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You are here: BAILII >> Databases >> First-tier Tribunal (Tax) >> Degorce v Revenue & Customs [2013] UKFTT 178 (TC) (04 March 2013) URL: http://www.bailii.org/uk/cases/UKFTT/TC/2013/TC02593.html Cite as: [2013] SFTD 806, [2013] STI 2050, [2013] UKFTT 178 (TC) |
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[2013] UKFTT 178 (TC)
TC02593
Appeal number: TC/2010/01916
Income tax - loss relief claimed from sole trader film distribution activity. Issues arising: (1) Was the Appellant carrying on a trade; (2) Was business carried on on a commercial basis; (3) Was business carried on with a view to the realisation/reasonable expectation of profit; (4) Were the profits calculated in accordance with GAAP; (5) What would profits calculated in accordance with GAAP have been; (6) Was the expenditure incurred wholly and exclusively for the business.
FIRST-TIER TRIBUNAL
TAX CHAMBER
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PATRICK DEGORCE |
Appellant |
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- and - |
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THE COMMISSIONERS FOR HER MAJESTY’S |
Respondents |
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REVENUE & CUSTOMS |
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TRIBUNAL: |
JUDGE J. BLEWITT |
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C. E. FARQUHARSON |
Sitting in public at Bedford Square , London on 1, 2, 3, 4, 8 and 9 May 2012 and 15 June 2012.
Mr Jonathan Peacock QC leading Mr Jolyon Maugham, Counsel, instructed by Field Fisher Waterhouse LLP for the Appellant.
Mr Michael Gibbon QC leading Mr Michael Jones, Counsel, instructed by the General Counsel and Solicitor to HM Revenue and Customs, for the Respondents.
© CROWN COPYRIGHT 2013
DECISION
Introduction
Background
5. Mr Degorce is one of twelve Related Appellants who participated in such transactions which led to HMRC opening enquiries on 22 June 2007 into their tax returns for the year ended 5 April 2007.
8. Mr Degorce and the remaining eight Related Appellants were informed by HMRC on 14 August 2009 that closure notices would not be issued to them as enquiries continued pertaining to unrelated aspects of their tax returns.
10. On 19 May 2010 HMRC served a Statement of Case which set out the questions referred.
11. On 25 January 2011 the Tribunal issued a direction under Rule 18 of the Tribunal Procedure (First-tier Tribunal) (Tax Chamber) Rules 2009 specifying Mr Degorce’s case as a lead case and staying the cases of the eleven other Related taxpayers.
12. The questions referred were:
(a) Whether any Case 1 trade losses arise from the sole trader film distribution activity; and
(b) If so, the amount allowable for tax purposes.
(i) Whether, during the year ended 5 April 2007, Mr Degorce carried on a trade;
Irrespective of our findings on this question, we were invited to consider the following points:
(ii) Whether the trade was carried on on a commercial basis;
(iii) Whether the trade was carried on with a view to the realisation of profits and, if so whether it was carried on so as to afford a reasonable expectation of profit;
(iv) Whether the profits of the trade, if any, for the year of assessment 2006-2007 were calculated in accordance with generally accepted accounting practice (“GAAP”);
(v) If the profits of the trade were not calculated in accordance with GAAP, what would those profits have been had they been calculated in accordance with GAAP;
(vi) Whether the expenditure of the Taxpayer on the rights in the films was wholly and exclusively laid out or expended for the purposes of the trade.
A Summary of the Transactions and Relevant Parties
Principal Parties
14. Mr Degorce entered into a complex set of transactions in relation to the acquisition and assignment of film rights and also in relation to the financing of that acquisition. It may be helpful at this stage to identify the principal parties involved.
Patrick Degorce |
A hedge-fund manager and the Lead Appellant (“Appellant”) in this case |
Christopher Petzel |
A media entrepreneur with Fierce Entertainment |
Goldcrest Film Distribution Limited (“GDistribution”) |
The assignee from Mr Degorce of certain distribution rights in the films |
Goldcrest Film Rights Limited (“GFilm”) |
The assignor of certain distribution rights in the films to Mr Degorce |
Goldcrest Funding Limited (“GFunding”) |
The provider of loan funding to Mr Degorce |
Goldcrest Pictures Limited (“GPictures”) |
The supplier of film and advisory services to Mr Degorce |
Mazars LLP (“Mazars”)
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A UK limited liability partnership which provided Goldcrest with valuations of the film rights and which was instructed to prepare accounts for the taxpayers participating in the transactions relevant to this appeal.
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Adam Kulick |
Corporate Finance Executive employed by Goldcrest Film Finance |
HMRC’s Case
15. It was HMRC’s case that the sole trade activity did not give rise to Case 1 losses in the year ended 5 April 2007. HMRC contended that Mr Degorce was involved in a tax avoidance scheme (“the Goldcrest Film Scheme” / “Goldcrest Pictures Scheme” or “the Scheme”), the primary aim of which was to generate artificial income tax losses for the participants and fees for Goldcrest. HMRC did not argue that the transactions entered into by Mr Degorce were a sham, but submitted that in determining whether or not Mr Degorce was carrying on a trade the Tribunal must examine the transactions in their entirety and assess the reality of the arrangements.
16. HMRC contended that the Scheme was designed to generate losses for the individual participants by ensuring that the film rights were acquired by the individual participants at a price which would far exceed the value of the future net income stream received in return for the onward sale of the film rights. It was for this reason that the price of the film rights was vastly increased between purchase by an entity of Goldcrest called Upsticks based in the BVI from Paramount and sale of those rights to GFilm (prior to their sale to individual participants of the Scheme such as Mr Degorce). The losses generated in respect of the participants did not represent true economic loss and the Scheme was intended to allow the participants to attain leverage for their losses through the use of limited-recourse financing. HMRC contended that GFunding’s recourse under the loan agreement was limited to the distribution revenues received by the individual taxpayer.
17. HMRC contended that the Scheme had three main drivers:
(a) The primary goal as far as the individual participants were concerned was to generate income tax losses to shelter their taxable income for 2006-2007;
(b) In respect of Paramount, the Scheme represented a means by which it could sell a limited share in the distribution proceeds of its films for what it considered to be a reasonable price for such a share;
(c) As regards Goldcrest, the Scheme generated fee income from the individual participants.
18. HMRC pointed to the terms of the transactions which demonstrate the circular movements of money over the course of one day and the lack of any real control exercised by Mr Degorce over the Rights.
19. It was submitted that the composite transaction of Mr Degorce was not of a trading nature. HMRC contended that even if Mr Degorce is found to have carried on a trade in 2006-2007, that trade was not carried on on a commercial basis with a view to the realisation of profits or so as to afford a reasonable expectation of profit.
20. HMRC further contended that the profits of the trade for the year of assessment 2006-2007 were not calculated in accordance with GAAP and that the expenditure by Mr Degorce on the film rights was not wholly and exclusively laid out/expended for the purposes of the trade.
The Appellant’s Case
22. Mr Degorce (and those appointed by him) exercised, on a commercial basis, discretion as to which films or territories to acquire and formed a commercial view about the right price for those Rights following negotiations.
23. Mr Degorce contended that he sought to make a profit from his exploitation of the Rights and that the accounts were properly prepared in accordance with UK GAAP.
24. It was submitted that HMRC’s assertion that the Scheme had an overall fiscal purpose is irrelevant and does not lead to the conclusion that Mr Degorce was not carrying on a trade or that such trade was carried on on a non-commercial basis.
25. The cost to Mr Degorce of acquiring the Rights was an expense that was wholly and exclusively incurred by him for the purpose of his trade of acquiring and on-selling film distribution rights. Even if (which is not accepted) money was expended for primarily fiscal reasons, that fiscal motivation does not prevent the expenditure being wholly and exclusively incurred for the purpose of its trade.
The Evidence
· Mr Patrick Degorce (in addition to his two written witness statements dated 14 October 2011 and 26 April 2012);
· Mr Christopher Petzel, on behalf of the Appellant (in addition to his witness statement dated 14 October 2011);
· Mr John Graydon, an expert instructed on behalf of the Appellant (who also produced 3 written reports dated 14 October 2011, 2 May 2012 and 2 May 2012);
· Mr Michael Thornton, an expert instructed on behalf of HMRC (who also produced a written report dated 29 February 2012);
· Mr Richard Cannon, an expert employed by HMRC (who also produced 2 written reports dated 29 February 2012 and 30 April 2012).
28. We should note at this point that where the terms “resale/sale” are used in this decision, we are referring to the second limb of the transaction whereby Mr Degorce assigned the rights he had purchased. Also, our use of the word “scheme” is not intended to prejudge any issues in this case, but rather is used for ease of reference.
Authorities
29. We were provided with a significant number of authorities to which we will refer in due course.
Relevant Statutory Provisions
30. There was no dispute between the parties as to the legislation applicable in this case which can be summarised as follows: Mr Degorce’s claim was made under the Income and Corporation Taxes Act 1988. Section 380 (1) ICTA 1988 provides that relief is allowed:
“Where in any year of assessment any person sustains a loss in any trade, profession, vocation or employment carried on by him either solely or in partnership.”
31. The only definition of “trade” is found in s 832 (1) ICTA:
“In the Tax Acts, except in so far as the context otherwise requires...”trade” includes every trade, manufacture, adventure or concern in the nature of trade.”
32. S 384 (1) ICTA qualifies the provision for claiming relief as follows:
“... a loss shall not be available for relief under section 380 unless for the year of assessment in which the loss is claimed to have been sustained, the trade was being carried on on a commercial basis and with a view to the realisation of profits in the trade...”
(a) A loss was sustained in a trade carried on by him;
(b) That the trade was carried on on a commercial basis; and
(c) With a view to a reasonable expectation of profit.
