The Supreme Court has held, obiter, that whether a contract has been varied or replaced with a new contract should be determined by assessing the parties’ common intention. The parties have a wide margin of choice as to whether to vary or replace a contract; the only limit is that the law should not give effect to a claimed variation that would be absurd.
The Capital Allowances Act 2001 provides that certain tax reliefs are available if expenditure is incurred under a contract made within a deadline. The appellants claimed that expenditure had been incurred under a contract made within the deadline and subsequently varied. HMRC, the respondent, claimed that the purported variation was actually a replacement of the existing contract and the replacement was not made within the deadline for claiming tax relief.
The Supreme Court found in favour of HMRC on other grounds. As a result, whether the original contract was varied or replaced was not determinative, but the question was sufficiently important to be addressed in principle.
HMRC argued for a two-stage test to determine whether there is a variation or replacement. First, identify the changes agreed, factoring in the parties’ common intention, objectively ascertained (the usual approach to interpretation). Second, assess whether the changes are so fundamental that the new terms constitute a replacement rather than a variation of the original contract.
However, the Supreme Court cited case law indicating that the basic common law principle of freedom of contract applies. The parties can generally determine whether they are varying or replacing their contract. There are limits to this freedom. If the parties’ characterisation of a change as a variation, rather than a replacement, produces an “utterly absurd” result, this would bring the law into disrepute. The court gave the example of a contract for a holiday being altered to become a contract to build a nuclear submarine and the parties describing this as a variation. Aside from extremes, the court acknowledged it is difficult to specify precisely where the limits lie on the parties’ freedom to categorise their changes.
In this case, the parties had clearly intended to vary the original contract to enable them to claim tax relief and they had labelled their agreement as a variation. From a common law perspective, it was a variation. However, the correct construction of the relevant legislation meant that tax relief was not available in the circumstances.
In2 the bargain 