Mike's Mighty Machine

RICHARD WILLIAMS tells the story of a disputed case involving whether a machine was 'on hire' when supplied with an operator.

And so it came to pass that a section 9A, Taxes Management Act 1970 notice was duly served on our client, Mike, a drainage contractor who offered his services as operator of a specialist machine.

In his opening letter the Inspector said that 'the extended definition of leasing in section 105(1)(a), Capital Allowances Act 2001 applies so as to ensure that letting an asset on hire is treated as leasing for this purpose'. Later, he added 'the rules … apply generally and restrict small and medium-sized businesses to claiming writing down allowances on leased assets…' (see Budget press release 66/97, published on 2 July 1997).

It will be recalled that first year capital allowances of 40 per cent are generally now available on machinery or plant purchased by small or medium-sized enterprises, but there is an exclusion in section 46(2), Capital Allowances Act 2001 where the equipment is provided for leasing.

We argued that although section 46(2) is 'self-standing', it must be viewed in context ('joined-up government'). The Inspector disagreed. However, we did both agree that if Mike's expenditure was on assets for lease or hire then section 46(2) applied, otherwise it did not.

One hire trade association that we consulted indicated that its advice was that section 46(2), Capital Allowances Act 2001 caught all leasing. Our associates sympathised with Mike's plight, but, as the legislation was fresh, they had no cases or experience to lend support. We and Mike were on our own!

From the outset, based on the engagement partner's knowledge of twenty plus years of dealing with Mike, we sought to establish that Mike was not buying his specialist equipment for 'hiring or leasing'. Instead, he was 'providing his services to which he brought the equipment'. This fact alone, in our view, took Mike out of the ambit of section 46(2). The first year allowance claim in question was for expenditure of £50,000 on a specialised piece of machinery. Several issues arose as follows.

Substance over form

Mike's business was described as 'Plant Hire' and the headed notepaper showed 'Plant Hire and Drainage Contractor'. The telephone directory said 'Drainage Contractor' and the invoices 'clearly indicate hiring', said the Inspector.

The Inspector had to be disabused of his understandable pre-conceptions with regard to the trade's description as opposed to reality.

'Plant Hire' was historic shorthand (and misleading in the light of recent legislation) and therefore warranted further explanation, which I duly gave to the Inspector. We also pointed out that Mike was not operating a 'hire' shop, leasing company, bank or similar institution. We suggested that 'it is the same as a haulage contractor providing the service of transporting goods, and charging per mile or at an hourly rate. This would not be regarded as the hire of a lorry, but the provision of services'.

'Helping business'

We are still not convinced that Parliament meant the anti-avoidance leasing rules to affect cases such as Mike's.

Although full allowances by way of writing down allowances and balancing allowances would eventually be due, to deprive a small owner-managed concern of first year allowance and the consequent cash flow benefits, contradicts the general proposition from this Government that it is 'helping business'.

We summarised the Revenue's own Budget news release (No 3) dated 2 July 1997, 1998 Budget release (No 10), the 9 March 1999 Budget release, and the Treasury's pre-Budget 1998 'pocket guide' under the heading of 'the Government's economic priorities'. We wrote:

'We do not see how depriving a trader of first year allowances falls within the Government's statements'.

Hansard

The Government (or is it the permanent civil service?) is to be congratulated for opening up some of its workings through the Internet. Lengthy research on the Internet at www.parliament.the-stationery-office.co.uk was spent studying the relevant standing committee debates.

Our studies led us to make the simple comment: 'We cannot find any mention of excluding traders (which are not lessors) from first year allowance …'.

The Inspector referred to the Inland Revenue's Inspector's Manual, paragraph IM5101. In the view of his head office, section 46(2) was not 'ambiguous or obscure'.

Definition - 'leasing or hire'

At the heart of section 46(2) is 'what is hire or lease?' Section 219(1), Capital Allowances Act 2001 defines a 'finance lease'. For 'hire' a dictionary definition is 'payment for use of a thing, labour, etc.; procure or grant use of for payment'.

With regard to section 46(2), the Inspector said '…the fact that an item of machinery or plant is provided with an operative is immaterial. If the item is hired (with or without an operative) on a fixed period basis for application by the customer then that is hiring within section 46(2)...'.

We asked for, and did not receive, the authority behind the phrase in italics, but, importantly, we added: 'In any case, the equipment in question is not "for application by the customer". The equipment is used by Mike for the provision of the service of …'.

