Icebreaker 1 LLP
| Jurisdiction | UK Non-devolved |
| Judgment Date | 05 January 2010 |
| Neutral Citation | [2010] UKFTT 6 (TC) |
| Date | 05 January 2010 |
| Court | First Tier Tribunal (Tax Chamber) |
[2010] UKFTT 6 (TC)
Howard M Nowlan (Judge) (Chairman), Nicholas Dee
Jonathan Peacock QC and James Rivett, counsel, for the Appellant
Peter Blair QC and Jonathan Davey, counsel, for the Respondents
Income tax - claim by an LLP to have incurred trading losses in relation to its trade of distributing films - whether circular payments resulted in expenditure "not having been incurred" - whether payments were deductible as trading expenses - whether part or all of any payments were capital payments - whether those payments that were deductible were deductible in the LLP's first period of account or whether payments made in that period included pre-payments - issues in relation to the closure notice - appeal substantially dismissed
The tribunal decided that expenditure by the taxpayer on film rights had been actually incurred on acquiring the rights to certain payments under a related agreement and not for generating future film-related receipts. Accordingly, the taxpayer had failed to establish that the vast majority of payments made on its first day of trading, virtually equal to its entire capital and resources, followed by the immediate closure of its accounting period, contributed to its allowable losses available for members to set against their other income for tax purposes.
The taxpayer had been formed, initially with two corporate members, in February 2004 with a view to conducting a trade of film distribution. On 5 April 2004 six individuals joined the taxpayer, contributing capital of 1,520,000 between them, 70 per cent of which (1,064,000) had been funded by way of non-recourse loans advanced by the bank. Also on 5 April approximately 26 documents were executed. The taxpayer paid 46,950 to a company ("SPAM") for the near exclusive ten-year licence interests in relation to the screenplay or other rights in relation to eight films, potential films and DVDs. Only one of the eight proved material, 20,000 being allocated to the licence rights in relation to a screenplay and other rights to a work called "Young Alexander" that was about to be filmed. The taxpayer also entered into an administrative and an advisory agreement with a company ("IML") under which, later on the same day, it paid the aggregate of 120,000 and 50,000 for services, having been invoiced for those sums that were due under the two agreements. The taxpayer appointed a company (C) to be its head distributor in relation to the exploitation of the acquired licence rights. Under that agreement (the "HDA") the basic expectation was that the taxpayer would pay fees, thereby meeting a proportion of the distribution costs (and the film production costs where a screenplay first had to be filmed, before it could be distributed) and under that agreement the taxpayer became entitled to various payments, some payable without any reference to whether there were any film distribution revenues or not and others only out of such revenues.
Under the HDA, C was required to procure and provide security for certain payments. That was achieved by the bank providing an effective guarantee to the taxpayer, in the form of a letter of credit, for C's payments. The bank's exposure under the letter of credit was itself secured by the bank taking a charge over a blocked deposit placed by C with the bank. The bank also took charges over all of the taxpayer's assets, including the letter of credit, for the repayment of the members' limited recourse borrowings of 1,064,000. Although the taxpayer could only have commenced its trade on 5 April 2004, it closed its first accounts on that day and claimed that virtually all of its expenditure contributed to a trading loss for the period. It was then claimed that the individual members of the taxpayer could set their respective proportions of the loss against their other income for income tax purposes.
HMRC opened an enquiry into the return and subsequently issued a closure notice containing the conclusion that the taxpayer's claimed loss was to be reduced from 1,491,816 to 11,900. The taxpayer appealed. This case raised a considerable number of points, most importantly as to the deductibility of the 1,064,000 element of the 1,273,866 paid to C under the HDA. HMRC contended that, because of the banking mechanics and the claimed elements of 'circularity', the right analysis was that the 1,064,000 element was not really paid or incurred at all. HMRC's alternative contention in relation to the 1,064,000 element was that it was still appropriate to consider that element of the payment separately from the payment of the balance of 209,866. The former element was paid to acquire rights broadly equivalent to those of a loan of 1,064,000, such that the payment of 1,064,000 had nothing to do with either the taxpayer's trade or the production and distribution of films, and only the balance of 209,866 could realistically be said to have been incurred as fees on production or exploitation at all.
