DECISION
Introduction
The decision under appeal
1. This
is an appeal by the company Lloyds TSB Equipment Leasing (No 1) Ltd (“the
Appellant”) against an amendment made on 24 April 2009 by The Commissioners for
Her Majesty’s Revenue and Customs (“the Commissioners”) to the Appellant’s
corporation tax self-assessment return for the year ended 30 September 2006.
2. The
subject of that amendment, and of this appeal, is a claim made by the Appellant
for writing-down capital allowances at the rate of 25 per cent in respect of
expenditure incurred by the Appellant on the provision of two vessels designed
and built to ship liquefied natural gas (“LNG”) from northern Norway to Spain
and the United States of America as part of a project for the exploitation of
natural gas fields under the Barents Sea by a consortium of energy companies.
The Appellant is UK tax resident and carries on a trade of finance leasing: it
claims such allowances in the computation, for tax purposes, of the profits of
that trade.
3. The
total expenditure incurred by the Appellant on the two vessels was
£198,226,884. The Appellant contracted to purchase the vessels in September
2002 and the vessels were delivered in the Appellant’s accounting period ended
30 September 2006, when the greater part of the expenditure on the provision of
the vessels was incurred. Instalment payments were made in earlier periods,
and capital allowances were accordingly claimed in those earlier periods for
such payments. In total, writing-down allowances of the amounts set out as
follows were claimed by the Appellant in the respective years specified:
Year ended 30 September 2002 £3,882
Year ended 30 September 2003 £2,393,318
Year ended 30 September 2004 £3,964,216
Year ended 30 September 2005 £17,221,144
Year ended 30 September 2006 £33,351,994
4. The
effect of the amendment made by the Commissioners to the Appellant’s
corporation tax return for the year ended 30 September 2006 is to deny the
Appellant’s claim to any capital allowances for its expenditure on the vessels
and, by way of a balancing charge, to recover in full the allowances claimed
and allowed in the earlier periods. The amendment results in an additional
amount of corporation tax payable by the Appellant for the year ended 30
September 2006 in the sum of £6,278,877, and to certain penalties payable by
the Appellant. The Commissioners’ decision to deny the Appellant’s claim to
capital allowances for its expenditure on the vessels has significance beyond
the amendment to its tax return for the year ended 30 September 2006, since, if
upheld, that decision precludes the Appellant from claiming writing-down
allowances for the balance of its expenditure on the vessels over subsequent
accounting periods.
A summary of the factual background
5. The
factual background to the dispute between the parties in this case as to the
entitlement of the Appellant to claim capital allowances for its expenditure on
the provision of the vessels can be summarised as follows:
(1)
The natural gas fields under the Norwegian sector of the Barents Sea are being exploited by a consortium of energy companies (“the Snøhvit Sellers”)
who require a fleet of dedicated and purpose-built vessels to ship the natural
gas, in a liquefied state, to its long-term customers. The two vessels
acquired by the Appellant (“the Vessels”) form part of that fleet;
(2)
The Snøhvit Sellers, acting through the lead consortium member, the
Norwegian energy company, Statoil ASA (“Statoil”) sought an owner and operator
of the Vessels who would hire the Vessels to the Snøhvit Sellers on a long-term
time charter on commercial terms specified by the Snøhvit Sellers whereby the
hire would reflect, over the time charter period, a return of the capital cost
of the Vessels and a finance charge on such cost, and also the expenses (or an
estimate of the expenses) of operating the Vessels. It was a requirement of
the Snøhvit Sellers that, since the Vessels would operate only within the Atlantic Basin, the commercial and technical management of the Vessels in the course of
their operation should be located in the European time zone;
(3)
After a tender process the mandate to own and operate the Vessels was
awarded to one of Japan’s largest and oldest shipping companies, Kawaski Kisen
Kaisha Limited (“K-Line”). K-Line had a strategic business plan to expand into
the LNG carrier business and also to expand its business in Europe and the Atlantic Basin and to manage that business regionally. In December 2001 K-Line entered
into the contracts with shipbuilders to purchase the Vessels (the Snøhvit
Sellers having, in effect, negotiated the technical and commercial terms of the
shipbuilding contracts to ensure that the Vessels met their stringent
specifications and requirements) and also entered into the time charter.
K-Line reserved the right to introduce other parties to co-own the Vessels, and
also the right to re-structure ownership rights and arrangements to accommodate
the financing of the Vessels (at the time it entered into the purchase
contracts and the time charters, K-Line was actively exploring a number of
financing options, including UK finance leases);
(4)
At this time K-Line had a UK incorporated and resident subsidiary
company, K-Line (Europe) Limited (“K-Euro”) which had an established shipping
trade comprising the operation of coastal container ships in European waters
and a general agency for K-Line’s container and car carrier business in
Europe. K-Line intended that, howsoever the Vessels might be financed, K-Euro
should be the company by which it met the requirements of the Snøhvit Sellers
for the commercial and technical management of the Vessels in the course of
their operation to be located in Europe;
(5)
In September 2002 K-Line had agreed financing for the Vessels on UK finance lease terms with the Appellant, and to effect such financing the following
principal transactions took place at that time:
(a)
The shipbuilding contracts for the Vessels were novated so that the
Appellant contracted to purchase the Vessels;
(b)
In the case of each Vessel respectively the Appellant granted a finance
lease of the Vessel to a joint venture company (“Northern LNG”), the
shareholders of which included K-Line and Statoil, on terms whereby the equity
reversionary value in the Vessel resided in Northern LNG. The primary lease
period of the finance lease was thirty years from delivery of the Vessel, with
provision for renewable secondary lease periods of one year;
(c)
Northern LNG entered into a bareboat charter of each Vessel with K-Euro
for a twenty year period (with provision for extension for up to a further ten
years) under which K-Euro was entitled to possession and use of the Vessel.
The hire payable by K-Euro under the bareboat charter was fixed for the first
twelve years and was expressed to be a fair commercial rate;
(d)
The time charter for each Vessel between K-Line and the Snøhvit Sellers
was novated so as to substitute K-Euro for K-Line as disponent owner;
(e)
Detailed and complex security arrangements were put in place to
safeguard the interests of the different parties and the flow of payments
pursuant to the lease and ancillary arrangements.
(6)
The business of K-Euro was expanded from 2002 onwards, in particular by
the establishment of a bulk and gas carrier division. For the purposes of that
business K-Euro took on time charter, or undertook the management of, a number
of LNG and bulk carriers;
(7)
With effect from 1 January 2006 the business of K-Euro was reorganised
with the result that K-Euro retained its interest in the Vessels by reason of
the bareboat and time charters described above, but it contracted out the
management of the Vessels to a fellow subsidiary in the K-Line group (“K-LNG”),
and also transferred to other fellow subsidiaries all other parts of its
business. In addition, the hire payable by K-Euro under the bareboat charters
was, for a specified period, reduced. Further (as part of this reorganisation,
but not effected until October 2006), the share capital of K-Euro was
reorganised so that its shareholders (and their respective shareholding
interests) corresponded with those of Northern LNG and its shareholders
contributed further share capital. This reorganisation was effected because it
was anticipated that, contrary to original expectations, K-Euro would make a
substantial loss in operating the Vessels and because certain of the security
arrangements with respect to the lease structure through which K-Euro held its
interest in the Vessels were proving to be a commercial restraint upon the
management and development of K-Euro’s other business interests;
(8)
The first of the Vessels was delivered in February 2006 and the second
in July 2006. The leasing arrangements in relation to each Vessel took effect
upon the delivery of the respective Vessels.
A summary of the basis on which the Appellant claims capital allowances
6. By
way of further introduction to this case it is helpful to explain, again in
summary, the basis upon which the Appellant claims capital allowances for its
expenditure on the acquisition of the Vessels:
(1)
Writing-down allowances at the rate of 25 per cent on a reducing balance
basis are generally available to a person who is carrying on a trade and who
incurs capital expenditure on the provision of plant or machinery for the
purposes of that trade. The Appellant’s expenditure on the Vessels is such
capital expenditure;
(2)
However, such allowances are (subject to certain exceptions) restricted,
where such plant or machinery is used by a person who (in broad terms) is
outside the scope of the UK tax charge (“overseas leasing”). Since in the
present case the end users of the Vessels, pursuant to the time charters, are
the Snøhvit Sellers (none of whom are liable to UK tax on their profits), the
restrictions apply unless the circumstances come within one of the exceptions;
(3)
Those restrictions may either be partial (so that the person incurring
the expenditure can claim 10 per cent writing-down allowances rather than 25
per cent) or total (so that no allowances can be claimed). In the present case
the circumstances of the Appellant’s leasing of the Vessels (in particular, the
circumstance that the primary period of the finance lease exceeds 13 years) are
such that, if 25 per cent allowances are not available, than no allowances can
be claimed;
(4)
It is an exception to the restriction on allowances (so that 25 per cent
allowances remain available) if the plant or machinery, although used for
overseas leasing, is nevertheless used for a “qualifying purpose”. Section 123
of the Capital Allowances Act 2001 (“CAA 2001”) is relevant in this context to
the Appellant’s circumstances, since it provides that a ship will be used for a
qualifying purpose (regardless of the identity of the end-user of the ship)
where it is let on time charter terms by a person carrying on a trade of
operating ships and that trade is within the UK tax charge. However, even if
these requirements are met, the allowances can be denied if a main object of
any of the transactions concerning the letting of the ship on time charter was
to obtain 25 per cent writing-down allowances.
7. The
Appellant contends that the leasing arrangements relating to the Vessels fall
within section 123 CAA 2001 and that accordingly the Vessels are used for a
“qualifying purpose” so that it is entitled to claim 25 per cent writing-down
allowances.
8. The
Commissioners contend that the circumstances of the time charter of the Vessels
by K-Euro to the Snøhvit Sellers and the nature of the trade of K-Euro are such
that the requirements of section 123 CAA 2001 are not met, and that, further,
it was a main object of certain of the leasing transactions that 25 per cent
writing-down allowances should be obtained by the Appellant. The Commissioners
therefore deny the Appellant’s claim to such allowances.
The significance of the legislative history of the “overseas leasing”
provisions
9. Having
outlined the capital allowance provisions relevant to this case, we should
mention at the outset that the “overseas leasing” provisions, with which this
case is particularly concerned, have a complex history, and that both parties,
in their respective submissions as to the proper construction of those
provisions, made extensive reference to that history. It will be necessary to
refer in detail to the earlier legislation when considering those submissions,
but it is helpful to set out at this point an overview of the development of
those provisions.
10. The “overseas
leasing” provisions (and the related “qualifying use” provisions) first
appeared in section 64 Finance Act 1980, originally to limit capital
allowances, where the asset was used by a person outside the UK tax charge, to
25 per cent writing-down allowances (rather than the 100 per cent first-year
allowances then otherwise available): our understanding is that before that
time entitlement had, in practice, been regulated under the exchange control
rules (those rules were abolished in 1979).
11. Further changes
were made in section 70 Finance Act 1982, introducing the restricted 10 per
cent writing-down allowances for “overseas leasing”, and denying all allowances
in certain cases (broadly, where the lease terms included provisions which had
the effect of skewing the lease or rental profile so as to exploit the
availability of 10 per cent allowances).
12. The Finance Act
1982 also amended section 64 Finance Act 1980 by introducing a “main objects”
provision in terms now recognisable in section 123(4) CAA 2001, but as a constraint
upon a claim for first-year allowances only.
13. First-year
allowances were phased out between 1984 and 1986, and the Finance Act 1986 made
changes which related the “overseas leasing” and “main objects” provisions
solely to writing-down allowances.
14. No further
substantive changes were made to these provisions, but they were re-stated on
consolidation of the capital allowances legislation in the Capital Allowances
Act 1990, and were re-stated once again (and differently) in the course of the
Tax Re-write project, in the legislation applicable in this case, the Capital
Allowances Act 2001.
Previous judicial review proceedings
15. A further point
must be mentioned by way of introduction. Pursuant to a long-standing and
published practice, the Commissioners, when applying the “qualifying purpose”
provisions of the capital allowances, have, where plant or machinery is leased
and sub-leased in a chain of leases, had regard only to the end-user (and the
final sub-lease in the chain) to determine whether or not the circumstances
comprise a qualifying purpose. That practice was changed in February 2005,
when the Commissioners announced that they would henceforth apply the
qualifying purpose provisions by reference to any lease in a chain – the
so-called “each lease” approach. They stated that such change in practice
would not apply to transactions entered into before 3 February 2005.
16. The original
statement of case prepared by the Commissioners in these appeal proceedings
indicated that the Commissioners intended to argue that the Appellant was not
entitled to claim capital allowances because the head lease was granted in
circumstances where the use of the Vessels pursuant to the head lease did not
comprise a qualifying purpose. The Appellant considered this to be contrary to
the terms of the Commissioners’ published practice with regard to transactions
entered into before 3 February 2005, which included all the transactions
relating to the leasing of the Vessels (all of which were entered into by 19
September 2002 at the latest). The Appellant therefore commenced judicial
review proceedings in the High Court, seeking an order directing the
Commissioners to apply their published practice.
17. The matter was
resolved between the Appellant and the Commissioners before the Appellant’s
application was heard by the High Court. They agreed that, in these
proceedings, the Commissioners would be bound by their practice as it stood
before February 2005, so that they would not take any point, in respect of the
qualifying purpose provisions, other than in relation to the end use of the
Vessels under the time charter to the Snøhvit Sellers. They also agreed that
the Commissioners, in arguing before this Tribunal their case as to the context
and construction of the “main objects” provision in section 123(4) CAA 2001,
could nevertheless make submissions as to the meaning and effect of section
123(4) CAA 2001 on the basis of the “each lease” approach. The agreement of
the parties in this regard is set out in a consent order signed by the parties
and stamped, by way of approval, by the High Court on 11 October 2010.
18. The terms of
that consent order are binding upon us in terms of the arguments which we can
hear in this appeal and the scope of our decision. We record that, in the case
put before us, the parties complied with the consent order, and as it
transpired the Commissioners did not, in advancing their arguments on the
meaning and effect of section 123(4) CAA 2001, make any submissions with
reference to the “each lease” approach.
Post-hearing written submissions
19. There is one
final point to mention by way of introduction. It is a matter of procedure.
At the hearing both parties made, in writing, substantial submissions on the
evidence. In the closing stages of the hearing, in the course of his reply to
the Commissioners’ case, Mr Peacock, appearing for the Appellant, handed up
further written submissions which were by way of comment upon the
Commissioners’ written submissions on the evidence. Those submissions also
referred to a number of documents from which the Commissioners had drawn
certain inferences in the course of their submissions. Mr Peacock challenged
the right of the Tribunal to take account of such inferences when neither the
documents in question nor the inferences drawn from them had been put to the
Appellant’s witnesses in cross-examination by Mr Ewart, who appeared for the
Commissioners in this case.
20. Mr Ewart pointed
out that since the Appellant had not put forward witnesses who were in a
position to comment on the documents in question, the Commissioners should not
thereby be constrained from drawing inferences from those documents, but that
it was for the Tribunal, in its evaluation of the evidence, to decide what
significance to attach to the inferences drawn in these circumstances by the
Commissioners.
21. Mr Ewart did
not, at the hearing, indicate that he needed to comment on these further
submissions in reply by the Appellant, but he said that he would, after the
hearing, re-issue his own submissions on the evidence to correct certain
typographical inaccuracies. What he then produced was a revised version of
those submissions with detailed comment (as he explained it, by way of
correction) on the points made by Mr Peacock in his reply.
22. The Appellant’s
solicitors wrote to the Tribunal objecting to this, as it sought to deny the
Appellant the “final say” in the appeal process. They asked the Tribunal to
disregard the Commissioners’ revised submissions, or to give the Appellant a
right to revise its own submissions so as to include a reply to the additional
points made by the Commissioners. They also asked the Tribunal to make an
award of costs against the Commissioners on an indemnity basis for the costs of
the Appellant in dealing with this issue of the Commissioners’ revised
submissions.
23. We took the view
that the Tribunal could not simply disregard the revised submissions made by
the Commissioners: those submissions, to the extent they were revised, in part
purported to be corrections of inaccuracies in the Appellant’s reply, and if
that were indeed the case justice would best served by taking account of such
submissions. It was equally clear to the Tribunal that the fairness inherent
in the normal hearing process required that the Appellant should have the opportunity
to reply to such submissions, at least to the extent that matters had not
fairly been dealt with in the Appellant’s reply at the hearing itself.
24. We therefore
informed the parties that we would allow the Appellant an opportunity to reply
in writing to the Commissioners’ revised submissions, but that thereafter there
would be no further submissions by either party other than at the request of
the Tribunal. We decided that we would make no order as to the additional
costs of the Appellant: in part this situation had arisen because the
Commissioners had not been given the opportunity to consider the Appellant’s
extensive written reply submissions before the end of the hearing. In our view
these further costs should, as part of the costs of the appeal, follow the
cause.
25. The Appellant
duly made further written submissions in reply to the Commissioners’ revised
submissions.
26. As to the
question of the inferences which the Commissioners invited us to draw from the
documents which were not put to the Appellant’s witnesses, we deal with this
below at paragraphs 117 to 119 below.
The issues to be determined and our decision
27. The parties
agreed that there are four issues in dispute between them which require our
determination and which, together, determine whether or not the Appellant is
entitled to the 25 per cent writing-down allowances it has claimed.
28. In order to
state those four issues, which all relate to the question of whether the
Vessels are used for a qualifying purpose within the provisions of section 123
CAA 2001, it is necessary to set out those provisions. So far as material to
this case they are as follows:
(1) A ship is used for a qualifying purpose
at any time when it is let on charter in the course of a trade which consists
of or includes operating ships by a person who is—
(a) resident in the United Kingdom or carries on the trade there, and
(b) responsible for navigating and managing
the ship throughout the period of the charter and for defraying—
(i) all expenses in connection with the ship
throughout that period, or
(ii) substantially all such expenses other
than those directly incidental to a particular voyage or to the employment of
the ship during that period.
(2) …
(3) For the purposes of subsection (1)(b) a
person is responsible for something if he—
(a) is responsible as principal, or
(b) appoints another person to be responsible
in his place.
(4) 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 a
series,
was to obtain a writing-down allowance
determined without regard to section 109 (writing-down allowances at 10%) in
respect of expenditure incurred by any person on the provision of the ship or
aircraft.
The issues
29. The four issues
are centred on the role and trading activities of K-Euro, the time charter by
which it hired the Vessels to the Snøhvit Sellers, and the transactions by
which it entered into the hiring of the Vessels by taking the bareboat charter
and a novation of the time charter. It is agreed by the parties that at all
material times K-Euro was resident in the UK.
30. The four issues
are as follows:
Issue 1: Whether K-Euro is responsible for
defraying all, or substantially all, expenses in connection with the Vessels
under the time charter throughout the charter period, within the meaning of
section 123(1) CAA 2001.
Issue 2: Whether K-Euro lets the Vessels on
charter in the course of a trade which consists of or includes operating ships,
within the meaning of section 123(1) CAA 2001.
Issue 3: Whether (because section 123(4) CAA
2001 refers to the objective of obtaining writing-down allowances determined
without regard to section 109 CAA 2001 (which denies 25 per cent allowances but
allows 10 per cent allowances instead where there is overseas leasing and no
qualifying purpose)) section 123(4) CAA 2001 can apply in the circumstances
where section 110 (rather than section 109) CAA 2001 is in point, namely where
there is overseas leasing and no qualifying purpose but the taxpayer is
entitled to no allowances instead of 10 per cent allowances.
Issue 4: Whether (if Issue 3 is determined so
that in principle section 123(4) CAA 2001 applies) 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 was to obtain the 25 per cent
writing-down allowances claimed by the Appellant.
31. It will be
apparent that Issues 1, 2, and 4 are to be determined largely on the facts and
the terms of the documents by which the parties entered into the relevant
transactions. Issue 3 is a matter to be determined solely by construing the
relevant statutory provision (it being common ground between the parties that
section 110 (and not section 109) CAA 2001 is relevant to the circumstances of
the Appellant, in that if there is no qualifying purpose, no allowances, rather
than 10 per cent allowances, are available to the Appellant).
32. There is some
logic to the approach adopted by Mr Ewart, appearing for the Commissioners, in
his submissions, of taking Issue 4 first, since if it is the case that a main
object of the relevant transactions was to obtain 25 per cent writing-down
allowances, that determines the matter against the Appellant without further
enquiry. However, since we are required to reach a decision on each Issue we
will consider them in the sequence which follows from the reading of section
123 CAA 2001.
The decision
33. As to Issue 1,
it is our decision that K-Euro is responsible for defraying all, or
substantially all, expenses in connection with the Vessels under the time
charter and throughout the period of the charter.
34. As to Issue 2,
it is our decision that K-Euro lets the Vessels on charter in the course of a
trade which consists of or includes operating ships.
35. As to Issue 3,
it is our decision that section 123(4) CAA 2001 can apply in the circumstances
where section 110 (rather than section 109) CAA 2001 is in point, and can
therefore in principle apply to the circumstances of the Appellant’s claim for
writing-down allowances for its expenditure on the provision of the Vessels.
36. As to Issue 4,
if (as we have decided in Issue 3) in principle section 123(4) CAA 2001 can
apply in circumstances where section 110 CAA 2001 has effect to deny a person
all allowances, then it was not a main object of any transaction or series of
transactions which includes the letting of the Vessels on charter to obtain the
25 per cent writing-down allowances claimed by the Appellant.
37. We therefore
allow the Appellant’s appeal against the Commissioners’ amendment, made on 24
April 2009, to the Appellant’s corporation tax self-assessment return for the
year ended 30 September 2006.
The relevant statutory provisions
38. Part 2 of CAA
2001 comprises the provisions which relate to capital allowances for capital
expenditure incurred on the provision of plant or machinery. By virtue of
section 11 CAA 2001 such allowances are available if a person carries on a
“qualifying activity” (which includes a trade) and incurs capital expenditure
on the provision of plant or machinery wholly or partly for the purposes of
that qualifying activity. In the present case it is agreed that the Appellant
carries on a trade; that the expenditure it has incurred on purchasing the
Vessels is capital expenditure incurred for the purposes of that trade; and
that such expenditure has been incurred on the provision of plant or machinery.
39. The general
requirement in the case of plant and machinery is that all expenditure incurred
by the taxpayer which qualifies for writing-down allowances is brought into a
“pool” of expenditure to determine the amount, in each chargeable period, for
which allowances may be claimed. The “pool” for any chargeable period takes
into account new expenditure in that period, the residue of expenditure in
prior periods for which allowances have not yet been claimed, and the proceeds
of plant and machinery disposed of during that period. The net amount thus
determined in that chargeable period is eligible for writing-down allowances at
the rate (in the years with which this case is concerned) of 25 per cent. The
balance of unallowed expenditure in that “pool” for that chargeable period
(that is, the 75 per cent) is carried forward to the “pool” for the following
chargeable period. Sections 53 to 56 CAA 2001 set out these general rules.
40. The normal
“pooling” rules are modified in the case of qualifying expenditure incurred on
the provision of a ship, with further special provision if the ship is provided
for leasing, and Chapter 12 of Part 2 of CAA 2001 sets out these provisions.
No issue in dispute in this case turns on the “pooling” provisions.
41. We are, however,
concerned in this case with the provisions of Chapter 11 of Part 2 of CAA 2001,
which deals with “overseas leasing”.
42. Section 105 CAA
2001 defines “leasing” to include letting a ship on charter, and provides that
for the purposes of Chapter 11 references to a lease include a sub-lease.
“Overseas leasing” is defined in these terms, by section 105(2) CAA 2001:
“Plant or machinery is used for overseas leasing
if it is used for the purpose of being leased to a person who –
(a) is not resident in the United Kingdom, and
(b) does
not use the plant or machinery exclusively for earning profits chargeable to
tax.”
In the present case, since the Vessels are let on charter
(which is by way of a sub-sub-lease) to the Snøhvit Sellers, none of whom are
resident in the UK, and who do not use the Vessels for earning profits
chargeable to UK tax, the Vessels are used for overseas leasing.
43. Section 105 CAA
2001 also defines “protected leasing”, in these terms (section 105(5)):
“´Protected leasing’ of plant or machinery means
–
(a) …, or
(b) if
the plant or machinery is a ship,… the use of the ship… for a qualifying
purpose under section 123 or 124 (letting on charter to UK resident etc.).”
44. Section 106 CAA
2001 deals with the concept of “the designated period”, which is, in relation
to expenditure incurred on plant or machinery, the period of 10 years beginning
with the date on which the plant or machinery is first brought into use. In
the present case the “designated period”, in relation to each Vessel, begins on
the delivery date of that Vessel, and will run for 10 years (or until the
Appellant ceases to own the Vessel, should that occur before the 10 year period
has expired).
45. Section 109 CAA
2001 applies to “expenditure incurred on the provision of plant or machinery
for leasing if the plant or machinery is at any time in the designated period
used for overseas leasing which is not protected leasing”. In the case of such
expenditure, the amount of the writing-down allowance to which the person
incurring the expenditure is entitled in the relevant chargeable period is 10
per cent (rather than 25 per cent).
46. Section 110 CAA
2001 is headed “Cases where allowances are prohibited”, and, so far as is
relevant to this case provides as follows:
“(1) A person is not entitled to any
writing-down or balancing allowances in respect of qualifying expenditure which
is within subsection (2).
(2) Expenditure is within this subsection
if -
(a) it
is incurred on the provision of plant or machinery for leasing,
(b) the
plant or machinery is at any time in the designated period used for overseas
leasing which is not protected leasing,
(c) the
plant or machinery is used otherwise than for a qualifying purpose (see
sections 122 to 125), and
(d) the lease
is within any of the items in the list below.
LIST
Leases in relation to which allowances are prohibited
1. The
lease is expressed to be for a period of more than 13 years.
2. ….
”
In the case of each Vessel the head lease (and also the
bare boat charter and the time charter) is for a period of more than 13 years.
Therefore section 110 CAA 2001 will apply to disentitle the Appellant from
claiming any writing-down allowances for its expenditure on the Vessels unless
it can establish that throughout the 10 year designated period, although the
Vessels are used for overseas leasing, that leasing is nevertheless protected
leasing, that is (see section 105(5)(b) CAA 2001), the Vessels are used for a
qualifying purpose under section 123 CAA 2001.
47. This brings us
to section 123 CAA 2001, whose application to the circumstances of the
operation and chartering of the Vessels is the essential matter in dispute in
this case. The Appellant contends that those circumstances fall within the
scope of section 123 CAA 2001 so that the Vessels are used for a qualifying
purpose, and hence the leasing of the Vessels is protected leasing, so that
neither section 110 CAA 2001 applies to prohibit it from claiming any
writing-down allowances, nor section 109 CAA 2001 applies to restrict its claim
to writing-down allowances at the reduced 10 per cent rate. The Commissioners
contend that those circumstances do not fall within the scope of section 123
CAA 2001, so that the Vessels are not used for a qualifying purpose, and
therefore the leasing of the Vessels is not protected leasing. In consequence,
by virtue of the term of each lease in the chain by which the Vessels are let,
section 110 CAA 2001 applies to the Appellant’s circumstances, and no
writing-down allowances can be claimed.
48. Section 123 CAA
2001, to the extent material to this case, is set out at paragraph 28 above.
The Statement of Agreed Facts
49. The parties
lodged with the Tribunal a Statement of Agreed Facts, in the terms set out in
paragraphs 50 to 102 following.
The parties
50. The Appellant is
a company incorporated and tax resident in the United Kingdom. It is a
wholly-owned subsidiary of what is now the Lloyds Banking Group. The Appellant
carries on a trade of finance leasing. The Appellant is the owner of two LNG
vessels (the “Vessels”).
51. The Respondents
are the Commissioners for Her Majesty’s Revenue & Customs.
Other relevant entities
52. Each of Northern
LNG Transport Co., I. Ltd (“Northern LNG I”) and Northern LNG Transport Co., II
Ltd (“Northern LNG II”, and together with Northern LNG I, “Northern LNG”) are,
and were at all material times, the lessee of one Vessel from the Appellant.
Northern LNG I and II were incorporated under the laws of the Cayman Islands in
2002 and registered in the Cayman Islands. Northern LNG I and II are tax
resident in the Cayman Islands. The shares of Northern LNG are owned by
Kawasaki Kisen Kaisha, Ltd, Mitsui & Co. Ltd, Statoil ASA, and Iino Kaiun
Kaisha, Ltd. (together, the “Snøhvit Sponsors”) in the following proportions:
|
|
Northern LNG I
|
Northern LNG II
|
|
K-Line
|
49%
|
36%
|
|
Statoil
|
14%
|
50%
|
|
Mitsui
|
20%
|
9%
|
|
Iino
|
17%
|
5%
|
53. In turn, the
Vessels are leased by Northern LNG to Polar LNG Shipping (UK) Ltd (formerly
known as K-Line (Europe) Limited), a company incorporated under the laws of
England and Wales in 1987 and registered in England under company number
02205323 (“K-Euro”). K-Euro is tax resident in the UK.
54. K-Euro was, at
the time the leasing transaction was entered into, owned as to 95% by Kawasaki
(London) Limited, a company incorporated under the laws of England and Wales in
1956 and registered in England under company number 00569042, which was, in
turn, an indirectly wholly-owned subsidiary of the global Japanese shipping and
logistics company, Kawasaki Kisen Kaisha, Ltd, (known as “K-Line”). The
remaining 5% of K-Euro’s share capital was owned by K-Line. In 2004, Kawasaki
(London) Limited sold its 95% holding in K-Euro to “K” Line Holding (Europe) Ltd.
