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:

(a) is a seagoing ship
(b) is not a harbour ferry
(c) is not a river ferry

The |Finance Act also defines "harbour or river ferry" as a vessel used for harbour, estuary or river crossings. (Trib. paras 7-10)

(3) The background to Western's election for tonnage tax

The court noted that Western had considered that its ships were entitled to be certificated for navigation at sea and that it was eligible to enter the tonnage tax regime. An application for pre-entry clearance to join the Tonnage Tax regime was made by Western in 2003. This was rejected by HMRC on certification and estuary grounds. The harbour point was not at that stage raised. Western sought formally to join the Tonnage Tax regime in February 2004. Since then there has been a continuing dispute with HMRC over Western's eligibility or tonnage tax (Trib. paras 82-83)
Western accounts Year to end March 31st 2010 says

"If Corporation Tax were to be payable, an amount of £625,259 would have been provided. The total corporation tax payable should the tonnage tax election would be £3,077, 967, plus interest, at March 31st 2010 … the company has taken legal advice on this matter and is confident of its position".

Instead of paying corporation tax the company had elected to pay £1,000 tonnage tax for that year as it had done since it elected for tonnage tax.

(4) The Issues before the court

The court had essentially to decide three issues:

(a) Were Western's ships sea-going, i.e certificated for navigation at sea (the Certification Issue)?
(b) Was Western's route an estuary crossing (the Estuary Issue)?
(c) Was Western's route a harbour crossing (the Harbour Issue)?

As the court noted, Western would have to get a "yes" answer to the first question and "no" answers to the second and third to win its appeal. HMRC just needed either a "no" to the first question, or a "yes" to the second, or a "yes" to the third issue for the appeal to fail (Trib. Paras 69-70).

(5) The Court's decision

The court found against Western on the first issue, but ruled in its favour on the second and third issues. That is, the court decided to accept Western's arguments that its crossing was not an estuary or harbor crossing but to reject its argument that its ships were sea-going.

The question of what defined an estuary was the subject of much contention and discussion. The court recognised that there were different definitions and interpretations of what was defined an estuary and where in practice one began and ended. The court stared with several definitions of estuary including:

An estuary is a semi-enclosed coastal body of water which has free connection with the open sea and within which sea water is measurably diluted with fresh water derived from land drainage.


The tidal mouth of a great river, where the tide meets the current of fresh water


That portion of a stream influenced by the tide of the body of water into which it flows. A bay, as the mouth of a river, where the tide meets the river current. (Trib paras 99-101)

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