Western Ferries, Tonnage Tax, and the public
interest
Summary: the recent tonnage tax judgment
on Western Ferries unsuccessful appeal claiming that they should
have been treated as exempt from corporation tax over the past
several years has major implications for the public interest,
some of which are discussed here. One immediate recommendation
here is that the Government should set in train measures to set
up price caps in the form of PSOs on Western's crossing to protect
the public interest here. It is noted that the nature of Western's
crossing makes it eligible for such measures under EU law.
(1) Introduction
After several years of a dispute, the courts in
the form of "First-tier Tribunal (Tax)" has dismissed
Western Ferries appeal that it should be allowed to be assessed
under the UK's tonnage tax regime rather than pay corporation
tax.
The judgment was actually released on April 12th
2011, but was not publicized at the time. After I learnt about
the ruling and blogged on 11th May on this website, it has been
picked up and covered by media outlets.
I am going to just try to cover some of the basics
here. There is a lot of relevant information about the Finance
Act, tonnage tax, and the Clyde ferries that can be readily found
through Google and/or on this website and so is not covered here.
The court's judgment is here
References to "Trib. para" are to the
relevant part of the court judgment.
(2) UK Tonnage tax
Tonnage tax was introduced by the UK government as a measure to
try to help stem the decline of the UK merchant shipping fleet.
Schedule 22 to the Finance Act 2000 provides tonnage tax as an
alternative regime to corporation tax. A qualifying company is
defined as one with qualifying ships strategically and commercially
managed in the United Kingdom. Where a qualifying company has
made the appropriate election, tonnage tax can replace corporation
tax for the company. For the purpose of the court judgment, the
crucial aspects of what is meant by a qualifying ship are that
it:
In the end, the court decided to settle the matter by reference
to salinity. The court decided "that the burden of the evidence,
which we accept, points to the seaward end of the estuary being
at or about the Tail of the Bank or to put it more broadly in the
vicinity of Greenock. It is only there that the mingling of sea
and fresh water begins. Seaward of this area the water is entirely
or almost entirely saline. The historical presence of the lookout
tower in this area provides some support that the seaward limit
of the estuary is in this area. The mud banks and shoals are also
an indicator of the seaward end of an estuary. Accordingly, the
Crossing does not lie to any extent within the Clyde estuary"
(Trib. para 197).
I will leave aside the notion that the mingling
of sea water and fresh only starts at Greenock, after which it
is "entirely or almost entirely saline". Even
if we are using the definition of mixing fresh and salt water
as a definition of estuary, this would seem to leave the estuary
as just a boundary or margin, rather than an extensive area. And
apart from anything else, I am advised this would lead to a movable
feast as regards the definition of estuary since salinity is very
dependent on conditions, including weather. I am sure this will
be a matter for subsequent debate and discussion.
The court anticipated that there that might be scratching
of heads in terms of the apparent implications of its judgment
that Western's ships did not ply their trade in a estuary but
were not fully certified for sea-going The court dealt with by
saying; "Finally, it was not suggested in argument by
either party that, if we concluded that the Crossing lies outwith
the estuary, the Crossing must be a crossing at sea, and accordingly
the Appellant's ships must be treated as having been certificated
for navigation at sea. We would have rejected such an argument.
In the first place, the Crossing lies within controlled waters
which are not generally regarded as sea. In the second place,
the Appellant's ships ply their trade by virtue of Class V certification;
neither party regarded such a certificate as amounting to certification
for navigation at sea. The Appellant, in submissions, regarded
the Class V certificates as irrelevant" (Trib para 203).
This judgment was not expected by many observers
and not just HMRC. I live in the village of Innellan and had always
been given to understand that the body of water that lay between
me and Inverclyde was the Clyde Estuary. I am not alone, If you
Google
Innellan +estuary
you will find a lot of others under the same
impression.
As we shall note below this finding could have major
implications even if it did not alter the judgment going against
Western.
(6) HMRC's position
On a crude reading it might be thought that this
judgment would be one that was in HMRC's favour and against Western.
