HMRC has won an appeal involving Dolphin Drilling Ltd (“Dolphin”) in a dispute relating to whether vessel hiring costs could be deducted when calculating profits for ring-fenced corporation tax. In its ruling, the Supreme Court has clarified the meaning of the word “incidental” in the context of the oil contractor activities rules, which will have wider implications for offshore oil and gas operators.

Partner Anastasia Nourescu reviews the Supreme Court’s analysis of the oil contractor activities rules and assesses the implications of the judgment.

Background to the appeal

In HMRC v Dolphin Drilling Ltd [2025] UKSC 24, the Supreme Court considered whether Dolphin fell within the scope of the oil contractor activities regime in Part 8ZA of the Corporation Tax Act 2010 (“CTA 2010”). This sets out the rules for the ring-fencing of profits from offshore oil contractor activities, including a “hire cap” that restricts contractors’ deductions of payments for the lease of a “relevant asset”. The aim of the hire cap is to stop operators from leasing assets (eg drilling rigs or accommodation vessels) from foreign companies with a view to deducting the lease payments from their profits for the purposes of corporation tax.

As explained in our previous article, an asset is a “relevant asset” under section 356LA of CTA 2010 if it is movable or “can be used” to drill for oil or provide accommodation for offshore workers. However, section 356LA(3) contains a carve-out to this rule: if an asset can be used to accommodate offshore workers, it is not deemed to be a relevant asset “if it is reasonable to suppose that its use to provide accommodation for offshore workers is unlikely to be more than incidental to another use, or other uses, to which the asset is likely to be put”.

The key issue in this case concerned whether the Borgsten Dolphin (“Borgsten”), a tender support vessel (“TSV”) that provided tender-assisted drilling (“TAD”) services to a minimum facility drilling platform (“MFP”), fell within the definition of a “relevant asset”. An MFP is a relatively low-cost alternative to conventional drilling platforms, but it cannot perform the drilling process without the TAD services provided by the TSV, which include the supply of materials used in drilling activities, warehousing, storage, workshops, offices, protection to seal the MFP in case of a catastrophic event and living space.

While both parties agreed that the Borgsten was movable and capable of accommodating offshore workers, they disagreed on whether the accommodation was likely to have been more than “incidental” to the primary TAD services.

The dispute centred on the meaning of the words “incidental” and “more than incidental” in section 356LA. Dolphin was successful before the First-tier Tribunal (“FTT”) and Upper Tribunal (“UT”), which held that accommodating offshore workers was no more than incidental to another use if it was subordinate or secondary to that other use. The Court of Appeal allowed HMRC’s appeal and overturned the FTT and UT decisions on the basis that the use of the Borgsten as accommodation was an independent end in itself, and it was not reasonable to suppose that that use was likely to be no more than incidental to its other uses.

Dolphin appealed against the Court of Appeal’s decision. Following a hearing in February 2025, the Supreme Court dismissed Dolphin’s appeal in a decision dated 24 June 2025.

The meaning of “incidental to another use”

Before the Supreme Court, Dolphin argued that the FTT’s interpretation of section 356LA had been correct in light of its legislative history, which showed that the hire cap was introduced to apply strictly to drilling rigs and accommodation vessels. The Court of Appeal’s interpretation, Dolphin submitted, would mean all support vessels would be caught by the hire cap, because they all have surplus accommodation that can be used to provide accommodation services.

Dolphin also argued that, on the basis of the Court of Appeal’s interpretation, the hire of the Borgsten fell outside section 356LA(3) because it was only used to provide necessary TAD services, and its use to accommodate offshore workers was a consequence of its use to provide those services.

Given that the word “incidental” is not defined in the legislation and there was no agreed interpretation, the Supreme Court started its analysis by considering a consultation that preceded the introduction of the exception to the hire cap. Based on the use of terms in the consultation and related documents, the court concluded that there was “no reliable basis in those materials for the conclusion that the legislation, so far as relevant, was aimed at vessels whose sole function was to be used as a mobile offshore hotel”.

The court then turned to the use of the words “incidental to another use” in section 356LA(3). It held that these words should be given their ordinary meaning. In this case, it adopted the FTT’s finding that the Borgsten had a primary use of providing TAD services to the Dunbar, and a secondary use of providing accommodation to offshore workers on the Dunbar. However, the court agreed with the Court of Appeal that one use (A) can be secondary or subordinate to another use (B), but if use A does not arise out of use B, it is independent and not incidental to use B. The test is not, as Dolphin had argued, that “but for the connection of the Borgsten to the Dunbar it would not have provided the accommodation services”.

The Supreme Court also rejected Dolphin’s argument that the Court of Appeal’s interpretation would lead to all support vessels being caught by the hire cap. Having surplus accommodation would not be enough to bring a vessel within the scope of the hire cap, because it is possible that a use of accommodation that is “trivial or casual” may be no more than incidental to the provision of TAD services. However, in this case, the contracts made provision for the extensive availability of accommodation on the Borgsten, indicating that accommodation was an independent use.

Interestingly, the Supreme Court did not derive assistance from the interpretation of the word “incidental” in other parts of the tax code, for example, in the context of the provisions determining liability for income tax for UK residents, as well as in other contexts in the CTA 2009. The court held that its findings on the meaning of the word “incidental” were confined to the oil contractor activities rules. It said it would not be appropriate for it to rule on the meaning of that word elsewhere in the tax legislation “as regard must be had to the context in which a phrase is used in a statute”.

Wider implications

The Supreme Court’s decision will no doubt come as a disappointment to Dolphin Drilling, particularly in light of its victory before the FTT and the UT. The tax at stake is substantial: £9.9m plus interest and costs, taking the total to £16m according to Dolphin’s press release.

The impact of the decision will no doubt also be felt by other operators in the offshore oil industry, considering that almost all domestic oil production takes place offshore. MFPs offer a low-cost alternative to traditional drilling rigs, but depend entirely on TAD services, which TSVs provide.

Although this dispute may seem to arise in a niche context, offshore operators may face similar scenarios and look to invoke the hire cap exception relatively frequently. Operators should bear in mind the fact that any disputes will be decided by reference to the contracts, and they may wish to revisit these in light of the Supreme Court’s judgment to ensure they reflect the services the parties intend to supply and receive.

Tax practitioners outside the oil and gas sector may have been eagerly awaiting the Supreme Court’s findings on the meaning of “incidental”, which appears in other parts of the tax code. However, the court has dispelled any notion that its findings have wider application, as the specific statutory context of each provision will be key. Given the narrow approach taken by the court in this case, many may consider this a relief.

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