After their loss in the Upper Tribunal (UT), discussed in our previous article in August 2019, the taxpayers sought leave to appeal to the Court of Appeal. Permission was granted, but only on limited grounds, so although the appeal was successful, the taxpayers have only succeeded in establishing a relatively small percentage of the losses claimed.
Why losses arose
Although this has been widely referred to as a “film scheme” case, it does not rely on special rules relating to tax relief for films, but deals with the fundamental question of whether an activity is a trade, and if so whether it is being carried on with a view to profit.
Investors typically subscribed 30% of the funds to a Limited Liability Partnership (LLP), with a further 70% being provided by a corporate member. The LLP claimed that it used 100% of the funds to carry on a trade of making films.
Because most films are unprofitable (although a few make significant profits) the value of each film was written down to 20% of its original cost for accounting purposes. The taxpayers claimed that this produced a loss which could be offset against other income. In order for the loss to be available, the loss had to be a trading loss, and the LLP had to be carrying on a trade with a view to profit.
These seemingly simple questions have required hearings of several weeks in the First-tier Tribunal (FTT), the UT and now the Court of Appeal, with evidence running to an incredible one million pages.
How much loss was allowed
The FTT held that the LLP was trading with a view to profit, but only to the extent of the 30% invested by the LLP members. On this basis, 30% of the losses would have been available. However, they also decided that most of the costs incurred were capital rather than revenue, so that only about 4% of the losses claimed were allowed.
The UT went further, and held that the LLP was not trading at all, so no losses were available. This also led to some significant practical difficulties, as an LLP which is not trading is not regarded as transparent for tax purposes, so is treated as a company rather than a partnership.
Court of Appeal
The taxpayers were given leave to challenge the UT decision, but only in relation to the key questions of whether the LLP was trading, and if so, whether that trade was being carried on with a view to profit. They were not entitled to challenge the “capital v revenue” decision, and despite strenuous efforts they were not permitted to revisit the factual evidence which had been given to the FTT.
This meant that the amount of stake was restricted to 4% of the original amount of losses claimed. However, as the total losses at stake were some £1.6b, this still amounted to over £60m.
The Court of Appeal decided that the UT should not have overturned the FTT decision, and that there were no errors of law by the FTT. In particular, the fact that transactions have a fiscal motive will not be enough to stop the transactions having the character of a trade, unless they “fell into the exceptional category of being so affected by fiscal considerations that they could not answer the description of trading at all.”
It seems that the Court of Appeal were reluctant to extend the scope of this “exceptional category”, perhaps in case it led to more uncertainty for other taxpayers.
The Court of Appeal also held that it was open to the FTT to conclude that the LLP was trading with a view to profit, provided its trade was regarded as being in relation to 30% (and not 100%) of the funds invested.
What happens next
The decision emphasises, yet again, the importance of the decision of the FTT on factual matters. Provided the FTT’s decision is not completely unreasonable, it is very unlikely to be overturned by the higher courts.
HMRC apparently offered to settle with the taxpayers for 30% of the losses claimed. The Court of Appeal has allowed 4% of the losses – which is better than the upper tribunal’s figure of zero, but still a long way short of what the taxpayers could probably have achieved if they had accepted HMRC’s settlement offer.
It remains to be seen whether HMRC will seek leave to appeal to the Supreme Court.
Court of Appeal decision: https://www.judiciary.uk/wp-content/uploads/2021/08/Ingenious-Games-LLP-v-HMRC-judgment.pdf
For more information, please contact Fiona Fernie or Heather Self using the details on this page.