Ingenious Games LLP & Ors v Revenue and Customs (INCOME TAX/CORPORATION TAX : Losses) (Rev 1) [2016] UKFTT 521 (TC) (02 August 2016)

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You are here: BAILII >> Databases >> First-tier Tribunal (Tax) >> Ingenious Games LLP & Ors v Revenue and Customs (INCOME TAX/CORPORATION TAX : Losses) (Rev 1) [2016] UKFTT 521 (TC) (02 August 2016) URL: http://www.bailii.org/uk/cases/UKFTT/TC/2016/TC05270.html Cite as: [2017] SFTD 1158, [2016] UKFTT 521 (TC)

CHAPTER II. THE CONTRACTUAL RIGHTS AND OBLIGATIONS

73. In this Chapter: we (i) explain the particular relevance of these matters to the issues in the appeal, (ii) set out our approach to the determination of these matters, (iii) set out the relevant provisions and our conclusions as to their legal effects (the rights and obligations which arise under them), and (iv) explain the effects of the provisions of the agreements which relate to creative control over the making of a film.

1. The Relevance of the Contractual Rights and Obligations to the Five Issues

74. The nature of the contractual rights and obligations of the LLPs under the contractual documents is relevant to:

(a) whether the LLPs were trading. Here questions arise as to whether the LLPs owned an asset, the film, which they sold, or whether they laid out monies in return for an income stream; and whether in some way they provided a service or merely invested;

(b) whether the LLPs’ activities were undertaken with a view of profit. The LLPs computed their profits on a basis which assumed that they had incurred 100% of the cost of the film, and were entitled to the portion of the distributable income described in the schedule 7 waterfall (without reference to other documents). We call that the “Ingenious basis”. Questions arise as to (a) whether on that basis a profit could realistically be expected or hoped for, and (b) whether in fact the LLPs’ profit or loss should be computed by reference to expenditure of 30 (35)% of the budgeted cost and a different income entitlement, and, if that was the case, whether that affected whether the LLPs had a view of profit;

(d) the legal matrix to which GAAP should be applied to compute the profits or losses of the LLPs; and

(e) finally, whether the nature of the arrangement between the CD and the LLP was a partnership.

2.The Approach to be Taken to Determining the Rights and Obligations and Their Nature

75. As the following discussion of the authorities indicates, the tribunal must undertake a two stage process: it is first necessary to determine what rights and obligations arise under an agreement or suite of agreements, and then necessary to characterise them. In conducting the second step the labels the parties attach are not conclusive.

Ensign Tankers (leasing) Ltd v Stokes [1989] STC 705, [1991] STC 136, [1992] STC 226.

76. The judgements of the High Court, the Court of Appeal and the House of Lords in Ensign played a large role in the arguments on a number of the issues in this appeal and we shall return to them later. At this stage it is sufficient to give some of the background, from which it will be seen that there are certain parallels with the LLPs’ appeals.

77. This case concerned a film, Escape to Victory, being made by Lorimar [4]. We shall return to the details of the case later but for present purposes the following bare summary is sufficient:

(a) Ensign became a partner in Victory Partnership, a limited partnership, and together with other partners contributed capital equal to 25% of the budget for the film;

(b) on the same day 16 further documents were entered into involving eight further parties. The most important of these were:

(a) a loan agreement between Lorimar and Victory Partnership under which Lorimar agreed to lend Victory Partnership 75% of the cost of the film;

(b) a production services agreement between Lorimar and Victory Partnership under which Lorimar agreed to complete the making of the film and Victory Partnership agreed to pay Lorimar 25% of the budget immediately and the remaining 75% in stage payments;

(c) a distribution agreement between Victory Partnership and two distributors under which the Victory Partnership granted the distributors exclusive distribution rights over the film in return for the gross receipts after deducting distribution fees and expenses.

78. The agreements provided that the loan was to be provided to Victory Partnership in tranches as Victory required the funds to meet the budgeted cost of the film but that those sums be paid into a special restricted bank account of Victory Partnership and on the same day repaid to Lorimar. The payments into the account were described as the making of the loan, and the payments out as the funding of expenditure on the film. The loan was expressed to be repayable only from 75% of the net proceeds of distribution (termed a non-recourse loan). By a letter the distributors were irrevocably directed to pay 75% of the net receipts to Lorimar. Those payments were documented as repayments of the non-recourse loan.

79. (The structure of the LLPs’ contracts differs in particular in the fact that in their case the non-recourse loans were made to the CM, not to the LLP).

80. In the House of Lords, Lord Templeman (at page 232D) said:

“The parties agree that the 17 documents dated 14 July 1980 were interdependent, and constituted one single composite agreement or transaction, which was a tax avoidance scheme and must be read as a whole.

“If the documents constituting the scheme are read as a whole, the rights of Victory Partnership under the scheme are the rights which were and remain vested in Victory Partnership after all documents had been signed. Similarly the obligations of Victory Partnership under the scheme are the obligations which were and remain enforceable against Victory Partnership after all documents had been signed. The financial consequences to Victory Partnership of the scheme are the consequences which flowed from the rights conferred and the obligations imposed on Victory Partnership. The taxation allowances and taxation liabilities of Victory Partnership are the allowances and liabilities which, pursuant to the taxing statutes are applicable to the final financial consequences.

“When all the documents had been entered into, Victory Partnership was subject to an obligation to pay [25% of the budget] to [Lorimar] and subject to an obligation whereby any money paid by Lorimar into the scheme current account was immediately transferred back to [Lorimar]…When all the documents had been entered into, Victory Partnership had a right to 25% of the net receipts from the exploitation of the film.”

81. Thus the tax results followed the financial consequences, and the financial consequences followed from the rights and obligations created by the documents and those were to be determined by considering the position under the composite agreement after all the documents had been signed.

82. In the first stage of that process, Lord Templeman describes the obligation of Victory Partnership as being to pay 25%, not 100% of the budget of the film, and its right as being to receive 25% of the net receipts. He thus regarded the legal effect of the agreement as being to remove from Victory Partnership the right to the 75% of the receipts directed to be paid to Lorimar.

83. At a later stage in his judgement he recognises the obligation to pay out of the current account but characterises it as merely an obligation to repay what Lorimar paid in.

84. In Agnew v Commissioner of Inland Revenue [2001] UKPC 28, [2001] 2 AC 710, Lord Millett said in relation to whether a charge was fixed or floating:

“The question is not merely one of construction. In deciding whether a charge is a fixed or a floating charge the court is engaged in a two-stage process. At the first stage it must construe the instrument of charge and seek to gather the intentions of the parties from the language they have used. But the object of this stage is not to discover whether the parties intended to create a fixed or floating charge it. It is to ascertain the nature of the rights and obligations which the parties intended to grant each other in respect of the charged assets. Once these have been ascertained, the court can then embark on the second stage of the process, which is one of categorisation. This is a matter of law. It does not depend on the intention of the parties.”

85. In Street v Mountford [1985] AC 809, where the question was whether an agreement gave rise to a tenancy or a licence, Lord Templeman said (819C - G):

“But the consequences in the law of the agreement, once concluded, can only be determined by consideration of the effect of the agreement. If the agreement satisfied all the requirements of a tenancy, then the agreement produced a tenancy, and the parties cannot alter the effect of the agreement by insisting that they only created a licence.”

86. In Antoniades v Villiers [1988] 3 WLR 139, Bingham LJ said that the effects of the House of Lords’ decision in Street v Mountford was that “the true legal nature of the transaction is not to be altered by the description the parties choose to give to it”. Likewise in Re Spectrum Plus [2005] UKHL 41, where the question was whether a charge was fixed or floating, Lord Scott said at [80]:

“Nor is there any doubt that the question as to how a particular charge be characterised depends upon the nature of the rights over the charged assets that have been granted to the chargee or reserved to the chargor. The label that the parties have attributed to the charge may have some indication of the rights the parties were intended to have but is not conclusive”.

and later: [119] “The nature of the charge depends on the rights of the chargor or chargee respectively over the assets subject to the charge ... and the label placed on the charge by the debenture cannot, in my opinion be prayed in aid to detract from that right.”

87. The first stage is therefore to determine what rights and obligations arise under the agreements.

3. The Agreements and the Rights and Obligations Arising

(a) The Agreements in More Detail

88. Each LLP had a Members’ Agreement. These were in similar terms for IFP2 and IG; that for ITP was somewhat different. These agreements were made between the founding members of the LLP, who included the CM. They provided for the accession to membership of individual members, capital contributions, and rights in relation to profits and drawing. These agreements were in place before the signing of the suite of agreements for any film undertaken by the LLP.

89. Shortly after the formation of each LLP it entered into an Operators Agreement with an Ingenious group company (the Operator) under which the Operator was appointed to manage and administer the LLP. The Operator agreed to provide promotional, operational, and administrative functions and to find and evaluate films to recommend to the Executive Committee. It was to negotiate the terms of the agreements and to represent the LLP in negotiations and execute agreements on its behalf.

90. In consideration of these services IFP2 agreed to pay 2.81% of aggregate capital contributions, and ITP agreed to pay 4% of each film budget and a success fee when receipts exceeded 105% of a film's budget.

91. The suite of agreements for any particular film or game was entered into at the same time as a single package. They included (clause numbers refer to the Hot Fuzz agreements):

(a) A licence of the screenplay by the CD to the LLP.

(b) The CDA. This recited that the CD had commissioned the LLP to make the film or game. It included provisions relating to the specification of the film and its delivery to the CD. It dealt with the relationship between the CD and the LLP in relation to decisions about the film or game. In schedule 7 (the waterfall) the gross receipts from the film were divided up. After the payment of certain expenses and distribution fees the balance, termed (in the IFP2 agreements) the Gross Distributable Income (“GDI”), was divided between the LLP and the CD in proportions which varied with the level of GDI.

(c) The PSA. By this agreement the LLP delegated to the PSC as principal the making of the film in accordance with the specification (mirroring the provisions in the CDA). Payment was to be made to a Production Account in the PSC’s name in accordance with an Agreed Budget and an Approved Cash Flow (which phased the receipts of money over the period of the making of the film). The agreement dealt with the delivery of the film and with rights in the film. It included provisions relating to creative control.

(d) A Loan Agreement between the CD and the CM. Under this agreement the CD agreed to make a facility available to the CM “to enable it to make [a] capital contribution to the LLP”. By clause 4.1 the loan was to be drawn down in accordance with the Approved Cash Flow, which phased the CD’s contributions over several months (11 in the case of Hot Fuzz), and was directed to be paid directly to the Production Account (or otherwise as the PSC required).

The amount of the facility was 70% (65%) of the Budget for the film. The loan bore no interest.

In the case of ITP the loan was repayable only from Borrower’s Receipts (“BR”) which were defined as 50% of the amount which was stated to accrue to the LLP under schedule 7 of the CDA.

In the case of IFP2 the loan was repayable only from “Borrower’s Distributable Receipts” (“BDR”). This was defined as a percentage of Borrower’s Receipts. That percentage varied, in tandem with the variation of the one of the elements of the CD’s share of GDI (the Studio Participation) under schedule 7 of the CDA.

Clause 5.4 provided that the CM could prepay the loan.

(e) A Guarantee Agreement (not present in the case of IG). For a fee a Completion Guarantor (in the case of Studio films a member of the Studio group) agreed to complete the film if it ran over budget (or to abandon it and return monies to the parties).

(f) A Deed of Acknowledgement, which incorporated a Notice of Assignment and Irrevocable Payment Instruction (the “Deed of Acknowledgment etc.”). Each of the Operator, the guarantor, the PSC, the CD and the LLP were parties to the Deed and the CM was the maker of the assignment and payment instruction. Under this combined document monies equal to BDR (BR) which were allocated to the LLP under schedule 7 of the CDA were agreed to be directed to be retained by the CD. It also gave details of the Production Account to which the CD should make payment under the Loan Agreement.

(g) A Pledgeholder agreement in which the film laboratory which held the master negative of the film undertook to hold it for the CD and the guarantor.

(h) Security Agreements under which rights in the film were assigned by way of security.

92. All the agreements for a particular film were entered into on the same day. They cross-refer and are not intended to take effect sequentially. We regard them as a single package to be construed as one composite agreement.

93. The suite of agreements for an Independent film differed somewhat. The documents for Blackball were provided to us as an example. Finance for that film came from a number of sources including the Isle of Man DTI, Mel Smith Enterprises (“MSE”), and a sale and leaseback organised by Ingenious. The Isle of Man DTI and MSE lent to the CD, which in turn entered into a loan agreement with the CM. A sales agent was involved as was an independent completion guarantor, Film Finance. Each of the agreements listed above formed part of the suite of agreements for that film but the schedule 7 waterfall provision in the CDA was replaced by a Collection Account Management Agreement. Under that agreement (and others) monies arising from the distribution of the film were to be paid into a collection account whose manager would pay them out – to the LLP and others – in accordance with the waterfall in that agreement (as affected by the terms of the Deed of Acknowledgement etc.).

94. The Appellants contend that the effect of these agreements was that the following monetary obligations and rights were created and satisfied:

(a) Under the CDA the LLP was obliged to fund the production of the film, and under the PSA the LLP had to “advance or cause to be advanced" 100 to the Production Account of the PSC;

(b) The CD was obliged to lend money (70) to the CM;

(d) The payment of 70 by the Lender to the Production Account satisfied the Lender’s obligation to lend, the CM’s obligation to contribute capital of 70, and part of the LLP’s obligation to pay 100;

(e) The LLP, having 30 cash from the contributions of ordinary members was obliged to satisfy the remainder of its obligation by paying that cash to the Production Account;

(f) When the CD began to receive monies from the exploitation of the film, the LLP had the right to receive the amounts set out in schedule 7 of the CDA;

(g) When that right arose the CM had a related right to drawings; and

(h) The Lender had a right against the CM for part of those drawings, namely BDR or BR to be retained by it, and the LLP consented to that retention.

95. The Appellants say it would have been inefficient and uncommercial for the parties to insist on these rights being replicated in actual cash flows because there would be banking, exchange and credit costs and risks at each stage They say that such inefficient and uncommercial cash flows were therefore “short-circuited” by the Deed of Acknowledgement etc., which provided that the funds advanced to the CM under the loan (70) should be paid to the Production Account at the same time as the LLP paid the balance (30) to the same account, and that the CD should retain BDR (BR). These short-circuit payments they say fulfil obligations and crystallise rights for all parties. They say that:

(a) for the Lender, its payment of 70 to the Production Account satisfies its obligation to advance funds under the loan agreement and that as a result the Lender becomes entitled to retain Borrower’s Distributable Receipts (BR);

(b) for the CM, the Lender’s payment of 70 into the Production Account “satisfies the CMs obligation to contribute capital to the LLP” and as a result the CM becomes entitled to (i) repayment of its capital contribution on a winding up and (ii) distributions or drawings out of the LLP representing the agreed share of gross receipts [5] ;

(c) for the LLP, the payment of 70 by the Lender to the Production Account: (i) causes the LLP’s obligation to contribute 100% to the PSC to become unconditional because it amounts to the advance of the CM loan on which its obligation to pay the PSC was contingent; (ii) discharges its obligation as to 70 and crystallises its obligation to pay the remaining 30; and (iii) crystallises lasting obligations up the chain from the PSC to the LLP to produce the film, from the LLP to the CM and from the CM to the Lender; and (iv) leaves the LLP entitled to its payments under the schedule 7 waterfall;

(d) for the PSC, the payments (of 70 and 30) satisfy the LLP’s obligation to advance production funding and therefore crystallise its obligations to make and deliver the film.

96. Overall therefore they say the Deed of Acknowledgement etc. fulfils, rather than removes, the LLP’s obligation under the PSA to pay the full price of 100 to the PSC and crystallises the rights of the LLP under the PSA which were contingent on that payment. Each document has the legal effect it is intended to have just as it would have had had the payment obligations under each contract been discharged in sequence rather than through the payment instructions.

97. For the reasons which follow in more detail below in paragraphs 101- 232 we do not accept this analysis. In our judgement the legal effects of the agreements are as follows.

(b) Capital Contributions and Membership Rights under the LLP Members’ Agreement

98. The questions of whether the CM had a liability to contribute capital, and whether the payment of 70 (65) by the Lender to the LLP constituted the contribution of capital for the purposes of the Members’ Agreements are particularly relevant in relation to our discussion of Expenditure in Chapter IX and GAAP in Chapter X. Mr Gammie says that as a matter of general principle a capital contribution must be something that serves to increase the asset base of the LLP.

99. The LLP Members’ Agreements were amended and re-stated at various times. Those referred to below are those we understood to be in effect by the end of the relevant LLP’s first year.

100. The CM was a party to, and acquired membership rights in, and obligations to, the LLP on the making of the LLP agreement. An individual member acquired membership rights under the LLP agreement on subscribing to the LLP and being accepted.

101. Each individual member’s capital contributions affect his or her share of the profits and drawings allocated to him or her and rights on a winding up. The CM’s capital contribution has no effect on such matters (other than in relation to capital gains and the quantum of allocation of losses): neither the amount nor the existence of such capital affects the CM’s right to drawings under the Members’ Agreement (see below). Nor does the amount of any CM’s “contribution” which may be treated as made as a result of the relevant agreements affect its rights on the winding up of the LLP (see below).

102. The provisions in relation to contributions by the CM differ between the ITP agreement and those for IFP2 and IG.

(i) The ITP Members’ Agreement

103. “Ordinary Members” are defined to mean individual members and the CM. The agreement defines a member’s “Contribution” as “any money paid into the account of or transferred to the ownership of the LLP by an Ordinary Member”. It provides that it is to be credited to his capital account. Thus, prima facie, Contributions are limited to monies paid or transferred directly to the LLP.

104. There is no express requirement in the agreement for the CM to make a contribution, but clause 2.3 provides that no investment shall be made in any film unless the Operator is satisfied:

“that the [CM] has entered into contractually binding commitments such that the [CM] will finance its agreed Contribution in respect of that film” in accordance with the agreed cash flow and budget.

105. One construction of this is that the CM's “Contribution” means a contribution to the cost of the film, not a contribution to the capital of the LLP, and accordingly that the CM’s contribution to the film, however made, is not a contribution to the LLP. That would be consistent with the definition of “Contribution” in the LLP agreement as limited to money “paid or transferred to the ownership” of the LLP, and would be supported by clause 11.10(f) of the Members’ Agreement, which requires a supermajority of individual members to alter any provision of the agreement.

106. The alternative argument it is that the capitalised “Contribution” in clause 2.3 of the Members Agreement indicates that its contribution to the budget of the film would be treated as a capital contribution to the LLP.

107. On the second construction the Loan Agreement between the CD and the CM (of which the Operator plainly had knowledge) may be regarded as evidence that, in relation to a particular film, the Operator could be satisfied as required in clause 2.3 of the Members’ Agreement. That is because it recites that the CM “has agreed” to make a contribution to be utilised for the film, and therefore is evidence of an “agreed” contribution, and it is a contractually binding agreement which could be regarded as being “such that” the contribution would be financed.

108. However, whichever construction is adopted, there is no provision in the ITP Members’ Agreement requiring the CM to make a contribution. Any agreement by the CM to make and for the LLP to accept a contribution could only have arisen on signing the suite of agreements for the film and therefore cannot be regarded as a pre-existing obligation of the CM which was changed or satisfied by those agreements. And there is no provision by virtue of which any sum due to be paid pursuant to the loan agreement becomes a capital contribution before it is actually paid.

(ii) The IFP2 and IG Members’ Agreements

109. “Capital Contributions” are defined in the Agreement as “money contributed” to the LLP as capital by Ordinary Members. Ordinary Members in these agreements are defined to exclude the CM. Ordinary Members become such on application and paying their capital contribution; the CM became a member on the making of the agreement.

110. Having defined Capital Contributions by reference only to Ordinary (individual) Members only, the Agreement then provides in clauses 8.3 and 8.4 that:

(a) The CM is entitled to make Capital Contributions at its discretion, but they may not exceed the aggregate of the Ordinary Members’ capital contributions (Cl 8.3).

(b) If at any time the Operator issues a written demand or if a winding up order is made, the CM becomes obliged to “pay” by way of Additional Corporate Member’s Contribution [6] an amount equal to the excess of the aggregate of the ordinary members’ capital contributions over the CM’s Capital Contributions at that time (Cl 8.4).

111. We asked the Appellants if the Operator had made such a demand. Mr Milne told us that they did not believe that one had. We conclude that none was made. A winding up order had not been made at any relevant time. As a result we find that no liability to contribute arose under clause 8.3 or 8.4. As a result any contribution to capital was purely voluntary. The CM had no obligation to contribute.

112. We also note that the definition of “contribution” as “money contributed” by individual members, which, although applicable only to individual members, suggests that a contribution otherwise than in cash to the LLP was not intended to be a contribution. If that is right then a variation of the Agreement would have been required to permit it to have been so made.

113. There is nothing in the Members’ Agreements which provides that a payment to the PSC by the Lender is to be treated as a (voluntary) contribution of capital by the CM or as satisfying an obligation created by an Operator’s notice, had one been given, for the CM to contribute capital or make payment. However, as was the case for ITP:

(a) in the Loan Agreement (between the Lender and the CM) the recitals contain a statement that the loan is made to enable the CM to make a capital contribution to the LLP (and clause 4.1 provides that “The [CM] hereby irrevocably directs the Lender that all sums drawn down by the Borrower shall be paid to the Production Account for the film)”, and

(b) recital (B) to the CDA (between the LLP and the CD) is a statement that the CD has agreed to make the loan to enable the CM capital contribution.

114. We conclude that the parties to those agreements intended that a payment by the Lender to the Production Account would be treated as a (voluntary) capital contribution by the CM, but did not make any express provision in the agreements to that effect. Further, whether or not that payment would be so treated by the LLP was governed by the pre-existing provisions of the Members’ Agreements, which as we have noted may have required amendment to have that effect. Although it was possible for the CM to agree with the LLP to renounce rights under the Members’ Agreement (as we conclude it did in relation to drawings) it was not possible for an agreement between the LLP and the CM to amend the Members’ Agreement so as to create rights in the LLP in the CM’s favour. We proceed on the basis that the LLP agreed to recognise some form of capital contribution from the CM as a result of the CD’s payment. We shall investigate the legal rights and obligations which arose as a result of such recognition later in this section.

(iii) ITP: Rights Arising as a Result of Making a Capital Contribution

115. Clause 8.1 of the Members’ Agreement requires the amount of any member’s capital contribution to be credited to his capital account. That of itself imposes no economic obligation on the LLP.

116. The making of a capital contribution by the CM does not affect its rights on a winding up. That is because clause 19.4 of the ITP Members’ Agreement provides that any surplus on a winding up shall be “payable to the Individual Members pro rata to their respective Contributions”. Nothing is due to the CM.

117. In heading (f) below we discuss the CM’s entitlement to drawings. The provisions set out there make clear that the CM’s entitlement to drawings under the ITP Members’ Agreement is unaffected by whether or not it has made a capital contribution or the amount of such a contribution.

118. Thus even if by virtue of the relevant agreements the CM is to be treated as having made some form of “capital contribution” to the LLP, that had no effect on its rights under the ITP LLP agreement (other than the administrative crediting of any contribution to the CM’s capital account).

(iv) IFP2 and IG: Rights Arising as a Result of Making a Capital Contribution

119. Clause 8.3 of the Members’ Agreement requires the amount of the CM’s capital contribution to be credited to its capital account. On its own that imposes no economic right on the CM or obligation on the LLP unless the agreement specifies an effect of such a balance being so credited. For the following reasons it seems that it does not.

120. Clause 22 of the IFP2 Members’ Agreement deals with rights on a winding up. Clause 22.1 provides for the application of any surplus first to individual members in respect of and up to part of their capital contributions, then to the CM in respect of its “Additional Corporate Member’s Contribution”, then for interest on part of the individual members’ capital contribution, then to the CM up to part of the balance of its “Capital Contributions”, then for interest on part of the CM’s Capital Contribution and then as to any balance equally between the individual members and the CM.

121. But clause 22.2 provides that for the purposes of clause 22:

“Capital Contributions shall be treated as made only when the amount of such Capital Contribution is actually received in freely transferable funds by the [LLP].”

It is clear to us that the LLPs never received any monies in from the CM “in freely transferable funds”. Thus the monies paid by the CD to the PSC did not give rise to a Capital Contribution for the purposes of clause 22.

122. As noted earlier, “Additional Corporate Member’s Contribution” is defined in clause 8.4 of the agreement to mean the sums the CM undertakes to pay on 14 days’ notice from the Operator (which notice was not given) or on the winding up of the LLP by way of:

“capital contribution…equal to any difference between the aggregate Capital Contributions made by the [CM] (including for the avoidance of doubt any payment made under this clause 8.4) and the aggregate Capital Contributions made and committed by the [individual] members”.

123. Not only does the drafting of this clause and clause 22 suggest that an Additional Corporate Member’s Contribution must be a Capital Contribution and so not relevant for the purposes of clause 22.1 unless received in freely transferrable funds, but no notice was given by the Operator requiring any contribution and there was no winding up in prospect.

124. Thus any capital contribution treated as made as a result of the agreements would not be an Additional Corporate Member’s Contribution or a Capital Contribution, and, as a result, would have no effect of the CM’s rights on a winding up.

125. We note that if the CM was properly to be treated as having made a capital contribution by virtue of the relevant agreements together with the CD’s payment, then IFP2 lost pro tanto the right to call for an Additional Corporate Member’s Contribution. But an Additional Corporate Member’s Contribution made in freely transferable funds carried with it the right to a distribution on the winding up of the LLP, whereas a capital contribution treated as made pursuant to the relevant agreement did not because it was not so made. Thus any loss of the right to call for an Additional Corporate Member’s Contribution by virtue of the recognition of a capital contribution by the CM carried with it the loss to the extent of that contribution of the LLP’s contingent liability to the CM on winding up.

