Film and games production LLPs not trading ‘with a view to profit’ (Ingenious Games LLP, Inside Track Productions LLP, Ingenious Film Partners 2 LLP v HMRC)
02/08/2019

Tax analysis: The Upper Tribunal (UT) has dismissed the taxpayers’ appeals and allowed HMRC’s cross-appeal from earlier decisions of the First-Tier Tribunal (FTT) with the result that two LLPs involved with film financing and production and an LLP involved in video game financing and production were not trading, so could not create tax losses for investors in the LLPs. The LLPs were also not carrying on a business ‘with a view to profit’ so even if they were trading, they were not UK tax-transparent and investors could not therefore access their losses. 
Ingenious Games LLP, Inside Track Productions LLP, Ingenious Film Partners 2 LLP v HMRC [2019] UKUT 0226 (TCC)
What are the practical implications of this case?
The LLPs in this case were being marketed as investment vehicles where individual investors expected to access significant tax losses which they could then set against other income by way of ‘sideways loss relief’; see Income Tax Act 2007, s 64. The amounts of loss relief at stake were very large and it was necessary to show both that the LLPs were carrying on a trade and that the trade was ‘with a view to profit’. Otherwise, the LLPs would not be treated as UK tax-transparent and hence loss relief would not be available to their members. The UT followed the approach of courts in previous cases in recent years of treating such arrangements with great caution. In particular, the UT declined to treat any of the LLPs as carrying on a trade, which effectively concluded the matter in HMRC’s favour. The UT has provided lengthy and useful guidance on this and a number of related matters. Nevertheless, the case may well be appealed. What does seem clear is that the days are long past when, as in the heyday of tax-based finance leasing, HMRC were prepared to accept that a special purpose vehicle set up to fund production activity in a tax-efficient manner could claim to be carrying on a trade because it had a technical proprietary interest in an underlying asset, even though it had leased or licensed that asset to others on terms which meant that it had little, if any say in how that asset was exploited.

What was the background?
The appellant LLPs were members of a family of UK LLPs, investment in which was promoted to individual investors by Ingenious Media Holdings plc. Two of the LLPs were involved in the production of films and one LLP was involved in the production of video games. The underlying contractual structures and cashflows were very complex but the basic idea was that each LLP would be funded with a mixture of capital provided by investors and non-recourse loan finance provided to each LLP’s corporate member. Individual investors only provided 30–35% of the necessary funding. Overall funding would then be paid over to third parties tasked with producing the relevant films and games and marketing them. Indeed the non-recourse funding passed direct to the third parties even though it was technically being lent to the LLP corporate member. Those third parties would also provide the non-recourse loan to the LLP corporate member and were granted all necessary contractual and proprietary rights to perform their functions. Technically, each LLP had a proprietary interest in the relevant film or game but the contractual structure meant that it had very little say in the development and production process and indeed was disincentivised to interfere. Furthermore, it had a limited interest in whether the whole exercise was ultimately profitable, bearing in mind that a key overall aim was to generate losses for investors in each LLP. A financial ‘waterfall’ was used to split income from the project between the third parties and each LLP. In cash terms, the latter could expect to receive 30–35% of the income arising, after deducting certain costs and fees. The remaining income would go to the third parties.