Alan Pink's item, 'Chauffeured cars', (Taxation, 25 January 2001, page 396) provided a timely reminder that a Revenue definition of leasing already existed, namely in RI120 (Tax Bulletin, August 1995, concerning the enterprise investment scheme and qualifying trades). This included the statement that 'in cases where the customer is not free to use the property as his own - for example, the "hire" of chauffeured cars or the storage of articles by the trader in warehouses or safes - the person using the property is the trader, not the customer. This is not regarded as leasing'.

The Revenue's Tax Bulletin, August 2001 (page 877) provided an 'updated version': 'It (leasing) … covers any trading activity which consists in allowing the customer the use of the trader's property'. Furthermore: 'It applies where, subject to reasonable conditions imposed by the trader, the customer is free to use the property for the purpose of which it is intended'. The Inspector was informed that 'Mike does not allow the customer to "use the machine"'.

The Inspector replied that '... a sophisticated machine … may require a trained operator. It is not unreasonable for a lessor to insist that their own personnel actually operate such a machine. This will not mean that the customer does not have "free use" of the machine under any reasonable definition. He may be able to direct where, when and to what end the machine is used. The fact that a customer does not actually drive or operate the machine will not necessarily mean the contract struck is not one of lease or hire but one of service'.

What are the origins of these 'definitions'? Taxation, 20 June 2002 at page 318 reported on the Court of Appeal decision (31 May 2002) in Lloyds UDT Finance Ltd v Chartered Finance Trust Holdings Plc and Others [2002] STC 1652 - a case concerning section 35(2) Capital Allowances Act 1990 and the £12,000 limit. At the Chancery Division hearing (22 November 2001, [2002] STC 1657), the Vice-Chancellor said:

'In Frazer v Trebilcock 42 TC 217 one issue was whether the car acquired for use in a driving school was provided wholly or mainly for hire to or for the carriage of members of the public. The Commissioners considered that it was. Mr Justice Buckley disagreed. He referred to the definition of a hire of chattels in Halsbury's Laws of England namely "a contract by which the hirer obtains a right to use the chattel hired in return for the payment … The proprietary interest in the chattel is not changed, but remains with the owner. But upon delivery the hirer becomes legally possessed of the chattel hired, so that if it is lent for a time certain, even the true owner is debarred during that time from resuming possession against the will of the hirer …". … this case is of relevance in demonstrating that one element of a contract of hire is the right to exclusive possession against the true owner/hirer'.

Mike was not debarred from 'resuming possession' of the machine. He never allowed 'exclusive possession' to anyone else. He and his machine could 'walk off the job' at any time. Of course, had he done so, the contractor would, presumably, not wish to re-engage him.

The contract

If contracts are 'for hire', section 46(2) bites, so it is most important to establish precisely what has occurred and why payments are being made. In Mike's case, work was largely obtained 'by word of mouth' unsupported by paperwork.

We had a difference of opinion with the Inspector of Taxes over:

• who should write to the contractor for any paperwork which they may have; and
• why we did not think it appropriate for there to be a meeting with Mike (the 'ins and outs' of which would make an article in their own right).

Closure

When the Inspector saw the paperwork, he reported that having examined the documents provided he was unable to conclude whether the particular arrangements did, in fact, amount to leasing (including hire). On that basis, a closure notice was issued, thereby confirming the first year allowance claim.

Subject to 'discovery', Mike has achieved 'finality' at least as far as that year's tax return is concerned. Mike's machine is 'not for hire'.

A wider problem

The Inspector, by 'bowing out gracefully' in this manner may not, however, have put Mike's future acquisition of 'first year allowance' plant beyond doubt, nor does it entirely assist in other cases.

Each transaction must be looked at on its own merits. If the machinery bought is for the provision of services, and is not itself 'for hire', section 46(2), Capital Allowances Act 2001 cannot be applied. Otherwise any 'hiring' precludes first year allowance.

It is hoped this article sheds some light as to what is 'hire'. It would more useful if the Inland Revenue were to give the fullest possible exposure of all its material on 'hire' including the basis of its Tax Bulletin 'definitions'.

Richard Williams is a tax manager at Ritson Smith (a member of MRI, Moores Rowland International) and can be contacted on 01358 720712.

Issue: 3869 / Categories: