Ingenious Games LLP and Others
| Jurisdiction | UK Non-devolved |
| Judgment Date | 17 May 2017 |
| Neutral Citation | [2017] UKFTT 429 (TC) |
| Date | 17 May 2017 |
| Court | First Tier Tribunal (Tax Chamber) |
Judge Charles Hellier, Julian Stafford
Income tax – Whether expenditure on rights to income from films was capital.
In a supplementary decision to that of the First-tier Tribunal (FTT) in Ingenious Games LLP; Inside Track Productions LLP; Ingenious Film Partners 2 LLP TAX[2016] TC 05270, the FTT held that expenditure on film rights was disallowed as capital under the Income Tax (Trading and Other Income) Act 2005 (ITTOIA 2005), s. 33 (previously, Income and Corporation Taxes Act 1988 (ICTA 1988), s. 74(1)) and not deductible in computing taxable profits.
This decision supplements the decision of the FTT in Ingenious Games LLP; Inside Track Productions LLP; Ingenious Film Partners 2 LLP TAX[2016] TC 05270 and was made without a further oral hearing with the benefit written submission and replies by the parties.
In the earlier decision, the FTT had considered the ability of the three appellant LLPs to claim trading losses allegedly incurred in the production of a significant number of films and video games. The FTT had dismissed Ingenious Games LLP's appeal finding that it was not carrying on a trade and allowed in part the appeals by Inside Track Productions LLP and Ingenious Film Partners 2 LLP on the basis that deals for the making of films to the extent that they required a capital contribution by the LLPs of 30 (or 35) out of 100 of the total contractual budget for each film amounted to trading with a view to profit. That hearing had then been adjourned for the parties to agree the figures, however, this had not been possible because there arose a dispute as to whether the sums which the FTT had regarded as properly deductible for GAAP purposes, as provisions for the impairment of the rights under the relevant agreements, were not deductible in computing taxable profits as a result of ITTOIA 2005, s. 33 (or its predecessor, ICTA 1988, s. 74(1)) on the basis that they were capital or of a capital nature.
In the earlier decision, the FTT had found that the LLPs had acquired an asset which was the right to payment of a portion of the proceeds of distribution of a film and that the LLPs' financial activity was the exchange of a sum of money paid to one party for a potential future financial reward from another. For accounting purposes, the rights were held “for use on a continuing basis in the business”, and so were not current assets for those purposes. In substance (as defined by the relevant accounting standards), the rights were not stock and should be treated as fixed intangible assets which should be accounted for at cost less any impairment (or onerous contract provision). The period over which a profit could be hoped from a film was five years but beyond that period the revenues became too uncertain to regard substantial future receipts as a realistic possibility. It was possible, however, the income could arise after that date although most films did not earn beyond 30 years.
HMRC argued that the FTT had found that the LLPs activities were akin to buying an income stream and that for UK GAAP purposes, the rights under the agreements were not current assets but fixed intangible assets held for use on a continuing basis in the business and as a result were capital in nature so that no deductions should be made in computing the LLPs' taxable profit or loss in respect of the impairment.
The appellants argued that it would be absurd if the expenditure on the rights was disallowed as capital and the LLPs remained taxable on the gross amounts received without any deduction for the cost of acquiring those amounts and that the FTT's decision that for accounting purposes the rights were not current assets did not inevitably lead to the conclusion that the expenditure on the rights was capital in nature.
The FTT were referred to 15 cases relevant to the concept of capital and wording of ICTA 1988, s. 74 and noted that what was clear was that there was “no single rule or touchstone has been devised for distinguishing between capital and revenue payments” (Lord Fraser in Tucker (HMIT) v Granada Motorway Services Ltd TAX(1979) 53 TC 92) but there were many factors, and many approaches, to be considered some or all of which may be relevant. The FTT, therefore, proceeded to consider what appeared to be the more important tests or indicators by reference to which the question was evaluated in the 15 cases cited before them.