“K” Line Holding (Europe) Ltd also purchased K-Line’s holding in K-Euro at the
same time. Kawasaki (London) Limited was then dissolved in 2005. Kawasaki (London) Limited (company number 05549644) is a dormant company, established in
order to retain the company name. In 2006, K-Euro was renamed Polar LNG
Shipping (UK) Ltd (“Polar”) and there was a reorganisation of part of the
K-Line group involving K-Euro. As a result of that reorganisation, the shares
in K-Euro (now Polar) are held by “K” Line Holding (Europe) Limited (49% A
shares, 36% B shares), Statoil ASA (14% A Shares, 50% B shares), Mitsui &
Co. Limited (20% A shares, 9% B shares) and Iino Kaiun Kaisha, Ltd (17% A
shares, 5% B shares).
The global LNG market
55. LNG is natural
gas which has been converted, temporarily, into liquefied form for ease of
storage and transportation. LNG is shipped in specialised refrigerated
tankers, such as the Vessels. Natural gas is transported by ship as LNG where
transportation of natural gas by pipeline is not practical.
56. The global LNG
market is characterised by long term supply contracts, due to countries’ needs
to ensure energy security, and the very high development costs for projects.
Unlike vessels used to transport other commodities such as coal and oil, the
“spot” market for LNG vessels is small. Currently, approximately 90% of the
LNG shipping fleet is tied into servicing long term contracts, with vessels
typically being built to service a particular project.
57. Vessels are
highly specialised and require a high degree of technical management and
maintenance to ensure that they are able to fulfil such contracts, particularly
as little tonnage is available on a spot basis to move cargo should the
contracted ship be off-hire. Further, the engines and propulsion systems of
LNG vessels are not the same as those used by other vessel classes, and
therefore require specific expertise.
History of the K-Line group’s presence in the UK and development of the LNG business
58. The first
company in the K-Line group, Kawasaki Kisen Kaisha Ltd (“K-Line”) was
established in Japan in 1919. K-Line is one of Japan’s largest shipping
companies, and has pursued its shipping activities on a global basis.
59. In 1927,
Kawasaki & Co., Ltd (London) was established. The company carried out various
shipping related activities, including chartering, collection of freights, and
payment of disbursements, as a representative of the K-Line head office in Japan. The office closed in 1934, due to the decline in the worldwide tramp business as a
result of the Great Depression.
60. In 1956, Kawasaki (London) Limited was established as a subsidiary of K-Line. Kawasaki (London) Limited acted in a representative capacity for K-Line for their liner service,
fuel contracts, charter parties and insurance contracts. Kawasaki (London) Limited did not have an agency function: K-Line used a third party agent until the
establishment of K-Euro.
61. In the late
1970’s, the K-Line group began to carry out LNG business relating to imports of
LNG to the Japanese market.
62. In 1983, Japan’s first LNG carrier, the “Bishu-Maru”, was delivered. This vessel was jointly owned
by K-Line, Nippon Yusen Kabushiki Kaisha (NYK) and Mitsui OSK Lines Ltd (MOL),
and technically operated by K-Line. The K-Line group’s move into LNG business was
part of a national project in Japan to develop LNG as an energy source (Japan
being a resource poor country).
63. K-Euro was
incorporated in 1987. At the time of its incorporation, its function was to
act as K-Line’s general agent in Europe, to supervise third party agency
companies. Japanese expatriates, who were in charge of container and car
carrier business, were transferred from Kawasaki (London) Limited to K-Euro.
64. As the Japanese
domestic market became saturated, in the late 1990’s the K-Line group started
to investigate business opportunities in the bulk and gas markets for
transportation in the Atlantic basin.
65. Since the late
1990’s the K-Line group has participated in large scale LNG transport business
starting with transport of LNG from Qatar to Japan, followed by projects such
as Petronet (Qatar to India) and RasGas II (Qatar to Europe), as well as the
Snøhvit project.
66. In addition to
K-Euro’s agency function, from 1995 to 2004 K-Euro conducted a European coastal
container business as an independent business, rather than as agent.
Accordingly, K-Euro issued its own bills of lading, and profits and losses
arising from this activity were for K-Euro’s account. In 2004, this business
was transferred to K-Line due to K-Line group’s internal business
restructuring.
The Snøhvit project
67. The Snøhvit LNG
project is a joint venture set up to extract, process and deliver to market LNG
from the Snøhvit, Albatros and Askeladd gas fields in the Barents Sea off the
north-west coast of Norway. The original project partners were Statoil, Petoro AS, TotalFinaElf, Norsk Hydro, Amerada Hess, RWE-DEA and Svenska Petroleum. In
their capacity as sellers of the LNG, and time charterers of the LNG vessels,
Statoil (handling the interest of Petoro), Norsk Hydro, Amerada Hess, RWE-DEA
and Svenska Petroleum are referred to as the “Snøhvit Sellers”. Since the
transaction was entered into, there have been changes made to the participants
in the Snøhvit Sellers and currently, the Snøhvit Sellers consist of Statoil
ASA only.
68. These gas
fields, which were first discovered in the 1980s, have estimated reserves of
193 billion cubic metres of LNG, 17.9 million cubic metres of condensate and
5.1 million tonnes of natural gas liquids. The development of the gas fields
was authorised by the Norwegian Parliament in 2002 and construction on the
project began in late 2003. The Snøhvit and Albatross fields came onstream in
2007, while the Askeladd field is due to come onstream in 2014-15. It is
estimated that production will continue until 2035.
69. Snøhvit was the
first project in Europe to be based on the export of LNG, previous gas projects
having transported gas by pipeline.
70. Due to the
location of the Snøhvit gas field in the high north, the LNG vessels which
service the field are “winterised” (winterised vessels have design features to
aid the safe operation of the vessel by the crew in winter weather conditions,
so for example, the bridge will be enclosed) or have other special features in
order to meet the requirements of the facilities.
71. The Snøhvit
Sellers originally sold the LNG produced at Snøhvit under long term contract to
the El Paso Corporation (for shipment to the US east coast) and Iberdrola (for
shipment to Spain). GdFSuez and Total lift and sell their share of the LNG produced.
At full capacity, the plant can produce about 4.3 million tonnes of LNG a year
from the Snøhvit fields, corresponding to one cargo every five or six days.
The tender process for the Snøhvit project
72. Statoil led the
tender process for selection of a counterparty. The tender process involved a
very detailed consideration of shipyards and operators to ensure that they
would meet the high standards required by the Snøhvit Sellers.
73. The tender
process commenced in January 2001. At the first stage of the process (the
“pre-qualification”) Statoil identified owner/operators it considered were
appropriate to be asked to indicate whether they were interested in
participating. Owner/operators were selected in accordance with a detailed
list of criteria including:
(1)
Experience of operation of LNG ships;
(a)
strong preference was given to owner/operators, rather than managers;
(b)
Experience of North Atlantic trading was seen as essential;
(c)
Establishment of management facilities in Europe was seen as essential;
(2)
Financial strength and standing to perform a long term contract;
(3)
Ship construction experience.
74. Approximately 55
companies were invited to participate in a pre-qualification process on the
basis of selection criteria designed to establish the points identified above.
The companies which responded were evaluated by Statoil using a comprehensive
scoring system. Invitations to tender were sent to potential counterparties on
15 January 2001.
75. K-Line’s initial
evaluation was completed in early February 2001. K-Line scored well on all of
the assessment criteria. K-Euro was identified as a suitable management office
in Europe. At this stage, the number of companies approved to tender for the
project was reduced to 11.
76. On 23 April 2001
Statoil produced a document entitled “Evaluation Procedure for the Time Charter
for LNG Carriers for the Snøhvit LNG Project” which sets out the detailed
procedure for the evaluation of tenders, and the organisation of and
responsibilities within the evaluation team. At this stage, the objective was
for Statoil and the other Snøhvit Sellers to enter into a time charter directly
with a ship owner. The criteria explored in the evaluation were:
(1)
A financial evaluation of the time charter rate, based on certain
assumptions; and
(2)
A technical evaluation, to verify compliance with the technical and
operational requirements identified in the pre-qualification process.
77. Also on 23 April
2001, K-Line submitted its first commercial offer. Under this offer, the
Vessels were to be owned by an Owning Company to be owned and established by
K-Line, but with K-Line retaining the option to invite other equity partners to
participate in up to 49% of the shares.
78. Following this
stage of the evaluation, the number of potential counterparties was reduced to
5. Statoil then met with these parties, meeting with K-Line on 5 June 2001.
79. K-Line’s rebid
was submitted on 15 June 2001.
80. Statoil met with
K-Line for a project update meeting on 28 June 2001.
81. K-Line’s second
rebid was submitted on 2 July 2001.
82. On 10 July 2001,
Statoil recommended to the Snøhvit management committee that the contract for
the Vessels be awarded to K-Line. K-Line’s contract was subject to the approval
of the Snøhvit LNG project by the Norwegian Parliament.
83. K-Line’s offer
initially expired on 31 July 2001. Due to delays in the approvals process with
the Norwegian Parliament, K-Line extended the validity of its offer twice: to
31 August 2001 and 12 September 2001. The approval of the Snøhvit project by
the Norwegian Parliament took a long time. The Norwegian Parliament approval
condition in K-Line’s contract was lifted on 31 May 2002, after the Preliminary
Stage (as defined in paragraph 84 below) had been entered into.
84.
On 19 December 2001, K-Line entered into:
A shipbuilding contract with Mitsui Engineering
& Shipbuilding Co., Ltd, in respect of the first Vessel;
A shipbuilding contract with Kawasaki Heavy
Industries, Ltd in respect of the second Vessel;
Two time charterparties with Statoil (as operator on
behalf of the Snøhvit Sellers); and
A memorandum of understanding (the “MOU”) with
Statoil.
Together, the arrangements above are referred to as “the
Preliminary Stage”.
Financing the Vessels
85. In order for
K-Line to prepare its tender for the project, it was necessary to seek
indicative pricing for financing the Vessels, so that a time charter day rate
could be calculated. K-Line met with a number of institutions in order to
discuss financing the Vessels.
86. In April 2001,
K-Line discussed financing the Vessels with Christiana Bank in outline. The
forms of financing discussed were debt financing, lease financing (UK, US, Spain, France or a Japanese operating lease) and securitisation of the project cash flows.
87. K-Line met with
BNP Paribas in May 2001 to discuss financing of the Vessels over a 10 year
term, and the possibility of French lease finance.
88. Meetings were
also held with Den norske Bank and Mitsui & Co in June 2001.
89. Also between May
and July 2001, K-Line met with;
(1)
Capstar Partners, a leasing arranger now owned by BNP Paribas, together
with UNI-ASIA, a debt and lease finance arranger specialising in Asian
borrowers. Capstar Partners and UNI-ASIA put two proposals to K-Line for the
financing of the Vessels, a defeased UK lease and a non-defeased UK lease;
(2)
Citibank, whose proposal was to finance the Vessels with a project bond
linked to a defeased UK finance lease; and
(3)
New Boston Partners, a leasing arranger owned by the Bank of
Tokyo-Mitsubishi.
90. New Boston
Partners were mandated to arrange the financing of the Vessels on 27 September
2001.
91. The form of the
financing to be utilised for the Vessels continued to be discussed between
K-Line, the other Snøhvit Sponsors, and New Boston Partners between the date of
New Boston Partners’ mandate and the Preliminary Stage.
92. The Preliminary
Stage, entered into on 19 December 2001, did not include any financing in
respect of the Vessels. The MOU recorded the parties’ intention to seek lease
financing in respect of the Vessels.
93. An Information
Memorandum, relating to the proposed lease financing, was prepared by New
Boston Partners, and sent to prospective lessor banks, in January 2002.
94. One of the
prospective lessor banks was Lloyds TSB Leasing Ltd.
95. Heads of terms
for the financing of the Vessels were entered into between the Snøhvit
Sponsors, Northern LNG and Lloyds TSB Leasing Limited on 16 April 2002.
Documentation of the transaction
96. The following
key transactions were entered into on 19 September 2002:
(1)
Novation agreements, between the shipyards, K-Line, the Appellant and
Northern LNG, pursuant to which certain of K-Line’s obligations under the
shipbuilding contracts were assumed by the Appellant and certain by Northern
LNG and K-Line;
(2)
Lease agreements (the “Headleases”), in respect of each Vessel, between
the Appellant and Northern LNG, pursuant to which the Vessels were leased to
Northern LNG on finance lease terms for a primary period of 30 years from
delivery and for lessee renewable one-year secondary lease periods;
(3)
Bareboat charters, in respect of each Vessel, between Northern LNG and
K-Euro, pursuant to which K-Euro was entitled to possession and use of the
Vessels over the 20 year bareboat charter period. The period may, under two
options exercisable by K-Euro, be extended for a term of five years under each
option.
(4)
Time Charter novation agreements, between K-Line, the Snøhvit Sellers
and K-Euro, pursuant to which the time charters entered into in respect of the
Vessels on 19 December 2001, were novated by K-Line to K-Euro.
Later
developments
97.
With effect from 1 January 2006, K-Euro’s business was reorganised. The
reorganisation involved the following steps:
(1)
The K-Euro LNG business, apart from the leases in respect of the
Vessels, was transferred to K-Line LNG Shipping (UK) Ltd (“K LNG”) ;
(2)
The Bulk shipping business was transferred to K-Line Bulk Shipping (UK)
Ltd (“K Bulk”);
(3)
A new company, named K-Line (Europe) Ltd was incorporated (“New
K-Euro”); and
(4)
The agency business in respect of the car carrier and container vessels
was transferred to New K-Euro.
98. K LNG retained
all of the ship management function in respect of the Vessels under a ship
management contract.
99. The first
Vessel, LNG carrier “Arctic Discoverer”, was delivered in February 2006.
100.K-Euro
changed its name to Polar LNG Shipping (UK) Ltd (“Polar”) on 3 February 2006.
101.The second
Vessel, LNG carrier “Arctic Voyager”, was delivered in July 2006.
102.In October
2006 (after the delivery of both Vessels), the share ownership of Polar
changed, so that “K” Line Holding (Europe) Limited held 49% of the A shares and
36% of the B shares, Statoil Hydro ASA held 14% of the A shares and 50% of the
B shares, Mitsui & Co held 20% of the A shares and 9% of the B shares and
Iino Kaiun Kaisha held 17% of the A shares and 5% of the B shares.
The evidence
Documents
103.We had before
us extensive documentary evidence comprising the transaction documents;
background, preliminary and advisory documents which resulted in the structure
of the transaction; accounts and tax returns of the relevant companies;
business strategy papers and proposals for the K-Line group of companies; board
minutes of K-Euro and other companies involved in the transactions; summaries
and explanations of the Snøhvit project, the LNG processes and the special
requirements for LNG carriers; documents relating to the tender processes
conducted by Statoil for the appointment of ship owners and shipbuilders;
documents relating to the obtaining by K-Line of financing for the Vessels;
documents in connection with, and giving effect to, the reorganisation of
K-Euro’s business in 2006; and correspondence (including email correspondence)
between the parties, their advisers and lawyers and other relevant persons in
relation to the foregoing. In all the documentary evidence filled 30 lever
arch files. The transaction documents in evidence related to the Vessel “Arctic
Discoverer” (Ex Hull No 1564): we were told that the transaction documents
relating to the other Vessel, “Arctic Voyager” were, in all material respects,
in identical form.
Witnesses
104.Four
witnesses gave evidence for the Appellant, and each had prepared a detailed
witness statement. The witnesses were Mr Steinar Thomassen, formerly of
Statoil; Mr Hiromichi Aoki of K-Line; Mr Akira Misaki, also of K-Line; and Mr
Richard Owen Williams of Lloyds Banking Group. Mr Williams’s evidence was not
challenged by the Commissioners, and so we accept his evidence as given in his
witness statement. The remaining three witnesses appeared before us, and were
cross-examined by Mr Ewart. In giving their evidence Mr Aoki and Mr Misaki had
the services of an interpreter, but for the most part their English was
faultless, both as to their understanding of the questions put to them and as
to their replies.
105.Mr Thomassen
was until 31 December 2007 the manager of the LNG Shipping division of Statoil
and as such had responsibility for the acquisition, construction and
supervision of the LNG carriers for the Snøhvit project. He joined Statoil in
1987, and held a variety of positions within Statoil and affiliated companies,
and since 1992 held senior management positions in various shipping divisions
within the Statoil group.
106.Mr
Thomassen’s evidence related to the Snøhvit project; the processes whereby
natural gas is turned into LNG and the special requirements of shipping tankers
to transport LNG; the long-term LNG supply contracts entered into by the
Snøhvit Sellers and their shipping requirements to enable them to carry out
those contracts; the tender process for the shipbuilding and ship-owning
contracts in relation to the Vessels; K-Line’s tender in that process; the
commercial requirements and objectives of Statoil and the other Snøhvit Sellers
with regard to the operation and management of the LNG carriers; the role of
Statoil and the other Snøhvit Sellers in specifying the terms of the time
charter; his understanding of the terms of the time charter, especially with
regard to the determination of the amount of hire payable by the time
charterers; Statoil’s attitude to, and involvement in, the financing by K-Line
of the Vessels and its participation as a Snøhvit Sponsor in Northern LNG; the
role of K-Euro; and the reasons for and implementation of the reorganisation of
K-Euro’s business and shareholdings in 2006.
107.We found Mr
Thomassen to be an impressive and convincing witness.
108.Mr Aoki is a
Managing Executive Officer of K-Line, with responsibility for all of the energy
transportation business of the K-Line group, which includes vessels shipping
crude oil, liquefied petroleum gas and LNG. Mr Aoki joined K-Line in 1981, and
from 1990 worked on the development of new and existing projects for shipping
LNG, initially projects shipping LNG to Japan. From July 2000 to March 2003 Mr
Aoki was the manager of the LNG division responsible for the development of new
LNG projects in the Atlantic Basin, and from the start of the Snøhvit tender
process in early 2001 his principal role was to represent K-Line in all aspects
of that process and the negotiation and implementation of the commercial and
financing arrangements which resulted from that process. Mr Aoki was not,
however, responsible for negotiating the financing of the Vessels by finance
lease or for the decision to finance the Vessels by that means: colleagues of
his in the finance department of K-Line had that responsibility. Mr Aoki was
part of the project team within K-Line (which included his finance department
colleagues) which jointly presented the proposals relating to the Vessels to
the K-Line board for approval.
109.Mr Aoki’s
evidence related to the historic development of and background to the market in
LNG, and K-Line’s involvement in that market; K-Line’s business strategy since
1998 and in particular its strategy to develop and operate from business hubs
close to its clients and to expand its bulk and energy (including LNG)
transport businesses in the Atlantic Basin; K-Euro’s role in implementing that
business strategy; K-Line’s involvement in the Snøhvit project and the tender
processes; K-Line’s involvement in the time charter and his understanding of
the terms of the time charter, especially with regard to the determination of
the amount of hire payable by the time charterers; the options for financing
the acquisition of the Vessels and the negotiation of the terms of such
financing; the advice sought as to the requirements which had to be met in
order that the lease financing should qualify for capital allowances; the
reasons for bringing other shareholders into Northern LNG; the role of K-Euro
within the lease structure and its anticipated profitability; and the reasons
for and implementation of the reorganisation of K-Euro’s business and
shareholdings in 2006.
110.Mr Aoki, too,
we found to be an impressive and convincing witness.
111.Mr Misaki is
General Manager of the LNG Division of K-Line. He joined K-Line in 1983 and
since July 2000 has worked in the LNG Division. Mr Misaki was not involved in
K-Line’s negotiations with the Snøhvit Sellers. In July 2002 he was seconded
to the K-Line group’s operations in London, where he remained until July 2008.
He worked initially for K-Euro as General Manager of the new Bulk and Gas Division
which K-Euro was establishing, in which position he had responsibility for the
development of K-Euro’s LNG business in the Atlantic Basin, including building
commercial and technical expertise in readiness for the operation of the
Vessels upon their delivery. Following the 2006 reorganisation of K-Euro Mr
Misaki became a director of K-Euro and also Managing Director and General
Manager of the commercial division of K-LNG.
112.Mr Misaki’s
evidence related to the business activities of K-Euro prior to its participation
in the chartering of the Vessels; K-Euro’s decision to participate in the
chartering of the Vessels; the business plans for the expansion of K-Euro’s
business into LNG and bulk carrier operations and the execution of those plans
(with particular reference to the development of the LNG operations); the
development of K-Euro’s LNG ship operation capability in readiness for
operating the Vessels on their delivery; the staffing of K-Euro and its
turnover and profits; the reasons for and implementation of the reorganisation
of K-Euro’s business and shareholdings in 2006; and the turnover and profits of
K-Euro/Polar in the years following that reorganisation.
113.Again, Mr
Misaki was an impressive and convincing witness.
114.The witness
statement of Mr Williams records that he is a Director in the Shipping team
which is part of the Structured Corporate Finance division of Wholesale Markets
Treasury and Trading, Lloyds Banking Group. He joined the Lloyds group in 1988
and has worked exclusively in asset finance. Mr Williams had supervisory
responsibility for the transactions in this case which the Appellant entered
into.
115.Mr Williams’s
evidence related to the activities of banks in providing finance to their
customers through leasing and the credit enhancement and security arrangements
which such banks customarily require; the extent of such business undertaken by
Lloyds group through its Lloyds TSB Leasing subsidiary companies and the
business strategy of Lloyds in 2002 in relation to leasing generally and ship
leasing in particular; the role of leasing advisors and arrangers in advising
customers seeking lease financing of the structure and risk allocation in such
financing; the review and consideration by Lloyds TSB Leasing of the proposals
for the lease financing of the Vessels and the internal approvals sought and
obtained within the Lloyds group; the credit enhancement arrangements included
in the structure and the complex intercreditor provisions required to regulate
those arrangements; the requirement of the Snøhvit Sellers to have untrammelled
rights to use the Vessels to ensure the continuing conduct of the Snøhvit
project, regardless of any enforcement of rights by financing parties; the tax
assumptions underlying the lease financing and the financial consequences for
the parties if those assumptions prove not to be correct; and the documentation
entered into on 19 September 2002 to effect the finance leasing transaction.
116.As mentioned,
the evidence of Mr Williams was not challenged, and we accept it.
117.We make one
further comment about the witness evidence. In the course of his
cross-examination of Mr Aoki, Mr Ewart, by way of challenge to the Appellant’s
case, put to Mr Aoki a number of documents, email exchanges and the like
relating to the advice which K-Line had received as to the requirements which
must be met if a finance lessor is to obtain 25 per cent writing-down
allowances by meeting the terms of section 123 CAA 2001. Mr Aoki was unable to
comment on some of those documents since although they involved K-Line, it was
clear that much of the detailed work relating to the consideration of these
matters, the seeking of advice from external advisers, and the decision to
proceed with this form of financing, was undertaken by colleagues of Mr Aoki in
K-Line’s finance department. As is apparent from the scope of Mr Aoki’s
evidence as outlined above, his primary focus was on the commercial aspects of
the transaction, although Mr Aoki explained that within K-Line the matter was
handled by a team (of which he was a member) drawn from different departments
which worked closely together with team members contributing their respective
expertises.
118.As we have
already mentioned, in his written submissions on the evidence Mr Ewart drew a
number of inferences from these documents and certain others which he had not
put to Mr Aoki. In his reply Mr Peacock questioned Mr Ewart’s right to draw
such inferences and the right of the Tribunal to take account of them. Mr
Ewart’s response was that he had not put the documents to Mr Aoki for his
comment since it was clear that he had no knowledge of or responsibility for
them as they related to matters dealt with by his finance department
colleagues, and those colleagues had not been put forward as witnesses by the
Appellant.
119.We have some
sympathy with Mr Ewart’s position. It is, of course, for the Appellant to
prove its case, and how it does so is its affair since it takes the risk of
failing to do so. But if the witnesses it puts forward do not have the
knowledge or experience enabling them to answer questions on documents produced
in evidence then that should not preclude the Commissioners from drawing what
appear to be reasonable inferences from those documents: the Appellant can
rebut those inferences in its reply if those inferences are not it its view
justifiable. It is not, in our view, open to the Appellant simply to say that
such inferences must be disregarded because the documents have not been put to
a witness when that witness was the person put forward by the Appellant in
relation to the matters in question and he had no knowledge of the documents in
question or of the circumstances surrounding them. We have therefore, in the
course of evaluating and giving weight to the range of evidence before us,
taken account of Mr Ewart’s submissions in this regard, including the
inferences he invited us to note, to the extent that we have considered them to
be reasonable in the light of the evidence overall.
The transaction documents
120.As mentioned,
we had in evidence all the transaction documents in relation to one of the
Vessels, “Arctic Discoverer” (Ex Hull No 1564). They are extensive, as is to
be expected for a substantial and complex financing and operating transaction
involving a variety of parties with differing commercial interests. They fill
eleven lever arch files.
121.The issues in
this case are, however, centred on a small number of the principal documents,
and in the course of the hearing many of the transaction documents were not
referred to by either party. In particular, much of the documentation relates
to the credit enhancement and security arrangements within the lease structure,
and with a small number of exceptions this part of the documentation was not
relied upon, or commented upon, by either party. We have therefore not felt it
necessary to review that part of the documentation for the purposes of reaching
our decision. In his witness statement Mr Williams set out a short description
of all the transaction documents which relate to the transaction as it stood at
19 September 2002, and we have reproduced that in an Appendix to this decision.
122.In this part
of our decision we set out, by way of our findings, the principal terms of the
relevant transaction documents. For the most part there was no dispute between
the parties as to the interpretation or effect of provisions of the transaction
documents. Where there was such dispute (and this was principally in relation
to the time charter of the Vessel – both as to the true nature of that charter
and as to the hire payment provisions) we refer to that, and set out our
findings as relevant, in our discussion of the Issue for which it is a material
matter.
123.All the
transaction documents referred to below are dated 19 September 2002, unless
otherwise stated (the principal exceptions are the shipbuilding contract and
the time charter, both of which were entered into on 19 December 2001, at the
“Preliminary Stage” as it is referred to in the Statement of Agreed Facts).
All the transaction documents are governed by English law.
The Shipbuilding Contract
124.The
Shipbuilding Contract is dated 19 December 2001 and is between K-Line as
Purchaser and Mitsui Engineering & Shipbuilding Co., Ltd as Builder. The
principal provisions relevant for the purposes of this case are the following.
125.By Clause 2,
the Builder agrees to design, build and complete the Vessel to the detailed
specification and to specified performance and other standards, and the
Purchaser agrees to accept Delivery of and pay for the Vessel. The Vessel is
described as a 140,000m³ Moss-Rosenberg tank type Liquified Natural Gas
Carrier with Hull No 1564.
126.Clause 3
specifies the price to be paid by the Purchaser for the Vessel. It is a fixed
price of US$175,726,000. There is separate provision for the price of Depot Spare
Parts. Clause 4 provides that the fixed price for the Vessel is payable by six
specified instalments on specified dates (the first of which is payable on 5
March 2002, and the final instalment is payable on Delivery).
127.Clause 9
deals with property and title, and provides that title to the Vessel passes to
the Purchaser on completion of Delivery. Clause 13 provides that Delivery of
the Vessel shall take place on 15 November 2005, or on an earlier date if both
parties agree or on a later date if the Purchaser exercises a right to extend
the Delivery date. The Builder is liable to pay liquidated damages at a
specified daily rate if there is a delay in Delivery.
Novation Agreement in respect of shipbuilding contract
128.The Novation
Agreement is between Mitsui Engineering & Shipbuilding Co., Ltd (the
“Builder”), K-Line (the “Original Purchaser”), the Appellant (the “New
Purchaser”), Northern LNG (as the fourth party, the “Replacement Purchaser”,
and as the fifth party, the “Lessee”).
129.Key
definitions include the “Vessel” (the LNG carrier identified as Builder’s Hull
No. 1564); the “Shipbuilding Contract” (the shipbuilding contract dated 19
December 2001 in respect of the Vessel, as above); the “Novated Rights” (all
the obligations of the Original Purchaser under the Shipbuilding Contract,
other than certain excluded rights relating to the right to receive liquidated
damages in certain circumstances such as late delivery and rights to certain
guarantees given by the Builder); and the “Novated Obligations” (all the
obligations of the Original Builder under the Shipbuilding Contract, other than
certain excluded obligations, which broadly correspond to the excluded rights).
130.By Clause 3
the Original Purchaser agrees to novate the Shipbuilding Contract to the New
Purchaser and the Builder consents to such novation. The Original Purchaser
releases and discharges the Builder from its obligations to the Original
Purchaser in respect of the Novated Rights; the Builder releases and discharges
the Original Purchaser from the Novated Obligations; the New Purchaser has the
benefit of the Novated Rights (so that the Builder performs its obligations in
respect of the Novated Rights in favour of the New Purchaser); and the New
Purchaser assumes the Novated Obligations so that it is substituted in place of
the Original Purchaser as a party to the Shipbuilding Contract.
131.There are
corresponding novation terms in Clause 4 whereby the Original Purchaser novates
the Excluded Rights to the Lessee and the Lessee agrees to perform the Excluded
Obligations.
132.At the time
of the Novation Agreement K-Line had paid the initial instalment of the
purchase price of the Vessel. By Clause 4 that payment is, in effect,
reversed, with the New Purchaser making a payment to the Builder of a amount
equal to the instalment, and the Builder making a matching payment to the
Original Purchaser.
