Heather Self and Fiona Fernie discuss the upper tribunal decision in Ingenious Games LLP , the latest instalment in a long-running saga of tax cases relating to film schemes used for tax avoidance.
The case illustrates some key points of wider application:
- What is a trade?
- The difficulty of overturning a first tier tribunal (FTT) decision on the facts.
- Impact on strategy in negotiating a settlement.
This case related to three separate LLPs: Ingenious Games LLP, Inside Track Productions LLP and Ingenious Film Partners 2 LLP.
Each LLP had a number of members, who typically subscribed 30% to the LLP, with a further 70% being provided by a corporate member, giving 100% of the investment used to make a film.
The arrangements were complex, and included a commissioning distributor (often a Hollywood studio) who provided the funding to the corporate member and acquired the film on completion.
The film was to be made by the LLP, but the actual production was outsourced to a production services company. The profit-sharing arrangements provided that the LLP was entitled to 30% of the profits from the film.
Ingenious claimed that the LLPs were carrying on a trade of making films. Accounting rules required that on completion the film should be valued at its net realisable value, and that would typically give rise to a loss in the first period.
If the film was successful, income would arise in later periods to offset the loss, so that overall there would only be a tax deferral for investors. Crucially, the initial loss was expected to be a trading loss which could be offset against other income.
Investment or trading?
HMRC contended that, fundamentally, this was an investment rather than a trading activity. HMRC also had a number of subsidiary arguments, any of which would deny loss relief to the investors.
The FTT held that the LLPs were trading, but only to the extent of the 30% contributed by the members and held that the expenditure incurred was capital, so no trading loss arose.
The upper tribunal (UT) went further and agreed with HMRC’s argument that this was not a trading activity. They also agreed with all of HMRC’s other arguments, but the decision on trading was key.
The UT began by considering whether the Ramsay principle was relevant to whether an activity was a trade. They concluded that it was and that the transaction must be considered as a whole, in the light of all relevant surrounding circumstances.
The UT then reviewed other case law authority but noted that the “badges of trade” set out in Marson v Morton [ BTC 377] were not “sufficiently analogous” to the facts of this case to be useful. The UT, therefore, considered several other film cases such as Ensign Tankers and Samarkand, [ BTC 110] and concluded that the activities did not amount to a trade. In doing so, they concluded that the FTT had made errors of law and there was no trade at all.
The approach taken by the UT is likely to be helpful in other cases. Firstly, it is useful to move away from the “badges of trade”, which do not fit the pattern of many modern activities. Second, if a business operates in a commercial way which is common to other similar businesses, it is likely to be trading – unless the whole activity is part of a complex scheme and, viewed realistically, no trade exists.
Overturning the FTT decision
The second key issue is the importance of the FTT decision on questions of fact. The LLPs felt strongly that the FTT had not understood the contractual relationships and had reached a decision which “no reasonable tribunal” could have made. The UT goes to some lengths to set out clearly the limits on the powers of an appellate court, particularly in reference to an appeal on Edwards v Bairstow [HL 25 Jul 1955] grounds. They note that, as HMRC submitted, “the bar to establishing an error of law based on the challenges to findings of fact is deliberately set high” and conclude their analysis by saying that “extreme caution” is required before setting aside conclusions of the FTT based on “careful evaluative findings of fact made on the basis of extensive evidence.”
The lesson for anyone contemplating litigation is that the FTT is, in many ways, the most crucial stage in the process. Getting the facts clearly articulated at the FTT is vital, and as this case shows, persuading an appeal tribunal that the FTT got it wrong will be difficult. No doubt the LLPs will wish to appeal further but they will have an uphill battle, and the Court of Appeal is even less likely to wish to re-examine evidence that has already been reviewed in detail by the FTT.
This is a reminder to all litigants that they should keep their position under review and consider carefully any settlement offered by HMRC.
It is understood that HMRC offered to settle on the basis of a 30% loss claim both before and after the initial FTT decision. With hindsight, many investors would have fared better by accepting that offer instead of getting nothing – unless this decision is overturned on further appeal.