GAAP and Case I trading profits
A Summary of the Transactions
The Scheme Mechanics
38. The following is intended to provide the background to the scheme and an outline of the transactions entered into by Mr Degorce and is taken from the facts, agreed by both parties in this appeal. Where the facts set out were disputed, we have either dealt with the issue at a later stage as the contentious fact relates to the issues to be determined, or we have set out our findings below, having taken the view that the findings are not material to the issues to be determined. We should note that any views expressed in relation to taxpayers other than Mr Degorce on the basis of documentary evidence, are made in order that the reader may fully understand the wider context of the Scheme and that in determining the issues in this case, we have focussed our attention on the transactions specific to Mr Degorce, having heard no direct evidence in respect of the eleven Related Appellants.
“Whilst the trade is carried on with a view to being a profitable venture, it is likely that a loss will arise in the first Accounting Period due to Generally Accepted Accounting Principles (“UK GAAP”)”.
“Upsticks will therefore have paid…to 5555,…to Grace Productions LLC. It will then pay to Goldcrest Pictures by way of a transaction fee £1,456,194 which will leave the company with a £25,000 day one fee.”
The £25,000 was also evidenced by an email dated 19 April 2007 from Mr Kulick requesting “£25,000 to be transferred from GFF LLP to the account below as compensation for Upsticks Limited” and a further email dated 20 April 2007 which had the subject “Upsticks Payment” and confirmed that the payment had been instructed via BACS.
The Film Rights Movements through the Scheme Structure
(email 01.26 from D. Friedman at Paramount to Mr Kulick)
“We have just concluded our meeting and we still would like to withdraw (blank). Please proceed with the contingency plans for Tropic Thunder and then Love Guru if necessary.”
It was after the Appellant had paid his contribution to GPictures that Paramount finalised the identity of the films to be used in the scheme, as evidenced by an email dated 4 April 2007 at 14:41 from Mr Kulick to the Appellant:
“…Unfortunately Revolutionary Road is no longer available. Angus, Tropic Thunder and Love Guru all have availability. When would you like to discuss?”
To which the Appellant replied (at 15:30 on the same day):
“…may be lets do after 5 to be sure mr petzel is out of his bed…”
And a further email at 15:36 from Mr Kulick to the Appellant which stated:
“…By the way, your cash contribution has just arrived”
(a) £12,967,428 for The Love Guru (being £1,705,826 and US$22,219,249 at an exchange rate of 1.9730:1 (USD:GBP));
(b) £12,382,777 for Revolutionary Road (being £1,628,910 and US$21,217,380);
(c) £7,349,660 for Angus (being £966,821 and US$12,593,341);
(d) £15,192,014 for Tropic Thunder (being £1,998,445 and US$26,030,893).
· Distribution Agreements for all of the individual participants in the Scheme;
· Acquisition Agreements;
· Studio Distributor Agreements;
· Head Acquisition Agreements;
· Sub-Acquisition Agreements for all of the individual participants in the Scheme.
57. On 5 April 2007, the Appellant entered into, inter alia, the following agreements:
(a) A Film Advisory Agreement dated 5 April 2007 pursuant to which GPictures was to provide the Appellant with advisory services for a fee of £1,623,959.60 plus a performance fee equal to 2% of receipts received from the exploitation of the distribution rights;
(b) A Loan Agreement with GFunding pursuant to which GFunding agreed to advance the sum of £17,100,295 to the Appellant exclusively for the purpose of his acquiring certain distribution rights (the “GFunding Loan”). Accompanying this was an irrevocable direction that the amount be paid by GFunding straight to the GPictures dollar account. Interest was to accrue on the outstanding principal amount of the loan at a rate of 8% per annum.
(c) One of the conditions precedent for the advance of the loan was the full execution of the Distribution Agreement between the Appellant and GDistribution;
(d) A Deed of Security Assignment in respect of the Loan Agreement with GFunding;
(e) A Sub-Acquisition Deed with GFilm, pursuant to which GFilm assigned to the Appellant all its rights, title and interest in:
· Love Guru in the territories of the USA, Canada, Scandinavia, France, Ireland, Far East, Eastern Europe and Other; and
· Tropic Thunder in the territories of the USA and Canada
For a term of 60 years commencing on 5 April 2007, for a total price of £20,299,495.
(f) A Distribution Agreement to assign to GDistribution the distribution rights in the films that the Appellant had purchased from GFilm for a term commencing on delivery of a Laboratory Access Letter in respect of the Films and concluding on 5 April 2067. The consideration for the assignment was:
(i) 100% of all Distribution Receipts (as defined therein) until the Distribution Receipts equalled 32.3% of the Purchase Price; and
(ii) Thereafter 100% of the remaining Distribution Receipts (to be on the basis of Net Proceeds.)
The term “Distribution Receipts” was defined in the Distribution Agreement as “all sums actually and indefeasibly received by [GDistribution] from the exploitation of the Distribution Rights pursuant to the Sub-Distribution Agreements”.
(g) A Deed of Security Assignment in respect of the Distribution Agreement with GDistribution.
(h) Payment Directions agreeing that any monies which the Appellant was entitled to under the Distribution Agreement were to be paid by GDistribution as follows:
(i) 55% to GFunding until the GFunding Loan was repaid;
(ii) 2% to GPictures in respect of the performance fee under the Film Advisory Agreement; and
(iii) The remaining 43% to the Appellant.
(i) A Notice of Assignment pursuant to which the Appellant notified GDistribution that, inter alia, he had assigned by way of security to GFunding the right to receive the monies he was entitled to receive under the Distribution Agreement and the benefit of his rights under the Distribution Agreement.
(j) Two Short form Assignments in respect of each of the Sub-Acquisition Deed and the Distribution Agreement.
(a) Until Defined Proceeds equalled 97% of the Purchase Price, Paramount Pictures Corporation was to retain 66.67% of 100% of the Defined Proceeds;
(b) Until Defined Proceeds equalled 97% of the Purchase Price, Paramount Pictures Corporation was to pay amounts equal to 33.33% of the Defined Proceeds to or at the direction of GDistribution;
(c) Once Defined Proceeds equalled 97% of the Purchase Price, 100% of the remaining Defined Proceeds are thereafter to be retained by Paramount Pictures Corporation;
(d) Paramount Pictures Corporation was thereafter to pay to or at the direction of GDistribution, an amount equal to 33.33% of “Net Proceeds”, until repayment of the 5555 Loan in full; and
(e) Upon repayment of the 5555 Loan in full, Paramount Pictures Corporation was thereafter to pay to or at the direction of GDistribution, an amount equal to 15% of the Net Proceeds until the end of the term.
“…For purposes of clarity, please find below our understanding of some of the commercial deal points.
…Our Sole Traders recoup on an Adjusted Gross Basis from the territory until they have received 15% net of any loan repayments and Studio Distributor recoups to 85% of direct costs (no studio overhead); thereafter we split net receipts on a 15%/85% basis…)”
Valuation of the Distribution Rights held in the Films
66. On or around 14 June 2007, further to the instructions and information provided by Goldcrest as the Appellant’s agent, Mazars provided financial statements for the Appellant for the period 2 April to 5 April 2007. The accountants’ report was made to the Board of GPictures, not to the Appellant. It stated that “Goldcrest Pictures Limited have acknowledged their duty to ensure that Patrick Degorce has kept proper accounting records and to prepare financial statements that give a true and fair view”. Mazars LLP reported to the board of GPictures and stated that they valued the rights in the Films held by the Appellant at the end of 5 April 2007 as follows:
(a) The rights in Tropic Thunder in the territories of North America and Canada at £380,487; and
(b) The rights in Love Guru in the territories of North America, Canada, Iceland, Scandinavia, France, Far East, Eastern Europe and Other (Israel, Middle East, Turkey, West Indies, India/Pakistan and airlines) at £501,310.
The Appellant’s Tax Return for the Year Ending 5 April 2007
The Issues
Was the Appellant carrying on a trade?
74. In Ransom v Higgs [1974] STC 539 (“Ransom”) (per Lord Reid) it was stated:
“The Income Tax Acts have never defined trade or trading farther than to provide that trade includes every trade, manufacture, adventure or concern in the nature of trade. As an ordinary word in the English language 'trade' has or has had a variety of meanings or shades of meaning. Leaving aside obsolete or rare usage it is sometimes used to denote any mercantile operation but it is commonly used to denote operations of a commercial character by which the trader provides to customers for reward some kind of goods or services.
…It is, however, in my view a question of law as to what is the meaning of “trade”...
In considering whether a person 'carried on' a trade it seems to me to be essential to discover and to examine what exactly it was that the person did....To be engaged in trade or in an adventure in the nature of trade surely a person must do something and if trading he must trade with someone.”
“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. It is with those words 'for profit' that the questions in the present case are primarily concerned.
....I take the law to be as follows:
(1) In order to constitute a transaction in the nature of trade, the transaction in question must possess not only the outward badges of trade but also a genuine commercial purpose.
(2) If the transaction is of a commercial nature and has a genuine commercial purpose, the presence of a collateral or ulterior purpose to obtain a tax advantage does not 'denature' what is essentially a commercial transaction. If, however, the sole purpose of the transaction is to obtain a fiscal advantage, it is logically impossible to postulate the existence of any commercial purpose.
(3) Where commercial and fiscal purposes are both present, questions of fact and degree may arise, and these are for the commissioners. Nevertheless, the question is not which purpose was predominant, but whether the transaction can fairly be described as being in the nature of trade.
(4) The purpose or object of the transaction must not be confused with the motive of the taxpayer in entering into it. The question is not why he was trading, but whether he was trading. If the sole purpose of a transaction is to obtain a fiscal advantage, it is logically impossible to postulate the existence of any commercial purpose. But it is perfectly possible to predicate a situation in which a taxpayer whose sole motive is the desire to obtain a fiscal advantage invests or becomes a sleeping partner with others in an ordinary trading activity carried on by them for a commercial purpose and with a view of profit.
(5) The test is an objective one...
(6) In considering the purpose of a transaction, its component parts must not be regarded separately but the transaction must be viewed as a whole. That part of the transaction which is alleged to constitute trading must not be viewed in isolation, but in the context of all the surrounding circumstances. But this must mean all relevant surrounding circumstances; that is to say, those which are capable of throwing light on the true nature of the transaction and of those aspects of it which are alleged to demonstrate a commercial purpose.