133.In Clause 6
there is provision for the New Purchaser to require a further novation of the
Shipbuilding Contract in favour of Northern LNG as the Replacement Purchaser (or
in favour of an affiliate of Northern LNG).
134.By Clause 7
the Original Purchaser is, with the consent of the Builder, to be appointed by
the New Purchaser as its agent to supervise the construction of the Vessel in
accordance with the terms of the Shipbuilding Contract (there is a separate
Supervision Agreement setting out the terms upon which that appointment is
made).
The Lease Agreement
135.This is the
finance lease of the Vessel between the Appellant as the “Lessor” and Northern
LNG as the “Lessee”. It runs to 286 pages (including the form of a Letter of
Credit which comprises one of the Schedules). In its terms it is a
conventional UK tax-based finance lease whereby (in broad terms), over the
primary period the Lessor recovers, by way of the quarterly rentals it
receives, its capital outlay on the purchase of the Vessel together with a
variable finance charge so as to give it a specified return or margin over the
primary period. The amount of those rentals is fixed at the outset by
reference to a number of assumptions as to interest and other finance costs and
as to the tax position of the Lessor with regard to the transaction (including
its entitlement to claim 25 per cent writing-down allowances on the amount paid
to acquire the Vessel) with provision to adjust the amount of the rentals
should those assumptions prove not to be correct at any time, so that the
Lessor’s post-tax return is maintained. Under various ancillary documents, on
the termination of the lease most of the value of the Vessel (after all amounts
have been paid to make good the Lessor’s investment and return) is rebated to
the Lessee.
136.Clause 3
provides for the lease of the Vessel by the Lessor to the Lessee for the
Primary Period and, if the Lessee so requests, the Secondary Period or successive
Secondary Periods. The Primary Period commences on delivery of the Vessel and
runs for thirty years. Provided it has complied with all the provisions of the
lease and the ancillary documents, the Lessee has the right to require that the
lease is extended for successive periods of twelve months after the end of the
Primary Period.
137.By Clause 5
the Lessor covenants that it will not, by its own actions, interfere with the
Lessee’s use, possession and quiet enjoyment of the Vessel nor permit specified
encumbrances on the Vessel to arise.
138.For the
duration of the term of the lease, the benefits which the Lessor has under
warranties and indemnities given to it as the purchaser of the Vessel under the
shipbuilding contract are assigned to the Lessee: Clause 6.
139.By Clause 7
the Lessee agrees to pay rent to the Lessor during the Primary Period on
quarterly rental dates. For the Secondary Period rent is paid annually.
140.The amount of
each rental payment during the Primary Period is determined by the Financial Schedule
to the Lease, which provides for a cashflow statement to be prepared taking
account of the financial and tax variable assumptions and non-variable
principles set out in detail in the Financial Schedule, so as to produce the
amount of rental required to maintain the agreed post-tax annual return for the
Lessor from its investment in the Vessel and the lease. For the Secondary
Period the annual rental is 0.1 per cent of the price paid for the Vessel.
141.Clause 12
provides that title to the Vessel remains at all times vested in the Lessor,
with the Lesee’s rights limited to the use of the Vessel as provided in the
lease. The Lessor is to be, and remain, the registered owner of the Vessel.
By Clauses 13 and 14 the Lessee is given the full and exclusive possession,
control, command and use of the Vessel, subject to the terms and conditions of
the lease. The Lessee is permitted to operate the Vessel in any part of the
world in any lawful trade for which the Vessel is suitable. The Lessee gives
wide-ranging undertakings to the Lessor to maintain and operate the Vessel to
specified standards and in compliance with relevant regulations. The Lessee
also undertakes not to use the Vessel for a purpose which is not a “qualifying
purpose” within the capital allowances legislation.
142.By Clause 15
the Lessee is permitted to sub-lease the Vessel by the bareboat charter of the
Vessel made between the Lessee and K-Euro, and it is permitted for K-Euro to
take a novation of the time charter of 19 December 2001 in respect of the
Vessel between K-Line and the Snøhvit Sellers. Any other sub-leasing must meet
certain requirements and in any event requires the consent of the Lessor, and
if the time charter is terminated, the Vessel must be let under a time or
voyage charter which ensures that the Vessel is used for a “qualifying purpose”
and is in other respects acceptable to the Lessor.
143.There are
extensive provisions in Clause 16 requiring the Lessee at its own cost to
insure the Vessel throughout the duration of the lease for specified risks
(including hull, fire, marine and protection and indemnity risks). The
Lessee’s obligations in this respect are satisfied if K-Euro, as sub-lessee,
undertakes such insurance obligations.
144.Clause 24 to
27 deal with early termination of the lease. The lease is terminated should a
specified event of default occur (which includes any change in the
shareholdings in the Lessee, unless the Lessor consents to such change), and
there is also provision for voluntary termination, upon notice, by the Lessee.
The Vessel is re-delivered to the Lessor, and provision is made for the sale of
the Vessel and for a rebate of rental to the Lessee for an amount equal to the
net proceeds of sale. A termination amount is payable by the Lessee to the
Lessor, calculated by means of a termination cashflow statement prepared upon
the terms specified in the Financial Schedule so as to repay the Lessor for its
investment in the Vessel and to give it the agreed return.
145.Clause 22
relates to security provision, requiring the Lessee to procure an irrevocable
standby Letter of Credit in favour of the Lessor in specified terms from a bank
acceptable to the Lessor. The amount secured by such Letter of Credit (once
the Primary Period has commenced) is the aggregate of the present values of the
amounts of Primary Period rentals as derived from a cashflow statement prepared
for the purpose. Should there be any change in the amount of rental payments
during the Primary Period (because a variable assumption has proved to be
incorrect), a further cashflow statement is prepared to recalculate the amount
required to be secured and a revised Letter of Credit must be procured. The
initial Letter of Credit was issued by HBOS Treasury Services plc.
Guarantees
146.The
shareholders of Northern LNG severally, and in proportion to their respective
shareholdings, guarantee to the Appellant the due performance by Northern LNG
its obligations to the Appellant under the head lease.
147.Lloyds TSB
Bank plc guarantees to Northern LNG the due performance by the Appellant of its
obligations to Northern LNG under the head lease.
The bareboat charter
148.The bareboat
charter is between Northern LNG (as the “Lessee”) and K-Euro (as the “Bareboat
Charterer”). By Clause 3 Northern LNG agrees to bareboat charter the Vessel to
K-Euro for an initial period of 20 years beginning with delivery of the Vessel
and thereafter (at Northern LNG’s option) for an extension period of 5 years
and a further extension period (again, at Northern LNG’s option) of 5 years.
The bareboat charter and the rights of K-Euro as charterer are expressed to be
subordinate to the rights of the Appellant as head lessor, so that the
chartering of the Vessel terminates if the head lease terminates.
149.Northern LNG
undertakes to K-Euro that it will not by its own action interfere with K-Euro’s
use and quiet enjoyment of the Vessel: no further warranty is given by Northern
LNG in respect of the Vessel: Clause 5.
150.For the
duration of the leasing Northern LNG assigns to K-Euro the warranty and
indemnity rights which were in turn assigned to Northern LNG by the Appellant
under the head lease: Clause 6.
151.The payment
of rent is provided for in Clause 7 and the Rental Schedule. Rentals are paid
monthly, and the amount paid is specified in the Rental Schedule for each month
during the hire period up to the 144th month. The amount paid per
month varies from US$1,130,000 to US$1,406,600. Rentals after the 145th
month are to be agreed in the final six months, with the termination of the
bareboat charter if no agreement is reached.
152.The Rental
Schedule provides: “The Rentals have been determined on the basis of what
[Northern LNG] and [K-Euro] consider at the date of this Agreement to be a
commercial, fair market charter rate for the provision and operation of the
Vessel on bareboat charter terms for its initial fixed period”. It then
provides that if at any time prior to delivery of the Vessel those rentals do
not continue to represent such a rate, then they may seek to negotiate revised
rentals to result in what is then a commercial and fair market charter rate for
the Vessel. If no alternative rate is agreed, the original rentals remain
payable.
153.By Clause 8
K-Euro agrees to pay all costs in relation to the Vessel and the operation of
the Vessel (other than the rental and other costs to be borne by Northern LNG
under the head lease and related documents).
154.In Clause 12
K-Euro confirms that title to the Vessel remains vested in the Appellant, and
that K-Euro’s sole interest in the Vessel is to use it upon the terms of the bareboat
charter. K-Euro, at its expense, is to register (and maintain the registration
of) the Vessel with the Appellant as the registered owner. K-Euro undertakes
that it will do nothing to jeopardise the interests of the Appellant and
Northern LNG in the Vessel.
155.K-Euro is
entitled to the full and exclusive possession of the Vessel, which is to be at
its absolute disposal and under its complete control and responsibility.
K-Euro is required to maintain the Vessel in a good state of repair and in
efficient operating condition and to dry-dock the Vessel for cleaning and
painting in accordance with good industry practice. It must ensure that the
Vessel is operated so as to comply with all applicable regulations, and not in
a manner which might render the Vessel liable to requisition or seizure or in a
manner which might imperil the Vessel’s registration or classification. The
Vessel may be operated by K-Euro in any lawful trade for which the Vessel is
suitable, and all costs of operating, manning and provisioning the Vessel are
for the account of K-Euro. The Vessel is not to be used by K-Euro for a
purpose which is not a “qualifying purpose” within the capital allowances
legislation.
156.The bareboat
charter is subject to the time charter in favour of the Snøhvit Sellers.
K-Euro cannot sub-let the Vessel on a bareboat or demise charter basis without
Northern LNG’s prior consent, and then only if the terms of such a charter
comply with certain requirements: Clause 15.
157.K-Euro
undertakes to comply with the insurance obligations specified in Clause 16 of
the head lease (effectively taking over Northern LNG’s obligations to maintain
insurance in respect of the Vessel and its operation). Risk to the use of the
Vessel is borne by K-Euro, and if there is a total loss of the Vessel the
bareboat charter is terminated. More generally, the bareboat charter is
terminated if a specified default occurs (which includes the termination of the
head lease and also the termination of the time charter where it is not
replaced with a time charter acceptable to Northern LNG). K-Euro may also
voluntarily terminate the bareboat charter at any time upon notice. On
termination K-Euro must re-deliver the Vessel to Northern LNG (unless the
Vessel is a total loss). No termination sum is payable in respect of future
rentals.
The time charter
158.The time
charter party in respect of the Vessel was entered into on 19 December 2001
between K-Line (“Owners”) and Statoil (on behalf of the Snøhvit Sellers). It
is subject to English law. It comprises 68 clauses, several appendices, and
five Addenda (the first three of which were also entered into on 19 December
2001). On 19 September 2002, as part of the lease financing arrangements, the
time charter was novated on terms whereby K-Euro took the place of K-Line as
“Owners”. Such novation was foreshadowed in Clause 65 of the time charter,
which gives K-Line the rights to novate its rights and obligations under the
time charter to any lender or lessee in connection with or for the purposes of
any financing arrangements in relation to the Vessel. This is further
bolstered by Addendum No 3, by which the Snøhvit Sellers consent in principle
to the financing of the Vessel by the Owners by means of a UK lease, and to
consequential changes in the documentation (including the novation of the time
charter) to facilitate such financing, provided that the substantive position
of the Snøhvit Sellers is not thereby adversely affected.
159.The time
charter was the particular focus of a number of the submissions made by both
the Appellant and the Commissioners: its terms are directly relevant to the
determination of Issue 1 and are relevant also to the determination of Issues 2
and 4. It is necessary to set out in full certain of those terms, not least
because the parties interpreted them quite differently in arguing their
respective cases.
160.Clause 1
(together with Appendix 1) specifies the technical requirements which the
Vessel must meet in order for it to carry LNG in international trade and the
detailed specifications and performance standards which must be met. Clause 2
requires K-Euro (it is convenient to look to the parties as they were after the
novation and as at delivery of the Vessel, when the time charter hire period
began) to provide a full and efficient complement of master, officers and crew
for the Vessel to the requisite standards and competence. K-Euro guarantees
that, throughout the charter period, the master, officers and crew will
prosecute all voyages and load and discharge cargo in accordance with the
instructions given by the Snøhvit Sellers.
161.Clause 3
requires K-Euro to maintain the Vessel.
162.The hire
period under the time charter is twenty years beginning on the date of delivery
of the Vessel, with the Snøhvit Sellers having the option to extend the hire
period for two successive five year extension periods. The Vessel is hired for
the purpose of carrying LNG cargo in any part of the world at the direction of
the Snøhvit Sellers. K-Euro is required to make the Vessel compatible, at the
date of delivery, with ship/shore interfaces at specified LNG loading and
discharging terminals. Modifications required to the Vessel to enable it to
trade to other loading or discharging terminals are at the cost of the Snøhvit
Sellers: Clause 4.
163.Clause 6
provides that K-Euro will provide and pay for all provisions, wages, shipping
and other costs or expenses relating to the Vessel and its crew, including
insurance, dry-docking, overhaul, maintenance and repairs. If the Snøhvit
Sellers require the Vessel to trade in an area where there is war or the threat
of war, any consequential costs or increased costs are to be borne by the
Snøhvit Sellers.
164.The
requirement in Clause 6 that K-Euro pays for insurance on the Vessel is
amplified in Appendix II, which sets out in detail the types of insurance cover
which is to be maintained during the charter period. It requires K-Euro to
collaborate with the Snøhvit Sellers in all insurance matters, including the
terms and extent of cover, deductibles, and premiums. Insurance requirements
are to be reviewed at least every five years. The Snøhvit Sellers have the
right to suggest changes to any insurance arrangements suggested by K-Euro, and
K-Euro must itself bear any additional costs it incurs if it does not follow
any such suggested changes. The types of cover required are categorised as
follows: hull and machinery insurance; protection and indemnity insurance and
social responsibility insurance; and war risks insurance and loss of hire
insurance.
165.K-Euro is
responsible for the payment of all insurance premiums and calls. Under the
heading “Reimbursement of Owner”, it is provided that the insurances required
by the time charter “are an item included in the Operating Element of Hire as
described in Appendix II of Charter. Changes in net premiums for [such
insurance] shall be dealt with as provided in Appendix II (Insurance cost
category of the Operating Element of Hire).” (It would seem that the reference
to Appendix II should be to Addendum No 1.) The provisions for the payment of
hire and the calculation of the amount of hire are referred to in paragraphs
174 to 184 below.
166.The Snøhvit
Sellers are required by Clause 7 to provide at their own expense or pay for all
fuel to run the Vessel and bunker oil (but not for fuel used in, or in
preparation for, dry-docking or repairing the Vessel); towage, tugboat and
pilotage expenses; port charges; expenses of loading and unloading cargoes
(including the employment of stevedores); and canal and similar dues. Such
expenses are for K-Euro’s account while the Vessel is off-hire, and K-Euro
bears the cost of fuel used in connection with the preparation for and the
dry-docking or repair of the Vessel.
167.The time
charter rate and payment of hire provisions are set out in Clauses 8 and 9 and
Addendum No 1, and are dealt with below. Clause 21 details the circumstances
in which the Vessel is to be regarded as off-hire, and hire is not payable in
relation to off-hire periods (but such periods count as part of the Charter
period). Hire ceases to be payable on the loss of the Vessel.
168.Although the
master and crew of the Vessel are provided at K-Euro’s cost, the Snøhvit
Sellers instruct the master as to voyage and sailing directions, and he is
under their direction as regards employment of the Vessel and as to signing
bills of lading.
169.The Vessel is
to be loaded and discharged at any port or dock specified by the Snøhvit
Sellers, who are not liable for any loss or damage resulting from conditions at
the specified port or dock unless such loss results from their fault or
neglect. These provisions are subject to the requirement for the Snøhvit
Sellers to ensure that terminal facilities in specified ports are compatible
with the Vessel.
170.The Snøhvit
Sellers may sub-charter the Vessel so long as they continue to remain liable to
K-Euro under the time charter.
171.There is
provision in Clause 22 for dry-docking and maintenance of the Vessel at
specified intervals, and for unscheduled dry-docking, with consultation between
the parties as to timing and the selection of the dry-dock port. K-Euro is
required to review with the Snøhvit Sellers the proposed specification for each
dry-docking (including the estimated costs), and to obtain their consent to
such specification and costs. During the period of dry-docking, and including
deviation time, the Vessel is off-hire.
172.K-Euro gives
undertakings as to the cargo capacity of the Vessel, the speed and fuel
consumption of the Vessel, and its capability to transfer its cargo within
specified parameters.
173.There are
extensive provisions requiring compliance with international regulations and
collision rules applicable to the Vessel and the carrying of LNG.
The time charter hire payment provisions
174.The time
charter hire payment provisions require special consideration in view of the
respective arguments of the parties in this case. By common consent of the
parties (the Appellant’s witnesses, too) the drafting of certain aspects of the
provisions relating to the adjustment of the hire payment is unclear.
175.Clause 8
provides that “as full compensation for the performance by [K-Euro] of [its]
obligations under this Charter, hire shall accrue in accordance with Addendum
No 1 appended hereto….”. Clause 9 provides for the payment of hire in US
dollars per calendar month in advance.
176.Addendum No 1
first provides that “Hire payable under this Charter shall consist of a Capital
Element and an Operating Cost Element each of which shall be determined in
accordance with this Addendum No 1”.
177.The Capital
Element of hire is then defined. It is a fixed US dollar amount based on the
shipyard price of the Vessels and related Depot Spares. For the initial 20
year charter period the amount is US$52,491 per day, and for any extension
period, US$25,000 per day. One-off adjustments by reference to a formula are
made to those amounts before the charter period begins on delivery of the
Vessel if the actual price paid for the Depot Spare Parts under the
Shipbuilding Contract is increased by reason of modifications to the Vessel.
The fixed amounts are predicated on a 20-year interest rate of 6.5 per cent,
and a further one-off adjustment is made if the actual 20-year interest rate as
at the execution of the time charter differs from that assumed rate.
178.The Operating
Cost Element of hire is comprised of three categories: Fixed Operating Cost;
Pass-Through Operating Cost; and Non-auditable Expenses.
179.The category
of Fixed Operating Cost covers: “Manning; Maintenance and Repair, including
consumables but excluding Dry-docking; and Dry-docking.” The Addendum provides
for an annual escalation and five-yearly review of Fixed Operating Cost in
these terms:
“For the first five years of the initial Charter
period the Fixed Operating Costs shall be escalated at an annual escalation
rate of 2.5%. For the subsequent five years period (and each subsequent five
years period thereafter) the applicable rate shall be reviewed and agreed
taking into account the actual costs incurred during the previous five years
period, the Vessel’s age and trades.”
180.The category
of Pass-Through Cost covers: “all premiums of Hull and Machinery (including War
Risks) Insurance; Loss of Hire (including War Risks) Insurance; Protection and
Indemnity Insurance; and Social Responsibility Insurance.” There is no
provision for escalation of such costs.
181.The category
of Non-auditable Expenses covers: “[K-Euro’s] administration costs in Europe
and the headquarters including but not limited to salaries of office staff,
security, office rental and travelling expenses for services rendered with
respect to the management of operation of the [Vessel]. For the initial
Charter period the Non-Auditable Expenses shall be escalated at an annual
escalation rate of 2.5%.”
182.Having
defined the Operating Cost Element and its component parts in this way, there
is then a table setting out “for the purposes of this Schedule, the Vessels’
initial five-year operating costs for each category specified … (in 2006
values).” The table is as follows:
(Daily costs in USD)
|
|
Year 1
|
Year 2
|
Year 3
|
Year 4
|
Year 5
|
|
(1) Fixed Operating
Element
|
|
|
|
|
|
|
Manning
|
4,260
|
4,370
|
4,860
|
4,590
|
5,110
|
|
Maintenance incl
consumables
|
820
|
730
|
1,390
|
1,000
|
1,650
|
|
Dry-dockings
|
|
|
6,340
|
|
9,390
|
Sub-total
|
5,080
|
5,100
|
12,590
|
5,590
|
16,150
|
|
|
|
|
|
|
|
|
(2) Pass through
Operating (estimated) Insurance
|
|
|
|
|
|
|
Hull+ Machinery (inc War Risk)
|
680
|
650
|
670
|
580
|
600
|
|
Loss of Hire (inc War Risk)
|
180
|
180
|
210
|
180
|
210
|
|
P & I (inc Supplemental
Calls)
|
160
|
160
|
170
|
160
|
170
|
|
Social Responsibility
|
220
|
220
|
240
|
220
|
240
|
Sub-total
|
1,240
|
1,210
|
1,290
|
1,140
|
1,220
|
|
|
|
|
|
|
|
|
(3) Non-auditable Management
Fee
|
2,240
|
2,290
|
2,500
|
2,380
|
2,600
|
|
|
|
|
|
|
|
Total Operating Costs Element
|
8,560
|
8,600
|
16,380
|
9,110
|
19,970
|
The Operating Cost
elements shown above in the table has been adjusted for 2.5% per annual
escalation where applicable.
183.The Addendum
then continues in these terms:
[K-Euro] and the [Snøhvit Sellers] shall meet at a
mutually agreed time at least ninety (90) days prior to the Delivery Date for
the purpose of establishing estimated operating costs for the period from the
Delivery Date to December 31 of the same year as that in which the Delivery
Date falls. Thereafter, at least sixty (60) days prior to January 1 of each
calendar year during the Charter Period, [K-Euro] and the [Snøhvit Sellers]
shall meet for the purposes of establishing such estimated costs with respect
to that year.
No later than ninety (90) days before scheduled
dry-docking and maintenance is due to take place pursuant to Clause 15 of the
Charter, K-Euro shall provide the [Snøhvit Sellers] with a budget estimate and
breakdown of the costs of dry-docking.”
184.As to “Pass
through Operating Insurance” hire, the amounts of insurance costs paid by
K-Euro in 2006 were US$495,000; in 2007, US$662,000; in 2008, US$762,000; and
in 2009, also US$762,000. These amounts, expressed as a percentage of the
total costs paid by K-Euro for the operation of the Vessels (disregarding the
amount of hire paid under the bareboat charter) are: in 2006, 8.91 per cent; in
2007, 8.04 per cent; in 2008, 7.725 per cent; and in 2009, 6.72 per cent.
The time charter novation agreement
185.For the sake
of completeness we note that in March 2002 there was a novation of the time
charter from Statoil (which in the time charter was expressed to be acting on
behalf of the Snøhvit Sellers) to all the Snøhvit Sellers as named parties.
186.The time
charter novation agreement with which we are concerned was, as we have already
mentioned, entered into on 19 September 2002 as part of the lease financing
transactions. It is the means whereby the chain of leasing is completed, from
the owner of the Vessel (that is, the Appellant) to the users of the Vessel
(the Snøhvit Sellers).
187.The parties
to the agreement are K-Line (the “Original Owner”); the Snøhvit Sellers (the
“Charterers”); and K-Euro (the “New Owner”). It recites that K-Euro has agreed
to assume as disponent owner all the rights and obligations of K-Line under the
time charter, and that the Snøhvit Sellers have agreed to the substitution of
K-Euro in place of K-Line in relation to the time charter.
188.The novation
is effected by Clause 3. K-Line novates the time charter to K-Euro, with the
consent of the Snøhvit Sellers, on and with effect from 19 September 2002.
K-Line releases the Snøhvit Sellers from their obligations to K-Line under the
time charter and the Snøhvit Sellers undertake to perform those obligations in
favour of K-Euro; the Snøhvit Sellers release K-Line from its obligations to
the Snøhvit Sellers under the time charter, and K-Euro undertakes to assume and
perform those obligations in substitution for K-Line; K-Euro has the benefit of
the rights under the time charter previously enuring to K-Line.
189.Various minor
amendments are made to the terms of the time charter by Clause 4, and by Clause
5 K-Line agrees to give to the Snøhvit Sellers a guarantee (in prescribed form)
of K-Euro’s due performance of its obligations under the time charter.
The Ship Management Agreement
190.Following the
reorganisation of K-Euro’s business in 2006, although K-Euro continued to lease
the Vessel under the bareboat charter and to charter it to the Snøhvit Sellers
by the time charter, it contracted out the management of the Vessel to its
associated company, K-LNG.
191.The Ship
Management Agreement is dated 9 February 2006 and is between K-Euro (now named
Polar LNG Shipping (UK) Ltd, and identified in the agreement as the “Owner”)
and K-LNG (the “Manager”). It runs for one year from 15 February 2006 and
thereafter until terminated by three months’ notice by either party. The
agreement is a standard Baltic and International Marine Council ship management
agreement. It identifies the following as the management services which K-LNG
will supply to K-Euro: crew management; technical management; insurance
arrangements; accounting services; and provisioning the Vessel. Commercial
management, (specifically, the sale or purchase of the Vessel, bunkering, and
chartering services) is specifically excluded from the management services
which K-LNG is to supply.
192.Clause 2
appoints K-LNG as manager of the Vessel, and by Clauses 3 and 4 K-LNG agrees to
carry out the management services in respect of the Vessel “as agent for and on
behalf of [K-Euro]”. By Clauses 5 and 8 K-Euro pays monthly in advance a daily
management fee of US$2,240 by way of remuneration of K-LNG for acting as
manager.
Further findings of fact
193.From the
documents in evidence, and from the evidence of the witnesses, we make further
findings of fact as set out in paragraphs 194 to 257 following. They are to be
read in conjunction with the Statement of Agreed Facts set out at paragraphs 50
to 102 above.
The LNG market and the Snøhvit Project
194.The shipment
of natural gas in liquefied form is a modern, highly-technical and
highly-specialised business. Natural gas is more commonly transported from
production field and terminal storage to the consumer market by pipeline across
land or under the sea, but where undersea pipelines are not feasible, the gas
can be liquefied by a freezing process and transported in that form in
purpose-built ships to a destination port terminal, where the liquefying process
is reversed and the gas can proceed by pipeline to the consumer market.
195.A feature of
the LNG market is that suppliers enter into long-term supply contracts with
their customers. In October 2001 the Snøhvit Sellers entered into such
long-term natural gas supply contracts with two customers, El Paso Global LNG
(for shipment to the US east coast) and Iberdrola SA (for shipment to Spain). These contracts were expected to run for between 17 and 20 years.
196.An LNG
carrier or tanker performs essentially as a pipeline providing the
infrastructure required to carry out the long-term customer supply contracts
entered into by the producer energy companies. It is therefore usual to have
vessels built to service particular gas production facilities and such
long-term contracts. By means of ownership or long-term charter arrangements
such vessels will effectively be dedicated to such service. There is little by
way of a short-term or “spot” shipping market for LNG (unlike that for, say,
bulk cargoes).
197.The producer
companies will want to ensure the reliability and safety of the supply over the
years to their customers and the maintenance of the high and specialist
technical standards required to ship this particular cargo. To that end the
producer companies will require control over the design and specification of
the carrier ships and over their operation.
198.The Snøhvit
Sellers had such objectives, and in order to obtain necessary government
consents to the development of the Snøhvit project they had to demonstrate that
they could secure long-term supply contracts and could meet the requirements of
those contracts in terms of the regular, long-term and reliable shipment of
LNG. The Snøhvit Sellers (other than Statoil) did not themselves have
experience of owning or operating ships, nor did they (including Statoil) have
the specialist expertise required to operate LNG carriers.
The tender process
199.The tender
process was designed to find shipyards to build the carriers which the Snøhvit
Sellers required to supply LNG to their long-term customers and to find a
shipping company which would purchase and own those carriers and lease them to
the Snøhvit Sellers on terms whereby the operation and management of the
carriers would be carried out by the shipping company. The two-fold tender
process, and the principal commercial terms which formed the arrangements which
resulted from that process, were devised by Statoil, under the leadership of Mr
Thomassen. As might be expected for such a specialised, technical and
commercially substantial venture conducted to the highest standards, the tender
and bidding process, as to both shipyards and shipping owners, was lengthy and
complex. The main features of the process were as follows:
(1)
The tender process began in January 2001, and by March 2001 six
shipyards were short-listed (including those which eventually built the
Vessels);
(2)
After an initial evaluation process eleven shipowners/operators were
invited to submit tenders in April 2001. The outline terms of the 20 year time
charter were specified by Statoil, including a rent to be calculated using a
Capital Element and an Operating Cost Element (the actual rate of hire was
negotiated as part of the tender process, and having regard to the cost of the
Vessels, likely finance costs, and the shipowner’s estimate of operating
costs);
(3)
The bids from the shipowners were evaluated against the commercial and
technical requirements of the Snøhvit Sellers. K-Line and four other
shipowners were shortlisted, and there was a re-bidding process in June 2001.
After further re-bids and evaluations in July 2001 K-Line’s bid was accepted,
subject to Norwegian government consent for the project (which was finally
forthcoming in May 2002). K-Line also met a further preference of the Søhvit
Sellers, in that it had experience of operating LNG vessels, and thus had
performed to the special technical and safety standards required in operating
such vessels;
(4)
All Statoil’s principal dealings with K-Line were with K-Line personnel
based in Tokyo;
(5)
From as early as July 2001 Statoil had reserved the option for one or
more of the Snøhvit Sellers to take an equity interest in the economic
ownership of the Vessels and K-Line had reserved its right to bring in
co-owners, as it did not wish to have the Vessels and their financing on its
balance sheet;
(6)
Statoil and K-Line proceeded to document their agreement, conditionally
on the consent of the Norwegian government, on 19 December 2001, and on that
date also K-Line entered into the shipbuilding contracts for the Vessels with
the chosen shipyards.