126. In heading (e) below we discuss the CM’s entitlement to drawings. The provisions set out there make clear that the CM’s entitlement to drawings under the IFP2 or IG Members’ Agreement was unaffected by whether or not it has made a capital contribution or the amount of such a contribution.

127. In the IFP2 Members’ Agreement losses may to be allocated to the CM up to the amount of 90% of its Capital Contribution. Thus the amount of any Capital Contribution it has made will affect the amount of losses which can be allocated to it. But the making or amount of any capital contribution does not thereby confer any right on the CM. (Any right to the allocation of profit flowing only from a previous allocation of losses or the 50:50 provision after losses have been compensated.)

128. Thus, as is the case for ITP, even if the effect of the relevant agreement was that the CM was to be treated as having made something called a “capital contribution” that had no effect on its rights under the IFP2 or IG Members’ Agreements (other than the right to have an accounting entry made in its capital account).

(c) Obligation of the LLP to Pay the PSC

129. In this discussion we refer to the terms of the Hot Fuzz suite of agreements. We understood that the agreements for other films had materially similar terms. In particular the suite of agreements for Independent films was somewhat different and some of the differences are noted in the discussion which follows; but those we saw contained terms with the same import as those described below.

130. The PSA has three clauses which relate to payment to the PSC:

(a) clause 3.1 provides that, subject to:

(a) other provisions of the agreement,

(b) the receipt by the CM of funding under the Loan Agreement, and

the LLP shall “advance or cause to be advanced the Production Funds to the Production Account”[7]. It will be recalled that the Loan Agreement requires the Lender to pay 70 to the Production Account;

(b) clause 3.2 provides that the LLP shall “pay or cause to be paid the Production Funds” (the 100) to the Production Account or such other account notified by the Guarantor, and that an LLP nominee shall be a signatory to that account;

(a) In the ITP agreements (Wimbledon) it provides that the LLP “will pay a sum equal to [35] (“the Initial Funding”) into the Production Account”, (and to the extent not immediately used interest on the unused portion of the Initial Funding will be paid to the LLP).

(b) In the IFP2 agreement it provides that so long as the PSC has delivered to the LLP:

“…evidence that the [Lender] has advanced a sum equal to …70%... of the Production Funds to the Production Account[8]…”,

the LLP will pay a sum equal to 30% of the Production Funds (“the Initial Funding”) to the Production Account in accordance with the Agreed Cash Flow.

In this context paragraph E of the Deed of Acknowledgment etc. provides that if the Guarantor abandons the Film the Abandonment amount (the unused funding) must be paid to the LLP up to the Initial Funding, and the balance to the Lender.

131. Clause 4.1 of the Loan Agreement deals with the drawing down of the loan. It includes the following provisions:

“The Facility shall be drawn down in accordance with the Approved Cash Flow upon satisfaction of the conditions precedent.”

“The [CM]… directs the Lender that all sums drawn down …shall be paid to the Production Account.”

132. And, for good measure, by the payment instructions in the Deed of Acknowledgment etc., the Lender is instructed to pay the proceeds of the loan “in accordance with the… Approved Cash Flow” to the Production Account of the PSC.

133. On its own clause 3.1 might appear to create a contingent obligation for the LLP to pay or procure the payment of the full amount of the Production Funds (100) to the PSC. But the contingency is the receipt of funding by the CM under the Loan Agreement and that agreement expressly provides for such funding to be advanced by payment to the Production Account. Thus the obligation in clause 3.1 arises only if 70 (65) has been paid to the Production Account by the Lender. As a result this clause cannot oblige the LLP to pay more than 30 (35).[9]

134. Furthermore, in the case of IFP2 clause 3.5 makes plain that the LLP’s obligation to pay (rather than to procure payment) is dependent on the Lender having paid 70 (65), and is to pay only 30 (35). Reading 3.1 and 3.5 together the obligation undertaken by the LLP is to pay (as opposed to procure payment of) only 30. And in the case of ITP imposes an obligation to pay 35 only.

135. It does not seem to us that clause 3.2 of the PSA creates a free-standing and absolute obligation on the LLP to pay, or procure the payment of, the full amount of the Production Funds to the LLP. That clause must be read in context. It deals with the administration of the account or its substitution by another: its purpose is administrative. It falls after clause 3.1 which makes any obligation to pay or cause payment contingent. In our judgement that contingency is applicable to the obligations under clause 3.2.

136. This of course leaves the question as to whether the LLP has an obligation to procure the payment of the 70 (65). If there is such an obligation it must flow from 3.1 or 3.2 (because 3.5 deals only with the obligation to pay 30 (35)). But clause 3.1 makes any such obligation contingent on the receipt of funding by the CM. The PSA acknowledges in the definitions clause the provisions of the loan agreement and the Deed of Acknowledgement etc. Clause 3.1 (and 3.2) must be seen, in the light of the provisions of those agreements, to mean that any receipt of funding under the loan agreement could and would only be by payment by the Lender to the Production Account. Thus any obligation to procure payment of the 70 (65) could arise only after that 70 had actually been paid by the Lender to the PSC because it is only then that funding would have been received by the CM under the loan agreement. Such an obligation does not seem to us to be capable of being described as an obligation of the LLP to procure payment of 70 (65).

137. These propositions may be tested thus: suppose the Lender did not pay the 70 and the LLP did nothing to try to procure the receipt of 70 by the PSC. What action could be taken against the LLP? The answer is none because it is not required to do anything under clause 3.1 until the Lender has made payment.

138. That conclusion is reinforced by the rights created to repayment in the case of the abandonment of the film. The LLP is entitled to receive only the Initial Funding – the 30% (35%).

139. Finally we should say that whilst we accept that under clause 4.1 of the CDA the LLP agrees to procure the making and delivery of the film, we note that under clause 16 of that agreement the LLP is absolved from all liability which arises as a result of a failure to comply with the agreement as the result of a failure of the CD to comply with the provisions of the loan agreement. Thus the CDA does not provide a back door obligation on the LLP to pay 100.

140. Mr Milne’s criticism of this analysis in his cross-examination of Mr Cannon relied on the proposition that the LLP was obliged to transfer the full 100 to the PSC and that its obligation was satisfied by the procurement, through the Irrevocable Payment and Assignment, of the payment of 70 directly to the PSC, and that that payment resulted in a cost to the LLP by reason of the corresponding reduction in the amount of the debtor representing the CM’s unpaid capital.

141. We reject that analysis for four reasons. First, there never was an obligation to transfer 100. There was never an obligation which was later satisfied: it all happened at the same time. The rights and obligations which arise under the relevant agreements lie in the difference between the legal position of the parties immediately before and immediately after the agreements were executed, not on what is expressed in the agreement to make up those obligations or how they are described by the parties.

142. Second, as we have concluded above, the CM did not have an obligation to make a capital contribution. In the case of ITP there was not even any express discretion conferred on the CM to make such a contribution. Thus the CM never became a debtor, and so it cannot be said that a cost to the LLP arose as a result of the reduction of the debt.

143. Third, even if the CM is to be treated as contributing capital of 70, the capital would be subscribed only when the CD pays 70 to the PSC.

144. Fourth, even if GAAP required the recognition of a debtor from the CM the question of whether any reduction of that debtor gave rise to a cost or an expense relates to the financial consequences of, and the accounting for, the transaction, not the determination of the rights and liabilities which arose under the documents. That accounting will depend in part on the legal rights and obligations. They are the starting point. We address the accounting effects later.

145. Finally we note that the provisions of clause 4.1 of the Loan Agreement (see [129] above) do not sit well alongside clause 3.5 of the IFP2 PSA. That clause subjects the LLP to an obligation to pay 30 only when the full 70 has been received by the PSC from the Lender. i.e. only when the PSC has delivered:

“ (d) evidence that the [Lender] has advanced a sum equal to seventy per cent (70%) of the Production Funds into the Production Account”,

but under the Loan Agreement the Lender is required to make payments only as required by the Approved Cash Flow. That phases payment over many months. If the loan was drawn down in this manner it would not be until the film had incurred at least 70% of its costs that the LLP would be obliged by clause 3.5 to make the Initial Funding payment of 30.

(d) Rights in Relation to Receipts from the Films or Games

146. The relevant provisions are the following:

147. Clause 11 of the CDA provides that the CD shall pay the LLP the entitlement to Gross Receipts set out in schedule 7. The CDA provides for the CD to pay the amount of the Gross Receipts determined by schedule 7 “to or at the direction of” the LLP.

148. The allocations in schedule 7 make reference to the Loan Agreement, in particular paragraph I(I) provides:

“Until repayment in full of the [CM loan] from the sums directed to the Studio by the CM pursuant to the payment instruction agreed between the [CM, the LLP and the CD], the [CD] shall pay…100% of the remaining Gross Receipts to or at the direction of [the LLP].”

149. The “Irrevocable Payment Instructions” referred to in that paragraph of schedule 7 to the CDA are annexed to the IFP2 Deed of Acknowledgement and provide that “Partnership Receipts (defined as amounts to which the LLP is entitled under the CDA) shall, until the loan… has been repaid in full …be paid…as to an amount equal to Borrower’s Distributable Receipts… at the direction of the CM and as to the balance to the [LLP’s bank account]”. The ITP instructions refer to BR but are otherwise the same.

150. The “Irrevocable” Payment Instructions are given effect in the Notice of Assignment in which the CM gives notice to the LLP (copying the CD) that the CM has assigned “its right title and interest in the Borrower’s Distributable Receipts” to the Lender “by way of security”, and gives “irrevocable” authority to the LLP to “pay the Borrower’s Distributable Receipts in accordance with the Payment Instruction”.

151. The Deed of Acknowledgement is from the LLP and the Operator to, inter alia, the Lender, the CD and the PSC. In it the LLP:

(a) acknowledges the notice of assignment and undertakes to comply with it,

(b) consents to the assignment of the right to receive BDR (BR in the case of ITP) to the Lender and agrees that the Lender is “now entitled to receive” BDR “in place of the corporate member”,

(c) “irrevocably” instructs the CD to make all distribution payments under clause 11 of the CDA in accordance with the payment instructions,

(d) makes provision for the repayment of the Initial Funding if the Guarantor abandons the film.

The Deed includes the agreement of the Lender and PSC to this arrangement.

152. A cursory reader of the relevant agreements might conclude that the LLP is first given an entitlement to 100% of the remaining Gross Receipts and that it then directs that part of its entitlement is to be paid to the Lender: indeed the documents themselves encourage that conclusion.

153. But such a reading is dependent on an assumption that the agreements be read as taking effect sequentially with a pause between each, so that rights might accrue and then be alienated. That assumption, however, is not justified: the agreements were made as part of a package, they were executed on the same day, they refer to each other as agreements which have been made – thus for example, clause I(I) of schedule 7 of the CDA expressly acknowledges the existence of the payment instructions and therefore evidences that they were contemporaneous with, or preceded, the CDA.

154. The documents must be read as coming into force together and must be read together. Reading the documents together, the effect of their payment provisions is that, from the time of execution of the documents, the Lender and not the LLP is entitled, together with any other entitlement under the CDA, to retain that portion of the receipts equal to BDR (BR) and the LLP entitled to receive the balance, and that there was never a time when the LLP was entitled to receive more.

155. In this context the provision in the Deed of Acknowledgement etc. that the Lender is “now” entitled to receive BDR “in place of” the CM is properly seen as describing the only entitlement which arises or arose under the agreements rather than as being the record of a change in existing entitlements.

156. The CD and the LLP are parties to the Deed and the CD expresses agreement to it. It is clear that it varies the rights and obligations which the parties would otherwise have had under the CDA alone. It does not do this after those rights have arisen, but as part of the composite agreement by which they arise.

157. In our judgement the effect of the Deed of Acknowledgement etc. and the CDA is that the only payment right the LLP acquires under the suite of documents is the right to the payment of the balance of GDI after deducting the amount of BDR (BR). Together these documents confer no right on the LLP to receive the amounts in schedule 7 without deducting the amount of BDR (BR). The LLP could not, after the coming into effect of these documents, compel the payment to it of schedule 7 amounts without the deduction of BDR (BR); and the Lender could resist any action to prevent it retaining BDR (BR).

158. The assignment by the CM of BDR (BR) is expressed to be “by way of security”. That does not in our view alter the effect of the agreements. That is for the following reasons:

(a) For reasons we discuss below it was not clear that the CM has a pre-existing right to drawings to assign in whole or part, or that if it had a right to drawings that right would be to an amount which equals or exceeds BDR (BR). The purported assignment was, to that extent at least, not an assignment of a right of the CD by way of security or at all, and can only have been an assent by the LLP to the method of computation of its right to receipt from the CD;

(b) The assent and agreement of all the other parties to the Deed indicate that they are agreeing to an alteration in what would otherwise be the rights to the receipt or retention of monies had schedule 7 not been part of the composite agreement, and, if the CM does not have any right to drawings which it can assign, that agreement of itself gives effect to the alteration, not the purported assignment;

(c) The Loan Agreement provides that the CM has to repay “to the extent it becomes entitled to BDR”, and that the CM’s entitlement be “assigned by way of security…to be applied in repayment of the loan”. The application in repayment of the loan is not ‘security’ for payment, it is payment. Even taking the assignment to be a security to pay the very amounts which arise under it, when a calculation is done and an amount notionally due to the LLP is arrived at, unless the security has been terminated, the amount thereof representing BDR belongs (or continues to belong) thenceforth to the CD/Lender.

(d) Even if the CM did have a right to an identifiable portion of the LLP’s income from a film as drawings, and even if that portion would always be more than BDR (BR), there is simply no way in which the right of the CD/Lender to retain an amount equal to BDR (BR) can be unwound at the election of the CM. The notice of assignment provides that the instructions cannot be revoked without the consent of the CD. In the Deed the LLP undertakes to the CD/Lender, the guarantor and the PSC to comply with the “irrevocable” instruction and gives its “irrevocable” authority for payment to be made according to Appendix 1. It provides that the CD/Lender “is now entitled to receive” BDR. Appendix 1 says in paragraph 1 that BDR is to be paid at the direction of the CM but in paragraph 3 says that such amounts “shall be retained” by the CD. The Deed of Acknowledgement etc. affects, not just the position of the CM, but the rights and obligations of the LLP and the CD.

(e) In Ensign the loan from Lorimar was expressed to be repayable from 75% of the proceeds of distribution of the film. Victory directed the distributor to pay that 75% directly to Lorimar and required the distributor to grant security over the rights granted to Victory under the distribution agreement. Lord Templeman described Victory as being entitled to 25% of the distribution proceeds.

159. Mr Milne says that it is wrong to regard the rights of the LLPs as limited to the receipt of 30% (35%) of GDI and their obligations as limited to being obliged to pay 30% (35%) of budget. He advances a number of reasons.

160. First he suggests that in Ensign Lord Templeman was applying a Ramsay analysis: that in effect he was applying a special tax world description of rights and liabilities. So that when he spoke of Victory’s right to 25% of the net receipts he did not refer to a contractual right enforceable in the courts.

161. We do not agree. Lord Templeman reads the agreements as a composite, but that is not the application of a special regime. Not only do later decisions emphasise that the Ramsay doctrine is one of general effect (and prevents tax lying on an island of its own) but cases such as Anthoniades v Villiers where Lord Templeman said “the two agreements were interdependent. Both would have been signed or neither. The two agreements must therefore be read together” show that analysing a set of agreements to determine the rights and obligations which arise from them as a composite is a general and proper approach.

162. Second, Mr Milne says that if an agreement provides for A to pay B £10 and for B to pay A £7 and for settlement to be a net £3, there is nothing objectionable in regarding the agreement as creating only an obligation on A to pay £3 and a right of B to receive £3. But if there are more than two parties and if the effects are not just ephemeral then such a simple approach is not possible. As a matter of general law one does not collapse and integrate contracts if there are a number of parties. Here the CM became liable under the loan. The loan was recognised in the accounts of the CM. It was not ephemeral. The making of the loan triggered the LLP’s obligation to pay, and the making of the loan had permanent consequences for the CM. Here the arrangements went round four sides of a square and the obligations at each stage were permanent obligations reflected, in particular, in the accounts of the CM.

163. In the same vein he says that in Ensign Lord Templeman was dealing with an arrangement between two parties, Victory and Lorimar, and that the same analysis is not appropriate for an agreement which involves more than two.

164. We do not find this convincing. The question is: what rights and obligations were created by the agreements? When the dust had settled who was obliged to do what and who had what rights? When there are more than two parties involved each may be left with some right or obligation and that right or obligation may have permanent effects, but until the remaining rights and obligations have been isolated those effects cannot be determined. The permanent effects do not determine the rights and obligations, they are their consequences.

165. Nor is Lord Templeman’s analysis in Ensign restricted to that between two parties. When he said: “When all the documents had been entered into, Victory Partnership had a right to 25% of the net receipts from the exploitation of the film”, that related to the position of the distributor, Lorimar and Victory Partnership. Mr Milne says that that might be possible if you had an ephemeral situation but here we have the loan and the CM’s subscription to the LLP and those elements do not disappear.

166. The effect of the relevant agreements was that if the CD paid the 70% (65%) to the PSC the CM became liable to the CD under the terms of the loan agreement (in so far as that can be called a liability). Whether that was a loan to the CM is a question of categorisation; the first step is to determine liability. Whether that liability is to be called a loan, and whether or not it has permanent effects on the CM does not affect the determination (not characterisation) of other rights and obligations under the agreements.

167. Third, Mr Milne says that in relation to receipts under the waterfall, the legal obligation of the CD is to pay 100% to the LLP and part of that is applied by the partnership for the benefit of the CM to repay its loan.

168. This to our minds is to try to determine the rights and obligations by reference to a narrative rather than to look at the obligations and rights created by the terms of the agreements. By the Deed of Acknowledgement etc. the LLP did not give away something it had, but agreed that it would ab initio be entitled to less. Treating the LLP as renouncing a right to the CM requires the prior conclusion that it had that right. That would be the case only if the right to 100% existed before the making of the Deed. But it did not. The LLP never had the right to receive 100% because the agreements read together did not give it that right.

169. The LLP may have had the right to enforce payment of BDR to the Lender. That would have been possible where the Lender was not the CD, although in all the Studio cases they were the same person. Logically, where the Lender and the CD were the same person, there can have been no right to enforce payment to the Lender. It may also be that the LLP had the right to require the Lender to treat the CM loan as reduced by the portion of GDI to be paid to or retained by the Lender. But neither of such rights are a right to receive payment or value.

170. Fourth he says that the irrevocable payment instruction did not affect the right of the LLP to 100%. It is common for lenders to direct that funds are transferred directly to where they are ultimately to be deployed. Such payment instructions do not replace the contractual steps which they fulfil. He relies on Lord Millett in Peterson v CIR [2005] STC 448.

171. In Peterson the taxpayers had paid $x+y under a production contract to make a film. $x was funded by the taxpayers out of their own resources and $y from a non-recourse loan made by a lender connected with the production company. Unbeknown to the investors on receipt of $x+y the production company immediately recycled $y to the lender and used only $x to make the film. The only issue before the Privy Council was whether the deduction of $x+y claimed by the taxpayers could be disallowed under the provisions of an anti-avoidance section of the New Zealand law.

172. Lord Millett, who gave the opinion of the majority, said that the taxpayers were induced to enter into the arrangement by tax advantages which arose from two features of the arrangement which were not uncommon in commercial financing, one was obtaining depreciation allowances and the other was to fund the investment with non-recourse loans which increased the amount of the tax allowances. He described a non-recourse loan as a “loan made on terms that the borrower has no personal liability to repay it.” ([14]). He continued:

“[15] Borrowed money belongs to the borrower not lender, and this is so whether the borrower incurs a personal liability to make repayment or not. Depreciation allowances depend upon the taxpayer having incurred the cost of acquiring an asset, not his liability to repay the lender. It does not matter how he came by the money to acquire the asset ...”

173. And later:

“[44] The leverage obtained by the use of a non-recourse loan meant that the investors did not sustain an economic loss after the tax deduction is taken into account [this was a potentially objectionable feature of the scheme] ... the fact that the investment was funded by a non-recourse loan did not alter the fact that the investors had suffered the economic burden of paying the full amount of $x+y. It was not and could not be suggested that either loan was on terms which meant that it was unlikely ever to be repaid. The investors have repaid one of the loans in whole or in part, albeit out of the film receipts ...

[45] The circular movement of money sometimes conceals the fact that there is no underlying activity at all. But each of the payments in the circle must be examined in turn to see whether it discharged a genuine liability of the party making the payment. It does not matter whether external funds were introduced into the circle or whether cheques were handed over and duly honoured. If the money movements did not discharge a genuine liability the introduction of external funds will not save it; if they did, their absence will not affect it. ... subsequent payments in a circle in which the investors were unaware and which they could not control did not alter the fact that they had borrowed y dollars and used it towards the discharge of their liability to the production company, thereby suffering the loss or incurring the relevant expenditure.”

174. He then noted that the New Zealand Board had conceded that the $x+y was paid as consideration for the making of the film.

175. Lord Bingham and Lord Scott delivered a trenchant dissenting opinion in the course of which they disputed that the $y represented the discharge of “genuine liability”.

176. Mr Milne relied upon [45] in particular as confirming that cash flow was irrelevant. What mattered was whether there was a genuine liability. In the present case he says that the loan to the CM was a real loan which created a real obligation to repay.

177. We found little help in Peterson. In relation to the question whether the LLP had a liability to pay 100, Lord Millett says that cash flow is not determinative and what matters is whether or not there is a genuine liability. Our conclusion is that there was not a genuine liability of 100 because the LLP, under the terms of the agreements was never obliged to pay any more than 30, and never became obliged to suffer the cost of paying more than 30.

178. Fifth, Mr Milne says that if, for example, he had agreed a fee of £1,000 with HMRC for his professional services and he directed HMRC to pay £700 of that fee to, say, Mr Cannon in satisfaction of a debt he owed Mr Cannon, no one would say that Mr Milne’s professional income should not include £700 of that £1,000.

179. But that example addresses a different question, namely, what is the extent of Mr Milne’s income. The first question is what right does Mr Milne have to compel HMRC to pay him the £700? And the answer is none (assuming the assignment was properly executed). In the later computation of his income he might well regard the extinguishment of his debt to Mr Cannon as income.

180. Sixth, he gave the example of a house-buying transaction where a bank advances a loan to a purchaser and short circuits payment to the buyer followed by his payment to his solicitor followed by payment to the seller, by making payment directly to the buyer’s solicitor or perhaps even directly to the seller. He says that there is no doubt that the buyer has a liability for the purchase price of the house and after the advance of the funds a liability to the bank. But to our minds: (i) the agreements in this appeal are different: the LLP is obliged to pay only when the CD has paid the PSC; in an ordinary conveyancing transaction the buyer’s obligation would not be so constrained; (ii) in the case of the house purchase, the agreement for the mortgage will create a debt due to the bank from the buyer when the money is paid; in the agreements in the appeals the only obligation which arises to the LLP is in some way to recognise a capital contribution from the CM. The issue is: what were the legal rights and obligations created by these particular agreements?

(e) Rights in Relation to a Film

181. The following provisions of the CDA (Hot Fuzz) are relevant:

(a) Clause 2.1 provides that from the Delivery Date (when the film is finished) the LLP assigns to the CD all its rights in the film. It says that, subject to the licence in clause 2.7, nothing in clause 2 shall vest rights in the film in the CD before the Delivery Date.

(b) By clause 2.4 an undated executed assignment is to be delivered by the LLP to the CD to have the delivery date inserted by the CD to give effect to 2.1.

(c) Clause 2.5 provides for a back up option for the CD to acquire the rights in the film if a court declares the assignment ineffective, (and the LLP acknowledges that specific performance would be an appropriate remedy if the option is not complied with).

(d) Clause 2.6 makes Clause 2 subject to the Reserved Copyright under the PSA and provides that the rights to that copyright transfer to the CD only when they move to the LLP from the PSC. (The Reserved Copyright is 5% of the copyright in the film, which under the PSA is reserved by the PSC from the assignment of all present and future copyright in the film to the LLP until the completion of the film when it is “assigned to [the LLP] simultaneously with and included within [the LLP’s] assignment of the copyright to the [CD]”).

(e) By clause 2.7 the LLP grants to the CD an exclusive and irrevocable licence of the rights in the film in perpetuity or until the date of the assignment (subject to the LLP’s right to produce, complete and deliver the film under the agreement). The carve out of the right to produce and deliver the film indicated that the licence was intended to exclude the LLP from using the film rights as well as prohibiting its granting such rights to others.

(f) Clause 6.3 gives the CD exclusive control over the distribution and marketing of the film; and clause 6.4 gives it the exclusive right to gross receipts, although it has to pay the LLP under the waterfall.

(g) In the warranties in clause 7 the LLP warrants that it will not authorise anyone else to exploit the film, create encumbrances over, or otherwise deal with rights to the film, and in clause 9.20 it agrees not to release the film to any third party.

182. In addition in the Deed of Guarantee, Security Assignment and Charge the LLP assigned by way of security such rights as it might have at any time in the film to the CD and, in another similarly entitled document, also assigned them by way of security to the Completion Guarantor. What rights the LLP had must have been limited to the equity of redemption under these deeds.

183. In the Pledgeholder Agreement to which the LLP, the PSC, the CD and the Guarantor are parties, the film laboratory associated with the production of the film agrees that it will “constructively hold” the film materials for the CD and Guarantor only, and will limit the LLP’s access to (i) obtaining dailies, (ii) access for inspection and cutting, and (iii) work on the film or the soundtrack by another laboratory if approved by the CD and Guarantor until receipt of the notice of Delivery.

