0.25%
of the company's turnover in that period from--
(a) its core qualifying activities,
and
(b) its qualifying secondary
activities to the extent that they do not exceed the permitted level,
the company's incidental activities in that period are
qualifying incidental activities.
RELEVANT SHIPPING
INCOME: DISTRIBUTIONS OF OVERSEAS SHIPPING COMPANIES
49--(1) Income of a tonnage tax company
consisting in a dividend or other distribution of an overseas company is
relevant shipping income if the following conditions are met.
…..
RELEVANT SHIPPING
INCOME: CERTAIN INTEREST ETC
50--(1) Income to which this paragraph
applies is relevant shipping income only to the extent that it would apart from
this Schedule fall to be taken into account as trading income from a trade
consisting of the company's tonnage tax activities.
(2) This paragraph applies to--
(a) anything giving
rise to a credit that would fall to be brought into account for the purposes of
Chapter II of Part IV of the Finance Act 1996 (loan relationships); and
(b) ...
(c) any credit
falling to be brought into account under Schedule 26 to the Finance Act 2002
(derivative contracts).”
Sub-paragraph (2) as set out
above applies up to and including 2008. For 2009 it reads:
“(2) This paragraph applies to—
(a)
anything
giving rise to a credit that would fall to be brought into account for the
purposes of Part 5 of the Corporation Tax Act 2009 (loan relationships); and
(b)
…
(c)
any
credit falling to be brought into account in accordance with Part 7 of the
Corporation Tax Act 2009 (derivative contracts)
GENERAL EXCLUSION
OF INVESTMENT INCOME
51--(1) Income from investments is not
relevant shipping income.
(2) To the extent that an activity gives rise to income
from investments it is not regarded as part of a company's tonnage tax
activities.
(3) For the purposes of this paragraph "income from
investments" includes--
(a)
any
income chargeable to tax under Schedule A or Case III of Schedule D, and
(b)
any
equivalent foreign income.
(4) "Equivalent foreign income" means income
chargeable under Case V of Schedule D that—
(a)
consists
in income of an overseas property business, or
(b)
is
equivalent to a description of income chargeable to tax under Case III of
Schedule D but arises from a possession outside the United Kingdom.”
Sub-paragraphs (3) and (4) as
set out above apply up to and including 2008. For 2009 a substituted
sub-paragraph (3) reads:
“(3) For the
purposes of this paragraph “income from investments” includes anything
chargeable to tax under—
(a)
Part
4 of the Corporation Tax Act 2009 (property income),
(b)
section
299 of that Act (loan relationships: non-trading profits),
(c)
Chapter
5 of Part 10 of that Act (distributions from unauthorised unit trusts), or
(d)
Chapter
7 of that Part (annual payments not otherwise charged).”
Subsection (5) applies for all
years in this form:
“(5) Sub-paragraph (1) above does not affect income that
is relevant shipping income under--
paragraph 49 (distributions of overseas shipping
companies), or
paragraph 50 (certain interest etc).”
Paragraph 51 is the last in Part
VI. Of the remaining relevant paragraphs, paragraph 53 deems the tonnage
activities to be a separate trade:
“(1) The tonnage tax
activities of a tonnage tax company are treated for corporation tax purposes as
a separate trade (the company's “tonnage tax trade”) distinct from all other
activities carried on by the company.”
Paragraph 61 deals with the
apportionment of finance costs:
“(1)
This paragraph applies to a tonnage tax company which is a single company carrying
on tonnage tax activities and other activities.
(2) An adjustment shall be
made if it appears, in relation to an accounting period of the company, that
the company's deductible finance costs outside the ring fence exceed a fair
proportion of the company's total finance costs.
(3) The company's
"deductible finance costs outside the ring fence" means the total of
the amounts that may be brought into account in respect of finance costs in
calculating for the purposes of corporation tax the company's profits other
than relevant shipping profits.
(4) A company's "total
finance costs" means so much of the company's finance costs as could, if
there were no tonnage tax election, be brought into account in calculating the
company's profits for the purposes of corporation tax.
(5) What proportion of the
company's total finance costs should be deductible outside the ring fence shall
be determined on a just and reasonable basis by reference to the extent to
which the funding in relation to which the costs are incurred is applied in
such a way that any profits arising, directly or indirectly, would be relevant
shipping profits.
(6) Where an adjustment
falls to be made under this paragraph, an amount equal to the excess referred
to in sub-paragraph (2) shall be brought into account as if it were a
non-trading credit falling for the purposes of Chapter II of Part IV of the
Finance Act 1996 (loan relationships) to be brought into account in respect of
a loan relationship of the company in respect of non-tonnage tax activities.”