What did the court decide?
Trading
Unlike the FTT, the UT concluded that none of the LLPs was carrying on a trade. In doing so, it decided that the FTT had made an error of law regarding the trading status of the film production LLPs. In the circumstances, the FTT decision could be set aside and the decision ‘remade’ by the UT on the basis of the facts found by the FTT. The UT considered a number of earlier cases on how to construe a complex web of interlocking contracts. It did not regard any of the contracts as being a ‘sham’ but nevertheless ruled that if the contracts were elements of a single transaction (which they were), then they were to be read together to determine their legal effect. This was not the same thing as saying that there was a ‘single composite agreement’ which there was not as a matter of construction. However, it was also appropriate to consider whether the transaction amounted to trading from the perspective of the Ramsay principle, as now set out by the House of Lords in Barclays Mercantile Business Finance Limited v Mawson (Inspector of Taxes) [2005] STC 1. This separate deployment of Ramsay  had been endorsed by the Court of Appeal in Eclipse Film Partners No 35 LLP v HMRC [2015] STC 1429, Samarkand Film Partnership No 3 v HMRC [2017] STC 926 and Degorce v HMRC [2017] STC 2226.
On basic principles of contractual construction, each LLP only had to pay 30 of the overall 100 of film-related costs, although the taxpayers had argued that it was technically liable for the full 100. In reality, the LLP was never at risk of having to pay more than 30. Correspondingly the 70 of funding provided by way of non-recourse loan to the LLP corporate member was in reality directed to the third parties and was not routed through LLP. Similarly, the LLP never had access to the revenues used to repay that non-recourse loan which were channeled directly to the lender, by way of a security assignment by the LLP in the lender’s favour. It was unreal to assume that the LLP could have prepaid that loan. Furthermore, the LLPs never truly acquired, owned or disposed of rights in the films or games: they had a ‘mere shell of ownership’ in those rights, even if it was not correct to say that they were constructive trustees of those rights. Their only real interest in those rights was in payments under the financial ‘waterfall’ which were derived from the third parties exploiting those rights.
Turning to the law on what amounts to trading, the UT found the famous ‘badges of trade’ to be of limited use in this context. Likewise, statements in earlier cases that trading requires the trader to have a ‘customer’. In deciding whether there was trading, a holistic approach was the right one. The simple fact that the taxpayer had a proper organisation and that it engaged in negotiations and repeat transactions was not conclusive when deciding whether there was trading. Such activity could also amount to mere investment. There was no trading here because the LLPs had insignificant ownership rights in the underlying films and games. They had simply negotiated a series of speculative financial investments in the income produced by the films and games, without having any serious ongoing involvement in production.
Interestingly, the UT did not find it necessary to rely on those cases (e.g. in relation to ‘dividend stripping’) which have decided that tax-motivated activity on the part of a taxpayer may, if sufficiently pronounced, prevent it trading. The UT regarded those cases as relevant only where activity was not clearly an investment and not a trading transaction. The House of Lords’ decision in Ensign Tankers (Leasing) Limited v Stokes [1992] 1 AC 655 was distinguished by the UT (not altogether convincingly) on the grounds that the film partnership in that case, which was found to be trading, had genuinely acquired the film master negative and was carrying on a trade of producing and exploiting film rights.
With a view to profit
It was not strictly necessary for the UT to consider this and subsequent points but it chose to do so, not least in case there was an appeal. Unless the LLP was carrying on a trade or business ‘with a view to profit’, it would not be regarded as a tax-transparent partnership for UK tax purposes and hence any tax losses would not be directly available to its members: see Income Tax (Trading and Other Income) Act 2005 (‘ITTOIA 2005’), s 863 and Corporation Tax Act 2009 (‘CTA 2009’), s 1273.
The UT said that this expression should have the same meaning as ‘with a view to profit’ in the general UK definition of ‘partnership’ in Partnership Act 1980 s 1. Following a review of a number of cases (both UK and Canadian), the UT ruled that whether activity was ‘with a view to profit’ was a subjective test to be determined over a future period. It was a qualitative test which required a ‘real and serious intention to make a profit’. Subject to that, it did not matter if making profit was an ancillary, not a predominant purpose. ‘Profit’ simply meant an excess of income over expenses, with no particular computation method being required. The test must be applied by reference to the LLP itself, not at the level of its members.
Again, the UT found that the FTT had made an error of law in relation to all three LLPs because it had, in particular, interpreted ‘with a view to profit’ in an objective manner. The FTT decision on this point therefore had to be set aside. The decision could nevertheless be ‘remade’ on the basis of the FTT’s findings of fact that there was in fact no subjective intention of the kind required: the LLPs’ focus had been on generating losses for their members, fees for the third parties and some level of revenue. An overall profit was neither necessary not a key driver. Consequently, the LLPs had not been carrying on business’ ‘with a view to profit’ for tax purposes.
Incurred
The UT agreed with the FTT that the LLPs only ‘incurred’ expenditure of 30, out of the full production cost of 100. Whether expenditure was ‘incurred’ was relevant for the purposes of ITTOIA 2005, s 34(1) and CTA 2009, s 54(1). Expenditure could be ‘incurred’ even if it was funded by a non-recourse loan, given the decision of the Privy Council in Peterson v Commissioner of Inland Revenue [2005] STC 448. However, as the FTT had correctly concluded, expenditure was only ‘incurred’ if realistically the LLPs bore the economic burden of the relevant liability. For reasons already discussed, they did so but only to the extent of 30 out of 100.
‘Wholly and exclusively’
The question of whether LLP expenditure had been ‘wholly and exclusively’ incurred for the purposes of the LLPs’ activities arose only if they were regarded as incurring the full 100 of cost, and not just 30, on the production of games and films.
If this was the case, the FTT was entitled to conclude that 70 out of 100 was incurred by the LLPs in order to secure tax benefits in the form of usable losses for LLP investors. Given the importance of those losses to the investors, this was not a mere effect of the expenditure but a purpose, aimed at benefiting persons other than the LLPs. Hence that 70 of expenditure was not ‘wholly and exclusively’ incurred for the purposes of the LLPs’ activities: see ITTOIA 2005, s 34(1) and CTA 2009, s 54(1). The 30 was a separate identifiable part of the expenditure and could therefore be treated separately because of ITTOIA 2005, s 34(2). However, 5 of that 30 was not ‘wholly and exclusively’ incurred by the LLP because it had in fact been paid by the LLP to provide cash for the organisers of the whole transaction. 
Accounting treatment
Having considered the expert accounting evidence, the FTT had rightly concluded that the LLPs had not properly applied UK GAAP when computing their profits and losses. The UT said that those profits and losses should have been computed by reference to expenditure of only 30% of the overall budget, as well as income ignoring certain specified receipts to which the LLP would not become entitled. The UT also ruled that the FTT had been entitled to reach the conclusions it did reach in relation to whether items were stock, as well as the net realisable value of a game or film. 
Capital versus revenue
The UT agreed with the FTT that the rights acquired by the LLPs had a capital nature and therefore expenditure on them was capital and hence non-deductible. Those rights were acquired once for all and continued to be held as such. They were of considerable duration, even if the monies expended on them were returned in the form of income. They also provided an ’enduring benefit’ to any trade carried on by the LLPs.

Case details

• 	Court: Upper Tribunal—Tax and Chancery Chamber
• 	Judges: Mrs Justice Falk, Judge Tim Herrington
• 	Date of judgment: 26 July 2019
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