Eclipse Film Partners No 35 LLP v The Commissioners for HM Revenue and Customs
| Jurisdiction | England & Wales |
| Judge | Sir Terence Etherton |
| Judgment Date | 17 February 2015 |
| Neutral Citation | [2015] EWCA Civ 95 |
| Docket Number | Case No: A3/2014/0643 |
| Court | Court of Appeal (Civil Division) |
| Date | 17 February 2015 |
[2015] EWCA Civ 95
THE CHANCELLOR OF THE HIGH COURT
Lord Justice Christopher Clarke
and
Lord Justice Vos
Case No: A3/2014/0643
IN THE COURT OF APPEAL
ON APPEAL FROM
THE UPPER TRIBUNAL (TAX AND CHANCERY CHAMBER)
Graham Aaronson QC and Jolyon Maugham (instructed by Freshfields Bruckhaus Deringer LLP) for the Appellant
Malcolm Gammie QC, Rajesh Pillai and Rebecca Murray (instructed by General Counsel and Solicitor to Her Majesty's Revenue and Customs) for the Respondents
Hearing dates: 13–15 January 2015
The Chancellor of the High Court ( Sir Terence Etherton):
This is the judgment of the court to which all the members of the court have contributed.
Introduction
This is an appeal by Eclipse Film Partners No 35 LLP ("Eclipse 35") from part of the decision of Mr Justice Sales in the Tax and Chancery Chamber of the Upper Tribunal ("the UT") dated 20 December 2012. The appeal is from his decision dismissing Eclipse 35's appeal from the finding of the First-tier Tribunal (Edward Sadler and John Walters QC) ("the FTT") that a closure notice issued by HM Customs Revenue & Customs dated 15 May 2009 correctly described Eclipse 35 as not carrying on a trade for the tax year ending 5 April 2007.
The proceedings raise a number of issues about the indicia of carrying on a trade in the context of tax legislation.
The issue
Members of Eclipse 35 borrowed money to contribute to its capital. They paid interest on the money borrowed. They may be able to claim tax relief in respect of that interest but only if Eclipse 35 was carrying on a trade and only if the borrowed money was used wholly for the purpose of that trade. That is the combined effect of the Income Tax (Trading and Other Income) Act 2005 ("ITTOIA") s.863 and the Income and Corporation Taxes Act 1988 ("TA 1988") ss.353 and 362.
Although the closure notice (and so this appeal) relates to Eclipse 35 itself rather than the personal tax position of any of its members, what is important in practical terms is whether the members are entitled to tax relief in respect of interest on their borrowings. Accordingly, it is convenient to treat TA 1988 s.362(1) as the critical provision by way of background. That provides as follows so far as relevant:
"Subject to sections 363 to 365, interest is eligible for relief under section 353 if it is interest on a loan to an individual to defray money applied –
…
(b) in contributing money to a partnership by way of capital or premium, or in advancing money to a partnership, where the money contributed or advanced is used wholly for the purposes of the trade, profession or vocation carried on by the partnership …"
Large sums are in issue. The members of Eclipse 35 ("the members") contributed a total of £840 million capital to Eclipse 35. They have paid a total of approximately £293 million in interest.
Eclipse 35's case is that in the relevant year of assessment it carried on the trade of acquiring and exploiting film rights. The case for the respondents, the Commissioners for Her Majesty's Revenue and Customs ("the Revenue"), is that Eclipse 35 has never carried on a trade but has merely organised a sophisticated financial model involving licensing and distribution rights in respect of two Disney films designed to give a series of pre-determined cash flows and with the ultimate object of giving rise to interest payments by the members (accelerated by prepayment) on borrowings for which they can claim tax relief to set against other income they have which is otherwise taxable.
The FTT decided that what Eclipse 35 actually did was not a trading transaction at all but rather it carried on the business of exploiting films not amounting to a trade, that is to say it carried on a "non trade business" of film exploitation within ITTOIA section 609.
If the FTT's decision is not overturned there will be very serious fiscal consequences for the members of Eclipse 35. They will be taxed on the income from the arrangements without any relief for the interest they have already paid.
The relevant transactions
Eclipse 35 and its members entered into a complex series of transactions in relation to the acquisition, distribution and marketing of film rights in relation to two films produced by the Disney group of companies, "Enchanted" and "Underdog" ("the Films").