The relevant provisions of the
Finance Act 1996 are in section 82 which deals with the way amounts are brought
into account:
“(2) To the extent that,
in any accounting period, a loan relationship of a company is one to which it
is a party for the purposes of a trade carried on by it, the credits …. given
in respect of that relationship for that period shall be treated ….--
(a) as
receipts of that trade falling to be brought into account in computing the
profits of that trade for that period;”
in section 103(1) which defines a
“creditor relationship” as:
“in relation to a company,
means any loan relationship of that company in the case of which it stands in
the position of a creditor as respects the debt in question”
and in section 103(2) which says
that, for the purposes of section 82(2) (amongst others) a company is treated
as being party to a creditor relationship for the purposes of a trade carried
on by that company:
“only if it is party to
the relationship in the course of activities forming an integral part of the
trade”.
For the accounting period ended
31st December 2009, the loan relationship legislation is found in
Part 5 Corporation Tax Act 2009, in sections 297(1) and (2), 298(1) and (2) and
302(5).
The Witness Evidence
13. On behalf of Euroceanica we
heard from three expert witnesses, all of whom had considerable experience of
ship financing and were involved in arranging the financing of the Sanpaolo and
Unicredit loans.
14. Mr Costalas (a non executive
director of Euroceanica and a qualified master mariner) explained that
Euroceanica had entered into a number of earlier loans to finance the Euro
Fleet, including on terms which had not required the provision of cash
collateral. However, it was common for Italian ship financing firms to require cash
collateral and many loans from other financing firms had some form of what Mr
Costalas described as a “cash trap”. He explained that while there was a
mortgage granted on the ships as security for the loans, it was very difficult
for a lender to take over a ship and sell it, so the lender tended to look for
liquid assets as well. He stated that in theory it might have been possible to
obtain a loan without the need for a cash deposit, but this would have meant
significantly more stringent loan covenants, a lower loan-to-value ratio (i.e.
a smaller percentage of the asset’s value would have been financed: Mr Costalas
estimated that only 60 – 65% of the vessel’s asset value could have been loan
financed without the cash collateral, as compared to the 80% which was actually
financed), or a higher interest rate. He also stated that the loan terms on
offer from the two Italian banks in question at that time were particularly
favourable.
15. This was corroborated by Mr
Biale (the Managing Director of an entity which held a significant percentage
of the shares in Euroceanica) who explained why these Italian banks were
particularly keen to finance Euroceanica’s ships on such favourable terms,
namely the very competitive nature of the banking market in Genoa (where these
bank branches were based) and the desire of both banks to regain the foothold
which they previously had in the ship financing business. Mr Biale also
supported the statements of Mr Costalas that while the provision of cash
collateral was not universal in ship financing, the lack of a cash deposit
would mean a lower loan-to-value ratio or reliance on a parental guarantee
(which was not possible for Euroceanica, since it was the parent company).
From Euroceanica’s perspective, as a commercial matter it was easier for them
to give cash collateral than to agree to more restrictive loan covenants. Mr
Biale stated that there had been an attempt to negotiate away the need for cash
collateral, but this had been resisted by the lenders.
16. Mr Browne, a non executive
director of Euroceanica, stated that the cash deposited as collateral as part
of these agreements was not intended to be an investment. Euroceanica had
never discussed the interest rate which could be obtained on these deposits.
The company’s expected rate of return from its shipping activities was
substantially higher at that time than the rate on the deposits, and the
company would have preferred to use the cash to generate shipping income. Mr
Costalas said that when the cash collateral was under consideration, tax advice
was taken, but it had not been Euroceanica’s assumption that the income from
the collateral would fall within the tonnage tax regime.
17. Finally, Mr Costalas also
explained in some detail why it had been necessary to bareboat charter back the
Crystal Fleet; purchasing a fleet for immediate operation under time charter
required significant due diligence, including actual inspection of the
vessels. This was not required for a bareboat charter at inception. When
asked why Euroceanica had not simply contracted in the required skills to
undertake these tasks, he explained that this was not practicable for the
relatively short time between the vessels’ purchase and the purchase date of
the operating company.
The Arguments
18. The essential argument
between the parties is whether the income arising from the cash collateral
deposited with the two Italian banks falls within paragraphs 46 (or 47 in the
case of the Unicredit deposit) or paragraph 50 of Schedule 22. The Appellant argues
that they fall within both; HMRC argues that they fall within neither.
