Ingenious Games LLP; Inside Track Productions LLP; Ingenious Film Partners 2 LLP
| Jurisdiction | UK Non-devolved |
| Judgment Date | 02 August 2016 |
| Neutral Citation | [2016] UKFTT 521 (TC) |
| Date | 02 August 2016 |
| Court | First Tier Tribunal (Tax Chamber) |
Judge Charles Hellier, Julian Stafford
Income tax – LLPs engaging in the making of films and video games – Whether trading – Whether trading with a view to profit – What amount was incurred on the acquisition of rights in respect of films and games, and what amount was incurred wholly and exclusively for the purposes of any trade – Whether profits had been computed in accordance with GAAP.
The First-tier Tribunal (FTT) dismissed Ingenious Games LLP's appeal on the basis 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.
These appeals made by three members of the Ingenious group of limited liability partnerships (LLPs) and companies were designated as lead cases in relation to five other appeals. The appeals concerned 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 was asked to decide upon five issues and the FTT added of its own volition a sixth issue which was not canvassed by the parties:
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1) Were the LLPs carrying on a trade?
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2) Were they doing so “with a view to profit”?
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3) Did they incur expenditure equal to 100% of the budget of the film or game?
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4) Was their expenditure incurred wholly and exclusively for the purposes of their trade?
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5) Were their losses computed correctly as a matter of generally accepted accounting practice (GAAP)?
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6) Did the agreements between each LLP and the distributor amount to separate partnerships?
Author's note: The decision notice in this case is lengthy (it extends over 248 pages (342 including appendices) and was set out in 13 different chapters each with separate sections and subsections). For ease of reference and wherever relevant and convenient, the same headings and subheadings will be used in this report.
Ingenious Media Holdings plc promoted investment to individuals in the three appellant LLPs which were in turn involved in the production of a large number of high profile films and video/ computer games. Hundreds of million pounds were expended in these activities by the three LLPs and they all argued that the activities had resulted in trading losses in a total sum of £1,620m. The individual investors as partners of the LLPs sought to reclaim tax in the total sum of £620m and due to the time elapsed, with interest and penalties, the total amount at stake is said to be some £1bn.
Investment in the LLPs was promoted to prospective investors by way of Information Memoranda and generally investors' subscriptions to a specific LLP were taken in the first year of launch and only for one fiscal year. Together, the LLPs were involved in the production of 65 films including the acclaimed: Avatar, Life of Pi, The Best 30 Exotic Marigold Hotel, Night at the Museum, Shaun of the Dead, Hot Fuzz and Girl with a Pearl Earring.
The FTT set out the workings of the agreements and arrangements in the case of Ingenious Film Partners 2 LLP (“IFP2”) explaining that Inside Track Productions LLP (“ITP”) was broadly the same and that very similar principles applied to Ingenious Games LLP (“IG”) even though it was involved in games instead of films.
The complex structure was known as the Commissioning Distributor Model and it was implemented as follows:
Each LLP had a number of individual members (who made capital contributions or subscriptions) and a single CM [term not defined in decision but assumed to be Capital Manager]. Although the agreements for IFP2 and ITP differed on the capital contribution (up to 50 for each 50 contributed by the members in IFP2 and nothing in ITP, in practice, the CM was treated as making a contribution of 70 for each 30 (or 65 for each 35) subscribed by the members.
The CM of IFP2 and IG were UK resident companies which were part of the ingenious group. The CM of ITP was a company owned by an unconnected charity.
Each LLP had an Operator (another Ingenious group company) which managed its activities for a fee pursuant to an Operator's Agreement.
Each LLP simultaneously entered into a suite of agreements in relation to each film or game and for a budgeted cost of 100:
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a) 30 (35 for ITP) of the cost was obtained from member subscriptions.
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b) And 70 (65 of ITP) was sourced from a Commissioning Distributor (“CD”) which often was a Hollywood studio (a “Studio”) or a vehicle formed by independent producers and financiers.
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c) A special purpose vehicle or Production Services Company (“PSC”) was provided with the whole budget of 100 in exchange for making the film or game to an agreed specification. The PSC instructed the same lawyers as the CD so they appeared to be connected somehow.