(7) If the purpose or object of a transaction is to make a profit, it does not cease to be a commercial transaction merely because those who engage in it have obtained the necessary finance from persons who are more interested in achieving a fiscal advantage from their investment. Even where the trader is the creature of the financier, the two activities are distinct and the object of one is not necessarily the object of the other.
(8) In FA & AB Ltd v Lupton, Lord Morris said ([1972] AC 634 at 647,47 TC 580 at 620):
'It is manifest that some transactions may be so affected or inspired by fiscal considerations that the shape and character of the transaction is no longer that of a trading transaction. The result will be not that a trading transaction with unusual features is revealed but that there is an arrangement or scheme which cannot fairly be regarded as being a transaction [in the nature of trade].'
In my judgment this is the true significance of a fiscal motive. Fiscal considerations naturally affect the taxpayer's evaluation of the financial risks and rewards of any proposed venture, and are often the decisive factor in persuading him to enter into it. First-year allowances, enterprise zones, government grants and the like operate as financial inducements to businessmen to engage in commercial activities which would be financially unattractive or unacceptably speculative without them. Such motivations, even if paramount, do not alter the character of the activities in question. But while a fiscal motive, even an overriding fiscal motive, is irrelevant in itself, it becomes highly relevant if it affects, not just the shape or structure of the transaction, but its commerciality so that, in Lord Morris's words, 'the shape and character of the transaction is no longer that of a trading transaction'. But nothing less will do.
(9) Accordingly, in my judgment, and adapting the words of Lord Simon in Thomson v Gurneville ([1972] AC 661 at 679, 47 TC 633 at 679), the question is whether, in the light of all relevant circumstances, the transaction is capable of being fairly regarded as a transaction in the nature of trade, albeit one intended to secure a fiscal advantage or even conditioned in its form by such intention; or is incapable of being fairly so regarded but is in truth a mere device to secure a fiscal advantage, albeit one given the trappings normally associated with trading transactions.”
76. The case also clarified that:
“It is not the law that a transaction the paramount (but not the sole) object of which is to obtain a fiscal advantage cannot be a trading transaction.”
77. In the Court of Appeal it was said:
“What is the ultimate question?
To summarise my views on the law in this case the position, in my judgment, is as follows:
(A) Whether a transaction is to be classified as commercial normally falls to be determined objectively by reference to the nature of the transaction itself ie is it a transaction of a kind similar to transactions of the same nature in the commercial world and carried out in a similar way.
(B) In addition to the outward badges of trade, in order to be a trading transaction its purpose must be commercial.
(C) The question 'was it trading?' is a question of fact for the commissioners.
(D) In deciding that question, the commissioners must look at the transaction as a whole including the steps taken for its implementation.
(E) The commissioners must decide whether the transaction was in reality merely a device to secure a fiscal advantage or a genuine trading activity.
(F) The ultimate question always remains 'what was the purpose of the transaction?' That question will normally be answered by an objective analysis of the transactions viewed as a whole.
(G) If the appearance of the matter (as shown by an objective analysis of the transactions) is equivocal, the subjective intention of the taxpayer is relevant in determining the purpose of the transaction and will generally be decisive.
(H) A transaction can be equivocal and therefore evidence of subjective intention relevant even if there was a possibility of the transaction producing a commercial profit (as opposed to a tax benefit) to the taxpayer.
(I) Although the purpose of the other party or parties to the transactions (being part of the circumstances) is relevant, the question in each case is whether the taxpayer was trading. Just because the other party to the transaction in question may have no fiscal object and viewed from his angle the transaction is one by way of trade, it does not follow that the taxpayer as a party to the same transaction is also engaged in trade.
(J) If the sole purpose of the transaction is to gain a fiscal advantage, in law that cannot amount to trade.
(K) If the transaction has some commercial features but also an element of fiscal advantage, it is for the commissioners to weigh the conflicting elements to decide whether the transaction was entered into by the taxpayer for essentially commercial purposes but in a fiscally advantageous form or essentially for the purpose of obtaining a fiscal advantage under the guise of a commercial transaction. In the former case, the transaction would constitute trading; in the latter it will not.”
78. The case of Marson v Morton [1986] STC 463 (at 470) (“Marson”) set out that:
“...a single, one-off transaction can be an adventure in the nature of trade.”
“The matters which are apparently treated as a badge of trading are as follows:
(1) That the transaction in question was a one-off transaction. Although a one off transaction is in law capable of being an adventure in the nature of trade, obviously the lack of repetition is a pointer which indicates there might not here be trade but something else.
(2) Is the transaction in question in some way related to the trade which the taxpayer otherwise carries on? For example, a one-off purchase of silver cutlery by a general dealer is much more likely to be a trade transaction than such a purchase by a retired colonel.
(3) The nature of the subject matter may be a valuable pointer. Was the transaction in a commodity of a kind which is normally the subject matter of trade and which can only be turned to advantage by realisation, such as referred to in the passage that the chairman quoted from Reinhold? For example, a large bulk of whisky or toilet paper is essentially a subject matter of trade, not of enjoyment.
(4) In some cases attention has been paid to the way in which the transaction was carried through: was it carried through in a way typical of the trade in a commodity of that nature?
(5) What was the source of finance of the transaction? If the money was borrowed that is some pointer towards an intention to buy the item with a view to its resale in the short term; a fair pointer towards trade.
(6) Was the item which was purchased resold as it stood or was work done on it or relating to it for the purposes of resale? For example, the purchase of second-hand machinery which was repaired or improved before resale. If there was such work done, that is again a pointer towards the transaction being in the nature of trade.
(7) Was the item purchased resold in one lot as it was bought, or was it broken down into saleable lots? If it was broken down it is again some indication that it was a trading transaction, the purchase being with a view to resale at profit by doing something in relation to the object bought.
(8) What were the purchasers' intentions as to resale at the time of purchase? If there was an intention to hold the object indefinitely, albeit with an intention to make a capital profit at the end of the day, that is a pointer towards a pure investment as opposed to a trading deal. On the other hand, if before the contract of purchase is made a contract for resale is already in place, that is a very strong pointer towards a trading deal rather than an investment. Similarly, an intention to resell in the short term rather than the long term is some indication against concluding that the transaction was by way of investment rather than by way of a deal. However, as far as I can see, this is in no sense decisive by itself.
(9) Did the item purchased either provide enjoyment for the purchaser (for example, a picture) or pride of possession or produce income pending resale? If it did, then that may indicate an intention to buy either for personal satisfaction or to invest for income yield, rather than do a deal purely for the purpose of making a profit on the turn. I will consider in a moment the question whether, if there is no income produced or pride of purchase pending resale, that is a strong pointer in favour of it being a trade rather than an investment.
I emphasise again that the matters I have mentioned are not a comprehensive list and no single item is in any way decisive. I believe that in order to reach a proper factual assessment in each case it is necessary to stand back, having looked at those matters, and look at the whole picture and ask the question—and for this purpose it is no bad thing to go back to the words of the statute—was this an adventure in the nature of trade? In some cases perhaps more homely language might be appropriate by asking the question, was the taxpayer investing the money or was he doing a deal?”
(1) To consider the badges of trade, bearing in mind that such features, where present, are not necessarily determinative of the issue;
(2) We bore in mind that even where an ulterior (even paramount) motive to obtain a tax advantage is present, this does not automatically “denature” a commercial transaction;
(3) To determine the question of trade as a matter of law and thereafter consider whether, on the facts, a trade existed;
(4) The test is an objective one;
(5) That the transaction must be analysed as a whole and viewed in the context of its surrounding circumstances where that context assists in determining the true nature of the transaction;
(6) To ask ourselves “What did Mr Degorce actually do?”
· Whether Paramount decided to exploit the films in question (absolute discretion on its part found in documents such as the Sub-Acquisition Deed between GDistribution and Paramount);
· The success of the films;
· The quantum of the manifold deductions that fell to be made against any of the film proceeds before any share of the income went to the Appellant.
84. On behalf of the Appellant it was submitted that Mr Degorce’s involvement in similar transactions prior to 2006-2007 and (as a sole trader) subsequent to 2006-2007, combined with his unchallenged evidence that he had been exploring opportunities in the film sector points to a badge of trade.
90. The Appellant disagreed and argued that the cases of Ensign Tankers, HMRC v Halycon Films LLP [2010] STC 1125 (“Halycon”), Micro Fusion 2004-1 LLP [2010] STC 1541 (“Micro Fusion”) and Icebreaker 1 LLP v HMRC [2011] STC 1078 support the contention that in each case it was common ground that the relevant partnership was trading where transactions involved the lease/licence of film rights/production for a stream of income of which the partnership had no control. The Appellant also contended that HMRC have failed to recognise that there was a purchase and a sale of the rights.
96. The Appellant agreed that the Rights were sold on the same day as purchased and the fact that Mr Degorce was contractually bound to do so, but the Appellant submitted that it cannot be ignored that an asset was purchased and sold with focus only on the resultant revenue stream. As such, the Appellant argued that this badge is a very strong pointer towards a trading deal.
Findings of Fact on badges of trade
99. We found as a fact that there was no element of repetition in Appellant’s transaction. We had no detailed evidence before us relating to Mr Degorce’s activities either pre or post 2006-2007. As regards those pre 2006-2007, there was no evidence to support the assertion on behalf of the Appellant that there existed a “deemed film trade” nor has any binding finding been made by a Court or Tribunal in that regard. Similarly, whilst we accepted that the Appellant had been involved in activities similar to that before us after the relevant period (2006-2007), we noted that those activities were subject of an enquiry by HMRC and again, no determination has been made on the issue of trade. In our view, it would be unsafe to accept the Appellant’s assertions in the absence of any detailed examination of the evidence and consequently found that we must deal with the transaction as a one-off transaction.
100. We accepted that Mr Degorce may well have explored opportunities in the film sector, but in our view the contemplation of any such activities is distinguishable from the reality of actually entering into such transactions.
102. As to the question of whether the transaction related to Mr Degorce’s day to day business, for the reasons set out above we did not consider his activities involving the film industry pre and post 2006-2007 in some way related to the trade which Mr Degorce otherwise carries on, namely that of a hedge fund manager.