Euroceanica’s business as a shipping company
19. Mr Goodfellow on behalf of
the Appellant explained that Euroceanica was set up in 2004, originally owning
two active vessels and involved in the dry cargo business. In 2005 the
Appellant moved into the chemical tanker market, which was perceived to be a less
volatile market. By the end of 2008 the Appellant’s fleet had expanded to 18
ships, financed to some degree some debt funding, including the Sanpaolo and Unicredit
loans under consideration here.
20. Mr Goodfellow also took the
Tribunal through the detailed provisions of both a Sanpaolo and Unicredit loan
agreements as entered into by Euroceanica, stressing particularly the
provisions of the May 2005 $53m facility from Sanpaolo and the cash deposit
provisions at clause 2(e), including the lender’s charge over the cash deposit
and clarified that there was no provision for setting off amounts paid on the
cash deposits against interest due on the loan itself. It was also stressed
that the terms of the loan meant that it could only be drawn down for the purchase
of a particular vessel (in the example given, that was for the vessel Isola
Atlantica). Similar provisions were contained in the Unicredit loan documents,
dated 22 December 2006, including at clause 5 an obligation to deposit cash
with the lender of $20m.
Does the operation of a ship include its purchase?
21. Mr Goodfellow’s contention
is that the purchase of all the vessels which were financed by the Sanpaolo and
the Unicredit loans was part of Euroceanica’s tonnage tax activities because the
concept of “operating ships” is defined by paragraph 18 of Schedule 22 as including
owning ships as well as chartering them in.
22. In Euroceanica’s view, the
ships could not have been chartered out if they had not been purchased, and
they could not have been purchased without the loan financing. The loan
financing would not have been available if Euroceanica had not provided the
cash collateral. So making the deposits is a part of the activity of
financing, and that in turn is part of the activity of purchasing the ships which
is a ship-related activity that is a necessary and integral part of the
business of operating the qualifying ships.
23. Mr Goodfellow, in support
of his position, referred to HMRC Statement of Practice SP 4/00 which states
that
“For example, it is accepted
the buying and selling ships is part of the normal operation of ships and is a
core qualifying activity” [paragraph 74(vii)]
for the purposes of the tonnage tax regime.
24. HMRC’s argument is that the
overall structure of the tonnage tax regime shows that tonnage tax activities comprise
types of receipts which would be treated as trading income under general income
tax (and corporation tax) principles. The sale and purchase of vessels cannot
give rise to such receipts, being a capital matter. In particular Mr Yates
referred to paragraph 64 (“Chargeable Gains – Tonnage Tax Assets”) of Schedule
22 in support of his arguments to show that capital assets are outside the
general remit of Part VI (and especially paragraph 44) of Schedule 22.
25. For HMRC, the conclusion to
be drawn from the references in Part VI to income from types of activity which
qualify as “secondary activities” and the reference in paragraph 48 of Schedule
22 to “turnover” is that these paragraphs are looking at trading income only.
Any other type of income can only be brought within the tonnage tax regime if
it is specifically picked up in another paragraph. As far as HMRC are concerned,
the “activities of operating qualifying ships” does not include their purchase,
and this is supported by the Explanatory Notes to Schedule 22.
26. In relation to whether the
interest arises from “other ship-related activities that are a necessary and
integral part of the business of operating its qualifying ships” and so a
qualify core activity (paragraph 46(1)(b)), HMRC take a restrictive view of
what it means for activities to be “necessary and integral” to activities of
operating ships. They draw on HMRC v Banerjee ([2010] STC 2318) for
a definition of “necessary”, as meaning an activity which is “essential” to the
operation of the trade and they limit the term to those activities which are
common to all ship operating companies (in Mr Yates’ words the “Platonic ideal”
of ship operating). In HMRC’s view the fact that the Tonnage Tax regulations
impose a restricted definition of “secondary activities” supports their view
that the ambit of Part VI of Schedule 22 is narrow.
27. HMRC’s view is that, while
the loan agreements including the cash collateral might have been commercial,
the giving of a deposit was not a mandatory or “necessary” part of the ship
financing and therefore it cannot be treated as part of the Appellant’s “other”
ship related activities which are core qualifying activities.
The Interaction of Paragraphs 44, 46 and 50
28. Mr Goodfellow’s
interpretation of paragraph 44 of Schedule 22 and the definition of “relevant
shipping income” is that the income arising from the cash collateral falls, for
the purposes of the Euro Fleet within paragraphs 45(1)(a) and 46(1)(b) as a
“ship related activity which is a necessary and integral part of operating a
qualifying ship”, as well as potentially within paragraph 50, as interest
income.