200.Part of the
documentation entered into between Statoil and K-Line on 19 December 2001 was a
Memorandum of Understanding setting out the further steps envisaged in
connection with the provision of the Vessels. This document records the intention
of the parties to finance the Vessels by way of a finance lease in the UK by
means of a structure largely corresponding to that eventually adopted in
September 2002, with K-Line novating the time charter to a company incorporated
and carrying on business as ship operator in the UK which, as disponent owner
holding its interest by means of the bareboat charter, would be responsible for
the commercial and technical management of the Vessels. There is provision for
the parties to arrange other financing if a UK lease is found not to be
economically or legally viable. It also records that Statoil will, if such
arrangements are implemented, have a minority shareholding interest in the
special purpose companies which respectively have the reversionary equity
interest in the Vessels (subsequently, Northern LNG).
201.It was an
essential requirement of the Snøhvit Sellers that all aspects of the management
of the Vessels (technical and commercial) should be carried out from a base in
a European time zone: this requirement was in consequence of previous
experience of Statoil where loss had been incurred because the operator/manager
of a vessel delayed responding to a problem because of time zone differences.
202.Further,
based on its experience with shuttle tankers in the North Sea, Statoil included
a requirement that the shipowner should also be the operator of the ship, so
that there would be a sense of responsibility for the ship as an asset, its
operation and its performance. It was not acceptable that the counterparty
should simply be a manager of a ship.
203.The K-Line
bid was attractive to the Snøhvit Sellers not simply by reason of its
commercial terms, but because K-Line met the requirements that it could, within
its group, both own and operate the Vessels and ensure that the Vessels were
operated and managed in a European time zone. As early in the tender process
as February 2001 K-Line had stated to Statoil that, in view of the proposed
operation of the Vessels in the Atlantic Basin, the “management office for
Snøhvit LNG Project is intended to be located in [K-Euro], a subsidiary
established in London. Representatives in the [K-Euro] office will act as an
interface between Charterers and K-Line Head Office”. Statoil’s principal
concern was for the efficient, reliable and safe operation of the Vessels by a
competent entity within the European time zone. The structure by which K-Line
achieved that was not of particular interest to Statoil.
K-Line and its business strategy
204.K-Line is one
of Japan’s largest shipping companies. It has a substantial presence in the
LNG shipping market: by the end of 2010 its LNG carrier fleet comprised 46
vessels out of a world fleet of approximately 360 vessels. Prior to its
involvement in the Snøhvit project its involvement in the LNG market was
confined to the East of Suez sector (principally shipping LNG to the Japan market).
205.From at least
2000 the published group strategy of K-Line was to diversify its business hubs
so as to keep up with globally expanding markets and to give greater autonomy
to overseas subsidiaries with shipping operations. This enabled it to provide
its shipping services to customers from bases local to those customers.
206.In its group
management plan of May 2002 K-Line stated that a fundamental part of its
management plan was “the enhancement of those aspects of globalisation that are
firmly based on regional communities”; it also referred to its intention to
“set up a business stronghold of tramper and LNG-carrier business in Europe,
putting [K-Euro], based in London, as the centerpiece in an attempt to secure
new business”; it also referred to the need for new penetration of energy
transport markets in Europe and the US, and to the development of certain
regional “business strongholds”, including K-Euro, with the shift of management
and jobs from head office to such business strongholds.
207.Minutes of a
board meeting of K-Line on 27 May 2002 refer to the establishment of a European
base for the group’s Bulk and Gas Division in pursuance of the group business plan.
The minute notes the expected growth in the market for transporting bulk and
energy resources, and the need to establish a business base in Europe in order fully to participate in the European sector of that market by operating in
close contact with customers. The minute states: “In addition, as the UK moves to introduce new leasing systems, this will help to establish our status as a bona
fide shipping company, enabling us to participate in shipping management and
transport, including LNG vessels.” The minute records the decision to
establish a bulk and gas division in K-Euro as from 1 July 2002, Phase 1 of
which will require a staff of three (two sent from head office and one
recruited locally), with further staffing for subsequent phases as shipping
capacity is added in relation to transport of bulk cargoes and LNG cargo
(including the Snøhvit Project vessels). The directors of K-Euro
correspondingly resolved, on 31 May 2002, to establish a Bulk and Gas Division.
208.K-Line saw a
commercial advantage in expanding its LNG carrier business into the Atlantic Basin in view of the anticipated growth of business in that sector with increasing
importation of LNG by the USA. It saw participation in the Snøhvit project as
attractive because of the political stability of Norway (compared with other
producer countries) and because it would give K-Line the competitive advantage
of participating in the first major LNG carrier venture within the Atlantic Basin.
The development of K-Euro’s business
209.K-Line’s
first UK subsidiary was established in 1927. Its business included chartering
tramp ships and acting as a representative for K-Line. The business was closed
down but since 1956 K-Line has had a UK subsidiary which acted as a
representative for K-Line in respect of a range of shipping activities.
210.K-Euro was
incorporated in 1987, and at that time its business encompassed acting as
K-Line’s general agent in Europe, operating both a UK agency and a general
agency. The UK agency was focused on the container business, with commissions
earned from dealing with the arrival and dispatch of shipments, and fees were
also earned for organising the transfer of shipments from intercontinental
ships to feeder vessels. The general agency business provided, on a fixed fee
basis, administrative and marketing services to K-Line in relation to its
container services and its car carrier business. In 1995 K-Euro began to
operate, on its own account, a European coastal container service, chartering
for the purpose four container ships by 2001, with K-Euro responsible for the
commercial management of the vessels.
211.The audited
report and financial statements of K-Euro for the year ended 31 December 2001
show that the principal activity of the company is “that of general shipping
agents and shortsea container ship operators throughout Europe.” Those
accounts show a turnover for that year of £30.327m, a gross profit of £7.292m,
and (after administrative expenses, interest and tax) a loss of £0.417m. In
the balance sheet shareholders’ funds are £0.149m. The average weekly number
of employees during the year is shown as 124.
212.As mentioned,
in May 2002 the board of K-Euro resolved to establish a bulk and gas carrier
division, and to that end a three-stage business plan was agreed in July 2002.
Phase 1 of the business plan as it related to the gas business was to seek
customers, projects and business in Europe and the Atlantic Basin and to act as
the point of contact with Statoil in respect of the Snøhvit Project; Phase 2
was to intensify and increase the Phase 1 activities; and Phase 3 was to
continue the expansion of the business and to gear up for the delivery and
operation of the Vessels. Each Phase required an increase in appropriate
staffing. The business plan for the bulk business similarly planned, on a
phased basis, for the development of a bulk carrier business in Europe and the Atlantic Basin.
213.A review of
the business plan in January 2004 shows that at that time K-Euro had a
management agreement for the LNG carrier “Al Thakhira” (of which K-Line is a
member of the consortium owner) which transports LNG from the Ras Gas II
Project in Qatar to Italy; was engaged in a tender process for selection of a
crew management company; was recruiting local LNG personnel to increase its
technical team to five people and had increased the senior management and
technical teams by secondments from K-Line and by local recruitment; had
engaged in significant marketing activity with the aim of increasing the number
of vessels in which it was involved; and was engaged in a tender process for a
coastal LNG vessel.
214.From the time
K-Euro decided to establish its bulk and gas division until the end of 2005 it
took on secondment from K-Line eight senior management and technical staff for
the purpose of developing the bulk and gas business, in addition to local
recruitment. It used the services of a recruitment consultant to assist with
recruiting marine and technical superintendents.
215.With regard
to the vessels which it chartered or managed in the course of developing its
bulk and gas division, K-Euro’s business developed as follows:
(1)
In September 2002 it participated in the Snøhvit Project by taking a
grant of bareboat charters of the Vessels and a novation of the time charters
to the Snøhvit Sellers (the Vessels were not delivered until 2006, after the
reorganisation of K-Euro’s business);
(2)
In April 2003 it entered into time charter arrangements for two bulk
carriers (both large vessels, one capesize, the other panamax), undertaking the
commercial operation of the vessels;
(3)
In 2004 it negotiated the contracts for the building of two capesize
bulk carriers which it was intending to own and manage (both vessels were
delivered after K-Euro reorganised its business in 2006);
(4)
In January 2005 it took delivery of a new build capesize bulk carrier,
which it owned and which it commercially managed;
(5)
In July 2005 it entered into time charter arrangements in respect of a
further capesize bulk carrier and a further panamax bulk carrier;
(6)
In November 2005 it entered into time charter arrangements for a further
new build capesize bulk carrier; and
(7)
In November 2005 it commenced management of the LNG carrier “Al
Thakhira”.
216.The audited
report and financial statements of K-Euro for the year ended 31 December 2005
state: “The principal activity of the company during the year was that of
general shipping agents for containerships and car carriers throughout Europe
as well as the operation of bulk vessels and ship management of LNG vessels
throughout the world. The company’s bulk division had eight bulk vessels in
its fleet as at the end of the year.” The turnover for the year is £42.633m,
and gross profit is £18.854m. Profit after administrative expenses, interest
and tax is £3.657m. The balance sheet shows equity shareholders’ funds of £5.889m.
The monthly average number of employees during the year was 163.
217.Following the
reorganisation of the K-Euro business with effect from 1 January 2006 the
component parts of that business are now operated by successor UK companies. By the end of 2010 the successor company carrying on the bulk business was
operating 18 bulk carrier vessels on a long-term basis (five of which are owned
by that company), and the business had a turnover of US$183m and a staff of 18
employees. As of March 2011 the successor company carrying on the LNG carrier
business (apart from the charter arrangements retained by K-Euro in respect of
the Vessels) operates eight LNG vessels (either as disponent owner or under a
ship management agreement, and including the Vessels, which that company
manages for K-Euro) and the business (for the year to 31 December 2009) had a
turnover of US$52.181m and a staff of 21. In the case of the LNG vessel for
which K-LNG is the disponent owner, the vessel is owned through a UK finance lease structure.
The lease financing of the Vessels
218.Once K-Line
was engaged in the tender process arranged by Statoil in 2001 it sought advice
from a number of financial institutions as to the ways in which it might
finance the purchase of the Vessels. Apart from other considerations, K-Line
needed to have a good sense of possible financing costs in order to include, in
its bid in the tender, a Capital Element within the hire rental in the proposed
time charter to the Snøhvit Sellers. Consideration was given to debt
financing, securitising ship rentals, and a variety of lease financing
structures based in different jurisdictions.
219.In September
2001 K-Line mandated a leasing arranger, New Boston Partners (a subsidiary
company of a major Japanese bank), to arrange the financing of the Vessels.
The London firm of solicitors, Watson Farley Williams, was engaged to provide
legal advice.
220.K-Line was
advised of the benefits of a UK finance lease where capital allowances are
available to the lessor. There was also discussion of the availability of the
tonnage tax rules. K-Line had no previous experience of UK finance leases and
relied on its advisers as to the requirements which must be met if a UK finance
lease lessor is to claim allowances, and the basis on which those allowances
are reflected in the finance lease provisions and financing terms.
221.Both New
Boston Partners and Watson Farley Williams advised in the course of autumn 2001
that a “bona fide UK shipping company” was required to operate the Vessels if
the “qualifying purpose” conditions were to be met. They advised that such a
company should, if possible, be a company owned by K-Line or by the joint
venture partners having the economic ownership of the Vessels (i.e. the
shareholders of Northern LNG). They advised that it would be necessary for the
ship operator to be in place as from delivery of the Vessels, and that it
should be a ship operator and not merely a manager of the Vessels. They also
advised that it would be helpful if the ship operator had a trading history and
could demonstrate that the operation of the Vessels was an extension of its
existing trading activities. This advice was specifically given with reference
to the terms of section 123 CAA 2001, including section 123(4) CAA 2001.
222.In the early
stages of the tender process K-Line had indicated to the Snøhvit Sellers that
K-Euro would have a role in the management of the Vessels (to meet the
requirement of the Snøhvit Sellers that the Vessels should be managed from a
base in a European time zone). In those early stages the exact way in which
K-Euro would carry out that role was not decided upon. From the discussions
between K-Line and its advisers K-Line was aware that for capital allowances to
be available it was necessary that K-Euro should operate (and not merely
manage) the Vessels in the UK finance lease structure.
223.In the course
of email exchanges between K-Line and its UK advisers in relation to these
matters and the role of K-Euro, K-Line sought advice as to the “proper profit
level” of K-Euro if it were to act as ship operator, and whether there was any
UK tax requirement in this respect – a concern which K-Line had was that, given
the limited LNG carrier market, there was little by way of example to judge
levels of profitability for a ship operator (as against a ship manager). Based
on that advice, it was anticipated that K-Euro would make a profit margin of
about 10 per cent of the Operating Cost Element of the hire received under the
time charter.
224.K-Line also
sought advice as to whether the establishment of a bulk and gas division by
K-Euro would result in K-Euro being a ship operator for the purposes of the UK capital allowances legislation, and, in that context, whether there was a critical
timescale in which that division had to be established.
225.K-Line was
also advised as to the risks which K-Euro should bear for it to comprise a ship
operator which would satisfy the requirements of the UK capital allowances
provisions, and that the costs flowing from such risks should they materialise
could ultimately and indirectly be borne by the shareholders of K-Euro
(including the Snøhvit Sponsors should they become such shareholders) by reason
of their respective shareholdings.
226.At this time
K-Line also considered entering into a joint venture with a third party ship
management company with experience in managing LNG carriers, in order to
establish a ship operator in the UK, using the expertise and business of the
joint venture party to establish rapidly a full service shipping company with
LNG expertise. That idea was rejected by K-Line on the grounds that it did not
fit with K-Line’s strategy for growth of the Bulk and Gas businesses at local
level within the K-Line group and that it might not be acceptable to Statoil.
K-Line recognised that it would be necessary to grow K-Euro’s business
organically so that it could function as a ship operator.
227.As mentioned,
the documentation entered into between K-Line and the Snøhvit Sellers on 19
December 2001 anticipates that K-Line might wish to arrange financing of the
Vessels in the form of a UK finance lease, and the leasing structure which that
would likely require, including K-Euro as the disponent owner of the Vessels.
228.In January
2002 prospective UK lessor banks were approached, including the Lloyds TSB
group. They were advised of the shipbuilding and time charter arrangements in
place and of the leasing structure which was proposed should the financing of
the Vessels be effected by a UK finance lease. Prospective lessors were
informed that the Vessels would be used for a “qualifying purpose” by reason of
K-Euro, as ship operator, satisfying the requirements of section 123 CAA 2001.
229.On 16 April
2002 Lloyds TSB Leasing Ltd entered into heads of terms with K-Line and the
other Snøhvit Sponsors and with Northern LNG setting out the terms under which
it was prepared to offer a UK lease facility in respect of the financing of the
Vessels, subject to negotiation of satisfactory documentation.
230.Negotiations
were completed in September 2002 (by which time parliamentary consent had been
obtained in Norway for the Snøhvit project), and the lease documents, as set
out above, were entered into on 19 September 2002.
K-Euro’s participation in the lease structure
231.All
discussions as to the structuring of the lease financing, and the negotiation
of the lease financing itself, were undertaken by K-Line. Similarly, the
proposals for establishing a bulk and gas division to operate within the Atlantic Basin as part of the business of K-Euro were initiated by K-Line.
232.K-Euro was
involved in the discussions concerning the Snøhvit project and the possible UK finance lease financing of the Vessels in the autumn of 2001, and in November 2001 a
director of K-Euro expressed the view that at that time K-Euro had no intention
either to own any LNG vessel or to charter such a vessel on bareboat terms. At
that time, although K-Euro had experience of operating container vessels, it
had no experience of operating or managing LNG carriers, and would not have
been credible to the Snøhvit Sellers as operator of the Vessels. K-Euro had to
be persuaded by K-Line that it should expand its business so that it would be
in a position to act as operator of the Vessels on their delivery.
233.At a board
meeting of K-Euro on 22 February 2002 there was discussion of the plan to
expand K-Euro’s business by the establishment of bulk and LNG carrier divisions
for operation in Europe, with the intention that K-Euro would operate and
manage the vessels employed in those divisions. That meeting also reviewed the
shipbuilding contracts and the time charters in respect of the Vessels entered
into on 19 December 2001 and the proposed finance leasing arrangements were
also discussed, including K-Euro’s intended part in those proposals. It was
noted that if the proposals were implemented with K-Euro’s participation,
K-Euro would be disponent owner of the Vessels, having responsibility for the
commercial and technical management of the Vessels but without the economic
risks of ownership. It was also noted that if K-Euro operated the Vessels its
aim would be to earn an operator’s profit, and that the question of K-Euro’s
profit margin had not yet been agreed. It was agreed that one of the directors
would continue to review the proposals on K-Euro’s behalf and to negotiate any
documents involving K-Euro, with that director reporting back informally to the
remaining directors.
234.Directors of
K-Euro (including the chief executive officer) were subsequently involved in
discussions as to the basis on which K-Euro would act as disponent owner, and
in particular as to the rate of hire under the proposed bareboat charter (the
terms of the time charter having been agreed in the December 2001 transaction,
the amount of the bareboat hire was a critical factor in determining the likely
profitability of the venture for K-Euro).
235.At a board
meeting of K-Euro on 12 September 2002 the directors were presented with the
terms of the lease financing of the Vessels and with the documents to which it
was proposed that K-Euro should become a party. It was noted that K-Euro would
become responsible for operating and managing the Vessels as disponent owner,
assuming obligations under the bareboat charter and having responsibility for
the commercial and technical management of the Vessels. It was also noted that
K-Euro could expect to make a profit from such operation.
236.At that board
meeting there was also produced to the directors a copy of the business plan,
dated July 2002, for the bulk and gas division of K-Euro. It was noted that
that division had been established on 1 July 2002 (following a board resolution
to that effect on 31 May 2002) in order for K-Euro actively to develop its bulk
and LNG carrier business in Europe by establishing bulk and LNG fleets. It was
also noted that the proposals whereby K-Euro became disponent owner of the
Vessels were in furtherance of the business plan. Resolutions were passed
approving the bulk and gas division business plan and authorising K-Euro to
enter into the relevant documents by way of implementation of the lease
financing arrangements.
237.As disponent
owner of the Vessels K-Euro is exposed to the commercial risks which flow from
its operating, crewing and maintenance responsibilities under the time charter
and from any deficit which may arise should the costs of carrying out those
responsibilities, together with the bareboat hire, exceed the hire paid under
the time charter. It was anticipated when K-Euro entered into the bareboat
charter and time charter arrangements that K-Euro’s profit would equate to the
non-audited management fee element in the time charter hire payment and a
margin above operating costs which was expected to be approximately 10 per cent
of such costs, but it became clear before delivery that actual operating costs
would be significantly higher than anticipated, and that a sizeable loss would
accrue without remedial action. K-Euro is also exposed commercially to the
extent that any obligations placed on it under the bareboat charter are not
off-set by countervailing rights it has under the time charter. K-Euro also
bears the risk of costs (without receipt of hire) for any off-hire periods,
(except for days 7 to 187 of any such periods, for which it takes insurance
cover).
238.The preferred
business model of the K-Line group is that where K-Line owns or part-owns a
vessel, then a member of the group should act as disponent owner time
chartering the vessel: this ensures that the commercial advantage is retained
of having the direct and operational relationship with the customer. But where
a vessel is owned by a consortium of shipping companies (which is common in the
case of LNG vessels, so that no one shipping company has the vessel, or its
financing, on its balance sheet) the consortium company will grant the time
charter and will contract out the management of the vessel to a third party
manager: this ensures that no one consortium member has, to the possible
detriment of the others, the commercial advantage of the operational
relationship with the charterer customer.
239.Although the
Vessels are, through Northern LNG, owned (economically) by a consortium, only
one other consortium member, Iino Kaiun Kaisha, Ltd, is a shipping company.
It, however, has no other LNG interests: therefore K-Line was able, in relation
to the Vessels, to apply its preferred model, with a group member (in this case
K-Euro) operating the Vessels. This has not generally been the case in
relation to other LNG vessels in which the K-Line group has an interest.
K-Euro has not acted as disponent owner of any other LNG vessels. K-LNG (the
successor, since 2006, to K-Euro’s LNG carrier business) is, however, the
disponent owner of an LNG vessel of which it took delivery in 2007: that is a
vessel in which the K-Line group has a full ownership interest through a UK finance lease. Different considerations apply to the ownership and operation of bulk
carriers, and K-Euro (and the successor to its bulk carrier business, K-Bulk)
has entered into time charter arrangements for most of its bulk carrier fleet.
The 2006 reorganisation of K-Euro’s business and share capital
240.With effect
from 1 January 2006 K-Euro reorganised its business at the direction of
K-Line. In summary, K-Euro retained only the bareboat and time charters in
respect of the Vessels, and all other parts of its business were transferred to
newly-formed UK subsidiary companies of K-Line (see paragraph 97 above).
241.Further,
since the personnel, expertise and other operative parts of the LNG business
had been transferred to K-LNG, K-Euro contracted with K-LNG by means of a ship
management contract for that company to carry out all the ship management
functions in respect of the Vessels. K-Euro remains liable to the Snøhvit
Sellers, as time charterers, for the operation of the Vessels as required by
the terms of the time charter, and liable to Northern LNG to perform the
obligations imposed by the bareboat charter.
242.In a related
transaction, in October 2006 the share capital of K-Euro was reorganised, with
the result that each of the Snøhvit Sponsors held a proportionate share of the
K-Euro share capital corresponding to their respective proportionate shares in
the share capital of Northern LNG I and Northern LNG II respectively. In the
course of that share capital reorganisation additional share capital was
subscribed to K-Euro.
243.The principal
reason for the reorganisation was to deal with anticipated losses in K-Euro in
respect of the operation of the Vessels; it had two further benefits in that it
enabled the bulk business to be brought within the UK tonnage tax regime; and
it freed the future development of the business from restraints imposed under
the UK finance lease documentation.
244.The hire for
the Vessels which K-Euro receives under the time charter is fixed, subject to
an escalation factor for certain parts of the Operating Cost Element of the
hire. There is a review mechanism at the end of each five-year period.
Correspondingly, the hire it pays under the bareboat charter is fixed (at least
for 12 years). Its operating costs of crewing, maintaining, provisioning and
repairing the Vessels are not fixed costs: they are subject to market
conditions. To the extent that they are not recovered out of the Operating
Cost Element of the time charter hire K-Euro suffers a loss in relation to this
part of its business.
245.In the years
following 2002 there was a significant increase in the number of LNG carriers
world-wide, and a consequent shortage of the specialist crew required for such
vessels. Crewing costs increased rapidly, outside the expected trend.
Exchange rate movements exacerbated the shortfall where (as in the case of
K-Euro) hire was received in one currency (US dollars) and a significant
portion of the crewing costs were payable in “stronger” currencies (such as the
Norwegian Krone).
246.It became
apparent to K-Euro, and to K-Line and the other Snøhvit Sponsors, well in
advance of delivery of the Vessels, that K-Euro would, following delivery, be
operating the Vessels at a significant loss. The Snøhvit Sellers had agreed
their deal in terms of the time charter hire, and were not minded to
renegotiate that deal.
247.In January
2003 K-Line wrote to the other Snøhvit Sponsors setting out its views that the
original understanding was that the risk of losses from operational expenditure
in running the Vessels would be shared by the Snøhvit Sponsors. K-Line set out
its proposals for those risks which it considered should be borne by K-Euro
(and in doing so K-Line referred to the need to ensure that K-Euro retained its
position as a “UK bona fide shipping company” for the tax purposes of the lease
structure), and a number of ways in which the arrangements might be
re-structured to achieve the sharing of risk. These proposals were not
acknowledged or taken up by the other Snøhvit Sponsors.
248.The Snøhvit
Sponsors, as economic owners of the Vessels through their shareholdings in
Northern LNG, did eventually accept that they should indirectly take a share of
the risks of K-Euro’s anticipated losses in respect of the operation of the
Vessels. To that end it was agreed that K-Euro would become, in effect, a
special purpose company (that is, its sole business would be that of operating
the Vessels), owned by the Snøhvit Sponsors. The Snøhvit Sponsors also agreed
to reduce the bareboat hire by approximately five per cent for a period of
three years following delivery. Finally, they agreed to become shareholders in
K-Euro, as implemented in K-Euro’s share capital reorganisation in October
2006, and to contribute further share capital to K-Euro.
249.The transfer
out of all the non-Snøhvit business ensured that the rest of K-Euro’s business
was unaffected by the risk of losses arising from the operation of the Vessels
and remained wholly within the ownership of the K-Line group.
250.The
reorganisation also resolved two constraints on the development of the
remaining part of K-Euro’s business. First, commercial developments and the
growth of the bulk carrier market meant that it was beneficial to bring the
bulk carrier business within the tonnage tax regime and for that purpose that
business had to be separated from the LNG carrier business. Secondly, the
security arrangements in relation to the UK finance leasing of the Vessels, and
in particular floating charges given over the assets and business of K-Euro,
required K-Euro to seek the consent of the relevant parties having the benefit
of those charges for any major business transactions, and K-Line saw this as a
potential limitation on its freedom to operate and expand its business based in
the UK.
251.As a result
of the reorganisation and the contracting out of the management of the Vessels
to K-LNG, the audited report and financial statements of K-Euro (then renamed
as Polar LNG Shipping (UK) Limited) for the year to 31 December 2006 (the year
in which the Vessels were delivered) show the principal activity of the company
to be “the operation and management of two LNG vessels”. Turnover for that
year is US$27.655m and there is an after-tax loss of US$0.005m. The company is
shown as having one employee (that employee is part-time, and is a partner in a
London firm of solicitors with a shipping practice who is not involved in
operational matters). It retained directors (including Mr Misaki) expert in
the operation of LNG carriers. The financial statements also show the
reorganised share capital of K-Euro and a loan from shareholders to the
company.
The operation of the Vessels
252.As set out
above, from 2002 K-Euro engaged management and technical staff (by way of
secondment from K-Line as well as recruitment in the market) in anticipation of
the delivery of the Vessels and to develop the business of its bulk and gas
division.
253.The operation
of the Vessels by K-Euro extends to the supply and management of the crewing
arrangements, the technical management of the Vessels, their commercial
management, the arrangement of insurance cover, the provisioning of the Vessels
in port, and the provision of accounting and financial management systems.
254.In 2003 the
decision was taken to outsource the crewing of the Vessels to a third party. A
principal reason for this was that K-Euro decided that officers and senior crew
operating ships in the Atlantic Basin should be Europeans (and preferably
Scandinavians, given the Norwegian “home” terminal used by the Vessels), and
the K-Line group had limited experience of such crews. After a tender process,
in the course of which crewing and training and other procedures were
finalised, K-Euro appointed a crew management company, OSM, to supply and
manage the crew for each of the Vessels. The appointment was finalised in
January 2005, and crew recruitment began immediately thereafter.
255.K-Euro is
responsible under the time charter for all aspects of technical operation of
the Vessels, including arranging dry-docking of the Vessels, inspecting the
Vessels, arranging repairs and maintenance, complying with safety management
and environmental protection systems, and complying with LNG cargo handling
procedures. In view of the specialised nature of LNG cargoes and carriers,
technical management is usually carried out as part of the operation of the
vessel rather than separately out-sourced to a third party.
256.Likewise, the
commercial management of the Vessels, the arrangement of insurance, the
provisioning of the Vessels in port, and the provision of accounting systems is
the responsibility of K-Euro under the time charter.
257.Under the
Ship Management Agreement K-LNG provides the agreed management services (crew
management, technical management, insurance arrangements and accounting
services) to K-Euro in relation to the Vessels as agent for K-Euro. Those
services do not extend to matters of commercial management. K-Euro, through
the agency of K-LNG, bears the costs of operating the Vessels in relation to
the matters managed by K-LNG and K-Euro pays a fixed daily fee to K-LNG for the
management services it provides.
Issue 1: is K-Euro responsible for defraying all, or substantially all,
expenses in connection with the Vessels?
258.The first
issue we are required to decide is whether, within the terms of section 123(1)
CAA 2001, K-Euro, as the person who lets the Vessels on charter, is responsible
for defraying all expenses in connection with the Vessels throughout the period
of the charter or substantially all such expenses other than those directly
incidental to a particular voyage or to the employment of the Vessels during
the charter period.
259.It is helpful
to set out here once more the provisions of section 123(1) CAA 2001:
(1) A ship is used for a qualifying
purpose at any time when it is let on charter in the course of a trade which
consists of or includes operating ships by a person who is—
(a) resident
in the United Kingdom or carries on the trade there, and
(b) responsible
for navigating and managing the ship throughout the period of the charter and
for defraying—
(i) all
expenses in connection with the ship throughout that period, or
(ii) substantially
all such expenses other than those directly incidental to a particular voyage
or to the employment of the ship during that period.
260.For the
purposes of this issue, and having regard to the terms of section 123(1) CAA
2001, it is common ground that K-Euro is resident in the UK, and that it is
responsible for navigating and managing the Vessels throughout the period of
the time charter. It is assumed that the Vessels are let on charter by K-Euro in
the course of a trade which consists of or includes operating ships (this is a
matter of dispute – it is the subject of Issue 2).
