HM Revenue and Customs v Micro Fusion 2004-1 LLP; HM Revenue and Customs v Halcyon Films LLP
| Jurisdiction | England & Wales |
| Judgment Date | 30 June 2008 |
| Date | 30 June 2008 |
| Court | Special Commissioners |
special commissioners decision
Edward Sadler, John Clark
Jonathan Peacock QC and Jolyon Maugham, instructed by DLA Piper, for the Appellant
Ingrid Simler QC and Andreas Gledhill, instructed by the General Counsel and Solicitor for HM Revenue and Customs, for the Respondents
Income tax - limited liability partnership - whether partnership engaged in trade of exploitation of films - yes - whether film constituted trading stock so as to deny relief under Finance (No. 2) Act 1992 section 42s. 42 F(No. 2)A 1992 or Finance (No. 2) Act 1997 section 48s. 48 F(No. 2)A 1997 - no - date of commencement of partnership's business and basis period applicable - Finance (No. 2) Act 1992 section 40B subsec-or-para 3s. 40B(3)(b)(ii) F(No. 2)A 1992 - date film completed - Finance (No. 2) Act 1992 section 43 subsec-or-para 3s. 43(3) F(No. 2)A 1992 - whether arrangements for exploitation of film a deferred income agreement in respect of a film which is within Finance Act 2005 section 60s. 60 FA 2005 - no - whether film consultancy fees incurred deductible - yes
The special commissioners decided that a company was carrying on "a trade or business which consists of or includes the exploitation of films" within Finance (No. 2) Act 1992 section 42 subsec-or-para 1s. 42(1) of the Finance (No. 2) Act 1992. However, as the company did not actually sell the film, it did not constitute trading stock, and accordingly the company was entitled to claim tax relief under s. 42 of the 1992 Act and Finance (No. 2) Act 1997 section 48s. 48 of the Finance (No. 2) Act 1997, as appropriate, in respect of expenditure incurred by it on the production of the film.
The taxpayer was a limited liability partnership which claimed to carry on a trade or business which consisted of or included the exploitation of films. During the tax year ending 5 April 2005 the taxpayer entered into a series of arrangements to acquire a one picture licence in the film Mrs Henderson Presents ("the film"), which was released in the UK on 25 November 2005 and won several awards. The first agreement, dated 6 April 2004, was a film consultancy agreement (FCA) retaining F to act as film consultants to the taxpayer. The second agreement of the same date was an exclusive acquisition financing agreement ("EAFA") under which the taxpayer acquired certain rights in connection with the screenplay.
On 1 October 2004 the taxpayer entered into an agreement with P under which it acquired a one picture licence of the "underlying rights", stated to be solely for the purpose of production, exploitation and distribution and delivery of the film. The film was a qualifying British film for the purposes of the Finance (No. 2) Act 1992, Finance (No. 2) Act 1992 section 40B section 42ss. 40B, 42 and the Finance (No. 2) Act 1997, s. 48. There was also a production services agreement ("PSA") and a distribution and commissioning agreement ("the distribution agreement") pursuant to which the taxpayer agreed to deliver the completed film, transfer the master negative of the film and license the full distribution rights to enable P to exploit the film on a continuing basis (for a period of 21 years) and to market and promote the film in all media all over the world and to earn revenues from doing so, in consideration of P making specified minimum payments to it during that period. At the end of that period P had the right to acquire the taxpayer's interest in the film upon payment of consideration equal to the market value of such interest.
In its partnership return for the tax year ending 5 April 2005 the taxpayer claimed a loss of £12,413,398, being an apportionment of a loss of £15,338,199 which the taxpayer claimed it incurred in its accounting period beginning on 6 April 2004 and ending on 30 June 2005. The loss of £15,338,199 comprised a claim for relief under the special provisions relating to expenditure incurred on films and a loss in computing profits arising by reason of the payment of fees to F for film consultancy services.
On 2 February 2007 the Revenue issued a closure notice amending the taxpayer's return by disallowing its claim to relief under s. 42 of the 1992 Act and s. 48 of the 1997 Act, and disallowing all but £188,156 of the loss claimed as a trading loss. The taxpayer appealed against that closure notice.