29. As respects the Crystal fleet, the same basic approach should be applied but in that case the income arises
from qualifying secondary activities within paragraph 47 and the Tonnage Tax
Regulations 2000. Regulation 3(3)(k) means that this interest should also be
treated as arising from “activities carried on by the company in relation to a
qualifying ship operated by another qualifying company in the same group”.
This is because they would be core qualifying activities (within paragraph
46(1)(b) of Schedule 22) of “the first-mentioned company” (Euroceanica) if they
had been carried on in relation to a qualifying ship operated by Euroceanica. (In
this instance, the activities are carried on by Euroceanica, but they relate to
the Crystal Fleet which was operated by Crystal, another group company). The
Unicredit deposit interest also falls within either paragraph 45(1)(b) as well
as paragraph 50.
30. As far as the application of
paragraph 50, dealing with interest income, is concerned, both parties accepted
that the collateral in question was properly treated as a loan relationship and
that the rules in section 82 Finance Act 1996 and the definition of loan
relationship trading credits in section 103(2) were in point. On Mr
Goodfellow’s interpretation, the credits in question did arise from activities
“in the course of” Euroceanica’s tonnage tax trade. In the his view, paragraph
50 makes it quite clear that loan relationship credits can be relevant shipping
income for these purposes. He argued that paragraph 61(5) of Schedule 22 supports
this interpretation, suggesting that it is possible to have trading credits
within the tonnage tax ring fence. Paragraph 51, dealing with investment
income, is not relevant to the case; the putting of money on deposit should not
necessarily be treated as the making of an investment. In any event, paragraph
51 is only in point if it is considered that the interest is from tonnage tax
activities and not within paragraph 50.
31. HMRC’s argument is that
interest income cannot fall within both paragraphs 46(1) and paragraph 50. Irrespective
of whether or not the interest potentially falls within paragraph 46(1), (and
HMRC say that it cannot because the purchase of a vessel is not a core
qualifying activity), the only relevant paragraph is paragraph 50. This is an
exclusive and overriding rule applying to all loan relationship credits and not
in any way subject to paragraph 46. Paragraph 46 is not relevant if the income
in question arises from a loan relationship. Equally, the exclusion of
“investment income” in paragraph 51 applies to both paragraphs of sub-paragraph
(1) of paragraph 46, so that if paragraph 50 did not apply, but somehow
paragraph 46 did, Euroceanica would still not succeed, as “income from
investments” is defined to catch all non-trading interest income irrespective
of whether it is from an investment in any more general sense of that word. Thus
the only relevant provision for interest income of any type is paragraph 50; and
to determine whether it applies the relevant provision is section 103(2) of the
Finance Act 1996.
32. HMRC support their view that,
in Mr Yates’ words, “all roads lead to paragraph 50” on the basis of
general principles of statutory interpretation. Paragraph 50 is a specific
provision and so should take precedence over the more general rules in the rest
of Part VI (and paragraph 46) of Schedule 22, (as to which we were referred to Bennion
on Statutory Interpretation 5th edition, pg 1164).
33. HMRC’s approach to paragraph
50 is that the interest income cannot fall within it because it is related only
to the purchase of the vessels, and this is not a trading activity for the
purposes of the tonnage tax legislation, and so not something which can be
taken into account as trading income from a trade consisting of the company's
tonnage tax activities. The company is not party to the loan relationships
giving rise to the interest in the course of activities forming an integral
part of any trade, whether the company’s actual trade or its deemed tonnage tax
trade.
The Decision in Nuclear Electric.
34. Both parties referred to the
Nuclear Electric case (Nuclear Electric plc v Bradley 68 TC 670)
as relevant to the interpretation of paragraph 50 of Schedule 22 and section 103(2)
Finance Act 1996 and the extent to which interest income can be treated as
trading income, but had different approaches to its relevance.
35. HMRC relied heavily in this
case on the statements of Millett LJ in the Court of Appeal decision that “the
nature of the trade must be such that it can fairly be said that the making and
holding of investments at interest is an integral part of the trade”. In
their view, Euroceanica was a ship operating company and the placing of
deposits at interest could not be treated as an integral part of its tonnage
tax trade.
