HMRC V Dolphin Drilling: The Supreme Court clarifies the meaning of ‘incidental’

Background

Total E&P UK Ltd (TotalEnergies) carried on drilling activities in the North Sea at the Dunbar oil platform (Dunbar) and engaged Dolphin Drilling (Dolphin) to provide tender assisted drilling (TAD) services to Dunbar. In order to provide these services, Dolphin chartered a vessel, the “Borgsten Dolphin” (the Vessel) from an associated company (the Charter).

The contract between TotalEnergies and Dolphin for the provision of TAD services stipulated that the vessel would initially provide accommodation for 102 people, but following a request from TotalEnergies, the accommodation provision was increased to 120 berths and the cost of this was met by TotalEnergies. As well as providing accommodation, the contract set out the TAD services that Dolphin were expect to deliver, including: “ (i) the uninterrupted supply of drilling mud, water, compressed air and cement to the platform, (ii) the provision of facilities, including warehousing, storage of materials, workshops with welding and machine facilities, deck storage, laboratory space, and office and conferencing facilities for the TSV crew as well as the operator’s personnel working on board the TSV, and blowout protection,¹”

Tax position

The key issue in the case was whether Dolphin was entitled to deduct the entire hire it paid under the Charter calculating its taxable profits. S356N of the CTA 2010 imposes a hire cap on contractors operating within the UK territorial sea or Continental Shelf (the Hire Cap). The effect of this is to restrict the deduction of payments under leases between connected parties in respect of any “relevant asset” in calculating the profits of the paying contractor from its “oil contractor activities”.

The central question was whether the Vessel was a ‘relevant asset’ for the purposes of CTA 2010. Section 2 356LA(2) provides that an asset is a ‘relevant asset’ if:

“it is a structure that—

1. can be moved from place to place (whether or not under its own power) without major dismantling or modification, and
2. can be used to—          
   1. drill for the purposes of searching for, or extracting, oil, or
   2. provide accommodation for individuals who work on or from another structure used in a relevant offshore area for, or in connection with, exploration or exploitation activities (‘offshore workers’). “

Whilst this section would seem to apply to the Vessel, there is, in s356LA (3), an exception to this which provides that an asset will not be a ‘relevant asset’ “if it is reasonable to suppose that its use to provide accommodation for offshore workers is unlikely to be more than incidental to another use, or other uses, to which the asset is likely to be put”.

Was the accommodation provision ‘incidental to another use’?

The Supreme Court said that the words ‘incidental to another use’ should, in the context of the statute, be given their ordinary meaning. When applied in this situation, this meant “use A of the asset must be incidental to use B (or uses B and C) of that asset” and the test to be applied was whether use A of an asset arises out of use B. On the facts of the case, the primary use of the Vessel was the provision of TAD services with the provision of accommodation being a secondary, separate purpose and so the provision of accommodation, whilst connected with the TAD services, did not arise out of these services. The Supreme Court said that whilst a ‘trivial or casual’ use of the Vessel for accommodation whilst providing TAD services could be incidental, the arrangements Dolphin and TotalEnergies had, and in particular, the request by TotalEnergies to increase the berths on board the Vessel, of which they bore the costs, meant that the accommodation had a separate, independent use. On that basis, the Vessel was subject to the hire cap and additional tax was due.