261.The
Appellant’s case is that K-Euro is responsible for defraying substantially all
expenses in connection with the Vessels throughout the charter period, other
than those that relate to a particular voyage or the particular employment of
the Vessels, which are the responsibility of the Snøhvit Sellers as time
charterers. The Appellant relies on the terms of the time charter for
establishing the different responsibilities attaching to the respective
parties. The Appellant further argues that the hire payments made by the
charterers are, regardless of the way they fall to be computed, payments for
hire of the Vessels and not a reimbursement of K-Euro’s costs.
262.The
Commissioners’ case is that the effect of the provisions in the time charter
for the payment of hire as it relates to the Operating Cost Element is that
substantially all the operating costs of the Vessels are borne by the Snøhvit
Sellers as time charterers since they are reimbursing K-Euro for such costs.
Accordingly, they say, K-Euro is not responsible for defraying such costs.
The Appellant’s submissions
263.Mr Peacock
began by drawing attention to what he regarded as two oddities in the drafting
of these provisions. First, that the qualification or exception for the
expenses which it is permitted for the end-user charterer (rather than the ship
operator) to defray (“…those directly incidental to a particular voyage or to
the employment of the ship during that period”) is limited to the second
category (i.e. sub-paragraph (1)(b)(ii)) (“substantially all such expenses”)
and does not extend to the first category (i.e. sub-paragraph (1)(b)(i)) (“all
expenses”). Secondly, that within that permitted exception, whilst “expenses
…directly incidental to a particular voyage” clearly differentiates
voyage-specific expenses (such as fuel for a voyage) which the user of a ship
is likely to bear under a time charter from the general charter costs of the
ship operator, “expenses …directly incidental …to the employment of the ship”
is, on its face, a broad concept.
264.As to the
first of those points, Mr Peacock referred to the antecedent legislation and
its evolution in the course of Finance Bill debates, from which it appeared
that the exception for voyage-specific and ship employment expenses more
clearly applied in the case of both categories (that is, to qualify “all
expenses” as well as “substantially all such expenses”). However, since K-Euro
is, in his submission, within the circumstances of the second category (that
is, it is responsible for defraying substantially all of the expenses in
connection with the Vessels throughout the relevant period), K-Euro’s case did
not require us to decide upon this matter of interpretation.
265.The second of
those points is relevant to K-Euro’s appeal, since it is necessary to see what
expenses K-Euro is responsible for defraying having regard to the terms of the
bareboat charter and the time charter and then determine whether the statutory
test is satisfied. Mr Peacock submitted that the expression “expenses
…directly incidental …to the employment of the ship” must take its meaning from
its context (so that it must be a proper cost of the charterer rather than of
the ship operator because it is specific to the use of the ship), but
nevertheless must mean an expense other than a voyage-specific expense. He
gave the example of a cost consequential upon laying up a ship, such as port
dues payable in the port in which the ship is laid up: that is not a cost of a
particular voyage, but is an expense which properly falls to the charterer.
The distinction made in the drafting may also reflect the distinction between
the expenses of a charterer where the ship is hired on a voyage charter, and
those of a charterer where the ship is hired on a time charter.
266.Mr Peacock
next referred to the question of whether K-Euro is “responsible …for defraying”
substantially all the relevant expenses. He pointed out that, by virtue of
section 123(3) CAA 2001, a person is responsible for something if he is
responsible as principal or appoints another person (such as his agent) to be
responsible in his place. He submitted that in the absence of any case law
guidance or statutory definition as to the meaning of “defraying”, the term
should have its ordinary meaning which, by reference to the Oxford English
Dictionary, he argued, is to pay, to pay out, to expend or to disburse money.
The pertinent question is therefore whether, by reason of the chartering
arrangements in relation to the Vessels, K-Euro is responsible for payment of
substantially all of the relevant expenses: the question is not whether
ultimately the cost in economic terms falls on K-Euro.
267.As to the
question of whether K-Euro is responsible for defraying “substantially” all of
the relevant expenses, that should be seen as a practical test or threshold.
He suggested that if at least 70 or 80 per cent of the relevant expenses were
defrayed by K-Euro then it could fairly be regarded as having defrayed
“substantially all” such expenses.
268.Turning to
the terms of the time charter, Mr Peacock referred to Clause 2, which obliges
K-Euro to provide a crew for the Vessels who will undertake the voyages
required by the charterers, and to Clause 6, under which K-Euro agrees to
provide and pay for all the crew and (subject to specified exceptions) “for all
requirements, costs or expenses of whatsoever nature relating to the Vessel and
her Master, officers and crew”. By this means, and having regard to section
123(1) CAA 2001, K-Euro has responsibility for defraying substantially all the
expenses in connection with the Vessel. Conversely, by Clause 7, specified
voyage-related costs (fuel, towage and pilotage, port charges, cargo loading
and unloading) are to be provided or paid for by the charterers at their own
cost unless the Vessel is off-hire (when the cost is for K-Euro’s account).
The specified exceptions to the Clause 6 costs borne by K-Euro (those
exceptions include the cost of modifications necessary for the Vessel to dock
at certain port terminals, or incremental costs of war risk where the
charterers require the Vessel to trade in a war risk zone) Mr Peacock submitted
are either voyage-specific expenses or charterers’ expenses incidental to the
employment of the Vessel, and hence are disregarded for the purposes of the
section 123(1) CAA 2001 test.
269.In summary,
therefore, Mr Peacock submitted that the arrangements for the chartering of the
Vessels are consistent with the terms of section 123 (1) CAA 2001: K-Euro is
responsible for defraying substantially all of the expenses in connection with
the Vessels throughout the period of the charter except for specified expenses
which are directly incidental to a particular voyage or to the employment of
the ship at the instance of the Snøhvit Sellers as charterers.
270.Mr Peacock
then dealt with the question of the payment of hire: despite the terms of the
time charter described above which place on the respective parties obligations
to pay particular costs, is K-Euro reimbursed its costs by means of the hire
payment arrangements so that it cannot be regarded as defraying the costs it
agrees to pay in relation to the Vessels? He referred to the relevant
provisions in the time charter relating to the accrual and payment of hire in
Clauses 8 and 9 and Addendum No 1 (see paragraphs 174 to 183 above). In his
submission Addendum No 1 provides a formula, using the defined concepts of
Capital Element and Operating Cost Element, by which the amount of the daily
hire, in US dollars, is calculated, and that amount so calculated is paid
monthly in advance. What is paid by the charterers, calculated by this means,
is paid as hire. It is not paid by way of reimbursement of K-Euro for the
expenses it has incurred. All ship operators chartering their vessels will
seek to agree a hire which ensures that their capital and operating costs are
recovered together with a profit margin – that does not mean that those costs
are paid by the charterer paying the hire.
271.Mr Peacock
found support for his argument in the terms of Addendum No 1 relating to Fixed
Operating Costs: those are to be calculated, for the first five years from
delivery of the Vessel, by reference to a specified daily amount (which
includes an annual escalation factor at the rate of 2.5 per cent). That daily
amount may be an estimate of anticipated costs for manning, maintaining and
repairing, and dry-docking the Vessel, but it is not a calculation of those
costs as they actually arise: K-Euro is at genuine commercial risk that the
actual costs will exceed the amounts taken to calculate the hire payment –
which in fact is what actually happened when unexpectedly high crewing costs
resulted in K-Euro facing a substantial loss, the prospect of which brought
about the reorganisation of its business in advance of delivery of the
Vessels. It is significant that the parties did not look to the terms of the
time charter as the means to eliminate or mitigate that anticipated loss.
272.As to the
provisions for adjusting the Fixed Operating Cost element of the hire for
subsequent five year periods, Mr Peacock acknowledged that the drafting of
Addendum No 1 is unclear, but he relied on the evidence of Mr Thomassen to the
effect that the Snøhvit Sellers entered into the time charter arrangements on
the basis of fixed costs, so that for each five year period the Fixed Operating
Cost element would be agreed taking into account actual costs for manning,
maintenance etc as they stood in the final year of the preceding five year
period, but with no escalation. Mr Aoki, on the other hand, understood the
bargain to be that a figure would be agreed for each year in the five year
period in respect of the Fixed Operating Cost element based on actual costs for
the final year of the preceding five year period, and with an annual escalation
percentage increase which would be based on the actual annual percentage
increase during that preceding five year period. Whichever of those
interpretations was correct, neither of the parties understood that K-Euro
would recover its actual operating costs by means of the calculation of the
hire payment.
273.As to the
insurance costs, the premiums paid by K-Euro for the agreed insurance cover are
referred to in Addendum No 1 as “Pass Through Costs”. Mr Peacock acknowledged
that there was a direct correlation between the expense defrayed by K-Euro in
paying such premiums and the amount included in the calculation of hire
(although estimated figures are given for the first five years for the purpose
of calculating the daily rate of hire). His principal submission was that the
legal analysis remains that K-Euro defrays the expense of the insurance
premiums, and that remains the case notwithstanding that part of the hire it
receives has been calculated to take account of the amount of such expense.
His further submission was that even if it could be said that the insurance
costs are borne by the time charterers on the grounds that they are reimbursing
K-Euro for its payment of the premiums, since, on the evidence to date, those
costs have averaged less than eight per cent of the costs which K-Euro pays to
K-LNG for the management and operation of each Vessel, it remains the case that
K-Euro is responsible for defraying more than 90 per cent of the expenses in
connection with the Vessel, and thus “substantially all” such expenses.
The Commissioners’ submissions
274.We were
assisted by submissions made by Mr Cooper on behalf of the Commissioners. His
submissions related to the nature and characteristics of a time charter and the
allocation of control, risk and cost between the disponent owner and the time
charterer, and he compared “standard” time charter arrangements (such as those
to be found in the Shelltime 4 charter, a common form of tanker charter) with
those entered into between K-Euro and the Snøhvit Sellers. His submissions
were pertinent to Issues 2 and 4, as well as to Issue 1, and for convenience we
record them here.
275.Mr Cooper
referred us first to the authorities as to what constitutes a time charter, and
in particular Wilford on Time Charters (sixth edition) at paragraphs I.4
to I.8. The essential nature of a time charter is that, in contrast to a
bareboat, or demise, charter, it is not a lease of a ship, since the owner
retains possession and the time charterer acquires a right to direct the use to
which the owner puts his ship: “A time charter…is a contract for services to be
rendered to the charterer by the shipowner through the use of the vessel by the
shipowner’s own servants, the master and the crew, acting in accordance with
such directions as to the cargoes to be loaded and the voyages to be undertaken
as by the terms of the charter-party the charterer is entitled to give to
them”: Lord Diplock in The Scaptrade [1983] 2 Lloyd’s Rep. 253, at pp
256 and 257.
276.We were also
referred to a more recent statement of the fundamental characteristics of a
time charter, by Lord Hobhouse in the case of Whistler International Ltd v
Kawasaki Kisen Kaisha Ltd [2001] 1 AC 638 at 652, where the contrast is
made with a voyage charter:
“A time charter is different. The owner still has
to bear the expense of maintaining the ship and the crew. He still carries the
risk of marine accidents and has to insure his interest in the vessel
appropriately. But, in return for the payment of hire, he transfers the right
to exploit the earning capacity of the vessel to the time charterer. The time
charterer also agrees to provide and pay for the fuel consumed and to bear the
disbursements which arise from the trading of the vessel.”
277.In Mr
Cooper’s submission, in relation to both the bareboat charter of the Vessels to
K-Euro and the time charter of the Vessels by K-Euro to the Snøhvit Sellers,
the responsibilities between the parties normally accorded by a bareboat charter
and a time charter are blurred both by the terms of the documents themselves,
and the surrounding arrangements. In particular, K-Euro did not have the
commercial autonomy which is to be expected of a disponent owner, since its
role was circumscribed by the control exercised by Statoil and the other
Snøhvit Sellers on the one hand and K-Line and the other Snøhvit Sponsors on
the other. This raises the question of whether K-Euro has a commercial purpose
within the overall arrangements for the financing and chartering of the
Vessels.
278.This is seen,
Mr Cooper argues, in the provisions relating to the payment of hire in Addendum
No 1 to the time charter. First, K-Euro is entitled to pass on directly the
costs of insurance (with the Snøhvit Sellers having a right to review all the
insurance costs and a right to suggest changes to the insurance arrangements,
requiring K-Euro to bear any additional costs if it failed to accept those
suggestions). Secondly, K-Euro is entitled to pass on indirectly the specified
Fixed Operating Costs, with an adjustment mechanism every five years, and with
the Snøhvit Sellers having the ability to scrutinise such costs, and, in the
case of dry-docking costs, to see a budget estimate and a breakdown.
Furthermore, the provisions in Addendum No 1 which provide for an annual
meeting in advance of each calendar year between K-Euro and the time charterers
“for the purpose of establishing [estimated operating costs] with respect to
that year” suggests that there was a mechanism by which annual adjustments
could be made to ensure reimbursement of K-Euro in relation to such costs.
279.Mr Cooper
also drew our attention to the specific provisions in the time charter relating
to dry-docking. He acknowledged that it is not uncommon in a time charter for
the charterer to have a say as to when the dry-docking is to take place, but
the additional rights of the charterers in the present case to review the works
to be done and the costs of dry-docking go beyond the normal protection for
charterers and gives them a greater degree of involvement and, in practice, a
degree of control in relation to such matters.
280.With regard
to insurance, Mr Cooper pointed out that there is specific requirement in the
time charter for K-Euro to arrange for the hull and machinery insurance to
provide for a deductible in a specified amount, and it is provided that the
charterers will bear the cost of such deductible by reimbursing it to K-Euro.
Further, the time charter provides in Addendum No 1 that insurance premiums are
included in the operating element of hire, and by this means the owner is
reimbursed the costs it incurs on such premiums.
281.Mr Cooper
also pointed to arrangements beyond the time charter itself to show that K-Euro
did not, overall, bear the risks of disponent owner. He referred to K-Line’s
letter to the Snøhvit Sponsors of 10 January 2003 with regard to risk
allocation and K-Line’s understanding set out in that letter that the Snøhvit
Sponsors, rather than K-Euro, should take the risks and benefits of operating
the Vessels, as co-owners. He referred to the 2006 reorganisation of K-Euro’s
business and the reduction in the bareboat charter hire. He argued that the
terms of the bareboat charter were unusual in that it imposes substantial
obligations on K-Euro, including the requirement that its rights are
subordinate to the rights of the Appellant as superior lessor, and K-Euro, as
bareboat charterer is required to accept delivery of the Vessel whatever its
condition, notwithstanding that it had no role in supervising construction or
delivery of the Vessel. He referred to certain of the security documents,
under which K-Euro is restricted from amending its rights, and is restricted in
its entitlement to deal with time charter hire payments it receives into its
bank account. In Mr Cooper’s submission all these factors indicated that
K-Euro had no independent or commercial function or purpose in the overall
leasing arrangements.
282.Mr Ewart then
made particular submissions as to the meaning of “responsible for defraying”
and as to what is meant by “substantially all such expenses”, and how those
terms apply in the present case.
283. As to
“defraying”, Mr Ewart submitted that it can mean, depending upon context, both
“to pay” and “to reimburse”, since the person who bears a cost defrays it.
Thus if a party pays an expense but has a right to be reimbursed or indemnified
for his expense by a second party, it is that second party who defrays the
expense because he is legally liable to make the reimbursement or pay out under
the indemnity, and therefore it is he who bears the cost. In the context of
section 123(1)(b) CAA 2001 it is necessary to look to the substantive point of
who bears the expense rather than the formal requirement of who makes the
payment, since that is the way to determine whether the time charter is of the
kind which will constitute a qualifying use.
284.With regard
to the insurance premiums, the terms of Addendum No 1, which, in saying how the
Operating Cost Element is to be determined, refer simply to “Pass Through Costs
– this category covers all premiums of [specified classes of insurance]”, make
it clear that there is a legal obligation on the time charterers to pay those
amounts to K-Euro, in effect by reimbursement, and therefore they, and not K-Euro,
defray that expense. That is the legal position and it accords with the
economic substance of the arrangement between the parties. Addendum No 1 is
less specific in its terms as to the Fixed Operating Costs, but they can be
read as an indirect reimbursement if, each year, there is an adjustment by
reference to the actual costs of the previous year.
285.With regard
to the “substantially all” test, Mr Ewart argued that it is not simply an
arithmetic test of comparing the amount of the expense in question against the
total expenses, as the Appellant had proposed, but it is a question of whether
the amount in question is substantial in its own right and whether, in its
nature and significance, it is peripheral or central. In the present case the
amounts paid in respect of insurance for each of the Vessels were in the order
of US$300,000 to US$400,000 per annum, which is a substantial amount, and those
amounts relate to a matter of central significance to the operation of the
Vessels, namely insurance cover for the Vessels themselves and for loss of hire
and other commercial risks.
286.In summary,
therefore, the Commissioners argue that it is the Snøhvit Sellers, as time
charterers, who defray the operating expenses in connection with the Vessels by
means of their reimbursement of K-Euro through the mechanism of the hire
payment. They argue that this is certainly the case with regard to the
insurance premiums paid by K-Euro, and by reason of this alone K-Euro cannot
say that it is responsible for defraying substantially all expenses in
connection with the Vessels other than the permitted exceptions of
voyage-specific expenses and expenses incidental to the employment of the
Vessels.
Discussion
287.As the case
developed in argument before us Issue 1 became focused on the rather narrow and
specific question of the proper interpretation of just two pages of the time
charter, namely those parts of Addendum No 1 which relate to the Operating Cost
Element of the hire rate payable by the Snøhvit Sellers as time charterers to
K-Euro as disponent owner.
288.The
Commissioners did not dispute the basic proposition put forward by the
Appellant that, under the bareboat charter and the time charter, K-Euro alone
is obliged to pay the expenses which, in the terms of section 123(1)(b) CAA
2001, are the “expenses in connection with the ship” throughout the period of
the charter (other than those expenses which are the permitted exceptions).
289.Mr Cooper
argued that there are unusual features of both the bareboat charter and the
time charter, and that, having regard to those and the wider arrangements
between the parties, K-Euro should not be regarded as having the control or
commercial role which one would expect to find were it in reality a disponent
owner of the Vessels. But those points go to the question of whether K-Euro
was letting the Vessels on charter in the course of a trade of operating ships
(Issue 2) and the question of whether a main object of the bareboat charter and
the time charter was to enable writing-down allowances to be claimed (Issue 4),
and we deal with those points, as appropriate, below when considering those
Issues.
290.Mr Cooper
also argued that it was never the intention that K-Euro should incur losses,
and that when the likelihood of such losses arose K-Line was quick to remind
the Snøhvit Sponsors of that fact and to seek to mitigate them (as eventually
happened by means of the 2006 reorganisation). But (and rightly in our view)
that was not advanced as an argument that K-Euro was not liable for the
expenses which, had it not been for the mitigating action, would have given
rise to such losses.
291.As we have
summarised in paragraph 268 above, Mr Peacock took us in some detail through
the terms of the time charter to identify the liabilities and costs imposed
upon K-Euro and those imposed upon the time charterers. His analysis, which we
accept, is that the liabilities and expenses reserved to the time charterers
are limited to those which, in the terms of section 123(1)(b) CAA 2001, are
“directly incidental to a particular voyage or to the employment of the
[Vessel] during” the period of the charter, and that all other liabilities and
expenses in connection with the Vessel throughout the charter period are the
responsibility of K-Euro.
292.The
Commissioners also accept, it would appear, that K-Euro remains liable (or, in
the terms of section 123(1)(b) CAA 2001, responsible) to pay such expenses
notwithstanding that, following the 2006 reorganisation, it is K-LNG, as the
manager of the Vessels appointed for the purpose by K-Euro, which contracts
with third parties and makes payment to them. That would in any event in our
view be the correct analysis, having regard to the principal and agent
relationship created by the Ship Management Agreement and having regard also to
the provisions of section 123(3) CAA 2001.
293.Before
turning to the detail of its hire payment provisions we have some general
observations to make about the time charter.
294.First, we
note that the time charter, both in its general shape and its particular
provisions, is designed to meet the requirements of the Snøhvit Sellers.
Statoil, through the particular agency of Mr Thomassen, conceived it and Mr
Thomassen was its principal architect. All the material terms (at least as to
their principle) were in place when it was put out to tender, although those
terms were refined in the tender process and the exact financial terms were
negotiated in the course of that process. The Snøhvit Sellers were clear that
although they needed a long-term and reliable arrangement to ship their LNG to
fulfil their long-term supply contracts, they did not want to own or operate
the tankers required for that task, but instead would entrust those functions
to shipowners with the relevant expertise. By means of the provisions in the
time charter they sought to provide for their requirements, and to
differentiate between the respective responsibilities of the shipowner/operator
and themselves as users of fully operating and provisioned vessels.
295.The Snøhvit
Sellers required a long-term arrangement for the use of each of the Vessels,
which were ships designed and built for the particular purpose of shipping LNG
from the far northerly terminal constructed by the Snøhvit Sellers onshore from
the gas fields. A time charter for a term of at least twenty years and
possibly thirty years is unusual in relation to general shipping, but Mr
Thomassen’s evidence (which we have no reason at all to doubt) is that at the
time of the tender process such long-term charters were generally a feature of
the then nascent LNG carrier trade – producers required such arrangements for
the reasons that the Snøhvit Sellers required them. It explains a number of
the features of the time charter, including the following: that the shipowner
recovers, or largely recovers, the cost of the Vessel over the term by means of
the hire received; that the shipowner recovers by the hire received its costs
of operating the Vessels and also the opportunity to make a profit margin; that
the time charterers are kept informed of key items of the shipowner’s
expenditure, such as insurance, when they are to be factored in to the hire
paid; and that the time charterers have a close involvement in key issues
relating to when the Vessel is out of service, such as the timing and extent
and estimated cost of dry-docking.
296.The time
charter was not structured with the terms of section 123 CAA 2001 (or, indeed,
of any other UK tax provision) in mind. At the time Mr Thomassen and his
colleagues drew up the terms of the time charter in early 2001 they had no knowledge
of or interest in such matters. Nor did they have any reason to think that a
shipowner who might successfully tender for the time charter would have any
such interest. It is true that by the time the time charter was entered into
K-Line were contemplating a UK finance lease as a means of financing the
Vessels, and the time charter anticipates that a novation may be required to
accommodate whatever means K-Line pursues to finance the Vessels, but that was
not, as far as we can see, an influence on the terms of the time charter.
297.Turning to
the detail, and the case each party argued before us with regard to Issue 1,
the essential difference between them is whether K-Euro is reimbursed by the
time charterers for certain of the operating expenses it incurs in relation to
the Vessels so that it is they, and not K-Euro, which is responsible for
defraying those expenses.
298.With regard
to the meaning of “responsible for defraying”, we agree with Mr Ewart that if
party A is liable to pay an expense to party C in circumstances where party B
has agreed unequivocally and by legally binding obligation to reimburse A for
that expense should A incur it, then as a matter of legal obligation (and not
simply as a matter of economic burden or cost) it is correct to say that B is
responsible for defraying that expense. Where we depart from Mr Ewart is in
the interpretation of the relevant provisions of the time charter: we do not
agree that they comprise such a reimbursement arrangement as leads to that
conclusion.
299.The starting
point is that the time charterers are required to pay hire to K-Euro as the
compensation for K-Euro providing the Vessel upon the terms of the time
charter. That hire accrues in accordance with Addendum No 1. There is
specific mechanism for payment of the hire. Addendum No 1 provides that “hire
payable under this Charter shall consist of a Capital Element and an Operating
Cost Element each of which shall be determined in accordance with this Addendum
No 1”. This is followed by provisions which tell us how the Capital Element is
calculated (to give an amount per day) and then how the Operating Cost Element
is calculated (with a specified amount per day for years one to five).
300.Therefore,
that which K-Euro is entitled to receive is hire calculated in a particular way
so as to give a daily rate or amount of hire. It is not, in terms, entitled to
seek reimbursement from the time charterers for an expense it has incurred. If
the hire is not paid K-Euro’s action against the time charterers is for payment
of the hire accrued, not an action to be reimbursed a particular sum which it
has expended. It is perfectly possible to conceive of circumstances where the
time charterers could raise a valid defence to a claim for payment of the hire
(for example, if the Vessel were for some reason not available to the time
charterers) whereas if the contract were one of reimbursement the obligation to
pay would arise once the expenditure in question had been made. That, quite
simply, deals with the point. Taking Mr Ewart’s view as to what constitutes
responsibility for defraying expenses, it is not the case that the time
charterers have agreed to indemnify or reimburse K-Euro in relation to its
expenses and thereby have a legal obligation to meet those expenses: they have
agreed to pay an amount of hire, which is something different.
301.Further, it
cannot be argued that this is reimbursement dressed up as hire. That becomes
clear if we look at that part of the Operating Cost Element referred to in
Addendum No 1 as the Fixed Operating Cost. In the tender process it appears
that the parties, in 2001, fixed on their estimate of what those costs (for
manning, maintenance and repair, and dry-docking) would be for each of the
first five years following delivery (itself some four to five years thence),
incorporating an escalation factor at the annual rate of 2.5 per cent. Those
figures are then shown in Addendum No 1 as a daily amount, and as such, a
component in the calculation of the daily rate of hire. There is nothing in
the terms of the time charter that provides that, during those five years,
those figures are adjusted to take account of the actual operating costs which
K-Euro incurred: they are, as the title given to them suggests, fixed. There
is reference to the parties meeting annually “for the purpose of establishing
estimated operating costs”, but that does not tie in to any mechanism for
adjusting the calculation of the daily rate for any year. Mr Thomassen’s
evidence was that this was an information-sharing exercise to enable the
parties to reach an agreement, when required, as to the level at which costs
should be fixed for the subsequent five-year period.
302.Neither is
there anything in the evidence to suggest that in fact those amounts were
intended to be or were in fact so adjusted. Mr Thomassen’s evidence is that
the purpose of the Fixed Operating Cost provisions was to fix an amount of hire
which would allow the operator to at least meet its estimate of what its
expenses would be, but that an important factor for the time charterers was the
certainty of the amount of hire, at least for each five year period.
303.The matter is
put beyond any doubt, in our view, by what actually happened between the date
of the time charter and delivery. K-Euro discovered that its costs for crewing
the Vessels would exceed very considerably their expectations, so that it knew
it would be faced with a significant loss if matters continued on that basis.
Were it the case that K-Euro was entitled to increase the Fixed Operating Cost
to meet that excess then that would have resolved the point. But it had no
contractual right to do that and the Snøhvit Sellers stood by their side of the
bargain in the time charter: other measures, effected in the 2006
reorganisation, had to be employed to assist K-Euro.
304.There was
some debate as to the agreement between the parties as to the means of
ascertaining the Fixed Operating Cost for the second and subsequent five-year
periods during the term of the time charter. The drafting is obscure, providing,
after a reference to the annual escalation rate, “the applicable rate shall be
reviewed and agreed taking into account the actual costs incurred during the
previous five years period, the Vessel’s age and trades”. Mr Thomassen and Mr
Aoki had different views, as we have referred to above, as to how the costs
would be rebased for a subsequent five-year period and whether or not there
would be an escalation factor and if so, whether that would be based on what
had proved to be the actual incremental increase in actual costs over the
previous five years. Neither of them understood that there would be, as it
were, a recouping in year six, or over the forthcoming five years, of any
shortfall in the operating costs used in the calculation for the previous five
years as against K-Euro’s actual costs for that period. Again, therefore,
there is nothing by way of reimbursement, direct or indirect, in these
provisions.
305.Mr Ewart and
Mr Cooper were more pressing in their case in relation to what are described in
Addendum No 1 as the Pass Through Costs, being the premiums in respect of the
insurance cover which K-Euro was required to put in place. Addendum No 1
provides no more elucidation than that simple description to explain how the
hire rate calculation takes account of such costs. A table for the first five
years sets out a daily rate for each of those years by reference to the
different types of insurance cover, but those amounts are specifically
identified as “estimated”. There is nothing to show if and how such estimated
daily rates are adjusted by reference to actual premiums paid by K-Euro. In
the insurance Appendix to the time charter there is a heading “Reimbursement of
Owner”, but the provision refers simply to Addendum No 1.
306.There was no
clear evidence on the matter, but we are prepared to assume that, by some
adjustment mechanism, that part of the Operating Cost Element in the
calculation of the hire which comprises the Pass Through Costs operates so that
the amount of the hire includes an amount which equals the insurance premiums
paid by K-Euro. This is not the case if and to the extent that K-Euro
disregards the recommendations of the time charterers and in consequence pays a
higher premium.
307.Given our
view that what the time charterers pay and what K-Euro receives is hire for the
use of the Vessel and not reimbursement by them of the expenses which K-Euro
incurs in order to make the Vessel available to them as required by the time
charter, the fact that an element of the hire is calculated by reference to the
actual premiums paid does not result in the time charterers being responsible
for defraying the expenditure on the insurance premiums, even taking account of
Mr Ewart’s definition of that concept.
308.If we are
wrong in that, so that in paying the hire representing the Pass Through Costs
the time charterers, rather than K-Euro, are responsible for defraying the
insurance premiums, can K-Euro nevertheless rightly claim that it remains
responsible for defraying “substantially all” the expenses of operating the
Vessel?
309.The phrase is
“all…or substantially all”. That does, it seems to us, look essentially to the
quantum (or proportion of quantum) of the expenses rather than to their nature:
“all” (certainly with regard to a group of expenses) is the totality or
aggregate without any concept of nature or characteristic, and where that
totality is qualified to indicate something less than the totality or aggregate
it requires clear language to introduce the concept of nature or characteristic
to show that the totality is to be qualified by reference to such concepts.
