Hardy; Moxon
| Jurisdiction | UK Non-devolved |
| Judgment Date | 16 October 2017 |
| Neutral Citation | [2017] UKFTT 754 (TC) |
| Date | 16 October 2017 |
| Court | First Tier Tribunal (Tax Chamber) |
[2017] UKFTT 0754 (TC)
Judge Swami Raghavan
David Southern QC, instructed by Simons Muirhead Burton solicitors appeared for the appellants
David Yates and Thomas Chacko, counsel, instructed by the General Counsel and Solicitor to HM Revenue and Customs, appeared for the respondents
Income tax – Losses – Appellants were shareholders in companies investing, with the assistance of limited recourse loans, in a general partnership (Vanguard) which acquired films from producers under distribution sale and purchase arrangements which included put options held by Vanguard and call options for the producer – Triggers for exercise of options and exercise price dependent on predicted revenue performance according to report made by film valuer shortly after public release of films – Cash flows from exercise of options linked to level of film budget and actual performance of film over time – Whether relief available on shares sold at loss dependent on whether Vanguard carrying on trade (ITA 2007, s. 137? – Vanguard not carrying on a trade – Whether loss for capital gains tax purposes? – No – Whether HMRC's enquiries opened under correct statutory provisions? – Yes – Appeals dismissed.
The First-tier Tribunal (FTT) ruled that a tax avoidance film scheme which sought income tax share loss relief under ITA 2007, s. 131 failed because: the Partnership was not trading; the companies did not exist wholly for the purposes of carrying on a qualifying trade, and the share disposals were not bargains at arm's length. Further, the capital loss would be reduced/extinguished under TCGA 1992, s. 17 (market value substituted for bargain not at arm's length) or s. 38 (to exclude expenditure represented by loans), or s. 30 and 125A (to increase consideration for benefit of loans released). Finally, the losses would also be disallowed under TCGA 1992, s. 16A (main purpose to secure tax advantage).
John Hardy and Richard Moxon (the appellants) entered into a tax avoidance film scheme known as the Vanguard scheme, marketed by various Matrix entities. The scheme sought to generate income tax share loss relief against general income under ITA 2007, s. 131. In short, the appellants bought shares in a company (PartnerCo), partly financed with their own money and partly with substantial limited recourse loans which created a large acquisition cost for the shares. The PartnerCos contributed these funds to a partnership (the Partnership) which carried out various transactions in film rights and the individuals then sold their shares in the PartnerCos at a loss.
For share loss relief to be available, ITA 2007, s. 137 requires that the company “exists wholly for the purpose of carrying on one or more qualifying trades” and the main question in the appeal was whether the Partnership (in which the companies were partners) was trading in intellectual property rights in films, although a total of ten issues were considered by the tribunal.
The transactions involved the individuals depositing a sum with Alliance and Leicester who made substantial loans to the individuals. These funds were used to subscribe for shares in the PartnerCos which in turn contributed the funds to the Partnership. The Partnership acquired three films from film producers (Lakeshore Entertainment group and Lionsgate). However, no money actually moved (other than the individual's initial deposit which was disbursed in fees) because the film producers acquired the loans from Alliance and Leicester so effectively paid themselves for the films (i.e. the transactional payments went from film producers to individuals (loans) to PartnerCos (share subscription) to Partnership (capital contribution) back to producers (purchase of films)).
At the same time, a distribution agreement was entered into between the Partnership and the film producers that the film produces would distribute the films and pay the Partnership a “defined proceeds” fee (film income less certain costs). Cross options were also entered into giving the Partnership a put option to sell the films back if “defined proceeds” fell below a certain amount (i.e. if the films were unsuccessful) and giving the film producers a call option to buy the films back if “defined proceeds” were above a certain level (i.e. the film were highly successful).
Following the release of the films, Matrix and the film producers (through different but connected entities) offered to buy the individual's shares in the PartnerCos for a price equal to the Partnerships put option price. The offers were accepted and the shares were sold at a loss. On the same day, the Partnership exercised the put option and sold the films back to the producers.
