Determining what is a ‘just and reasonable’ apportionment of taxable profits

Wed 31 Jan 2018

The First tier Tribunal (FTT) has held that the calculation of a just and reasonable apportionment of north sea oil profits by two entities in the Maersk group subject to UK corporation tax, was indeed just and reasonable.  The case concerned a dispute over £6.87m of corporation tax on ring fence profits for the accounting period ended 31 December 2011.

The case concerned the 23 March 2011 increase in supplementary charge on ring fence profits from 20% to 32%. The legislation provided that companies with an accounting period straddling this date should treat the periods before and after the change as two separate accounting periods, and allocate their profits on a time apportioned basis.  Where this gave rise to an unjust or unreasonable result, a just and reasonable apportionment could be applied by election.

Determining a just and reasonable allocation of profits where a time apportionment basis produces an unreasonable result, is of particular interest at present. This is how allocation of results of straddling accounting periods for the commencement of the corporate interest restriction and corporate loss reform rules, are to be determined (though no election is required in these cases).  HMRC do have the power under the corporate interest restriction rules (TIOPA Sch7A para 54) to impose their own just and reasonable basis, which can only be challenged by appeal on the basis it is not just and reasonable.

Background

Maersk Oil North Sea UK Ltd (MONS) and Maersk Oil UK Ltd (MOUK) carry on oil related trades, being operators of six oil fields in the North Sea. On 4 February 2011 there was a severe storm causing significant damage to its Floating Production and Storage Offloading vessel at one field and most of the associated subsea equipment.  As a result four of the fields suffered a ‘shut in’ period pending repair of the equipment, with one field shut for a two year period.

As a result of storm damage significant capital expenditure was incurred in the period after 23 March 2011, with a significant insurance claim treated as arising for tax purposes on 4 February 2011. MONS and MOUK considered that a time apportioned allocation of year ended 31 December 2011 taxable profits was unreasonable, and elected to apply a just and reasonable apportionment, which HMRC agreed it was able to do.

Using management accounts, the companies allocated profit to the period before 24 March 2011 (147% of total ring fence profits for MOUK and 102% of total ring fence profits for MONS). This was mainly due to the fact that the capital expenditure, generating significant first year allowances, was deemed to arise in the period after 23 March 2011 when it was incurred.  This apportionment meant that none of the companies’ profits for 2011 were subject to the increased rate of supplementary charge.

HMRC pointed to the fact that the majority of the turnover of each company (68% for MOUK and 65% for MONS) occurred in the second period. They were also not prepared to accept that all the tax effect of the capital expenditure should be allocated to the second period.

While some possible refinements could be made to the Maersk profit allocation, the FTT considered it was a just and reasonable apportionment. They also considered that it was justifiable to treat the divided period as two separate accounting periods with the tax impact of the capital expenditure allocated to the later period.

Principles for just and reasonable apportionment

The FTT outlined some principles it considered were important in arriving at its conclusion, which included:

• Using a method that is not contrived, applied consistently consistent, whether it gives an advantage or not;
• That first year capital allowances are not given on time apportioned basis, but on an incurred basis.
• A just and reasonable alternative does not have to be the most just and reasonable alternative.

Further information

For a further discussion of just and reasonable apportionment and any points arising from the corporate interest restriction rules or corporate loss reform, please get in touch with a member of the Mazars corporate tax team.