36. HMRC argued that since the Court
of Appeal decision was contemporaneous with the issue of draft clauses for the
(then) new loan relationship code incorporating what became section 103(2), it should
be assumed that the statute was intended to be a codification of Millett LJ’s
statements and should be interpreted in the light of those statements. They
relied in this regard on decisions including Goodes v East Sussex County Council ([2000] 1WLR 1356), to indicate that it is possible to import existing
case law into the meaning of contemporaneous legislation. They also stated that
while the House of Lords did not endorse the approach of Millett LJ, neither
did they specifically overrule it.
37. Mr Goodfellow considered
that it was misconceived to attempt to argue that section 103(2) should be
interpreted in line with the statements of Millett LJ in the Nuclear
Electric case. These statements did not represent the final position of
the UK courts; the House of Lords judgment superseded this. In any event, the
wording of section 103(2) is not the same as that used by Millett LJ, whose
statements were only intended to apply to financial concerns such as banks and
insurance companies. The 1996 loan relationship legislation was new law and
there was no basis to assume that it was intended to be a codification of
existing case law, or the view of one particular judge in one particular case.
38. In Mr Goodfellow’s view, the
salient test, taken from the House of Lords judgement in the Nuclear
Electric case (and following the line of reasoning from Bank Line Ltd v
Commissioners of Inland Revenue, ([1974] STC 342)) is whether the funds in
question were being held apart from, and not employed in, the business. In the
Nuclear Electric decision, this was the case, whereas Euroceanica was utilising
the cash deposits as a current asset in the trade. The relevant question on
the basis of those authorities was, what was the nature of the taxpayer’s
business and what was the purpose for which the funds in question were held.
“In the course of activities” – s 103(2) Finance Act
1996.
39. In relation to section
103(2), Mr Goodfellow suggested that the inclusion of the term “in the course
of activities” means that the test is a broad test, and that section 103(2)
should be taken to apply to activities which are “a series of actions or steps
which are intended to carry out the activities of the trade”. In his view, the
cash collateral credits fulfilled this test because they ensured that the loan
financing was provided on terms which were commercially acceptable to
Euroceanica, particularly taking account of the loan-to-value ratios applied by
the lenders. Mr Goodfellow referred to the case of Barnetts (a firm) v
Revenue & Customs Commissioners ([2010] UKFTT 286 (TC)) as supporting
the statements of Lord Jauncey in Nuclear Electric and the meaning of
interest arising “in the course of” activities, in that instance the
professional activities of a conveyancing solicitor.
40. HMRC’s interpretation of the
meaning of “in the course of activities” for these purposes was different,
suggesting that the test should be applied at a high level of abstraction and
not on a loan by loan basis, impacting the qualitative nature of the
activities, rather than their temporal scope.
The Bareboat Charter period.
41. Paragraph 18 of Schedule 22
sets out a number of circumstances in which vessels will not be treated as
being within the tonnage tax regime, including if they are out on “bareboat
charter”. (A “bareboat charter” is defined for these purposes at paragraph 143
of Schedule 22. There is no dispute about whether or not the vessels were so
chartered out). However, if a vessel is put out on bareboat charter terms for less
than three years and the reason why it is chartered out is as a result of
“short term over-capacity”, the tonnage tax rules will still apply during that
period. (Paragraph 18(5) of Schedule 22).
42. Mr Goodfellow explained that
in December 2006 Euroceanica negotiated the purchase of five chemical tankers
from a Finnish vendor (the Crystal Fleet). Taking on five new ships was a
significant undertaking for Euroceanica, including the amount of due diligence
which was required before the vessels could be purchased. In order to solve
this problem, the five new vessels were bareboat chartered back, on 28 December
2006, to the vendor group until Euroceanica was in a position to manage them
itself, at which stage the bareboat charters fell away. The bareboat charter
was always intended to be a “temporary expedient”.
43. Therefore, while accepting
that bareboat chartering otherwise takes shipping activities outside the scope
of the tonnage tax regime, Mr Goodfellow argued that the reason for the
bareboat charter in this instance was “over-capacity” i.e. Euroceanica had more
vessels than it could manage from December 2006 until March 2007 and therefore
the exception at paragraph 18(5) of Schedule 22 applies.
44. From HMRC’s viewpoint, the
Appellant’s interpretation of paragraph 18(5) was incorrect for two reasons,
first because the reference to “over-capacity” in that paragraph is intended to
be a reference to over-capacity in the market, not an over-capacity of ships in
the hands of the taxpayer and second because it applies to prevent a tonnage
tax company being treated as having “ceased to operate” ships, whereas in
respect of the Crystal Fleet, Euroceanica had not yet started operating them.
