Eclipse Film Partners No 35 LLP v HM Revenue and Customs
| Jurisdiction | UK Non-devolved |
| Judgment Date | 20 April 2012 |
| Neutral Citation | [2012] UKFTT 270 (TC) |
| Date | 20 April 2012 |
| Court | First Tier Tribunal (Tax Chamber) |
[2012] UKFTT 270 (TC)
Edward Sadler, John Walters, QC (Tribunal Judges)
Jonathan Peacock, QC and Jolyon Maugham, counsel, instructed by Freshfields Bruckhaus Deringer LLP appeared for the Appellant
Malcolm Gammie, QC, Rajesh Pillai and Rebecca Murray, counsel, instructed by the General Counsel and Solicitor to HM Revenue and Customs, appeared for the Respondents
Income tax - limited liability partnership acquired licence to film rights and sub-licensed rights to distributor - complex financing arrangements involving loans to members of the partnership and defeasance deposit by the distributor - whether partnership carrying on a trade (a precondition for members to claim relief for a prepayment of interest on their borrowings) - Income and Corporation Taxes Act 1988 section 362s. 362 ICTA 1988 - whether the arrangements as a whole were designed to give a series of pre-determined cash flows with object of giving members allowable interest payments - whether licensing of film rights was a trading activity - partnership not carrying on a trade, but a non-trade business - appeal dismissed
The First-tier Tribunal decided that the taxpayer, on a commercially meaningful basis, had no customer and did not offer to provide any goods or services by way of business.
The acquisition and sub-licence of the rights although having legal effect according to their terms, could not be characterised realistically as a provision of services by way of business. It ruled that the taxpayer's paramount object was to obtain the returns inherent in the distribution agreement. It was not a trading transaction at all, though the same could not be characterised simply as a mere device to secure a fiscal advantage. The taxpayer could not rely on the legal effect of the agreements it entered into to show that it was conducting a trade
The taxpayer company ("Eclipse"), a limited liability partnership, appealed against the decision of HMRC that in the tax year ended 5 April 2007, it was not carrying on a trade, or if it was carrying on a trade, it was not doing so with a view to profit.
Eclipse was in the business of production, distribution, financing and exploitation of films, which included the licensing and exploitation of film rights. It was comprised of 289 members and two designated members, all or most of them individuals liable to UK income tax, and for whom tax relief would be available for interest paid on borrowed monies applied by them by way of contribution to the partnership capital of Eclipse if the relevant conditions were met. It made a partnership tax return for the year ended 5 April 2007 claiming that it was carrying on a trade of acquiring and exploiting film rights, although no profits from that trade had accrued in that year. HMRC started an enquiry under the Taxes Management Act 1970, Taxes Management Act 1970 section 12ACs. 12AC and issued a closure notice.
Eclipse's concerns started on 3 April 2007 when it obtained a licence of specified rights to exploit and distribute two films produced by a film company ("Disney"), for a period of 20 years. It paid a licence fee of approximately £503m and also a variable royalty. The licence fee was divided into 20 annual instalments. On the same day, it paid Disney the aggregate amount of £503m as an advance against its obligation to pay annual instalments.
Also on 3 April 2007, Eclipse entered into an agreement with another company ("the distributor"), which was a member of Disney's group of companies. The agreement was by way of sub-licence of the exploitation and distribution rights in the films for a term of 20 years. The distributor was required to exploit the films and ensure their distribution. As a consideration, the distributor was obliged to pay Eclipse specified sums annually over 20 years, variable distributions, and contingent receipts, being amounts payable under a complex formulation if gross receipts from the exploitation of the films exceeded a certain threshold after payment of prior charges.
As security for its obligations, the distributor provided a letter of credit issued by a bank ("Barclays"). The issuance of the letter of credit relieved the distributor from its payment obligations to Eclipse and in effect, the latter substituted Barclays' risk for the distributor's risk. The distributor deposited the sum with Barclays and charged that sum to Barclays to secure the issuance of the letter of credit and to fund Barclays of its obligation under the letter of credit. Eclipse was financed by its members, who, on 3 April 2007, contributed capital to the partnership in an aggregate amount of £840m. Each member chose to finance his capital contributions in part from his own resources but substantially borrowing approximately 94 per cent under a 20-year facility made available to him by a financing company ("Eagle"), a wholly-owned subsidiary of Barclays. The terms of the Eagle facility provided for a fixed rate of interest and required the borrowing member to pre-pay the interest accruing over the first ten years of the borrowing.
