Supreme Court determines that the parties’ common intention decides whether a contract is varied or replaced

R (on the application of Cobalt Data Centre 2 LLP and another) (Appellants) v Commissioners for His Majesty’s Revenue and Customs (Respondent) [2024] UKSC 40

The question

How will a court determine whether a contract has been varied or replaced?

The key takeaway

Whether a contract has been varied or replaced depends on the common intention of the parties unless the parties’ freedom to choose produces an absurd result. For example, a contract for a holiday being altered to become a contract to build a nuclear submarine could not be a variation, even if it was described by the parties as such.

The background

An appeal to HMRC, by Cobalt, concerned the conditions for the availability of a capital allowances scheme (ie tax relief) arising from expenditure incurred in relation to a contract to construct buildings in an enterprise zone (the Contract).

Cobalt, who had purchased data centres, made a claim for tax relief in relation to the construction costs of the buildings on the basis that the expenditure was incurred under the Contract (as varied) before the end of the relevant time period. Cobalt argued that, as a matter of common law, it was open to the parties to the Contract to choose whether to alter their contractual rights and obligations by either variation or replacement and that it was intended by the parties that this should take effect as a variation of the Contract.

HMRC rejected Cobalt’s entitlement to tax relief on the basis that the agreement to vary the Contract was actually a replacement of the Contract which was made after the enterprise zone period had expired. HMRC argued that a two-stage process applies when assessing whether an alteration of contractual rights and obligations takes effect by way of variation or replacement:

• What alteration has been agreed by the parties (by way of an objective assessment of the parties’ common intention)?
• Is the alteration so fundamental that the new set of rights and obligations has to be regarded as constituting a replacement rather than a variation?

When applying this test, HMRC submitted that the alteration of contractual arrangements was so extensive that it must be characterised as a replacement of the Contract and not a variation.

The decision

The Supreme Court stated that the variation/replacement issue raised in this case provided an important unresolved question of pure common law, ie whether and to what extent the characterisation of a contractual alteration to a contractual relationship as either a variation or a replacement of the original contract depends upon the common intention of the parties, objectively ascertained. Lower court decisions had disagreed on this and the Court of Appeal had not provided uniform reasoning on it.

The test to be applied when determining whether a contract is varied or replaced

The court determined that the common intention of the parties governs the nature of the contractual arrangements between them, including whether a contract is varied or replaced, and the parties have a wide margin of choice in this regard. The intention of the parties had to be gathered from all the circumstances. The fact that the alterations to the contractual relationship were fundamental was relevant to ascertaining the common intention of the parties but it did not operate as a separate rule of law, contrary to HMRC’s argument.

The court found that the limit to the parties’ ability to agree that a change in their contractual arrangements should be a variation rather than a replacement could be tested by extreme examples such as:

“Suppose there is a contract for a holiday in Edinburgh … could they [the parties] agree to change the contract … into a contract to build a nuclear submarine and agree that this will be by way of variation …?”.

In referencing this extreme example, the Court held that the law would not give effect to the intentions of the parties to the extent that it would bring the law into disrepute or damage its legitimacy in the eyes of the public.

Was the agreement a variation or a replacement?

The court held that the parties to the Contract clearly intended to alter their rights and obligations under it by way of a variation rather than a replacement for two reasons. First, both parties intended for the tax reliefs afforded by the enterprise zone to apply to the altered contractual relationships. This could only be done if the contract was varied, otherwise they would be time barred. Second, the parties expressly labelled the new alteration agreements as “variations”.

Why is this important?

In many cases when parties to an original contract later agree to make alterations to their rights and obligations they do not usually care whether those alterations are characterised as variations of the original contract or as a replacement of it. However, where this does turn out to be significant, this case brings into focus the test to be applied when determining whether a contract is varied or replaced.

Any practical tips?

In advance of entering into a “variation”, consider any implications on a contract if it were to be held that a new contract had been formed rather than varying the existing contract. Consider expressly labelling the variation of a contract as such, to act as an indicator of intention that there has been a variation of the original contract and not a replacement of it. However, note that the courts will not give effect to the parties’ intention, if to do so would produce an absurdity or bring the law into disrepute.

Spring 2025