109. As to whether the purchaser intended to sell at the time of purchase; if the transactions are viewed, as urged by the Appellant, as a sale and subsequent resale of the Rights, it points to trade. However, in our view, to ignore the role of the income stream as part of the composite transaction would not reflect the reality of the situation which, properly viewed following analysis of the documents and from a realistic perspective the transactions were a composite whereby Mr Degorce made payment of a lump sum in return for the potential income stream and there was no evidence upon which we could be satisfied that there was any intention to sell at the time of purchase.
111. We concluded that the overall indication in applying the badges of trade is that the nature of the composite transactions was not of a trading nature. However, this is not necessarily decisive of the issue and we therefore went on to consider what Mr Degorce actually did.
What was the transaction? What did Mr Degorce actually do?
Time Line
112. The following represents a brief overview of the process by which Mr Degorce acquired the film rights. We should note that this time line was devised by us and is designed to provide an overview to assist the reader; not all of the information contained in this chart would have been known to the Appellant nor is it intended as an exhaustive list of the sequence of events.
Date |
Event |
February 2007 |
Mr Petzel visited the Appellant at home and had general discussions regarding the Appellant’s interest in the film industry |
5 March 2007 |
Email from Mr Kulick to Ward Consultancy which stated “How has the Friday announcement affected your selling season? We have counsel’s opinion on another structure…that still works despite the recent changes. We’re aiming to roll it out in the next week or so.” |
8 March 2007 |
Email Phoros Group to Mr Kulick dated 8 March 2007 which stated “What is the write down on your scheme insofar how much tax back. Also what fees are you paying on the gross earnings to be sheltered?” |
31 March 2007 |
Email from Mr Kulick to Ward Consultancy which stated “…please confirm whether your numbers below are the amounts to shelter or gross amounts to pay…” |
1 April 2007 |
Email from Mr Kulick to Paynter Granby requesting assistance in closing a deal “the matter is of some urgency as we are aiming to close on Wednesday” |
2 April 2007 |
Letter from Ms Challons at HSBC Specialist Tax Group setting out the “Goldcrest Pictures Business Proposal” including the taxation position and the Appellant’s capacity to shelter income for the tax year 2006-07 |
2 April 2007 |
Acceptance form of GPics signed by the Appellant and witnessed by Ms Challons which included the irrevocable agreement at clause 3.4 that the acceptance once submitted “cannot be cancelled, rescinded or revoked”. |
2 April 2007 |
Loan Application from GPics signed by Mr Degorce and confirmed by Ms Challons |
2 April 2007 |
Minutes of telephone meeting between Mr Degorce and Mr Petzel which confirm that Appellant had signed acceptance form and was considering acquiring the rights to Star Trek. Mr Petzel informed the Appellant that he was very familiar with the deal structures of Goldcrest and had been in discussions to assist them with the valuation of distribution rights. The Appellant agreed a fee of $20,000 for Mr Petzel to assist with an economic analysis. Mr Petzel agreed to inform Goldcrest of the conflict and the Appellant would inform Goldcrest of Mr Petzel’s engagement. |
3 April 2007 (11.46 and 11.51) |
Two Emails; one from Ms Zitouni (HSBC) to the Appellant requesting confirmation of the amount to transfer from Appellant’s capital account to his new Sole Trader account as £4,854,534. Second email from Ms Zitouni to Mr Dodds at HSBC confirming the amount of the transfer as £4,862,234. |
4 April 2007 (09.57) |
Email from Mr Kulick at Goldcrest Films to Mr Degorce explaining that Star Trek was no longer an appropriate film for the structure. |
4 April 2007 (12.09) |
Email from Mr Kulick to Mr Degorce setting out information on Love Guru, Tropic Thunder and Angus. The email states that once the territories are selected by Mr Degorce, Goldcrest aim to execute all documentation on that day (4 April 2007). |
4 April 2007 |
Email from Mr Degorce to Mr Kulick stating that he would like to discuss the film options as soon as possible and has asked Mr Petzel to call when he wakes up. Mr Degorce states: “I guess we will do a blend of both movies given size”. |
4 April 2007 (15.36) |
Email from Mr Kulick confirming that Mr Degorce’s cash contribution has been received. |
4 April 2007 (16.00) |
Minutes of telephone call between Mr Degorce and Mr Petzel in which Mr Degorce requested that his engagement agreement with Mr Petzel be amended to replace Star Trek XI with Tropic Thunder and Love Guru. Mr Petzel confirmed that he would provide an economic analysis and that Mr Kulick would be informed of the intention to proceed with Tropic Thunder and Love Guru (subject to valuation.) |
4 April 2007 (17.45) |
Minutes of telephone meeting between Mr Degorce and Mr Petzel in which it was stated that the transaction involving Tropic Thunder and Love Guru would be conditional on Mr Petzel’s valuation which would be provided later that day. |
4 April 2007 (22.30) |
Minutes of telephone meeting between Mr Degorce and Mr Petzel in which draft valuations for Tropic Thunder and Love Guru were discussed. Mr Degorce felt that the analysis of Mr Petzel supported the transaction and agreed to inform Mr Kulick of the same. |
4 April 2007 (23.00) |
Minutes of telephone meeting between Mr Degorce, Mr Kulick and Mr Petzel in which Mr Degorce confirms that he is content with the price and territories on Love Guru but is looking for a discount on Tropic Thunder. Mr Kulick indicates that he is unwilling to reduce the price on Tropic Thunder. |
4 April 2007 (23.33) |
Email from Mr Kulick to Mr Degorce indicating one last amendment: the total purchase price was lowered by £313,500 and Switzerland substituted for Easter Europe on Love Guru. Mr Kulick states “it’s a good deal, honest.” |
5 April 2007 (14.09) |
Email from Mr Kulick to Mr Degorce confirming that “we closed today”. |
28 June 2007 |
Letter from GPics to the Appellant enclosing his accounts in respect of film distribution rights which have been reviewed by Mazars LLP |
“You will sell your distribution rights to Goldcrest Distributor, a wholly owned subsidiary of Goldcrest Film Finance LLP, who will purchase and distribute your rights under the terms of the Distribution Agreement.”
115. In addition to advice provided by Goldcrest, Mr Degorce also took advice from Mr Petzel, Howard Kennedy Solicitors and HSBC Private Bank. An assistant was employed by Mr Degorce to assist in managing the trade.
116. Reliance was placed by the Appellant on the discretion used by Mr Degorce in deciding which films or territories to acquire, whereupon he would negotiate the price to be paid for the rights.
Mr Degorce’s Evidence
117. Mr Degorce explained in his oral evidence that he understood Ms Challons to be in charge of HSBC’s tax department. Ms Challons had contacted him upon being made aware that the Star Trek rights were available as she was aware of his interest in the film business. In March 2007 Ms Challons introduced Mr Degorce to Mr Kulick at Goldcrest. Mr Degorce accepted that the agreement he had entered into with Goldcrest contained a disclaimer, for example in relation to the accuracy of financial illustrations, but stated that he was provided with advisory services by one of the Goldcrest companies. He stated in oral evidence (transcript 01/05/12) that one of the reasons for hiring Mr Petzel was to “review all the models, all the assumptions” as he did not want to rely solely on Goldcrest’s opinion. In addition, he received advice from HSBC and Howard Kennedy.
118. Mr Degorce understood that the rights he acquired would have to be re-sold. He did not agree that the trade put forward to him was the purchase of the rights, which were sold as part of the package and thereafter he did nothing; he clarified that the business was still continuing as he had instructed audits to be carried out. He accepted in oral evidence (transcript 01/05/12) that there was no option to avoid entering into an agreement with Goldcrest in relation to film advice, or that he could obtain a loan elsewhere: “No, it was – it’s a package, as you say”.
119. Mr Degorce did not rely on the comparables provided by Goldcrest, preferring instead to rely on Mr Petzel and therefore the financial illustrations provided by Goldcrest had not formed part of his consideration. He understood that the law allowed him to engage in a risky industry with the safety net provided by tax relief. He agreed that there was a downside protection and only an upside if the film was a large success. As to what he understood from the Goldcrest documents and figures provided at the time, Mr Degorce stated in oral evidence (transcript 01/05/12):
“...I understood that the law and the structure will allow me to buy movie rights with a safety net which is exactly what I did...I made no money whatsoever from the return of those movies...I made no money from any forms of tax.”
120. In cross-examination as to whether or not Mr Degorce understood that the scheme was a tax avoidance scheme within the meaning of the 2006 Regulations and therefore disclosable, the evidence was unclear. Mr Degorce understood that the tax benefit could be viewed as a tax avoidance scheme and consequently he sought advice from HSBC and read legal advice on the issue. He accepted in oral evidence (transcript 02/05/12) that if the tax treatment was not as suggested by Goldcrest, then the transaction would not be worth entering into, nor would he have entered into the scheme without the loan from Goldcrest:
Mr Gibbon QC: “…You fully understood, therefore, that if the tax treatment was not as Goldcrest suggested, this wouldn't be worth entering into?
Mr Degorce. Yes.”
121. Mr Degorce accepted that it was part of the package offered by Goldcrest that his accounts were prepared on the instructions of Goldcrest, which provided figures to be inserted into Mr Degorce’s accounts.
122. In respect of the short time frame over which the documents were executed, Mr Degorce stated to the Tribunal (transcript 02/05/12) that as long as he had sufficient time to be comfortable with the transaction, the time frame was irrelevant, although he accepted that potentially Goldcrest were attempting to put together a package for a number of people before the end of the tax year and later in his oral evidence he stated that “there was some rush put on us by Goldcrest...I have a recollection at least for one document that I have to sign the document before my lawyers were 100% comfortable with the loan agreement.” He stated that HSBC had ample time to review the scheme and he had relied on their advice. There were no documents to show exactly when Mr Degorce received advice from Howard Kennedy. A note of a telephone meeting with Mr Petzel on 2 April 2007 implied that Howard Kennedy had not, at that point, provided a legal opinion, however Mr Degorce could not recall the sequence of events.