“Substantially all” does not do that. There is nothing in the context of the
provision which points to the exercise Mr Ewart would have us carry out,
attributing a significance to the different expenses (in his terms, central or
peripheral) to judge whether or not a threshold has been reached. The purpose
of the provision is to enable the qualifying use test to apply notwithstanding
that some of the ship operating costs – a small proportion relative to all of
them –are met by the user of the ship: the nature of the costs which the user
meets is not a factor.
310.In the
present case in each year to date K-Euro has been responsible for defraying
more than 90 per cent of the ship operating costs even if it is the case that
it is not responsible for defraying those costs which relate to insurance. We
consider that it has therefore been responsible for defraying substantially all
expenses in connection with the Vessels throughout the charter period,
other than those directly incidental to a particular voyage or to the
employment of the ship during that period.
311.Accordingly,
we decide Issue 1 in the Appellant’s favour.
Issue 2: does K-Euro let the Vessels on charter in the course of a trade
which consists of or includes operating ships?
312.The second
issue we are required to decide is whether K-Euro lets the Vessels on charter
in the course of a trade which consists of or includes operating ships – it is
a requirement of section 123(1) CAA 2001 that it should so let the Vessels if
they are to be regarded as used for a qualifying purpose.
313.The question
of whether K-Euro lets the Vessels in the course of a trade looks to the period
beginning with the delivery of the Vessels in 2006. By that time the 2006
reorganisation of K-Euro’s business had taken effect, so that its only activity
was taking hire of the Vessels under the bareboat charter and hiring the
Vessels to the Snøhvit Sellers under the time charter. Pursuant to those
arrangements K-Euro was responsible for operating the Vessels, and it
contracted out the tasks required to do that to K-LNG under the Ship Management
Agreement.
314.The
Appellant’s case is that K-Euro was engaged in the activity of operating the
Vessels; that it carried on a trade consisting of operating ships; that it let
the Vessels on charter; and it did so in the course of its trade. Any fiscal
motive which there may have been on the part of K-Euro or on the part of K-Line
in requiring K-Euro to participate in the transactions comprising the letting
of the Vessels is not relevant to the question of whether a trade is actually
carried on by K-Euro.
315.The
Commissioners’ case is that, if one looks to the overall arrangements entered
into by all the relevant parties, K-Euro’s part in those arrangements with
regard to the hiring and operating of the Vessels lacked commerciality.
Therefore, although K-Euro lets the Vessels as a matter of the contracts it
entered into, it does not do so in the course of a trade.
The Appellant’s submissions
316.Mr Peacock submitted
that there was no challenge to the reality of the transactions which K-Euro has
engaged in and, given the evidence, no basis for any such challenge. K-Euro
has taken a lease of the Vessels under the bareboat charter and has let the
Vessels on time charter terms to the Snøhvit Sellers. It is responsible for
the operation of the Vessels and has engaged K-LNG to ensure that the Vessels
are properly operated so that those responsibilities are discharged. Those
responsibilities extend to the crewing, supplying and provisioning of the
Vessels; their technical and commercial management; maintaining the requisite
insurance cover; and providing record-keeping and accounting services. In
carrying out those activities on K-Euro’s behalf K-LNG employs the services of
a substantial number of staff. All those transactions are in themselves
commercial and of a trading nature.
317.Mr Peacock
further submitted that even if (which the Appellant did not accept) there was a
fiscal motive on the part of those entering into the transactions in that they
procured that K-Euro should take the role of disponent owner in order to enable
the Appellant to claim capital allowances, such a motive is not relevant to the
question of whether K-Euro is actually carrying on a trade. He referred to F.A.
& A.B. Ltd v Lupton (Inspector of Taxes) [1972] AC 634 as authority for
the proposition that it is necessary to look at the form and characteristics of
what is said to be the relevant trading transaction to determine whether it is
such, not whether that transaction was motivated by an intention to achieve a
particular tax benefit or result. Fiscal considerations, such as the
availability of capital allowances, may be the paramount inducement for a
taxpayer to enter into a transaction, but that is relevant only if it affects
the commerciality of a transaction because then it will no longer be a trading
transaction in its form and characteristics: Ensign Tankers (Leasing) Ltd v
Stokes (HM Inspector of Taxes) 64 TC 617 at 697 (the judgement of Millet
J). Mr Peacock also referred us to the decision of the Court of Appeal and its
review of authorities in New Angel Court Ltd v Adam (HM Inspector of Taxes)
[2004] 1 WLR 1988 and the decision of the House of Lords in Barclays
Mercantile Business Finance Ltd v Mawson (HM Inspector of Taxes) [2005] 1
AC 638.
318.Mr Peacock
also argued that any fiscal motives which there might have been on the part of
the Appellant or K-Line or the Snøhvit Sellers in structuring the transactions
so that capital allowances were available to the Appellant could have no
bearing on the question of whether the activities of K-Euro amounted to a
trade, just as in the Ensign Tankers case the fact that the partners in
the limited partnership in that case were motivated by the wish to obtain
capital allowances did not impugn the trading nature of the activities of the
limited partnership itself.
The Commissioners’ submissions
319.We have
already referred to Mr Cooper’s submissions with respect to the terms of the
bareboat charter and the time charter which K-Euro entered into and his
argument that K-Euro had no independent or commercial function or purpose in
the overall leasing arrangements (see paragraphs 277 to 281 above).
320.Mr Ewart
developed this line of argument. He said that the evidence showed that K-Euro
had exercised no independent action in entering into the leasing arrangements,
but had simply done what K-Line had told it to do: there was no commercial
negotiation carried out by K-Euro and no commercial reason why K-Euro should
become the disponent owner of the Vessels. The evidence showed that K-Line was
concerned to structure the arrangements so that K-Euro would earn just such a
profit as would enable it to claim that if was “a bona fide shipping company”,
so that the capital allowances would be secured. By the time the Vessels were
delivered, K-Euro’s role had diminished to virtually nil, since all the
activities were carried out by K-LNG, and K-Euro’s only employee had company
secretarial functions only. The transactions it entered into were not in
reality transactions which had the form and characteristics of the trade of
chartering ships, but were transactions which were designed to achieve a tax
benefit and for that purpose were given the colour of trading. It could not be
said that K-Euro acted in a commercial manner with regard to the Vessels. Mr
Ewart did not disagree with Mr Peacock’s understanding of the ratio of the
decision in F.A. & A.B. Limited v Lupton. In his view K-Euro’s
circumstances fell within the scope of that decision, since the absence of any
commerciality on K-Euro’s part with regard to the transactions and the
chartering of the Vessels resulted in those transactions lacking the
characteristics of a trade.
Discussion
321.The question
we have to decide is whether K-Euro is carrying on a trade consisting of or
including operating ships and if so whether the Vessels were let on charter in
the course of that trade. As mentioned, that question falls to be answered by
reference to K-Euro’s activities in the period beginning with the delivery of
the Vessels (strictly, the delivery of the first of the Vessels, in February
2006).
322.By that time
K-Euro was a quite different animal from what it had been prior to the 2006
reorganisation. Its audited report and financial statements for the year ended
31 December 2005 give an indication of the nature and extent of its activities
in the period immediately prior to the 2006 reorganisation (see paragraph 216
above). After the reorganisation it had shed all its activities save for the
chartering of the Vessels, and it had outsourced the operation of the Vessels
to K-LNG. Its audited report and financial statements for the year ended 31
December 2006 show how matters stood following the reorganisation and the
commencement of the chartering of the Vessels once they had been delivered (see
paragraph 251 above).
323.In answering
the question as to whether or not K-Euro is trading in the
post-delivery/post-reorganisation period it seems to us that we should have
some regard to K-Euro’s activities in the preceding period. This is so for at
least three reasons. First, those activities provide, in some measure, a
context in which to judge the nature of the activities in the later period,
especially since the 2006 reorganisation was not in itself motivated by the
need or desire to change the inherent nature of K-Euro’s activities (the need
was to “isolate” the Snøhvit transactions from the bulk carrier and the other
LNG carrier activities). Secondly, the letting of the Vessels, although it
commenced on delivery, was put in place by transactions entered into in that
preceding period (as far back as September 2002 and contemplated in December
2001) and without any expectation of what occurred subsequently in the 2006
reorganisation. Thirdly, the development of K-Euro’s business (both with
regard to the activities undertaken to equip it so as to be in the position
whereby it could operate the Vessels on delivery and with regard to the general
growth of its bulk and gas carrier activities) in the period up to the 2006
reorganisation is relevant to help judge the form and characteristics and also
the commerciality of the position as it stood following delivery of the
Vessels.
324.There is no
significant difference between the parties as to the guidance we should derive
from case law when considering whether or not K-Euro is trading. From the line
of cases which have analysed and applied F.A. & A.B. Limited v Lupton
it is clear that the proper approach is to look to the purported trading
transaction – at what actually happens – and then discern whether, in its form
and character, it is a trading transaction. It is irrelevant that the
transaction was entered into with the intention of securing a tax benefit, such
as obtaining capital allowances for expenditure incurred, unless that results
in the transaction so lacking commerciality that it cannot be said to have the
form and character of a trading transaction.
325.What actually
happens in the case of K-Euro – what it actually did – is that it entered into
a bareboat charter pursuant to which the Vessels have been made available to it
on lease for a substantial period of time. It also entered into a time charter
of the Vessels, again for a substantial period of time, pursuant to which it
has agreed to make the Vessels available on terms whereby it operates the
Vessels at its cost. At the time it entered into those arrangements it
anticipated that it would directly undertake all the operational activities
necessary to meet its obligations to the time charterers, drawing on its
existing expertise and resources utilised in its other shipping activities, and
building further expertise and resources from April 2002 as it expanded its
business in the period running up to anticipated delivery. The 2006 reorganisation
resulted in a different state of affairs: the larger part of K-Euro’s bulk and
LNG carrier businesses, and the expertise, staff and other resources required
to operate them, were transferred out of K-Euro, so that K-Euro, through the
Ship Management Agreement, engaged K-LNG to supply to K-Euro the services and
facilities K-Euro required to operate the Vessels in compliance with the time
charter.
326.Mr Cooper
argued that certain of the features of the time charter were unusual, but we
saw nothing that was uncommercial in the arrangements between K-Euro and the
Snøhvit Sellers: they were negotiated between parties acting at arm’s length
and motivated solely by commercial factors. As we have said, those features
where the time charter may be said to depart from the norm can be accounted for
by the particular requirements of the Snøhvit Sellers acting under Mr
Thomassen’s guidance and by the unusually long term of the time charter (itself
a commercial requirement of the Snøhvit Sellers, and, as Mr Thomassen
explained, at the time of the tender process a requirement generally in the
case of LNG tanker chartering).
327.Mr Cooper
also argued that the bareboat charter had features which called into question
its commerciality. He mentioned the payment of hire which delivered, over the
period of hire, the value of the Vessels to K-Line and the other Snøhvit
Sponsors (the head lessees of the Vessels), and he also mentioned the security
and other arrangements in favour of the Appellant as ultimate owner of the
Vessels whereby certain of K-Euro’s rights were subordinated to the interests
of the Appellant in that capacity. We do not consider that those features are
so significant as to give a particular nature and character to K-Euro’s
transactions. As a matter of commerciality, if a shipowner leases a vessel on
bareboat charter terms for a period of 20 or 30 years then he is likely to seek
a return in the hire he receives which reflects the capital value of the vessel
(and, correspondingly, the charterer in such a case is likely to recover a
corresponding amount when letting the vessel on a long-term time charter). As
to the security and other arrangements, any party financing the purchase of a
vessel (whether by finance lease or loan) is most likely to insist on protecting
– the borrowing party might say over-protecting – its interests and for that
purpose securing the income flow derived from the operation of the vessel so
that it is available to discharge the ultimate financing obligations. An
interim party, such as K-Euro in this instance, has the benefit of the use of
the vessel at a rental which, to a degree, reflects the favourable terms of the
financing, and therefore is indirectly a beneficiary of the financing and might
in consequence expect to be drawn into the security arrangements affecting the
flow through of the income from the vessel. We see nothing uncommercial in
that, although we do note that some of these constraints limited the free hand
which K-Euro had to extend its business (which was a subsidiary reason for the
2006 reorganisation).
328.Mr Ewart
argued in this regard that it was not commercially required that K-Euro should
be a disponent owner of the Vessels – the commercial requirements of the
Snøhvit Sellers would have been met if K-Euro had managed the ship on behalf of
K-Line and the other Snøhvit Sponsors. It is true that Mr Thomassen and his
colleagues required that the person with day-to-day responsibility for
operating the Vessels should be based in a European time zone, and that this
did not necessarily entail that such person should have a property interest in
the Vessels (although there was a preference that this should be the case).
But that is not to say that the transactions actually entered into by K-Euro
with respect to the Vessels were inherently uncommercial. The activity of
managing a vessel is different in nature from that of operating a vessel as
disponent owner. There may be many reasons why a party chooses to undertake
one kind of activity rather than another, including the respective risks and
rewards, the nature of the relationship with a customer, and the consequences
for other existing or proposed business activities. We do not consider that
the transactions actually entered into by K-Euro can be disregarded or denied
as trading transactions because it might have entered into a transaction of a
different nature.
329.Mr Ewart
questioned the commerciality of K-Euro’s transactions on the grounds that it
was little more than a cipher or puppet of K-Line and the other Snøhvit Sponsors.
He pointed out that all the negotiations for the transactions to which K-Euro
was a party had been carried out by K-Line executives in Japan and that the minutes of certain key board meetings had been drafted by K-Line’s
solicitors. He also pointed to the fact that all the activities which K-Euro
was required to carry out to operate the Vessels were devolved to K-LNG.
330.We do not
agree with Mr Ewart’s characterisation of the role of K-Euro. First, we note
that K-Euro was at the material times a wholly-owned subsidiary of the K-Line
group, and therefore, to a large degree, likely to be compliant with the
requests or directions of the group parent company in carrying out transactions
for the ultimate benefit of the group as a whole and for which it had been
identified as particularly suited. That is how large groups of companies
work. It does not mean that the subsidiary so identified and conforming to
such requests and directions by entering into the transactions is acting
uncommercially so as to call into question the trading character of those
transactions – it is necessary to see whether in so conforming it undertakes
activities which comprise its trade or part of its trade.
331.This brings
us to the second point: K-Euro was a company of some significant substance in
April 2002 with a range of shipping and shipping agency activities which it
carried out for its own account as part of the European operations of the
K-Line group. Its directors, in carrying out those activities, were no doubt
answerable to its parent company shareholder, but there is nothing in the
evidence before us to suggest that they acted upon instructions to undertake
activities lacking in commerciality. There is one telling piece of evidence to
the contrary: when the parent company first raised the possibility with
K-Euro’s board in the course of the tender process that it should charter the
Vessels to the Snøhvit Sellers the board were reluctant for K-Euro to be
involved, on the grounds that K-Euro did not have the necessary expertise or
resources for such a specialist task and therefore lacked both the ability to
carry it out and the credibility to tender for it. It appears that there was
also concern about the operational risks which K-Euro might incur. It was only
when K-Line, after the successful tender, set this in the context of its wider
strategy to develop the group’s business in Europe through the local hub
offered by K-Euro, and, in pursuit of that, agreed to enable K-Euro to equip
itself with the expertise and resources required to achieve that, that K-Euro
agreed to take on the chartering of the Vessels.
332.It is
certainly true that negotiation of the lease terms for the financing of the
Vessels which K-Line had agreed to purchase was undertaken by K-Line employees,
and that those terms were reflected in the bareboat charter between Northern
LNG and K-Euro. That is not surprising since K-Line itself (through its
shareholding in Northern LNG) had a principal interest in the head lessee, and
it is reasonable to assume that financing expertise resided in the finance
department at the group’s head office and not with the operating subsidiaries.
We do not think that that tells against the commercial nature of K-Euro’s
activities with regard to the chartering of the Vessels. Nor do we attribute
much significance to the fact that certain key board minutes were drafted in
part by the solicitors acting for the K-Line group in the leasing transactions:
the question is not who drafted the minutes, but whether they are a proper
account of the deliberations and decisions of the board at the meeting of which
they purport to be a record. We saw no evidence that this was not the case,
nor was there any challenge to the competence of the directors to exercise a
judgement or reach a decision on the matters in question.
333.The third
point is that, once K-Euro had entered into the bareboat charter and taken a
novation of the time charter, it set about the task of equipping itself to
ensure that it could operate the Vessels in accordance with the obligations it
had undertaken in those documents. This was carried out in the broader context
of K-Euro establishing a bulk and LNG carrier business according to a phased
business plan which the board of K-Euro regularly reviewed. Mr Misaki’s
evidence was clear and compelling in this regard. Staff were engaged (both by
secondment from K-Line and by direct recruitment) with the necessary range of
technical and commercial management expertise; where specialist services were
required which could not be supplied by internal expertise (for example, the
engagement and management of crew with knowledge of North Atlantic waters and
seaboard ports and with relevant language skills), supply contracts were
entered into with appropriate specialist suppliers; and throughout there was
full liaison with the Snøhvit Sellers.
334.Taking these
points together we have no hesitation in concluding that K-Euro’s activities
have the form and characteristics of trading. Both with regard to the
operation of the Vessels and the broader business of which the operation of the
Vessels formed a part, it was engaged on its own account in a serious,
substantial and properly managed business endeavour. That endeavour was
intended to result in a profit which reflected both a management fee and a
mark-up on operating costs, and thus a profit which accorded with K-Euro’s
position as an operator rather than a manager, and which also took account of
the risks of that position. As it happened those risks eventually proved to be
real: certain market conditions moved against K-Euro (especially as to the cost
of manning the Vessels) and it became clear that losses would result once the
chartering arrangements took effect on delivery of the Vessels. It therefore
cannot be said that the trading nature of those activities falls to be
disregarded – that in fact they cease to be trading activities – because they
lack commerciality.
335.The only
remaining question is whether there should be a different conclusion having
regard to the post-2006 reorganisation of K-Euro’s business and share capital,
since it was in this pared-down form that K-Euro actually embarked upon the
operation of the Vessels. We think not. For the reasons we have already
given, the pre-reorganisation position must inform the nature of the post-reorganisation
activities of K-Euro. Further, K-Euro retained the obligations to operate the
Vessels after the reorganisation to the same extent as before, and discharged
those obligations at its own cost. That it discharged those obligations through
the management agency provided by K-LNG supplying the necessary services to
K-Euro cannot change the form and characteristics of the ship operating
activities undertaken by K-Euro. It does not matter whether the twenty or more
individuals who, by Mr Misaki’s evidence, are variously engaged in the variety
of activities required to operate the Vessels, are directly engaged by K-Euro,
or whether instead K-Euro has the benefit of their endeavours by means of the
services and management contract it has entered into with K-LNG.
336.The only
material difference consequent upon the 2006 reorganisation is that the
activities of K-Euro have been reduced so that its sole activity is the
operation of the Vessels: that activity is no longer part of a wider business
enterprise, and on any basis K-Euro’s trading activities must be regarded as
shrunken. Have they been shrunken to the point that they no longer comprise a
trade? We do not think that this is the case. The operation of a single
vessel is in itself a substantial business venture. The audited report and
financial statements of K-Euro for the year ended 31 December 2006 indicate the
size of the business retained by K-Euro by reference to its turnover. It is
the case that it retains a trade by virtue of chartering and operating the
Vessels alone.
337.We therefore
conclude that K-Euro lets the Vessels on charter in the course of a trade which
consists of or includes operating ships.
338.Accordingly,
we decide Issue 2 in the Appellant’s favour.
Issue 3: does section 123(4) CAA 2001 apply in the circumstances where
section 110 (rather than section 109) CAA 2001 is in point, namely where there
is overseas leasing and no qualifying purpose but the taxpayer is entitled to
no allowances instead of 10 per cent allowances?
339.This is a
narrow point of statutory interpretation of the terms of section 123(4) CAA
2001. It is helpful to set out the subsection here:
(4) Subsections (1) and (2) do not apply if
the main object, or one of the main objects—
(d) of the letting of the ship … on charter,
(e) of a series of transactions of which the
letting of the ship … on charter was one, or
(f) of any of the transactions in such a
series,
was to obtain a writing-down allowance
determined without regard to section 109 (writing-down allowances at 10%) in
respect of expenditure incurred by any person on the provision of the ship or
aircraft.
340.In general
terms (and disregarding for the moment the points on statutory construction
advanced by the Appellant which are the subject of Issue 3) the purpose of
section 123(4) CAA 2001 is (in the present case) to deny a person who has
incurred capital expenditure on a ship the right to claim capital allowances
even if he has satisfied the requirements of section 123(1) CAA 2001 (and has
therefore shown that the ship is used for a “qualifying purpose”). This is so
if the main object, or one of the main objects, of relevant transactions was to
obtain a writing-down allowance. The substantive question of whether or not
the Appellant is denied allowances by reason of the “main object” test is Issue
4 between the parties.
341.However, the
Appellant first argues that that substantive question is never asked, because
of the way in which the closing words of section 123(4) CAA 2001 are drafted.
The Appellant argues that in its circumstances, if it does not show “a
qualifying purpose”, it is within the scope of section 110 CAA 2001 (which
denies a right to all allowances) and not within the scope of section 109 CAA
2001 (which reduces the amount qualifying for allowances from 25 per cent to 10
per cent), and therefore it can never be said to have a main object of
obtaining “ a writing-down allowance determined without regard to section 109
…in respect of expenditure incurred on the provision of” the Vessels.
342.The
Commissioners argue that the Appellant’s construction cannot be supported on
the grounds of the legislative history of the provisions in question, the logic
of the language in section 123(4) CAA 2001, or policy. They argue that section
123(4) CAA 2001 is an anti-avoidance provision, and it would be absurd if it
applied in circumstances where, under the “qualifying purpose” rules, a
taxpayer would claim 10 per cent (rather than 25 per cent) writing-down
allowances, but not in the more “offensive” cases where his circumstances would
preclude him from claiming any allowances whatsoever.
343.Both parties
sought to rely on the rather complex legislative history of what is now section
123(4) CAA 2001 and related provisions. We have outlined in paragraphs 9 to 14
above the legislative history of the “qualifying purpose” provisions as they
relate to ships let on charter. The provisions of CAA 2001 are a product of
the Tax Re-write project, but in relation to section 123(4) CAA 2001 there is
nothing in the Explanatory Notes issued with the legislation to suggest that
any change in the law was intended or thought to have been made by the
re-write.
344.The immediate
predecessor legislation is the consolidation statute, the Capital Allowances
Act 1990. In that statute the provisions of section 123 CAA 2001 are found in
section 39 and the provisions of sections 109 and 110 CAA 2001 are found in
section 42. Both parties made reference to those provisions, and it is helpful
to set them out here.
345.The relevant
parts of section 39 Capital Allowances Act 1990 are as follows:
(6)Without prejudice to subsections (1) to (5)
above but subject to subsection (8) below, a ship is also used for a qualifying
purpose at any time when it is let on charter in the course of a trade which
consists of or includes operating ships if—
(a)the person
carrying on the trade is resident in the United Kingdom or carries on the trade
there, and
(b)that person is
responsible as principal (or appoints another person to be responsible in his
stead) for navigating and managing the ship throughout the period of the
charter and for defraying all expenses in connection with the ship throughout
that period or substantially all such expenses other than those directly
incidental to a particular voyage or to the employment of the ship during that period.
(7)…..
(8)Subsection (6) above does not apply if the
main object, or one of the main objects, of the letting of the ship or aircraft
on charter, or of a series of transactions of which the letting on charter was
one, or of any of the transactions in such a series was to obtain—
(a)if the expenditure
in question is old expenditure, a first-year allowance, or
(b)if the expenditure
in question is new expenditure, a writing-down allowance of an amount
determined without regard to section 42(2),
in respect of expenditure incurred on the
provision of the ship or aircraft whether that expenditure was incurred by the
person referred to in subsection (6)(a) above or some other person.
346.The relevant
parts of section 42 Capital Allowances Act 1990 are as follows:
(1)This section has effect with respect to
expenditure on the provision of machinery or plant for leasing where the
machinery or plant is at any time in the requisite period used for the purpose
of being leased to a person who—
(a)is not resident in
the United Kingdom, and
(b)does not use the
machinery or plant for the purposes of a trade carried on there or for earning
profits or gains chargeable to tax by virtue of section 830(4) of the principal
Act,
and where the leasing is neither short-term
leasing nor the leasing of a ship, aircraft or transport container which is
used for a qualifying purpose by virtue of section 39(6) to (9).
(2)In their application to expenditure falling
within subsection (1) above, sections 24, 25 and 26 as they have effect—
(a)in accordance with
section 41, or
…
shall have effect, subject to subsection (3)
below, as if the reference in section 24(2) to 25 per cent. were a reference to
10 per cent.
(3)No balancing allowances or writing-down
allowances shall be available in respect of expenditure falling within
subsection (1) above if the circumstances are such that the machinery or plant
in question is used otherwise than for a qualifying purpose and—
(a)…
(d) either the lease
is expressed to be for a period which exceeds 13 years or there is, in the
lease or in a separate agreement, provision for extending or renewing the lease
or for the grant of a new lease so that, by virtue of that provision, the
machinery or plant could be leased for a period which exceeds 13 years;
The Appellant’s submissions
347.The
Appellant’s case was based on what Mr Peacock claimed was the natural reading
of section 123(4) CAA 2001: it was common ground that the Appellant could never
have claimed 10 per cent writing-down allowances within section 109 CAA 2001 if
the leasing of the Vessels were not protected leasing; instead, because the
lease period of the finance lease exceeded 13 years, if the Vessels were not
used for a qualifying purpose, the Appellant would be within section 110 CAA
2001, which denies it a right to claim any allowances. It could therefore
never be said that in entering into the relevant transactions it was a main
object “to obtain a writing-down allowance determined without regard to section
109”. In particular, section 123(4) CAA 2001 is not phrased, as the
Commissioners wish to apply it, in terms of whether a main object of entering
into the transactions in question was to ensure that the ship is used for a
qualifying purpose by satisfying the conditions of section 123(1) CAA 2001.
348.In looking at
the legislative history of these provisions it is necessary to bear in mind
that sections 109 and 110 CAA 2001 reflect two related but distinct mischiefs.
First, where assets were leased to a non-resident lessee (who would otherwise
derive benefit from the 25 per cent writing-down allowances available to the
lessor) allowances were reduced to the rate of 10 per cent broadly to align the
allowances to the stream of rental received by the lessor: this was effected by
provisions which are now section 109 CAA 2001. Secondly, and distinctly, when
attempts were made to avoid that alignment of allowances to rentals by using
leases to non-residents with extended lease periods or variable lease rental
profiles, all allowances were denied: this was effected by provisions which are
now section 110 CAA 2001. The “main objects” restriction in the case of ships
let on charter originally applied to first-year allowances, and when it was
applied to writing-down allowances on the abolition of first-year allowances it
related specifically to section 70(2) Finance Act 1982, which was the provision
dealing with the reduction in the rate of allowances from 25 per cent to 10 per
cent. This is followed through into the terms of section 123(4) CAA 2001.
349.Given that
section 123(4) CAA 2001, with its specific reference to section 109 CAA 2001,
has a purpose in its own terms (that is, where the circumstances are such that
the lessor could claim 10 per cent rather than 25 per cent writing-down
allowances), it is not open to the tribunal to construe it as though there were
also specific reference to section 110 CAA 2001. Thus even if the eventual
conclusion is that there is an oversight in not bringing the circumstances of
nil allowances within the scope of the anti-avoidance provision, it is for
Parliament, and not the courts, to remedy matters – the tribunal must apply the
provision in accordance with its terms.
The Commissioners’ submissions
350.Mr Ewart, in
his survey of the “archaeology” of these provisions, looked primarily to the
immediate predecessor provisions in the consolidation statute, the Capital
Allowances Act 1990. He argued that it was legitimate to do so since there was
no intention, in the Tax Re-write comprising CAA 2001, to change the law.
351.He pointed
out that the structure of section 42 Capital Allowances Act 1990 is to provide
cumulative conditions in subsections (1) to (3), which was recognised in the
decision of the Court of Appeal in the case BMBF (No 24) Ltd v Commissioners
of Inland Revenue 79 TC 352. The failure of the conditions in subsection
(1) leads to allowances being given at the 10 per cent rate rather than the 25
per cent rate (as provided in subsection (2)). That subsection is expressly
subject to subsection (3), which provides that no allowances are available when
the lease has any of the specified “offensive” terms. By this means
subsections (1) and (2) are stepping stones to subsection (3) – if the
taxpayer’s expenditure is on a ship and it is not used for a qualifying purpose
within section 39(6) (i.e. not let on a time charter by a UK operator) then
subsection (2) applies to reduce the allowances to 10 per cent, but if the
lease has “offensive” terms, subsection (3) applies to reduce the allowances
further to nil.
352.Section 42(1)
Capital Allowances Act 1990 includes the condition (by its reference to section
39(6) Capital Allowances Act 1990) that the ship is used for a qualifying
purpose by reason of being let on time charter by a UK operator. Therefore,
when section 39(8) Capital Allowances Act 1990 (the predecessor provision of
section 123(4) CAA 2001) makes reference to a main object of a transaction
being to obtain “a writing-down allowance of an amount determined without
regard to section 42(2)”, that implicitly incorporated a reference to a claim
for a writing-down allowance on the grounds that the ship was being used for a
qualifying purpose, regardless of whether (were there no qualifying purpose)
allowances would have been available at 10 per cent or no allowances would have
been available.
