R (on the application of Cobalt Data Centre 2 LLP and another) v Commissioners for HMRC

Expenditure incurred during the second ten years of an enterprise zone qualifies under section 298(1)(b) of the Capital Allowances Act 2001 only if, by the tenth anniversary, a binding contractual relationship contained the requisite commitment to the expenditure. The commitment may permit later unilateral selection or alteration, and a later agreed variation does not necessarily defeat relief. The court must compare the substance of the commitments at the tenth anniversary with the expenditure and building project ultimately undertaken.

Parties generally have a wide common-law freedom to choose whether contractual alterations operate by variation or replacement. Their objectively assessed common intention ordinarily governs that choice, subject to marginal cases where the stated characterisation is incompatible with the mechanism actually used.

The appellants claimed 100% enterprise-zone capital allowances for expenditure on two data centres. Their predecessors had entered a building contract within the first ten years of the enterprise zone. The contract required selection of one of six projects and permitted changes to the selected works. The data centres were commissioned after the tenth anniversary through purported change orders and later contractual arrangements.

The Upper Tribunal allowed the relevant tax appeals, holding that the original contract had been varied rather than replaced. The Court of Appeal, in [2022] EWCA Civ 1422, allowed HMRC’s appeal. It held unanimously that the change orders exceeded the contractual power, although its members differed over the contractual analysis that followed.

The Supreme Court considered whether the expenditure resulted from unilateral contractual rights, whether section 298 treated expenditure introduced by a later variation as incurred under the original contract, and, if necessary, whether the later arrangements varied or replaced that contract.

1. Appeal dismissed unanimously. Lord Briggs and Lord Sales gave the judgment, with which Lord Burrows, Lady Rose and Lord Richards agreed. The relevant expenditure did not satisfy section 298(1)(b) of the Capital Allowances Act 2001. The court reached that result for reasons different from those of the Court of Appeal.

2. Section 298(1)(b) requires a substantive comparison at the tenth anniversary. The court must ask whether a contractual relationship then existed under which the relevant expenditure had been agreed or could arise from building work which the developer already had a contractual right to select or change. The commitment must bind both developer and contractor and must require no further bargaining before it becomes, or can unilaterally be made, unconditional. A later agreed variation may remain compatible with relief where it does not detract in substance from that earlier commitment. The statutory inquiry is not a rigid “same building, same site” test and does not depend merely on whether the parties used the legal mechanism of variation rather than replacement: paras 94–103.

3. The taxpayers’ construction would undermine the purpose of the ten-year limit. It would allow parties, through a variation made during the second period, to obtain allowances for expenditure to which they had made no substantive commitment during the first period. The statutory purpose was to secure, within ten years, either qualifying construction or a contractual commitment to qualifying development: paras 82–107.

4. The expenditure on the two data centres had not been agreed, or committed to in substance, by the tenth anniversary. It could qualify only if it resulted from unilateral selection or change rights contained in the original contract. It did not: paras 104–107.

5. Clause 12 permitted changes only within the design, quality or quantity of the works comprised in the selected option. Those works were defined by the building’s purpose and location. The clause did not permit unilateral substitution of a substantially different building outside those boundaries. Change Orders 2 and 3 were therefore invalid under clause 12: paras 108–124.

6. Although unnecessary to the outcome, the court explained that parties generally have a wide common-law freedom to choose whether an alteration operates by variation or replacement. Their objectively assessed common intention ordinarily governs, subject to limits at the margins where the stated characterisation does not match the mechanism used. Fundamentality is relevant evidence of intention, not an independent rule compelling replacement: paras 129–151.

1. United Kingdom Supreme Court: Dismissed the taxpayers’ appeal unanimously in [2024] UKSC 40, while rejecting the Court of Appeal’s construction of section 298(1)(b) of the Capital Allowances Act 2001.
2. Court of Appeal: In [2022] EWCA Civ 1422, unanimously allowed HMRC’s appeal. It held that the change orders exceeded clause 12, although the judges differed in their analysis of the later contractual arrangements.
3. Upper Tribunal: Allowed the taxpayers’ appeals on the relevant issue. It held that the original contract had been varied, rather than replaced, and that the expenditure was incurred under that contract as varied. No citation is stated in the judgment.