“Goldcrest have requested you sign their confidentiality agreement.”
124. The reply from Mr Stephenson on the same date stated:
"Rather odd to ask a law firm. The agreement doesn't make a great deal of sense and probably doesn't work the way Goldcrest wanted to. There's also a technical conflict of interest...If they want an agreement that any document is applied to me ahead of HK being instructed by the investors to provide a tax opinion will be kept confidential and only used for the purposes of providing legal advice to persons who are or may become clients of HK, which they inform me are potential investors and presumably have signed up to NDAs with Goldcrest then I can do that...What I am being asked to sign up to is a general NDA [non disclosure agreement] in relation to discussions between the parties in connection with their respective business affairs. Without wishing to be pedantic, there are no such discussion and, based on our conversations, I doubt that we'll ever need to as all I am doing is advising individual investors on the tax aspects…”
125. A further email dated 27 March 2007 from Mr Stephenson to Mr Kulick stated:
“Either Goldcrest or Tim will be supplying me with documentation relating to the Goldcrest scheme. This is being sent to me as background information on the basis that I will be instructed by potential investors to provide tax opinions…”
126. It was put to Mr Degorce that Howard Kennedy were recommended to him by Goldcrest to provide tax advice on this scheme (inferring that the advice was not wholly independent) to which he clarified that although Howard Kennedy may have been recommended to him, possibly by HSBC, he had paid Howard Kennedy, not Goldcrest and the main advice he received related to the loan documentation which was complex.
127. Mr Degorce stated that there was an understanding, in his signing the agreement with Goldcrest which was, on the face of it “irrevocable”, that the deal would be void if his lawyers were not comfortable with the document. There is no documentary evidence to support his contention, however Mr Degorce stated that he trusted Goldcrest to be honest and true to their word, although he accepted that Goldcrest could have forced his position once he had signed the power of attorney document.
128. Mr Degorce was referred to the letter from Ms Challons dated 2 April 2007 which he stated he had not read prior to engaging with Goldcrest as the advice he had received from Ms Challons had been provided orally to him. In particular, Mr Degorce was referred to the statement by Ms Challons that “As requested, I have considered you capacity to shelter income for 2006-2007 tax year, which I have summarised below...” Mr Degorce stated that this referred to the amount of capital which he could potentially invest as defined by the tax environment of that investment. He did not accept that he had specifically asked for calculations in respect of sheltering income, but rather had sought to understand the tax safety net.
129. A number of documents were put to Mr Degorce which, it was suggested in cross-examination, showed that the scheme was promoted by Goldcrest primarily on a tax basis. Mr Degorce had not seen a number of the documents and confirmed that although there was an undeniable tax benefit in investing in the films, he used it as a way to invest in movies with limited risk.
130. He believed he had acquired the rights for Star Trek and instructed payment to be made either on the evening of 3 April 2007 or morning of 4 April 2007. By the time he was informed that Star Trek was not available, the payment had been instructed and so he had two options; either to take the money back or wait. He made it clear to Goldcrest that he would not pay any more and, as a businessman, he was able to make a quick commercial decision, leaving the other issues to his advisors. Mr Degorce stated that he discussed the economics of the profit with HSBC and asked Mr Petzel to check the assumptions relating to revenue and profit. On the issue as to the comparables used, Mr Degorce could only make limited comment. He stated that there was a great deal of consideration as to whether Goldcrest had used the correct comparables, but he accepted that there was no evidence in the documents provided to the Tribunal to show that any comparables other than those provided by Goldcrest (for which Goldcrest assumed no responsibility) had been used.
131. Mr Degorce highlighted the fact that he had rejected other films, such as Angus Thongs and Full Frontal Snogging, in which to invest, stating in his oral evidence (transcript 02/05/12):
“…my only focus on those transaction, and you might qualify me as a careless businessman but I think my track record speaks for itself, was about the commerciality of those movies and how much I will have to pay for the movies…I don't need three months…to value a movie…It took me exactly 10 seconds to reject Angus.”
132. In respect of the final purchase prices, Mr Degorce agreed that he had agreed the final price in respect of Love Guru, but had sought movement on the price for Tropic Thunder. Mr Gibbon QC on behalf of HMRC queried why, subsequently, Mr Kulick had lowered the price of Love Guru (having refused to move on the price of Tropic Thunder) and suggested that this was done for convenience to meet the difference required for Mr Degorce to reach the same overall price that he was going to pay for Star Trek (and thereby the amount Mr Degorce sought to shelter). Mr Degorce disagreed, stating that it was in the interests of Mr Kulick, in order to get the deal completed to balance the two figures. Mr Degorce agreed that the films were looked at globally and it did not matter where a reduction was given.
133. Mr Degorce appeared to agree that he had understood the economics of what would be paid to him in the event the rights produced a distribution both during the loan repayment and after, which was 15% either way, although he could not recall the exact percentage figures.
Mr Petzel’s Evidence
135. Mr Petzel explained that his role was to verify that the information given to Mr Degorce was accurate and whether the performance assumptions would lead to the waterfall portrayed in the Goldcrest documents. Mr Petzel agreed that this could be broken down into three elements; the ultimates, the cash flow assumptions (as to when the money from the ultimates would come in – the timing model) and knowledge as to how the waterfall works.
136. He had spoken to Mr Degorce about opportunities in the film industry in February 2007. Mr Degorce later explained the general terms of the scheme, but his involvement really began when he spoke to Mr Kulick in April 2007, having been engaged by Mr Degorce. In his oral evidence (transcript 03/03/12) he described the transaction as:
“It is basically -- you know, Patrick actually very, you know, sort of astutely sort of describes it as a kind of -- the acquisition of a call option on future revenues. So, you know, options are derivatives that are there to manage risk of a portfolio. So, in other words, what the studio is -- if you just sort of step aside from the structure and the implementation on an economic level, the studio is giving up a share of its future revenue in return for an amount of cash.”
139. The minutes of meetings between Mr Degorce and Mr Petzel were prepared after the event by Mr Petzel from his contemporaneous handwritten notes following a request being made by Mr Degorce in March/April 2007 that detailed notes were taken. The notes were then checked by Mr Degorce. It was put to Mr Petzel that the later minutes, unlike the earlier ones, contained times of meetings which were suggestive of a deliberate paper trial. Mr Petzel explained that he had gained experience over time and his Company, as a result, had become more organised. Mr Petzel agreed that a number of the documents were similar, if not identical in parts as a result of using the older documents over which he typed the new minutes. He could not recall why on a number of documents the wording was similar but not identical, and therefore could not be the result of writing over an old document. He stated that he understood that it was important to Mr Degorce that proper records be kept and, depending on what else was going on at the time, the notes were made a day to a week after the discussions took place.
142. As regards the comparables provided by Goldcrest, Mr Petzel stated that they appeared commercially sensible on the basis that they were similar in genre, release patterns and actors. It was pointed out to Mr Petzel that two of the comparables for Love Guru, a movie featuring the actor Mike Myers, were films which featured Ben Stiller, however even though there are a number of movies featuring Mike Myers, Mr Petzel did not find the comparables odd. Mr Petzel stated that he did look at sequels to Mike Myers films but that his task was not to research the comparables and he did not undertake any detailed analysis of alternatives to those provided in the Goldcrest document. He had not discussed with Mr Degorce whether the comparables were reasonable, stating in his oral evidence:
“…we didn't really talk about whether those comparables were reasonable, it was basically what Patrick asked of me is to say, if we assume, can you please check that the logic that follows from this level of performance is the right performance because of the summary nature of this piece of paper.”
143. Mr Petzel confirmed that of the eight films in which Mr Degorce had acquired rights between 2007 to date, only one film, Twilight, has made a return.
Findings of Fact on the Issue of Trade
“What is the write down on your scheme insofar how much tax back. Also what fees are you paying on the gross earnings to be sheltered?”
Whilst we note that Mr Degorce would not have been privy to the email, we inferred from the email dated 4 April 2007 from Mr Degorce to Mr Kulick that the purpose of Mr Degorce entering into the transaction was to shelter his income and that the email referred to the amount of money which he sought to shelter:
“I guess we will do a blend of both movies given size”
145. We found that this inference which we had drawn was reinforced by the advice received by Mr Degorce from Ms Challons, in her specific capacity of a tax specialist within HSBC. Mr Degorce stated that he had not read the letter from Ms Challons dated 2 April 2007; we found this unlikely given the value of the transaction. Accepting, however, that this was the case, we had no doubt that the information contained within the letter had been, at the very least, verbally communicated to Mr Degorce. The letter states:
“…As requested I have considered your capacity to shelter income for the 2006-07 tax year, which I have summarised below…The loss required to shelter your partnership income for 2006-07 is £18,785,905…”
We were satisfied that part of the advice provided by Ms Challons related to the amount of income Mr Degorce could shelter and that this advice was provided as a result of Mr Degorce’s query. In our view, this was the only logical conclusion for the letter to read “as requested...”
146. It was submitted on behalf of the Appellant that Mr Degorce had received advice from HSBC about Goldcrest and the deal structure. We saw no evidence to support this assertion; in our view the advice received was limited to the tax issues surrounding the transaction and the fee of £438,469.10 (plus VAT) paid by Mr Degorce to HSBC was more likely to be an introductory fee.
147. Mr Degorce’s evidence as to the role played by Howard Kennedy was vague. We inferred from the documentary evidence to which we were referred that Howard Kennedy were not a firm independently chosen by Mr Degorce to provide advice, but rather it was more likely that Goldcrest had suggested the firm to Mr Degorce. In our view, this was another example of the structured nature of the scheme in which Mr Degorce, and others, participated and there was no evidence upon which we could be satisfied that Mr Degorce had taken any independent steps to receive advice on the scheme.
148. The transaction took place over an extraordinarily short period. We did not accept Mr Degorce’s evidence that there had been no rush to complete the deal; whilst it was open to Mr Degorce not to participate, once the decision had been taken to join the scheme, we were satisfied that it was in the interests of Mr Degorce to complete the transaction prior to the end of the financial year, a fact acknowledged by Mr Petzel. It was also clear from the emails between Mr Kulick and the Appellant, both the speed at which the exchanges took place and their content, that it was intended that the transaction had to be executed within a very short space of time.