In fact, HMRC had considerable reason to be dismayed by the judgment
on both the harbor and the estuary counts. The court found in
favour of Western on the harbor issue, but if this is taken to
set a precedent then it could have implications for other cases
involving tonnage tax. As the court noted; "Since Schedule
22 was amended in 2005, HMRC and Red Funnel have been in dispute
over Red Funnel's continuing eligibility for tonnage tax. The
dispute relates to whether their vessels are harbour ferries".
(Trib. para 141).
We do not know if this case would have implications
for Red Funnel and other cases but we can guess that HMRC will
be concerned about this. One of Red Funnel's directors actually
gave evidence for Western in the case. It would be ironic if Western
finished up losing its case but also finished up helping Red Funnel
make its case.
On the estuary issue, the interpretation of estuary
is also one that would likely concern HMRC since like the harbor
issue it has the potential to reduce and limit its tax raising
ability compared to what it had presumed and argued had been set
out by the Finance Act.
(7) The European Commission's position
While HMRC's concerns would be with potential loss of tax revenues,
the European Commission would also have interests and likely concerns
in this matter from another angle, that of possible State aid.
In 2000 the European Commission agreed that tonnage tax was an
important, necessary and justifiable fiscal measure to reverse
the decline of the UK-flagged maritime fleet and that was in conformity
with the Community Guidelines on State aid to maritime transport.
The Commission reviewed the UK Scheme at length and noted also
that qualifying hips would be those which are sea-going, while
vessels that are harbour and river ferries would be excluded as
qualifying ships. (Trib. paras 42-44)
As the court noted "it is plain that the
intention of Parliament must have been to enact a provision which
was consistent with the Commission's views on tonnage tax, which
did not fall foul of its Treaty obligations in relation to State
aid and which would not lead to infraction proceedings by the
Commission against the United Kingdom" (Trib para 163)
.
A number of other EC countries operate their version
of tonnage tax regimes. As we know, the Commission is already
looking closely at the current town centre tender to make sure
it complies with competition and State aid issues. The court's
ruling on Western's existing route could also interest the Commission
from the perspective of possible State aid in terms of other countries
regarding this as possible precedent for their own tax and shipping
regimes.
If the Commission could be interested here, then
the UK government could be concerned.
On the estuary issue, when the Commission investigated
the Gourock-Dunoon ferries along with other Scottish ferry services,
it noted that "Western operates only on the Clyde Estuary
between Gourock, situated on the upper Firth of Clyde, and Dunoon"(underlining
added). It illustrates this with a map "maritime routes on
the Clyde Estuary shown both the CalMac and Western routes, see
here
para 20.
In fairness the Commission's description of what
is the Clyde Estuary was probably given to the Commission by Scottish-based
authorities. And of course the Commission may well accept this
court's differing interpretation on what constitutes the Clyde
Estuary. But it is quite likely that the Commission will now be
looking at what was then quite possibly just a geographical label
through legal lenses. It is also worth noting that the court was
aware of this observation by the Commission (Trib. paras 143-44)
but notes "The nature and bounds of an estuary were not discussed
in the Commission's report".
(8) The public interest dimension
At the moment Western Ferries controls almost all vehicle-carrying
across (what is commonly described as) the Clyde Estuary. After
the tender for Gourock-Dunoon town centre route is deployed and
put into operation in a few days it will almost certainly control
all the vehicular traffic across the Clyde Estuary. If it wins
the tender for this service it will control all the user traffic
across the Clyde Estuary. Judged by standard economic criteria
it is already makes profits well in excess of what could be considered
reasonable for a ferry service of this nature see here.
It certainly already has the market dominance and power to raise
its fares significantly should it wish to, or see the need to
do so. If, as is likely, the town centre route goes passenger-only
in June, it will then have the monopoly power to raise its fares
significantly should it wish to, or see the need to do so.
Given the tax issues and the expansion plans, it
would be rational for it to look at its fares in the light of
short term pressure to maximize profits given these market opportunities
and pressures.
