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TMI Blog1992 (3) TMI 354X X X X Extracts X X X X X X X X Extracts X X X X ..... al allowances for expenditure of $14m. although the partners were never liable to spend more than $3¼ m. of their own money. By section 41 of the Finance Act 1971, Parliament sought to encourage a British trader to spend capital on machinery or plant for the purposes *See the computation of his income-tax or corporation tax to deduct the expenditure from his profits in the year of expenditure. Section 41(1) is in the following terms : " where (a) a person carrying on a trade incurs capital expenditure on the provision of machinery or plant for the purposes of the trade, and (b) in consequence of his incurring the expenditure, the machinery or plant belongs to him at some time during the chargeable period related to the incurring of the expenditure, there shall be made to him for that period an allowance (in this chapter referred to as 'a first-year allowance') which shall be of an amount determined in accordance with section 42 below. . . . " In 1980 the master negative of a commercial film constituted plant for the purposes of this section and the first year allowance was 100 per cent. In March 1980 Lorimar Productions Inc. ("L. P. I."), a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ntire period of copyright. By clause 6 of a production services agreement, L. P. I. agreed to make the film "Escape to Victory" in Hungary or elsewhere as L. P. I. should decide in accordance with an approved budget of $12,996,502 but on behalf of Victory Partnership. By clauses 6 and 17, the approved budget included the sum of $4,780,951 which had already been spent by L. P. I. in making the film. By clause 7, Victory Partnership agreed to provide the finance required for the approved budget and L. P. I. agreed to provide the finance required to complete the film if the costs exceeded the approved budget. By clause 13, L. P. I. assigned to Victory Partnership the film negative which had already been shot and the right to the complete film negative as and when the film was continued and completed. By a loan agreement, Victory Partnership agreed to provide $3¼m. towards the cost of the film and L. P. I. agreed to lend Victory Partnership $9-3/4 m. ("the production loan") required to provide the balance of the cost of the approved budget and also to lend to Victory Partnership the amount required ("the completion loan") to complete the film if, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ost of the film. By a letter addressed by Victory Partnership to and accepted by the distributors and agreed and accepted by L. P. I., the provision in clause 11 of the distribution agreement providing for 100 per cent. of the net receipts from the exploitation of the film to be paid to Victory Partnership was replaced by an irrevocable authority and direction to the distributors to pay 25 per cent. of the net receipts to Victory Partnership and to pay 75 per cent. of the net receipts to L. P. I. until Victory Partnership had received $3¼ m. Thereafter 100 per cent. of the net receipts from the exploitation of the film were to be paid to L. P. I. until L. P. I. had received an amount equal to the production loan, the completion loan and interest and other moneys payable under the loan agreement. Thereafter 75 per cent. of the net receipts were to be retained by the distributors and 25 per cent. were to be paid over to Victory Partnership. By a waiver and consent, Chemical Bank which, as will appear, was to receive the benefit of the payment of $3¼ m. by Victory Partnership in reduction of its loan to L. P. I., agreed to the documents I have outlined and thereby redu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ounting to $3 m. L. P. I., having paid $10_ m. towards the cost of the film, has received 75 per cent. of the net receipts or $9 m. No one is liable to pay L. P. I. anything in the future save the distributors if and so far as they receive further moneys from the exploitation of the film. Victory Partnership in the tax year 1980 to 1981 incurred capital expenditure amounting to $3¼ m. in the provision of plant, namely, the film. The negative belonged to Victory Partnership subject to the exclusive rights of exploitation vested in the distributors and there also belonged to Victory Partnership 25 per cent. of the net receipts from the exploitation of the film. In these circumstances, Victory Partnership fulfilled all the conditions necessary to generate a first year allowance of $3¼ m. provided that the expenditure of that amount was incurred for the purposes of a trade carried on by Victory Partnership, namely, the production and distribution of the film "Escape to Victory". By section 155 of the Income and Corporation Taxes Act 1970 the benefit of any first-year allowance generated by Victory Partnership in connection with the cost of the film "Escap ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... The financial consequences to Victory Partnership of the scheme are the consequences which flowed from the rights conferred and the obligations imposed on Victory Partnership. The taxation allowances and taxation liabilities of Victory Partnership are the allowances and liabilities which, pursuant to the taxing statutes, are applicable to the financial consequences. When all the documents had been entered into, Victory Partnership was subject to an obligation to pay $3¼ m. to L. P. I. and subject to an obligation whereby any money paid by