149. We inferred from the time over which Mr Degorce and Mr Petzel were involved that the asset subject of the transaction was, in reality, unimportant. Mr Degorce had initially paid on the basis that he was to acquire the rights to Star Trek. As can be seen from the timeline, Mr Degorce signed the agreement and loan application with GPics on 2 April 2007. It was only after having done so that Mr Degorce engaged Mr Petzel to analyse certain aspects of the scheme. Payment was made on 3 April 2007, after which Mr Degorce was informed (on 4 April 2007) that the rights to Star Trek were no longer available. Mr Degorce was then provided with information relating to Love Guru, Angus and Tropic Thunder. The email from Mr Kulick dated 4 April 2007 states that once territories were selected Goldcrest aimed to complete the scheme on the same date. Although Mr Degorce stated that his signing the acceptance form was not, as stated on the document, irrevocable, there is no indication that Mr Degorce contemplated withdrawing from or delaying his participation in the scheme once informed that the rights to Star Trek were unavailable; to the contrary, the documents suggest that this was a transaction with which Mr Degorce would go ahead, irrespective of the films involved.
150. We noted that having agreed a price for Love Guru, which had been accepted by Mr Degorce, Mr Kulick subsequently reduced the price. Mr Degorce’s oral explanation (transcript 02/05/12) that it was in the interests of Mr Kulick to complete the deal was vague and, in our view, lacked commerciality:
Mr Degorce: “Let me rephrase it properly, as I told this morning: the amount of capital I invested were determined by the risk I was willing to take on that trade, and obviously the risk I'm taking on that trade is by definition defined by the law because there is a tax safety net defined by the law.”
It seemed to us that the only logical inference was that the films, individually, were of little importance but rather the aim was to provide Mr Degorce with an asset or assets by which Mr Degorce could shelter the amount of income as advised by Ms Challons.
151. We were satisfied that at the time of signing the documents, Mr Degorce had a limited understanding of the detail of the scheme and in particular the valuation aspect otherwise there would have been little point in engaging Mr Petzel.
152. The precise role of Mr Petzel was unclear from his evidence. Mr Degorce stated that he engaged Mr Petzel to review all of the models provided by Goldcrest as he did not wish to rely solely on the information provided by Goldcrest however Mr Petzel’s evidence did not support this contention as he accepted that he did not analyse or question the comparables provided by Goldcrest. We concluded that the exercise carried out by Mr Petzel in reality provided little assistance to Mr Degorce beyond that already obtained from Goldcrest and HSBC.
153. Mr Petzel also appeared to suggest that his task was to analyse the waterfall from the point of view of Mr Degorce. It was unclear which documents Mr Petzel had been provided with at the time of his engagement, and we were satisfied that he had, in the main, relied on oral information communicated to him by Mr Degorce and Mr Kulick as he stated in evidence. It was certainly clear, and accepted by Mr Petzel in his oral evidence to the Tribunal (transcript 03/05/12) that he was not aware of specific details of the scheme such as step-down after repayment of the loan, which he stated had no impact on his analysis:
“No, I sort of -- like I said, I was not kind of analysing the transaction sort of at those levels. I was sort of looking at what to value sort of from Patrick's perspective. So kind of following through these kind of definitions to levels where, you know, I simply didn't have the information at the time, in any event.”
We could not understand how in those circumstances, without being aware of the details of each part of the scheme, how Mr Petzel could provide Mr Degorce with any meaningful analysis of the overall benefit of the scheme to the Appellant or true value of the film rights.
Mr Petzel: Okay. There was -- hold on. Somewhere in there there is sort of a calculation mistake which sort of makes the number, the actual number higher, it was either in Love Guru or Tropic Thunder. Where is the plus sign here? Yeah, so this is -- there is a -- let me see, I can tell you exactly what happened there. The actual international box office would've been higher had I calculated it properly, and actually there's some calculation mistakes in the total column, although the total column has no bearing on the model. It's not used anywhere, so because...
Mrs Farquharson: I can see there is a number duplicated.
Mr Petzel: Yeah, basically it's kind of when the formula refers to the wrong thing.”
155. Given the value of the transaction, we found it unlikely that had Mr Degorce intended to rely on Mr Petzel’s advice in any meaningful way, he would have been content to proceed on the limited documentation provided to Mr Petzel and an analysis which contained errors which were clear. We concluded that the only real understanding Mr Degorce had of the scheme at the time he entered into it and soon thereafter was in respect of the tax implications.
156. We will say more about the price paid for the Rights by the Appellant in due course, however in our view it is relevant to the issue of trade in that when we looked at what Mr Degorce did, he purchased film rights for £20,299,495, which he then sold on the same day at a loss of £19,417,698 (not taking into account professional fees/finance charges). In our view, this cannot be viewed as a purchase and subsequent sale of an asset; the transactions were inextricably linked and there was no regard to the true value of the Rights. When we asked ourselves “what was Mr Degorce trading” we concluded that his activities were, in reality, focussed on the close of the financial year and that his activity was limited to obtaining fixed receipts as proscribed by the Agreement signed which cannot be deemed as “trade”. We concluded from the evidence that the asset purchased was irrelevant for the purpose of the scheme; the sole requirement was a lump sum figure which was initially paid for Star Trek, and thereafter matched for Love Guru and Tropic Thunder, in return for the potential income stream. We concluded that this was not an adventure in the nature of trade.
Trade “Denatured”
“some transactions may be so affected or inspired by fiscal consideration that the shape and character of the transaction is no longer that of a trading transaction” (relying on Lupton (Inspector of Taxes) v FA &AB Ltd.)
159. In response the Appellant relied on Lupton v FA & AB Ltd [1972] AC 634, 47 TC 580, (“Lupton”) per Lord Morris on the question of motive:
"There may be occasions when it is helpful to consider the object of a transaction when deciding as to its nature. In the Harrison case my view was that there could be no room for doubt as to the real and genuine nature of the transaction. The fact that the reason why it was entered into was that the provisions of the revenue law gave good ground for thinking that welcome fiscal benefit could follow did not in any way change the character of the transaction.”
“...once it is accepted, as it must be, that motive does not and cannot alter or transform the essential and factual nature of a transaction it must follow that it is the transaction itself and its form and content which are to be examined and considered. If the motive or hope of later obtaining a tax benefit is left out of account, the purchase of shares by a dealer in shares and their later sale must unambiguously be classed as a trading transaction.”
Findings of Fact on denatured
162. We have already concluded that the Appellant’s activities were not an adventure in the nature of trade, but if we are incorrect in our findings, we accepted the submissions made by HMRC that if the Appellant’s activities could be deemed to be trade, that trade was denatured. Our findings set out above in respect of what Mr Degorce actually did are relevant to this point and we do not simply repeat the findings made thereon.
163. In reaching our conclusions, we did not unduly focus on the scheme as a whole, but rather the specific activities of Mr Degorce. Viewed realistically, we found that this was a scheme designed and planned to take place over the course of a very short period of time. In our view, Mr Degorce’s only activity was to participate in a scheme suggested to him (other than on the advice of his tax advisor) without any real understanding of it. He did not negotiate in the sense that, in our view, would be expected in a normal commercial trading transaction, nor was he responsible for selling. No service was provided by him, nor did he seek out or deal with a customer. We concluded that the sole purpose of the scheme, and therefore the sole purpose of Mr Degorce’s participation therein was to shelter his taxable income. In those circumstances we found that the transaction was so affected by fiscal consideration that “it affects not just the shape or structure of the transaction, but its commerciality so that, in Lord Morris’ words “the shape and character of the transaction is no longer that of a trading transaction.” (per Millett J in Ensign Tankers).
Commercial Basis/View to Profit
HMRC’s Case
170. HMRC did not accept that Mr Petzel had made a meaningful attempt to provide true valuations of the rights, but rather he had used the US box office figures provided by Goldcrest and produced broadly comparable prices to those of Goldcrest by applying sensitivities of 10%. It was contended by HMRC that there was no arms length negotiation of the prices ultimately paid by Mr Degorce as would be expected in an independent commercial transaction; the total of the amounts paid for Love Guru and Tropic Thunder were the same as that paid for Star Trek. The reduction given by Goldcrest to the amount already agreed by Mr Degorce for Love Guru was designed to facilitate the correct amount of money being invested into the scheme by Mr Degorce.
171. HMRC also relied on the oral evidence of Mr Degorce (transcript 02/05/12) as a further indication that he did not fully understand the detail of the transaction in which he was participating, nor did he care about the detail of the documents which defined what he was actually buying, which HMRC submitted was not the attitude of a person carrying on trade on a commercial basis and who is seriously interested in profit:
Mr Gibbon QC: “I am talking about the crunch in this deal here. There's the whole range of documents where you're having to place reliance on your lawyers, and we don't know how long precisely your lawyers had those documents.
Mr Degorce: You --
Mr Gibbon QC: From early April, was it?
Mr Degorce: I don't know. It's -- my only focus on those transaction, and you might qualify me as a careless businessman but I think my track record speaks for itself, was about the commerciality of those movies and how much I will have to pay for the movies. The rest, I can't care less. That's what I pay an advisor, to do that. So to make a judgment on that, I don't need three months, nor Christopher need three months to value a movie. He's been 15 years in business. It took me exactly 10 seconds to reject Angus...At the time when we're discussing those things, I knew for a fact that not only Christopher will review and discuss with Mr Kulick how the economics work, but that job has been done previously, not, you know, by you know HSBC beforehand, and once again you know those waterfall could be complex, you know those documents are not easy to read and I was not -- I mean I've no capacity to understand, so I much more likely to rely on experts to tell me how things work than do it by myself.”
Appellant’s Case
180. The price paid was, and was intended by Mr Degorce, to be a reasonable and commercial price; furthermore Mr Degorce has made “massive profits” on Twilight.
181. It was not put to Mr Degorce that he was certain to make a loss or indifferent to profit and the Tribunal, as a matter of law, cannot reach such a finding.