In principle, these powers would be curbed by monopoly
legislation, in practice even though the service is of crucial
importance to surrounding economies it would likely fall below
the radar of the OFT. In any case it is usually assumed that such
services are dealt with through regulatory intervention and control
- which so far is completely missing in this sector.
As we have seen with past problems, if any issues
or disruptions arise with the town centre service, the only realistic
alternative to the town centre service for most users is Western's
own existing service. The road alternative to the Gourock-Dunoon
ferries is 84 miles (by comparison, the road alternative to the
Forth bridges on the Forth estuary is much shorter).
For these reasons, guidelines issued by the European
Commission in 2003 mean that both the present Western and CalMac
routes can be designated public service routes under EU law and
subject to regulatory control and intervention in the form of
PSOs (public service obligations) . That has not happened yet
in the case of Western's present route.
In addition to this potential tax liability and
its interest in the current Gourock-Dunoon tender, Western Ferries
have major multi-million expansion plans. In January 2010, its
managing director Mr Gordon Ross revealed "that moves
have already been made to design a new vessel for (Arran) that
would mean a new service could be introduced in early 2012. But
it could be earlier if a suitable vessel can be found on the charter
market". see here
Normally whether a company is facing multi-million
pound demands from the tax man or is planning multi-million pound
expansion plans would be seen as just (or primarily) a private
commercial matter for the company. Not here, not in Argyll and
Inverclyde where so much of the local economies and the overall
welfare of the dependent communities rely on these essential services.
Whether or not Western appeals, these issues mean
there are major public interest concerns here. If it accepts the
ruling, then it faces a big tax bill, with interest. If it decides
to appeal, it will be entering a domain which HMRC, the European
Commission and the UK Government all have reasons to be interested
in the outcome. Of course any future rulings will be again be
made on legal grounds but as discussed above there is more riding
on this in UK and European terms than just a single business on
the Clyde Estuary (however the latter is defined). And of course
also it will be the company that will be directly liable for any
costs and risks that will be incurred either way. However, given
its position as a dominant (and shortly probably monopoly) provider
of essential vehicular ferry services over the Clyde, consideration
also has to be given to any potential costs and risks to those
users and communities affected by and dependent on these public
services, especially if it remains committed to the Gourock-Dunoon
tender and its expansion plans to Arran and possibly elsewhere.
These are issues that are of crucial importance
for the public interest, and the company should be asked to confirm
and explain its plans for Gourock-Dunoon and Arran as a matter
of urgency. If it is going to appeal, it has to do so by early
June and should be asked to make public its decision as soon as
it is made (bearing in mind we only found out about the first
failed appeal a month after it was announced, and that by accident)
There are a number of things that could and should
be done to protect the public interest here (many of which could
and should have been done earlier), some of which have been discussed
elsewhere on this website. But one specific thing which the Scottish
Government should explore as a matter of urgency especially given
these developments is the imposition of a price cap in the form
of a PSO on the Western service. They should commission independent
experts to advise on this possibility (for reasons I go into at
length in my current petition here
the Government's Transport Scotland officials do not have the
competence to advise on such issues).
It is widely believed that you only apply PSOs where
you are going to compensate (subsidise) a service, but that is
not the case. The conditions in EU law under which PSOs can be
applied and the conditions where compensation or subsidy can be
given for PSOs have different bases in EU law, even though they
are often covered in the same legislation. There are precedents
in Mediterranean ferry services for EU governments imposing PSOs
without compensation (subsidy).
The Commission's 2003 Guidelines make clear that
a ferry service with the physical characteristics of Western Ferries
may be treated as a public service in line with the EU 1992 Martime
Cabotage Regulation. That being the case, it opens up the principle
that PSOs in the form of a price cap to protect the public interest
can be applied to the Western service should the government deem
it appropriate. Since there would be no State subsidy or compensation
involved for the PSO, there are no obvious reasons why the Commission
would be concerned about State aid issues should the Scottish
Government chose to pursue this policy.
The Government cannot just stand on the sidelines
and wash its hands of the issues here, it should take action in
the public interest starting with a fares PSO on Western.
Neil Kay 15th May 2011