This month’s Chartered Accountants Tax Case Digest looks at a case which examined the distinction for capital allowances purposes between buildings and plant. This is an important distinction as building expenditure generally does not qualify for plant and machinery allowances under the capital allowances regime.

Whilst the decision in this particular case is based on its specific fact pattern, the judgment is useful for interpreting the relevant legislation in this area. Although the decision is limited to the treatment of gas storage cavities, the steps the Tribunal followed in arriving at its judgment are relevant when considering if other borderline assets are plant or part of the premises in which the trade is carried on.

Background

This appeal concerns the tax treatment of expenses incurred in creating gas cavities. The appellants were Cheshire Cavity Storage 1 Limited (“CCS”) and EDF Energy (Gas Storage Hole House) (“EDF”).

Each appellant appealed against conclusions in closure notices issued by HMRC which amended the company’s tax returns for certain periods.

The effect of the closure notices was to deny both companies capital allowances in respect of the cost of de-brining gas cavities, and to deny EDF capital allowances in respect of the cost of leaching gas cavities.

The decision facing the Tribunal was one in principle on whether the appellants were entitled to capital allowances on these costs.

Both appellants were in the EDF Energy PLC corporate group. The business of the group is energy generation and distribution in the UK. The group supplies gas to customers over the National Transmission System owned by National Grid. As part of its business, the group has to store gas.

The business of CCS and EDF is the development, construction and operation of gas storage facilities in the UK. Each company operates gas storage facilities on adjoining sites in Cheshire. Between them, the two sites represent seven percent of the UK’s gas storage capacity and can hold up to 20 percent of the UK’s daily delivery capacity.

In order to use the cavities, CCS and EDF incurred expenditure on boreholes, pipework, pumping and dehydration equipment, and on control mechanisms. All this expenditure was accepted by HMRC as qualifying for plant and machinery allowances. The dispute related solely to the cost of leaching and de-brining cavities.

In Cheshire, there was and is naturally occurring salt rock underground. In some locations this can be “solution” mined by drilling a borehole and then injecting water which is designed to permit the extraction of much of the resulting salty water (brine). This process is referred to as ‘leaching’ and eventually creates a tear-shaped cavity underground which is full of brine.

The cavities are never emptied, but at the end of the leaching process are left full of brine which puts pressure on the surrounding rock. An empty cavity would also risk fractures in the surrounding rock and ultimately total/partial collapse of the cavern and possible subsidence on the surface. The cavities are also not left full of water because water would react with the surrounding of the cavity making the cavity even bigger and potentially unstable.

Over a period of about three months, a suitable salt cavern can be converted to gas storage by the slow exchange of the brine with gas via pipes through the borehole. This is known as de-brining.

Once filled with gas, sufficient gas to fill the cavern at a certain minimum pressure must always be left in the chamber to avoid the risk of partial or total collapse of the cavity. This gas is referred to as ‘cushion gas’ and cannot be sold onto the grid but must remain in the cavity. HMRC accepted that the cushion gas in the cavities was plant.

Arguments and decision

The main argument of the appellants was that the expenditure on leaching and de-brining the cavities was qualifying expenditure as the cavities were plant meaning that this expenditure qualified as capital expenditure on the provision of plant under section 11(4)(a) of the Capital Allowances Act (“CAA”) 2001.

The appellants maintained that the cavities were not passive, as they stored gas under pressure and in some circumstances that pressure was used to move the gas to the National Transmission Service. Even if they were passive, they cited the authority of Jarrold v John Good & Sons Ltd (1962) as justifying their categorisation as plant.

They also argued that their business of storing gas meant that they were in the business of gas distribution and gas processing. However the Tribunal did not accept that they were in the business of processing gas. The evidence provided clearly showed that any processing was merely a necessary incident of storing the gas.

HMRC argued that the cavities were the housing, setting or premises from which the appellants’ business was carried on and not the plant with which it was carried on meaning the expenditure was not incurred on the provision of plant under section 11(4).

After reviewing relevant case law in this area, the Tribunal judge stated that previous case law on storage established that providing shelter and protection to plant or stock-in-trade or customers’ possessions was a premises function, at least in respect of immovable property.

On that basis and given the finding that the appellants’ business was short-term storage of gas, the significant and predominant function of the cavities was shelter and confinement and they were not therefore plant. Their ability to do so at high pressure meant merely that they were ‘very good premises for storing gas.’ This meant that the expenditure did not qualify under section 11(4).

Although not necessary to dispose of the appeal, the Tribunal then considered if the expenditure was excluded in any case by section 22 CAA 2001.

Specifically, was it:-

1. expenditure on the provision of a structure in use for the purposes of an undertaking for the extraction, production, processing or distribution of gas, in which case it was not so excluded (by virtue of paragraph 7(b) of List B in section 22 CAA 2001); or
2. expenditure on works involving the alteration of land and therefore excluded under section 22(1)(b) CAA 2001

In respect of (a), it was agreed that extraction and production were not relevant to the activities of the appellants. The question therefore was whether or not the cavities were used for the purposes of an undertaking for the processing or distribution of gas. The appellants did process the gas but did so in a processing plant above ground and as an incident of storing it. Processing the gas was not their purpose. Nor was their purpose gas distribution – they simply sold the gas they stored. Therefore, the cavities were structures falling within List B and were not excepted by paragraph 7(b) in that list. Expenditure on them was therefore excluded expenditure.

Regarding (b), it was the Tribunal’s view that if expenditure did not fall within section 22(1)(a) CAA 2001 as incurred on providing a structure as listed in List B, it fell within section 22(1)(b) CAA 2001 and was thus excluded expenditure.

In dismissing the appeal, the First-Tier Tribunal held that underground cavities adapted for the storage of gas under pressure were not plant for the purposes of capital allowances on plant and machinery and, even if they were, expenditure on them was excluded from being qualifying expenditure by section 22 of the Capital Allowances Act 2001.

The full judgment in this case is available from:- http://www2.bailii.org/uk/cases/UKFTT/TC/2019/TC07301.html