184. The effect of those clauses of the CDA is to deprive the LLP of any substantial right in relation to the film while it is being produced. Its rights are limited to those in relation to the making of the film and, if it can be said to be a right, a right to deliver what interest it has on the Delivery Date (a “right” to which the CD, not the LLP, gives effect by dating the assignment required by clause 2.4). Any attempt by the LLP to renege on the agreement would in our view be subject to a remedy of specific performance in favour of the CD. Moreover the interest the LLP has is subject to the terms of the exclusive licence to the CD and its obligations not to exploit the film.

185. Before the date of completion of the film the LLP is in a position analogous to that of a trustee of the film. It is the holder of 95% of the copyright in the film but, as a result of the licence, the benefit of that copyright is enjoyed exclusively by the CD. After the date of completion of the film the LLP has no different right to exploit the film and the CD’s right to exploit the film is the same as it was beforehand.

186. The remaining 5% of the copyright is assigned to the LLP and by the LLP to the CD at the same time. The effect is that the LLP never has the right to that 5%.

187. The commercial effect of the provisions is that the LLP can do nothing with any part of the rights associated with the film at any time during its production. It is bound by iron fetters. The LLP cannot even get its hands on rights to exploit the film by defaulting on the agreement since the laboratory would not let it have the materials, the licence would remain in effect and specific performance would almost certainly be given.

188. Mr Gammie argues that the LLP is not just in a position analogous to a trustee but holds such rights as accrue to it under the PSA on constructive trusts for the CD. He says that a specifically enforceable agreement will give rise to an immediate constructive trust in favour of the purchaser. Where the whole of the consideration has been provided the vendor loses any beneficial interest and becomes a “bare trustee” of the property (Lloyds Bank plc v Carrick 4 All ER 633 at 637F. He relies on Mountney v Treharne [2002] EWCA Civ 1174 [203) CH 135 where Jonathan Parker LJ said that although the basis of the equitable jurisdiction was founded on an order in personam, equity treated as done that which ought to have been done. That was why under a specifically enforceable contract for the sale of land the purchaser was trustee in equity for the owner and a trust beneficiary was immediately entitled to his interest in the trust property; “the plaintiff’s rights, although founded upon the ability of the courts to make an order in personam ... became an interest in the property itself. Once the decision is reached that an order for specific performance could have been made ... thereafter the legal owner holds the property shorn of all those rights ...which the courts of equity would hold belong to another”.

189. For the purposes of the equitable principle he says that a formal transfer is irrelevant if there is nothing outstanding from the intended transferee. Here the contractual assignment of the rights was not dependent upon any further action by the CD – the CD had provided consideration in the form of its promise to make payments of receipts under the composite transaction. The principle extends to personal property and was not affected by the fact that the agreement is to be assigned a right which will be acquired (or blossom) in the future.

190. The Appellants say:

(a) that the obligation to assign is in the future. It seems to us that Mountney v Treharne shows that this does not prevent a constructive trust arising;

(b) that because clause 2.1 of the CDA requires the assignments to take place without further formality on that date there is little scope for a constructive trusteeship. We were not persuaded by this argument: the object of equity is to create an immediate interest in the property;

(c) that the LLP’s obligation was to make a film and then transfer it. It was not an existing asset. We were not convinced by this. The rights in the film accrue as to 95 % to the LLP as they arise. As they arise they may be subject to the constructive trust;

(d) that in certain circumstances the agreements provide that the rights will be transferred to the Completion Guarantor: they say that makes HMRC’s analysis impossible: the CD cannot be beneficial owner when its entitlement depends upon the contingency, namely the completion of the film as opposed to its abandonment by, and transfer to, the Completion Guarantor.

191. The guarantee provides that the guarantor will ensure timely delivery of the film but that it may choose to abandon the film. In that case it provides that the guarantor must pay the LLP 30 and the LLP is required to transfer to the guarantor all the LLP’s interest in the film. The LLP’s obligations are secured by one of the Deeds of Security Assignment and Charge in which, as noted earlier, the LLP assigned to the Completion Guarantor by way of security “all of its rights, title and interest (if any) ... in relation to the Film”.

192. The LLP’s obligations under the completion guarantee must be read with clause 2.1 of the CDA, which provides that “with effect from the Effective Date (a date no later than a set date) and subject only to clause 4.8 (which deals with the LLP rescinding the agreement) the [LLP] irrevocably transfers and assigns to the [CD] all of its rights in the film free of any encumbrance other than pursuant [to the completion guarantee or the security for it]”.

193. It seems to us that the agreement with the Completion Guarantor was an encumbrance to which the film was subject and that, since the CD has notice of that encumbrance, any interest it has in the film will be subject to the rights of the completion guarantor. Thus specific performance would vest the film in the CD subject to the rights of the guarantor. We therefore consider that the LLP is a constructive trustee of the rights it holds in the film for the benefit of the CD or, if the contingency arises, the guarantor notwithstanding clause 2.1 of the CDA. But whether or not that is the case it is clear to us that the LLP was always devoid of any of the benefits of ownership of the film.

(f) The CM’s Entitlement to Drawings or to an Amount Equal to BDR/BR

194. The quantitative effect of the limitation in the LLP’s right to payment from the CD depends on what is BDR (or in the case of ITP, BR). BDR is defined as a percentage (varying with GDI) of Borrower’s Receipts (“BR”), which in turn is defined as 50% of the LLP’s Receipts under schedule 7.

195. The Appellants say that BR represents the entitlement of the CM to drawings under the LLP Members’ Agreements. As the following discussion shows, however, there may be a difference between BR (and BDR) which is an amount determined as a fraction of GDI, and the rights the CM may have had to drawings prior to the signing of the suite of agreements for a film. The ITP and IFP2 Members’ Agreements differ in this regard.

(i) ITP

196. The Members’ Agreement provides for profit and losses to be allocated 99:1 between the individual members and the CM until the LLP’s aggregate receipts from the film equal its budget, and thereafter at the discretion of the Operator.

197. In relation to drawings, clause 9.6 provides that aggregate receipts for a year be distributed between the individual members and the CM in the Drawings Proportion. (see below). Clause 9.5 provides that the “Operator shall be entitled but not obliged” to make to the CM an advance distribution of the receipts in respect of any film. By clause 9.6(a):

(a) “as soon as practicable after the end of each accounting year … an amount equal to the aggregate Receipts received in that year as shown on the Individual Film Accounts for each film shall be allocated for distribution, net of any deductions to be made in accordance with this agreement, by way of drawings between the [individual ] members and the [CM] in the Drawings Proportion for that film”.

198. By clause 9.6(b) if the amount of advance distributions to the CM exceeds the CM’s entitlements under 9.6(a) the CM “shall use its reasonable endeavours” to repay the excess within 10 days and in any event before the year-end distribution is made.

199. The Drawings Proportion for a film is defined to be the proportion to be determined by the Operator under the Operator’s agreement. The definition of Net Individual Members’ Entitlement in the Members’ Agreement indicates that individual members will get at least 40%, so that the maximum that could be allocated to the CM is 60%, but there is no further determination. There is thus no determination of Drawings Proportion in that agreement. The Drawings Proportion is not made dependent upon any capital contribution by the CM.

200. In response to the tribunal’s questions the Appellant said that the Operator “determined to allocate 50% of the receipts as drawings to the CM” pursuant to its rights under the agreement. However we saw no evidence of any such determination other than that which might be drawn from the agreements for a film. Clause 12.2 of the Operator’s agreement requires the Operator to endeavour to operate consistently with the Information Memorandum and the Information Memorandum says that drawings will be allocated typically no less favourably to the individual investors than 45:55 :: Individual:CM. Again that merely indicates that any determination would be unlikely to allocate more than 55% to the CM. We concluded that no determination of the Drawings Proportion for any film had been made before the signing of the relevant agreements.

201. Thus we concluded that, apart from anything which could be derived from the terms of the film agreements negotiated by the Operator, there was no express or implied entitlement for the CM to drawings under the Members’ Agreement equal to 50% of the receipts of the LLPs from any film or otherwise. There was thus no pre-existing right of the CM to a particular amount or proportion of drawings which was capable of being assigned or alienated by the relevant agreements.

202. The effect of the relevant agreements is not wholly clear:

(a) The advance allocation of drawings permitted to be made by clause 9.5 is not an entitlement to such drawings (as is shown by the recovery provisions of clause 9.6(b)). And yet it appears to be an entitlement that the CM purports to assign because what is being assigned is not any right to end of year drawings but to receipts as they accrue;

(b) “Receipts” are defined as any income of the film “indefeasibly received” by the LLP. By virtue of the Deed of Acknowledgement etc., BR is not indefeasibly received (or receivable) by the LLP because the LLP has irrevocably agreed that its entitlement will be reduced by that amount. Thus under the Members’ Agreement there would be a lesser pot of income to allocate for distribution. If the Operator set a 50:50 Drawings Proportion then the CM would receive half the net income as well as receiving the benefit of any indebtedness it might have to the CD being reduced by BR.

(c) In the Deed of Acknowledgement etc. the CM purports to assign its right to BR, and yet, absent any determination by the Operator, it appears to have no such entitlement.

203. The Operator’s Agreement charges the Operator with negotiation of agreements on behalf of the LLP. It seems to us that by its negotiation of the agreements, and its accession to the Deed of Acknowledgement etc. in which the CM states that it has “assigned our right, title and interest in and to Borrower’s Receipts” to the Lender and the LLP agrees that its income will be reduced accordingly, the Operator either:

(i) implicitly agreed that it would fix a 50:50 Drawings Proportion for the relevant film until the CM loan indebtedness was discharged, or

(ii) agreed, in the context of the LLP having agreed that an additional amount equal to BR would be retained by the Lender, that what would otherwise have been set as the Drawings Proportion of the CM would be reduced accordingly.

204. We prefer the second of these. The first gives difficulties with the definition of Receipts in the Members’ Agreement. If all the Operator had done was to agree that the Drawings Proportion should 50:50, there would also have to have been some amendment to the definition of Receipts, since the part of the exploitation proceeds of the film which was BR would not indefeasibly be received by the LLP. The result would have been that the individual members would be allocated only half of what was left after deducting BR. The Operator is given power to determine the Drawings Proportion “on behalf of the Individual Members”: so to reduce their share would seem to us to fall outside that power.

205. We conclude that by the agreements the LLP is agreeing to its right to income being the schedule 7 amount reduced by the amount of BR, and the Operator is agreeing to set the Drawings Proportion to such that no drawings are to be allocated to the CM in respect of the film and the CM is concurring.

(ii) IFP2 and IG

206. Clause 9.2 of the IFP2 Members’ Agreement provides for losses to be allocated first to individual members up to 90% of their capital contribution and then to the CM up to the amount of 90% of its Capital Contribution and then 50:50 between the CM and the individual members. When profits arise they are to be allocated first to individual members to absorb the losses previously allocated to them, then to the CM to absorb the loss allocated to it and then “subject to clause 9.8”, 50:50 between the individual members and the CM.

207. Clause 9.8 provides that at the Operator’s discretion it may elect to allocate 100% of particular profits to the Ordinary (individual) members but that such an election applies only in relation to profits in respect of which such an election is made.

208. Mr Reid told us that this discretion applied only to income from non-production activities. We cannot read that limitation into the words used; it may be that in practice such was the case, but in describing the CM’s rights under the Members’ Agreement they must be regarded as subject to the contingency that the Operator could make such an election.

209. In a Payment Deed in the Fox deals and for an IG deal with Codemasters, the Operator and the LLP agree that the CM’s share of receipts will be 50% – so that effectively the Operator agrees not to exercise the clause 9.8 discretion while the CM loan is outstanding.

210. The drawings allocations are in clause 10 (it is to be noted that the CM’s rights to drawings are independent of whether or not it has made a capital contribution of any sort):

“10.1 The Ordinary Members (taken as a whole) and the corporate member shall each be entitled to draw 50% respectively of all Partnership Income (defined as the income received by the LLP less operating expenses) … Such drawings shall be paid … from time to time during the course of each accounting period at the direction of the Operator.

10.2 When the Operator has elected to allocate 100% of the profit [to the Ordinary Members] pursuant to clause 9.8, the drawings entitlement set out in clause 10.1 shall be altered such that the Ordinary Members shall be entitled to draw 100% of such Partnership Income …”.

211. Thus, unless the Operator makes an election, the CM is entitled to be paid drawings equal to 50% of receipts after deducting expenses at such times as the Operator in its discretion shall decide. So, absent such an election, Borrower’s Receipts will be the same amount as the CM’s entitlement to drawings before its reduction by expenses. But if the Operator made such an election the CM’s drawings entitlement would be to nothing.

212. There are a number of difficulties with the purported assignment of BDR by the CM because the CM does not have an entitlement under the LLP Members’ Agreement to 50% of the receipts as drawings. Instead:

(a) The right to drawings is to 50% of income received after deducting operating expenses. There is no such deduction in relation to payments of BDR;

(b) The drawings provision makes the time of payment of such drawings a matter for the Operator. The right to payment therefore may arise after the time of receipt by the LLP, but the right to BDR arises at the same time as the LLP would have acquired, were it not for the Deed, the right to payment;

(c) The LLP Members’ Agreement envisages that the CM’s right to drawings is defeasible at the election of the Operator, whereas the retentions by the CD are fixed;

(d) Further, the effect of the agreements is to deprive the LLP of any entitlement to the payments of BDR. Thus the amount of BDR cannot form part of the income of the LLP and cannot be part of the drawings.

213. Some of these difficulties are avoided in those cases where a Payment Deed was executed. That Deed purports to fix the CM’s drawings entitlement at 50% of Receipts, thus preventing the deduction of expenses and any election under clause 9.8. It seems to us, however, that this works only in relation to the election under clause 9.8: there the fact that the Operator is party to a deed must prevent it from exercising the election in relation to the relevant film, but it does not seem to us to be capable of amending the rights of the members under the Members’ Agreement so as to enhance the CM’s right to drawings by removing the effect of the deduction of expenses. Nor does the Payment Deed deal with the timing of payments.

214. But whatever the difficulties with the mechanism of the assignment, the effect of the agreements must be that after they had been signed the CM has agreed that its right to drawings was different from what it was before. In the case of ITP it will have no rights to drawings from the film, in the case of IFP2, its rights will be to (i) what it would have been had the LLP’s income been increased by BDR, less (ii) BDR.

(g) The Loan Agreement

215. Mr Gammie argues that the transaction which results from the Loan Agreement is not a loan. He says that, just as Lord Templeman did not regard the flow of Lorimar’s money into Victory Partnership and back as giving rise to a loan, so too the flow of money from the CD to its associate company, the PSC, is not a loan to the CM even if the parties attempted to characterise it as such.

216. Mr Gammie refers us to Chitty on Contracts 32nd edition where at 39 – 258 it is said that a loan is a contract “whereby one person lends or agrees to lend a sum of money to another in consideration of a promise ... to repay that sum on demand or at a fixed or determinable future time, or conditionally ..., with or without interest [but that] where A pays money to B at the request of C on terms that he is to be repaid by C, it is sometimes a difficult question to say whether the transaction amounts to a loan by C”. In this appeal the Appellants argue that there was a loan by the CD to the CM on precisely that (difficult) basis.

217. In Potts Executors v IRC [1951] NEC 443 the question arose as to whether a director’s current account to which there were debited payments the company made to third parties at the director’s request gave rise to “a sum paid by way of loan” to the director for the purposes of section 40 FA 1938. The majority of the House of Lords held that on a fair meaning of the words in the statute the payments made were not “by way of loan”. There was a division among their Lordships as to whether the “payment by A to B” example in the preceding paragraph could be regarded as a loan to C.

218. In Re HPC Productions Ltd [1962] CH 466 Plowman J considered whether sums of foreign currency paid by A (TV limited) to C, a third-party, at the request of B were the lending of foreign currency for the purposes of section 1 (1) of the Exchange Control Act 1947, which made such lending an offence. He held they were not: first he rejected the proposition that “to lend” means to grant “financial accommodation – the temporary use of money in return for a promise to repay an equivalent sum”, secondly he held the nature of A’s claim against B was generically and commercially different from money lent, and thirdly he relied on the majority in Potts.

219. In Aspect Capital Ltd v HMRC [2004] UKUT 81 (TCC) the UT was concerned with whether for the purposes of section 419 TA 88 a company had made a loan or advance to a participator. Section 419(2) provided that the company should be regarded as making such a loan in a case where the participator incurred a debt to the company. The UT held that whether there was a loan between A and C (using the Chitty appellation) depended on the circumstances, and that the circumstances of that case gave rise to a loan for the purposes of the Act.

220. These cases Mr Gammie says lead to the conclusion that there was no loan between the CM and the CD no matter how the Loan Agreement was entitled or how it described the transactions. A loan involves an obligation to repay: here there was in substance no such obligation. The label “loan” was a legal pretence. The characterisation of the CD’s contribution to the Budget as a loan to the CM (and a capital contribution by the CM to the LLP) was the mischaracterisation of a transaction which was in reality an income sharing transaction between the CD and the LLP.

221. In this context Mr Gammie says that if the nature of the rights and obligations arising under the agreements was such that there was no loan and no capital contribution, then the expense of 70 cannot have been incurred by the LLP. The transaction was simply a means of facilitating an income sharing agreement between the LLP and the CD. As a matter of general principle a capital contribution must be something that serves to increase the asset base of the LLP: the CM contributed nothing to the LLP as a result of the Studio’s payment and at best divested itself of part of what would have been its share of future receipts.

222. Mr Milne says that in Potts Lord Simmonds was concerned with the statutory question of whether monies were paid to the director by way of loan – for he had said that the question was not what the transactions were but whether they fell within the fair meaning of the section. Lord Oaksey had said that in the particular circumstances of the case the payments made in accordance with long-standing practice were not made by way of loan ([466]). Lord McDermott (dissenting) said that when bankers accommodate a customer by allowing a payment to a third party which creates or enlarges an overdraft they are in effect lending to that customer.

223. Mr Milne relies upon the Commissioner of Taxpayer Audit and Assessment v Cigarette Company of Jamaica [2012] STC 1054 PC. There the Jamaican authorities challenged an undocumented, interest-free, inter-company loan. The Jamaican Court of Appeal had held the loans were genuine, the main reasons being (1) that the loans were in the audited accounts of the debtor, and (2) that they had been repaid. In the Privy Council Lord Walker noted that it was now accepted that the loans were real loans “their existence was acknowledged regularly by the directors of Carreras signing the balance sheet”. The same, says Mr Milne, is true of the CM loans since they appear in the audited accounts of the CM and Mr Holgate’s evidence had been that that was the correct treatment. And they had been repaid, at least in part.

224. We do not think that Lord Walker's remarks in that case are wholly persuasive. He was recounting what had been accepted rather than reaching a judgement, he recounts the signing of the balance sheet as the acknowledgement of, and therefore as evidence of, indebtedness, and he continues “Carreras was at all times in a position to repay the whole of the loan out of cash or readily realisable investments”. The CM, by contrast, was not able to make repayments under the Loan Agreement: it had no substantial assets (and there was some doubt whether it even had a bank account), the presence of the loan in a signed balance sheet might acknowledge indebtedness but it does not determine whether or not that indebtedness is a loan, and the proper accounting must be based on a proper understanding of the rights and liabilities not the other way around.

225. It seems to us, however, that it does not matter in considering the tax position of the LLP whether the transaction between the CM and the Lender was or was not a loan. What matters is first what rights and obligations arose to the LLP from the composite transaction, and second what were the consequences of those rights and obligations for the LLP. It does not seem to us that the characterisation of the relationship between the CM and the Lender affects the rights and obligations of the LLP or their characterisation. The question is whether the LLP incurred an expense, not whether the CM incurred a loan obligation.

226. We note that the CM had a right under clause 5.4 of the Loan Agreement at any time to pay the CD the balance of the 70, and that the agreements do not specify what would happen if the CM did pay the CD the balance of the 70. The payment instructions in the Deed are irrevocable; the LLP consents to the retention of BDR by the CD. It would require a good deal of implication of terms to be able to conclude that if the CM did “repay” the balance of the 70 that thereafter (i) the LLP would be entitled to payments from the CD inflated by BDR (BR), or (ii) the CM would become entitled to additional drawings. We do not think that such terms could be implied. The absence of provision for such matters shows that such a happening was never realistically contemplated. We conclude that the rights of the LLP under the transaction would not be affected by any payment by the CD under clause 5.4.

(h) Summary: The Rights and Obligations Arising Under the Relevant Agreements

227. In summary we conclude:

(a) The Members Agreements did not in the circumstances confer an obligation on the CM to make any capital contribution. Further:

(a) the provisions of the LLP Members’ Agreements were such that whether or not the CM made, or was obliged to make, a capital contribution to the LLP, the CM’s rights to profits and drawings and on a winding up were unaffected; and

(b) we doubt whether the payment by the Lender of 70 to the PSC’s Production Account constituted the making of a capital contribution to the LLP by the CM in accordance with the Members’ Agreement;

(b) No obligation was conferred by the agreements on the LLP to pay or cause to be paid any more than 30 to the Production Account (and as we later conclude, no cost was incurred by the LLP by reason of the CD’s payment of 70). Further, in any event that liability to pay 30 arose only once the whole of the 70 was paid, but the payment of the 70 was required to be made in accordance with the Approved Cash Flow and not all at once. Thus the liability to pay arose only at the end of production of the film;

(c) The agreements conferred on the LLP a right to receive from the CD only the schedule 7 amounts as reduced by BDR (or BR). In the next Chapter we show that the amount of this entitlement was 30% (35%) of GDI;

(d) The rights the agreements conferred on the LLP in relation to a film between signing and completion of the film were, or were in their incidents, those, or equivalent to those, of a mere trustee for the CD, and those (negligible) rights were the only rights transferred to the CD by the LLP on completion of the film; and

(e) Whilst the agreements confer on the CD the right to retain BDR (BR) in computing the amount payable to the LLP, it is not completely clear that the CM had a right to payments of that (or any) amount by way of drawings, but any such right was relinquished to the extent of BDR (BR).

228. As a result of those conclusions as to the rights and obligations of the parties we concluded that the commercial and financial consequences for the parties of the agreements were these:

(i) The LLP was obliged to pay 30, suffered no other cost, and became entitled to 30% of GDI;

(ii) The CD was obliged to pay 70 and became entitled to retain 70% of GDI;

(iii) The PSC was obliged to make the film; once made its ownership transferred to the CD; while it was being made the CD had (apart for 5% held by the PSC) rights in the film equivalent to those of a beneficial owner;

(iv) In ITP the CM had no right to drawings in relation to the film unless the Operator decreed; in IFP2 it had a right, defeasible at the election of the Operator, to drawings equal to half the net receipts from the film less BDR.

229. Mr Milne regarded an analysis of the type which gives rise to the preceding paragraphs as wrongly reliant on cash flow. He drew our attention to the decision of the FTT in Eclipse 35 in which they said:

“[367] Therefore whilst the cash flows … can be said to be fundamental to Eclipse 35’s participation in the arrangements entered into … it does not follow that the arrangements do not have the commercial purpose of effect which on their face they purport to have.”

230. Mr Milne says the cash shortcuts taken do not affect the financial consequences for the parties. That seems to us to ask us to determine those rights by reference to a deal other than the one the parties actually agreed to. It is abundantly clear that the Studio negotiated a deal in which the substantial sums it would invest in a film would never go through the LLP. The form of the agreements indicates to us that the Studio would never have allowed the funds to be freely available to the LLP. The deal which was negotiated was not one under which a shortcut was taken but one in which it was never intended that the LLP should have free access to the funds. If the LLP had had free access to the funds would it then have agreed to pay 100% of the cost for only at most 54.55% of GDI?

231. We must determine the rights and financial consequences of the parties from the deal they actually signed, not the one which they want to require the tribunal to think they signed.

4. Control Over Making the Film

232. In the following paragraphs references to clauses are to the Hot Fuzz agreements but these clauses were, we understood, common to all the film packages.

233. The PSA provides for the PSC to make the film as an independent contractor. The film is defined as the film conforming to a specified screenplay and a Specification which details, among other things, the producer, director, proposed artist(s), location, length, budget and delivery date.

234. Clause 2.3 of the PSA provides that creative control shall be exercised by the LLP (although day-to-day decisions are to be made by the PSC [10]) but that the LLP is prohibited from taking any decision which would impair the approval rights of the CD under the CDA (see below). The PSC acknowledges that certain matters are, under the CDA, subject to the approval or consent of the CD and agrees to obtain CD approvals on behalf of the LLP and keep the CD informed.

235. Clause 4.1 of the PSA sets out matters over which the LLP is initially expressed to have a right of approval but requires that the LLP and the PSC shall “consult meaningfully” with each other over them, and that if there is any dispute the Completion Guarantor’s decision shall be final. The relevant matters include items such as producer, directors, cast, crew, composer, designer, screenplay and cash flow. In relation to these matters, the effect of this clause is to give the LLP a chance of influencing the making of the film but only if its suggestions or ideas are acceptable to, or coincide with, those of the Completion Guarantor (a company associated with CD). It has the right to be heard.

236. The obligations placed by the PSA on the PSC to make the film are mirrored in obligations of the LLP under the CDA. The CDA provides that the LLP shall proceed with the production of the film (which is defined by reference to the same specification as in the PSA). It provides that the CD shall have an absolute right of approval over the list of all the matters which were in clause 4.1 of the PSA. It too provides for meaningful consultation between the CD and the LLP, but also provides that on any dispute the Completion Guarantor’s decision shall be final.

237. The CDA provides that the film shall conform to the specified screenplay and, subject to the list of approvals, permits the LLP to exercise, in consultation with the CD, creative control over other matters, but also that the LLP shall comply with all lawful requests of the CD in relation to the film. Taken together with the equivalent terms of the PSA this gives the CD or an associate company effective control over the making of the film.