L. P. I. into the scheme current account was immediately transferred back to L. P. I. The financial consequence to Victory Partnership of its obligations under the scheme was the expenditure by Victory Partnership of $3¼ m. When all the documents had been entered into, Victory Partnership had a right to 25 per cent. of the net receipts from the exploitation of the film. The financial consequence to Victory Partnership of its rights under the scheme was the receipt by Victory Partnership of $3 m., being 25 per cent. of the net receipts from the film. The taxation consequences were that Victory Partnership, provided it were trading, g ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hip. In the course of his judgment Millet J. said [1989] 1 W.L.R. 1222, 1228* : " In purely financial terms, Victory Partnership was in effect a sleeping partner with a minority interest. It was putting up 25 per cent. of the cost and taking a 25 per cent. equity participation. L.P.I. was putting up the remaining 75 per cent. of the cost and its associated company was retaining a 75 per cent. participation. " This statement is not wholly accurate. Victory Partnership did not put up 25 per cent. of the cost but only $ 3¼ m. L.P.I. did not put up 75 per cent. of the cost but the whole of the cost of $14m. in excess of $3¼ m. The associated company did not retain a 75 per cent. participation. In the events which happened, the participation was that of L.P.I. which was entitled to receive and did receive 75 per cent. of the net receipts amounting to $9m. Allowing for these inaccuracies the judge was quite right in his analysis of the true legal effect of the transaction. The transaction was a joint venture and contained no element of loan. That analysis leads to two conclusions. First, upon the true construction of the 17 documents dated 14 July 1980 read as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... provisions of the scheme, the money of L.P.I., at all times under the control of L.P.I., was electronically transferred from Hollywood to the City of London and back again without serving any useful purpose and leaving no trace except entries on computer prints. The scheme is one of many ; it reflects no credit on Guinness Mahon, the merchant bank which invented it, or on the appellant and the other industrial companies which purchased it for many hundreds of thousands of pounds. If successful, the scheme would have been operated at the expense of the British public and, whether successful or unsuccessful, involved the exploitation of British capital allowances for the making of a foreign film. Mr. Gardiner sought to escape from the legal, financial and taxation consequences of the true effect in law of the scheme documents read as a whole by submitting that a taxpayer may enter into a transaction in any form he chooses and that the court is not entitled to ignore or contradict the form of the transaction. In the present case the transaction took the form of a purchase of the film by Victory Partnership and the completion of the film by L.P.I. as agent for Victory Partnership wit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e a fiscal advantage or a genuine trading activity : " per Sir Nicolas Browne-Wilkinson V.-C.[1991] 1 WLR 341, 357 * : There are therefore two rival submissions. Mr. Gardiner submits that the taxpayer may enter into any transaction in any form he pleases and the court is confined to that form and cannot have regard to the rights and obligations which flow from the transaction because the court cannot consider the substance of the transaction. The revenue on the other hand appear to look upon tax avoidance as a corporate cancer which infects and destroys any fiscal effect advantageous to the taxpayer. In the present case although the contribution by Victory Partnership to the cost of the film of the sum of $3¼ m. in consideration for 25 per cent. of the net receipts from the exploitation of the film can only be described as trading, Victory Partnership did not generate a first year allowance of $3¼ m. because the trading was part of a tax avoidance scheme designed to procure a first year allowance of $14 m. The resolution of this dispute requires an examination of the principles and authorities dealing with tax avoidance schemes. Oliver Wendell Holmes once s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is wages but accepted the whole of his annuity, the financial consequences to the Duke were that he paid the annuity and the taxation consequences were that he was entitled to deduct the amount paid in computing his liability to income tax and surtax. The dictum of Lord Tomlin, applied to the obligations of the Duke, is not inconsistent with later authority. But if the dictum of Lord Tomlin implied that any tax avoidance scheme which was not a sham and not unlawful must be allowed to succeed, subsequent authorities have determined otherwise. The Westminster case does not assist the appellant in the present case. In the Westminster case the fiscal consequences claimed by the Duke corresponded to the legal consequences of the transaction as construed by the majority of this House. In the present case the fiscal consequences claimed by the appellant do not correspond to the legal consequences of the scheme documents read and construed as a whole. In the last two decades there have been a number of tax avoidance schemes which have proved unsuccessful despite the taxpayers' reliance on the dictum and decision in the Wesminster case. In Lupton v. F.A. and