Therefore, for the period of the bareboat charter at least, the Unicredit
collateral interest should be excluded from the tonnage tax regime. It was
accepted by both parties that, if HMRC are right on this point, there may be
other adjustments to be made, including under paragraph 61 of Schedule 22(finance
costs).
Decision
45. This is a boundary dispute,
concerning what types of income can be included within the favourable tonnage
tax regime set out in Schedule 22. The receipts in question are interest
receipts arising on cash collateral given as part of ship financing transactions.
For the purpose of this decision we are applying our reasoning to the interest
under both the Sanpaolo and Unicredit loans. Although (at least on Mr
Goodfellow’s arguments) different paragraphs of Schedule 22 apply to each bank
loan, we consider that the arguments in respect of the collateral and interest
receipts under these loans are the same.
The commercial agreement
46. In sum, the expert witness
evidence has led the Tribunal to conclude that the giving of collateral under
these loans was part of a genuine commercial agreement which was common at
least in the Italian banking sector for ship finance and that the terms of the
loans would have been different (and less favourable to Euroceanica) had the
collateral not been given.
47. We heard a significant
amount of evidence for the Appellant about whether it was normal to give cash
collateral as part of a ship financing loan. The Tribunal does not consider
whether or not this was standard market practice is particularly relevant. The
only relevant question is what was the actual commercial deal entered into by
Euroceanica; in this instance that included the giving of collateral. This was
integral to the financing deal done by Euroceanica. The deal could have been
done on different terms (lower loan-to-value ratio, higher interest rates, more
restrictive covenants), but the cash collateral was a significant component of
how the loan was priced and its other terms.
The meaning of “operating a ship”
48. On the question of the
meaning of “operating ships”, the Tribunal agrees with the Appellant that the
tonnage tax regime only makes sense if it includes within its remit the
acquisition and sale of qualifying ships, which are the fundamental framework
for the tonnage tax activities (and dealing with any other ownership rights).
This is supported by HMRC’s own statements in Statement of Practice SP 4/00 and
their Tonnage Tax Manual at TTM06060 that “activities involved in the
acquisition or disposal of ships” are core qualifying activities.
The interaction of paras 44, 46, 50 & 51
49. The Tribunal accepts that
the drafting of Part VI of Schedule 22 is not entirely straightforward, but
considers that the most natural and straightforward reading of the relevant
paragraphs is that credits arising from loan relationships and derivative
contracts i.e. from asset financing activities of this kind, fall to be tested only
by reference to paragraph 50 and to no other paragraph. In this regard they
accept HMRC’s point that specific provisions should usually be taken to
override more general legislation. On this basis the Tribunal considers that
the only significant issue is whether the reference in section 103(2) Finance
Act 1996 to a company being a party to a creditor relationship “in the course
of activities forming an integral part of the trade” applies here to make the interest
credits under consideration income which falls to be taken into account as
trading income from a trade consisting of the company's tonnage tax activities.
50. Accepting the argument that
paragraph 50 is an exclusive provision, it is not strictly necessary for the
Tribunal to consider the question of whether the interest receipts could be
treated as falling within either paragraph 46(1)(b) or 47(1) as core or
secondary tonnage tax activities. Were it necessary to consider this point the
Tribunal would have concluded, for the reasons set out below in respect of
section 103(2), that the interest income should be treated as falling within
paragraph 46(1)(b) as income from “other ship related activities which are a
necessary and integral part of the business of operating its qualifying ships”,
which we consider to be in substance the same test as the test applied by paragraph
50 relating to loan relationship income.
51. In relation to the
application of paragraph 51, again it is not strictly necessary to consider
this, as, finding as we do that the interest credits fall within paragraph 50,
they cannot be excluded by paragraph 51. But on the basis of the evidence
given to the Tribunal, we have concluded that it is not correct to treat this
interest income as “income from investments” in the general sense of the words.
We do not consider that the cash deposits carried any of the characteristics of
investments: their purpose was not to provide a long term return to the
“investor”. This is reflected by the fact that the rate of return was neither
favourable nor negotiated by the “investor” (based on the evidence of Mr Browne
and Mr Costalas). There was no element of choice or interest in what the long
term return on these cash deposits might be, they were a mandatory component of
a commercial transaction which supported the day to day business of
Euroceanica. The fact that they generated interest income was incidental to
their purpose. This is an instance in which it is not correct to assume that
the existence of an interest return means an investment purpose. The real
commercial “return” on these deposits was the income return generated by the
vessels which the Sanpaolo and Unicredit loans financed.