238. In their first Note of Evidence HMRC show in relation to the film Australia how each obligation of the PSC to the LLP under the PSA in relation to the making of the film is matched by corresponding obligation of the LLP to the CD although there are three obligations of the LLP to the CD under the CDA (to deliver a cost statement, copies of documents in relation to the film and rushes) which are not mirrored in the PSA. The summary is not disputed by the Appellants.

239. Thus, after the documents were signed all the LLP had to do under the agreements was to pay and sit back and wait. If asked it could consent to matters in the Approvals List, but it could always be overridden by the CD through the Completion Guarantor, and in any event it was likely that anything it was asked to approve had the approval of the CD (since the PSC was its associate). If it wanted it could make suggestions but it had no right to compel the execution of its ideas or at least any ideas of substance. But there was also a disincentive to interference: clause 16.2 of the CDA (Hot Fuzz; clause 17.2 in Australia) provided that the LLP would not be liable for any default which derived from a default of the Studio, the Completion Guarantor or the PSC unless the PSC’s default derived from an autonomous act of the LLP. If the LLP interfered it did so at its own risk.

240. In summary: the CD had control over the creative content of the film. The LLP had a right to be heard but was incentivised not to interfere.

Stage		(i)	(ii)	(iiia)	(iiib)	ITP***
Aggregate GDI		Under 165	Over165, under 204	Over 204, under 417.4	Over 417.4
CM Loan repaid		No	No	No	Yes	No
Incremental GDI		10	10	10	10	10
A: Distributor Commission	30%	(3)	(3)	(3)	(3)	(3)
B: Studio Participation	15.45%; 34.71%, 27.14%	(1.55)	(3.47)	(2.71)	(2.71)
C: Remaining GDI		5.45	3.53	4.29	4.29	7
D: Borrower’s Distributable Receipts (BDR)	45%, 15%, 30%, 30%	2.45	0.53	1.29	1.29	50%x7 =(3.5)7
E: Total cash to studio (A+B+D)		7.00	7.00	7.00	7.00	*6.5*
Total cash to LLP (GDI-E)		3.00	3.00	3.00	3.00	*3.5*
F: Profit allocation to corporate member**		Nil	1.76	2.15	1.5	Nil
G: Cash via LLP to corporate member		0.27	1.24	0.86	1.5	Nil
Corporation tax on CM profit**		Nil	0.53	0.65	0.45	Nil
Net CM retention**		0.27 =5% x C	0.18 =5% x C	0.2 =5% x C	1.05 =~24% x C	*Nil*

** The calculation of these figures is explained in Appendix 4, which also contains references to Mr Bower’s evidence on the subject.

*** Comparison prior to loan repayment

265. The Appendix also explains how the stages match the levels of revenues at which revenue is such that (i) the first year write down has been extinguished, (ii) the allocations to the LLP will approximate to budget, and (iii) the CM loan has been repaid.

266. Thus the effect of the step provisions is to channel into different pockets of the Studio different proportions of the GDI flow which accrues to the Studio. The aggregate flow to the Studio is 70% of GDI in all cases [12] but as the volume of the flow changes taps and sluice gates are opened and closed or raised and lowered so that the entitlement flows into (or remains within) different pools under the same ownership. The effect, among other things, is to alter the rate of repayment of the CM loan depending on the level of GDI.

267. No commercial reason for the Studio seeking such different rates of allocation was suggested to us, and for the reasons which follow it seems to us that these taps and sluice gates were added to the waterfall for the benefit of a member of Ingenious’ group, the CM: for the provisions result in a cash and economic benefit to the CM. In the ITP waterfall the CM was an orphan and these provisions were not included. We conclude that they were included for the benefit of the Ingenious group in order to deliver a return of at least 5% after tax to the CM.

268. In the ITP structure the Operator’s agreement provided for the Operator to receive a “success fee” which became payable when total individual members’ receipts exceeded 105% of budget; by contrast the benefit to the CM shown in the table arose as soon as revenue started flowing from the films. This provided an incentive in the IFP2 structure for Ingenious to manage that LLP so as to receive revenues.

269. We should note that we found it odd that the IFP2 and IG Information Memoranda made no prominent mention of this benefit to the Ingenious group, although the allocation of 50% of drawings to the CM is clearly stated.

270. We should note that in this section we have set out the amount of cash the various parties would receive under the combined effect of the relevant documents. In the preceding section we have set out our understanding of the parties’ legal entitlements under those documents. We should record that Mr Milne regarded the two as different, but that our analysis was that they were the same.

2. The Importance of GDI

271. One of the conclusions we draw from the quantitative illustrations above is that GDI was shared 70:30 (or 65:35) between the CD and the LLP. Mr Milne argues that this is to overstate the importance of GDI, and that this effect cannot be taken as an implicit admission that there was a 70:30 (65:35) economic deal between the LLP and the CD. He says that the 70:30 analysis is inappropriate mathematically, legally and commercially, because GDI depends on the “off the tops” that come into the calculation before the setting of GDI. He says that the same overall commercial deal could have been reached by increasing the Studio’s off the tops and reducing its share of GDI.

272. Mr Milne points to an analysis which Ingenious prepared for HMRC which used a leaked distribution statement for Harry Potter and the Order of the Phoenix. In that analysis it is shown that under the ITP model, with a Distribution Fee of 20% and a Distribution Commission of 35%, the same result was delivered as was delivered in the leaked statement in which there was charged a 35% Distribution Fee only.

273. Whilst we agree that if Distribution Expenses and talent etc. participations (together ‘non-fee off-the-top expenses’) are a constant percentage of Gross Receipts a change in the Distribution Fee can be compensated by a change in the Distribution Commission so that the LLP and the CD receive the same sums for any level of Gross Receipts, that is not the case where non-fee off-the-top expenses are not proportionate to Gross Receipts, and that will be a particular concern if Gross Receipts turn out to be small.

274. Thus for example if Gross Receipts are 100 and non-fee off-the-top expenses are 85 (because there was an unsuccessful expensive advertising campaign) a fee of 15% leaves GDI of nil, so that the total retention by the CD will be 15. But if the fee was 10% GDI would be 5 and only an increase in the Commission to 100% would leave the CD in the same position, which would mean that however successful the film (if the advertising had paid off) the LLP would receive nil. This effect was of course one reason for the gross corridor obtained by IFP2 but the presence of that corridor does not materially affect the example just given.

275. The reverse effect applies if a film is spectacularly successful and receipts become disproportionately large in comparison with non-fee off-the-top expenses (an effect to which Mr Briggs in some of his Ultimates gave voice by capping P&A expenditure); in such a case the value of a percentage point change in GDI is worth disproportionately more than the percentage change in the fee which would have balanced it had there been no slow down in the rate of P&A expenditure as a proportion of Gross Receipts.

276. Further the striking of GDI in our view represents the point at which the spoils are divided between the distribution activity and the activity of financing and making the film. For Independent films GDI is the equivalent of the amounts available for distribution from the collection account. For such films the balance on the collection account represents Gross Receipts less expenses less the distribution agents’ fees and costs. Thus for Happy Go Lucky the Collection Account Management Agreement provided that the balance on the collection account was, after payment of the collection account manager’s fees and sales agent’s expenses, to be divided up between the LLP, the financiers and the CD. In the Studio agreements the Studio is both maker and distributor, and the division between fee and interests in GDI represents the division between those activities.

277. In that connection:

(a) Mr Olsberg indicated that for Independent films distribution fees would be in the order of 15-25 %.

(b) We were told that Ingenious had managed to negotiate lower fees for the IFP2 deals, normally at 15%, than for the ITP deals – normally 20%.

(c) Mr Clayton, when speaking of negotiation with Fox over the waterfall about the level of the distribution fee said that at that time “the market rate was more like 15%”.

(d) Mr Reid said a 15% distribution fee was about a right arms-length fee and that the CD’s distribution fee was “for the job of distributing” (although there was some profit in that).

(e) Mr McKenna described the Studios as having profit centres to each of which was ascribed part of the monies retained by the CD. A distribution fee of 15-20 was a reasonable fee for the distribution activity (or profit centre).

278. A consequence of our conclusion that GDI represents the return to the makers and financiers of a film is that the CD’s “Distribution Commission” (rather than the distribution fee) is not compensation for distribution, despite its name, but a producer’s profit allocation.

3. Items in the Budget

279. The CDA and the PSA and others of the suite of documents referred to an Approved Budget and an Approved Cash Flow.

280. In each case the Approved Budget consisted of the direct costs of actors and filming together with the addition of (i) Studio Overheads of 15% of the direct cost, (ii) a Completion Bond Fee of 2% of the direct cost, (iii) a Contingency of 10% of the direct cost and (iv) an Executive Producer Fee payable to an Ingenious entity of 5% of the direct cost.

281. The Approved Cash Flow showed the agreed weekly costs of production and the payments to be made by the CD and the LLP. Certain costs such as those relating to the writing of the script were (at least in Hot Fuzz) scheduled to be paid before the agreements had been signed. The Executive Producer Fee was scheduled to be payable in the week of signing as was the Completion Bond Fee. The Hot Fuzz Cash Flow suggested that the Studio Overhead was to be paid when the film was complete.

282. In what follows it is to be recalled that the PSCs appeared to have been subsidiaries or associates of the CD.

(a) The Studio Overhead

283. Mr Reid told us that he assumed that the CD invoiced the PSC for this. We saw no evidence of any agreement between the PSC and the CD for the payment of this sum. We were uncertain whether it would in fact have been paid, since it would just be paying back to the CD what the CD had paid to the PSC.

(b) The Completion Bond Fee

284. The Completion Guarantee is between the LLP and the completion guarantor (an associate of the CD in Studio deals). It recites that it is given in consideration of a bond fee received by the guarantor. For Hot Fuzz this was £191,339. The agreement does not make express who paid the fee. In the cash flow and budget for Hot Fuzz this amount is shown as being payable as part of the budget of the film.

285. The Guarantor (for Hot Fuzz) was a subsidiary of the CD and its obligations were guaranteed by the CD.

286. If the film goes over budget and the Guarantor funds the deficit, its outlay is recouped in the schedule 7 waterfall after distribution fees and costs (and for IFP2 the gross corridor), but before the striking of GDI.

287. Independent films often had completion guarantors. Mr Finney noted that normally films made by Studios did not: the over-budget risk was borne by the Studio.

288. Clause 7 of the IFP2 Hot Fuzz CDA provides that if the actual cost of the film is less than budget (including the contingency) then the surplus in the production account is to be paid to (retained by) the PSC.

289. In the ITP agreements unused contingency was to be repaid to the LLP and the CD in the ratio 70:30 through the waterfall.

(d) The Executive Producer Fee

290. As part of the suite of documents for a film, the PSC entered into an Executive Producer Agreement with an Ingenious company (the “EP”) under which the EP agreed to render to the PSC:

“services of a nature generally and usually rendered by Executive Producers as shall be mutually agreed and shall be rendered (to the extent mutually agreed) in the manner customary in the production of feature films including ... cooperating with and advising the [PSC] with respect to the finalisation of the production budget and the financing arrangements for the film (the “Services”)”;

a somewhat vague description of the services to be rendered, and encompassing activities – the financing of the film – which had already taken place.

291. The EP agreement provided for a payment of a fee of 5% of the budget for these services. The Deed of Acknowledgement provided for the LLP to withhold the EP fee from the first payment of Initial Funding, which would otherwise be paid by the LLP to the PSC, and required it to be paid instead to the Operator (presumably for the account of the EP).

292. In his book The International Film Business, Mr Finney says that the term “Executive Producer” is often applied to “a producer who takes a specific role in co-financing a feature”, although he says that the term has been much abused and has been applied to those involved in early development without active responsibility of the film-making process. Mr Finney told us that a typical Executive Producer Fee was 2 to 2.5% of Budget.

293. Mr Milne argued that it was typical of such agreements in the film world that they would be a little vague or flexible in their terms. He noted that in the Producer’s agreement between Simon Channing Williams and the PSC for Happy Go Lucky, a similarly vague clause introduces the producer’s obligations “to render all such services as are usually rendered by a first-class producer ... conscientiously and in a businesslike manner ...”. But we note that the later clauses of that agreement include much more detail: to ensure the film is produced, to assist in cutting, editing and promotion, to engage artists and to control certain expenses.

294. Mr Clayton said that the agreement could perhaps have been more detailed but perhaps “by the time we came to sign it we had actually rendered the services that were required and there was nothing further contemplated”. It was, he agreed, all to do with financing and getting the film ready. When Ingenious personnel were putting together the finance for a prospective film Mr Clayton regarded them as working for the EP. But that was work done prior to contracting for the film and before the making of the EP agreement.

295. Mr Reid was less clear about the role of the EP. He said that the EP fee was there “essentially for work we were doing closing the film”, but also for being available during the production to “troubleshoot”. He described the agreement as a way of charging for Ingenious’ services as Operator of the partnership (in addition to the Operator’s fee) in a way such that the fee was also borne by the other parties to the production (namely the CD); in that respect he saw an overlap – the wearing of two hats by Ingenious personnel – in acting for the LLP and (presumably prospectively) for the PSC. He said that Pathé normally charged a 10% Executive Producer Fee essentially for the services provided by its infrastructure.

296. Mr Bower said that the EP role started around the time of closing, and comprised a period when Ingenious personnel wore two hats: those of the Operator and the EP.

297. Many of those with whom Ingenious dealt appeared to regard the Executive Producer as a large financing fee. Miss Rossolini of Fox said that the fee was, by a multiple, higher than any “co-financing fee” she had seen; and Paula Jalfon of Ingenious said that Film Finance regarded the LLPs as financiers and so did not have to hold back the EP fee until production commenced. The correspondence showed the fee as being required as part of the deal by Ingenious personnel.

298. Although we received evidence of what Ingenious did in putting together the parties and the agreements for a film before the agreements were signed, there was sparse evidence of any services rendered by the EP after the signing of the Executive Producer Agreement. Whilst, once the film had been signed, consents were given by Ingenious personnel under the PSC, and under the CDA receipts were monitored, these were activities for the LLP and not for the PSC. Yet the EP fee was large: for example the Golden Compass EP fee represented 7 man years’ work at £400 per hour (although Mr Reid made the point that in the film world people would not look at fees in that way).

299. We conclude that the EP fee was not in return for any service rendered to the PSC in the making of the film. The words of the Agreement were misleading. We accept that in Ingenious’ hands it might be described as a fee received for bringing the financial support of the LLP to the film, and it is likely that the CD so regarded it. We are not concerned with the tax treatment of the fee from the PSC’s perspective. If we were we would regard it as at best a fee of a capital nature for arranging finance, and at worst as not incurred for any service.

300. Mr Milne suggested that the fee was deductible in the LLP’s computation either as a fee it had to pay to keep its trade going or as part of the film budget. We address these questions in Chapter IX Expenditure.

CHAPTER IV. THE LLPS’ FILMS – the Films, the Move to Studio Films, Shortfall Financing, Co-production and The Avatar Hedge

1. The Films and the Move to Studio Films

301. ITP’s Films. In 2002/3 ITP undertook 7 films of which one, Wimbledon, was a Studio film, two were wholly independent, and four were independently produced and distributed by Pathé. The cost of the 6 Independent films was recorded by Mr Forster as £36m, and that of the Studio film £31m.

302. IFP’s Films. In 2004/5 IFP contracted for 12 films of which we think 7 were Studio films and 5 independent. Mr Forster records the total cost of those seven films as £348m, which was 91% of the total recorded cost.

303. IFP2’s Films. In 2005/6 IFP2 contracted for 22 films of which 8 were independent and 14 Studio. The cost of the Independent films was recorded by Mr Forster as £44 million and that of the Studio films as £993 million. Thus some 96% of the expenditure was on Studio films. Of the 14 Studio films eight were with Fox, two each with Universal and Time Warner, and one with each of Paramount and Working Title (part of Universal).

304. Thus the number of Independent films and the average expenditure on them (about £5m) remained constant.

305. These figures show a proportionate move from Independent to Studio films across the period.

306. Mr Reid told us about trips to the US from 2002 to court the big Studios. They were eventually successful. Mr Clayton, who it will be recalled joined Ingenious in 2003, explained to us how in the years thereafter the team involved with the LLPs grew in numbers and sophistication. He was involved in the development of the IFP model, in trips to Los Angeles to meet representatives of the Studios, and in many contacts with film-makers over potential films. Mr Clayton became Ingenious’ principal contact with Fox and developed a good working relationship with Vicki Rossellini at Fox. This enabled discussions between Fox and Ingenious about the films Fox was preparing to make, and the funds which the LLPs might raise to apply in the production of those films. Mr Clayton described Fox as being the anchor of IFP and IFP2's slate; he and Miss Rossellini spoke four or five times a week.

307. Figures Mr Crossley produced for Mr Reid in February 2005 show the advantages for Fox for doing a deal with Ingenious. The principal advantage was cash flow: the LLPs provided 30% or so of the cash needed to make the film (perhaps less after taking account of the EP fee); but there was also an effect of the standard waterfalls on Fox’ risk and reward. If a film did badly Fox was less exposed to losses, at the expense of doing less well after a break-even point.

308. Fox had its own green-lighting procedure, and the LLPs would commit only to Fox films which had passed that test. We believe the same was true for the other Studios. We obtained the impression that Ingenious and the green-light committee relied quite heavily in making their decision about a film on the fact that the Studio was intending to make it (or was willing to make it with additional capital supplied through Ingenious). Nevertheless we accept that there were occasions on which the green-light committee expressed preferences or reservations about films proposed by Fox.

309. There seem to us to have been a number of reasons for the increase in Studio films. One was that the arrangements Ingenious developed with the Studios, in particular with Fox, enabled a flexible allocation of large amounts of money at fairly short notice.

310. One of Ingenious’ difficulties was predicting the influx of capital into an LLP from individual investors. Many such investors were likely to invest close to the tax year end and it was not possible to predict how much would be raised until late in the tax year. There were two opposite problems: either insufficient funds would arrive to finance those films which Ingenious had lined up, or more than expected would arrive without films to put the money into.

311. The first of these difficulties had been met for some films by incorporating into the contracts a right for the LLP to withdraw if its funding did not arise (an “unwind letter”)[13]. Also some films had a “Shortfall funding” mechanism. We describe that below.

312. The second problem made it necessary that there be some scope for adding to a prospective film portfolio. Otherwise the subscribed capital would have to be returned to investors as required by the Members’ Agreements: and that would be embarrassing for Ingenious and would also reduce the fees it would earn (via the Operator and the Executive Producer). We note in this context that Mr Bower said that they would never approve a bad film just to earn their fee, but to our minds there is a difference between taking on a bad film and not being assiduous about assessing its potential for contributing to the LLP’s profit.

313. It seems to us that, especially in the context of IFP2, this difficulty was addressed by having a flexible pot of Fox films into which money could be deployed. In the context of other later operations Mr Bower described such films as “valve” films. Mr Clayton said that they had a template agreement with Fox. That meant that much of the documentation for additional films could be prepared moderately quickly. But in which films? It appeared that the practice developed of green-lighting a number of proposed Fox films and giving Fox flexibility to decide in which of them the LLP should invest.

314. Thus in an e-mail of 28 March 2006 to Miss Rossellini, Mr Clayton explains that Ingenious had an order of priority of films to use the (expected) available funds in and that because another producer might “pull the prestigious UK film we want” he had been able to promote the Fox film Used Guys in the list. As a result he could make a firm commitment “to give you $60 million in direct costs now ...”, “I know”, he says, “Used Guys is more than this, but $60 million was the lower end of your indicative range”. (The eventual budget for Used Guys appears to have been £84 million.) He continues: “In terms of the shortfall on Used Guys I'm afraid we would not be able to top up ... however across Die Hard 4, Used Guys, there's an aggregate commitment of $184 million of direct cost which you can allocate between the films as you wish ... I appreciate that this isn’t the full Flex that you’re used to”.

315. This appears to have been given voice in the Aggregate Funding and Allocation Side Letter of 31 March 2006 in which IFP2, Fox and others agreed that Fox must allocate funding of £42m so that it covered the full amount of the Initial Payment for Fantastic Four but the balance could be allocated between Used Guys, Life of Pi and Die Hard 4 as Fox thought fit.

316. This of course meant that the portion of each budget of those other films which was to be funded by the LLP might be less than 30%. This possibility was taken care of by the Shortfall Mechanism.

317. This flexibility enabled the LLP to use all the amounts subscribed, but it also meant that it became Fox’s decision to decide how the available funds would be allocated between the selected films. Mr Clayton agreed that Fox were more likely to allocate Ingenious’ money to the films they thought less commercially promising, but he said that Fox’s view may not have been Ingenious’ view. Nevertheless we conclude that in giving Fox this flexibility the LLPs were prioritising the investment of subscriptions over their assessment of their likely possible profitability.

318. A second reason for the move towards a greater proportion of Studio films may have been that there was less work for Ingenious to do. Independent films required putting together; Studio films came packaged by the Studio. Ingenious’ staff were largely bankers, lawyers, and accountants, although some like Mr Bower were seriously interested in film. Contracting with a Studio took away the need to consider the creative aspects of a film package and left only the finance.

319. We have noted that the numbers of Independent films undertaken remained much the same while the number of Studio films increased. The activity of Ingenious therefore became proportionately weighted towards Studio films.

320. Mr Clayton said that some films were “oven ready”. Ingenious had standard form contracts for deals with Studios. The contractual structure for Independent films was more complex: there were more parties involved in financing the film and in distributing it, and each had their own angle. Thus there was more work involved in Independent films not only in putting the deal together – ensuring that all the parties were ready to go – but also in the negotiation of the documentation.

321. A third reason was in our view the profile of Studio films. There is a hint of that in Mr Clayton’s e-mail quoted a few paragraphs above, that Ingenious might lose a “prestigious UK film” and also in an e-mail to him from Miss Rossellini in which she sets out a list of prospective films wanting to give comfort that Fox had “plenty of top, high visibility, commercial films from which we could find films to partner you on”. High visibility films, the sort Studios made, looked good.

322. A fourth possible reason may have been the absence of presales. For Independent films the effect of presales was to increase NRV; since the film had been pre-sold the NRV could not be less than the aggregate presales. If presales were sufficiently high then NRV could be more than 20% of Budget. If the LLPs were to deliver the 80% tax loss in the first year, presales of 20% or more could be a problem. On the other hand, Ingenious sought Independent films which had some measure of presales because they validated the commercial prospects of the film. It is likely that there was some tension between these two considerations. Mr Reid said that presales were a good thing. Overall, we do not regard this possible tension as significant either as a factor in the move to Studio films.

323. A final reason was that one might expect that Studio films were less likely to be loss making. A safer bet.

2. Shortfall Financing

324. Certain of the agreements with Fox (e.g. Life of Pi and Avatar) contained Shortfall provisions. In the PSA there was a provision [14] that if the LLP was unable to find the Initial Funding (its 30%), the PSC might procure another party, a Shortfall Financier, to finance the Shortfall. (The LLP was entitled to repay the Shortfall before the film was completed and to restore the status quo ante). Correspondingly schedule 7 of the CDA provided for the Shortfall Financier to receive the Shortfall Percentage (the Shortfall divided by the Initial Funding) of GDI (and of sums which would become payable under the gross corridor).

325. By this mechanism the Shortfall Financier and the LLP shared part of GDI in proportion to their direct contribution to the Film. The effect was that where it applied the LLP funded less than 30% of the cost of the film and received proportionately less GDI. Indeed as the Aggregate Funding and Allocation Side Letter – described above – indicated, the LLP’s percentage could fall to nil. Thus it could also be very small [15].

3. Co-production with another LLP

326. As we shall explain in relation to Avatar, it appears that from 2006 some films were undertaken by more than one LLP. Thus Mr Forster’s Exhibits show that IFP2 and IFP were both involved in DragonBall, I Love You Beth Cooper, and Wolverine.

4. The Avatar Hedge

327. Avatar had the largest worldwide box office takings of all time. More than one LLP was involved in its production. It was contracted for by IFP2 in its second year (2006/7) and was released in 2009. Mr Forster’s figures showed that by 5 April 2013, over four years later [16], IFP2 had recognised a cost of £149m and receipts of £129m, a book loss of £20m. The figures are more complex than this and Mr Milne told us that there had been an error in the calculations, which when corrected gave a profit of £9m. We return to the figures in more detail in section 11 of Chapter VIII. At this stage we relate the history of the LLPs’ involvement in the context of the way in which their funds were deployed.

328. Mr Clayton told us that he had first heard from Fox of the development of Avatar before 5 April 2006 (the end of IFP2’s first year), and later in 2006 had been told of the work that Fox were doing on its script and budget and that those working on it at Fox were hoping to get the internal green-light in September 2006. It did not form part of the IFP2 year 1 slate.

329. That slate had included the films Used Guys, Life of Pi and Die Hard 4, all of which had shortfall provisions.

330. The Completion Guarantee for Used Guys provided that the guarantor could by notice abandon the film and repay the funding. This it did by a notice of November 2006, although earlier intimation of its decision had been given to Ingenious: Mr Clayton records that a decision was made to apply the remitted funds in contracting for Avatar alongside IFP3, which would be raising new capital in 2006/7, and that work on documentation started in September 2006.

331. As a result in November 2006 IFP2 and IFP3 (acting jointly) entered into a single CDA, PSA and related documents with Fox for the production of Avatar with an Approved Budget of £185m. In a letter of 6 November 2006 – contemporaneous with the Avatar CDA etc. – Fox and IFP2 agree that the amount to be paid to IFP2 on the abandonment of Used Guys, £19.14m, would be applied by IFP2 in making payment of the Threshold Funding of Avatar.