A. B. Ltd. [1972] AC 634 t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he precedent of Lupton's case was followed by the Court of Appeal in the instant case. But in dividend-stripping cases the tax avoidance scheme negatives trading because on the true analysis of the transaction the trader does not trade at all. In Lupton's case where there was neither a profit nor a loss the House did not consider the present situation in which on the true analysis there was trading involving an expenditure of $3¼m. The financial consequences of the scheme namely the expenditure by Victory Partnership of $3¼m. on the making of a film, produce the corresponding fiscal consequence of a first year allowance of that sum. The task of the courts is to construe documents and analyse facts and to ensure the taxpayer does not pay too little tax or too much tax but the amount of tax which is consistent with the true effect in law of the taxpayer's activities. Neither the taxpayer nor the revenue should be deprived of the fiscal consequences of the taxpayer's activities properly analysed. In Black Nominees Ltd. v. Nicol [1975] 50 TC 229, a tax avoidance scheme which employed a number of companies, settlements and agreements for the purpose of app ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... true construction of the documents Victory Partnership was not a borrower and expended $3¼ m. only. In Chinn v. Hochstrasser this House treated all the documents in the transactions carried out by the taxpayer as one single composite transaction, read the documents as a whole and applied the taxing statutes to the true legal effect of the transaction, ignoring the sale of the contingent reversionary interest and the purchase of the shares which were in effect self-cancelling. The consequence of the transaction in Chinn v. Hochstrasser was the acquisition by the taxpayer of the shares as a beneficiary. In the present case the loan by L. P. I. deposited in the Scheme Current Account followed immediately by payment out of that account back to L. P. I. were two self-cancelling operations. The true legal effect of the transaction as a whole was that Victory Partnership expended $3¼ m. and no more. In my opinion, the submissions of Mr. Gardiner in the present case are inconsistent with the decision of this House in Chinn v. Hochstrasser. A similar result was reached in W. T. Ramsay Ltd. v. Inland Revenue Commissioners [1982] A. C. 300, which approved Black Nominees Ltd. v. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... brought about by arranging that the scheme included a loss which was allowable for tax purposes and a matching gain which was not chargeable. In Ramsay the loss arose on the disposal of the appellant's shares. . . . In Rawling it arose on the disposal of the appellant's reversionary interest in the . . . . settlement. But it is perfectly clear that neither of these disposals would have taken place except as part of the scheme, and, when they did take place, the taxpayer and all others concerned in the scheme knew and intended that they would be followed by other pre-arranged steps which cancelled out their effect. . . . There is, therefore, no reasons why the court should stop short at one particular step. . . . The absence of contractual obligation does not in my opinion make any material difference. " The scheme in the present case had the apparently magic result of creating for tax purposes an expenditure of $14 m. while incurring a real expenditure of only $3¼ m. In Inland Revenue Commissioners v. Burmah Oil Co. Ltd. [1981] 54 T. C. 200 dealing with another tax avoidance scheme Lord Fraser of Tullybelton said, at page 221 : " The result was that alt ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... avoid capital gains tax exchanged them for shares in a company incorporated in the Isle of Man, a transaction to which capital gains tax did not attach, and then procured the Isle of Man company to sell the original shares to the purchaser. The House held that capital gains tax was chargeable on the shares. Lord Fraser of Tullybelton said, at page 512 : " The importance of this case is, in my opinion, in enabling your Lordships' House to explain the effect of the decision in W. T. Ramsay Ltd. v. Inland Revenue Commissioners [1982] A. C. 300 and to dispose of what are, I think, the misunderstandings about the scope of that decision which have prevailed in the Court of Appeal. In Ramsay, the House had to consider an elaborate and entirely artificial scheme for avoiding liability to tax. Viewed as a whole, it was self-cancelling. In the present case, the scheme was much simpler, and it was not self-cancelling ; on the contrary, it had what Vinelott J. described as 'enduring legal consequences'. But while the cases differ in that respect, it is not a sufficient ground for distinguishing the present case from Ramsay. The true principle of the decision in Ramsay was t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... enditure which entitles him to that reduction. " The appellant claims that Victory Partnership generated a first year allowance of $14 m. without incurring the expenditure of $14 m. This is tax avoidance and falls within the principles of Ramsay and subsequent decisions of this House. Attacks on the principles have been mounted. In the Ramsay's case [1982] A. C. 300, Lord Wilberforce rejected the argument that the judges were legislating beyond their sphere. After discussing the argument, at pages 300, 325, he said, at page 326 : " While the techniques