Northern Gas Networks Limited v The Commissioners for HMRC

1. The appellant company (“NGN”) appeals against the decision of the First-tier Tribunal (Tax Chamber) (the “FTT”) dated 2 March 2020 (the “Decision”). In the Decision, the FTT dismissed NGN’s appeal against HMRC’s refusal of its claim for land remediation relief under Schedule 22 of the Finance Act 2001 (“Schedule 22”). 2. NGN owns and operates one of the eight regional gas distribution networks in the UK. It acquired that network in 2005 and thereby obtained, and became responsible for, some 37,000 kilometres of gas pipeline much of which was made of iron. Iron pipes are liable to corrode or fracture over time and thus gave rise to the risk of escaping gas and gas explosions. In consequence, the Health and Safety Executive has, since 2001, introduced a compulsory requirement for gas distribution companies, such as NGN, to update and improve their networks of iron pipes. That programme was known as the “30/30 Programme” because it required the replacement or improvement, over a 30-year period, of “at risk” mains pipelines located within 30 metres of a building. Following its acquisition of the network in 2005, NGN complied with this requirement by replacing certain of its iron pipes with high density polyethylene (“HDPE”) pipes or lining existing iron pipes with HDPE pipes. The dispute between the parties relates to the question whether this expenditure qualified for land remediation relief. Summary of issues arising in this appeal 3. NGN’s expenditure was of a revenue rather than a capital nature. Therefore, its entitlement to land remediation relief, which provided for an enhanced deduction of 150% of the amount that would otherwise be allowable, was governed by Part 2 of Schedule 22. The parties were agreed that, at [7] of the Decision, the FTT had correctly summarised the relevant requirements necessary for NGN’s expenditure to qualify namely that all the following conditions are met: (1) NGN acquired “land” in the UK. (2) The land was acquired for the purposes of NGN’s trade. (3) At the time of acquisition, all or part of the land was in a “contaminated state”. (4) NGN incurred qualifying land remediation expenditure (“QLRE”) in respect of the land. (5) The QLRE was allowable as a deduction in computing the profits of NGN’s trade. (6) The land must not have been in a contaminated state wholly or partly as a result of anything done or omitted to be done at any time by NGN or a person with a relevant connection to NGN. 4. It was common ground before the FTT that Conditions (2) and (5) were satisfied. The FTT determined, contrary to HMRC’s submissions, that Conditions (1) and (3) were satisfied. The FTT also decided, contrary to NGN’s submissions that Condition (4) was not satisfied. That was enough to dispose of NGN’s claim for land remediation since NGN needed to satisfy all of Conditions (1) to (6). However, the FTT went on to conclude that Condition (6) was not satisfied either. 5. NGN appeals against the FTT’s conclusions on Conditions (4) and (6). HMRC do not seek to challenge the FTT’s conclusion on Condition (1). HMRC have, however, asked in their Response to NGN’s appeal, that this Tribunal revisit the FTT’s decision on Condition (3). NGN disputes HMRC’s entitlement, as a matter of procedure, to raise this issue in a Response, arguing that, applying the principles set out in the recent judgment of the Court of Appeal in Revenue & Customs Commissioners v SSE Generation Ltd[2021] EWCA Civ 105, since HMRC have made no application to the FTT for permission to appeal against the Decision, they are not entitled to argue the Condition (3) issue in the Upper Tribunal. 6. NGN has also applied to put forward additional witness evidence in the Upper Tribunal proceedings that was not before the FTT. HMRC contested that application. The Decision 7. At [2], [3], [11] and [12], the FTT made findings of fact. None of these findings is disputed in this appeal (there was also little if any dispute before the FTT) and we gratefully adopt all of them. The following summary of the factual background is particularly relevant to the issues under appeal: (1) NGN acquired its gas distribution business by means of a purchase of assets (referred to as the “hive down” before us) from National Grid Transco plc (“NGT”) in 2005. At the time of the hive down, NGN was a subsidiary of NGT (see [12(1)] of the Decision). A few months after the hive down, the shares in NGN were sold out of the NGT group with the result that, at that point, NGN ceased to be a subsidiary of NGT. (2) One category of assets that NGN purchased from NGT consisted of the pipes comprising a gas distribution network. It was common ground that the pipes themselves were chattels and not fixtures which had become part of land (see [15] of the Decision). Those pipes were laid underneath various pieces of land, some privately owned (including by NGN itself) and some publicly owned (see [12(6)] of the Decision). (3) Accordingly, when NGN acquired its business and assets from NGT, it also obtained certain rights to locate those pipes on land owned by others, and to access those pipes. In relation to pipes located on private land (though not pipes located on private streets) NGN took an assignment of private law land rights that NGT had previously obtained from owners of the relevant land. In relation to pipes located on public land, NGN obtained its rights under Schedule 4 to the Gas Act 1986 (see [12(7)] and [12(8)] of the Decision). (4) No new iron pipes have been laid since the 1970s for the purposes of transporting gas. It was common ground before us that neither NGN, NGT or any company connected with either of them had themselves laid the iron pipes that were the object of the expenditure in dispute. (5) The 30-30 Programme imposed statutory obligations on NGN to replace or renew its network of iron pipes (see [2] and [12(11)] of the Decision). It was common ground between us that, when performing work on a particular pipe, NGN would ensure that the flow of gas through that pipe was suspended. It was also common ground that it would not have been practicable for NGN to pause all transmission of gas through iron pipes until those pipes were satisfactorily renewed or replaced. Such a pause would have lasted for several years at least, would have prevented many households in the North and North East of England from obtaining gas during that period and would have caused NGN to be in breach of its statutory and regulatory obligations. 