Spc00642

Income Tax  -   Foreign Earnings Deduction  -   Definition of “offshore installations”  Appeal dismissed

THE SPECIAL COMMISSIONERS

	JOHN A LANGLEY	Appellant

-	and –

	THE COMMISSIONERS FOR HER MAJESTY’S REVENUE & CUSTOMS 	 Respondents

		

				Special Commissioner:  HOWARD M NOWLAN

Sitting in public in London on 10 October 2007

G F Robertson of DISS Accounting and Taxation Services (European) Limited, for the Appellant 

Colin Williams for the Respondents

© CROWN COPYRIGHT 2007

DECISION

1.      This was an appeal, in part on an error or mistake basis, in which the Appellant contended that his assessments in respect of employment income for the tax years 1999/2000, 2001/2002 and 2002/2003 should all be reduced.   This was on the ground that he was entitled, contrary to the contentions of Her Majesty’s Revenue and Customs (“HMRC”), to the benefit of the foreign earnings deduction for seafarers under section 192A Taxes Act 1988.

2.      The case was a relatively simply one involving two points of interpretation.  I gave an immediate decision in favour of the Respondents and this written decision simply confirms that oral decision. 

3.      It had been accepted by HMRC that the Appellant satisfied all but one of the requirements for claiming the foreign earnings deduction. His duties were accepted to have been performed wholly or partly outside the UK, and were accepted to have been performed in the course of a qualifying period within the meaning of the section.  The only point in contention was whether “the duties of the employment [were performed] as a seafarer”. It was common ground that this issue turned on whether the vessel or structure on which the Appellant performed his duties was “a ship”, since section 192A (2) clearly provided that “employment as a seafarer” meant “an employment consisting of the performance of duties on a ship”. 

The Facts

4.     I can state the facts very shortly because the basis on which I have decided the case renders many of the facts irrelevant. 

5.     The structure or vessel on which the Appellant performed his duties was a self-propelled oil drilling rig, called the Sedco Express. The Appellant served on this rig from May 1999 to the year 2004. This period spanned the construction of the Sedco Express in Brest; its sea trials; a period whilst it was moving to Egypt to commence drilling operations; a period of drilling, and then a period during which the rig was renovated because the owners had no immediate contract for further drilling work. 

6.     Whilst the following more detailed facts have no bearing on my decision, I will record them because they could be relevant, were my decision to be overturned. The relevant facts are that the rig was initially constructed in a dry dock, and whilst it was in the dry dock the four main pillars and the cross-bracing were welded to the two base pontoons; six diesel engines were installed in the base pontoons though at this stage the “thrusters” (effectively propellers that could rotate through 360°) had not been attached; and the top pontoon, accommodation area and the central operating tower were all installed. In February 2000 the assembled rig was floated out from the flooded dry dock for the thrusters to be attached. Whilst people on the rig could at this stage direct from the rig how the tugs should manoeuvre the rig from the dry dock to the quay area where the thrusters were to be attached, and while indeed the engines had been installed, the rig was not at this stage capable of moving under its own power. The next stage was that the thrusters were attached so that the rig could be moved under its own power. The sea trials then commenced in mid-April 2000.       On 9 October 2001, the Sedco Express sailed for Egyptian waters and it commenced drilling on 2 December 2001.  

7.     One other fact that I should mention is that I was told that the design of the particular rig rendered it unsuitable for service in the North Sea, or indeed anywhere in the territorial sea of, and Continental Shelf surrounding, the UK. The rig was designed only to operate in the calmer waters around Africa.

8.     The conceivable relevance of some of these facts will become clear in due course. 

The law and the relevant definitions

9.    In outline, the test for determining whether the rig ranked as a ship at various times involves a slightly complicated three-stage process.

10.     It is first necessary to decide whether the rig was a ship within the general meaning of that word. I will not give the accepted definition of that term because it is not material. If the rig is not a ship at a particular time within the meaning of that word, then the people employed on it at that time cannot be seafarers. Assuming that the rig is a ship, it is then relevant to note that section 192A (3) Taxes Act 1988 provides (and has so provided since an amendment made in 1998) that:

	“(3).    For the purposes of this section a “ship” does not include:-

(a) any offshore installation within the meaning of the Mineral Workings (Offshore Installations) Act 1971, or

(b) what would be such an installation if the references in that Act to controlled waters were to any waters”.