of tax avoidance progress and are technically improved, the courts are not obliged to stand still. Such immobility must result either in loss of tax, to the prejudice of other taxpayers, or to Parliamentary congestion or (most likely) to both. To force the courts to adopt, in relation to closely integrated situations, a step by step, dissecting, approach which the parties themselves may have negated, would be a denial rather than an affirmation of the true judicial process. In each case the facts must be established, and a legal analysis made : legislation cannot be required or even be desirable to enable the courts ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n established by a substantial number of our eminent predecessors in this House. There has been a difficulty in defining and identifying a single composite transaction distinct from two or more transactions which are independent. In Craven v. White (Stephen) [1989] A. C. 398 this difficulty led to a difference of judicial opinion. But the difficulty does not arise in the present case and cannot affect the principles of Ramsay [1982] A. C. 300 and subsequent cases once a single composite transaction is either admitted or proved. In the present case the argument for the appellant amounts to no more than a repetition of the dictum of Lord Tomlin in the Westminster's case [1936] A. C. 1, 30. Subsequent events have shown that though this dictum is accurate so far as tax mitigation is concerned it does not apply to tax avoidance. The principles of Ramsay and subsequent cases do not compel or authorise the court to disregard all the fiscal consequences of a single composite transaction read as a whole on the grounds that it appears that the transaction is a tax avoidance scheme. In the present case, the commissioners felt bound to ignore all the fiscal consequences which are benefic ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... imes illuminated and sometimes obscured the identification of a trading purpose. But in every case actions speak louder than words and the law must be applied to the facts. In Religious Tract and Book Society of Scotland v. Forbes [1896] 33 S. L. R. 289, a society founded for the diffusion of religious literature sent out agents who travelled from door to door with the object of engaging a customer in religious discussions so as to spread the gospel while selling the Bible and religious tracts. The sales by the agents were carried on at a loss. It was held that an agent was a missionary and not a trader. In Iswera v. Inland Revenue Commissioners [1965] 1 W. L. R. 663, the taxpayer wished to live near the school attended by her daughter and for that purpose was obliged to buy a site of two acres. She divided the site into 12 lots and sold the lots except for two lots upon which she built her house. She was held to have traded. Lord Reid said, at page 668 : " If, in order to get what he wants, the taxpayer has to embark on an adventure which has all the characteristics of trading, his purpose or object alone cannot prevail over what he in fact does. But if his acts are equiv ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... : see Sharkey v. Wernher [1956] A. C. 58. What I think is not possible is for an asset to be both trading stock and permanent investment at the same time, nor to possess an indeterminate status neither trading stock nor permanent asset. It must be one or other, even though, and this seems to me legitimate and intelligible, the company, in whatever character it acquires the asset, may reserve an intention to change its character." This case illustrates a difficulty which does not arise in the present case and does not give rise to any question of fact determinable by the commissioners. The only facts are the 17 documents and the activities which were carried out pursuant to those documents. In Coates v. Arndale Properties Ltd. [1984] 1 W. L. R. 1328, a group of companies included a property developing company, a property dealing company and an investment company. The property development company spent £5.2 m. in developing leasehold property but at the end of the day the lease was only worth £3 m. so that the property development company and the group were faced with a capital loss of £2.2 m. The group secured the assignment of the lease from the property de ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... taxpayer company was to transmute the base metal of an exchange loss on capital account into the pure gold of a revenue loss. A transaction designed to achieve that fiscal alchemy is not a trading transaction. " In the present case the legal effect of the transaction, whatever its design was a trading transaction whereby Victory Partnership expended $3¼ m. towards the production of a film in which Victory Partnership had a 25 per cent. interest. All these authorities were dealing with the identification of a trading transaction. In the present case, a trading transaction can plainly be identified. Victory Partnership expended capital in the making and exploitation of a film. That was a trading transaction which was not a sham and could have resulted in either a profit or a loss. The expenditure of $3¼ m. was a real expenditure. The receipts of $3 m. were real receipts. The expenditure was for the purpose of making and exploiting a film and entitled Victory Partnership to a first year allowance equal to the expenditure. The receipts imposed on Victory Partnership a corporation tax liability. I would set aside the orders of the Court of