8. At paragraphs [14] to [25], the FTT considered Condition (1), namely whether NGN had acquired land in the UK. The definition of “land” for these purposes is set out in paragraph 31(1) of Schedule 22 as meaning: any estate, interest or rights in or over land. 9. Accordingly, the FTT engaged in a detailed analysis of the precise nature of the rights that NGN acquired from NGT including the question whether, by acquiring the pipes, NGN also acquired “rights in or over land” consisting of rights to locate the pipes on land that NGN did not own. Since the FTT’s conclusion on Condition (1) is not under appeal, it is sufficient to note that, at [25] of the Decision, the FTT concluded that in relation to certain categories of pipes, Condition (1) was satisfied. 10. At [26] to [48], the FTT considered Condition (3), namely whether the land that NGN acquired was in a “contaminated state”. In doing so, it applied the statutory definition set out in paragraph 3(1) of Schedule 22 as follows: 3 Land in a contaminated state (1) For the purposes of this Schedule land is in a contaminated state if, and only if, it is in such a condition, by reason of substances in, on or under the land, that— (a) harm is being caused or there is a possibility of harm being caused; … 11. Paragraph 31(1) of Schedule 22 sets out a definition of “harm” which includes “harm to the health of living organisms” and “damage to property” 12. Paragraph 31(1) also contains the following definition of “substances”: “substance” means any natural or artificial substance, whether in solid or liquid form or in the form of a gas or vapour. 13. Although superficially straightforward, the test set out in paragraph 3(1) of Schedule 22 gave rise to some difficulty. First, the question posed was whether “land” was in a contaminated state. However, the definition of “land” to which we have already referred appeared to be directed at a legal estate or interest in land (a “non-physical incorporeal asset” as the FTT put it at [30] of the Decision) rather than to “physical” land. The FTT resolved this difficulty by concluding that paragraph 3(1) should be construed as asking whether physical land was in a “contaminated state” (see [39] of the Decision) and both parties now accept that to be the correct approach. This has the result that the word “land” has a different meaning in different parts of Schedule 22, but we are satisfied that the differing contexts and purposes of its use justify such a conclusion. 14. The FTT concluded that there were two relevant “substances” that were present in, on or under the land for the purposes of the definition in paragraph 3(1): the iron pipes themselves and the gas flowing through those pipes. 15. As regards the gas, the FTT concluded that it was present “in, on or under the land” (by virtue of being contained within pipes underneath the land) and was so present at the very moment NGN acquired the land (see [46]). The presence of the gas in pipes under land gave rise to a risk of “harm” because it could escape and cause an explosion. That caused the FTT to conclude that the land in question was in a “contaminated state” and that Condition (3) was met. 16. The position with the iron pipes was more complicated. The FTT considered that the iron from which the pipes were made was a “substance”. However, the FTT said at [43] that there was force in the view that risk of harm did not arise from the iron itself, or indeed from the pipes themselves, and instead arose from the gas in the pipes. Against that at [44] the FTT noted that the fact that the pipes were made of iron was not wholly irrelevant because, since iron pipes were more likely to fracture than pipes made of HDPE, the risk of “harm” could be said to arise from the material out of which the pipes were constructed. Ultimately the FTT decided that it did not need to reach a settled conclusion on these issues because its conclusion set out at [46] of the Decision was sufficient for Condition (3) to be met. 17. The question whether NGN incurred QLRE is at the heart of this appeal. Paragraph 2 of Schedule 22 provides as follows: 2 Qualifying land remediation expenditure (1) For the purposes of this Schedule “qualifying land remediation expenditure” of a company means expenditure of the company that meets the conditions in sub-paragraphs (2) to (6). (2) The first condition is that it is expenditure on land all or part of which is in a contaminated state (see paragraph 3). (3) The second condition is that the expenditure is expenditure on relevant land remediation directly undertaken by the company or on its behalf (see paragraph 4). (4) The third condition is that the expenditure is incurred— (a) on employee costs (see paragraph 5), or (b) on materials (see paragraph 6), or is qualifying expenditure on sub-contracted land remediation (see paragraphs 9 to 11). (5) The fourth condition is that the expenditure would not have been incurred had the land not been in a contaminated state (see paragraph 7). (6) The fifth condition is that the expenditure is not subsidised (see paragraph 8) 18. The parties were agreed that the third condition and the fifth condition, set out in paragraphs 2(4) and 2(6) were satisfied. The dispute was therefore focused on the other conditions. 