11.      In applying the two limbs of sub-section (3) just quoted, one has to follow a rather circuitous chain, and indeed a chain in which one link appears to be missing. 

12.      Having initially been referred to the “Mineral Workings (Offshore Installations) Act 1971 (“the 1971 Act”) for the definition of an “offshore installation”, one first notes that an amendment to that Act directs one to use the definition of “offshore installation” contained in the Offshore Installations and Pipeline Works (Management and Administration) Regulations 1995 (“the 1995 Regulations”) to ascertain the meaning of the phrase “offshore installation”. The definition (basically the second test to be applied), contained in Regulation 3 of those Regulations, is as follows:-

“3(1)   Subject to the provisions of this regulation, in these Regulations, the expression “offshore installation” means a structure which is, or is to be, or has been used, while standing or stationed in relevant waters, or on the foreshore or other land intermittently covered with water:-

(a)  for the exploitation, or exploration with a view to exploitation, of mineral resources by means of a well; 

(b), (c) and (d) [irrelevant},

and which is not an excepted structure.”

13.      The definition of “an excepted structure” (the third test to be considered) is then contained in the following sub-clause of the same Regulation 3, and reads as follows:-

“(2)     For the purposes of paragraph (1), the excepted structures are:-

(a), (b) and (c) [irrelevant];

(d) a structure which has ceased to be used for any of the purposes specified in paragraph (1), and has since been used for a purpose not so specified;

(e)  a mobile structure which has been taken out of use and is not for the time being intended to be used for any of the purposes specified in paragraph (1); and

(f) [irrelevant].”    

14.     I must finally refer to two further definitions. The 1995 Regulations contain a definition of the phrase “relevant waters”, which it will be noted was used in Regulation 3(1) quoted in paragraph 12 above.  This phrase is defined to mean:

“(a) tidal waters and parts of the sea in or adjacent to Great Britain up to the seaward limits of territorial waters; and 

(b) any area designated by order under section 1(7) of the Continental Shelf Act 1964”.  

A definition of the phrase “controlled waters” was then inserted by Part II of Schedule 1 to the 1995 Regulations back into amended section 12, the interpretation section, of the 1971 Act. The result of the amendment is that the phrase “controlled waters” is defined in absolutely identical terms to the way in which the 1995 Regulations define the term “relevant waters”.

15.     Before summarising the various contentions and admissions of the parties, I should just mention three points in relation to the definition of the two terms “relevant waters” and “controlled waters”.  Firstly there is the obvious point that the two terms are simply meant to refer to the “territorial sea and Continental Shelf of the UK”.    Secondly both the 1971 Act and the 1995 Regulations have nothing to do with taxation. I was informed that they provided for various regulations such as health and safety regulations that apply in the UK sector of the North Sea and the rest of the territorial sea and Continental Shelf area. The third fairly unimportant point to note is that the term “controlled waters”, adopted in and re-defined in the 1971 Act was presumably chosen because the territorial sea and Continental Shelf area were the areas over which the UK government assumed regulatory “control”.   

The points conceded  on behalf of the Appellant and the Respondents

16.    It was initially conceded on behalf of the Appellant that when the rig was on station in Egypt, and was in use for the purpose mentioned in Regulation 3(1) (a) of the 1995 Regulations, the rig was for that period deemed not to be a ship, and it was accepted that the Appellant’s employment could not then be employment as a seafarer. This concession was implicitly withdrawn when the Appellant raised what I will refer to as the Appellant’s second contention. 

17.      Leaving aside the issue of whether the rig was simultaneously “an offshore installation”, it was conceded by the Respondents that the structure became a ship within the general meaning of that term, when the thrusters were attached to it such that it could move under its own power.  It was also conceded by the Respondents that once the rig had been used as a drilling rig, then when it was subsequently taken out of use for major refurbishing purposes, and was not for the time being to be used for any of the purposes mentioned in Regulation 3(1), then it ceased to be an “offshore installation”, because during the refit it ranked as “an excluded structure” under Regulation 3 (2)(e). It thus dropped back to being regarded as a ship, and for this period, the Appellant’s employment was employment as a seafarer.

