Continuing the review of recent Supreme Court decisions, Cobalt Data Centre 2 LLP v HMRC considers the availability of 100% Enterprise Zone Allowances (EZAs) and, in particular, how strictly the statutory time limits are applied.
Whilst EZAs are no longer part of the current capital allowances landscape, the case remains relevant. It provides a useful insight into how the courts approach substance over form, particularly where taxpayers seek to rely on contractual structures to secure a tax outcome that is not fully aligned with the underlying commercial reality.
By way of background, the case related to the development of data centres within an enterprise zone. The taxpayers incurred significant expenditure, including £54.8 million on DC2 and £42.3 million on DC3, with total claimed allowances running into over £150 million in respect of DC2 alone following acquisition of the development interest.
The planning was structured. A “golden contract” was entered into just before the 10-year enterprise zone deadline, giving the developer flexibility to choose between different development options and make changes later. The intention was clear, to secure the benefit of the extended 20-year window for claiming allowances.
The dispute centred on whether the later expenditure was incurred “under” the original contract. The taxpayers argued that it was, and therefore fell within the extended time limit. HMRC’s position was that, in substance, the later works (DC2 and DC3) were not part of the original contractual commitment and therefore fell outside the regime.
The Supreme Court agreed with HMRC and denied the allowances.
The key point in the judgment is that the Court focused on substance over form. It was not enough that there was an original contract in place. For expenditure to qualify, there needed to be a genuine contractual commitment within the initial 10-year period to incur that expenditure on the relevant development.
In this case, the later data centre developments were materially different from what had originally been contemplated. They could not be delivered through the developer’s existing contractual rights alone and instead required new agreements or fundamental changes, meaning the expenditure was not incurred under the original contract.
From a practical perspective, this is a clear reminder on structuring. The use of flexible or “protective” contracts will not succeed where the underlying commercial reality is that the commitment to incur the expenditure only arises later. The courts will look beyond how arrangements are documented and focus on what has actually been committed to in substance.
It also reinforces that the purpose of the enterprise zone regime is time-bound. The legislation is designed to incentivise development within a defined period, not to allow that incentive to be effectively extended through contractual mechanisms.
Whilst the specific rules in this case relate to a historic regime, the principle carries through. Across capital allowances, the analysis repeatedly comes back to substance, whether in determining if expenditure has truly been incurred, whether an activity qualifies, or how directly costs relate to the provision of plant. The way arrangements are documented is secondary to what is actually happening in practice.
For advisers, the takeaway is that timing is critical, but so too is substance. It is not sufficient to have a contract in place if it does not reflect a genuine obligation to incur the relevant expenditure.
Overall, the decision draws a clear line. Where the underlying obligation to incur expenditure arises outside the qualifying period, allowances will be denied, regardless of how the arrangements are structured.