19. The FTT decided at [58] that the three conditions in dispute all required a degree of nexus between expenditure and land specifically. Paragraph 2(2) required the expenditure to be “on land”. By paragraph 2(3) of Schedule 22, the expenditure in question had to be “on relevant land remediation” which, when the definition of that term in paragraph 4 was applied, required that the expenditure be “in relation to land”. The FTT also proceeded on the basis that paragraph 2(5) required an application of the test laid down by paragraph 7 in order to determine whether the expenditure would not have been incurred had the land not been in a contaminated state and that paragraph 7 of Schedule 22 necessitated an examination of whether expenditure was “on the land” As we explain later in this decision, it is common ground that the FTT was wrong as regards its interpretation of paragraph 2(5). . 20. The FTT started by considering whether the requisite nexus between the expenditure and the land was present in situations where NGN laid a completely new HDPE pipe, concluding that it was not for the following reasons: 60. If we start first with the situations where the Appellant lined an existing irons mains pipe with an HDPE pipe, we consider that that expenditure clearly related in its entirety to the improvement of a chattel — being the iron mains pipe through which the new HDPE pipe ran — and cannot properly be said to be expenditure “on land”, “in relation to land” or “on the land” through which the chattel ran. As such, none of the first, second or fourth conditions in paragraph 2 was met in relation to that expenditure, which amounted to 80% to 90% of the expenditure which is the subject of this appeal. 21. The FTT then turned to the situation where NGN laid an HDPE pipe alongside an iron pipe. The FTT took “pause for thought” because in this case it considered that NGN would be exercising a right to occupy a different part of the land from that previously used in connection with the existing iron pipe. The FTT’s conclusion on this expenditure was set out at [61] of the Decision as follows: 61…the key question in this context is not whether the Appellant exercised a right in or over land in order to carry out the replacement but rather whether the expenditure which was incurred in effecting the replacement was incurred on or in relation to a right in or over land and, in that regard, when one examines the expenditure itself, that expenditure was still “on” and “in relation to” the chattel comprising the new pipe. It was not “on” or “in relation to” the right in or over the land itself. 22. At [63] and [64] the FTT considered NGN’s submission that, using the first condition set out in paragraph 2(2) as an example, the requirement was not that the expenditure should be incurred “on land”, but rather that it should be incurred “on land … in a contaminated state”. Therefore, NGN submitted that expenditure that NGN incurred on changing the state of the land met the requirements of paragraph 2(2) and, by similar reasoning, the other requirements of paragraph 2. The FTT rejected that argument holding that the requirement was that expenditure be on, or in relation to, physical land. 23. Therefore, the FTT concluded that NGN had not incurred any QLRE so that its claim for land remediation relief necessarily failed. For completeness the FTT went on to consider Condition (6) – namely whether the land was in a contaminated state wholly or partly as a result of anything done or omitted to be done by NGN or a person having a relevant connection with NGN. The statutory provisions relating to Condition (6) are set out in paragraph 12 of Schedule 22 as follows: 12 Entitlement to relief (1) This paragraph applies if— (a) land in the United Kingdom is, or has been, acquired by a company for the purposes of a Schedule A business or a trade carried on by the company, (b) at the time of acquisition all or part of the land is or was in a contaminated state, and (c) the company incurs qualifying land remediation expenditure in respect of the land. (2) A company is entitled to land remediation relief for an accounting period if the company’s qualifying land remediation expenditure is deductible in that period. (3) The company’s qualifying land remediation expenditure is deductible in that period if it is allowable as a deduction in computing for tax purposes the profits for that period of a Schedule A business or a trade carried on by the company. … (4) A company is not entitled to land remediation relief in respect of expenditure on land all or part of which is in a contaminated state, if the land is in that state wholly or partly as a result of any thing done or omitted to be done at any time by the company or a person with a relevant connection to the company. 24. The FTT concluded that paragraph 12(1)(b) required Condition (6) to be tested at the “time of acquisition”, namely when NGN acquired its interest in the land that was contaminated As we explain in more detail later in this decision, it was common ground that this approach was not quite right as a matter of law. . At this point in time, NGN was a subsidiary of NGT and so NGT had a “relevant connection” with NGN. 25. At [69], the FTT reasoned that the land was in a “contaminated state” because of the existence of gas in iron pipes that was liable to escape. That state of affairs existed at the time of NGN’s acquisition because, at that time, NGT was using the pipes as part of its gas transportation business. Accordingly, judged at the time of acquisition, the land NGN acquired was in a contaminated state because of action taken by NGT, a company which had a relevant connection with NGN. Accordingly, Condition (6) could not be satisfied, supplying a further reason why NGN was not entitled to land remediation relief.