The contentions advanced on behalf of the Appellant

18.     The following contentions were advanced on behalf of the Appellant:-

•	It was contended that the structure became a ship within the general meaning of that term once it floated, even though its engines could not at that point power the vessel.   
•	The first main contention was then that once the vessel ranked as a ship within that general meaning, it was not excluded from ranking as a ship under the definition of offshore installations until it was actually used as a drilling rig.    In the period prior to such use the rig ranked as an excluded structure under Regulation 3(2)(e), just as it did on the Respondents’ admission when it was temporarily taken out of use, after having been first used as a rig.  Thus it was excluded from ranking as an offshore installation, and qualified as a ship, during the whole period of the final construction of the structure, during its sea trials, and up until the time when it was actually taken into use as a rig.
•	Following a general discussion about the confused statutory use of the two different terms “controlled waters” and “relevant waters”, a second and alternative contention was advanced on behalf of the Appellant. This was that section 195A (3)(b) modified the wrong term, and that as nothing modified the term “relevant waters” that was used in the relevant definition of “offshore installations”, then only rigs designed or capable of being used in the UK territorial sea or UK Continental Shelf ranked as “offshore installations”. It was thus contended that since the Sedco Express was never intended to be used in the UK territorial sea or Continental Shelf and was unsuitable to be so used, its use and intended use could never lead to its being regarded as an offshore structure under Regulation 3(1) at all. On this second contention it would of course follow that the structure would still rank as a ship (contrary to the initial concession on behalf of the Appellant), when it was actually being used as a rig in the seas off Egypt, because the waters off Egypt and Africa would not rank as “relevant waters”.
•	I should add finally that it was suggested that HMRC had accepted that personnel on other rigs qualified for the Foreign Earnings Deduction as seafarers when serving on rigs during sea trials etc in the period before the rigs had been taken into use as drilling rigs, and so had been applying the law inconsistently. 

The contentions on behalf of the Respondents

19.     The following contentions were advanced on behalf of the Respondents:-

•	It was contended that whilst a dumb barge could rank as a ship, a vessel that was intended to operate under its own power could not rank as a ship until it was capable of operating under its own power. Thus leaving aside when the vessel might have also ranked as an offshore installation, it could only rank as a ship under the general meaning of that term when its thrusters had been installed.
•	The right interpretation of Regulation 3(2)(e) was that an offshore structure could only rank as an excluded structure under this paragraph if it had first been used in one of the ways provided for in Regulation 3(1), such that “it was then taken out of use”, and could then be said “not for the time being [to be] intended to be used for any of the purposes specified in paragraph (1).”
•	It was finally contended that on the authority of the Court of Session decision in Palmer v. HM Revenue and Customs 77 TC 738, section 192A (3)(b) did succeed, when substituting the phrase “all waters” for “controlled waters”, in modifying the definition of the term “offshore installation “(and the use of the different term “relevant waters” in the 1995 Regulations), such that a drilling rig used or intended to be used in any waters should rank as an offshore installation.  

My decision

20.      I accept that the authority of the case of Perks v. HM Inspector of Taxes [2001] EWCA Civ 1228 means that the structure in this case ranked as a ship once it could operate under its own power. The following point is immaterial to the decision that I have actually made but I add that I was not convinced that the structure became a ship at some earlier point, prior to the installation of the thrusters, merely because it could be towed, and merely because instructions to the tug masters might be given by radio from on board the rig. A dumb barge, never intended to have motors and always intended to be towed, could be a ship but a structure or vessel intended to operate under its own power but not yet capable of doing so was not a ship. 

21.     On the initial assumption that the tax test in section 192A (3) and the definition of “offshore installation” in the 1959 Regulations should be read as if the references to “relevant waters” in Regulation 3(1) were to “all waters”, I have no doubt that the rig in this case was an “offshore installation” even before it ranked as a ship. I then also have no doubt that none of the paragraphs of Regulation 3(2) could possibly treat the rig as an excepted structure, such that it would cease to be an offshore installation and revert to being treated as a ship, until at least it had first been brought into use as a drilling rig.