332. The sum of the ordinary members’ capital allocated to the film and the CMs’ loans did not amount to £184m. In total they amounted to £84m or 45.6% of the budget.

333. The balance of the funding was to be provided by a “Shortfall Financier”. Schedule 7 of the CDA provided for what would have been GDI to be reduced by the Shortfall Percentage before being split between the Studio and the LLP(s), and for that percentage of GDI to be paid to the Shortfall Financier.

334. Thus under the November 2006 documents the Shortfall Financier would take 54.6% of what would have been GDI, and the remainder divided between the Studio and the two LLPs (in accordance with schedule 7 and the Deed of Acknowledgement etc.).

335. IFP3’s fundraising was, however, curtailed by changes in the availability of sideways loss relief in March 2007. Ingenious decided that IFP2 would assume IFP3’s contractual obligation and IFP2 would raise additional funds from existing members for Avatar, Life of Pi and Die Hard 4.

336. During the remainder of the 2006/7 tax year IFP2 raised further capital as a result of ordinary member subscriptions. Mr Bower told us that the green-light committee did not want to put all its eggs in the Avatar basket, but that Fox wished the monies to be employed in Avatar. The solution was the Avatar Hedge.

337. This took effect under the following documents, which were executed by the relevant parties on 5 April 2007, varying the agreements of 6 November 2006:

338. A Deed of Amendment which added IFP as a “new producer”.

339. A Deed of Termination, Release etc. which released IFP3 from all obligations and rights under the agreements for Avatar, set a new budget for the film of £182m, and divided that budget between Budget A of £89.37m and Budget B of £92.59m. It provided that IFP2 was to provide “supplemental Funding” of 27.37% of Budget B, and for it to pay to the Production Account 100% of the Initial Funding for Budget A.

340. A Funding Side Letter. This created the ‘Avatar Hedge’. It provided:

(a) for new budgets for Life of Pi and Die Hard 4;

(b) for IFP2 to pay the (27.37% x £92.59m =) £25.32m to the Production Accounts of the three films;

(c) for Fox to allocate the whole of the additional expenditure to Avatar and to direct that the 27.37% x £92.59m = £25.32m be paid to the Avatar Production account;

(d) but for the purpose of the determination of rights to Receipts from the three films the additional monies should be treated as if they had been applied:

(a) 54.58% for Avatar,

(b) 4.07% for Life of Pi,

(so that, as we understand it, the shortfall in the funding IFP2 had thitherto provided in respect of those films would be reduced by the additional contribution, and accordingly so that the Shortfall Percentage, by which rights to GDI was reduced, should be correspondingly smaller in respect of each of those films);

(e) for schedule 7 of the CDA for each film (the waterfall provision) to be divided into a Budget A and a Budget B, and for the Shortfall under Budget A to be nil and to arise only under Budget B. The division of the Gross Receipts between the A Receipts waterfall and the B Receipts waterfall was specified as:

(a) Avatar: A: 49.17%; B 50.83%,

(b) Life of Pi: A: 84.97%; B: 15.03%,

(f) and for the Shortfall to be allocated only to the B Receipts calculation.

341. Mr Bower described the effects of these transactions thus:

(a) before March 2006 IFP2 had deployed £84m in Avatar (including therein the CD’s contribution via the CM), being 45.6% of the budget;

(b) by March 2007 IFP2 had raised additional capital of which £65m (calculated to include the CD/CM element) was to be spent on film production;

(d) but it was agreed that it would receive income as if it had deployed it in agreed proportions between the three films.

342. Mr Bower said that Avatar had been more successful than Life of Pi and Die Hard 4, and if the Funding Side Letter had not been entered into IFP2 would have recognised by 30 April 2013 some £20m of additional income, and that the lifetime projections would have shown an increase in IFP2’s profit of some £132m.

343. Mr Bower produced calculations showing the computation of these figures. We accept the logic of the calculations. We set out the way they were done in Appendix (so that any interested party may see the reasoning we have accepted), but there is no advantage to the current exposition in setting them out here.

344. There are a number of conclusions which we draw from the circumstances of the Avatar Hedge:

(a) had IFP2 not entered into the Funding Side Letter, it would, on the basis of the figures in the Appendix 6, by 30 April 2013 have recognised £20m of additional income, and the Ingenious lifetime projections for IFP2 (the ‘2010 Ultimates’) would have been £132m greater.

(b) IFP2 entered into the Hedge because the green-light committee put its foot down. It was not toothless or moribund.

(c) It was not inimical to the LLP’s business models not to provide or procure the provision of all the finance for a film:

(i) IFP2 and IFP3 were the initial co producers of Avatar. Their liabilities were stated to be joint and several but each was clearly to provide some of the finance;

(ii) Shortfall finance was an element of the November 2006 and the March 2007 Avatar agreements and of the Die Hard 4 and Life of Pi agreements. The shortfall financier obtained an income stream calculated on the same principles as the LLP’s entitlement and in proportion to the amount financed (but without the 70% loan mechanics or the Studio deductions).

(d) By entering into the Hedge, IFP2 was in effect buying interests in the income streams from the films rather than the right or obligation to produce them.

(e) It was not essential to IFP2’s business model that the completed films be delivered to it for onward delivery to the CD: para (c) of the Funding Side Letter provides that the delivery of the completed film by the PSC to any one of IFP, IFP3, IFP2 satisfied the PSC’s obligation to deliver to each of them.

(f) It was acceptable for any creative influence over the production of the film residing in the LLPs to be exercised jointly with one or more other LLPs (see (a) of the Funding Side Letter).

(g) The negotiation of these agreements would not have been a simple process. They are complex arrangements. It was not analogous to buying an investment.

(h) The funding provided by IFP for some of the films, even after including the CM’s loan contribution, was less than 50% (see Die Hard 4).

The transaction provides an indication of the financial nature of the LLPs’ businesses. These conclusions are referred to later in particular in Chapter VII: With a View of Profit, and Chapter VI: Trading.

CHAPTER VI: TRADING

1. What Did the LLPs Do?

348. We have discussed the monetary rights and obligations of the LLPs in Chapter II above.

349. We conclude that the obligation of the LLP to deliver the film to the CD was almost meaningless since all the material rights in the film were held by the CD or the PSC at all times. As we noted in section 3(d) of Chapter II the rights the LLP held in the film – both the IP rights and in the physical film – were nugatory. Whilst there might be a formal assignment of the film to the CD at the end of production, there was no further action needed by the LLP to convey any vestigial rights it held to the CD.

350. In section 4 of Chapter II we concluded that the contracts gave effective creative control over the production of the film to the CD (through the LLP) and provided an incentive for the LLP not to interfere.

351. In Section 4 of Chapter IV we concluded that:

(a) By entering into the Hedge, IFP2 was in effect buying interests in the income streams from the films rather than the right or obligation to produce them.

(b) It was acceptable for any creative influence over the production of the film residing in the LLPs to be exercised jointly with one or more other LLPs.

(c) The negotiation of these agreements would not have been a simple process. They were complex arrangements. It was not analogous to buying an investment.

352. From Mr McKenna’s evidence we find that in practice Ingenious regarded the creative aspects of the production of the film as settled at the time the agreements were signed. After that, people making the film would not want the LLP to interfere, and in practice the LLPs did not interfere in any substantial way, although occasionally Ingenious personnel offered their views on certain matters. Mr McKenna said that he regarded any creative control as exercised at the time that the nature of the films was written into the agreements. In like vein we concluded in Chapter IV that the LLPs were content to exercise any creative influence they may have had during filming jointly with other Ingenious LLPs.

353. Although Mr McKenna had wide experience in the commercial and financial side of the film industry, and other Ingenious personnel (like Mr Bower who had a library of screen plays) had an informed interest in film production, the only person with any previous experience in film production was Paula Jalfon, and we obtained the impression that her contribution to the making of a film after the documentation was signed was nominal.

354. Under the Operator’s Agreement the LLPs appointed the Operator who undertook matters on their behalf. The Operator agreed to provide defined Services. These included evaluating and identifying suitable films for recommendation to the green-light committee, and negotiating and making agreements on behalf of the LLPs. Clause 14 (ITP: 14) of that agreement provided that nothing in it made one party the agent of the other, but that clause in our view must be read subject to the express inclusion in the Services of the Operator’s duty to negotiate and execute on behalf of the LLP. Thus, whereas the activities of finding films were not necessarily conducted as agent of the LLP so that they cannot be attributed to the LLPs, the activities of negotiation were undertaken by the LLPs through the Operator. In turn the Operator’s work was carried out by Ingenious’ staff. What then did those staff do for the LLPs?

355. In Appendix 1 we set out the conclusions we draw from the evidence on this question. There we conclude that activity conducted by the LLPs through those persons can be described as constituted by the following principal elements:

(a) Considering for green-lighting films proposed by Ingenious entities. In that context we note here that we do not regard the LLPs as having gone out to search for new films save perhaps in the discussions Mr Clayton had with Fox close to 5 April when new films were sought to mop up subscribed capacity, or a “valve” operated to cope with situations in which subscriptions were insufficient;

(b) Complex, serious and detailed negotiation of the commercial terms of agreements for the making of films;

(c) Entering into contracts for the making of films and in relation to their exploitation under which substantial sums were put at risk;

(d) Keeping an eye on what was going on in the making of the films and in particular paying some attention to the costs of production but without any significant involvement in the creation of the films.

(e) Receiving revenue and reviewing revenue statements from films;

(f) Accounting and administration.

356. In section 1 of Chapter IV above we described the increasing proportion of Studio films which formed part of the LLPs’ slate. We explained that the work involved in putting together a deal for a Studio film and finalising its documentation was less than for an Independent film. For a Studio film Ingenious had a lesser role in the film: the Studios were huge, diversified multinationals with all the requisite resources to produce films without reference to anyone else; they wanted the involvement of the LLPs for their money and to lay off risk; the LLPs and Ingenious had no role in putting the film together, what they did was by comparison closer to buying an income stream in a complex way.

2. Legal Principles

357. Apart from including a “venture in the nature of trade”, “trade” is not defined by the statute. It is left as a word of common understanding. As Lord Wilberforce said in Ransom v Higgs [1974] STC 539 at 554:

“Trade has for centuries been, and still is, part of the national way of life; everyone is supposed to know what “trade” means …

“Trade” cannot be precisely defined, but certain characteristics can be identified which trade normally has. Equally some indicia can be found which prevent a profit from being regarded as the profit of the trade. Sometimes the question whether an activity is to be found to be a trade becomes a matter of degree, of frequency, of organisation, even of intention, and in such cases it is for the fact-finding body to find on the evidence where the line is passed ...

“Trade involves, normally, the exchange of goods, or of services, for reward ... there must be something which the trade offers to provide by way of business. Trade, moreover, presupposes a customer (to this too there may be exceptions, but such is the norm), or, as it may be expressed, trade must be bilateral – you must trade with someone ...”

358. In considering whether an activity is trade it is necessary to “examine what it was exactly that the person did” (Lord Reid: Ransom v Higgs). That means what the LLPs did, not their members, and not what was done by Ingenious for itself or other persons. It will involve a weighing of a number of factors, the relevance and importance of which will depend on the circumstances. There is no complete list of those factors and no rule that any one or more of them are decisive; some of them, the “badges of trade”, are set out in Marson v Morton [1986] STC 463 at 470 ff, others, with particular relevance to transactions which have an element of fiscal advantage, in the judgement of Millett J in Ensign.

359. Whatever else in determining whether something is a trade, the tribunal must stand back and take an unblinkered view of all the circumstances: the totality of the person’s activity and enterprise. That is not a result of any particular facet of the Ramsey doctrine but of the nature of the word “trade” – archetypically whether someone is trading is a conclusion based on commercial substance rather than form. Trade is not a narrow legal concept but a broad commercial one: transactions planned and executed as a single transaction must be viewed as a whole.

360. We shall return to those factors, but given the prominence of Ensign in the arguments before us we should now say a little more about the judgements in that case (which are also relevant to the Expenditure issue discussed in Chapter IX).

361. In Ensign the Special Commissioners noted the tax motivation of the scheme, the projections which showed that the taxpayer (rather than the partnership itself) did better in cash terms if the films performed badly, the lack of evidence of negotiation over the financial return, and the lack of evidence of activity or expenditure control after the signing of the agreements, and concluded that the paramount fiscal motives of the transactions prevented them from being trading transactions.

362. In the High Court Millett J held that the partnership was trading:

(a) he said that whatever the financial substance, the legal structure was that the Victory Partnership acquired a 100% interest in the film, not a 25% one, and paid 100% of the cost, not 25%, although it did so with the assistance of the non-recourse loan (759G);

(b) “The production of a film, or the completion of an uncompleted film (or, I might add the purchase of a completed film), in each case with a view to its distribution and exploitation for profit, are all typical (though highly speculative) commercial transactions in the nature of trade”;

(i) in order to be trading a transaction “must possess not only the outward badges of trade, but also a genuine commercial purpose”;

(ii) the presence of a collateral fiscal purpose does not denature a commercial transaction;

(iii) but if the sole purpose of the transaction (not the taxpayer’s motive) is fiscal it cannot have a commercial purpose (by definition);

(iv) the purpose of the transaction is to be objectively determined considering it as a whole in the light of all the circumstances;

(v) a transaction whose purpose is to make a profit does not cease to be commercial because those who provide the finance may have a fiscal purpose;

(vi) in some cases the shape and character of the transaction is so affected by fiscal considerations that it ceases to be a commercial transaction;.

(d) he said that the Special Commissioners:

(a) were wrong in treating the distinguishing criterion as being whether there was a “paramount” rather than a sole fiscal objective (764E);

(b) based their decision on features which threw no light on the question namely:

(aa) the motive of Ensign rather than that of the partnership, and

(bb) the lack of evidence of activity after the agreement was signed, the lack of interest in controlling expenditure and odd provisions in the agreements. These were merely “footling” considerations;

(e) he said that in his judgement the only possible conclusion was that Victory Partnership was trading. If Lorimar had, as must have been the case (767F) a commercial hope of profit, so would Victory Partnership. (Effectively as to 25% of the total.) The only conclusion could be that the transaction entered into by Victory Partnership was a commercial transaction;

(f) at 768C, he said that the facts that a person obtained financing from investors who were motivated by fiscal considerations and that the transaction was structured to achieve a fiscal advantage “without ceasing to be commercial or jeopardising the prospects of profit” did not prevent a commercial transaction entered into with a view of profit from being a trading transaction;

(g) the transaction had all the characteristics of a typical though speculative trading transaction and none of those of investment – he mentioned the purchase of an uncompleted film, the arrangement for its completion with a view to exploitation, and the uncertain profit and negligible residual value (768J).

363. In the Court of Appeal, Browne Wilkinson V-C came to the conclusion that Millett J had wrongly regarded the Special Commissioners as taking the motive of Ensign as the motive of Victory Partnership and had therefore based his decision on wrong grounds. He regarded it as permissible, when the commerciality or purpose of the transaction was equivocal to look at evidence of the subjective motives of the taxpayer as itself evidence of the purpose of the transaction. That he thought was what the Special Commissioners had done, although, quite wrongly, they had directed themselves that paramount rather than sole fiscal purpose was enough to deprive the transaction of trading status.

364. The case was therefore to be remitted to the Special Commissioners but an appeal to the House of Lords intervened. Lord Templeman gave the leading speech with which the others agreed. The appeal took a different turn because the question of whether Victory Partnership had “incurred” the full 100% of the cost which had lain dormant since Millett J’s decision was resurrected by a cross appeal. Lord Templeman records (at 232 CD) the Revenue argued that the Victory Partnership did not generate any first-year allowance because it was not engaged in trade, and, alternatively by cross-appeal, that it contended that any first-year allowance should be limited to 25%. That was the argument that Victory Partnership had incurred expenditure of only 25%.

365. Before turning to what Lord Templeman had to say we should mention what Lord Goff and Lord Jauncey said in their concurring speeches.

366. Lord Goff said that he accepted that title to the film’s negative did indeed vest in Victory Partnership although “the distribution arrangements which formed part of the same composite transaction deprived that legal ownership of any meaningful effect” (245A): “the transfer or vesting of title to the negative had no function other than to give colour to a tax avoidance scheme”: since the net profits were to be shared 25:75 it could be “treated as irrelevant” (247B). He regarded it as a misuse of language to describe the payments made to the bank account which bounced back to Lorimar as a loan to Victory Partnership to finance Victory Partnership’s investment. It followed that the money paid back to Lorimar could not be regarded as expenditure incurred by Victory Partnership on the film.

367. Lord Jauncey limited his remarks to the question of whether the trading transaction of 25% investment for 25% of the profits had been so eclipsed by the non-trading measures designed to inflate the allowances claimed that it could no longer be treated as a trading transaction. He concluded that was not the case.

368. Lord Templeman started his analysis by saying (231G) that Victory Partnership had incurred 25% of costs, that the negative belonged to it subject to Lorimar’s exclusive rights to distribution, and that there also belonged to it 25% of the net receipts. In those circumstances it was entitled to a first-year allowance of 25%. But the taxpayer claimed 100%.

369. He explained that Victory Partnership only ever expended 25% and was “never liable” to pay more. He criticised Millett J’s description of the transaction and said “the transaction was a joint-venture and contains no element of loan”.

370. At 234g he recited the Crown's arguments:

“The Crown on the other hand argues that a tax avoidance scheme is ineffective and taints the transaction involved in the scheme. In the present case Victory Partnership entered into a scheme with the object of avoiding tax and not with the object of trading. In the course of the scheme Victory Partnership contributed [25%] to the cost of the film and became entitled to 25% of the net receipts; that transaction in isolation would admittedly constitute trading in the making and exploiting of films. But the transaction was only part of a tax avoidance scheme. It follows that the conditions of section 41 of the 1971 Act are not fulfilled. ... Victory Partnership did not carry on trade and did not incur capital expenditure for the purposes of trade ...

“There are therefore two rival submissions. Mr Gardiner submits that the taxpayer may enter into any transaction in any form he pleases and the court is confined to that form and cannot have regard to the rights and obligations which flow from the transaction because the court cannot consider the substance of the transaction. The Crown on the other hand appears to look upon tax avoidance as a corporate cancer which infects and destroys any fiscal effects advantageous to the taxpayer.”

371. It is not wholly clear that in the third sentence of the first quoted paragraph Lord Templeman is expounding the Crown’s submission or setting out his own conclusion. If the Crown were accepting that a 25%:25% transaction would be trading, then the question of whether it was trading did not formally arise. There is no record in the decision that the question was argued. Taking his statement only as a recital of the Crown’s acceptance of trading is consistent with his description of the rival submissions in the following paragraph. On the other hand, as we show below, there are many occasions on which the view that it was a trade does appear to be accepted.

372. He then considers Duke of Westminster [1936] AC 1 and concludes that it does not assist Victory Partnership: “In the Duke of Westminster case the fiscal consequences claimed by the Duke corresponded to the legal consequences of the transactions as construed by the majority of this House. In the present case the fiscal consequences claimed by the taxpayer do not correspond to the legal consequences of the scheme documents read and construed as a whole.”

373. Turning to FA & AB Ltd v Lupton [1972] AC 634 he recited the Crown’s reliance on it because the House of Lords had held tax avoidance was not trading. He then said:

“But in dividend stripping cases the tax avoidance scheme negatives trading because on the true analysis of the transaction the trader does not trade at all. In FA & AB Ltd v Lupton where there was neither a profit nor loss the House did not consider the present situation in which on the true analysis there was trading involving an expenditure of [25%]. The financial consequences of that scheme ... produce ... a first-year allowance of that sum. The task of the courts is to construe documents and analyse facts to ensure the taxpayer does not pay too little tax or too much tax but the amount of tax which is consistent with the true effect in law of the taxpayer’s activities. Neither the taxpayer nor the Crown should be deprived of the fiscal consequences of the taxpayer’s activities properly analysed.” [our italics]

374. The italicised words indicate that Lord Templeman considered that the 25%:25% transaction was trading.

375. Lord Templeman then moved on to discuss the Ramsay line of cases. After discussing Chinn v Collins [1981] STC 1 he says that “in the present case Victory Partnership claims to be a borrower of [75%] and to have expended that sum borrowed in making a film. However on the true construction of the documents Victory Partnership was not a borrower and expended [25%] only”. At 239C “It is crucial, when considering the tax avoidance scheme in the present case to take the analysis far enough to determine where the expenditure on the film is really to be found. The expenditure of [75%] is really to be found to have been incurred by [Lorimar]”.

376. He later discusses the passage in which Browne Wilkinson V-C distinguished between the Commissioners’ finding that the sole object of the transaction was a fiscal advantage – which could lead only to one conclusion, and a conclusion that a paramount intention was a fiscal advantage where a weighing exercise might be necessary and says:

“My Lords I do not consider that the commissioners or the courts are competent or obliged to decide whether there was a sole object or paramount intention nor to weigh fiscal intentions against non fiscal elements. The task of the commissioners is to find the facts and to apply the law, ... the facts are undisputed and the law is clear. Victory Partnership expended capital of [25%] for the purposes of producing and exploiting a commercial film. The production and exploitation of the film is a trading activity. By section 41 of the 1971 Act capital expenditure for a trading purpose generates a first-year allowance. The section is not concerned with the purpose of the transaction but the purpose of the expenditure. It is true that Victory Partnership only engaged in the film for the fiscal purpose of obtaining a first-year allowance but that does not alter the purpose of the expenditure. The principles of Ramsay and subsequent authorities do not apply to the expenditure of 25% because that was real and not magical expenditure by Victory Partnership.

377. As Mr Gammie says, Lord Templeman deals in this paragraph with two issues (1) whether something which was unequivocally a trading transaction was prevented from being such by a fiscal purpose and (2) the extent to which the Ramsay principle affects the understanding and application of the word “incurred”.

378. Mr Milne said that the issue of whether or not Victory Partnership was trading was squarely before the House of Lords. It seems clear to us that the focus of the argument before the House was on the Crown’s two arguments (1) that the fiscal motive denatured trading activity, and (2) that only [25%] was incurred. There is no indication of any detailed argument as to whether the transaction, understood as a 25%: 25% deal, was a trading activity although it is clear that Lord Templeman (and in the High Court, Millett J) instinctively considered that it was. Although Millett J overturned the Special Commissioners’ decision he did so because he considered they had applied the wrong test in relation to fiscal purpose. It seems to have been assumed without argument before him that a simple transaction under which 25% of the film rights were acquired for 25% of the cost and 25% of the income received would be a trading transaction.

379. Overall we do not therefore regard Ensign as holding that as a matter of law the acquisition of film rights and their exploitation in return for a share in the receipts is a trade. But it is, we accept, a strong indicator that a transaction such as that undertaken by Victory may be a trade.

380. Mr Milne says that the LLPs were in a position closer to the trading paradigm than was Victory Partnership: (i) almost all the LLPs’ films had started filming after the agreements were signed; Outland’s filming had been finished when its contracts were signed, Victory’s filming had started by the time the contracts were signed; (ii) Victory Partnership did a lot less than the LLPs: the LLPs selected films, negotiated the terms of the contracts in what had been acknowledged to be a hard-headed way, monitored the production and checked receipts.

381. Mr Gammie says that in Ensign the partnerships acquired the rights to the negatives in the films; Victory Partnership contracted for the completion of production and for the exploitation of the film. Under Victory Partnership’s distribution agreement the title to the negative was to belong to Victory; the distributors merely had licences to exploit it. The LLPs by contrast had no interest in the film other than perhaps the bare legal interest of a constructive trustee. In Ensign Victory Partnership contracted with the equivalent of the PSC to acquire the negative; the LLPs contracted with the PSC because they (and the CD) wanted to divest themselves of production responsibility.

382. We do not think that the precise distinction between the rights to the negative which were held by the Victory Partnership, and those rights in the film held by the LLPs provides any real commercial distinction between the two. Lord Goff said that the Victory Partnership distribution arrangements deprived its ownership of any meaningful effect; we have found that an LLP has no more than the rights of a constructive trustee.

383. Whilst some form of ownership of the negative was relevant to Victory Partnership’s claim to capital allowances, it seems to us that in relation to the commercial question, “was it trading?”, the difference in ownership rights between Victory’s legal ownership “without meaningful effect” and the LLP’s limited rights is not of significance.

384. Nor is it possible in our view to characterise the Victory Partnership’s transaction as an acquisition and then something akin to a sale; there, as in the current appeal, everything was agreed at the same time. Under the single composite transaction Victory became obliged to pay 25% and obtained the right to 25% (or so) (and retained a right in the negative which had no meaningful effect).

3. Comparison with Eclipse 35, Samarkand and Degorce

385. Each of these cases involved a transaction in one or more films which resulted in the expenditure of a sum of money in return for an income stream. In each case the FTT found that the activity was not a trade. In each case that conclusion was not disturbed on appeal.

386. Mr Milne distinguishes the facts in Ensign, and those in the present appeals, from the later cases of Proteus and Samarkand [2012] SFTD 1, Eclipse 35 [2012] SFTD 823 Eclipse Film Partners No 35 v HMRC [2015] EWCA Civ 95 and Degorce [2013] SFTD 806 FTT. By contrast he says that the transactions under consideration in those cases were single composite transactions which had the form of a purchase of film rights and their exploitation, but in which the asset acquired and sold was commercially immaterial, and by which the taxpayers merely acquired an income stream (of a substantially fixed nature in the first two cases but of a more speculative nature in Degorce) for a capital sum.

387. In Proteus and Samarkand a transaction “had the nature of the payment of a lump sum in return for a series of fixed payments over 15 years”. The FTT held that was not a transaction in the nature of trade. The consequences of the transactions in those appeals are, we agree, quite different from those in the LLPs’ appeals and, even if regarded purely as monetary transactions, the return on the LLP’s outlay on any film is uncertain and speculative. Further the way in which the transactions were undertaken by the LLPs and the surrounding activity distinguishes the LLPs’ transactions from those in Proteus and Samarkand.