“We are after the extreme cases in which expenditure very greatly exceeds income or any possible income which can ever be made in which, however long the period, no degree of profitability can ever be reached.”
185. It was submitted (relying on the Goldcrest Distribution Rights Proposal) that the transactions were presented to Mr Degorce on the basis that he would trade profitably over time, as has happened with the profits generated by Twilight and is likely to happen with Eagle Eye, from which Mr Degorce expects to receive at least £10,000,000. As such, the Tribunal was invited to accept Mr Degorce’s view as to the likely profitability of the two films relevant to this appeal.
Findings of fact on the issue of whether the trade was carried on on a commercial basis and in such a way that profits could reasonably be expected to be realised in that period/within a reasonable time thereafter/with a view to the realisation of profits
186. We respectfully agreed with the comments in the case of Samarkand Film Partnership No 3 v HMRC [2012] UKFTT 610 (TC) (“Samarkand”), which we adopted as our preliminary approach to this issue:
“The activity of a partner in investing in a partnership may well be part of a commercial enterprise, but if it is that does not mean that the partnership business is necessarily carried on on a commercial basis. It may well be that a partner’s borrowing, investment in the partnership and use of tax reliefs is as a whole commercial, but that is irrelevant to the assessment of the commerciality of the partnership’s business...
Thus the question for us is whether the activities of the partnership were carried on on a commercial basis...
It seems to us that this decision does not compel the conclusion that profitability is irrelevant to whether a venture is commercial...It seems to us that the serious interest in a profit is at the root of commerciality. Christmas is commercialised when it is used for profit. The hobby art gallery is not run with a serious eye to making money; nor is the loss making market garden. But a serious interest in profit does not to our mind mean simply an interest in an excess of receipts over expenditure especially where longer term cashflows are involved. In those cases the well known and well understood technique of discounting future cashflows to derive their present value would be used to evaluate the project or investment.
It seems to us that if an entity enters into a transaction which has a negative net present value the transaction cannot be descried as commercial unless there are other collateral benefits expected or hoped for which are expected to outweigh the negative effect of the transaction. If you buy an asset for £10 and exchange it for something worth £7 that is not a commercial transaction unless you have a collateral hope for at least £3 profit elsewhere.”
188. The Film Advisory Agreement, pursuant to which GPictures provided the Appellant with advisory services, required a fee of £1,623,959.60 plus a performance fee equal to 2% of Mr Degorce’s receipts from the exploitation of the distribution rights.
189. The Loan Agreement with GFunding, by which GFunding agreed to provide the sum of £17,100,295, was exclusively for the purpose of Mr Degorce acquiring certain distribution rights. Interest was to accrue on the loan at a rate of 8% p/a.
190. We noted that Clause 3.4 of the Loan Agreement entitled Mr Degorce to prepay the loan, however we accepted HMRC’s submissions on this point. We concluded that the possibility of the loan being prepaid was so remote as to render the Clause ineffective in practice on the basis that the need to pay back the loan only arose when distributions received and, as Mr Degorce himself acknowledged, the loan was part of the “package”. In those circumstances, viewing the transaction as a composite we concluded that the loan was effectively non-recourse.
191. The Sub-Acquisition Deed with GFilm assigned Mr Degorce the rights, title and interest in the two films for a term of 60 years commencing on 5 April 2007 for a total price of £20,299,495. On the Appellant’s figures, those same rights were sold on the same day for £881,797. 15.76% of the £20,299,495 was funded by the Mr Degorce’s cash contribution and the remainder by the loan. Of Mr Degorce’s contribution in the sum of £4,823,160, 66.33% was spent on the acquisition of the film rights and the remainder was paid by way of fees to Goldcrest.
· 100% of all Distribution Receipts until those receipts equalled 32.3% of the purchase price (i.e. £20,299,495); and
· Thereafter 100% of the remaining Distribution Receipts to be on the basis of Net Proceeds (as defined in the Distribution Agreement as “all sums actually and indefeasibly received by [GDistribution] from the exploitation of the Distribution Rights pursuant to the Sub-Distribution Agreements).
· 55% to GFunding until the loan was repaid;
· 2% to GPictures for the performance fee under the Film Advisory Agreement; and
· 43% to Mr Degorce.
· Until Defined Proceeds equalled 97% of the Purchase Price, Paramount Pictures Corporation was to retain 66.67% of 100% of the Defined Proceeds;
· Until Defined Proceeds equalled 97% of the Purchase Price, Paramount Pictures Corporation was to pay amounts equal to 33.33% of the Defined Proceeds to or at the direction of GDistribution;
· Once Defined Proceeds equalled 97% of the Purchase Price, 100% of the remaining Defined Proceeds are retained by Paramount Pictures Corporation;
· Paramount Pictures Corporation was thereafter to pay to or at the direction of GDistribution, an amount equal to 33.33% of Net Proceeds, until repayment of the 5555 Loan in full; and
· Upon repayment of that loan in full, Paramount Pictures Corporation was to pay to or at the direction of GDistribution, an amount equal to 15% of the Net Proceeds until the end of the 60 year term.
195. In effect, this meant that when the 5555 loan was repaid, Mr Degorce continued to be entitled to a maximum 15% share of the proceeds of the film rights.
197. We did not find the Appellant’s reliance on his receipts from Twilight assisted him; an appendix annexed to HMRC’s written closing submissions showed that even where the film was a worldwide success, the returns made by Mr Degorce were only profitable on a post-tax basis. In our view, whilst the tax benefits were no doubt a sensible consideration from Mr Degorce’s perspective in deciding whether to enter into the scheme, such allowances cannot be decisive of the issue of whether the trade was carried on on a commercial basis.
198. We did not accept that the price paid for the rights was intended by Mr Degorce to be a reasonable and commercial price; having looked at his activities in purchasing and assigning the rights, we could find no basis upon which Mr Degorce could be satisfied that the price paid was commercial; there was no detailed independent valuation prior to Mr Degorce signing the agreements and making payment nor was such a matter within his own knowledge. When viewed against the loss at which the rights were sold, for which again there was no independent assessment, we concluded that the entire focus of the transaction was on the potential tax relief and that this was not a trade that was carried on on a commercial basis.
199. HMRC did not put (although we note to do so would be speculative as there was no direct evidence on the point) that Mr Degorce was certain to make a loss or indifferent to profit, but we did not accept that this prevented us from reaching a conclusion on the issue of profit on the basis of the evidence before us. Mr Degorce accepted in his oral evidence (transcript 02/05/12) that he only cared about the “commerciality of those movies and how much I will have to pay” yet there was no evidence of any in depth analysis as to how he assessed “commerciality” or how this was balanced against the amount he paid. Added to the limitations in what Mr Degorce could expect and the lack of any evidence that Mr Degorce ever queried or took the time to fully understand the potential receipts or the timeframe within which he could expect to make a profit, we concluded that this was not the attitude or actions of a person carrying on a trade on a commercial basis with a serious view to profit.
200. We could not ignore the view of Mazars, which was used in the Appellant’s accounts. Even if the view that each film had a 1 in 20 chance of being successful was not correct, this was the most current information which Mr Degorce had at the end of the tax year and, at the very least, it gave rise to a concern that the likelihood of potential receipts was remote. That this was never queried by Mr Degorce was, in our view, indicative of Mr Degorce’s failure to exercise the prudence and diligence we would expect of a professional man entering into a commercial transaction.
201. As to the submission that the “success” of a film is not synonymous with a trade being carried on with a view to profit, in our view there must be some evidence of a serious interest in profit of some description (whether large or small) and which, in order to be achieved by Mr Degorce, would require recouping any loss. The films did not necessarily need to be worldwide successes in order to achieve this, but given the restricted potential receipts, combined with the amount paid and received for the rights, taken together with the evidence that to date, Mr Degorce has made no economic return on the two films we concluded that the trade was not carried on on a commercial basis and in such a way that profits in the trade could reasonably be expected to be realised in that period or within a reasonable time thereafter and there was, in reality, no basis upon which Mr Degorce could have had a reasonable expectation of financial benefits/profit (beyond the fiscal benefits).
The Profit/Loss position on the Trade
202. The parties agreed that the issues to be determined under this heading are as follows:
(i) Whether the profits for the year of assessment 2006-2007 were calculated in accordance with generally accepted accounting practice (“GAAP”);
(ii) If the profits of the trade were not calculated in accordance with GAAP, what would those profits have been had they been calculated in accordance with GAAP.
· Expenditure on professional fees of £1,609,426;
· A provision of £19,417,698 against the cost of film rights acquired;
· A net loss of £21,028,124; and
· A loan falling due after more than one year of £17,100,294.
204. There are three accounting debates between the parties:
(a) At what value should the deferred Consideration be shown in the Appellant’s accounts at 5 April 2007? (the “Valuation point”);
(b) Ought one to adopt a linked presentation in accounting for the Loan and the Consideration (or should one write down the face value of the Loan for other reasons)? (the “Linked Presentation point”); and
(c) Are the Rights properly accounted for as trading stock? (“the Trading Stock point”).
GAAP and FRS 5
Financial Reporting Standard 5
“Objective
The objective of this FRS is to ensure that the substance of an entity’s transactions is reported in its financial statements. The commercial effect of the entity’s transactions, and any resulting assets, liabilities, gains or losses, should be faithfully represented in its financial statements.”
The Witnesses
“…when his analysis of linked transactions was exposed as fundamentally flawed, he advanced an alternative route to the same end result. His analysis of both the trading stock and the linked presentation points were…simply untenable and were characterised by an inability to articulate the conceptual basis for his view and/or a refusal to contemplate the possibility that he might simply be wrong.”
We did not accept this submission; to the contrary, our interpretation of Mr Cannon’s evidence was that he had adopted a very fair approach by considering dual (as opposed to alternative) possibilities.
Issues agreed between the parties
212. The issues agreed by Mr Graydon and Mr Cannon were:
(a) Mr Degorce’s accounts for the period ended 5 April 2007 should follow UK GAAP;
(b) The transaction entered into by Mr Degorce as described by the Sub-Acquisition Deed dated 5 April 2007 represents the acquisition of an asset of circa £20 million (although there was no agreement as to the exact nature of this asset);
(c) The resultant asset in the accounts of Mr Degorce at 5 April 2007 was a financial asset.
