Two LLPs claimed 100% enterprise zone capital allowances for expenditure on data centres built under a 'golden contract' entered into just before the 10-year deadline. The Supreme Court dismissed the appeal, holding that expenditure on buildings not contractually committed to within the first 10-year period did not satisfy section 298 of the Capital Allowances Act 2001.
Background
The Tyne Riverside Enterprise Zone was established on 19 February 1996. Two days before the expiry of the first 10-year period (on 17 February 2006), Highbridge North Tyneside Developer One Limited (‘the Developer’) and Highbridge North Tyneside Contractor One Limited (‘the Contractor’) — both wholly owned subsidiaries of the same corporate parent — entered into a building contract known as ‘the Golden Contract’ for the construction of a building at the Cobalt Business Park within the enterprise zone. The Golden Contract gave the Developer a right (and obligation) to select one of six specified building projects (‘Works Options’), each differing significantly in size, scope, site, and cost. The contract also incorporated clause 12 of the JCT Standard Form (as amended), conferring on the Developer a unilateral right to make changes to the design, quality, or quantity of the selected Works Option.
During the second 10-year period (2006–2016), the Developer and Contractor agreed variations (Variation 1 and Variation 2) enabling the Developer to select more than one Works Option. Change Orders were then issued purportedly under clause 12, instructing the construction of three data centres (DC1, DC2, and DC3). The appellants, Cobalt Data Centre 2 LLP and Cobalt Data Centre 3 LLP, acquired by assignment the Developer’s rights relating to DC2 and DC3. They claimed 100% initial capital allowances (‘EZAs’) under section 298 of the Capital Allowances Act 2001.
Section 298(1)(b) provides that expenditure incurred more than 10 but less than 20 years after a site was first included in an enterprise zone qualifies for EZAs only if it is incurred ‘under a contract entered into within those 10 years’.
The Issues
Three principal issues arose for determination:
(i) The Clause 12 Issue
Whether the Developer’s expenditure on DC2 and DC3 was triggered by the unilateral exercise of the right to change under clause 12 of the Golden Contract in its original form, such that the expenditure was incurred ‘under’ the Golden Contract.
(ii) The Section 298 Issue
Whether section 298 on its true construction permits expenditure incurred pursuant to a contractual variation made during the second 10-year period of a contract originally made in the first period to be treated as expenditure incurred ‘under’ the original contract.
(iii) The Variation Issue
Whether the alterations to the Golden Contract which provided for DC2 and DC3 amounted to a variation or a replacement of that contract under the common law.
The Court’s Reasoning
The Section 298 Issue
Lords Briggs and Sales, delivering the joint judgment with which Lord Burrows, Lady Rose, and Lord Richards agreed, gave a purposive construction to section 298. They identified the purpose of the 10-year time limit as securing a contractual commitment to qualifying development expenditure within the first 10 years, as the quid pro quo for the incentive of 100% capital allowances. They stated:
the taxpayers’ construction of section 298(1) entirely fails to implement the statutory purpose of the 10 year time limit in a case such as the present, and all the more so if the taxpayers’ case about the common law meaning of variation (as depending purely upon the parties’ intention) is correct.
The Court held that section 298(1)(b) requires the court to look back to the tenth anniversary and ask whether there was by that date a contractual relationship under which the relevant expenditure had been either agreed upon in terms or arose from building work that the developer had a contractual right to require by the exercise of unilateral rights to select or change existing as at that date. Changes made after the tenth anniversary by contractual variation do not satisfy section 298 unless the building project upon which the expenditure is incurred is in substance the same as that contracted for under the original contract. The Court rejected HMRC’s rigid ‘same building, same site’ test but held that the question was one of substance:
section 298(1)(b) looks to the substance of the contractual commitments in place at the first 10 year anniversary and compares that to what was done within the second 10 year period. The relevant question is not the form or mechanism which the parties later chose to use, but whether the change detracted in substance from the existence of the requisite commitment to the relevant expenditure as at the tenth anniversary.
Applying this test, the Court found that there was plainly no contractual commitment on the tenth anniversary to the expenditure incurred on DC2 and DC3. The Golden Contract had been made only two days previously and the Relevant Expenditure was not committed to until after the first period. Accordingly, section 298 was not satisfied.
The Clause 12 Issue
The Court agreed with the Upper Tribunal and the Court of Appeal that Change Orders 2 and 3 were not validly issued under clause 12. The right to change under clause 12 was expressly limited to alterations or modifications of the design, quality, or quantity of ‘the Works’, which meant the particular building specified in the selected Works Option. DC2 was a fundamentally different building on a different site. Lords Briggs and Sales observed:
A naval example may illustrate the point. A shipbuilding contract for the construction of an aircraft carrier may contain a right to alter or modify aspects of its design, quality or quantities. But if the Admiralty decides instead that it wants a nuclear submarine, this will not be a matter of alteration or modification to the design, quality or qualities of the specification for the aircraft carrier. That specification will have to be abandoned and completely replaced.
The Variation Issue
Although the Court’s conclusions on the section 298 and Clause 12 Issues rendered the Variation Issue academic, the Court addressed it in view of its public importance. The Court rejected HMRC’s contention that an objective ‘magnitude of change’ test, divorced from party intention, governs whether an alteration to a contract is a variation or a replacement. Citing Morris v Baron & Co [1918] AC 1 and British and Beningtons Ltd v North Western Cachar Tea Co Ltd [1923] AC 48, the Court held that the general common law affords parties a wide margin of choice in deciding whether an alteration should be by variation or replacement, and that this is generally determined by their common intention assessed objectively. However, there are limits at the margins:
While the description given to the transactions by the parties would not necessarily be conclusive if the alleged variation substituted a different subject matter, that cannot be said of either of the deeds of variation.
The Court also held that the tax context was a legitimate part of the relevant background for assessing intention, disagreeing with Lewison LJ’s characterisation of the tax motive as merely subjective desire.
Practical Significance
This decision authoritatively clarifies the construction of section 298(1)(b) of the Capital Allowances Act 2001, establishing that the relevant question is whether the expenditure incurred during the second 10-year period was in substance committed to by the tenth anniversary through contractual arrangements in place at that date. The Court overruled the Court of Appeal’s interpretation which had treated expenditure under a contractual variation of a qualifying contract as automatically qualifying. The decision significantly limits the use of ‘golden contracts’ as vehicles for preserving EZA claims where the actual development expenditure bears no substantial relationship to the contractual commitments made within the first 10-year period. The Court’s obiter remarks on the Variation Issue — affirming party autonomy in choosing between contractual variation and replacement, subject to outer limits — provide important guidance on a previously unresolved question of general contract law.
Verdict: The appeal was dismissed. The Supreme Court held that the relevant expenditure on DC2 and DC3 was not incurred under a contract entered into within the first 10-year period as required by section 298(1)(b) of the Capital Allowances Act 2001, albeit for different reasons from those given by the Court of Appeal.