Absurdity or unfairness: although the idea of profits being calculated without taking into account the depreciation of capital assets was absurd to accountants in practice, particularly recognising the accruals concept of matching expenditure with income over the period the income arose (not distorting profits by reflecting deductions in one year which relate to income earned over more than one year). However, the authorities had recognised the unfairness in the statutory provision which denied deduction for capital expenditure and that the move to calculating taxable profits based on UK GAAP in the Finance Act 1998 (FA 1998), s. 42 was subject to any rule of law of which ITTOIA 2005, s. 33 was one. Accordingly, the question had to be resolved without regard to whether the result might be absurd or unfair.
Fixed or circulating capital – raw material: a distinction drawn in some of the authorities to determine the matter was as between fixed capital (which produced income without further action) and circulating capital (which was used temporarily and circulated within the business). The principle being that changes in the value of fixed capital were ignored in calculating annual gains and profits but changes in circulating capital taken into account. The FTT noted this principle did not align with accounting practice which recognised both current and fixed assets in the balance sheet and annual profits calculated by reference to changes in the balance sheet value from year to year, including deduction for depreciation on fixed assets. Nevertheless, this was the context in which capital was to be understood in the Act. The FTT rejected the appellants' analogy that the rights acquired were akin to raw materials as they were exhausted finding that the rights did not play this role since they were not used. As for fixed or circulating capital, the FTT found that the there was no recycling of monies received and no circulating of capital because when the money came in it was distributed to the members. The FTT concluded that although the nature of the trade weighed in favour of the rights as being revenue, this was balanced by a lack of circulation with the balance resting on whether the rights in context had too long a life to be revenue.
Enduring benefit: the FTT noted that if “enduring” meant an indefinite time then the LLP's rights were technically enduring as although normally they would have little value after five or ten years, there was a possibility of receipts over a much longer period. That would point towards capital. However, the FTT noted that enduring benefit was to be considered by asking what was the nature of the asset in the context of the trade? The LLP's trade was about longer term financial contracts and although the returns were expected over a period of five years, the question remained how long a shadow was cast by the longer term nature of the rights?
Once and for all – recurrence: the principle being once and for all expenditure was capital whereas recurring expenditure was income. The FTT noted that only one LLP was open for investment in any one year, the intention was to return monies received to the members but that it was possible the LLPs could redeploy monies from films which did not proceed. However, the recurrence of expenditure or continuous or constant demand for expenditure was not part of the business model and this pointed away from revenue.
Ordinary commercial contracts: the principle here being that receipts from ordinary commercial contracts were revenue receipts whereas receipts from contracts regulating the trader's activities were capital. The FTT noted the rights were under the ordinary commercial contracts of the LLPs' trade, they did not regulate the LLPs' activities and this pointed towards a revenue nature.
Accounting practice: whether to debit the profit and loss account with the whole of the payment or take to the balance sheet as capital and write down each year. The FTT noted that BP Australia Ltd v Commissioner of Taxation of the Commonwealth of Australia ELR[1966] AC 224 preferred treating as revenue and although the accountancy evidence was different, what the FTT regarded as GAAP was more in line with what the preference indicated by this decision, that the impairment of the rights was a revenue item not one in respect of capital.
“Upon” assets or “with” assets: the demarcation between creating the permanent structure of a business and the cost of earning the income itself could lead to distinctions between a profit made “upon” assets or “with” assets; and contracts relating to the structure of the business were capital. Although the LLPs contracts were long term, they were the substance rather than the structure of the LLPs business as monies flowed from the contracts, not by deploying them. This weighed towards revenue not capital.
How long was sufficient? The appellants argued that BP Australia supported that something lasting 20 years was capital, five years was revenue and ten years could also be revenue. The FTT noted that although the rights were generally exploited over a five year period, the rights would last as long as the business given they were the substance of it and should be treated as having a life of longer than five years. The role the rights played in the business further seemed to extend over too large a tract of time to escape the attraction of the idea that profits were “annual” whereas things which lasted a long time were capital.
The approach in BP...
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