HMRC's offshore tax deduction analysis confirmed by the UK Supreme Court
**Dolphin Drilling v HMRC: Supreme Court Clarifies 'Incidental Use' in Offshore Support Vessel Deductions**
In a significant ruling for offshore contractors, the UK Supreme Court has clarified the interpretation of the term "incidental use" under section 356LA(3) of the Corporation Tax Act (CTA) 2010. The Court's decision in the **Dolphin Drilling v HMRC** case sets a precedent for expenditures to qualify for corporation tax relief, requiring that the use of assets must be genuinely incidental to the primary qualifying activity.
The case centred around the Borgsten Dolphin, a vessel chartered by Dolphin Drilling from an associated Singaporean company and used to provide drilling support services at the Dunbar platform in the North Sea. Total, the operator of the Dunbar, had contracted for 120 berths, including space for personnel working on the platform, demonstrating that the accommodation use was essential to the overall operation.
Dolphin Drilling had sought tax deductions under the relevant CTA provisions, arguing that the hire cap, which restricts the deductibility of lease payments made under intra-group arrangements involving offshore oil and gas assets, did not apply to vessels whose sole function was to provide accommodation commonly known as flotels. However, the Court upheld HMRC's interpretation that the Borgsten's accommodation role was not merely incidental to its provision of TAD services.
The court applied an objective test to assess the "incidental" nature of the accommodation, considering both contractual arrangements and actual use of the vessel. The court found it decisive that Total needed the accommodation services of the Borgsten to enable more than 60 personnel to work on the Dunbar. The Borgsten's accommodation role was neither a by-product nor arising out of its TAD services.
As a result, the Borgsten Dolphin was found not to be merely incidentally used for accommodation, falling within the scope of the statutory restriction on tax deductions. The additional tax liability for Dolphin Drilling was assessed at GBP 6,730,695, for the 2014 and 2015 accounting periods.
The Supreme Court's decision clarifies the scope of the hire cap and narrows the application of the "incidental use" exception in section 356LA(3). Offshore contractors leasing vessels or other assets within a group must ensure that the asset's use aligns primarily with the statutory purpose defined by section 356LA(3) for tax relief to apply. If the asset is used mainly for purposes ancillary or incidental to the leasing arrangement, tax deductions may be denied.
This interpretation adds complexity to intra-group leasing because the nature of use must be carefully documented and justified to withstand HMRC scrutiny and potential legal challenge. The ruling underscores the need for offshore companies and contractors to evaluate the functional use of leased assets critically and ensure alignment with statutory requirements to secure allowable tax deductions under the CTA 2010 framework.
In the context of the Dolphin Drilling v HMRC case, the Supreme Court's decision highlights that offshore companies leasing assets, such as vessels, ought to ensure primary usage of these assets is aligned with the statutory purpose for tax relief, as assets used mainly for purposes ancillary or incidental to the leasing arrangement may not qualify for tax deductions under the Corporation Tax Act 2010. Moreover, for offshore contractors in the business and finance sector, it is crucial to document and justify the nature of use of leased assets to meet tax regulations and withstand HMRC scrutiny.