Still on 3 April 2007, following the contribution by members of their capital and pursuant to a provision to that effect in the partnership agreement, Eclipse made a payment to the members of an aggregate amount of approximately £293m which enabled the members to make the prepayment of interest to Eagle.
Prior to April 2007, Eclipse entered into a consultancy agreement with another financing company ("Future"), whereby the latter was appointed to provide a number of services relating to the selection, acquisition and exploitation of films and film rights and the management of such on behalf of Eclipse. Eclipse agreed to pay Future a fee based on a percentage of the partnership capital it raised and of the net proceeds from the exploitation of any film rights licensed by it. Pursuant to this, Eclipse paid Future a fee of approximately £44m on 3 April 2007. The payments made between the parties on 3 April 2007 and the payments due over the 20-year term of the transactions, were in accordance with cash flow statements produced from financial models devised by Future. The financial models were used by Future in the promotion of Eclipse to potential investors early on.
Previous to the transactions made in April 2007, Eclipse entered into an agreement with a marketing company ("WDMSP"), also a member of Disney's group of companies, whereby WDMSP agreed, for a fixed fee plus a share of any contingent receipts, to act as Eclipse's agent in developing marketing and release plans for the films and to provide services relating to the supervision of the distributor in its implementation of such plans.
Eclipse contended that the only issue relevant to its appeal was whether or not it was carrying on a trade. It argued that all the relevant transactions were genuine transactions entered into for a commercial purpose, and following lengthy negotiations, with a leading entertainment and media corporation. It contended that it entered into the transactions to which it was a party in the course of carrying on its trade of acquiring and exploiting film rights.
Eclipse argued that it paid for and acquired highly valuable licences from Disney giving it the right to exploit two films which were characterised as having franchise potential. It claimed that it exercised that right to exploit those films by entering into the distribution agreement with the distributor, licensing those rights in consideration of specified periodic payments over 20 years (which in themselves ensured over that period profits for Eclipse), together with the possibility of receiving further earnings (the contingent receipts) if the films' gross income exceeded certain thresholds.
Eclipse pointed to the arrangements it entered into with WDMSP for the creation of release and marketing plans for the films, and the supervision of the distributor in the implementation of those plans, to show that it had an active role in the distribution and exploitation of the film rights. It further argued that the trade was in view to a profit since over the period of 20 years - and leaving aside the prospect of receiving any contingent receipts - an aggregate profit of approximately £474.4m would accrue to it, based on financial computations.
Eclipse argued that the borrowings by the members might be relevant to any claim which the members might make for tax relief for the interest paid on such borrowings. However, the manner in which and the extent to which the members financed themselves to provide their capital to the partnership could not be relevant to the issue as to whether Eclipse was carrying on a trade.
HMRC did not argue that the transactions entered into by Eclipse were a sham, but argued that in determining whether or not Eclipse was carrying on a trade, the effect of those transactions should properly be understood by examining them in their entirety and context and with regard to the reality of what they effected, and not just their form. They submitted that the reality of the arrangements was that Eclipse organised a sophisticated financial model involving all the parties, which was designed to give a series of pre-determined cash flows with the ultimate object of giving the members interest payments (accelerated by prepayment) on borrowings for which they could claim tax relief to set against other income they had which was otherwise taxable. The movements of cash on financial close of the transactions entered into on 3 April 2007 set up the cash flows, and in their commercial result achieved only one thing: the payment by Eclipse of approximately £6 million to Disney ("the Studio Benefit") in return for Disney making itself available to the transaction for little more than a day and the remote possibility of Disney paying the contingent receipts to Eclipse. Consequently, Eclipse was not carrying on a trade by reason of...
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