The Court of Appeal has issued its decision in the Ingenious Film Partners case, giving a somewhat pyrrhic victory to the taxpayers. After their loss in the Upper Tribunal (UT), the taxpayers were only granted leave to appeal on limited grounds, such that although they have been successful in the Court of Appeal, only a small proportion of the losses originally claimed have been allowed. In a wider context, the case illustrates the importance of good case management (not least establishing the facts in the First Tier Tribunal (FTT)) and a useful reminder of the partnership rules. The analysis of how to approach the question of whether a trade exists in the context of complex transactions is also interesting.
The Court of Appeal decision in Ingenious Games LLP & others v HMRC [2021] EWCA Civ 1180, issued on 4 August 2021, represents the latest step in the long-running Ingenious Film Partners tax litigation, concerning a collection of Limited Liability Partnerships (LLPs) related to the Ingenious Media group. The Ingenious Media group (led by Patrick McKenna) was a major player in the world of investments designed to be tax efficient, particularly in relation to film schemes during the 1990s and 2000s.
Most film scheme cases relate to specific tax incentives targeted on the film industry (F(No. 2)A 1992 s 42 and the more generous F(No. 2)A 1997 s 48) which accelerated tax deductions for expenditure on film production and acquisition. However, in the Ingenious Film Partners case, the losses were claimed as trading losses under the general tax code. The losses were generated by write-downs of film assets produced and enhanced via gearing, using bank finance and a complex network of inter-company agreements. HM Revenue & Customs (HMRC) challenged this treatment, and the case has now reached the Court of Appeal, with two key questions remaining: was the activity conducted by Ingenious Film Partners a trade; and if so, was that trade conducted with a view to profit?
Background
The case related to three LLPs: Ingenious Games LLP, Inside Track Productions LLP and Ingenious Film Partners 2 LLP. Ingenious Film Partners 2 LLP and Inside Track Productions LLP both funded film production, whilst Ingenious Games LLP funded video games production. These three LLPs represent a test case for the wider Ingenious group of LLPs, with total loss claims in dispute totalling £1.6bn.
Two key questions remaining: was the activity conducted by Ingenious Film Partners a trade; and if so, was that trade conducted with a view to profit?
The schemes were promoted as sheltering the income of higher-rate UK taxpayers from Income Tax at 40% by claiming sideways loss relief, available to them as an individual member of a ‘trading’ LLP. Individual members would subscribe for 30% of the LLP, with a further 70% contributed by a corporate member (related to the Ingenious Media group) and funded via non-recourse loan funding from a ‘commissioning distributor’. The commissioning distributor would typically be a Hollywood studio who would then acquire the rights to the film on completion.
The LLP would sub-contract the production of the film to a ‘production services company’, set up solely to produce the film in question. The loan to the corporate member of the LLPs would be paid directly from the commissioning distributor to the production services company. The losses of each LLP would arise because the film assets created had to be valued for each accounting period at the lower of cost or net realisable value, and given the unpredictable nature of the film industry, net realisable value was likely to be only 20% of cost, even though, ultimately, some of the films produced might later generate significant profits.
100% of the losses generated by the LLPs were allocated to individual members of the LLPs, such that they were available to set against other income in their tax returns, even though they had only contributed 30% of the equity to the LLP. In order for sideways loss relief to be available, the LLP had to be carrying on a trade, and to be doing so with a view to profit. HMRC challenged this interpretation, disallowing the losses via amendments to the partnership returns. The LLPs appealed, and the case was first heard by the First-tier Tribunal (FTT) in 2016 ([2016] UKFTT 521).
At the FTT hearing, five main issues were considered:
- Were the LLPs trading?
- Were the LLPs carrying on their activities with a view to profit?
- Did the LLPs incur expenditure equal to 100% of the budget of the film/game?
- Was the expenditure incurred wholly and exclusively for the purposes of the trade?
- Were the losses computed correctly in line with GAAP?
The FTT held that the two film LLPs were trading, and with a view to profit, but – on the FTT’s interpretation of the contracts involved – only to the extent of the 30% investment made by the individual members (the 30:30 basis). However, after the losses had been calculated to be in accordance with GAAP and considerable amounts of the expenditure made were held to be capital, the losses available for use by the individual members were reduced to approximately 4% of the original amounts (still a significant sum of £60m). The games LLP was held not to be trading.
On appeal, the Upper Tribunal ([2019] UKUT 226) took a more stringent line, and agreed with HMRC’s interpretation, holding that the LLPs were not trading, and that activities were not conducted with a view to profit. On the interpretation that the losses incurred by the LLPs were not trading losses, the individual members could not use the losses against their other income. Furthermore, the LLPs lost their status as transparent entities, causing some practical difficulties in determining whether new assessments needed to be issued to the LLPs, to replace the original partnership assessments.
Key points from the Court of Appeal
The taxpayers sought to appeal the UT decision on wide grounds, but permission was only given in respect of the trading issue and the view to profit issue. In particular, the taxpayers were not permitted to appeal the decision of the FTT that most of the expenditure claimed was capital, meaning that the level of losses that could be claimed by the individual members would be severely restricted regardless of the outcome of the Court of Appeal hearing.