52. To the extent that the
interest was wrapped up in the overall financing, we do not think it can be
correct to treat the interest arising as “investment income”. We say this
despite the evidence that the interest payments were included as “investment
income” in the accounts of Euroceanica which we were shown (for 2007). We
recognise however that had we found that paragraph 50 did not apply, the
interest credits would have fallen to be non-trading credits for the purposes
of the loan relationships legislation and therefore for the purposes of
paragraph 51(3) or (4) (in the pre-2009 version) or paragraph 51(3)(b) (in the
2009 version), and would not be relevant shipping income.
The significance of the Nuclear Electric case.
53. The Tribunal does not accept
HMRC’s argument that there should be some read across from the specific
statements of Millett LJ in Nuclear Electric into the interpretation of section
103(2). No admissible evidence has been provided that this was the intention
of the drafter of the legislation in 1995 and 1996. Even if there was any such
evidence, there is no rule of statutory interpretation which suggests that it
is necessary to import current case law into the drafting of contemporaneous
legislation. The decisions of both the House of Lords and Court of Appeal in Nuclear
Electric can provide guidance on this point, but cannot be treated as
giving a definitive view of the intended application of section 103(2). In any
event, even if it could properly be shown that the drafter was instructed to
codify the statements of Millett LJ (and which ones), it is for the Tribunal to
determine whether they were successful.
54. The authorities cited by
HMRC (principally the Goodes decision) do not support their position
that a read across from contemporaneous case law is always a legitimate approach
to statutory interpretation. The Goodes decision (concerning the
meaning of “maintaining a highway”) referred back to a clear body of common law
which had been established since the days of Dickens and Mayhew. It is not
clear to the Tribunal that a similar approach should be taken when the relevant
body of common law (the meaning of investment as compared to trading income for
tax purposes) is itself complex and in places contradictory, with few agreed
principles.
Was the interest income an “integral part of
Euroceanica’s trade”?
55. To the extent that the
decisions in Nuclear Electric are relevant, we take the most relevant point
to be that made by Lord Jauncey in the House of Lords decision, that there is
no hard and fast rule for determining when investment income can be treated as
a trading receipt and that at the end of the day the question is always one of
fact.
“I know of no formula
which can discriminate in all circumstances what are and what are not the
profits of a trade” Earl Loreburn in Liverpool & London &
Globe Insurance Company v Bennett ([1913] 6 TC 327)
56. In particular the Tribunal
would treat the statements of Millett LJ with some caution because his approach
is premised on the existence of an investment which gives rise to interest
income. As made clear above, we have concluded that the cash deposits under
consideration here should not be treated as “investments” and therefore the
test as formulated by Millett LJ is not entirely appropriate.
57. The Tribunal accepts that
for a non-financial trader, determining whether interest income should be
treated as trading or investment income is a difficult distinction to make. It
is clearly not the case that only financial traders can treat interest income
as trading income. Whether a non-financial trader can will depend on the facts
and circumstances of each individual case, but we do not accept the suggestion
of HMRC, reflecting the approach of Millett LJ in Nuclear Electric, that
the character of the income is entirely determined by the nature of the trade
being undertaken.
58. Our view is that, on the
basis of the reasoning in the Bank Line decision, which was carried
through to the House of Lords in Nuclear Electric whatever the nature of
the taxpayer’s trade (from solicitor, to ship owner, to utilities company) a
fund and its related income can be treated as part of a taxpayer’s trading
activities to the extent that it is currently actively supporting that trade.
On that premise, it would be perfectly possible for the interest from a fund to
be treated as trading income for one period and investment income for the next,
depending on whether the trader was accessing the funds for current trading
purposes. That the issue comes down to one of timing rather than
characteristics seems correct to us, reflecting as it does the fundamental
distinction made for tax purposes between trading and investing.
59. On that basis, we consider
the crucial question to be: are the funds from which the interest income arises
being currently used for the purposes of the taxpayer’s trading activities? To
use the terminology from those earlier cases, does the interest arise from cash
which was “at risk” in Euroceanica’s trade?
“The interest and
dividends constituted trading receipts only when they arose from capital which,
in the relevant accounting period had been actively employed in the trade in
question and was in a real and practical sense at risk in the ordinary course
of that trade” Lord President Emslie in the Bank Line decision.
