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Tribunal allows capital allowances claim on hydro-electric scheme

Capital allowances were available on part of the expenditure incurred by energy company SSE on a hydro-electric scheme, the UK's First-tier tax tribunal has decided.15 Aug 2018

SSE had constructed a hydro-electric plant at Glendoe near Loch Ness and claimed capital allowances on around £260 million of expenditure. The UK's HM Revenue & Customs (HMRC) refused the claims in relation to expenditure of around £227m.

"Capital allowances are a significant issue on infrastructure projects as much of the expenditure on works and installation can fall close to disqualified items. The decision gives useful guidance on the interpretation of some of the terms in the legislation, such as 'tunnels' and 'aqueducts', and on when expenditure on alteration of land can be said to be only for the purpose of installing plant and therefore allowable," said Christine Yuill, a tax expert at Pinsent Masons, the law firm behind Out-law.com.

She added: "Taxpayers with disputed expenditure on assets similar to those in the SSE case should review their position."

HMRC refused claims in relation to expenditure on the water collection and transmission infrastructure involved in the scheme. It also refused claims relating to the construction of an underground chamber in which the generation and transformer equipment was housed and related access tunnels.

Capital allowances are available for expenditure on plant used for the purposes of a trade. The case focused on restrictions which deny allowances for expenditure on buildings and other specified structures, and on works involving the alteration of land. However, these exclusions do not apply to expenditure on the alteration of land only for the purpose of installing plant and such expenditure may qualify.

The hydro- electric scheme involved the construction of infrastructure to collect and divert water into a reservoir (referred to as the intakes), the routing of water at high pressure from the reservoir to a generator in an underground chamber (through a channel referred to as the headrace) and the onward routing of the water into Loch Ness (through tunnels and conduits known as the tailrace). Expenditure in relation to the dam and reservoir was not in issue.

The underground location of the generator meant that much of the water transmission was routed wholly or partly through underground conduits, many of which were bored and reinforced with concrete.

In relation to the water intakes, headrace and tailrace, HMRC argued that the expenditure on these fell within excluded categories of structure, particularly dams, reservoirs, tunnels or aqueducts, or otherwise fell within the general exclusion for works involving the alteration of land.

HMRC also challenged the expenditure on the underground generator chamber as incurred on a building or involving the alteration of land. Work on access tunnels which allowed people and equipment into the project was challenged as either being incurred on tunnels or the alteration of land.

The tribunal took a methodical approach to analysing the expenditure and exactly what the works involved. It also made a site visit to inspect the project.

The tribunal's approach required an analysis of whether the relevant items were plant for capital allowances purposes before looking at the exclusions for structures and altering land. It was agreed that the water intakes, headrace and tailrace were plant as they performed the function of transmitting water to and from the generator. There was a related question of whether the works should be analysed as a single piece of plant but the tribunal considered the correct approach was to analyse the items individually.

In looking at whether expenditure was on excluded structures of tunnels, aqueducts or barrages, the tribunal refused to hear evidence of the civil engineering usage of these terms. It said the proper test was to look at the dictionary definition in the context of the legislation rather than commercial usage.

"It is good to see the tribunal adopting a detailed analytical approach against some of the broad brush arguments advanced by HMRC and rejecting the use of civil engineering evidence in deciding the proper interpretation," Yuill said.

The tribunal acknowledged that the capital allowance position was very fact-dependent and that the legislation could produce what appeared to be arbitrary distinctions. For example, certain parts of the tunnels comprised in the intake works were held not to be 'tunnels' within the legislation,  because that term was held to require that people or transport could pass through it, but did fall within the term 'aqueduct'.

Certain of the items were potentially disqualified as falling within the definition of an aqueduct or otherwise involving the alteration of land but the tribunal found that for almost all these items, the alteration expenditure was for the only purposes of installing plant.

This meant that the expenditure did in fact qualify as alteration of land only for the purposes of installing plant is allowable expenditure. This included those tunnels where the expenditure on boring and concrete reinforcement effectively created the item of plant.

An exception was a 'cut and cover' conduit which was held to be disqualified as an aqueduct but not to involve an alteration of land for the purpose of installing plant. The tribunal acknowledged that in this case, the method of construction had resulted in a different capital allowances outcome.

The result was that almost all of the disputed expenditure on the intakes, headrace and tailrace was held to be allowable.

Expenditure on constructing the underground cavern was however disallowed as the cavern was the setting in which plant was installed, rather than itself being plant. Related expenditure on flooring and other substantial structures in the cavern was held to be sufficiently integral to the generation and maintenance equipment to be allowable.

Expenditure on access tunnels was disallowed as falling within the disqualification for 'tunnels' and not saved by any of the other provisions.