213. The issues where no agreement was reached between Mr Graydon and Mr Cannon were as follows:
(a) Whether the acquisition represented the purchase of stock in trade or an intangible fixed asset;
(b) The treatment of the transaction described in the Distribution Agreement;
(c) Whether the financial asset should be classified as a Fixed Asset or Current Asset;
(d) Whether the transactions entered into by Mr Degorce should be viewed as a whole;
(e) Whether the loan and asset should be treated using the provisions of FRS 5 for linked presentations.
214. Using the Appellant’s terminology, the issue can be divided into the following points:
· The “Valuation” point;
· The “Linked Presentation” point; and
· The “Trading Stock” point.
(a) The Valuation Point
217. The valuations were as follows: (percentage of purchase price shown in brackets)
|
The Love Guru |
Tropic Thunder |
Total |
Mazars |
501,310 (4.35%) |
380,487 (4.33%) |
881,797 (4.34%) |
Mr Thornton |
1,656,449 (14.38%) |
1,300,389 (14.81%) |
2,956,798 (14.57%) |
Mr Graydon (as amended) |
837,803 (7.27%) |
- |
- |
Purchase Price |
11,520,375 |
8,779,120 |
20,299,495 |
Findings on the Valuation Point
(b) Linked Presentation
“Where a transaction involving an item previously recognised as an asset is in substance a financing – and therefore meets the condition of paragraph 21 regarding no significant change in the entity’s access to benefits or exposure to risks – but the financing “ring-fences” the item such that –
The finance will be repaid only from proceeds generated by the specific item it finances (or by transfer of the item itself) and there is no possibility whatsoever of a claim on the entity being established other than against funds generated by that item (or the item itself),there is no provision whatsoever whereby the entity may either keep the item on repayment of the finance or re-acquire it at any time, and all of the conditions given in paragraph 27 are met, the finance should be shown deducted from the gross amount of the item it finances on the face of the balance sheet with a single asset caption (a “linked presentation”). The gross amounts of the item and the finance should be shown on the face of the balance sheet and not merely disclosed in the notes to the financial statements. A linked presentation should also be used where an item that is financed in such a way that all of the above three conditions are met has not been recognised previously as an asset.
A linked presentation should be used only where all of the following are met:
(a) the finance relates to a specific item (or portfolio of similar items) and, in the case of a loan, is secured on that item but not on any other asset of the entity;
(b)the provider of the finance has no recourse whatsoever, either explicit or implicit, to the other assets of the entity for losses and the entity has no obligation whatsoever to repay the provider of finance;
(c) the directors of the entity state explicitly in each set of financial statements where a linked presentation is used that the entity is not obliged to support any losses, nor does it intend to do so;
(d) the provider of the finance has agreed in writing (in the finance documentation or otherwise) that it will seek repayment of the finance, as to both principal and interest, only to the extent that sufficient funds are generated by the specific item it has financed and that it will not seek recourse in any other form, and such agreement is noted in each set of financial statements where a linked presentation is used;
(e) if the funds generated by the item are insufficient to pay off the provider of the finance, this does not constitute an event of default for the entity; and;
(f )there is no provision whatsoever, either in the financing arrangement or otherwise, whereby the entity has a right or an obligation either to keep the item upon repayment of the finance or (where title to the item has been transferred) to re-acquire it at any time.”
227. Further guidance is given in paragraphs 76 to 78 and paragraph 5 of the summary.
Clause 3.1:
“Lender’s entitlement to repayment in full of the Loan together with all interest and other sums due hereunder (together the “debt”)…is with recourse only to distribution revenues and other sums…received by you in respect of the Assigned Rights under the Distribution Agreement together with the Collateral…This recourse only to the Distribution Revenues and Collateral does not apply to amounts under Clause 7.2.”
Clause 3.4:
“Notwithstanding your requirement to prepay in clause 3.3, you may prepay the Debt at any time in whole or in part without penalty.”
Clause 3.5:
“If any of the following acceleration events (Acceleration Event”) occur…”
Clause 7.2:
“You shall on demand indemnify and keep indemnified the Lender from and against all costs, expenses, claims, losses, damages, liabilities or proceedings suffered by the Lender whatsoever arising directly or indirectly as a result of:
…The occurrence of any Acceleration Event…”
232. According to Clause 7.2, under certain circumstances specified in Clause 3.5 the Lender does have recourse to Mr Degorce personally and is therefore not limited solely to receipts from the deferred consideration asset. Such circumstances include default on the normal repayment terms, breach of any of the undertakings of Mr Degorce under the loan agreement and where Mr Degorce or other entities party to the transactions in rights are deemed insolvent for the purposes of s 123 (1) of the Insolvency Act 1986.
234. Paragraph 81 of FRS 5 provides further guidance on the conditions necessary in order to use linked presentation. In this paragraph it states: “the entity must have no right or obligation to repay the finance from its general resources.” The loan agreement states in Clause 3.4 that Mr Degorce has the right to repay the loan at any time in whole or in part without penalty.
236. Mr Cannon for HMRC argued that the asset and limited recourse loan should be presented in the balance sheet in a linked presentation. He accepted that the Loan Agreement (at Clause 3.4) entitles Mr Degorce to prepay the loan. However, in his opinion the possibility of Mr Degorce prepaying the loan from his general resources is so remote that the clause will not have a commercial effect in practice and should not determine the correct accounting treatment. He relied on the fact that the loan is effectively non-recourse in that repayment is only made out of proceeds of the distribution and the fact that Mr Degorce entered into the Payment Directions.
Findings on Linked Presentation
237. We note that FRS 5 paragraph 14 states that:
“A reporting entity’s financial statements should report the substance of the transactions into which it had entered. In determining the substance of a transaction, all its aspects and implications should be identified and greater weight given to those more likely to have a commercial effect in practice. A group or series of transactions that achieves or is designed to achieve an overall commercial effect should be viewed as a whole.”
“The objective of FRS 5 “is to ensure that the substance of an entity’s transactions is reported in its financial statements. The commercial effect of the entity’s transactions and any resulting assets, liabilities, gains or losses, should be faithfully represented in its financial statements.”
Where the substance of a transaction falls within the scope of FRS 5 and also directly within the scope of another accounting standard or statutory requirement, “the standard or statute that contains the more specific provision(s) should be applied…Nevertheless, the specific provisions of any standard or statute should be applied to the substance of the transaction and not merely to its legal form and, for this purpose, the general principles set out in FRS 5 will be relevant.””
(c) The Trading Stock Point
Findings on the Trading Stock Point
If the profits of the trade were not calculated in accordance with GAAP, what would those profits have been had they been calculated in accordance with GAAP?
Whether expenditure was incurred wholly and exclusively for the business
The Parties’ Submissions
251. It was submitted by HMRC that the loan is limited recourse and that, relying on Lord Walker in TowerMCashback LLP and another v HMRC [2011] STC 1143 (“Tower MCashback”) although there was a loan, there was not in any meaningful sense, an incurring of expenditure or other associated costs, but rather it went into a loop in order that the Appellant could participate in a tax avoidance scheme. HMRC contended that the Appellant had failed to address this key conclusion (which is, in the view of HMRC, unanswerable) but instead cited uncontroversial propositions taken from the judgment.
252. The Appellant highlighted the following key propositions from Tower MCashback:
(a) The question is whether there was real expenditure on the acquisition of the rights;
(b) It is not enough for HMRC to point to the money going round in a circle; and
(c) It is material that the acquisition of the rights was on fully commercial terms.
“Given the tax avoidance motivation of the scheme, it cannot be said that the charge in the taxpayers’ accounts for the cost of the film rights was wholly and exclusively laid out or expended for the purposes of trade (sic.), and so the charge falls to be disallowed under section 74 (1) (a) of ICTA.”
Subsequently HMRC sought to rely on the “facts surrounding the acquisition of the rights” rather than the “tax avoidance motivation.”
Conclusion on whether expenditure was incurred wholly and exclusively for the business
“I have already…quoted Lord Goff in Ensign… The facts of that case were different, since in that case there was not "in any meaningful sense" a loan at all. In this case there was a loan but there was not, in any meaningful sense, an incurring of expenditure of the borrowed money in the acquisition of software rights. It went into a loop in order to enable the LLPs to indulge in a tax avoidance scheme…
Ancillary Matters
261. The Appellant relies on Markem v Zipher [2005] EWCA Civ 267 (“Markem”) in which it was stated:
“Where the court is to be asked to disbelieve a witness, the witness should be cross-examined; and a failure to cross-examine a witness on some material part of his evidence or at all, may be treated as an acceptance of the truth of that part or the whole of his evidence.”
264. With reference to Markem, HMRC submitted that the essence of the rule is that:
“Procedural fairness not only to the parties but to the witnesses requires that if their evidence were to be disbelieved they must be given a fair opportunity to deal with the allegation.”
“…it will not do to impeach the credibility of a witness upon a matter on which he has not had any opportunity of giving an explanation by reason of there having been no suggestion whatever in the course of the case that his story is not accepted.”
Conclusion on ancillary matters
· Where the court is to be asked to disbelieve a witness, the witness should be cross-examined
· a failure to cross-examine a witness on some material part of his evidence or at all
· may be treated…
Decision
(i) During the year ended 5 April 2007 the Appellant was not carrying on a trade.
We considered the remaining questions as if our answer to (i) above was that the Appellant had carried on a trade.
(ii) That the trade was not carried on on a commercial basis;
(iii) That the trade was not carried on with a view to the realisation of profits/so as to afford a reasonable expectation of profits;
(iv) That the profits/losses of the trade were not calculated in accordance with GAAP;
(v) That the profits/losses should be calculated using the valuation method of Mr Graydon;
(vi) That the expenditure on the rights in the films was not wholly and exclusively laid out or expended for the purposes of the trade.
274. The reference is determined accordingly.
J. BLEWITT