Whether the taxpayer had succeeded in establishing that various payments that it made on its first day of trading gave rise to tax-deductible losses in its trade of distributing films; whether a major element of the payments made by the taxpayer had nothing to do with its trade but simply generated guaranteed receipts; and whether various elements of the taxpayer's remaining expenditure were capital or income payments, and whether the income payments included pre-payments or not.
The First-tier Tribunal (Howard M Nowlan and Nicholas Dee) (allowing the appeal in part) said that the payment of 1,064,000 was not a deductible trading expense since it was not expended by the taxpayer for trading purposes of its film distribution trade, and was thus not tax deductible. The taxpayer clearly acquired the right to the 'certain payments' under the HDA and those rights were all totally unrelated to the production and distribution of the film, and so unrelated to the taxpayer's trade. The payments were due, regardless of whether there were ever any film distribution receipts, and there was no relationship (in the sense of adjustment to payments, timing or source and funding for payments, or security for the payments) between the rights to the 'certain payments', and the possible receipt of film distribution income. Having identified those acquired rights, it was realistic to attribute the payment of 1,064,000 to the obtaining of the relevant rights because that was the amount that any entity would require for granting the rights described. In addition, all parties knew with absolute certainty that the deal being implemented on 5 April 2004 was one under which 1,064,000 had to be credited by C to the blocked account that delivered and secured the 'certain payments'. It naturally followed that the 1,064,000 was not available to be spent on film production or distribution, even in the sense of C being able to use borrowed money for that purpose.
As regards the deductibility of the 209,866 element, ignoring the accounting issues concerning prepayments, the taxpayer was paying for various services that might fall to be treated differently for tax purposes. Thus it was appropriate to consider whether there was any difference, from a tax perspective, in obtaining and paying for services designed to produce the master negative of a film and those designed to pay for distribution. Assuming that the taxpayer's total expenditure of approximately 250,000 was all on production of the film, it followed that, having suffered the 30 per cent commission that all head distributors would have charged for administration, the taxpayer had retained, and was then entitled to, about 25 per cent of film revenues, net of the commission. In all the circumstances, the amount of expenditure incurred on the production of the film would influence the percentage of income derived by the taxpayer during the ten-year period and the production of the film would affect, and enhance, the value of the taxpayer's intermediate rights under its licence, and directly affect the value of those very rights.
The expenditure on producing the film that inherently increased the value of the taxpayer's ten-year rights was capital expenditure. It increased the value of a long-term asset and of the taxpayer's only asset, the purchase price of which had been accepted to be capital. It made no sense for the purchase of the rights to be treated (rightly) as capital, and for the far greater expenditure designed to increase their value to be treated differently.
By contrast, expenditure on arranging the distribution of the film was different. It might create the apparatus, which would be required to obtain any income from the film, and successful distribution arrangements might increase the expected income flows, but that expenditure did not as such change the value of the film or the taxpayer's licence rights or any other capital asset owned by the taxpayer. Accordingly, to the extent that the taxpayer was incurring expenditure on the production of the film, that expenditure was capital, and to the extent that it contributed towards the costs of setting up distribution arrangements, it was revenue expenditure of its trade.
Turning to the payment of the aggregate figure of 170,000 to IML under the two agreements, where an entity promoting tax avoidance schemes or an investment bank promoting tax-based products charged each client that used the scheme or concept a very considerable price for the scheme, the reality regarding the risk of costs being regarded as capital switched. The trade of the promoter or investment bank was to devise schemes and concepts and to sell them as often as possible for significant fees, and there was thus no occasion for a disallowance in the hands of the promoter or investment bank. By contrast, it was then realistic to say that the charges against the client were not for administrative services that might be given in the course of...
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