Aside from Eclipse 35 and its members, the following were the principal parties involved.
| Barclays Bank plc ("Barclays") | The issuer of a letter of credit securing the payment by the Distributor of certain sums due to Eclipse 35 under the film distribution arrangements; also the funder of Eagle. |
| Eagle Financial and Leasing Services (UK) Limited ("Eagle") | A wholly-owned subsidiary of Barclays, which made loans to the members and received, as security for such loans, the benefit of the letter of credit issued by Barclays. |
| Walt Disney Pictures ("Disney") | A US corporation and a member of the Disney group of companies which on 3 April 2007 as grantor entered into a licensing agreement with Eclipse 35 (as licensee) in relation to the Films. |
| WDPT Distribution VIII LLC ("the Distributor") | A US corporation and a member of the Disney group of companies which on 3 April 2007 as licensee entered into a distribution agreement with Eclipse 35 (as licensor) in relation to the distribution of the Films, and which procured the issue by Barclays of the letter of credit to secure its payment obligations to Eclipse 35 under the distribution agreement. |
| WDMSP Limited ("WDMSP") | A UK company which is a member of the Disney group of companies and which entered into an agreement with Eclipse 35 for the provision of marketing and advisory services in relation to the Films. |
| Future Films Limited ("Future") | A UK company which arranged the financing of films and also the production and distribution of films, which for a consultancy fee promoted Eclipse 35 and provided film advisory and other services to Eclipse 35. |
Eclipse 35 was incorporated as a UK limited liability partnership on 3 October 2006. As the enumeration "35" indicates it was one of a number of Eclipse partnerships involved in film licensing transactions offering tax advantages for their members. Its partnership deed, which was executed on 13 March 2007, states that Eclipse 35 will carry on the business of the production, distribution, financing and exploitation of films, including the licensing and exploitation of film rights acquired from Disney.
On 3 October 2006 Eclipse 35 entered into a consultancy agreement with Future ("the Future consultancy agreement"), under which Future agreed to provide Eclipse 35 with a number of services relating to the selection, acquisition and exploitation of films and film rights. Eclipse 35 agreed to pay Future a fee based on a percentage of the partnership capital raised by Eclipse 35 and of the net proceeds from the exploitation of any film rights licensed by Eclipse 35.
On 3 April 2007, which was the date on which all the relevant principal documents took effect and was described in them as "Financial Close", Eclipse 35 had 289 members. All or most of the members are individuals liable to UK income tax, and for whom, if the relevant conditions are met, tax relief will be available for interest paid on borrowed money contributed by them to the partnership capital of Eclipse 35.
On 3 April 2007 Eclipse 35 entered into a licensing agreement with Disney ("the Licensing Agreement"), under which Disney granted Eclipse 35 a licence of specified rights to exploit and distribute the Films for a period of 20 years ("the Rights"). As consideration for the licence Eclipse 35 agreed to pay an aggregate licence fee of approximately £503 million and also a variable royalty. The licence fee was divided into 20 annual instalments. On 3 April 2007 Eclipse 35 paid Disney the entire aggregate amount of the licence fee as an advance against its obligations to pay the annual instalments.
Also on 3 April 2007 Eclipse 35 entered into an agreement with the Distributor ("the Distribution Agreement"), by which Eclipse 35 granted a sub-licence of the Rights to the Distributor for a period of 20 years. As consideration the Distributor agreed to pay Eclipse 35 specified sums annually over 20 years (called "Annual Ordinary Distributions") totalling approximately £1,022 million, variable distributions (which match the variable royalty Eclipse 35 must pay to Disney under the Licensing Agreement) and 40 per cent of "contingent receipts", being amounts payable under a complex formulation if gross receipts from the exploitation of the Films exceed a certain threshold after payment of prior charges ("the Contingent Receipts").
As security for its obligations to pay the Annual Ordinary Distributions to Eclipse 35, the Distributor provided a letter of credit issued by Barclays ("the Letter of Credit") to Eclipse 35 on 3 April 2007. Payments under the Letter of Credit directly correspond to the Annual Ordinary Distributions. Issue of the Letter of Credit relieved the Distributor from its payment obligations to Eclipse 35. On the same day the Distributor deposited approximately £497 million with Barclays and charged that sum to Barclays to secure the issue of the Letter of Credit and to fund Barclays in respect of its obligations under the Letter of Credit.
Eclipse 35 was financed by its Members. On 3 April 2007 they contributed capital to the partnership amounting in aggregate to £840 million. That...
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