388. Mr Gammie relies on Eclipse. In Eclipse an LLP took a licence from Walt Disney of rights in two films and granted a sub-licence to a Disney subsidiary. Under the sub-licence the LLP was entitled to a fixed royalty and “contingent receipts”. As part of the arrangement Eclipse entered into a marketing services agreement with another Disney subsidiary under which that company would assist with marketing plans and help supervise distribution. The FTT found that, given Walt Disney’s own expertise, this latter agreement had little effect in practice (and did not make the subsidiary an agent of the LLP). They were unable to conclude that Eclipse had a meaningful part in directing the release of the films by the distributor.

389. The FTT concluded that the prospect of contingent receipts being payable was remote. As a result they found that the transaction lacked the speculative element normally expected in a trading transaction. They said it was difficult to see what services Eclipse offered to Disney by way of business and regarded the “customer” test as not satisfied. They held that Eclipse was not trading. That finding was not disturbed on appeal to the Upper Tribunal or the Court of Appeal.

390. Mr Gammie says that the LLPs were similar: in practice they had nothing they could provide, and nothing they did provide towards the making of the films other than finance.

391. To our minds what principally distinguishes the LLPs from Eclipse 35 is the nature of the LLP’s receipts. Eclipse received a fixed royalty whose amount was independent of the success of the film and had the right to contingent receipts: the only element of its return which could be called speculative was the right to the contingent receipts and that was nugatory; but the LLPs’ whole return was speculative and substantial. There are also differences in what the LLPs did. Eclipse entered into agreements in relation to two films; the LLPs evaluated films, and negotiated and entered into many agreements; Eclipse had a marketing services agreement which was moribund; the LLPs played a small administrative role: they also gave approvals – albeit fairly automatically, they interfered a bit, they looked at budgets; they may have done this in order to look like producers, but the question is not why they did it, but what they did.

392. Mr Gammie does not accept Mr Milne’s dismissal of the relevance of Degorce. In that case the taxpayer became entitled to a speculative return as a result of “prearranged contracts which were designed to, and did, follow each other in very quick sequence”, and as a result of which it was clear that at the end he “would be left with only the income stream”. The UT upheld the decision of the FTT that the transaction was not a trade and distinguished Ensign ([99]). Mr Gammie says that the LLPs were in a similar position to Mr Degorce.

393. In Degorce the taxpayer purchased film rights and immediately sold them for a share of the film receipts determined by a contractual waterfall. The taxpayer asserted that he was trading and that he had suffered a trading loss by reference to the written down valuation of his rights under the waterfall. Those rights depended on the performance of the film and were not fixed as in Samarkand or Eclipse 35. The FTT held that despite the speculative nature of the transaction the taxpayer was not trading. The UT did not disturb that finding.

394. In Degorce the FTT first considered the Marson v Morton badges of trade. It found that there was no repetition and no link to any existing film production of the taxpayer. It found of significance that the purchase and assignment of the film rights took place simultaneously and were entered into without regard to the true value of the rights: the transactions amounted to nothing more than the payment of a lump sum for an income stream. It concluded that the only real understanding that Mr Degorce had of the (complicated) scheme was in respect of its tax implications. It concluded that the actual asset purchased under the scheme (the film) was irrelevant to Mr Degorce.

395. The FTT’s recital of the factual background gives a clear impression of a complex packaged scheme sold to Mr Degorce to reduce his tax bill and put into effect over the course of three or four days.

396. By contrast the LLPs through the Operator conducted complex negotiations for their contracts, in varying degrees they evaluated the films – they were not just any old films, and were concerned about the size of their budgets. They entered into more than one contract. The nature of what they did was different.

4. “Production”: What’s in a Name[17]?

397. The Information Memoranda speak of the LLP’s “producing” films and games. The relevant agreements speak of the LLP as the Producer. Those negotiating the agreements wanted the LLP “to be seen as the producer”. In their evidence Messrs McKenna, Reid, Clayton and Bower spoke of the LLPs as the “producers” of the films and games and Mr Olsberg thought that the LLP could be described as a producer.

398. Further we have little doubt that some of the actions taken by Ingenious’ staff after contracts had been signed were designed to give the impression that the LLPs were involved in the actual production of the film during its filming. Details of telephone numbers were received, requests were made for information they would not use etc. But the motive for these actions does not take away from the fact that they took place and were a part of the activity which must be objectively evaluated, even if a fairly pointless or less weighty part.

399. Mr Finney described the work a traditional producer might do: organising the development of the screenplay; finding a director, cast and crew; arranging finance; putting everything together; and managing the organisation of the actual making of the film. That sort of activity we think would normally be a trade, but it is different from the activity which was undertaken by the LLPs.

400. But Mr Milne made clear that the LLPs were not arguing that they were producers in that sense. This was not a dispute about a name. Instead they relied on what they actually did as being the activity of a trade by whatever name (if there was a name) that activity could be described.

5. The Relevant Factors

402. In the following headings we shall address the factors which the precedents have indicated may be relevant to the assessment of whether an activity is a trade.

(1) A Customer

403. At [355] above we cited Lord Wilberforce’s comment in Ransom v Higgs, that trade presupposes a customer or, as it may be expressed, trade must be bilateral – you must trade with someone. In Eclipse the Court of Appeal explained that that comment (and a similar comment by Lord Reid) was made in a context where the taxpayer did not have a counterparty. They said: “[116] Undoubtedly, trading activity involves a counterparty of some description. We do not find it helpful however, in a complex transaction … to seek to identify whether the counterparty is … properly characterised as a customer.”

404. It was clear to us that despite the way in which the relevant agreements had been drawn to give the impression of the acquisition by the LLP of rights in a film and their later sale to the CD, such was not their substantial legal, or commercial effect. Not only were the agreements part of a single deal but the LLP never acquired any substantial interest in a film. The most that could be said is that it contracted for a film to be delivered to the CD for a share in the income arising. It did not sell the film to the CD: but it provided finance to the CD.

405. But it seems to us that however one describes the nature of the LLPs’ activity there is not such an absence of a counterparty as to deprive its activities of a trading nature. The CD was a counter party with which each LLP had commercial relations under which it agreed to do things and obtained substantial rights to receive money. The PSC was also a party to which the LLPs paid money in return for its agreement to make the film. The LLP’s financial activity was the exchange of a sum of money paid to one party for a potential future financial reward from another.

406. We accept that the LLPs’ counterparties may have regarded them as sources of finance rather than as film producers (and that, on occasions, Ingenious personnel so described the LLPs’ activities), but nevertheless those counterparties did deals with the LLPs.

(2) Organisation

407. This again is one of Lord Wilberforce’s factors [18]. This may be in the way in which things are done or in the resources used to do them. A well-run ordered activity with well defined strategies, and a business which employs serious resource and effort exhibit characteristics of traders.

408. This factor is present. The Ingenious personnel provided not insignificant resource for the selection, negotiation, and follow up of film contracts. The work undertaken in putting together Independent film projects may have been greater than that in negotiating with Studios, but in each case there was an organisation geared towards promoting the business of contracting for films and receiving the income from them.

409. This factor in our view points towards trade.

(3) Repetition

410. This is one of the Marson v Morton badges of trade (as are (4) to (11)).

411. There was repetition. Each LLP undertook a number of films or games. They generally tended to be contracted for quite close to the 5 April year end, but there were a number of distinct transactions in the case of each LLP.

412. Mr Gammie says that repetition does not alter the character of an activity, but we think it may form part of the character, or at least illuminate that character.

(4) Is the transaction related to an existing trade?

413. For each LLP’s first year it could not be said that it had an existing trade of which its transactions in that year were a part or an expansion. IFP2 continued contracting for films after its first year. That continuation was not clearly indicated as an intention in its Information Memorandum and cannot retrospectively affect the first year’s activities.

414. Consideration of this factor does not point to trade.

(5) The nature of the subject matter: was the subject matter the kind of thing which is normally the subject matter of trade or can only be turned to advantage by realisation?

415. Mr Gammie says that viewing the facts realistically the composite transactions consisted merely in the acquisition of rights to possible future revenue. Indeed in some correspondence Ingenious personnel speak of their contribution as arranging finance for films (though it is not always wholly clear whether that activity was carried on for Ingenious or an LLP).

416. We agree that this was the financial effect of the rights and obligations which arose under the contractual matrix. The Avatar Hedge illustrated this. There was, realistically (and we would say legally) speaking, no acquisition of any beneficial right in a film or game of any value and no disposal of it. But a bank trades in making loans. A bookmaker trades in money and risk. Each of them tends to do it over a long period and with a degree of organisation.

417. Overall we think that consideration of this factor may not point to trade but does not point away from it in the circumstances. We note that in Ensign Lord Jauncey said that as Lord Templeman had pointed out expenditure “of [25%] on the making of the film in return for 25% of the net receipts carried all the characteristics of trade”. Yet Victory Partnership’s transaction was not substantially different from many of the film transactions carried out by the LLPs, and the LLPs had, through the Operator, more going on than ever Victory Partnership did. Victory Partnership’s “meaningless” right to the copyright in the film makes no commercial difference. We conclude it does not in the case of the LLPs point away from trade.

(6) The way in which the transactions were carried through: was it done in a way typical of a trading in that subject matter?

418. If the subject matter of the transactions is regarded as a film, then they were conducted in a novel manner: the CD Model was an innovative structure. Mr Finney told us it was (at least initially) unusual. Mr Antoniades told us that it later became a recognised structure. But it does not seem to us to be a structure for dealing in a film but one for the acquisition of an interest in the proceeds of exploitation of a film.

419. What was typical of the transactions was the effort involved in their arrangement and negotiation. Overall we think this consideration points towards trading, or at least not away from it.

(7) The source of finance. Borrowing to buy may point to resale in the short term.

420. The LLPs did not borrow. They were financed by the capital subscriptions of their members. This factor does not point towards trade.

(8) Was work done on the object? Work done may point to a trade.

421. The form of the contracts was that the LLP took on a liability to produce a film. The legal effect of the contracts was that once the LLPs had paid they had no obligation to do anything further in relation to the making of the film: they were liable only if they interfered with what the PSC was doing (See section 4 Chapter II above). The LLPs did not add anything substantial to the making of the film once the contracts were signed.

422. Mr McKenna’s evidence was that the LLPs’ creative input took place before the contracts were signed. We accept that there may have been some such activity in relation to Independent films but we saw no relevant evidence of it in relation to Studio films where the film was developed by the Studio and was ready to go when Ingenious stepped in.

423. For Independent films we accept that Ingenious paid a greater role in putting together the finance for the film and that to an extent the Ingenious personnel undertaking that activity may have done it in part for the LLP (although it was also clear that in part it was also done for other Ingenious vehicles as, for example, where a sale and lease back of the film was also organised).

424. Overall we think it can be said that there was some work done by the LLPs which was akin to work done on an object which was to be sold.

(9) Breaking down into lots may suggest trade.

425. Consideration of this factor does not point to trade.

(10) Whether the purchaser intended to sell at the time of purchase “if before the contract of purchase is in place a contract for sale is already in place that is a very strong indicator of a trading deal rather than an investment.”(per Browne-Wilkinson V-C at 471 in Ensign).

426. If the asset is viewed as the film, then this points towards trading; Mr Gammie says that viewed realistically the rights acquired were future revenues designed to be held for the long term.

427. Browne-Wilkinson V-C’s explanation of this factor may at first sight seem to encompass the arrangements made for the film, but it seems to us that he is considering the situation, not where by virtue of the contractual matrix the acquisition is merged into the sale, but where there is a contract of sale followed at a later time by a purchase: a speculative short.

428. We agree with Mr Gammie, the commercial (and legal) reality was that the right acquired was the right to income and the LLP did not intend to dispose of it although the right was realised (so in effect consumed) as monies flowed into the LLP.

429. Consideration of this factor does not point to trade.

(11) Did the asset provide enjoyment or an income pending resale? If so it would be more likely to be an investment.

430. We do not regard any satisfaction the members of the LLPs had in knowing that they were indirectly associated with well known films as relevant. We do not think it realistic to regard the LLPs as acquiring a film or game which they held pending resale. Viewed as a right to income the asset was income pending exhaustion, but it was not the type of income one expects from an investment, which would normally have some residual value. Consideration of this factor does not point to investment but on balance does not point towards trade.

(12) Speculation: the possibility of profit; the undertaking of risk.

431. In Ensign Millett J regarded the speculative hope of profit as indicative of trade. (But we note that in Harrison 40 TC 281 at 293 Lord Reid says that absence of profit motive may not be fatal to a conclusion that a person is trading.) In Eclipse (at [398]) the FTT regarded the speculative hope of profit as an important factor.

432. This factor is present. There was a possibility of profit and a risk of loss. We discuss the nature and the measurement of the likelihood of such a profit later in this decision, but we conclude that there was a speculative hope of profit of some kind.

433. (13) A genuinely commercial purpose: a transaction must possess not only the outward badges of trade but also such a purpose. This may be regarded as a requirement rather than a factor to be accorded appropriate weight. This was the first of Millett J’s list in his judgement in Ensign.

434. It was clear that in Ensign Millet J regarded this condition as satisfied. In that case the Victory Partnership acquired as a result of the composite transaction an interest in 25% of the film revenues. In the instant appeals the LLPs acquired as a result of the composite transaction a specified interest in the film revenues. In each case there is a possibility of profit. In Ensign the Victory Partnership acquired the film negative beneficially; in the instant appeals the LLP had no beneficial interest in the negative. But Lord Goff regarded the interest in the negative as “irrelevant”; it is thus difficult to see that as a distinguishing feature.

435. We find this requirement is satisfied. In commercial substance the LLPs paid and were obliged to pay 30% (35%) of the budgeted cost and received and were entitled to receive 30% (35%) of GDI. That was a genuine commercial deal.

436. If we were wrong and the legal effect or commercial substance of the transactions was that the LLPs bought the film or game for 100% of budget and became entitled to at best 54.45% of GDI we would find that the deal was not commercial, and that this test was not satisfied.

Overall

437. We must now stand back and look at the whole picture having particular regard to what an LLP actually did.

438. In relation to Independent films there was more substance to the LLPs’ activities; for Studio films the activities had more of the characteristics of arranging and monitoring investments in an income stream (that was particularly the case where an LLP came into the picture at a very late stage when almost all the elements of the film had been pulled together and principal photography was about to start). But the two activities were part of the one business.

Taking all this together we conclude, on balance, that the LLPs were trading: the Operator did more than act as an investment manager of a portfolio of investments: through its actions and those of its agents the LLPs engaged in speculative, organised, repeated transactions in a way which involved work beyond that which would have been involved in the mere making of an investment.

6. Fiscal Motive

439. If the taxpayer’s acts are equivocal his purpose may be a material factor in weighing the total effect of all the circumstances, and if the shape and character of the transaction is so affected by fiscal considerations that it ceases to be a commercial transaction it will not be a trading transaction.

440. There was no doubt in our minds that the obtaining of loss relief for investors in the LLPs was understood, and regarded as important, by those at Ingenious who managed the LLPs. The Ingenious organisation was well acquainted with tax-based products and promoted a number of them. There was no lack of tax experience in the organisation. Other persons such as HSBC obtained the impression from their dealings with Ingenious that its business included devising tax-advantaged products.

441. For the reasons which follow we have concluded that one of the purposes of IFP2 in entering into the CDA/PSA format for the agreements for films was to attempt to secure a tax benefit for the investors.

442. Mr McKenna told us that the ability for investors to claim loss relief was an important part of investment in an LLP. Investment in film was very risky and it was irrational not to offer investors an opportunity for loss relief.

443. If the tax results of investment into an LLP turned out to be as anticipated by the Information Memoranda, then the effect of the tax repayment or reduction following sideways loss relief would be that the investors’ subscriptions would be substantially matched by a repayment or reduction in liability within a few months. Thereafter the investor would suffer no further loss (ignoring for the moment the non-film business) but would realise a net after-tax profit on any distribution by the LLP. It seems to us that when Mr McKenna described it as a business opportunity with a tax advantage, he understated the benefit of the tax advantage – which was substantially to remove, rather than to mitigate, the risk of investment.

444. It is true that as an LLP receives money from a film, the initial tax benefit is unwound, and that if an LLP becomes profitable that benefit is completely unwound. But that does not affect the removal of the investment risk afforded by the initial tax repayment or reduction.

445. The LLPs were, as Mr McKenna accepted, promoted on the basis of models which assumed their tax efficiency. Third parties described them as tax funds, and on occasion they were similarly described by Ingenious personnel. They were promoted to those high-net-worth UK resident individuals who paid tax at 40% and could make best use of the losses. A calculator supplied to financial advisers steered the investment decision by reference to the amount of the investor’s taxable income which could be sheltered by the first year losses. A letter for financial advisers to send to their clients in relation to IG explained that “tax relief alone could return your cash investment”. The Information Memoranda set out the anticipated tax results. Mr McKenna retorts that that investment in an LLP was not a tax shelter but a bona fide business opportunity with tax advantages. But it is a large tax advantage.

446. Mr McKenna accepted that, when in 2007 sideways loss relief was withdrawn, a number of Ingenious staff were made redundant in the expectation that there would no longer be a market for investment in the LLPs: one needed the tax relief for investment in a high-risk area.

447. The businesses of the LLPs were managed with the loss relief in mind. There was, as Mr McKenna accepted, a policy of signing deals before 5 April but not afterwards. (Indeed the Members’ Agreements provided for the refund of members’ subscriptions if made after the relevant 5 April.) It was clear to us that this was to ensure that the losses arose in the year of investment rather than in subsequent years (where they would have been delayed and possibly diluted by the receipt of income). Further as we explain in Appendix 9 the calculations of NRV were made on a very conservative basis, which would enhance the tax losses. That suggested an approach which was at least consistent with ensuring tax losses.

448. It was also clear that a significant factor in the development of the IFP2 structure (the addition of the Tranche A and B loans for the investors and the non-production activities) was to enable loss relief to be obtained at the rates which had previously been obtained in ITP by reference to the same funding from the investors’ own resources.

449. It seems to us that the Commissioning Distributor Model was designed at least in a material part to obtain greater loss relief by routing, or purporting to route, the full cost of the film through the LLPs. That is for the following reasons:

(a) the model is shown in two facets of its actual use not to require the LLP to be responsible for 100% of the cost. Those facets are: (i) the shortfall financing when, because the LLP could not raise the full 30%, additional finance was provided by a Shortfall Financier who took a proportionate share of GDI as a result (see Chapter IV section 2); and (ii) the occasion, such as happened in the case of Avatar where another Ingenious LLP “co-produced” the film, each provided part of the funds;

(b) the desire to be at the heart of production could have been achieved by having the same rights and obligations in relation to production but having the CD and the LLP being obliged to fund the PSC separately and directly without the arrangement for the CM loan. There was nothing in the evidence which indicated that those rights and obligations could not have been the same in the relevant agreements if the funding obligation had been changed.

(c) the aspects of the model which limited development risk, financing risk, and distribution risk would have been unaffected by a change in the expressed funding obligation; and

(d) in fact a proper construction of the rights and obligations imposed by the contractual structure reveals that in law and in practice the LLP was only obliged to fund 30% (35%).

450. Thus we conclude that those managing IFP2’s business arranged for the particular 100% contractual arrangement in order to deliver (enhanced) tax losses to the members.

451. Mr Gammie says that the way the transaction has been fashioned gives the game away, and that fiscal considerations informed almost the entirety of the design of the Commissioning Distributor Model: those considerations explain its awkwardness and contrivance. In this way he says that the “shape and character” or “form and content” of the transactions can be seen to have been so affected by fiscal considerations as to mean that they are fiscal and not trading in nature. In the alternative, if the application of the normal factors or badges produces an equivocal result, the shaping of the transactions effectively tips the balance and denies them trading status.

452. It does not seem to us that this analysis can stand in the light of Ensign and our conclusions as to the rights and obligations which arise under the agreements. In Ensign an ordinary 25%: 25% transaction was dressed up as a 100% investment using money which bounced through Victory Partnership’s bank account. The ordinary transaction was a trading transaction. When the clothes of the dressed up transaction were removed, the transaction which remained was the ordinary transaction. The House of Lords held that the attempts to dress it up did not denature it.

453. The same is true in this appeal. The ordinary transaction is a 30% (35%) investment for a 30% (35%) share of GDI. It is dressed up to look like 100% investment for a share of GDI of no more than 54.55%. On examination of the composite agreement it is seen that the legal obligation is to make a 30% (35%) investment and the legal right is to receive 30% (35%) of GDI. Once the clothes are removed, the ordinary transaction is revealed. If that ordinary transaction is a trading transaction then attempts to dress it differently do not prevent it from being a trading transaction.

454. We referred earlier to Millett J's summary of the law applicable when there was a fiscal purpose. Applying the relevant parts of that summary to the 30:30 transaction actually entered into by the LLPs: objectively it was a transaction which had a commercial purpose; despite the fiscal motive of the LLP in entering into it and dressing it up as something else, it was not denatured and could fairly be described as a trading transaction; the objective nature of the transaction had at its core a 30% investment for 30% of GDI; the shape and structure of that transaction was not determined by the fiscal purpose.

455. Mr Gammie says that the question of whether or not the LLPs were trading has to be answered by reference to the tax construct which was designed to give the impression of a 100% investment when only 30% (35%) was contributed, not by reference to the commercial aims of all the other parties. We agree that the aims of the other parties are not relevant, but we consider that the transaction which must be examined is that which is embodied in the actual rights and obligations of the parties and their practical implementation, not the clothes in which they have been disguised, or by reference to a story designed to provide a sequential picture of the acquisition and disposal of rights and obligations, which is not relevant to the ascertainment of the nature of the LLPs’ rights and obligations or their financial consequences.

456. If we are wrong and the legal effect of the agreements is as the Appellants contend (100 of expenditure for no more than 54.55% of GDI etc), then we would conclude that the transactions lacked commerciality and that the fiscal motive of the LLPs (acquired by them from Ingenious personnel through the Operator) when taken in the balance would mean that they were not trading.

5. The Evidence Given by the Controlling Minds of the LLP’s

593. Each LLP’s Operator was an Ingenious company. It was clear to us that the controlling minds of those companies, and thus of the LLPs were Mr McKenna, Mr Reid, and, after 2003, Mr Clayton. Mr Bower joined in 2005: we did not regard him as a controlling mind, but his evidence assisted in evaluating the evidence of the other three.

Mr McKenna

594. Mr McKenna spoke in his witness statement about the balance between risk and reward. He said that to focus on maximising profit is usually to accept an unsustainable level of risk. Their aim, he said, was to mitigate risk to the fullest extent possible “while still preserving the ability to profit from successful films”. He says that when green-lighting each film they believed “that they were capable of delivering profits”.

595. The business model, he said, was designed to enable the LLPs to scour the market for the best and most commercially promising projects with the greatest potential for making profit. Their aim he said was to produce best-of-breed films for a worldwide audience with the clear aim of making as much profit as possible. He told us that they cherry-picked films because only certain films had the potential to make a profit. They only green-lit a film which they believed had a realistic chance of making a profit. That was the threshold. He preferred making hit films: seeking hits was what Ingenious did. He suggested that seeking profits was an essential part of the model, because unless they sought profits investors would have no access to the tax losses.

596. Mr McKenna also told us that:

(a) films which produced a substantial return for their backers were like hen’s teeth. British films rarely recouped their budget;

(b) one of the objects of having a slate of films was to increase the likelihood of securing a hit, and to mitigate the effects of disasters. For an LLP to make a profit the hits had to make good all the losses;

(c) in the case of IFP, but not ITP, the “first dollar corridor” from gross receipts increased the likelihood that a film which did not make a profit for the LLP would provide some contribution to the LLP even if its performance was dire;

(d) the first dollar corridor and presales would mean that investors would receive some return of their investment even if a film did not make a profit for the LLP;

(e) the Ingenious film personnel knew that unless an LLP was managed with a view to profit it would not deliver to the investors the tax benefits advertised in the Information Memoranda. As a result the LLPs were managed with a view to profit;

(f) Ingenious’ rule of thumb was that a film was likely to be profitable for an LLP if, in the case of a Studio film WWBO > 2x budget, and in the case of an Independent film, collected gross receipts > 2x budget.

597. We note that even a casual glance at the composition of the list of the films in which the LLPs participated shows that the LLPs took part in many high-quality, high-profile films. Many were involved in Oscar and BAFTA nominations and wins, and many of their titles will be known even to infrequent film watchers. That success, however, is different from profit: Closer proved that – it was an Oscar-winning film but never recouped its P&A expense and the LLP got nothing from it.

598. We comment on Mr Mckenna’s 2x budget rule of thumb in section 7 below.

599. We have four comments on Mr McKenna's evidence:

600. (i) First, that he spoke mainly of the capability or ability or potential to make profit rather than the likelihood of profit. We accept his evidence that there is no way to guarantee the performance of a film in advance, but there is a difference between thinking that something is possible and that something is likely or realistically possible.

601. (ii) Second, there is a difference between profit for the CD or Studio, profits for the LLPs computed on the Ingenious basis, and profit for the LLPs on the 30:30 basis. Mr McKenna illustrated his expectation that WWBO of more than 2 x budget would deliver a profit on the film for the LLP by some “kitchen table calculations”. We return to them later, but inherent in the Ingenious basis of profit computation is that the LLP is at a disadvantage compared to the CD, and thus in order for a film to be profitable for the LLP it has to perform even better than it would have to be profitable for the CD. We accept that Mr McKenna sought successful films, but there was no indication in Mr McKenna’s evidence of any recognition that the measure of success needed to deliver a profit on the Ingenious basis was thus higher than that required for a Studio.

