Judgment summary
This is an appeal by FB Shipping Limited and FC Shipping Limited (the Appellants) against a decision of the First-tier Tribunal (FTT) released on 6 November 2024, which had dismissed their appeal against HMRC's disallowance of capital allowances on capital expenditure incurred in acquiring five ships (1) to (5), [1]-[3].
The Appellants had leased the ships through a structured financing arrangement involving head leases with Fortis Finance (UK) Limited (FF), sub-leases from FF to operating companies (OpCos) within the Vroon group, and a guarantee from Fortis Bank S.A./N.V. (FBSav) of FF's obligations, [7].
The Upper Tribunal (Judge Thomas Scott and Judge Amanda Brown KC) concluded that the FTT made no error of law and dismissed the appeal on all four grounds advanced by the Appellants, [3], [139].
Background
The tonnage tax regime (TTR) is a form of state aid providing an alternative basis for taxing shipping companies, calculating taxable profits by reference to ship tonnage rather than actual earnings, and specifically excluding capital allowances for shipping companies within it, [6].
Lessors of ships to shipping companies within the TTR can in principle claim capital allowances, but paragraphs 89 to 91 of Schedule 22 to the Finance Act 2000 restrict that entitlement where the lease, or transactions of which it forms part, removes the whole or the greater part of the non-compliance risk that would otherwise fall on the lessor ("defeased leasing"), [8]-[9].
The Appellants, UK-resident subsidiaries of Alliance & Leicester Commercial Finance plc (later Santander Asset Finance plc), acquired five qualifying ships through novation of shipbuilding contracts, at a total capital expenditure of approximately US$84m for the FB Ships and US$79.7m for the FC Ships, [11(1)-(3)]. Each Appellant entered into a 25-year Head Lease with FF, which in turn sub-leased each ship to the OpCos for 25 years, [11(5)-(6)]. FBSav guaranteed FF's obligations under the Head Leases, [11(8)]. The OpCos prepaid substantial portions of rent under the Sub-Leases, exceeding 50% of total rental obligations (79.85% for the FC Ships), [11(10)].
The FTT found that the arrangements formed a single composite transaction, that FF was a special purpose vehicle with no independent income streams, and that at least one purpose of the structure was to convert exposure from shipping risk to bank risk, [21]-[27].
Core dispute
The substantive issue was whether paragraph 90 of Schedule 22 applied to deny the Appellants capital allowances because the leasing arrangements, taken with associated transactions, removed the greater part of the non-compliance risk that would otherwise fall on the Appellants as lessors, [32].
The Appellants raised four grounds of appeal: (1) that the FTT wrongly measured the reduction in non-compliance risk as a proportion of an already reduced level of risk rather than against a notional 100% baseline; (2) that the FTT wrongly treated the identity of the Head Lessee, FF, as a "provision" of the lease by comparing the actual arrangements to a hypothetical direct lease; (3) that the FTT wrongly rejected the Appellants' expert evidence that non-compliance risk should be measured as the amount of loss arising on an assumption of non-payment, rather than the probability of non-payment; and (4) that the FTT wrongly concluded the FBSav Guarantee was not an "excepted security" under paragraph 91(5), [47].
HMRC also raised a Response Issue as to whether the FTT had erred in finding the Prepayments were not themselves a risk-reducing "provision", though the Tribunal did not need to determine this given its conclusions on the other grounds, [48], [138].
A further issue concerned the relationship between paragraph 90 (defeased leasing) and paragraph 41 (general anti-avoidance) of Schedule 22, raised by the Appellants in oral submissions, [50]-[61].
Court findings
On the relationship between paragraph 41 and paragraph 90, the Tribunal held that paragraph 90 is the specific, targeted mechanism denying capital allowances to lessors in defeased leasing cases, and that paragraph 41, a general anti-abuse provision with the sanction of exclusion from the TTR, was not intended by Parliament to operate as an alternative mechanism for the mischief addressed by paragraph 90, [59]-[61].
On Ground 2, the Tribunal agreed with the FTT that the interposition of FF between the Appellants and the OpCos was a "provision" of the Paragraph 89 Lease (comprising the Head Lease and Sub-Lease together, which the Appellants no longer disputed) capable of reducing non-compliance risk, and that this did not involve any impermissible rewriting of the parties' actual arrangements, [67]-[72].
On Ground 4, the Tribunal upheld the FTT's conclusion that the FBSav Guarantee was not an "excepted security" under paragraph 91(5): the Prepayments made by the OpCos to FF constituted a deposit of money "by way of security" within paragraph 91(5)(a), regardless of whether they benefited the Appellants directly, and separately the Guarantee extended to liabilities beyond rental payments in default, breaching paragraph 91(5)(d), [84]-[90].
On Ground 3, the Tribunal agreed with the FTT that "non-compliance risk" in paragraph 90(2) requires an assessment of the probability of loss, not merely the amount of loss assuming total non-payment and total insolvency (the "Bencard 2" approach), which was rejected as producing an absurd result inconsistent with the statutory language and purpose, [107]-[112].
On Ground 1, the Tribunal held that the "greater part" of non-compliance risk under paragraph 90(1) must be assessed by comparing the actual level of risk with and without the impugned provisions, not against a hypothetical baseline of 100% risk, and that this approach did not produce an arbitrary or unfair "cliff edge" result, [130]-[135].
The Tribunal endorsed the FTT's overall conclusion that the combination of the intermediate Head Lease structure with FF and the FBSav Guarantee substituted bank risk for shipping company risk and removed the greater part of the non-compliance risk, consistent with the legislative purpose of Part X of Schedule 22, [91], [137].
Outcome
The Upper Tribunal dismissed the appeal on all grounds advanced by the Appellants, [3], [139]. It did not need to consider the HMRC Response Issue, [138].
Major issues / areas of contention
- Whether the Head Lease and Sub-Lease together constituted the relevant "lease" for the purposes of paragraph 89 of Schedule 22 (this point was conceded by the Appellants on appeal).
- Whether the identity of the Head Lessee, FF, could constitute a "provision" of the lease under paragraph 90, and whether assessing its effect involved an impermissible comparison with a hypothetical direct lease.
- Whether the FBSav Guarantee satisfied the conditions for an "excepted security" under paragraph 91(5), including whether the Prepayments amounted to a deposit "by way of security" and whether the Guarantee was limited to rental payments in default.
- Whether "non-compliance risk" under paragraph 90(2) requires an assessment of the probability of loss or only the amount of loss assuming non-payment has occurred.
- Whether the "greater part" of non-compliance risk under paragraph 90(1) should be measured against the actual level of risk or against a notional 100% baseline.
- The relationship between the general anti-avoidance provision in paragraph 41 of Schedule 22 and the targeted defeased leasing rule in paragraph 90.