60. The Tribunal’s view is that
there are a number of distinguishing facts in Euroceanica’s case which point to
the interest income fulfilling these tests: unlike in Nuclear Electric,
the interest arose from funds which were being used for current purposes,
namely to collateralise the financing of ships which were being used for the
trade. The cash deposits and related loans were of a relatively short term
nature and were in some instances use to fund current liabilities, including,
in some instances the interest due on the loans themselves. In Euroceanica’s
position, the Tribunal has concluded that the capital in question (the Sanpaolo
and Unicredit cash deposits) were being actively employed in the trade in
question during the relevant accounting periods and that the relevant interest
income should be treated as trading income.
61. The taxpayer set some store
by the meaning of “in the course of activities” under section 103(2). We are
not convinced that this extends the scope of section 103 in the way that the
taxpayer argues (in length as well as breadth), but we are not overly concerned
with this, since in our view the credits are both commercially and legally an
intrinsic part of the taxpayer’s trade and it is not necessary to rely on an
over strained interpretation of “in the course of” to conclude this.
62. HMRC referred us to the Banerjee
decision and the meaning of “necessary activities” in the context of employment
income. We do not consider that decision to be sufficiently analogous to the
facts and legislation to be relevant here. In our view it is clear that the
giving of cash collateral was a necessary part of Euroceanica’s ship financing,
that financing was necessary for the purchase of the ships and the ships were a
necessary part of Euroceanica’s shipping activities.
63. This view is supported both
by the (agreed) treatment of the payments under the interest rate swap which
the Appellant entered into as part of the financing arrangements (which has
been treated as falling within the Tonnage Tax regime by virtue of we assume
paragraph 50(2)(c) of Schedule 22) and HMRC’s statements in their Tonnage Tax Manual
concerning the treatment of interest payments arising from a defeased finance
lease. HMRC did not attempt to argue that there was any distinction between
the latter case and the cash collateral arrangements here and we cannot see one
either. Not for the only time in this case Mr Yates was forced to submit that
the Manual must be wrong.
64. Therefore, the interest
income arising should be treated as “arising in the course of activities which
are an integral part of the taxpayer’s trade” for the purpose of section 103(2)
Finance Act 1996 and therefore of paragraph 50 of Schedule 22.
65. For these reasons we
conclude (subject to the bareboat charter period relevant to the Unicredit loan
referred to below), that the interest credits in respect of the collateral held
under both the Sanpaolo and the Unicredit loan financing constitute relevant
shipping income under Part VI of Schedule 22 and fall to be taxed under the Tonnage
Tax regime and excluded from the general corporation tax on profits.
The Bareboat Charter.
66. On the basis that they
failed to convince the Tribunal of their main arguments, HMRC suggest that for
the period from 28 Dec 2006 until the Crystal Fleet was fully operated under
time charter by the Appellant (around 1 March 2007), credits in respect of the
Unicredit loan were outside the scope of Tonnage Tax because of the
restrictions in paragraph 18 of Schedule 22 relating to bareboat chartering.
67. The Appellant argues that
the reason for the bareboat charter was outside of their control and falls
within the definition of over-capacity for the purposes of paragraph 18(3) of
Schedule 22 – the over-capacity being the Appellant’s having more ships than
they were able to manage themselves.
68. On this point the Tribunal
agree with HMRC. First the “over-capacity” envisaged by paragraph 18(3) is not
apt to cover the Appellant’s position, which was more an under-capacity of
management ability than an over-capacity of ships. Second, paragraph 18 is
premised on a relevant shipping activity having commenced in relation to a
particular ship before the bareboat charter is entered into, which was not the
case here, save for the scintilla of time between the signing of the agreement
for the acquisition of the Crystal Fleet and the entering into the bareboat
charter, which all occurred on the same day (28 December 2006). For this
reason we conclude that the interest receipts for that period relating to the
Unicredit loan should be excluded from the Tonnage Tax regime and any relevant
apportionment under paragraph 61 and any other adjustments required should be
made and agreed between the parties.
69. This document contains full
findings of fact and reasons for the decision. Any party dissatisfied with this
decision has a right to apply for permission to appeal against it pursuant to
Rule 39 of the Tribunal Procedure (First-tier Tribunal) (Tax Chamber) Rules
2009. The application must be received by this Tribunal not later than 56
days after this decision is sent to that party. The parties are referred to
“Guidance to accompany a Decision from the First-tier Tribunal (Tax Chamber)”
which accompanies and forms part of this decision notice.
RACHEL
SHORT
TRIBUNAL JUDGE
RELEASE DATE: 26 April 2013