602. (iii) Third, Mr McKenna described real moneymaking films (like The Full Monty or Four Weddings and a Funeral) as like hen’s teeth. There were many more losses than hits in the business. He said that it was easy to express a view on a finished film, but much more difficult to say with any certainty how a film would turn out. The LLPs were picking films which could make a loss or could make a profit but where the chance of a real hit was low. That raised the question of whether the LLPs seriously considered the overall position rather than film by film. If it was unlikely that they would choose a real hit but likely that a material proportion of the films would make a loss (however computed), would the profits of the moderately successful films make up for the losses? Save in relation to the illustrations in the Information Memoranda (as to which see below) we saw little evidence that the LLPs had given serious or detailed consideration to this issue.

603. The “slate approach” did not provide an answer: as we noted earlier its ability to deliver a better chance of an overall profit depended upon the distribution of probabilities of possible outcomes. This dependence on the distribution of probability of profitability was alluded to in an e-mail Mr McKenna sent Mr Reid on 25 July 2003 in relation to a proposed project in which Ingenious would not participate in the receipts from the start. He said that the message to be delivered to the promoters of the other project was that:

“1. One big film in the slate doesn't pay for the others when you don’t participate in the first 70% of income arising from the other films, and 2. You can still make a full recovery of the slate budget and a handsome profit/return when you get one hit and participation in income arising at different levels from other films in the slate.”

604. Thus one unlikely big hit coupled with early access to receipts might ensure profits, but if there was no big hit would the slate be profitable? And how big a hit did it have to be to deliver under the waterfall enough income to mop up the losses?

605. (iv) Fourth, we accept that it is likely that Mr McKenna, Mr Reid and Mr Clayton knew the importance for investors’ tax position of the LLPs being managed with a view to profit. They knew that they had to have that intention, but knowing you have to do something is only the beginning, and not its execution.

Mr Reid

606. In his witness statement Mr Reid said (in parallel terms) that IFP2/IG “worked very hard to ensure that every [film/game] it produced had the potential to be a hit, and only green-lit [films/games] it genuinely believed could deliver substantial profits in success.”

607. He said that despite the tax benefits which the structure delivered to investors “the driving concern of each Inside Track partnership was to make money from the commercial success of films. To that end they needed to identify commercially successful films which would generate profits for our partnerships.”

608. He gave an example in relation to Blackball: that additional expenditure on changes to the film was authorised because they thought it would enhance the chance of larger revenues.

609. He explained how Ingenious used its growing commercial strength to obtain better terms – he gives examples of a reduction in the distribution fee from 20% to 15% for IFP2 and the gross corridor in the IFP deals.

610. Mr Reid provided a list of about 200 films which had been rejected by Ingenious for Inside Track. He said that proposals were rejected for a variety of reasons including the following:

(a) the developer had failed to attract the 70% finance required for Ingenious’ involvement;

(b) doubts over the quality of the proposed financial commitments of others;

(d) failing to sign the star or director needed.

611. He explained that Ingenious was searching for films which could be “made ready to go into production in the short term and which met certain objective criteria:

(a) commercial viability (by which he meant that the project involved well-known actors or directors);

(b) an experienced day-to-day producer;

(d) a sales agent for Independent films.

612. We had reservations about this evidence which were similar to those we had about Mr McKenna’s evidence:

613. (i) The evidence was generally of the potential to make profit, rather than the likelihood of profit.

614. (ii) There was no recognition that, on the Ingenious basis of determination of profit, it was more difficult for the LLP to make a profit: that a film had to be more than usually successful.

615. (iii) Improved terms may deliver profits or make more profits, but may also limit or reduce losses and provide income (not profits) to investors.

616. (iv) The likelihood of profits for the LLP depended on the distribution of the likelihood of profits and losses of the films or games.

Mr Clayton

617. Mr Clayton said that in working for the LLPs they had both the LLPs’ and the individual investors’ interests in mind: “[t]he overarching aim was to optimise both the [LLP]’s chances of profitability and returns for the members.” He explained that the structure gave access to revenues in the waterfall which had previously been the preserve of banks. We comment that optimising the chance of profit is not quite the same as having a realistic aim of profit, and that returns for the members are not the same as profit for the LLP.

618. Mr Clayton was an investor in an LLP. Mr Stafford asked him what he was expecting from his investment and whether he expected distributions in excess of his original investment. He said that he knew he would get sideways loss relief and his cash back, “I knew that on the Independent films we had contracted presales would deliver a positive return and then I hoped that my upside would come from further presales and hit movies from the Studios driving revenues and profit through the partnerships and then out the other side into my hands.”

619. We comment that the returns for members arose well before the LLPs became profitable because drawings were paid from immediate receipts. Although income received by the LLPs after the initial write down to NRV gave rise to the recognition of a profit, the LLP did not become profitable until that income exceeded the cost of the film. Mr Clayton’s hope as an investor was in effect to get something more than his tax back, not to invest in an LLP which recouped in aggregate more than its original investment in the films. This understanding of the position of the investors would, in our view have affected the way in which the business of the LLP was conducted.

620. Mr Clayton said that ITP sought (i) top-end cinema films, (ii) with a strong creative pedigree (well-known major participators), (iii) distribution arrangements, and (iv) a strong commercial deal. Taking these together he says “we believed the films in question were capable of making a profit for the relevant LLP”. Mr Clayton did not go so far as to say “likely” or realistically possible.

621. It seems to us that top-end cinema films with well known artists and other participants may be likely to draw cinema goers and give rise to revenues, but whether the film is profitable for the LLP depends on its cost and on the waterfall. Most of the characteristics Mr Clayton lists ensure visibility. Good distribution was linked to profitability, but crucially profitability depended on the terms of the waterfall.

622. Mr Clayton said that had they not been interested in profit this hearing would have been considering films no one had heard of that generated no revenues at all. This in our view shows that big well-known films were the objects of the LLPs’ desire. Such films were likely to bring revenues in, but that is not the same as making profits.

623. Mr Clayton, who had heard some of Mr McKenna’s evidence, said that his approach was to “try to find and submit films to the green-light committee that were capable of hitting the 2.2 x box office hurdle”. This he said was done by reference to the quality and track records of the producer, the film making team and the distributor). A hit was more than 2.2 x box office. We comment on this in section 7 below.

HMRC’s Criticisms

624. Mr Gammie says that the evidence of Messrs McKenna, Reid, Clayton and Bower must be viewed with some caution since they knew they had to show a view of profit. He says that the surrounding circumstances show that in fact they were not concerned about profit for the LLPs no matter how they might have painted the picture at the time, or in their evidence.

625. First, he says that for the Ingenious organisation, profit for the LLPs was unnecessary. Ingenious received its Operators fee (2.81% of total capital contributions (including the amount treated as a CM contribution) – so 5.6% (IFP2) or 4% (ITP) of individual members’ contributions and the Executive Producer fee (5% of the film cost) up front. Ingenious was dependent upon overall subscriptions not profits. In the IFP structure the CM was a member of the Ingenious group and made an after-tax profit of at least 5% of the net distributed income (see Chapter III: The Tap). That was the spur to get as much income as possible for the LLP and that was different from having a view that such income (in aggregate) would exceed the LLP’s expenses (in aggregate).

626. We accept that this required a guarded approach to their evidence. For most commercial organisations achieving a surplus of income over costs is essential to their continued existence. If they want to continue in business they must aim for a profit. This was not the case for the LLPs. They were vehicles set up to deliver returns to investors which would be good even if they did to make profits. They were set up as single-year vehicles, as Mr McKenna said, one for each year (although there were originally unplanned later investments in IFP2), and did not need profit to survive.

627. Nor did those running the LLPs (through the Operator) or who provided their services to the Operator who provided the results of their activities to the LLPs need the LLPs to make profit to secure their continued employment. That was dependent on the continued profitability of Ingenious, and Ingenious’ income came from: the one-off charges made by the Operator and the EP (which required no continuing profit of the LLP), the 5% or more of GDI retained by the CM (and in the case of ITP an Operator’s success fee, which was rather unlikely to materialise). Those sources of income might motivate a seeking of receipts for the LLP but did not require LLP profit.

628. Thus those managing the activities of the LLPs were not subject to pressure from investors to achieve a profit or subject to the usual commercial incentives to conduct the business with a view of profit.

629. Second, he says that there was no pressure from investors for the LLP to make profits. A list “of complaints received in the past” in one of Mr Bower’s notebooks contains grumbles about entry costs, responsiveness, complexity and a perception of arrogance, but makes no mention of lack of profit even though there had been none. That result is not surprising – the returns the investor made (if they obtained the tax loss relief) were positive from Year 1 onwards when all or substantially all of their original investment would have been refunded by tax repayments or reductions, and thereafter every £1 of receipts (£5 of drawings less £4 tax) was further bounty. They were interested in more income but not on whether the LLP was profitable.

630. He says that the commercial pressure on the Ingenious personnel running the LLPs was to ensure that there was some modest level of receipts for the LLP – to provide the investors with their easy profit – and that there was no pressure to manage an LLP so that it made a real profit: to aim for a flow of receipts which exceeded the cost of a film.

631. He says that Ingenious’ interest was really in the flow of income from the films rather than in income which exceeded the cost of the films (or income which in aggregate exceeded the cost of all the films). That was evident in the CM’s 5% retention referred to above, in the returns to the members, and in a negotiation in relation to the gross corridor when in order to obtain some fairly small share of revenue before P&A expenses had been recouped, a lower share of profit after recoupment was offered.

632. We accept that the LLP did not have to recoup its costs before the investors started to make a positive after-tax return. Almost any amount of film income from a film’s waterfall secured a profit for an investor.

633. In this context we note the e-mail from an Ingenious investor (no 1105) who asks whether in the light of the good box office figures and the reported budget of a particular film, the film would be profitable for IFP2, bearing in mind that it looked profitable for the Studio. An Ingenious employee sent an e-mail to Mr Clayton with a draft for a reply to this e-mail in which he said “I guess the key point is that the investors just need partnership receipts to be profitable anyway as they are already at cash breakeven.” (No doubt because of their tax recovery).

634. We accept that in some of their evidence Mr Reid and Mr McKenna conflated the concept of profits for the LLP with revenue (for example Mr Reid’s statement that an LLP would have substantial taxable income because it was trading with a view to profit; when revenues were received in a year in excess of the NRV of a game or film the partnership would recognise a profit in that year, but it would not realise an overall profit on the film or game until the total revenues exceeded its cost).

635. A number of elements of the evidence indicated the importance of receipts rather than profits:

(a) in the IFP2 Information Memorandum it was said that “IFP2 will only produce films where … it is able to secure participation in sales receipts, not just profits.” That was a recognition that sales receipts – income – would be more important for an investor than the LLP achieving a profit. Aiming for receipts is part of aiming for profit but only if the aim is to obtain receipts which cover costs;

(b) the IG Information Memorandum spoke of “maximising the return through participation in revenues arising from games exploitation receipts rather than profits”: a recognition of the comparative importance of receipts;

(d) Mr Clayton’s description of his hopes for the results of his own investment in an LLP and his answer to Mr Stafford’s question recorded in section 5 of this Chapter;

(e) an e-mail from Mr McKenna to a Richard Harris about the advantages of investing in Inside Track. Mr McKenna said that it represented “an opportunity to participate in the gross sales income (not, non-existent profit!) arising from a portfolio of films with a minimum net of tax return of 6% and with the investment being returned within 6 months.” The words in parentheses are those of Mr McKenna;

(f) the negotiation of the gross receipts corridor. Not only was there some suggestion that later benefit (and thus a greater possibility of profit for the LLP) could be given up for participation in earlier receipts, but the effect was to provide receipts for the benefit of investors even if a film did badly. It evidences an aim of income even if it also mitigated losses and could assist in LLP profits (after all, all income assists in the path to profit).

636. To our minds the evidence indicates that revenues were important and were sought by the LLP, but this does not mean that an overall profit was not also sought.

637. Third, Mr Gammie says that Ingenious’ main interest was to secure the tax relief for investors. It was that relief which provided the recoupment of, and return on, their investment. The nature of the film agreements put in place under the CD Model was intended to secure that relief by having the result that 100 was treated as invested in the film for each 30 (35) provided by the investor, but the nature of that agreement came with its effect that although 100% was treated as expended only at best 54.5% of the distributable income after expenses was received. The importance of the tax relief meant that getting a good deal on profit was put in second place.

638. Mr Gammie also notes an e-mail Mr Gardiner of Ingenious wrote to Mr McKenna saying that a high level of presales would mean “that the return to investors in the tax write-offs is considerably reduced”. HMRC suggest that films which sales agents were willing to back – films which were thought by experts to be likely to be successful – were eschewed by the LLPs.

Conclusions: Controlling Minds’ Evidence

639. We agree with Mr Gammie that the first two considerations lessened the commercial pressure on Ingenious to seek profit for the LLPs, but set against that was the undoubted knowledge which all the relevant people had that the LLPs had to have a view of profit in order to deliver the tax benefit. That too was a commercial pressure. The question is whether Ingenious took steps to alleviate the pressure rather than just persuading themselves that they had that objective.

640. We have addressed the question of tax motivation in Chapter VI: Trade. We agree that obtaining the advertised tax results for the investors was a real concern of those at Ingenious and that it resulted in income (on the Ingenious basis) at a level which made it much harder for the LLPs to make a profit and easier for them to make a loss.

641. Taking this together with our earlier evaluation of the evidence of Mr McKenna, Mr Reid and Mr Clayton, we were not convinced that the controlling minds’ evidence was enough to conclude that the LLPs had a material intention that the business would be so conducted as to have a realistic chance of making a profit on the Ingenious basis.

£m	2006	2007	2008	2009	2010
Turnover	nil	11.9	66.8	74.2	60.8
Cost of Sales	(89.9)	(9.2)	(40.7)	(28.2)	(17.1)
Gross Profit	(89.9)	2.7	20.1	46.0	43.7
Management Fee	(5.6)
Operating Profit/Loss	(95.5)	2.7	20.1	46.0	43.7

649. The 2006 cost of sales figure represented the effect of the write down to NRV of the full budgeted cost of all the films contracted for in that year. The turnover in subsequent years represented receipts from those films and also receipts from the proposed non-production activities. The illustration suggests that a combined aggregate profit from both activities could be made in years 2 to 5 of £112.5m so that over the five-year period a gross profit of £22.6m, and an operating profit of £17m, could be made.

650. If these figures were a realistic appraisal of the results of IFP2’s intended activities they would suggest that, at least for the activities which took place in 2006 (the contracting for 22 films), those activities could realistically have been, and be considered to have been, undertaken with a view to profit.

651. The structure and much of the content of the IFP2 Information Memorandum followed that of the IFP Information Memorandum.

652. The IFP2 table shown above was based upon a spreadsheet, LS202, which illuminated the assumptions underlying the figures in the table. The calculations in that spreadsheet shared some common features with those used for the IFP memorandum.

653. LS202 shows the composition and derivation of the figures in the illustration. We note at this stage that LS202 shows that £118.6m of the total turnover in the table related to film production, and that, of the total cost of sales in the illustrative table, £112.4m related to film production. Thus LS202 indicates that a 6% profit margin was being illustrated for film production over a 5 year period. That is only a modest profit, and a modest profit may be more susceptible to variations in circumstances than a large one, and if there are many uncertainties it may not be a reliable illustration of a realistic outcome.

654. The balance of the figures in the table was attributable to non-production activities. They were projected to provide a slightly higher profit margin of about 8.6%.

655. We understood that the Appellants do not rely on the effect of non-production activities. As a result our enquiries relate only to the film production part of the illustration.

656. The IFP Information Memorandum was based on a spreadsheet entitled Financial Model 13; we shall call it LS101. There were a number of iterations of LS101 before a version was settled upon whose outputs were used in the IFP Information Memorandum. It appears that initially assumptions were made about matters such as the spread of films undertaken, their box office success, the ratios of various costs to budget or to box office and the effects of the waterfalls. Applying these assumptions to LS101 the net receipts of the LLP were calculated. This was described as the “top-down” method.

657. We were referred to 8 versions of the IFP Information Memorandum. These reflected the effects of changes to:

(a) the number of films on the slate and the split between Studio and Independent films,

(b) the ratio of gross receipts to budget,

(d) variations in the timing of receipts and expenses.

658. After about four iterations the mechanics were changed. Rather than starting at the top with assumptions about film performance and predicting profits, a particular level of overall profit was put in at the bottom, and the film performance was ‘backsolved’ on the basis of the intermediate assumptions built into the model. Thus in broad terms, assuming the fairness of the intermediate assumptions, the model became an indicator of what level of box office performance would be required to deliver the chosen profit. Mr McKenna said that a modest level of profit was selected and the resultant levels of film performance reviewed.

659. Mr Hellier thinks that this is a perfectly sensible way of preparing a budget. If you start at the top in preparing your budget for a year using particular assumptions about your income and expenses and you come out with a disastrous deficit, or an unbelievable profit, you may well go back and revise the figures to get an end result you can live with. But (generally) budgets are used to guide expenditure. Here we are interested in the illustrative projections as evidence of what the LLPs may have had in view and of the likelihood of fruition. Mr Stafford thinks that it is quite the wrong way round and that the starting point for most budgets is expected sales, and that costs and profit or loss follow from that starting point.

660. To our minds the illustrations were explanations to investors of what might happen. “Our aim” wrote Mr Reid, “was to illustrate the performance required to achieve a modest level of profitability”, or as he said “let’s show a modest profit and then benchmark the key assumptions about income”. They do not appear to be statements of the LLPs’ expectations or intent. The description of the figures as illustrative, the selection of a modest profit, and the working back to film portfolio and performance, are redolent of a mind-set of telling investors: “all being well these are the sort of results which could arise, and look, these results are not implausible because the assumptions we have made are within the bounds of possibility.” They were statements of what they thought could be achieved not of expectation or intention. Thus we regard the presentation of the illustrative figures as not itself providing evidence that the LLPs had a view of profit.

661. But the illustrations may also be a way of examining whether it would have been realistic to have expected a profit. If the assumptions were, at the time they were made, realistic, then it would have been realistic to expect a profit, and if not, and if, on the basis of realistic assumptions a profit would not have resulted, then the adjusted results may show that it cannot have been realistic to expect or hope for or have a view to a profit.

662. Further, if it could be shown that Ingenious knew that the assumptions or estimates were unreasonable and that corrected assumptions or estimates would deliver a loss, that would be evidence that the LLPs did not have any subjective hope of profit (because they knew it was likely that they would make a loss).

663. HMRC advance a number of criticisms of the assumptions underlying the illustrative figures for IFP2. In brief these are:

(a) that the DVD cost ratio was too low;

(b) that the P&A ratio was too low;

(d) that other assumptions were made which were inconsistent with data which was held by Ingenious; and

(e) that even if the illustrations did not suffer from these defects, the performance they required from the LLP’s films in order to make the modest profit was unrealistic, and ignores Ingenious’ own data in relation to the performance of films previously undertaken by ITP.

664. We address these concerns and the witnesses’ replies to them in the following headings.

(1) The DVD/Video Cost Ratio

665. In LS202 a figure of just over 23.1% was used as the ratio of video and DVD costs to video and DVD income (the “DVD cost ratio”). In the spreadsheets for ITP, a figure of 35% had been used; in the NRV calculations for IFP2 made after the Information Memorandum had been promulgated, the 35% ratio had also been used. HMRC showed that if a 35% DVD cost ratio had been used in LS202 it would have resulted in an 11% loss over the 5 year period (leaving all other assumptions fixed).

666. The 35% ratio used in the IFP calculation had been based on data supplied to Ingenious by a consultant, Julian Stanford, who had been formally engaged by Ingenious in 2004.

667. Mr Reid demonstrated that the 23.1% figure had been derived from some data prepared by, or in collaboration with, Focus (which, it was not disputed, was a reputable media consultant respected as a revenue and cost forecaster). Ingenious had obtained the Focus material from Mosaic in June 2005. This data included a table showing the components of revenue and costs for 7 films produced by Chuck Roven and Atlas Entertainment between 1992 and 2004. The table showed individual and total figures for domestic and foreign video revenues and for the associated video/DVD costs. The 23.1% DVD cost ratio used in LS202 was obtained by dividing the total video distribution costs for those seven films by the total video revenues from those films.

668. Notes to the table relating to those films from which these figures were taken indicated that five (possibly six) of those films’ video income had been calculated by grossing up the amount of a 20% royalty which had been attributable to Chuck Roven. For a further film, the amount of domestic rentals had been similarly obtained, although the foreign international video rental element appeared to be that actually received.

669. The notes also indicated that in two, possibly three, cases, the video costs had been calculated thus:

“video costs @ 20% of domestic revenue & 25% of foreign revenue”.

670. This formula had not been applied in relation to others of the seven films [21].

671. Mr Reid told us that the use of this formula indicated that Focus’ view was that the overall DVD cost ratio would be between 20% and 25%. Precisely where it fell in that interval would depend upon the ratio of domestic and foreign video revenue. If all the DVD cost figures in the table had been calculated on that formula then the overall DVD cost ratio would have been a weighted average of 20% and 25%.

672. But because the 20%/25% formula had not been applied to all the seven films in the Mosaic table, the ratio of total DVD costs to total DVD revenue was not determined solely by the weighted average of 20% and 25%, but also by those other figures which it seems likely that Focus had gathered from the actual costs. That could, in theory, have meant that the average fell outside the 20% – 25% interval.

673. There was some discussion as to whether the calculation of the DVD revenue made by grossing up royalty income affected the reliability of the overall ratio obtained from the seven films’ data. We should say that we do not think that it would have had any effect if the 20/25% cost formula had been applied across all seven films. If for each film DVD cost is obtained by applying 20% and 25% to domestic and overseas income respectively, then the DVD cost ratio will lie between 20% and 25% depending on the ratio of those packets of income. And if the 20/25% formula had been applied to each film then any inconsistent basis in the calculation of DVD income would only have affected the point on the 20% to 25% scale at which the average lay.

674. There were, however, a number of more serious criticisms of the use of the 23.1% figure in LS202:

(i) it is the result of a particular ratio of overseas to domestic income which may not be reflected in the films which the LLP was to make. In particular we note that LS202 uses 23.1% for both domestic and foreign DVD costs;

(ii) it is a result in part (because some of the figures for DVD costs in the table were not plainly derived from the application of Focus’ 20% or 25% formula) of actual figures (or possibly figures determined in some other way) for three films released between 1999 and 2004, all of which were made by Chuck Roven/Atlas and distributed by Warner Bros, and in part of figures based on Focus’ 20/25% applied in the context of films released between 1992 and 1998, all of which were also made by Chuck Roven/Atlas, and three out of four of which were distributed by Warner Bros. That does not look like a representative sample;

(iii) it is unclear whether Focus’ use of 20/25% was geared to the period 1992 to 1998. In that period DVD was in its infancy and so may not have been the ratio Focus would have used after 2004;

(iv) elsewhere in the Mosaic material are some forecasts for income and expenses for proposed films. There are six such forecasts and all infer or use a DVD cost ratio of nearly 28%. This material bears the Focus’ imprimatur;

(v) 35% continued to be used after the preparation of the IFP2 Information Memorandum in calculating NRV figures including those for IFP2. Mr Crossley though had used the 23.1% ratio in some other work he had done at the time in relation to Mamma Mia;

(vi) Mr Bower, when explaining to us the workings of the waterfall, said that “DVD costs at 35% of revenue is, broadly speaking, the ratio one usually observes, something in that ballpark”; and

(vii) Mr Stanford’s advice was that the DVD cost ratio was 33% both domestically and internationally.

675. Taking these considerations together, we do not consider that the Mosaic material gave any realistic comfort that the DVD cost ratio should be anything less than 28%. We are comforted in this conclusion by the fact that Messrs Olsberg, Briggs and Sills gave ranges for the DVD cost ratio of: 30 to 40%, 25 to 37.5% and 30 to 40% respectively, although we accept that they gave these views in 2014, not 2005.

(2) A Contingency

676. Mr Reid noted that in LS202 distribution fees for domestic distribution were assumed to be 15% of gross domestic income, but those for international income were taken as 30% of that income. The average, weighted by the respective income, was 22%. He said that in 2005 they knew that they could negotiate distribution fees of 15%: as a result there was in the 22% weighted average figure a contingency margin. Mr Reid told us that he was aware that the forward-looking statements in the Mosaic/Focus material contained DVD cost ratios exceeding 23.1% (he said that he thought these statements used 25%; but, at (iv) in the paragraph before last, we have noted the figure of 28%), and that perhaps that was one of the reasons why they felt some contingency provision in the (international) distribution fees was a good idea.

677. Mr Reid also explained that in the work Mr Crossley was doing at the time for Mamma Mia 23.1% was used for the DVD cost ratio, 15% for the US distribution fee (assuming a Studio distribution) and 30% for international distribution fees (assuming independent distributors). The independent distribution attracted a higher distribution fee. These figures are replicated in LS202. It does not seem that this was accidental since, in a note to Mr Reid, Mr Crossley spoke of having “been more prudent in the costs of distribution” in the IFP2 Information Memorandum. On the other hand, as Mr Reid acknowledged, independent distribution may involve a higher distribution fee and LS202 does not make any allowance for that. Mr Reid said, however, that Independent films were projected to provide only a minority (30%) of IFP2’s income, so that the additional distribution fee which would need to be provided in respect of such films would not be a full 30% for the slate as a whole. (We offer a figure of at most an extra 4.5%, being 30% of the slate (taken as Independent films) times (30% -15%). On which basis the weighted average fee would be 19.5%, so that the contingency element would be 3.5% of Gross Receipts.)

