Total – Court of Appeal considers meaning of "just and reasonable" apportionment of profits

In Total E&P North Sea UK Ltd and Another v HMRC [2020] EWCA Civ 1419, the Court of Appeal (CoA) allowed the appellant companies' appeal and decided that the basis of the companies' apportionment of adjusted ring-fence profits was just and reasonable, for the purposes of an election under section 7(5), Finance Act 2011 (FA 2011).

Background

Total E&P North Sea UK Ltd and Total Oil UK Ltd (the Companies) both carried on "oil-related activities" and so were subject to a supplementary charge on their adjusted ring fence profits from those activities. Between 2006 and 2011, the supplementary charge amounted to 20% of adjusted ring fence profits. However, on 23 March 2011, it was announced that the supplementary charge would be increased to 32% from midnight. The change in rate was subsequently carried into effect by section 7, FA 2011, which received royal assent on 19 July 2011.

Section 7(4), FA 2011, provides that, where a company had an accounting period beginning before 24 March 2011 and ending on or after that date (the straddling period), for the purpose of calculating the amount of the supplementary charge, the adjusted ring fence profits were to be apportioned between the period before 24 March 2011 (the Earlier Period), and the period on or after 24 March 2011 (the Later Period), in proportion to the number of days in those periods. However, section 7(5) provided that, if that basis of apportionment "would work unjustly or unreasonably in the company's case, the company may elect for its profits to be apportioned on another basis that is just and reasonable and specified in the election".

The Companies had an accounting period which ran from 1 January to 31 December 2011. The Companies sought to make an election, pursuant to section 7(5), FA 2011, on the basis of considering the Earlier Period and the Later Period independently and allocating income, expenditure and allowances to the periods according to when they arose. The Companies’ approach resulted in all their adjusted ring fence profits for the 2011 accounting period being allocated to the Earlier Period rather than the Later Period, which meant they avoided the 32% rate of supplementary charge.

HMRC did not consider the Companies' apportionment basis to be "just and reasonable" and issued a notice of amendment to the self-assessment for the 2011 accounting period for Total E&P North Sea UK Ltd, and a closure notice assessing Total Oil UK Ltd to additional tax. The Companies appealed to the First-tier Tribunal (FTT).

FTT decision

The appeals were allowed.

In the view of the FTT, the Companies' approach was "just and reasonable" and concluded that section 7(5) applies to all companies “whose profits are not smoothly spread throughout the year, but whose profits differ greatly from one part of the year to the other, and who could be disadvantaged by … a change of tax rate part way through an accounting period".

HMRC appealed to the Upper Tribunal (UT).

UT decision

The appeal was allowed.

The UT decided that time apportionment under section 7(4) was intended to be the default position and that it would apply unless, for reasons specific to the company concerned, time apportionment would work unjustly or unreasonably. The UT considered that to be "just and reasonable", an alternative basis of apportionment must do no more than take account of factors specific to the company in question.

The UT concluded that the Companies’ basis of apportionment was not "just and reasonable" for the purposes of section 7(5).

The Companies appealed to the CoA.

CoA judgment

The appeal was allowed.

Lord Justice Newey (with whom the other Lord Justices agreed) considered that the application of section 7(4) could only be said to work "unjustly or unreasonably" if time apportionment would prejudice the company in question to a more than minimal extent. However, he considered that any company which earned profits at a significantly faster rate in the Earlier Period than the Later Period, and so stood to be materially prejudiced by time apportionment, could avail itself of section 7(5). He was of the view that it did not matter whether the differential profitability arose from the exceptional or the routine.

Comment

Although the CoA agreed with the UT that time-based apportionment was the default position, taking a purposive approach to section 7, FA 2011, it rejected the UT's analysis and held that the focus on a particular taxpayer's circumstances did not mean that only factors unique to that taxpayer permitted alternative apportionment, rather, the focus was on factors (whether unique or of general applicability) affecting the taxpayer concerned. 

Although this case specifically concerns the application of section 7, FA 2011, the CoA's decision may provide useful guidance in relation to other situations where a "just and reasonable" apportionment is required. 

Given that HMRC was successful before the UT, it would not be surprising if it sought to appeal to the Supreme Court.

The judgment can be viewed  here.