On the trading issue, the Court of Appeal considered that the FTT had validly found that the LLPs were trading on the 30:30 basis. They disagreed with the UT that the FTT had erred in law, and hence found that the UT had no authority to remake the FTT’s decision on this issue. The Court of
Appeal noted the following (amongst other things):
- The question of the trade concerned the single business of each LLP, which included the funding of several films made by both studio and independent producers. The more intensive work required on independent films therefore gave evidence as to the nature of the whole business.
- The 30:30 basis for the calculation of profits and losses of the LLPs was not a ‘partial trade’, as described by the UT, but an acceptable interpretation of the effects of the contracts involved by the FTT.
- That consideration of the badges of trade, as a long-established part of tax law, could not constitute an error of law on the part of the FTT, even for what may seem a sophisticated tax avoidance scheme.
As the FTT had determined that the games LLP was not trading, that appeal could only succeed on Edwards v Bairstow [1956] AC 14 grounds (i.e. that the findings of fact were such that no tribunal properly directed could have come to), which the Court of Appeal could see no proper basis to pursue.
As with the trading issue, the Court of Appeal rejected the UT’s decision that the activity of the LLPs was not conducted with a view to profit, noting that there was adequate evidence in place to reach this conclusion on the 30:30 basis.
Therefore, at present, 4% of the taxpayers’ losses have been reinstated, which is likely to be little consolation to the taxpayers involved. It is unclear whether HMRC will seek to appeal this decision to the Supreme Court. No further appeal by the taxpayers is possible.
Therefore, at present, 4% of the taxpayers’ losses have been reinstated, which is likely to be little consolation to the taxpayers involved.
Implications and points of importance
The case concerned is a lead case for a further appeal by another five Ingenious Media LLPs, and (subject to any appeal to the Supreme Court) should bring this chapter of the saga to an end. However, other litigation is still being played out: for example, Ingenious Media itself as well as the advisers (such as private banks) who marketed Ingenious schemes are now being sued by taxpayers for mis-selling, on the basis that investors had not been properly informed of the risks involved.
The case highlights, yet again, the importance of the FTT’s determination of the facts. The evidence before the FTT (amounting to over one million pages in this case) is not re-evaluated by the higher courts unless the high hurdle of Edwards v Bairstow is reached. An appeal to the higher courts lies only on a question of law, and permission to take an appeal to the Court of Appeal will only be given where the case raises an important point of principle or where there is another compelling reason for a second appeal.
This restricts the cases that reach the Court of Appeal in the first instance, and in the case of these LLPs, the scope of the grounds for appeal allowed has vastly restricted the quantum of losses available. It is therefore critical for us as advisers to remember that the FTT trial is ‘the first and last night of the show’; the factual findings are critical and deserve particular attention in both the preparation for, and at, any hearing.
The decision is a reminder of the tax rules for partnerships and LLPs, which hinge on whether the partnership is operating with a view to profit. Within the Ingenious case (and indeed in many tax avoidance schemes involving LLPs), it was important that the losses were incurred in the course of a trade, such that the individual members of the LLPs could access sideways loss relief. However, it is important to remember that the ‘view for profit’ issue has much wider repercussions: a partnership can only be established where persons are carrying on a business together with a view to profit, whilst an LLP will only be taxed on a transparent basis where it carries on a trade or business with a view to profit.
With respect to the trading issue, the hearing demonstrates that the Ramsay principle (WT Ramsay Ltd v IRC [1982] AC 300), of taking a realistic view of the transactions and a purposive view of the legislation, does not inevitably run against the taxpayer. Although the Ingenious LLPs used a series of agreements to enlarge the trading losses available, the fundamental transaction – on a 30:30 basis and without ‘dressing-up’ – was found to be one with the character of trade.
Finally, although it was undoubtedly the case that the LLP’s members had a fiscal motive in investing into the LLPs, the Court of Appeal noted that it was only the LLP’s motive that was relevant in determining the issue of trade. Of course, if transactions do have a fiscal motive, these will not necessarily bar them from the definition of trade unless the transactions have been so altered by the fiscal motive that they are no longer recognisable in ‘shape and character’ as a trading transaction (the Lupton principle; see FA & ABLtd v Lupton [1972] AC 634).
Final thoughts
The Court of Appeal’s decision to reinstate (partial) losses to the taxpayer in this case by overturning the UT’s decision on the trading issue and the view to profit issue reflects the pivotal role that these two concepts play in UK tax law. The Court of Appeal recognised that to take an unduly narrow meaning of these concepts simply to tackle tax avoidance in this case could have had unfortunate implications in more straightforward situations.
For related reading visit www.taxjournal.com
X Cases: Ingenious Games LLP and others v HMRC (12.9.21)
X Ingenious: genuine trading endeavour or MacGuffin? (G Sanitt, 10.9.19)
First publish in Tax Journal on 29 September 2021.
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