353.In this way
the Capital Allowances Act 1990 provisions give the only logical result, that
the “main object” anti-avoidance provision applies (if the “main object” test
is satisfied) regardless of whether the lessor would have claimed 10 per cent
allowances or no allowances if he were unable to satisfy the condition that the
leasing was a “qualifying purpose”. In the Tax Re-write what was section 42
Capital Allowances Act 1990 has been divided into individual sections (sections
109 and 110 CAA 2001), and the cumulative and interdependent nature of the
conditions within the different subsections of section 42 Capital Allowances
Act 1990 has been lost in the process – instead, the conditions are set out
independently in each of sections 109 and 110 CAA 2001.
354.The
Commissioners rejected the Appellant’s argument that the “separateness” of
sections 109 and 110 CAA 2001 reflect two distinct “mischiefs”: there was only
one “mischief”, namely leasing to an overseas lessee where the benefit of the
allowances was being “exported” from the UK, and the refinement of nil
allowances (rather than 10 per cent allowances) was introduced when the benefit
of allowances was still being “exported” by means of delayed rents through
extended lease periods or variable rent payment terms.
355.In all these
circumstances section 123(4) CAA 2001 should be construed to give effect to the
provisions as they originally had effect, and to give a sensible result having
regard to the scheme of the legislation.
Discussion
356.As discussed,
the narrow point of dispute between the parties is the significance, in section
123(4) CAA 2001, of the phrase “determined without regard to section 109
(writing-down allowances at 10 per cent)”. Both parties agree that the
Appellant is not in a position to claim allowances at 10 per cent under section
109 CAA 2001 because the term of the lease exceeds 13 years. Instead, (and
prospectively) the Appellant’s circumstances bring it within section 110 CAA
2001 so as to disentitle the Appellant from claiming any writing-down
allowances whatsoever if the leasing is not protected leasing. Therefore the
Appellant is either entitled to 25 per cent allowances on its expenditure on
the provision of the Vessels (if it meets the “qualifying purpose” conditions
of section 123(1) CAA 2001, and that provision is not disapplied by the “main
objects” provision of section 123(4) CAA 2001) or it is entitled to no
allowances (either because it fails to meet the “qualifying purpose” conditions
of section 123(1) CAA 2001, or it meets those conditions, but section 123(1)
CAA 2001 is disapplied by the operation of section 123(4) CAA 2001).
357.Mr Ewart
submitted that the position which the Appellant was contending for is absurd,
and we agree with that. There can be no grounds of logic or policy (and
certainly none which Mr Peacock could identify to us) to limit the application
of the “main objects” anti-avoidance provision to the circumstances where the
taxpayer’s claim (if he is unable to show a “qualifying purpose”) is to 10 per
cent allowances and to let the more “mischievous” taxpayer (who is denied all
allowances if he is unable to show a “qualifying purpose”) escape its
clutches. Mr Peacock’s final shot was that Parliament had got it wrong, but we
find that an unattractive approach in the case of legislation which has been,
in one guise or another, in operation since 1982.
358.In construing
and applying section 123(4) CAA 2001 we consider that it is legitimate to have
regard to the corresponding provisions in the Capital Allowances Act 1990,
particularly where there is an apparent absurdity, and where that appears to
have arisen from the Tax Re-write project, and where (as the parties agreed was
the case) there was no intention to change the law.
359.Those
provisions, sections 39 and 42 Capital Allowances Act 1990, are themselves not
(with regard to the point presently under consideration) a model of clarity.
They are the result of piecemeal amendment over a number of years between 1982
and 1986 to accommodate major structural changes to the capital allowances
regime and to thwart the ingenuity of the equipment leasing industry as it
sought to circumvent or diminish the effect of stricter conditions under which
capital allowances could be claimed in the context of leasing transactions.
Thus it is the case that the provision which is now section 123(4) CAA 2001 has
its origins in denying a taxpayer first-year allowances, and that original
provision was adapted to apply to overseas leasing as that came to the fore
following the phasing out of first-year allowances.
360.By reference
to the provisions in the Capital Allowances Act 1990 we were persuaded by the
analysis put forward by Mr Ewart for the Commissioners. We have set that out
in some detail above. The essence of his case as to the construction of
section 39(8) and section 42 Capital Allowances Act 1990 was that subsections
(1), (2) and (3) of section 42 are linked, in that they are cumulative, a
proposition which finds support in the BMBF (No 24) Ltd case. The first
question is whether the expenditure falls within section 42(1), that is, is it
expenditure on the provision of machinery or plant for overseas leasing where
the leasing is not of a ship used for a qualifying purpose within section 39.
If that is the case, section 42(2) applies to reduce writing-down allowances
for the expenditure within section 42(1) from 25 per cent to 10 per cent, but
that is subject to section 42(3), which denies all allowances for expenditure
within section 42(1) if the lease has “offensive” terms.
361.Turning to
section 39 Capital Allowances Act 1990, a ship is used for a qualifying purpose
if it is let on a time charter by a UK-based operator (section 39(6)), and if
that is the case the expenditure on the ship is not expenditure to which
section 42(1) applies (and so neither sections 42(2) nor 42(3) come into
play). But if there is a “main object” of obtaining a writing-down allowance,
section 39(8) disapplies section 39(6), so that the expenditure falls within
section 42(1) (the ship is not used for a qualifying purpose), which in turn
requires that section 42(2) is applied, and it has effect subject to section
42(3) if the lease terms so require. The reference to “a writing-down
allowance of an amount determined without regard to section 42(2)” in section
39(8) is not to be seen as limiting the operation of section 39(8) to the
situation where 10 per cent allowances are available, but, because of the
inter-related subsections of section 42, to the situation where there is
expenditure which falls within subsection (1) of section 42 (which is
expenditure which may qualify for 10 per cent allowances or nil allowances as
subsection (2) has effect, including where it has effect subject to subsection
(3)).
362.In the course
of re-writing these provisions as they appear in CAA 2001, sections 109 and 110
CAA 2001 have been “disconnected” – effectively each is made to stand alone,
which has had the apparent consequence (unintended, since there was no purpose
to change the law) of giving the reference to section 109 CAA 2001 in section
123(4) CAA 2001 a limiting significance which is not found in the corresponding
reference to section 42(2) Capital Allowances Act 1990 in section 39(8) Capital
Allowances Act 1990.
363.We consider
that we should construe section 123(4) CAA 2001 having regard to the provisions
of which it is a re-statement, so that the reference to section 109 CAA 2001
does not have the limiting or restricting effect which on its face it has.
That gives a sensible result which accords with the scheme of the legislation.
364.We can arrive
at the same conclusion by a different, and equally valid, route. The
expression we are concerned with is “determined without regard to section
109”. The phrase “without regard to” means “without taking into account”, or
“without heed to” the matter in question. If no account is to be taken of the
position under section 109 CAA 2001, it does no matter whether section 109
could or could not apply in this context, because it is immaterial. If what
the taxpayer sought to obtain was a 25 per cent writing-down allowance then
that does not involve an allowance that is determined under section 109 CAA
2001 – section 109 CAA 2001 is not in point. If section 109 CAA 2001 is not in
point either because it could not apply or because it could only apply if 25
per cent allowances were not available, then the exercise of determining
whether or not the taxpayer sought to obtain a 25 per cent writing-down
allowance can be carried out without regard to section 109 CAA 2001.
365.Therefore for
this further reason the reference in section 123(4) CAA 2001 to section 109 CAA
2001 should not be read as having the limiting effect for which the Appellant
contends.
366.For these
various reasons, therefore, we conclude that section 123(4) CAA 2001 can apply
in the circumstances where section 110 (rather than section 109) CAA 2001 is in
point, and can therefore in principle apply to the circumstances of the
Appellant’s claim for writing-down allowances for its expenditure on the
provision of the Vessels.
367.Accordingly,
we decide Issue 3 in the Commissioners’ favour.
Issue 4: if Issue 3 is determined so that in principle section 123(4) CAA
2001 applies, was 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 the 25 per cent writing-down allowances claimed by the
Appellant?
368.Having
concluded, as a matter of the proper statutory construction of section 123(4)
CAA 2001, that in principle it can apply in the circumstances of the Appellant,
we have to decide whether on the facts of the case it does so apply so as to
deny the Appellant the right to the 25 per cent writing-down allowances it has
claimed in relation to its expenditure on the Vessels.
369.As mentioned,
section 123(4) CAA 2001 has to be considered if the Appellant has demonstrated
that the Vessels are used for a “qualifying purpose” by satisfying the
requirements of section 123(1) CAA 2001 (in the present case, if it succeeds in
Issue 1 and Issue 2) – section 123(4) CAA 2001 is the final hurdle it needs to
surmount.
370.The question
we have to determine is whether the main object, or one of the main objects, of
the letting of the Vessels on charter, or of a series of transactions of which
the letting of the Vessels on charter was one, or of any of the transactions in
such a series, was to obtain the 25 per cent writing-down allowances claimed by
the Appellant in respect of its expenditure on the provision of the Vessels.
If that is the case, the writing-down allowances cannot be claimed.
371.The
Appellant’s case, in summary, is that the provisions of section 123(4) CAA 2001
must be applied so as to accord with their context and the reasons for which
they were enacted: capital allowances provide an incentive to investment with
special protection for shipping businesses genuinely carried on in the UK, and
an anti-avoidance test should not be construed so as to negate the purpose of
the incentive. Each of the transactions in the leasing and chartering
arrangements has a real and significant commercial purpose for the parties
concerned, and although it is undeniable that the parties sought to ensure that
capital allowances would be available, that was subservient to the main object
of the transactions, which was to meet the commercial objectives which the
different parties had.
372.The
Commissioners identified the grant of the bareboat charter and the novation of
the time charter to K-Euro (thus, the interpositioning of K-Euro into the
leasing structure) as the transactions in the series of leasing transactions
which had as their main object, or as one of their main objects, the obtaining
of the allowances. These transactions, they say, were entered into only after
K-Line had taken advice as to what steps had to be taken to enable capital
allowances to be claimed through a UK finance lease structure, and were not
motivated by commercial requirements or undertaken to pursue a commercial
purpose: the commercial objectives of the parties could have been achieved
without K-Euro becoming the disponent owner of the Vessels by means of these
transactions.
The Appellant’s submissions
373.Mr Peacock
explained that what is now section 123(4) CAA 2001 had been introduced by
section 71 Finance Act 1982 (in the context of the 100 per cent first-year
allowances regime) in order to narrow the scope of what is now section 123(1)
CAA 2001. The relevant Finance Bill debates, to which he referred us, show
that the government considered that the concession which had been made in
previous legislation (in the Finance Act 1980) to preserve first-year
allowances for UK companies chartering ships to overseas charterers (which
would otherwise have been subject to the rules restricting allowances under the
“overseas leasing” provisions) was being exploited by the use of “brass plate”
chartering companies in the UK. The “main object” anti-avoidance provision was
introduced to deny allowances in such cases, but Treasury ministers repeatedly
stressed that they wished to safeguard the right to first-year allowances in
cases where ships were chartered to overseas lessees by companies carrying on a
genuine shipping business in the UK (and where there would be benefit to the UK
in the form of taxable profits from such business), and that the provisions
would be operated with that intention. Mr Peacock argued that we should
construe and apply section 123(4) CAA 2001 with that purpose and context in
mind.
374. Mr Peacock
submitted that the proper approach to applying section 123(4) CAA 2001 is to
consider the transaction or series of transactions of which it is asserted that
the main object is obtaining the allowances, and to assess the objects of such
transactions at the time they were entered into. So far as the language of the
statute permits, the provision should be interpreted to take account of the
purpose of the statute (both the abuse at which it was directed and the
beneficial use which is to be safeguarded), and it should not be applied so as
to frustrate the incentive specifically created and preserved for those cases
which fall outside the mischief at which the provision is directed. In
ascertaining whether an object of a transaction or series of transactions is a
“main object” it is necessary to attribute weight to those matters which can
fairly be regarded as the objects of the transaction or transactions (the
achievement of one or more commercial purposes, the obtaining of allowances,
etc) so as to establish a priority of such objects.
375.In
encouraging us to adopt this approach, Mr Peacock referred us to the cases of Commissioners
of Inland Revenue v Brebner [1967] 2 AC 18 and Barclays Mercantile
Industrial Finance Limited v Melluish (Inspector of Taxes) [1990] STC 314,
both being cases where the courts were concerned with anti-avoidance provisions
based upon whether the obtaining of a tax benefit was the main purpose or
object of transactions or other arrangements.
376.In the Brebner
case it is made clear (see Lord Upjohn at p 30) that where a taxpayer carrying
out a commercial transaction has the choice in deciding how to structure his
transaction, it should not necessarily be inferred when considering whether he
is within the scope of a tax anti-avoidance provision that if he chooses the
structure that is the more tax efficient (that is, results in his paying less
tax) then one of his main objects is to avoid tax: “No commercial man in his
senses is going to carry out a commercial transaction except upon the footing
of paying the smallest amount of tax that he can.”
377.The Barclays
Mercantile case shows that if the taxpayer claiming capital allowances is
engaged in a commercial transaction where the allowances are nevertheless a
significant factor in rendering that transaction commercially viable, obtaining
the allowances is not a main purpose of the transaction.
378.Mr Peacock
then proceeded to review each of the transactions in the leasing chain in the
Appellant’s case, arguing that in each transaction there was a genuine
commercial objective for the parties in entering into that particular
transaction, whether to earn profits, share commercial risk, pursue a business
strategy, or ensure reliable and long-term transport facilities for the gas
products of the Snøhvit project. If one looked at the transactions as a whole,
the only objective is the entirely commercial one of acquiring ships with
appropriate financing and making them available on commercial terms to
transport LNG from supplier to customer. All parties were alive to the
benefits to be derived from the cheaper financing of the Vessels by reason of
the capital allowances, and most parties, in different degrees, derived
advantage from those benefits. They therefore sought advice to ensure that
they met the conditions upon which the capital allowances, and the benefits
which they offered, were dependant. That is not to say, however, that it was a
main object of any of the transactions (or of some or all of the transactions
taken together) to obtain those capital allowances – the Appellant argues that
it is not an object at all of the transactions. The only objects – and
certainly the only ones which could be described as main objects – of the
parties in entering into the transactions were to achieve their respective
commercial purposes.
379.With
particular regard to the participation of K-Euro in the transactions, (taking
the hire of the Vessels under the bareboat charter and chartering them to the
Snøhvit Sellers by the time charter novated to it), the evidence established
that K-Euro was an established UK shipping company whose business was being
developed in pursuit of a wider strategy which the K-Line group was
implementing. Its activity as disponent owner chartering the Vessels was in
furtherance of those business objectives. It was far removed from the “brass
plate” companies at which the “main object” provisions of section 123(4) CAA
2001 were directed.
The Commissioners’ submissions
380.It is the
Commissioners’ case that it was the main object, or one of the main objects, of
at least two of the transactions in the series of transactions comprising the
letting of the Vessels on charter to obtain writing-down allowances for the
Appellant’s expenditure on the Vessels. Those two transactions, entered into
in September 2002, were the grant of the bareboat charter by Northern LNG to
K-Euro and the novation of the time charter to K-Euro, that is, the transactions
whereby K-Euro became the disponent owner of the Vessels and let them on
charter to the Snøhvit Sellers. Those transactions were undertaken so that the
Appellant could claim that the terms of section 123(1) CAA 2001 were satisfied
and the Vessels accordingly used for a “qualifying purpose”.
381.Mr Ewart
dismissed the Appellant’s attempts to give scope to the meaning and application
of section 123(4) CAA 2001 by reference to ministerial statements and Inland
Revenue press releases: the section is clear, and not ambiguous, in its meaning
and must be construed in the normal way. In any event, he argued, the
situations referred to in the ministerial statements, with their emphasis on
genuine UK shipping businesses, are far removed from the circumstances of
K-Euro.
382.Mr Ewart and
Mr Cooper referred to the evidence in support of their case that it was at
least a main object of the transactions they had identified that 25 per cent
writing-down allowances should be available to the Appellant. We have already
mentioned their respective submissions as to the lack of commerciality in the
charter-party arrangements and in K-Euro’s position as disponent owner. Mr
Ewart drew our attention to the following additional points:
(1)
Whilst it was clear that the Snøhvit Sellers required that the Vessels
should be managed by someone in the European time zone, it was not their
requirement that the owner or operator of the Vessels should be located in
Europe – that step was taken by K-Line only at the later stage when it realised
(having taken advice) that it was necessary in order to obtain UK tax-based
lease finance for the Vessels;
(2)
K-Line could offer no commercial justification or advantage for
inserting K-Euro into the lease structure as disponent owner – any commercial
objectives it had to develop the bulk and gas business in Europe could have
been achieved without K-Euro acting as disponent owner in this particular
transaction: that was demonstrated by the 2006 reorganisation (which separated
out all the other business) and by the fact that, in relation to other vessels
operated in the European time zone, K-Euro did not act as disponent owner;
(3)
Similarly, the Appellant’s claim that it was a primary object of
bringing in K-Euro that it had an “owner’s” relationship with the time
charterers does not stand up to scrutiny in view of the other shipping
transactions where K-Euro acted as manager and in view of the restructuring of
K-Euro’s business in the 2006 reorganisation – and in any event it is not such
a significant factor that it displaces, as a main object, the aim of obtaining
the capital allowances in the financing arrangements;
(4)
The true commercial deal was represented by the arrangements documented
in December 2001 with K-Line (and the other parties it wished to bring in as
co-owners of the Vessels) chartering the Vessels to the Snøhvit Sellers on the
terms of the time charter – everything which happened subsequently in terms of
the structure was designed (following detailed and specific advice from
specialist UK tax and financial advisers) to achieve the requirements of the
financing (including the availability of UK capital allowances) whilst not
disturbing the commercial deal already in place; and
(5)
K-Euro played the role of a disponent owner for the sake of the
allowances, but the commercial reality was that K-Euro was always seen as a
manager, with limited exposure to risk and a profit based on a mark-up on its
costs (that profit being determined upon advice as to what would be acceptable
for establishing a “bona fide shipping company”). It was the understanding of
the Snøhvit Sponsors that they – as the real owners of the Vessels – would bear
the risks and benefits derived from the operation of the Vessels, as was
eventually shown to be the case with the 2006 reorganisation.
383.Mr Ewart
submitted that, in ascertaining the main objects of the relevant transactions
it is necessary to look individually at the objects or purposes of the parties
entering into those transactions. In the case of Northern LNG (looking to its
shareholders, the Snøhvit Sponsors), their objective in entering into the
bareboat charter could only have been to secure cheaper finance for the Vessels
through a tax-based lease, that is, to ensure that the requirements of section
123(1) CAA 2001 were satisfied: they could show no commercial objective beyond
that. In the case of K-Euro itself, it acted upon the direction of K-Line and
therefore had little or no independent objective, but in so far as it had, it
was aligned with the objectives of K-Line, and for the reasons given, those
objectives were substantially to ensure that the requirements of section 123(1)
CAA 2001 were satisfied. As for the Snøhvit Sellers, their only objective in
accepting the novation of the time charter to K-Euro was to maintain the
commercial terms of the time charter which they had negotiated in 2001.
384.The
conclusion therefore was that, taking all points of view, it was at least one
of the main objects of the relevant transactions for the letting of the Vessels
on charter that the terms of section 123(1) CAA 2001 should be met so that a 25
per cent writing-down allowance might be obtained in respect of the Appellant’s
expenditure incurred on the provision of the Vessels, and accordingly section
123(4) CAA 2001 applies to deny that outcome.
Discussion
385.In
considering the meaning, scope and application of section 123(4) CAA 2001 we
agree with Mr Ewart (who referred us to R v Secretary of State for the
Environment, Transport and the Regions, ex parte Spath Holme Ltd
[2001] 2 AC 349) that the language of the provision is not ambiguous or obscure
in its meaning. We also agree that the ministerial comments on this provision
(or, rather, its previous incarnation), made in the course of the relevant
Finance Bill committee stage debates, do not comprise a clear and unequivocal
statement addressing the circumstances of the Appellant (or K-Euro). We
therefore take no account of those statements in considering the application of
the provision to the circumstances of this case.
386.We agree with
Mr Peacock that it is necessary to discern the meaning and scope of the
provision in its context: in particular the context of a statutory regime whose
purpose is to encourage taxpayers to make capital expenditure on certain assets
(including ships) in certain circumstances. In this respect the provision
differs from other “main object” or anti-avoidance provisions in the tax code
aimed at denying the taxpayer a tax advantage (such as utilising a tax loss, or
claiming a deduction) which might otherwise be available to him. Section
123(4) CAA 2001 cannot have been intended to emasculate the incentives
available through the capital allowances legislation by reason of section
123(1) CAA 2001.
387.An incentive,
by its nature, is designed to influence behaviour – to encourage a person to
choose a particular course of action he might otherwise not have chosen to
take. To an extent (and that extent will vary according to the circumstances
of the person concerned) the obtaining of that incentive will be a motive for
the course of action chosen. In some situations the incentive will be the
prime motive, as where a taxpayer would not have made a particular capital
investment without the benefits provided by capital allowances. In other
situations the incentive will shape a transaction, rather than bring it about,
as where a taxpayer intends, entirely for commercial reasons, to make a capital
investment, and chooses to structure it one way rather than another so that
capital allowances are available to him or to another person who can take the
immediate benefit of those allowances. In yet other situations a taxpayer will
make a capital investment entirely for commercial reasons, and the capital
allowances will be a welcome, but incidental, benefit, perhaps influencing marginally
the timing of the investment, but nothing more. There is a wide spectrum here,
and every taxpayer’s circumstances will place him at a particular point in that
spectrum. Section 123(4) CAA 2001 must be applied with these factors in mind.
388.We consider,
therefore, that it is not fatal to a taxpayer’s claim to capital allowances,
where that claim is based on section 123(1) CAA 2001, that the taxpayer has
taken steps which seek to secure or bolster his likelihood of obtaining those
allowances. The question which has to be answered is whether a main object of
the relevant transactions was the obtaining of those allowances, and this
envisages that there may be a range of objectives motivating the transactions,
and that they must be assessed in some sort of priority or hierarchy and then
some basis applied to separate those which are of sufficient significance to
count as “main” from those which are not. The issue is then which side of the
line falls any objective of obtaining the allowances.
389.In the
present case the parties focused on the commerciality of the transactions, and
in particular those which directly involved K-Euro. The Appellant argued that
the arrangements put in place – in their overall scope and in their particular
detail – were in pursuance of a strategic commercial ambition, and that should
be seen as the prime motivation of the relevant parties. At his boldest, Mr
Peacock argued that the availability of the capital allowances was merely a
welcome and incidental consequence of the transaction, albeit one in respect of
which the parties had taken expert advice to ensure that it would indeed
follow. The Commissioners argued that the key transactions – those which
brought about the involvement of K-Euro – lacked any commercial justification and
therefore would not have been undertaken but for the capital allowances which
the parties hoped to obtain for their various benefits.
390.We agree that
in determining the objectives of the transactions, and ranking those
objectives, a key factor – perhaps the key factor – is the commercial basis or
justification for entering into those transactions, or, perhaps, the commercial
purpose which is served for the parties in entering into those transactions.
It will throw light on what the true objectives are and what their relative
significance is if there is a range of objectives.
391.This was the
approach of the court in the case of Barclays Mercantile Industrial Finance
Ltd v Melluish (Inspector of Taxes), to which Mr Peacock referred us. The
case concerns a finance lessor’s claim for 100 per cent first-year capital
allowances in respect of its expenditure on the acquisition of two films which
it acquired from its lessee in a sale and lease-back financing transaction. In
order to claim successfully the allowances in the particular circumstances of
the case the taxpayer finance lessor had to satisfy a “main object” test
similar to that faced by the Appellant in this case. In the Barclays
Mercantile case the relevant provision (what was then paragraph 3(1)(c),
Schedule 8 Finance Act 1971) was as follows:
Where a person incurs capital expenditure on the
provision by purchase of machinery or plant which has been in use for the
purposes of a trade carried on by the seller, and…it appears with respect to
the sale, or with respect to transactions of which the sale is one, that the
sole or main benefit which, but for this sub-paragraph, might have been
expected to accrue to the parties or any of them was obtaining of [a first-year
allowance], a first-year allowance shall not be made in respect of the
expenditure….
Both the Special Commissioners and Vinelott J accepted
the taxpayer’s submission that its main object was to make a profit by
acquiring and leasing the film, and this was so even though it was probable
that it would not have been in a position to offer a lease on acceptable terms
had it not been able to obtain and utilise the first-year allowances. Vinelott
J went further, stating: “Paragraph (c) as I see it is aimed at artificial
transactions designed wholly or primarily at creating a tax allowance.”
392.Before
looking at the commercial basis or justification of the relevant transactions,
section 123(4) CAA 2001 requires us to identify the transaction or transactions
which (in shorthand) are tax-motivated. The Commissioners, in seeking to deny
the Appellant’s claim for writing-down allowances, contend that the grant of
the bareboat charter of the Vessels by Northern LNG to K-Euro and the novation
to K-Euro of the time charter of the Vessels are transactions in a series of
transactions of which the letting of the Vessels on charter was one, and, of
course, they further contend that the main object, or one of the main objects,
of those transactions was to obtain the writing-down allowances in question.
The Appellant does not deny that those transactions were transactions in a
series of transactions of which the letting of the Vessels was one.
393.Those
transactions were entered into on 19 September 2002, when the finance lease and
related documents were also entered into. It should be noted, however, that
they were in contemplation at what is described in the Statement of Agreed
Facts as “the Preliminary Stage”, that is, at the time (19 December 2001)
K-Line entered into the Shipbuilding Contract and granted the time charter to
the Snøhvit Sellers. The Memorandum of Understanding which Statoil (on behalf
of the Snøhvit Sellers) signed with K-Line on that date anticipates not just
that K-Line will seek to finance the purchase of the Vessels by means of a UK
finance lease or some other form of financing (with a consortium company having
the economic equity interest in the Vessels), but that the Vessels will be
operated by a company carrying on business as ship operator in the UK, for
which purpose the consortium company will grant a bareboat charter and the time
charter will be novated.
394.The
significance of this is that there was an element of the case argued by the
Commissioners that the transactions documented in December 2001 (the
Shipbuilding Contract and the time charter) comprised the “real” commercial
deal struck between the K-Line group and the Snøhvit Sellers, and that the
insertion of K-Euro into the structure in September 2002 was a later
arrangement conceived once K-Line understood what needed to be done in order for
capital allowances to be available in the course of the financing of the
Vessels. That view cannot be sustained in the light of the Memorandum of
Understanding. The entirety of the structure, as it stood following the 19
September 2002 documentation, was the aim of the parties in December 2001, and
their commercial (or other) purpose in entering into the relevant transactions
should be viewed with this in mind.
395.This is so
notwithstanding that K-Euro is not a party to the Memorandum of Understanding and
that it is not identified as the ship operating company referred to in that
document. It is no more than the application of routine commercial reality to
ascribe to individual members of a group of companies the objectives of the
group as a whole (or, rather, that part of the wider group engaged upon the
same endeavour) unless the evidence shows otherwise. K-Euro’s objectives (in
so far as in themselves they are relevant to ascertain the objectives of the
transactions to which it was a party) should therefore be viewed in the light
of the K-Line group’s objectives as well as with regard to its own actions and
the decisions of its directors – and its directors acting commercially will
have regard to group policy and objectives.
396.Having
identified the transactions to which the “main object” test must be applied,
the question arises as to the time at which that test falls to be applied. In
the normal case of a transaction entered into (that is, documents signed and
delivered) and its terms executed shortly thereafter, the objects of the
transaction are judged by reference to the circumstances, actions and motives
of the parties at the time they enter into the transaction (including their
circumstances, actions and motives as they are apparent from the terms or
effect of the transaction). In the present case the execution of the terms of
the transaction documents (that is, the letting of the Vessels on charter) did
not begin to be carried out until delivery of the Vessels some years after
those documents were entered into – and by which time the circumstances of a
key party – K-Euro – had very significantly changed first by reason of the
development of its business and then by the 2006 reorganisation of that
business. Nevertheless, it would seem that the objects of the transactions we
are concerned with should be ascertained as at the time that the documents
effecting them were entered into – later events are relevant only if and to the
extent that they can be shown to shed light on the parties’ purposes or aims at
that earlier time (as might be the case, for example, where the later events
were in contemplation or were foreseeable at that earlier time).
397.In the
present case we have the further complication that the transactions in
question, although entered into in September 2002, were in clear contemplation
in December 2001, although not necessarily at that time in the contemplation of
K-Euro itself (indeed, the evidence is that K-Euro had some reluctance to
involve itself in the tender process which resulted in the December 2001
documentation). Further, plans and objectives could have changed up until the
moment the relevant transaction documents were entered into, but since the
scope and general effect (but not the detailed terms) of the transactions documented
in September 2002 were a matter of formalised and documented intent in December
2001, that would seem to be a key point at which to ascertain the objects of
the relevant transactions – but taking account of subsequent matters in the
period until 19 September 2002 (including the actual terms of the documents
then entered into) which may show an influence upon the parties’ objectives.
398.We turn now
to ascertaining the objects of the identified transactions on the basis of the
evidence before us.
399.We have already
drawn some conclusions as to the commerciality of K-Euro’s activities when
considering, for the purposes of deciding Issue 2, whether it was letting the
Vessels on charter in the course of a trade. We take those conclusions into
account also in looking to the aims of the relevant transactions for the
purposes of deciding whether or not section 123(4) CAA 2001 should apply.