22.     Addressing first the opening wording of Regulation 3(1), the rig was plainly a structure whenever it was a ship and I consider that it was a structure from a date when most of the assembly (bar final fitting out) had been completed, and whilst thus the rig was still in the dry dock. It is equally plain that it was a structure which was to be used, while stationed in [any waters] “for exploitation, or exploration with a view to exploitation, of mineral resources by means of a well”. Since the quoted part of this test looks forward to intended use, and no other conceivable intended use was contemplated, it is plain that this part of the test was satisfied at all times on the assumption that I made in paragraph 21 above. 

23.     One must then address the question of whether any of the paragraphs of Regulation 3(2) could exclude the structure from ranking as an offshore installation, and only paragraphs (d) and (e) are of any conceivable relevance. Paragraph (d) could obviously not apply to the period before the rig had been brought into use as a rig because this paragraph contemplates only a cessation of such use, followed by the commencement of some other use, not covered by Regulation 3(1). Neither limb of that test was satisfied. 

24.     That leaves the possible application of paragraph (e) of Regulation 3(2). On a straightforward interpretation of that paragraph it contemplates the structure being taken out of use in one of the ways contemplated by Regulation 3(1), and then being in the state that it was “not for the time being intended to be used for any of the purposes specified in paragraph (1)”. Thus the situations apparently contemplated by this paragraph are that the structure, having first been in use as a drilling rig, would be renovated, or simply moth-balled for a period on account of the owners being unable to find oil companies wishing to charter and use the rig. Whilst these two periods both appear to be periods when few seamen would be on board anyway,  the paragraph could apply in some situations and indeed it was accepted by HMRC that part of the Appellant’s service in the tax year 2002/2003did rank as foreign service as a seaman during the refit period after the rig had initially been used.

25.     In support of the interpretation adopted in paragraph 24 above, I consider that the fact that the opening words refer to a structure “which has been taken out of use” without specifically saying “taken out of use for any of the purposes specified in paragraph (1) above” does not undermine the interpretation. In the context of the two paragraphs together, namely (d) and (e), and in the light of the fact that paragraph (e) goes on to distinguish the use from which the structure has been extricated (or “taken out”) with the situation where no paragraph (1) use will “for the time being” be intended, it must follow that the use from which the structure has been extricated is “use for any of the purposes specified in paragraph (1)”.

26.   Additional support for this interpretation is derived from the fact that even supposing that the “use” from which the structure had been “taken out” could be some other use distinct from a use falling within paragraph (1), it was not suggested what that use might be. It seems to me to be a distortion of language to say, when a rig is being built or constructed, that it is being “used for construction”. Equally when a rig is undergoing its sea trials, it would be very odd to say that a “rig was being used for the purpose of having sea trials”. The appropriate wording is to say that the ship-yard was constructing a rig, and then performing sea trials, and once those were complete, the hope would be that the rig would move under its own power on to station and then be used. I would be perfectly happy to accept that the rig might well be said also to be being used as an offshore installation when moving to its first drilling site, but I think that it would be a misuse of language to talk about the rig “being used for sea-trials”, or indeed used in any way on the facts of this case until it was used in the only way contemplated, namely as a drilling rig. 

27.     On the assumption that I made in paragraph 21, I thus decide that the structure was an offshore installation and not an excepted structure, and thus precluded from ranking as a ship, throughout the whole period until, having once been used as a rig, it was taken out of use and was then able to satisfy the test contained in Regulation 3(2)(e).

28.    All of the conclusions in paragraphs 21 to 27 above are based on the initial assumption that I made, namely that section 192A(3)(b) succeeded in its plain intended purpose of modifying the definition of “offshore installation”, by substituting the phrase “any waters” for the phrase actually used in the definition to which we are directed, namely for the phrase “relevant waters”, when in fact section 192A(3)(b) purports to change the different expression “controlled waters”.

