If you are going to construct an offshore windfarm you will need to carry out extensive preliminary studies before you commence construction. How will it affect the landscape? What is the risk of birds flying into the turbines? Are there important archaeological sites within the vicinity? These and many other issues need to be researched, at considerable costs. The question in the case of Gunfleet Sands Ltd and other companies v HMRC [2022] UKFTT 35 (TC) was whether these costs were eligible for capital allowances. The wind turbines and associated equipment clearly qualified. But did the preliminary expenditure?
Expenditure on items such as transportation and installation can qualify, so there is no doubt that some items which are not directly plant themselves are eligible. The question here, as so often, was where the borderline should be drawn. Were the studies part of the expenditure on the plant or were they, as HM Revenue & Customs ('HMRC') suggested, too remote to qualify?
The taxpayers (four subsidiaries of Orsted A/S, a Danish incorporated and resident company) incurred around £48 million on the following categories of expenditure ("Preliminary Studies") whose capital allowances eligibility was being disputed by HMRC:
Environmental impact studies and assessments.
Metocean studies (including studies on water level, wave regime, currents and wind conditions).
Geophysical and geotechnical studies.
Project management, design and procurement.
The decision covers a complex area of capital allowances claims - the allocation of indirect costs - which will have wider relevance beyond the very specialist nature of windfarm construction. The taxpayer won the principle on most points but not all and FTT introduced a new, more complicated and onerous test for (1) to (4) to qualify for capital allowances. The two parties are now instructed to settle the quantum of allowances based on the decision or appeal to the Upper Tribunal.
Single or multiple plant assets
A windfarm comprises a number of items and the first question facing First-tier Tribunal (FTT) was whether the turbines, cables and substations functioned as a single item of plant ("the generating assets") or whether the component assets needed to be considered separately on a piecemeal basis.
FTT took the view that, as a whole, that individual components 'directed towards a single purpose' could be treated as a single asset and compared the windfarm to a power station. Viewed as a whole the asset was directed solely towards the generation of electricity from wind, and therefore should be considered a single item of plant.
It is worth noting that a power station is not not normally regarded as a single item of plant and in previous informal guidance HMRC has specifically rejected single entity plant status for offshore windfarms so this decision is not without controversy.
Eligibility of preliminary studies
The second question facing FTT was whether the 'preliminary studies' qualified as being 'on the provision of' plant and machinery in accordance within the Capital Allowances Act (CAA) 2001 s11 (a topic referenced in a recent case for Satellite launch costs). HMRC's official guidance CA20070 states that:
"Professional fees, such as survey fees, architects’ fees, quantity surveyors’ fees, structural engineers’ fees, service engineers’ fees or legal costs, only qualify for PMA as expenditure on the provision of plant or machinery if they relate directly to the acquisition, transport and installation of the plant or machinery and as such are part of the expenditure incurred on the provision of the plant or machinery."
Despite the above published guidance, HMRC argued that expenditure on design is 'too remote and cannot be said to be incurred on the provision of plant' which was rejected by FTT and resulted in much discussion and a fresh examination of the principles set out in Ben-Odeco Ltd v Powlson (1978) [52TC459] of what expenditure was too remote or indirect to qualify. In doing so, FTT drew a a new distinction between necessary and unnecessary design alongside the fact that expenditure must directly relate to the fabrication, installation or construction of plant.
In what is now becoming an increasingly complex analysis, three categories were identified to allocate the various preliminary studies for which only one (3) would now qualify for allowances:
Studies proposing no mitigations and therefore having no impact on the design/construction of the assets;
Studies impacting the design/construction but the changes proposed were not ‘necessary’ (e.g. they related to the type of lighting on the wind turbines); and
Studies impacting the design/construction in a way that impacted the operational ability or effectiveness.
Scoping to assess site feasibility and general positioning was found to be too remote and not directly related to the safe and effective construction or installation of the wind turbines.
Landscape, seascape and visual assessments to mitigate the impact of the completed windfarms were found to be not on the provision of the wind turbines nor on their installation even although such assessment could affect final positioning.
Benthos studies which involve the impact of construction and operation on the flora and fauna found on the sea bed or sediments were found to be allowable but with different reasons for each which may affect quantum.
Ornithology and collision risk studies which dealt with the windfarms impact on birds (noise, vibration, habitat loss) during construction and operation were held to not directly relate to the design construction or installation of either the windfarm or the wind turbines.
Fish and shellfish studies which dealt with the impact on fish habitats, spawning grounds and migration results did have an impact on both turbine and windfarm construction (with some determining the timing of construction operations during the year).
Marine mammal studies which typically dealt with the windfarms construction impact on dolphins, porpoises, grey seals, whales and turtles and resulted in mitigation measures were found by FTT to be allowable for capital allowances.
Archaeology, wrecks and cultural heritage studies which included determining the
number of maritime sites and finds such as known wrecks, reported losses and recorded obstructions within the windfarms. FTT agreed with HMRC that these works did not relate to the design of the wind turbines themselves but did impact on construction.
Noise assessment studies to assess the impact of the proposed windfarm during the construction and operational phase were deemed duplicate to the marine mammal studies and too remote to qualify for allowances.
Telecoms and radar interference studies to determine the level of underwater and airborne noise during construction, operation and decommissioning were also found not to qualify for allowances. Whilst linked to design there were not 'necessary' in that there was no evidence to suggest that without these studies, the wind turbines would not have been constructed safely and operated effectively to generate electricity.
Traffic, transport and tourism studies to assess the level and type of air or maritime traffic in the windfarm areas did have an impact on the method of construction but not on design.
Socio-economic and tourism studies to determine the impact of the windfarm construction and operation on the human environment in the region, including any increase in employment and impact on tourism was found not to impact on the design or construction of the windfarms.
Metocean studies comprised both the initial desk-top assessment of electricity outputs based on comparable data during feasibility stage and detailed modelling for the eventual design of the wind turbines. FTT concluded that only the detailed studies were capable of qualifying for allowances.
Geophysical and geotechnical studies involved assessing site topography, seabed
features, geology and variability to better inform the foundation design and layout of the wind turbines within the designated sites. FTT concluded that the studies did relate to the necessary design of the windfarms and the turbines installed.
Project management (design and procurement) associated with the design and construction was allowable in line with JD Wetherspoon but only to the extent that they could be properly allocated to plant (or as the case may be) non plant costs and this was something FTT left to the parties to resolve.
Trading deductions in lieu of capital allowances
A common mistake in capital construction projects is to try and treat feasibility studies or non-qualifying capital allowances costs as a revenue deduction and FTT confirmed that costs which relate to capital assets cannot be re-categorised in this way (expenditure can be capital and relate to an asset without qualifying for capital allowances).
This is the first tax case to deal with windfarm expenditure and it remains to be seen what impact it will have on other commercial projects and the deductibility of related fees (e.g. feasibility cost studies, architect's fees and environmental impact studies etc.).
For further details please contact bryan.crawford@furastaconsulting.com.