400.Mr Aoki’s
evidence was most pertinent to this issue. We have set out Mr Aoki’s position
and his role in the K-Line group’s involvement in the Snøhvit project at
paragraph 108 above. He was well placed to speak of the aims of that group and
of the reasons why group companies entered into the transactions with which we
are concerned. As we have said, he was a convincing witness, and we accept his
evidence.
401.Taking the
broader picture first, it is clear that the K-Line group’s decision to acquire
and let the Vessels on the terms of the time charter as specified by the
Snøhvit Sellers was taken in order to pursue the group’s business strategy of
expanding its business (specifically, it gas and bulk carrier business) into
the Atlantic Basin: it had a leading position in such business (including in
respect of LNG carriers) in the regions described to us as East of Suez which
gave it the standing to make that step, which the Snøhvit Sellers recognised by
accepting its tender. K-Line saw the Snøhvit project as a high-profile
operation, commercially valuable in itself and with the further value that it
would give the K-Line group substance and credibility in the market in which it
intended to develop its business. The broad objective, therefore, of letting
the Vessels on charter was entirely to achieve a particular commercial aim.
402.Concurrently
the K-Line group had the strategy of devolving business away from its main
business centre in Japan to regional centres in order to develop relationships
with customers at local level and to be more immediate in responding to their
requirements. In this regard the Snøhvit project also offered the K-Line group
the opportunity to pursue that strategy, since it was a requirement of the
Snøhvit Sellers that at least the management of the Vessels for their benefit
as time charterers should be carried out within the European time zone. (In
his oral evidence Mr Thomassen explained that there was also a preference for
the Vessels to be operated by a party with an ownership interest in the
Vessels, rather then “externally” managed, since in his experience more care
was given to the proper running of a vessel if the person managing it had a
stake in the vessel’s well-being.)
403.The K-Line
group identified K-Euro as the entity within the group which would comprise its
regional centre and which would develop its bulk and gas carrier business in
the Atlantic Basin. The Snøhvit project was an opportunity to pursue those
aims, and to do so by the participation of K-Euro in that project. As we have
mentioned, K-Euro had an established presence in the UK and European coastal
shipping market (but not in respect of bulk and gas carriers operating in the
Atlantic Basin), and it was the natural choice of entity through which the
K-Line group could realise its plans generally and specifically in respect of
its involvement in the Snøhvit project.
404.It was
recognised, by both K-Euro itself and by the K-Line group, that if it were to
achieve all the ambitions which the group had for it, and if it were to operate
(or even manage) the Vessels as required, then it would have to increase very
significantly its capability. As we have described, this is what it did, and
as a result it developed a significant business operating and managing bulk and
gas carriers based in, or operating to and from, the Atlantic Basin. This development of K-Euro’s business was largely carried out after September 2002, but
the decisions to pursue that course, and the initial steps, were taken before
September 2002, no doubt in part to convince the Snøhvit Sellers before the
intentions of December 2001 became legal certainty in September 2002 that
K-Euro would be in a position to operate the Vessels when they were delivered.
405.Mr Ewart
sought to argue that once K-Line was made aware by its advisers of the need for
K-Euro to be “a bona fide commercial UK shipping company” if the lease
financing were to secure capital allowances, then it set about creating a
business which would pass that test: its one real, or at least predominant,
motive was to do what was thought necessary to ensure the allowances were
available. We do not agree. That argument disregards the wider business aims
of the K-Line group evident in its strategy, and it also disregards the
commercial reality and substance of what actually happened. In the period up
to the 2006 reorganisation K-Euro expanded its business in a genuine,
methodical and commercial way and to a substantial extent. By the time of that
reorganisation it had (in addition to the Vessels) nine bulk or gas carriers
which it was operating or managing or which it was committed to operate or
manage on their eventual delivery. To argue that such an enterprise was
undertaken principally to give credence to a claim for capital allowances in
relation to the Vessels is not sustainable.
406.Again,
therefore, taking the broader view we conclude that K-Euro’s participation in
the chartering of the Vessels was undertaken in order to pursue commercial
objectives by entering into commercial transactions which were the more
commercially attractive in that they were indirectly funded by financings whose
costs were reduced by the tax allowances taken elsewhere.
407.We need,
however, to look at the nature of K-Euro’s participation in these arrangements
– a critical strand of the Commissioners’ argument is that, whilst K-Euro’s
participation can be seen as meeting a requirement of the Snøhvit Sellers and
therefore is commercially justified, it was not a requirement that it should be
the disponent owner of the Vessels, and that requirement could have been met by
appointing K-Euro as manager of the Vessels. They point to the fact that
K-Euro, in expanding its business, took the manager’s function in relation to
other vessels, and that following the 2006 reorganisation its role in relation
to the Vessels was little more than that of manager.
408.It is helpful
to look first at the different interests in the Vessels. The Appellant has
legal ownership of the Vessels, but, under the finance lease documentation, the
economic ownership – or at least the equity in the Vessels – resides with
Northern LNG. Northern LNG is a consortium company representing, in effect,
the interests of its consortium member shareholders, the Snøhvit Sponsors (the
proportions of their respective shareholdings differ as between the different
Northern LNG companies for each Vessel, but nothing turns on that). With the
exception of K-Line itself the Snøhvit Sponsors have no business involvement in
operating LNG carriers: they have an investment interest in the equity in the
Vessels. They were therefore not in a position to operate the Vessels in order
to hire them to the Snøhvit Sellers on the terms of the time charter. They
could have engaged a ship manager to ensure that the Vessels were operated to
meet the requirements of the time charter, but that would have left them with
the operational and commercial risks of operating the Vessels. They passed on
those risks to K-Euro by granting the bareboat charter so that it took on the
risks of the disponent owner.
409.It is
questionable whether it does in any event assist the Commissioners’ case to
say, in effect, “They could have done it differently”, having regard to Lord
Upjohn’s comment in the Brebner case. But it is even less tenable to
say, “They could have done it differently, notwithstanding that it would have
given rise to different interests, risks and commercial consequences”. Mr
Ewart sought to deal with this by suggesting that a third party, or K-Line
itself, could have been the disponent owner, contracting out the management of
the Vessels to K-Euro so as to meet the “locally operated” requirement of the
Snøhvit Sellers. The first response to this is to question why they should
take that course of action when the commercial logic, in the context of the
group’s plans for its European business, was for K-Euro, rather than any other
person, to take on this role.
410.Mr Aoki’s
evidence provided a different response to the Commissioners’ contention on this
point. He said that it is a common arrangement for the ownership (or economic
ownership) of bulk and gas carriers to be held by a consortium (usually to
ensure that the entirety of the ship and its financing is not on the balance
sheet of any single owner). The K-Line group’s preferred structure, where it
is in such an arrangement, is to ensure that it has the role of operating the
vessel, not only to enjoy the operator’s profit, but to maintain the closest
working relationship with the time charterers of the vessel, who are customers,
or potential customers, across the K-Line group businesses. Where the other
consortium members are competitor shipping lines, no one member will normally
be permitted to take, additionally, the operator role in case that secures a
competitive advantage over the other members, and in that situation a third
party will be involved to operate the ship, sometimes on the basis that one or
more consortium members provides management services. In relation to the
Vessels, where there were no interests within the consortium competing with
K-Line (the only other consortium member which was a shipping line did not
operate LNG carriers), the group was able to adopt the preferred business
structure by having K-Euro operate the Vessels as disponent owner taking the
risks and (as intended) reaping the rewards.
411.The
Commissioners point to the 2006 reorganisation to question whether in reality
K-Euro had a genuine commercial role to justify its participation in the
leasing structure. They refer to the fact that all its other business
activities were stripped out and that it was in no position to fulfil a larger
commercial purpose, but that it merely retained its contractual entitlements and
obligations, and its obligations to operate the Vessels were contracted out to
K-LNG under the Ship Management Agreement. It was, in consequence, a mere husk
of a company with a single part-time employee whose role was limited to company
and regulatory compliance matters. They argue that this demonstrates that the
commercial justifications claimed for interposing K-Euro have little
significance.
412.As we have
said, the point at which one should judge the objects of transactions is the
time they are entered into. Subsequent events may shed light on motives at an
earlier time, especially if they were foreseeable at that earlier time. There
is no evidence that K-Line, K-Euro or any of the other parties anticipated that
such a reorganisation would be required – there could have been no purpose in
putting in so much cost and effort to develop K-Euro’s business if it had been
anticipated that much of that business would have to be transferred elsewhere,
with the consequent risk of damage to business relationships. Even if one were
to accept the Commissioners’ argument that such business was developed to give
a cloak of commerciality to K-Euro’s participation in the Snøhvit project, that
would hardly have been undertaken if it had been foreseen that the contrivance
would be dismantled before the Vessels had been delivered and the letting
begun.
413.The principal
reason for the 2006 reorganisation was the unexpected increase in the manning
costs of the Vessels which it became apparent would leave K-Euro with substantial
losses once it took delivery of the Vessels. There is also evidence that some
of the constraints imposed by way of security arrangements were beginning to
chafe on K-Euro’s ambitions to develop its business. K-Line brought these
matters to the attention of the Snøhvit Sponsors, who eventually accepted the
need to take remedial action. There is nothing to suggest that that remedial
action was in any way welcomed by K-Line or K-Euro: it was an act of expediency
required to deal with a serious commercial threat.
414.In these
circumstances we do not consider that the 2006 reorganisation throws any
significant light back to the parties’ intentions or motives at the time they
entered into the relevant transactions. Nor does it call into question the
commercial basis for adopting K-Euro in 2002 as the group company to develop
the European bulk and gas carrier business. As mentioned, by the time of the
2006 reorganisation that business was substantial and well-developed. There
was no evidence as to whether the business or any part of it was damaged by the
reorganisation, but we can see that it may well have reached a state, in terms
of customer relationships, market credibility and so forth where it was not put
at serious risk by the reorganisation. That presumably was the calculation of
the K-Line group management concerned, as they weighed up the need to solve the
problems stemming from the anticipated losses in K-Euro from the operation of
the Vessels against the risks consequent upon transferring the other businesses
to other UK group companies. In these circumstances it is too facile to say
that because K-Euro was not required for the European business in early 2006 it
could not have been a serious commercial objective in early 2002 that it should
be the lynch pin for the development of that business.
415.The
Commissioners argue, as they did in relation to Issue 2, that K-Euro’s role was
not truly or commercially that of disponent owner, since it was always the
intention – realised eventually in the 2006 reorganisation – that it should be
protected by the Snøhvit Sponsors from the commercial risks of that role:
accordingly, they argue, K-Euro was put in place in the structure principally
to secure the availability of the capital allowances for the Appellant. We
have dealt with this in part in the discussion above in relation to Issue 2,
but since the Commissioners placed much significance on the point in relation
to section 123(4) CAA 2001 we need to consider their case here also.
416.There is
nothing in the transaction documents themselves which supports this argument –
K-Euro is exposed to the commercial risks of chartering the Vessels. It
remains so exposed following the 2006 reorganisation, since the only action
taken which impacts upon K-Euro itself in that reorganisation is the reduction,
for a specified period, of the rent payable under the bareboat charter, and the
increase in its share capital at the time of the reorganisation of its share
capital, both designed to enable it to continue its activities.
417.The principal
evidence which the Commissioners point to in support of their argument on this
matter is a letter from a Mr Yasui, described as the General Manager of the LNG
group of K-Line, to the Snøhvit Sponsors (other than K-Line) and dated 10
January 2003. It is headed “Snøhvit LNG Project: Proposal of Risk Allocation
Scheme”. It mentions that the Snøhvit Sponsors had the risks and benefits as
co-owners of the Vessels until the grant of the bareboat charter, when K-Euro
assumed certain of those risks (including the risk of the Vessels being off
hire; the risks of operating expenses exceeding hire from the time charterers;
and the credit risk of the time charterers). It notes that K-Euro must
continue to bear those risks if it is to remain a “bona fide UK shipping company”, and then makes a number of limited proposals for the removal of
K-Euro from the leasing structure if there is insolvency of a time charterer,
or if a Vessel is off hire for more than 180 days.
418.Mr Thomassen
in his evidence said that Statoil and (he believed) the other addressee Snøhvit
Sponsors had not replied to the letter. He said that the general intention had
been that the Snøhvit Sponsors, as equity owners of the Vessels, would, as a
general proposition, share in both the upside and the downside of the project,
but that it was not until 2005 that it became apparent to all the parties that
K-Euro’s costs would significantly exceed the agreed hire paid for the Vessels
by the Snøhvit Sellers. The Snøhvit Sponsors took the view that it was not in
their long-term interests as equity owners of the Vessels that losses should
continue to accrue in K-Euro in this way, since that put at risk the long-term
flow of rental to them and to the finance lessor, and hence they agreed to
reduce for a period the bareboat charter hire. They were by then prepared to
participate as a consortium in the fortunes of K-Euro as regards its role as
operator of the Vessels, and this was eventually achieved by the 2006
reorganisation, when they could take a proportionate shareholding (and increase
proportionately K-Euro’s share capital) once K-Euro’s other businesses had been
transferred out.
419.We do not
consider that the letter from Mr Yasui has much bearing on this point. It
confirms the change effected in September 2002, namely that the risks of
owner/operator were then assumed by K-Euro, and recognises that the entitlement
to allowances may be jeopardised if K-Euro is relieved of those risks. The
proposals made (none of which were acknowledged by the Snøhvit Sponsors, far
less implemented) were to extricate K-Euro in the extreme circumstances of
insolvency of one of the Snøhvit Sellers or a Vessel being off hire for the
long term (a remote possibility in view of the nature and purpose of the time
charter). We cannot see that this is a basis for a case that K-Euro was not
commercially engaged as operator of the Vessels, or that it was in some way
simply a representative for the Snøhvit Sponsors. Even if one were to accept
that it was always the intention that they should be proportionate shareholders
in K-Euro (and there is no clear evidence that that was the intention in
September 2002 – there was the obvious objection to that from K-Line’s
viewpoint, namely that they would thereby participate as such shareholders in
all the other business which K-Line intended that K-Euro should undertake),
that does not of itself mean that K-Euro did not charter the Vessels for its
own commercial objectives and as a matter of commercial substance. This course
of events in itself demonstrates the commercial nature of the arrangements,
which had to be re-negotiated to deal with changing circumstances: K-Euro was
seeking to make a commercial profit (and not one which was in any way
guaranteed or at a fixed margin), and when that profit proved to be illusory,
and losses threatened K-Euro’s activities, the relevant parties eventually
agreed upon alternative arrangements.
420.We conclude
therefore that a main object of the letting of the Vessels on charter, and of
the grant of the bareboat charter to K-Euro and the novation of the timecharter
to K-Euro, was to secure for K-Euro a commercial benefit, that commercial
benefit accruing from operating the Vessels on charter with the intention of
realising a profit for K-Euro. We also conclude that K-Euro entered into those
transactions as part of, and in order to achieve, a wider commercial objective,
namely the development of its business, in pursuance of the business strategy
of the K-Line group, of operating and managing ships transporting bulk and gas
products within, or to and from, the Atlantic Basin.
421.The question
then is whether it was also a main object of the transactions to obtain the
writing-down allowances. In arguing that this was so, the Commissioners
pointed to the extensive and detailed advice as to UK tax and capital
allowances which K-Line obtained during the period in which it was planning the
arrangements for the financing of the Vessels.
422.The nature,
extent and timing of that advice is set out in paragraphs 218 to 227 above. K-Line
had no prior knowledge of the UK tax regime as it related to capital
allowances, and relied on expert advice to assist it in its consideration of
the funding possibilities available to it for the purchase of the Vessels. By
the time K-Line entered into the Preliminary Stage in December 2001 it had
concluded that a UK tax lease offered the most favourable funding option, and
from January 2002 its advisers began the process of seeking possible finance
lessors on the expressed basis that capital allowances would be available for
their expenditure on the Vessels by reason of section 123 CAA 2001.
423.What is clear
from the extensive and detailed emails between K-Line (its finance department
in particular) and its advisers is that K-Line required the most precise and
thorough advice as to the conditions which had to be met in relation to the
chartering of the Vessels if the capital allowances were to be available. Much
of that advice related to what was required in order that a company should be
“a bona fide commercial UK shipping company” (shorthand for a person who lets a
ship on charter in the course of a trade within the scope of section 123(1) CAA
2001). K-Line even sought advice as to the profit margin which such a company
would be expected to earn.
424.The Appellant
says that once K-Line was aware that in principle capital allowances were
available for the financing of the Vessels within the context of arrangements
which accorded with the K-Line group’s commercial intentions, it was merely
prudent for K-Line to satisfy itself that it could and would meet the complex
“qualifying purpose” conditions.
425.The
Commissioners say that the purpose of seeking such detailed advice, which
spilled over into matters such as the profitability of K-Euro which were
commercial matters entirely within the competence and experience of K-Line, was
to tailor the structure of the leasing of the Vessels so as to give the basis
for a claim for the capital allowances.
426.It is clear
that K-Line was intent on securing finance lease funding of the Vessels. Such
funding offered certain non-tax commercial benefits (such as full funding
without any initial deposit) and a UK finance lease prospectively offered the
further commercial benefit of reduced cost of funding by reason of the capital allowances
available to the finance lessor and shared by means of reduced rentals. The
parties, in entering into the transactions for the letting of the Vessels on
charter, had as an objective that the capital allowances should be obtained.
K-Line sought advice so that it knew what the circumstances and conditions were
that must obtain or be met in order that that objective could be achieved. We
would characterise K-Line’s attitude in seeking advice as being one of due
diligence – the course of action was decided upon, but it needed to be as
certain as it could before approaching prospective lessors that the
arrangements it intended should be implemented would indeed secure the benefits
to be derived from the capital allowances.
427.The objective
of obtaining capital allowances was not a main objective of the transactions
for the letting of the Vessels on charter. In our judgment the commercial
objective we have identified above was paramount. Each transaction in the
series of transactions relating to the letting of the Vessels on charter had a
commercial purpose: it created an economic interest, transferred or shared a
commercial risk, or was in pursuance of a genuine business endeavour. Overall,
it is the case that the main objective of the transactions whereby, in
September 2002, K-Euro took on the rights and obligations which would, on
delivery of the Vessels, make it the disponent owner of the Vessels, was to
achieve a commercial benefit distinct from, and not dependent upon, obtaining
capital allowances. The capital allowances were a route to reduced cost of
funds for the financing of transactions already decided upon. The parties knew
this to be the case if the capital allowances proved to be available, and they
wanted to obtain the benefit of such allowances, by ensuring that, in carrying
out their commercial objectives, they would comply with the necessary
conditions upon which the capital allowances were dependant. In terms of
priority or hierarchy, that was subservient to, or of lesser importance than,
achieving the commercial purposes of the relevant transactions.
428.We therefore
conclude that the obtaining of writing-down allowances was not the main object,
or one of the main objects, of the letting of the Vessels on charter or of any
of the transactions in a series of transactions of which the letting of the
Vessels on charter was one.
429.Accordingly
we decide Issue 4 in the Appellant’s favour.
Conclusion
430.Having
decided each of the Issues as we have, we allow the Appellant’s appeal in this
case.
Costs
431.At the
hearing the parties made no submissions as to costs. If this case has not been
excluded from the costs regime which may apply to cases allocated as a Complex
case under the provisions of Rule 10 of the Tribunal Procedure (First-tier
Tribunal) (Tax Chamber) Rules 2009, the Appellant may apply to us for an order
for its costs and expenses.
Right to appeal
432.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.
EDWARD SADLER
TRIBUNAL JUDGE
ADRIAN SHIPWRIGHT
TRIBUNAL JUDGE
RELEASE DATE:12 January 2012
Authorities referred
to in skeletons or included in authorities bundle and not referred to in the
decision:
Inland Revenue Commissioners v
Willoughby [1997] 1 WLR 1071
Wilson v First Country Trust
Ltd (No. 2) [2004] 1AC 816
Peterson v Commissioners of Inland
Revenue [2005] STC 448
APPENDIX
Short description
of the transaction documents as appearing in the unchallenged witness statement
of Mr Richard Owen Williams of Lloyds Banking Group
The transaction was signed on 19
September 2002. The structure of the documentation was as follows:
(a) A Novation Agreement in respect of two Shipbuilding
Contracts each dated 19 December 2001 (as amended and supplemented from time to
time) (the “Shipbuilding Contracts” made (1) between Mitsui Engineering
& Shipbuilding Co. Ltd and Kawasaki Kisen Kaisha, Ltd (“K-Line”) in respect
of the Vessel with Hull Number 1564 and (2) Kawasaki Heavy Industries Ltd and
K-Line in respect of the Vessel with Hull Number 1532 (the “Shipbuilding
Contract Novation Agreements”) pursuant to which the Appellant agreed to
assume certain of the rights and obligations of K-Line to purchase, take
delivery of and pay for each Vessel (the Shipbuilding Contracts as amended and
novated by the Shipbuilding Contract Notation Agreements being the “Novated
Shipbuilding Contracts”). The Novated Shipbuilding Contracts also made
provision for a possible further novation to a replacement buyer.
(b) A Lease Agreement in respect of each Vessel pursuant to
which the Appellant agreed to lease the Vessels to Northern LNG Transport Co I
Limited and Northern LNG Transport Co II Limited (each a “Lessee” and together
the “Lessees”) and the Lessees agreed to lease the Vessels from the
Appellant (the “Leases”). This contains the rental obligations and the
obligations of the Lessees to provide or procure the provision of security to
the Appellant for the amounts due under the Lease.
(c) A Bareboat Charter Agreement of each Vessel (the “Bareboat
Charters”) pursuant to which the Lessees agreed to charter each Vessel to K
Euro as the Bareboat Charterer.
(d) A Novation Agreement in respect of each Vessel pursuant to
which K-Line novated its rights and obligations under two Time Charterparty
Agreements to K Euro (each charterparty dated 19 December 2001 (as amended and
supplemented from time to time) with Statoil ASA as operator (on behalf of the
Snøhvit Sellers) pursuant to which Statoil agreed, following delivery, to take
each Vessel on charter for an initial period of twenty years with two optional
five year extensions (the “Original Time Charters”)) (the “Time
Charter Novations”).
(e) A Quiet Enjoyment Letter for each Vessel addressed to
Statoil and signed by, inter alia, the Appellant. The Bank of
Tokyo-Mitsubishi, Ltd, as agent under the debt financing arrangements (the “Agent”),
K Euro and each Lessee, pursuant to which, among other things, the signatories
acknowledged they would not interfere with Statoil’s full use and enjoyment of
each Vessel provided Statoil performs its obligations under the Time Charter
Novations (the “Quiet Enjoyment Letters”).
(f) A Supervision Agreement in respect of each Vessel pursuant
to which the Appellant appointed K-Line and K-Line accepted appointment as
supervisor to supervise the construction of the Vessels on behalf of the Appellant
(the “Supervision Agreements”).
(g) A standby Put Option Deed in respect of each Vessel between
the Appellant and Northern LNG Leasing Co Limited (the “Standby Purchaser”)
pursuant to which the Standby Purchaser granted the Appellant an option to sell,
as the case may be, each Vessel to the Standby Purchaser (the “Standby Put
Option Deeds”). The obligation of the Standby Purchaser to pay the
required purchase price under each Standby Put Option Deed would be funded by a
bank or financial institution acceptable to the Appellant (the “Standby
Lender”).
(h) A Lease Agreement entered into between (i) the Standby
Purchaser and (ii) each Lessee in relation to each Vessel and in respect of the
leasing of each Vessel by the Standby Purchaser to the Lessee following
delivery of each Vessel to the Standby Purchaser in accordance with the Standby
Put Option Deeds (the “Standby Leases”).
(i) A Deed of Application and Proceeds in respect of each
Vessel entered into between (1) the Appellant, (2) each Lessee, (3) Statoil,
K-Line, Mitsui & Co, Ltd and lino Kaiun Kaisha, Ltd (the “Project
Partners”), (4) the Agent, (5) K Euro, (6) Lloyds TSB Bank plc (City
Office) as Proceeds Account Bank, (7) the Hedging Bank, (8) the Standby
Purchaser and (9) each other Lessee, dealing with the application of all
proceeds under the Transaction Documents (as defined in the Leases) (the “Deeds
of Application and Proceeds”).
(j) A Guarantee in respect of each Vessel granted to the
Appellant by the Project Partners guaranteeing of each the obligations of each
Lessee and any Replacement Buyer (as defined in the Leases) under the Lease
Documents (as defined in the Leases) (the “Guarantees”).
(k) A Letter of Guarantee in respect of each Vessel issued by
Lloyds TSB Bank plc in favour of each Lessee and the Agent guaranteeing the
obligations of the Appellant under the Leases and the Deeds of Application and
Proceeds (the “Lessor Parent Guarantees”).
(l) A Letter of Guarantee in respect of each Vessel issued by
Lloyds TSB Bank plc in favour of each of Mitsui Engineering & Shipbuilding
Co, Ltd and Kawasaki Heavy Industries Ltd, guaranteeing the obligations of the
Appellant under the Shipbuilding Contract Novation Agreements and the Novated
Shipbuilding Contracts (the “Lessor Parent Builders Guarantees”).
(m) A Deposit Deed and Deed of Assignment and charge entered into
between (1) each Lessee, (2) Lloyds TSB Bank plc and (3) the Appellant pursuant
to which Lloyds TSB Bank plc agreed to accept payments made into a cash
collateral account opened by each Lessee and each Lessee charged all amounts
standing to the credit of the cash collateral accounts to the Appellant as
security for the obligations of each Lessee under the Lease Documents (as
defined in each Lease) (the “Deposit Deeds and Deeds of Assignment and
Charge”). This was to ensure that if problems occurred with the LC bank,
that arrangements were in place under which the Appellant could obtain
immediate alternative security from the Lessee; it was not expected that any
amounts would even be paid into the cash collateral account, it was just there
as a back up security.
(n) A Contribution Deed in respect of each Vessel entered into
between the Appellant and each Lessee (the “Contribution Deeds”)
pursuant to which each Lessee agreed to make certain capital contributions to
the Appellant in respect of amounts payable by the Appellant under the
Shipbuilding Contracts and the Shipbuilding Contract Novation Agreements.
(o) A Letter of Credit in respect of each Vessel given in favour
of the Appellant by HBOS Treasury Services plc (the “LC Bank”) (the “Letters
of Credit”). It should be noted at the time this transaction was completed
HBOS was not part of the Lloyds Banking Group.
(p) A Panamanian Vessel Mortgage granted by the Appellant to
each Lessee as security, inter alia, for the payment of all sums payable by the
Lessor to each Lessee as rebate of rental on sale of the Vessel (the “First
Preferred Panamanian Vessel Mortgages”).
(q) The
following security was granted to the Appellant:
(i) a Second Priority Security Assignment in respect of each
Vessel granted to the Appellant by each Lessee as security for the obligations
of each Lessee under each Lease (the “Second Security Assignments”).
(ii) a Second Priority Floating Charge in respect of each Vessel
granted to the Appellant by K Euro over all of K Euro’s assets (the “Second
Floating Charges”);
(iii) a Second Priority Deposit Accounts Control Agreement in
respect of each Vessel entered into by each Lessee and the Appellant as
security, inter alia, for the obligations of each Lessee under each Lease (the
“Second Deposit Accounts Control Agreements”).
(iv) a Second Priority Shares Mortgage in respect of each Vessel
granted to the Appellant by the Project Partners over each of their respective
shares, stocks or other securities and investments in each Lessee (the “Second
Shares Mortgages”);
(v) a Deed of Covenants in respect of each Vessel entered into
between (1) K Euro (2) each Lessee, (3) the Appellant and (4) The Bank of
Tokyo-Mitsubishi Ltd as the Bareboat Charterer Account Bank (the “K-Euro
Deeds of Covenants”) pursuant to which K Euro provided certain covenants
and assumed certain obligations in favour of the Appellant and the Lessee.
(vi) a package of security documents to be entered into giving
the Appellant second priority security interests following the exercise of the
standby arrangements.
(r) A Lessor Proceeds Account Charge in respect of each Vessel
granted by the Appellant to the Agent to secure the obligations of the Appellant
to pay all amounts payable to each Lessee by way of rebate of Rental (as
defined in the Leases) under each Lease and to discharge the Lessor Proceeds
Obligations (as defined therein) (the “Lessor Proceeds Account Charges”).
(s) A Letter of Undertaking given by each of Mitsui Engineering
& Shipbuilding Co. Ltd and Kawasaki Heavy Industries Ltd to the Appellant
in respect of each Vessel (the “Builders’ Undertakings”).
(t) A Letter of Undertaking given by each of Mitsui Engineering
& Shipbuilding Co. Ltd and Kawasaki Heavy Industries Ltd to the Agent in
respect of each Vessel signed by the Appellant (the “Builders’ Undertakings
to the Agent”).
(u) The following side
letters were also issued (the “Side Letters”):
(i) Tax Disputes Letter pursuant to which each Lessee and the
Appellant agreed, inter alia, to inform and consult with each other and assume
certain obligations towards each other on certain tax matters.
(ii) Indexation
letter.
(iii) Pooling
letter.
(iv) Negotiation
Fee Letter.
(v) Swap
Letter.
(vi) Change
of Law Letter.
(vii) Standby Purchaser Administration Instruction Letter between,
inter alias, the Company, the Agent and QSPV Limited.