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d) Once the film or game were completed, it would be distributed by the CD and the proceeds of distribution would be divided in accordance with a “waterfall” which specified the order of payment for each party and the amounts to be paid to the LLP and paid to or retained by the CD.
The agreements which constituted the suite of agreements for each project (film or game) provided as follows:
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a) A licence of the screenplay by the CD to the LLP.
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b) A loan agreement by which the CD lent 70 (65) directly to the CM. The loan was repayable partly (or entirely in ITP's case) from the CM's drawings from the LLP.
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c) A Production Services Agreement (the “PSA”) by which the LLP engaged the PSC to complete the project to specification and on an Approved Budget of 100. It also provided for payments to the PSC in accordance with an Approved Cash Flow.
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d) A Commissioning Distribution Agreement (the “CDA”) pursuant to which the LLP agreed to complete the project to the same specification/ Approved Budget and deliver it to the CD. Receipts from the project would be distributed in accordance with a waterfall or “Schedule 7” of that agreement.
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e) A Guarantee Agreement (not for IG) by which the Completion Guarantor (in Studio films, a member of the Studio group) agreed to complete the film if it went over budget or abandon it and return all monies to the parties in exchange for a fee.
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f) A Deed of Acknowledgement signed by all parties. This provided that the payments to be made under the loan, the PSA and the CDA were varied and that the LLP's share under the waterfall would be directed to be retained by the CD.
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g) A Pledgeholder Agreement in which the film laboratory would hold the master negative of the film for the CD and the guarantor.
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h) Security Agreements under which rights in the film were assigned by way of security.
The combined cash effect of the loan agreement, the PSA and the CDA was that the CD would pay 70 (65) to the PSC and the LLP would pay 30(35) to the PSC. 30% (35%) of the income arising from the project after the deduction of costs and fees would be paid to the LLP.
The LLPs allocated all the reported losses to the members in the first accounting period of each LLP. This enabled a 40% rate taxpayer to recover 40% of the allocated loss.
In subsequent years, the LLPs allocated 99% of profits to members (ITP) or profits up to the amount of losses previously allocated (IFP2). Any profits were to be shared between the CM and the members. Drawings were not paid in tandem with the allocation of profits and the drawings paid to the individual members from year 2 were 50% of the amounts the LLP received under the waterfall. This was an attractive proposition for investors as in year 1 an individual could make a return of £32 for each £35 invested (for a film written down to 80% and a 40% tax rate) and in year 2 a net return of £5 (if the LLP recognised 50 in profit and paid 25 drawings to members, the members would pay tax on the profit element at 40% × 50 = 20 and keep the remaining 5).
In ITP the CM was allocated 1% profits and losses until the LLP broke even but was treated as allocated drawings of 50% of the LLP's waterfall income which were applied to service the CM loan.
In IFP2 the CD retained a percentage of the LLP's waterfall income in reduction of the CM loan. That was treated as satisfying the CM's drawings. The result was that the CM (a member of the Ingenious group) retained after tax at least 5% of the net income of the film after relevant expenditure.
The FTT had to consider, in addition to large volumes of documentary evidence, six witnesses of fact, four expert witnesses in the film field and two experts in the games field, and accounting expert evidence from three witnesses (including one officer of HMRC).
It is widely known in the industry that making a film is complex and financially risky. Films are either made by a Studio (“Studio Films”) which is one of the six major Hollywood Studios (Warner Brothers, Disney, Fox, Columbia, Paramount and Universal), or by other companies (“Independent films”).
Both types of film start with the main idea written up as a screenplay. If sufficiently attractive, a producer has to be found to find a director, a cinematographer, actors and a film crew and to develop the screenplay. In the case of an Independent Film, the producer also has to simultaneously find sources of finance.
Films can earn income from various sources:
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1) Cinema showings with 98% of income within the first 6 months of the premiere;
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2) Video/ DVD hire and sale and TV on-demand sales (over a much longer period);
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3) Television broadcasting (over many years/ decades);
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4) Music rights;
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5) Franchised goods and toys.
Naturally, each source of...
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