(3) Use of Other Mosaic/Focus Ratios

678. In addition to the use of the Mosaic data for the DVD cost ratio, LS202 used that material for the ratios of:

(a) Theatrical Rentals: US and international box office

(b) Pay Per View: US and international box office

(d) Print Expense: US and international box office

(e) Advertising Expense: US and international box office

(f) Other Expenditure: US and international box office

679. But the following ratios for income from DVD/video, cable, network and TV as a percentage of US and international box office were not used:

%	Ratio Used by Ingenious	Mosaic Ratio
US Video Income/Box Office	110%	72%
US Cable Income/Box Office	20%	16%
US Network Income/Box Office	15%	10%
US TV/Box Office	5%	4%
International Video/Box Office	110%	46%

680. In each case Ingenious used higher income ratios than those indicated by the Mosaic data. Mr Reid, unprepared for the question, was unable to explain why this was.

681. Mr Reid suggested that the way in which the DVD/video figures in the Mosaic material had been obtained – in part by grossing up a royalty payment, and the changing landscape of video and DVD sales meant that the Mosaic video ratio “might not have been a very good source to estimate sales income going forward”, so that other sources were used.

682. Otherwise Mr Reid was not able to offer an explanation for this approach other than to venture that because the Mosaic film data was old the relationship between cable and TV to box office may have been different by 2005. That was a weak explanation in the context of the acceptance, for example, of the international cable ratio from the Mosaic data and the rejection of the domestic cable ratio.

683. We conclude that there was some unwarranted optimism built into these ratios.

(4) P&A Assumptions

684. LS202 assumes that P&A costs will be 37.5% of gross box office on average. This figure was derived from the information about the seven Chuck Roven films in the Mosaic data. The data indicated an average P&A to gross box office ratio (“P&A/GBO ratio”) of 47% for domestic P&A and 28% for international. 37.5% is the average of the two (LS202 applies 47% and 28% individually to US and international box office to obtain the related P&A costs).

685. We have related that in 2004 Ingenious engaged a consultant, Julian Stanford, to provide it with information on likely P&A and DVD costs. Mr Stanford advised that the P&A/GBO ratio would depend on the level of GBO. He provided a table dividing GBO into seven levels or “buckets” each with a different P&A/GBO ratio. Ingenious used Mr Stanford’s analysis together with some figures from the Motion Picture Association of America (the “MPAA”) in LS101 with the result that in that spreadsheet P&A amounted to 50% of GBO. Ingenious also used these results in 2006 as a starting point in computing NRVs for IFP’s accounts, but in view of the known actual performance of nine films undertaken by ITP multiplied each of Mr Stanford’s ratios by 1.76 (see Appendix 9: NRV) thus using an even higher ratio than followed from his advice.

686. Ingenious say that the Mosaic data on P&A ratios was the best available to them at the time of preparation of the IFP2 Information Memorandum because it was film specific. This seems to us to make sense only if there was some correspondence between the Chuck Roven films and the LLP’s films but no particular parallel was apparent or suggested to us.

687. Mr Reid agreed that in parts of the Mosaic information following the Chuck Roven film data there were forward-looking simulations in which a higher blended average P&A/GBO ratio appeared (something like 40% he said) but he said that was another reason for building in the contingency in the distribution fee. HMRC say that the ratio used was too low (and that Ingenious deliberately or recklessly picked a low figure).

688. A number of issues therefore arise in relation to the P&A/GBO ratios used in LS202.

689. First, as mentioned in the antepenultimate paragraph, the Mosaic data also contained six forward-looking analyses for a venture involving 10 films. These analyses or forecasts were separated into those covering four and five-year periods and were given for a Best case, a Base case and a Break-even case. From each forecast a P&A/GBO to ratio may be extracted. For the Best case it was 39% (47% domestic, 30% International), for the Base case 40%, and for the Break-even case 46%. These figures, taken together with the fact that the seven Chuck Roven films were fairly old and had features in common, suggest that Focus’ then current estimation of the P&A/GBO ratio would generally have been higher than 37.5%.

690. Second, Mr Bower told us that the Julian Stanford methodology was still used by Ingenious and “actually it tends to be very reliable in practice in getting to the right ballpark number in most cases.” But he accepted that Mr Stanford’s ratios had been adjusted upwards in NRV calculations for actual known film performance. That suggests that the same view might reasonably have been held in 2005/6.

691. We accept, however, that the NRV calculations were done to determine the “minimum value” rather than a possible or illustrative outcome, and that the choice of higher ratios for them does not of itself indicate that the ratios chosen for LS202 were unrealistic.

692. Third, in preparing LS101 the Julian Stanford bucket analysis was used coupled with the use of figures from the MPAA which indicated that P&A was on average 61% of budget. The ratio for P&A/GBO used in LS101 was the weighted average (1 part Stanford; 2 parts MPAA) of the results of these two approaches. The MPAA ratio, combined with the average GBO/budget ratio in LS101 of 1.96, meant that the MPAA figure suggested a P&A/GBO ratio of 31%. The addition of the Julian Stanford bucket ratios brought the average P&A/GBO ratio for the slate up to 50%. That all suggests that the ratio of 37.5% may be on the low side.

693. Fourth, Mr Briggs told us, and we accept, that generally the P&A/GBO ratio would be lower for films with high box office although P&A is higher in absolute amount for more successful films (the advertising drove the performance to some extent). This was consistent with Mr Briggs’ practice of capping P&A expenditure when box office sales really took off. Mr Stanford’s seven buckets reflect that effect: for his ratios diminish from about 200% for a film with box office takings of about £5 million to 36% – 46% for a film taking over £150 million.

694. Further it seems likely that the P&A spend will to some extent depend upon the film’s budget: Mr Reid acknowledged that the big budget films tend to have big budget P &A to launch them but that if they flop the P&A expenditure is scaled back.

695. In this context HMRC point to the ratio used by Ingenious in LS101, in which an approximately inverse relationship[22] appears between the box office/budget ratio of the illustrative films and the P&A/GBO ratio. They say that looking at that relationship, while the average box office/budget ratio achieved by the Chuck Roven films of 2.8 was consistent with the P&A/GBO ratio of about 40%, i.e. close to 37.5%, LS202 assumes an average box office/budget ratio of 2.2, which would be consistent with a P&A/GBO ratio of about 47% (and 37% would be achieved only with a box office/budget ratio of 3).

696. Fifth, as we have recounted, in estimating NRVs for IFP2’s accounts, shortly after LS202 bore fruit, Ingenious increased the P&A/GBO ratio by some 76% to reflect its own experience on the nine films undertaken by ITP. That suggests that the Stanford/MPAA approach was not thought to be overly cautious at that time.

697. Finally, Mr Reid made the point that with the benefit of hindsight it appeared that the actual P&A costs for IFP2 were less than those illustrated in the IFP2 Information Memorandum: he said that the P&A/GBO ratio had turned out to be 23.5%. Without Avatar it would have been 36.3% – very close to the figure used in the illustration.

Conclusion: P&A Ratios: In 2005/6 it seems to us that the fixed estimate for the P&A/GBO ratio of 37.5% was not realistic and that the lowest realistic estimate at that time was 40% (the Base case Focus average).

(5) Modelling the Waterfall

698. HMRC contend, and we accept, that by the summer of 2005 when LS202 was being instructed, Ingenious personnel had been agreeing sets of commissioning distributor agreements for film deals for some time, and had settled on the form of a standard waterfall for those deals – at least so far as concerned Studio films.

699. Those standard forms provided for a 30% distribution commission and for levels of Studio participation which varied with GDI (see section 1 Chapter III):

15.45% of GDI until GDI exceeded 165% of budget,

increased to 34.71% when GDI fell between 165% and 204% of budget,

and thereafter 27.14%.

700. (As we have recounted elsewhere these complicated steps ensured that, while the CD continued to receive 70% of GDI, the CM was able to retain at least 5% of GDI after corporation tax; although Mr Reid suggested that Mr McKenna had a plan to eliminate these steps in the waterfall, we think that his recollection was mistaken – see Chapter III The Tap.)

701. LS202 did not, however, take account of the step changes. The effect of its formulae was that if the Distributor Commission was taken as 30% rather than 20% it modelled the Studio participation as a straight 15.45% of GDI. This affected, and increased, its estimation of the revenues which accrued to the LLP in relation to the three Studio films in the illustrative portfolio. Each of these films was illustrated as achieving GDI of 247% of budget – so that the participation commission should have been a weighted average rather than be the 15.45% actually used:

{15.5%x165 +34.71%x(204-165) +27.14% x(247-204)}/(165+39+43) = 20.6%.

702. HMRC showed to our satisfaction that the combination of an adjustment to reflect a distributor commission of 30% and this change in participations converted the computed profit into a 2% loss.

(6) LS202: The Combination of the Factors Discussed Above

704. HMRC's second Note on the Evidence contained a section showing the effect on the illustrative profit and loss of making changes in the assumptions. That note looks at the effects of individual changes but does not look at the effect of eliminating any contingency in the distribution fee or at the combined effect of the changed assumptions.

705. Following this lead we made the following changes to LS202:

(a) we reduced the international distribution fee to 15% (a conservative reduction given our conclusions in relation to the contingency in (2) above) to eliminate the contingency (varying cell Film Prodn Income tab C48);

(b) we increased the DVD cost ratio to 28% (Film Prodn Income tab C27 and C54);

(c) we reduced the US advertising ratio to 36% and increased the International advertising ratio to 36% (Film Prodn Income tab C25 and C52) so that the sum of advertising and prints was 40%;

(d) We carried the resultant ratio of total gross receipts (89%) to total box office income arising in D64 of the Film Prodn Income tab to R14 of the Film Production tab.

(e) We adjusted the distribution commission to 30% and the gross participation to 20.6% (R17 and R19 Film Production tab). The increase in GDI which resulted from step (d) meant that this figure should have been somewhat higher (and thus calculated profit somewhat lower).

706. The net result was that, allowing no contingency, LS202 indicated a loss of 2% on film production over the 5 year period. But prior profitability could be restored if the three Studio films in the calculations achieved about 3.3 x budget (rather than 2.9), an average across the slate of about 2.4 x budget.

707. One of the effects of selecting a modest profit is that it is vulnerable to small changes in the underlying assumptions. It would therefore be wrong to conclude that because the changes we made to some of the underlying assumptions resulted in a loss that a loss was necessarily to be expected. But the nature of the exercise conducted above is different: it is designed to determine what film performance, on reasonable assumptions, will enable the LLP to break even. The result is higher multiples of budget than used by Ingenious personnel.

Our Conclusions on LS202

708. We asked ourselves whether the projections in LS202, suitably adjusted, indicated that IFP2 had, or did not have, a realistic prospect of achieving its modest profit over a 5 year period. We took a five year period because: generally the majority of first-cycle income arises in such a period, that was the period Ingenious suggested for the LLPs in the Information Memoranda, and the prospect of income after that seems generally remote.

709. If films were chosen on the basis that on average they would achieve a 2.2x multiple – or as Mr Clayton said films which “were capable of hitting the 2.2 times box office hurdle” – it seems to us that the business was not conducted with a view to profit since that multiple did not appear to be likely to secure a profit for the LLP on the basis of reasonable assumptions.

710. If films were chosen on the basis that they would achieve at least 2.2x budget on average but with a hope that they would achieve a better result, then whether or not that hope was realistic depends on how likely it was that films would perform at that level. The result of LS202 adjusted to reflect realistic assumptions indicates that the three Studio films would have to achieve WWBO of about 3.3x budget for the LLP to have been profitable. For the reasons in headings (7) and (8) below that seems unlikely.

711. We conclude that LS202 indicates that the LLPs’ businesses were not conducted with a realistic possibility of profit.

(7) Ingenious’ Own Data on Film Performance

712. It appears that Mr Crossley had maintained a spreadsheet record of the reported box office receipts for the films produced by ITP, IFP and also three other LLPs, IT1, IT2 and IT3. There had been a version of the spreadsheet in existence in September 2005 – thus at around the time of the preparation of LS202. This record permitted the known GBO/budget ratio of films which had been produced by those LLPs to be compared with the illustrative performance in the IFP2 Information Memorandum (the result of the bottom-up exercise).

713. Further, Mr Reid and other witnesses acknowledged that within six months after the release of a film the box office takings would be close to their final amount, so that, having regard to films released before March 2005, and assuming the information possessed or received by Ingenious was up-to-date, that information would give a fairly good idea of the past box office performance of films chosen by Ingenious.

714. It was not clear to us that the Studios were prompt in delivering distribution statements in all cases and we accept Mr Reid’s inference that the reporting of box office results for Independent films, particularly in small territories, could be slow. Nevertheless, particularly for films released 12 months or so before September 2005, it seems likely that Mr Crossley’s figures would show an amount of GBO close to the eventual final figures. Also Mr Crossley’s spreadsheet included tabs in which he had recorded the box office takings week by week for a number of films; Mr Reid mentioned that Mr Crossley had obtained these from IMBD; that all suggests that these those figures were as up-to-date as the figures provided on IMDB.

715. The films undertaken by ITP had all been released at least 6 months before September 2005. The sole Studio film, Wimbledon, had achieved GBO/budget ratio of 0.7, and the four Independent films for which Mr Crossley had entered information, a ratio of 1.07.

716. HMRC added to Mr Crossley’s data IMBD data for the Independent films for which Mr Crossley had not recorded GBO. Taking account of this data the ITP Slate had an overall GBO/budget ratio of 0.75, and an Independent films ratio of 0.76.

717. The figures for IT1 involved some films released after February 2005. Removing those films and their figures, and including IMDB figures for Inside I’m Dancing, the overall GBO/budget ratio at September 2005 for IT1 was 1.8.

718. For IT2 five out of the six films had been released by January 2005. For those five films the GBO/budget ratio was about 1.6 (the inclusion of IMDB information for the sixth film give a ratio of 1.54).

719. The Appellants say that “the commercial deals entered by the IFP partnerships were generally more attractive than those entered into by the Inside Track partnerships.” They refer in this regard to the first dollar gross corridor introduced after Closer and Wimbledon. But the gross corridor did not enhance the success of the films, it merely ameliorated failure. By contrast had the appellant been able to show that the budgets for IFP films had been more tightly controlled, that would have suggested that better GBO/budget ratios could have been obtained by IFP. But there was no evidence that such was the case.

720. It may also have been the case that, with its increasing experience and expertise, Ingenious may have become better at picking films which did well at the box office. Mr Clayton told us that as the enterprise had grown so had its cumulative expertise. We accept that. That might be a reason for some modest expectation of improved results, as also might have been an expectation of a greater number of Studio films (which were individually more likely to achieve high box office figures, and carried the benefit of a large Studio’s assessment and distribution clout), but it seems to us that Ingenious’ own experience made an expectation of an overall average GBO/budget ratio of 2.2 somewhat unrealistic.

(8) WWBO to Budget Ratios Required for the LLP to be Profitable

721. The effect of the bottom-up approach to the preparation of the illustrative table in the IFP2 Information Memorandum was that the projected modest profit could be obtained if on average films achieved WWBO of 2.2 x their budget. The Information Memorandum listed six actual films which had achieved that multiple over the period 2000 – 2001, and noted that over the period 2000 – 2004 the top 200 films had achieved an average performance of over 3.7 times budget. It said that an Independent film, The Blair Witch Project, had achieved a multiple of over 7,000. The Memorandum said that the most successful films in the slate were assumed to achieve 2.9 x budget. It was also assumed that on average films would generate gross receipts of 4.2 x budget.

722. HMRC advance three criticisms of this:

(a) the assumption in LS202 was that all three Studio films achieved 2.9 x budget. That was unrealistic;

(b) the treatment of Independent films was incorrect;

(a) 2.9 Times Budget

723. HMRC say that LS202 purported to show that the modest profit could be achieved if all three Studio films (representing 61% of the available funds) achieved more than 2.9 x budget and the Independent films achieved between 40% and 190% of budget (so that the weighted average was 2.2). Thus all 3 Studio films would have to perform on average at 2.9 x budget. This meant that all three Studio films would have to perform in such a way as to get a place in the top 180 films of 2000 – 2005.

724. Further, the budgets for IFP2’s Studio films were inflated by the addition of the 5% EP fee, the added Studio overheads of 15%, and the contingency of 10% which, if unspent was usually kept by the PSC. HMRC illustrated that the publicly available information about the budget of the (first) 22 films with which IFP was involved showed that the budgeted costs as shown in the relevant agreements were 25% larger than the cost in the publicly available data (these results were not materially contested by the Appellants). Thus it was likely that the publicly available performance data was based on budgets which did not contain the additional items in Ingenious’ films’ budgets. Had they done so the ratios for the top performing films in the public data would have been lower and there would have been still fewer films which between 2000 and 2005 had performed at the levels above 2.9 times budget.

725. Finally they say that the list of the 200 top-performing films is skewed towards high-budget US Studio films, and Ingenious had striven to focus on British films. It was less likely that such films would appear in the list.

726. Although, by 2005 the relationship with Fox was in full swing and a greater number of high-budget Studio films might have been expected, we accept most of these challenges. Ingenious appeared to accept that it would be less likely that Independent films would make money (although it was possible) so that the real profits had to be made by the Studio films. Although the same gross income might have been received from one Studio film which achieved a 5x multiple and two which achieved 2x or less, the levels of performance needed suggest that it would be possible but unlikely that on average the Studio films would achieve a result of more than 2.9x budget.

(b) Independent films

727. HMRC say that by their underlying blanket assumption that on average films achieved WWBO of 2.2x budget, the calculations assumed a direct relationship between the box office performance of Independent films and what IFP2 would receive. That they say was wrong because of the way Independent films were sold: the receipts would depend upon the terms of the deal with the agents and distributors. If the distributor pays a minimum guarantee or advance, then until the sales reach an agreed level no further amount is received, although thereafter overages may be received. As sales increase the sum of the overages and the minimum guarantee or advance will approach the receipts less a commission, but the relationship between sales and receipts is not linear although asymptotically it becomes such.

728. Mr McKenna and Mr Reid say that box office is a proxy for the nature of the returns on Independent films. HMRC say it is a poor proxy, and, that because the assumption in LS202 is that the 7 Independent films in the slate do not fare particularly well, they would not have been in overage territory so that all that should have been modelled was the minimum guarantee or advance receipts from the distributors.

729. Whilst we accept that Ingenious may have had the data from other Independent films which they could have used to model the effect of sales to distributors, we were not convinced that, as an indicator of how well an Independent film had to perform, the estimates of the box office ratios obtained by working back from a profit contribution were an unrealistic way to benchmark the profit assumption.

730. If one assumes that the distributor is a good commercial judge – and if they were not they would soon go out of business – they would tend to pay a sum equal to their estimate of the likely income from the film less a profit margin. Thus there would be a relationship between how well they thought the film would do and collected receipts. The model replaces the distributor’s estimate by one which in effect assumes that the distributor gets it right. The only missing element is the margin the distributor takes for taking on the risk. The distribution fee may be a proxy for that. The 15% or 30% used for the distribution fee in LS202 may be a bit low, but we were not persuaded that the approach Ingenious adopted suggested an unrealistically low estimate of the level of success necessary to achieve the distribution income projected. (The issues of the level of distributor commission and participation which are explored elsewhere in this section of this Chapter remain relevant.)

731. The Information Memorandum notes that smaller films could achieve remarkable multiples of budget at the box office. It notes that The Blair Witch Project achieved a multiple of almost 7,000 times box office. HMRC say this was misleading because the budget of that film was so low that the LLP would not have undertaken it.

732. We regard that statement as mere puff. In context it simply says that some small films really do breakout but that is like winning the lottery: the import of the statement is that people sometimes do win the lottery. But it provides no support for any of the multiples used in the projections.

(9) A Five Year Vehicle

733. The illustration in the Information Memorandum shows the results over a 5 year period. The illustrated aggregate profit for the 5 year period arises only at the end of that period. That profit is based on the accrual of cinematic, DVD/home video and TV revenues. It assigns no figure for the residual value of the film at the end of that period. Indeed in the IFP2 Information Memorandum it is said that “by the end of the third year … the majority of recoupable costs will have been recouped on the successful films”.

734. By contrast the 2010 Ultimates (and Mr Forster’s figures for lifetime results) and Mr Briggs’ calculations take into account income for a much longer period; in particular Mr Briggs’ figures take into account second-cycle income, which is income arising after the first 10 years.

735. A residual value (or possible sale value) at the end of the 5 year period might be computed from Mr Briggs’ figures with a suitable discount for the time value of money and uncertainty.

736. On the one hand the omission from LS202 of residual values indicates a conservative approach to the estimation of the LLP’s results (and the benchmarking of film performance), but on the other hand it prevents the Ultimates from being comparable with the illustrations.

737. It seems to us that five years is a reasonable period over which to hope to make a profit from a film, and that beyond that period the revenues become too uncertain. A film is not like a power station which could reasonably be expected to continue to work for decades, even if there were uncertainties about energy and fuel prices; most films stop producing significant income after 5 years. As a result, regarded as a window onto the LLP’s hopes or as a yardstick to judge whether there was a realistic chance of profit, it does not seem to us that the Ultimates or the hope of residual value after 5 years may be prayed in aid.

Our Conclusions on the IFP2 Information Memorandum

738. We have said that we regarded the illustration in the Information Memorandum as a statement of what Ingenious personnel thought possible, not of their expectation. As such it was not an indication that they intended to conduct the business so that it would achieve the illustrated modest profit, but merely an indication that they considered that such a profit was possible.

739. We have concluded that some of the assumptions in the calculations behind the illustration in the Memorandum were unrealistic. When corrected they illustrate a loss (on the Ingenious basis) or that in order to have considered there to be realistic prospect of profit (on the Ingenious basis) the selected films would have had to perform at levels in excess of those which Ingenious personnel considered sufficient and which were very unlikely to be achieved.

740. We conclude that the Memorandum does not indicate that the business was conducted with a realistic possibility of profit (on that basis) and does not indicate that those managing the LLPs had that aim or view.

(10) LS101

741. HMRC do not launch the same multi-faceted attack against LS101 in which DVD/video costs were estimated at 35% and the P&A ratios were drawn from the Stanford data. HMRC attacked only one assumption, namely the assumption of a distribution fee of 12.5%; they say that a realistic fee would not have been less than 15%, perhaps 20%. Mr Reid agreed that the fee used was lower than that they had achieved in relation to other films at the time but he said that it was their target. Prior to IFP they had been achieving a 20% fee – they thus went in to battle for 12.5% and save in one case where 12.5% was achieved came away with 15%.

742. HMRC showed how a change in the assumed fee to 20% in LS101 caused the overall 5 year result to change from an 8% profit to a 24% loss. Changing the fee to 15% produced a 3% loss.

743. Mr Reid responded that some other assumptions in LS101 may have embodied an element of contingency. We did not have sufficient evidence to test this suggestion, particularly since the calculation of the distribution commission and participation appear to have been made differently in LS101. We also observed that the reduction in the distribution fee could affect the rate of the Studio participation because LS101 showed it varying with different levels of recoupment.

744. Overall therefore, while not satisfied that LS101 on realistic assumptions would predict a loss on the basis of the presumed performance of the illustrative slate, we were not satisfied that it provided support for the proposition that it was realistic to expect a profit.

	INGENIOUS GAMES LLP INSIDE TRACK PRODUCTIONS LLP INGENIOUS FILM PARTNERS 2 LLP	Appellants
	- and -

	THE COMMISSIONERS FOR HER MAJESTY’S
	REVENUE & CUSTOMS	Respondents

Gross Receipts	300	500	700
CD Fee (20%)	(40)	(100)	(140)
Dist Expenses	(210)	(300)	(360)
GDI	50	100	200
CD Commission	15	30	60
Schedule 7 LLP entitlement	35 (=50-15)	70	133*
Retained by CD as loan repayment	17.5 (=50%x35)	35	65
Balance of GDI once loan repaid	Nil	nil	10
Total actually to be paid to LLP	17.5	35	68
LLP receipt as % of GDI	35%	35	34%
Individual members drawings	17.5	35	>35

At 5 April 2013	Year 1 slate	All films
ITP	£(57m)	£(57m)
IFP	£(284m)	£(323m)
IFP2	£(600m)	£(715m)

Lifetime Projection	Year 1 slate	All films
ITP	£(55m)	£(55m)
IFP	£(171m)	£(206m)
IFP2	£290m	£206m

Forster: Adjusted to 30:30	To 5 April 2013	Lifetime
IFP	£(59m)	£1m
IFP2	£(90m), but £(116m) without Avatar	£399m but £66m without Avatar

GDI	P/L on Ingenious Basis	P&L 30:30 Basis
40	(78)	(18)
100	(45)	Nil
140	(23)	12
182	Nil	25
200	10	30

£m	Actual at 5 April 2013	2010 Ultimate Projection
The other 6 Films	(26)	(26)
Wimbledon	(31)	(30)
LLP Profit/(Loss) on Films	(57)	(56)

£m	Ingenious 2010 Wimbledon as Notting Hill	Briggs Notting Hill	Tribunal Crude Adjustment to Briggs Notting Hill	Briggs FTI
The 6 Other Films	(26)	(26)	(26)	(26)
Wimbledon	41	33	21	15
ITP Profit/(Loss)	15	7	(5)	(11)

£m	Forster 2010 Ultimate Adjusted	Briggs Wimbledon-as-Notting Hill Adjusted	Tribunal’s Crude Adjustment Adjusted
The Six Films	(10)	(10)	(10)
Wimbledon	(10)	35	25
ITP Profit/(Loss)	(20)	25	15

TRIBUNAL:	JUDGE CHARLES HELLIER
	JULIAN STAFFORD

Eventual profit	£(10)m	£nil	£100m
Number of films	60	39	1

First-tier Tribunal (Tax)