Court of Appeal: film partnerships were trading with a view to profit

However, the court held that a third partnership investing in video games was not trading with a view to profit. In addition, although loss relief was available for the film partnerships, relief would only be available in respect of around 4% of the losses claimed due to decisions on other arguments raised by the parties.

Tax disputes expert Ian Robotham of Pinsent Masons, the law firm behind Out-Law, said that the court’s finding that these specific film partnerships were trading with a view to profit “brings with it a small glimmer of hope to other film partnerships, albeit that each partnership will be determined on its own facts”.

“In recent years HMRC has successfully challenged a plethora of film partnerships on the basis that they are not trading with a view to a profit,” he said. “The judgment also gives useful guidance on the meaning of ‘with a view to profit’, which will be helpful in many other cases.”

The case involved limited liability partnerships (LLPs) marketed by scheme promoters Ingenious to UK taxpayers, which invested in films or video games. The schemes were designed to enable individual taxpayers to claim ‘sideways’ loss relief on income which would otherwise have been subject to the higher rate of income tax.

HM Revenue & Customs (HMRC) denied the loss claims and there was a lengthy hearing in the FTT to consider a number of issues at which the LLPs were partially successful, followed by an appeal to the Upper Tribunal (UT) at which the LLPs lost on all counts. Permission was only given to appeal to the Court of Appeal on the questions of whether the LLPs were trading for income tax purposes and if they were whether this was ‘with a view to profit’, which was required for the losses to be available to the investors in the LLPs (the partners).

The Court of Appeal confirmed that whether a trade was carried out ‘with a view to profit’ was a wholly subjective test depending on the actual intentions of those concerned, although it said the likelihood of profits and the timescale in which they might be achieved will often be relevant to testing whether there is a genuine subjective view to profit.

The court said that the motive of the partners, even if it was tax related, did not matter as long as they had an actual intention to make profits.

“It is the genuine subjective purpose of the partners to make profits from their trade, profession or business which is the defining feature of a partnership,” the court said.

Robotham said: “The Court of Appeal was very aware that the tests of trading and of doing so with a view to profit are relevant in many different tax and non-tax contexts and said specifically that it should resist any temptation to give them an unduly narrow meaning because they were being considered in relation to a tax scheme”.

The court endorsed the UT’s opinion that there is no need for profit to be the predominant aim but that when any profit-making aim is subsidiary to other purposes, it is necessary to consider at what point the line is crossed and there is in fact no view to profit. In that case the UT said some sort of ‘reality check’ is needed and it is necessary to identify whether there is a real intention.

The Court of Appeal said that the likelihood of profits would be relevant to testing whether there was a genuine subjective view to profit. However, different individuals may be willing to take different levels of risk and may be prepared to take a higher level of risk where it is someone else's money that is at risk of being lost. The extent of the risk taken may depend not only on the risk appetite of the investors but on the degree to which the individuals making the decisions are answerable for any failure, or incentivised by success, the court said.

For the investors to obtain sideways loss relief from income tax at 40% in an amount sufficient to recoup their initial contribution to the LLP, it was necessary for their investment to be geared so that the sums contributed by the LLP to the making of a film would be substantially greater than the sums put in by the individual partners, but the anticipated losses would nevertheless be allocated in their entirety to the individual members. The typical arrangement was that for every 30 contributed by the individual members to the LLP, a further 70 would be contributed by a corporate member of the LLP.

HMRC succeeded in an argument in the FTT and the UT that even if losses were available, the LLP investors were only entitled to losses commensurate with the amount they had contributed so that they would only be entitled to 30% rather than 100% of the losses. HMRC also successfully argued in the FTT and the UT that the rights in respect of the films acquired by the LLPs were capital in nature. The effect of these decisions, which the LLPs were not given permission to appeal, meant that around 96% of the losses were disallowed in any event.

The FTT had decided that the taxpayers were trading with a view to a profit if they were entitled to 30% of the losses, but it decided they were not trading with a view to profit if its decision was wrong and they were entitled to 100% of the losses. The Court of Appeal disagreed with the UT’s view that the FTT’s decision on the ‘view to a profit’ point was incorrect because the taxpayers had only argued that they were trading with a view to a profit on the basis that they were entitled to 100% of the losses. They had not specifically argued the point on the basis that they were entitled to 30% of the profits, and it was only on the 100% basis that the projected tax benefits for the individual investors in the LLPs could be achieved.

The Court said that whilst obtaining 100% of the losses provided the motivation for the participation of the LLPs in the transactions, view to a profit was a “much narrower question … which is simply whether the controlling minds had a subjective view to profit in causing the LLPs to enter into the relevant transactions”. The court said that “the answer to this straightforward question of fact should not be infected by the underlying fiscal motivation which drove the whole exercise”. The fact that the FTT found that the LLPs had failed to establish the necessary subjective intention on the 100% basis did not preclude the FTT from finding that the subjective test was satisfied on a correct legal analysis of the composite transactions which the LLPs entered into.

On the question of whether or not the LLP was trading, the Court of Appeal reiterated that the UT could only interfere with the FTT Decision if there had been an error of law and said it is immaterial whether the UT would itself have come to the same conclusion on the totality of the evidence.

The Court of Appeal said that none of the alleged errors of law identified by the UT had any substance and as it was not suggested that the FTT misunderstood or misdirected itself in relation to the underlying legal principles, there was no basis upon which the UT could properly interfere with the conclusion of the FTT on the trading issue.

It was also not prepared to overturn the FTT’s finding of fact that the partnership which had invested in video games (Ingenious Games) was not trading. The appeal could only succeed on the basis that the findings of fact made by the FTT were erroneous in point of law. The court described this as a “hopeless endeavour” and said it was in no position to review the mass of evidence which the FTT had to consider.

“The decision reiterates how difficult it is to overturn a finding of fact by the FTT,” said Ian Robotham. “In this case the FTT had heard the case in a number of hearings over 48 days in total so it is not surprising that the Court of Appeal was reluctant to interfere with the FTT’s decision reached after a process described by the Court of Appeal as ‘meticulous’.”