CA judgment finds that time apportionment is not always ‘just and reasonable’ for allocation of profits in a straddle period.
Total E&P North Sea UK Limited and Total Oil UK Limited were subject to the UK ring fence corporation tax regime for upstream oil and gas companies when the supplementary charge to corporation tax was increased from 20 percent to 32 percent from 24 March 2011. For accounting periods straddling this date, taxable profits should be allocated on a pro-rata basis unless time apportionment could result in an outcome that would work ‘unjustly’ or ‘unreasonably’, in which case a taxpayer could elect for an alternative just and reasonable apportionment. In their corporation tax returns for the year ended 31 December 2011, the two companies elected for an alternative basis of apportionment, based on the actual income and expenditure incurred on the basis that there were significant tax losses in the latter part of the year as a result of operational shut-ins at the production sites.
The taxpayers’ view was that the time apportionment of profits between the periods up to and after the rate change was not just and reasonable and a more just and reasonable method, namely allocating income and expenses on an actual basis, should be applied.
HMRC rejected the use of the alternative basis of apportionment, which was appealed by the taxpayers at the First-tier Tribunal (FTT). The FTT allowed the taxpayers’ appeals, although this was subsequently reversed by the Upper Tribunal in favour of HMRC, taking the view that the taxpayers’ approach did not give rise to a just and reasonable result.
The Court of Appeal, however, agreed with the taxpayers’ position, noting that the provisions allow all taxpayers to apply a different method of apportioning profits where they are not smoothly spread throughout the year and who could be disadvantaged by a change in tax rate. They found that HMRC’s position effectively resulted in the retrospective taxation of profits. The taxpayers in the case had a strong fact pattern that supported the position, having suffered from operational challenges in the period which distorted the timing of income and expenditure.
The Court also agreed that the making of claims for capital allowances in the period in which expenditure was incurred was just and reasonable.
This case will be of interest to many taxpayers who, for one reason or another, are required to allocate taxable profits in straddle periods. While the usual method is to use time apportionment of profits, the Court of Appeal has acknowledged that the taxpayer was entitled to use an alternative method, where it could show that the time apportionment method was unfair and unjust and that its revised methodology was fair and just.
Where time apportionment does not give a just and reasonable outcome, taxpayers may wish to consider alternative, more suitable methods in light of the Court of Appeal’s reasoning.
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