29.     This point of construction has already been addressed by the Court of Session in the case of Palmer v. HM Revenue and Customs 77 TC 738.  In that case Mr. Palmer contended “that the amendments of the 1971 Act were inept, and produced a meaningless reference for the purposes of the Income and Corporation Taxes Act because they failed to provide a definition of the term “controlled waters” as that expression was used in section 192A(3)(b).” The Court told Mr. Palmer that his construction and criticism were “flawed”, and that the definition should be read in the sensible way in which I assumed in paragraph 21 above.

30.     Aside from the fact that I am bound by this decision of the Court of Session, I consider that the right interpretation is the one that I adopted in paragraph 21, though I do agree with Mr. Palmer that the amendments inserted into section 192A Taxes Act in 1998 were inept. My criticism of them is slightly different from the one attributed to Mr. Palmer in the passage that I have just quoted, because it seems to me that the clear drafting error lies in modifying the wrong term, since the term that needed to be modified in the definition of “offshore installation” was the term that is now used, and the term that was indeed used in 1998 as well, namely the term “relevant waters”.   Nothing appears to modify that term, and it is the different term “controlled waters” that is modified.  I agree with the Court of Session that that term is still used in the 1971 Act, and indeed I agree that the Schedule to the 1995 Regulations changed the definition, in section 12 of the 1971 Act, of the expression “controlled waters”.    Although that term is indeed still used in the 1971 Act, it is clearly not used as any  part of the current definition of what constitutes an “offshore installation”.     Accordingly I cannot myself follow that Mr. Palmer’s argument in the Court of Session case was to be faulted on the ground that he had failed to note some deeming provision or some cross-link between the various provisions that meant that his argument was wrong. Whilst it might be over-stating the position to say that counsel for the Respondents in this case agreed with that analysis, I think it fair to say that counsel did confirm that he could not point to a provision that clearly corrected the drafting error, and seemed to accept that there was indeed an error. The way in which the point was put to me was first that I was bound by the Court of Session decision, and secondly that if there was a way in which the provisions could be applied so as to avoid an apparent absurdity, then that approach should be followed. 

31.   The reasons why I interpret the provisions in what I have described as the sensible manner based on the assumption that I made in paragraph 21, aside from being bound to reach this decision by the Court of Session decision, are that:-

•	Section 192A(3)(b) is clearly drafted in the expectation that it will operate to modify the definition of “offshore installations”, and it will only have that effect if it modifies the expression “relevant waters” contained in Regulation 3 of the 1995 Regulations;
•	Were section 192A(3)(b) only to modify the definition in the 1971 Act of  “controlled waters”, it would then have no relevance for any tax purpose because it would modify a definition that was used in the 1971 Act for quite different purposes;
•	Both of the expressions “controlled waters” and “relevant waters” are defined by the same Regulations (in one case by inserting a change back into the 1971 Act) to mean precisely the same thing.
•	Whilst I am not persuaded that there is some drafting link that corrects the error, and whilst I indeed agree with Mr. Palmer in the Court of Session case that the drafting appears to have been inept, I still consider that the error is so obvious, almost as if it were an obvious printing error, that the Parliamentary intention is clear. This is not in other words a case where both interpretations could make some sense, but rather a case where the error, and the sensible modification that has to be made to correct it, are both obvious.  And because both terms are defined to mean precisely the same thing, the modification required to substitute obvious sense for absurdity is very minor.    

32.     My decision is accordingly that both because I am bound to follow the Court of Session decision, and for the reasons given in paragraph 31 above, the right application of these provisions is the one that I assumed in paragraph 21, and that thus no employment on the rig in question can qualify for the foreign earnings deduction until the period of the refit following the use of the rig on station. 

33.   It follows that the Appellant’s appeal is dismissed in relation to the years of assessment 1999/2000 and 2001/2002 and that for the year 2002/2003 the foreign earnings deduction will be available to the extent that the provision of Regulation 3(2)(e) is then satisfied, with the parties to agree the resultant figures. 

34.   I should finally mention that while I can see that the provisions that I have considered have in the past been applied somewhat inconsistently by HMRC, this is not something that can influence me, or indeed lead me to make what would seem to be a wrong decision that would only increase the confusion. 

HOWARD M NOWLAN
SPECIAL COMMISSIONER

RELEASED: 30 October 2007

SC 3052/2007