Whether the taxpayer was carrying on "a trade or business which consists of or includes the exploitation of film" within the Finance (No. 2) Act 1992, s. 42(1) (the nature of trade issue); whether the film constituted trading stock (as defined in ICTA 1988, Income and Corporation Taxes Act 1988 section 100 subsec-or-para 2s. 100(2)) of the taxpayer (the trading stock issue); if so, whether that trade commenced on 6 April 2004, and if it did not, the date on which that trade did commence (the commencement issue); whether the film was "completed" (as defined in Finance (No. 2) Act 1992 section 43 subsec-or-para 3s. 43(3) of the 1992 Act) on or before 30 June 2005 (i.e. within the "relevant period" in relation to the taxpayer, as provided in s. 42(3)(a)) (the completion issue); whether the arrangements the taxpayer entered into for the exploitation of the film comprised a "deferred income agreement in respect of a film" to which the provisions of the Finance Act 2005. Finance Act 2005 section 60s. 60 applied (the s. 60 issue); and whether the fees of £1,616,889 incurred by the taxpayer to F under a film consultancy agreement were properly deductible in the calculation of the profits of the taxpayer's trade for the purposes of its tax return for the tax year ended 5 April 2005 (the deductibility of fees issue).
The special commissioners (Edward Sadler and John Clark) allowed the appeal.
The taxpayer, by entering into the distribution agreement, was exploiting the film by means of its interest in the rights it held in the film (its ownership of the physical record and intellectual property rights). The taxpayer had retained an interest not only in the copyright of the film, but also in the master negative and other physical record in the film. The word "film" in the phrase "the exploitation of films" in the Finance (No. 2) Act 1992, s. 42(1) meant something more than the master negative or other physical record of a film. On the facts the taxpayer had retained such rights as to retain for itself a continuing interest in the physical record of the film, albeit of a residual or reversionary nature, being subject to the distribution and related rights it conferred on P. Accordingly, the taxpayer was properly to be regarded as acquiring all its rights in the film (including the master negative) and then, in sequence, licensing or disposing of them. Therefore it was carrying on "a trade or business which consists of or includes the exploitation of films" within s. 42(1) of the 1992 Act.
As the taxpayer did not actually sell the film, it did not constitute trading stock, as defined in ICTA 1988, s. 100(2). The transfer of title to the master negative and other physical film material under the terms of the distribution agreement were not an outright disposal, nor was it a sale since title and ownership reverted to the taxpayer without payment at the end of the 21 year licence period (or earlier in certain events of default) unless P exercised its buyout rights. Nor could it be said to be legally or commercially inevitable that P would acquire the taxpayer's rights in the film at the end of the licence period so that the distribution agreement was not a sale with delayed completion. Accordingly the taxpayer was not denied relief under s. 42 of the 1992 Act and s. 48 of the 1997 Act by reason of s. 42(8) and the taxpayer was entitled to claim relief under those provisions, as appropriate, in respect of expenditure incurred by it on the production of the film.
For a trade to be regarded as commenced in advance of any sales or equivalent earning of income, activities had in fact to be "operational" in the sense of undertaken and actively and single-mindedly pursued so as to result in a profit earned. The taxpayer had failed to show that that was the case in relation to the screenplay in contrast to the position with the film. On the facts the taxpayer had commenced its trade on 20 September 2004, the date on which shooting began of principal photography of the film as firm evidence of a commercial commitment to the arrangements documented on 1 October 2004.
It had not been established that either the EAFA or the transaction recorded therein was a sham. The taxpayer had acquired the rights to the screenplay that the EAFA conferred on its face. That was a necessary preparatory action which put the taxpayer in the position to commence its trade by the exploitation of films, but it was not itself the action of exploiting films. Therefore the taxpayer's trade commenced on 20 September 2004 rather than 6 April.
Therefore, in determining the amount of relief for the tax year 2004-05, the definition of "relevant period" for the purposes of s. 42 was the basis period for that tax year, i.e. from 20 September 2004 to 5 April 2005. The concept of "relevant period" had three purposes in terms of the relief given for expenditure qualifying for relief under s. 42 or s. 48: (1) it determined the period in which the deduction for the expenditure was taken under s. 42(1); (2) it determined when a claim could be made, i.e. the period in which the film was completed or some earlier period (s. 42(2)); and (3) it determined the amount of relief which could be claimed, e.g. one-third of the expenditure with a proportionate reduction for a period of less than 12 months (s. 42(4) and (5)). For those different, but related, purposes the only sensible meaning of "relevant period" in s. 40B(3) of the 1992 Act was "if...
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