Oil & Gas: Offshore accommodation and the meaning of “incidental”

Summary  

In HMRC v Dolphin Drilling Ltd [2025] UKSC 24 the Supreme Court unanimously dismissed the taxpayer's appeal, concluding that the words “incidental to another use” required a use that arises out of the primary use, rather than an independent but secondary use. In practical terms this meant that significant, specifically contracted-for accommodation functions on support vessels could trigger the application of the ‘hire cap’, limiting the tax deductibility of lease payments`. For offshore oil and service companies, there are potentially important implications for projects where inter-affiliate leasing arrangements are used.

Background

The case concerned the application of the oil contractors ring fence, which is set out in Part 8ZA Corporation Tax Act 2010 (the “Act”). Not to be confused with the general ring fence regime applicable to UK exploration and production activities, the contractors ring fence applies to companies in the supply chain that lease certain mobile assets to those carrying on those activities. In particular, the regime imposes a “hire cap” (at section 356N), which limits a contractor’s ability to deduct for corporation tax purposes payments it makes under a lease of a “relevant asset” from an associated person.

The taxpayer, Dolphin Drilling Ltd, (“Dolphin”) had been invited by Total E&P UK Ltd (“Total”) to tender for the provision of a tender support vehicle (“TSV”) at the Dunbar oil platform in the North Sea. The nature of the Dunbar platform was such that a TSV was required to provide tender assisted drilling (“TAD”) services to support a proposed drilling campaign on the platform.

Dolphin proposed to use a semi-submersible drilling rig called the Borgsten Dolphin (the “Borgsten”), which could be converted into a TSV and was hired from an associated entity of Dolphin. The Borgsten, in addition to the space to be used for the TAD services, had the capacity to accommodate 102 persons on board, of which it was expected there would be around 47 surplus berths beyond those to be used by Dolphin and its subcontractors.

Total subsequently awarded the contract to Dolphin, and the contract originally included a requirement that the Borgsten supply accommodation for its own crew and 40 Total personnel. Subsequently, it was agreed that the accommodation of the vessel would be increased to 120 people, in return for an additional sum paid to cover the modification costs.

In Dolphin’s tax returns it assumed that it was entitled to take account in the calculation of its profits for corporation tax purposes the entirety of the fees it paid to its associated entity for the hire of the Borgsten. HMRC’s view, however, was that the hire cap should apply to restrict the tax deductions available to Dolphin as a result of the Borgsten being a “relevant asset” within section 356LA of the Act.

This definition broadly encompasses assets that are mobile, and which can either be used to drill exploration or production wells (which was not relevant to the TSV) or to “provide accommodation for individuals who work on or from another structure used in a relevant offshore area”.

However, an asset otherwise falling within this second category is excluded (under section 356LA(3) of the Act) 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”, and the central issue in contention was whether the exclusion applied to the Borgsten.

The First-tier Tribunal (“FTT”) found in favour of Dolphin, holding that the exclusion did apply, and this was upheld in the Upper Tribunal on appeal by HMRC. The Court of Appeal allowed HMRC’s appeal, concluding that the exclusion did not apply, and the taxpayer appealed to the Supreme Court.

Decision

The central focus of the Supreme Court was on what it meant for one use to be “incidental to” another, which should be given its ordinary meaning, and in considering the alternative approaches taken by the lower courts.

The FTT had broadly concluded that something was incidental to another matter if it was subordinate, or secondary, to it. Since the primary use of the Borgsten was providing TAD services, and the provision of accommodation was a secondary use, the exclusion was capable of applying. In contrast, the Court of Appeal had found that that the words in question were ordinary words, and that use A was incidental to use B, “if it arises out of use B, something that is done because of use B, or in connection with use B, or as a by-product of use B”. This was not the case if use A were an unconnected and independent purpose in itself.

The Supreme Court preferred the approach taken by the Court of Appeal – with the unanimous judgment wholly agreeing with the key analysis in the Court of Appeal – and concluded that unless use A arose out of use B, it was independent and not incidental to use B. Since the provision of accommodation did not arise out of the TAD services, it was not incidental to them, and the exclusion was not capable of applying.

The Supreme Court did note that in principle, the use of accommodation on a TSV which was “trivial or casual” may not be more than incidental to the provision of TAD services, but concluded that, “those are not the circumstances of this appeal where Total stipulated for the use of extensive accommodation on the Borgsten and extra accommodation on the Borgsten was created for and paid for by Total”.

Dolphin had argued that the case raised a point of law of general public importance because of the frequency of the use of the words “incidental to” in other taxing statutes. The Supreme Court concluded, however, that it was not appropriate for it to make any rulings on the phrase “incidental” or “incidental to” as it appears in other statutory contexts as it is important to read those words in their specific statutory context.

Comment

Given the deductibility of leasing costs is likely to have a material impact on the tax position of contractors, the case is a potentially significant one for the UK oil and gas supply chain (in particular, companies that lease multi-purpose offshore assets). It is not uncommon for TSVs to have surplus accommodation which could be used to provide accommodation services to offshore workers. The Supreme Court’s decision confirms that if a vessel’s accommodation function is a significant independent part of its use – especially where it is specifically contracted for and paid for by the operator – the hire cap will apply, limiting the tax deductibility of lease payments. Whether it can be said that such provision arises out of or in connection with other services will need to be carefully considered by taxpayers in light of the Supreme Court’s decision and considering the factual findings of the FTT on which those findings were based.

In this context, it is interesting to note the comment that the provision of accommodation services may still fall within the exclusion where they are “trivial or casual”, even if it this was not the case here. This suggests that on different facts there may be a route to such accommodation services still being accepted as incidental. This does though seem to partly replace the question of what is meant by incidental with the question of what is meant by trivial or casual, and (unless HMRC guidance is forthcoming on the point) this may be an area of focus for taxpayers who wish to determine whether the hire cap applies to them.

The Supreme Court’s conclusion that the phrase “incidental to another use” refers to use which arises as a result of a primary use (as opposed to a use which is merely less important than the main use) may also have wider relevance in other legislative provisions, notwithstanding the comments of the Supreme Court regarding the important of statutory context.  

Potential practical implications for those in the industry are:

• reviewing existing and future leasing arrangements for offshore assets to assess whether the accommodation function could be considered more than “incidental”;
• ensuring that contractual documentation clearly sets out the intended uses of the asset, and considering the tax implications of any modifications or upgrades to accommodation capacity; and
• seeking appropriate advice on the potential impact of the hire cap on proposed structures.