Again, however, no money actually moved because the film producers loaned (to the share purchase entities) the share purchase monies which were used to repay the loans to the individual's, and the put option proceeds (receivable by the Partnership) used to discharge the share purchaser's loans (i.e. once paid to the Partnership, the put option proceeds could have been paid up to PartnerCos and then out to share purchaser entities and then used to repay their borrowings for the share purchases so these steps were short-cut). Effectively, this meant the transactional money movements for the sale of the shares went from film producer (as lender) to share purchaser entity (as purchasers) to the individuals (as vendors) back to film producer (as lenders to the individuals); and for the exercise of the put option, from film producer (as film purchaser) to itself (as lenders to the share purchase entities).
At the end, the balances remaining on the original loans to the individuals (by Alliance and Leicester but transferred to the film producers) were written off.
The tax issues:
- Whether the Vanguard 1 Partnership was carrying on a trade during the periods in which the appellants held shares in the PartnerCos such that the conditions in ITA 2007, s. 137 were satisfied for the period required under s. 134.The FTT noted that ITA 2007, s. 137 required the company exists wholly for the purpose of carrying on one or more qualifying trades and that s. 189 provided that a trade is a qualifying trade if it is conducted on a commercial basis and with a view to the realisation of profits. HMRC argued that the Partnerships were not trading because 1) they had deliberately sought to make a loss and/or 2) even if they did intend to make a profit, the structure of the transactions was more akin to an investment than a trade.On the first argument, the FTT found that whilst the evidence suggested the appellants were indifferent to making a profit, it was insufficient to establish that losses were deliberately sought. In terms of whether the Partnerships were trading, the FTT noted that the relevant factors to consider were the activities, once stripped to its essentials; the likelihood of profit; and the intentions of the Partnership.The activity was not about buying or selling films nor was it about trading in film rights. Rather a package of rights was bought. Stripping the transactions to their essentials, a template set of agreements were applied to a film whereby the purchaser obtained the right if certain conditions were met to an uncertain income stream depending on the amount. There were a small number of transactions with uncertain and low likelihood of reward and indifference to making profit on the part of the Partnership. The Partnership was not involved in any significant activity in selecting films and there was no opportunity for subsequent activities e.g. through promotion of income components or reduction of costs to maximise defined proceeds value and so as to turn a profit. The Partnership was very much a passive participant. Accordingly, the FTT concluded that the Partnership was not carrying on a trade.However, the matter did not end there as ITA 2007, s. 137 provided a further hurdle that the companies themselves must exist wholly for the purpose of the qualifying trade. In this respect, the FTT concluded that, irrespective of whether the Partnership was carrying on a qualifying trade, it was clear that the PartnerCos, ignoring any incidental purpose, did not exist for the purpose of carrying on a qualifying trade. As with the company in Kerrison [2017] TC 05800, the companies existed to facilitate the use of a tax scheme, in this case one which involved the accessing of loss relief under s. 131. The investor presentations referred to a special purpose company and there was no mention of the scenario of not using a company. As HMRC alluded to, it was likely that companies were used to circumnavigate the legislation changes in 2007 which restricted sideways loss relief by individual partners. Accordingly, even if wrong about the Partnership trading conclusion, the trading requirement in s. 137 was nevertheless not satisfied.
- Whether, if the Vanguard 1 Partnership was carrying on a trade during either such period, such trade was conducted on a commercial basis and with a view to the realisation of profits within the meaning of ITA 2007, s. 189.Although this issue arose only if the FTT were wrong in concluding that the Partnership was not trading, the FTT considered the submissions and concluded that even if the Partnership was trading it was not trading on a commercial basis (1) because it was not carried out in a way which someone seriously interested in profit would carry it out and (2) because of the low likelihood of profit and the uncertainty, if any profit were achieved, that such profit would be of sufficient amount to justify the low likelihood of it materialising in the first place. In view of the fact that the Partnership and the appellants were indifferent to making a profit the test of with a view to realisation of profit was not satisfied either.
- Whether the PartnerCos satisfied the trading requirement in ITA 2007, s. 137 on the date and for the period required under s...
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