Appeal and Millett J. an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a capital allowance in respect of that expenditure. But the function of the various documents signed on 14 July 1980 is to present a different picture, under which L. P. I. made the film on behalf of V. P., which incurred the total cost of $14 m., the balance over and above $3¼ m. being lent by L. P. I. to V. P. to enable V. P. to finance the remainder of the film. On this basis, it has been the contention of V. P. that, since it spent $14 m. on the making of the film, it is entitled to a capital allowance in respect of that sum. Like my noble and learned friend, Lord Templeman, I approach this case on the basis that there is a fundamental difference between tax mitigation and unacceptable tax avoidance. Examples of the former have been given in the speech of my noble and learned friend. These are cases in which the taxpayer takes advantage of the law to plan his affairs so as to minimise the incidence of tax. Unacceptable tax avoidance typically involves the creation of complex artificial structures by which, as though by the wave of a magic wand, the taxpayer conjures out of the air a loss, or a gain, or expenditure, or whatever it may be, which otherwise would never hav ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pay sums of money to V. P. ; but each sum was to be paid into a bank account opened by V. P. at a bank nominated by L. P. I., and an exactly equivalent sum was on the same day to be paid out of the same account to L. P. I., so that at the close of the day's trading the account was never in debit or in credit. In the documents, the sums so paid by L. P. I. to the credit of V. P. were characterised as loans of money advanced by L. P. I. to enable V. P. to finance the balance of the approved budget for the film (the production loan) and any further sum required to complete the film (the completion loan) ; the sums recredited to L. P. I. were characterised as payments made by V. P. to finance the making of the film ; and the distribution to L. P. I. of a 75 per cent. share of the net profits from the film was characterised as repayment of the money lent by L. P. I. to V. P. But the so-called loan by L. P. I. to V. P., and the so called payments by V. P. to finance the making of the film, were self-cancelling transactions ; and the distribution of net profits to L. P. I. was consistent with an investment by L. P. I. in the film equal to the balance of the cost of the film over and a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o-called loan. (5) The so-called loan was repayable to L. P. I. by payments out of the net profits of the film under arrangements which were inconsistent with the concept of a commercial loan. For example, (a) repayment to L. P. I. of the production loan ranked equally with the recoupment of V. P.'s investment of $3¼ m. ; (b) V. P.'s investment of $3¼ m. was to be recovered before repayment of L. P. I.'s completion loan ; (c) although provision was made for payment of interest to L. P. I., payment of interest was postponed until after V. P. had recovered its investment of $3¼ m. (with the effect that, in the present case, no interest was in fact recovered by L. P. I.) ; and (d) after repayment of the production and completion loans with interest, and recovery by V. P. of its investment of $3¼ m., the balance (if any) of the net profits was to be distributed as to 75 per cent. to subsidiaries of L. P. I. and as to 25 per cent. to V. P. Had the so called production and completion loans been ordinary commercial loans by L. P. I. to V. P. to enable it to finance the production of the film, the loans and interest would have been repayable before ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... too, has no function other than to give colour to the tax avoidance scheme, since the net profits from the film were in any event to be shared in accordance with the parties' respective contributions ; it can therefore be treated as irrelevant for present purposes. Finally, the distribution of net profits to L. P. I. can be treated for what it in truth was, the arrangement being wholly inconsistent with the repayment of a commercial loan. From the foregoing analysis, I conclude that V. P. was trading, though only to the extent of its investment of $3¼ m. and no more ; and that that sum constituted, on a true construction of the statute, the only capital expenditure incurred by V. P. in the making of the film. This conclusion leads to the sensible and realistic consequence that V. P. is not deprived of a capital allowance in respect of that sum, which would have been the case if V. P. had been held not to have been trading at all. For these reasons, and for the reasons given by my noble and learned friend, Lord Templeman, I concur in the order proposed by him. Lord Jauncey of Tullichettle. My Lords, there is one matter upon which I should like to add a few words to tho ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... entered into and carried out for the purpose of establishing a claim against the revenue under section 341, I for my part would have no hesitation in holding that it does not form part of the trading activities of a dealer in stocks and shares. " My Lords, at first sight I was inclined to the view that these observations were in point in the present case where there is no doubt that by far the greater number of steps in the transaction were directed to obtaining a capital allowance in relation to a sum in excess of the $3¼m. truly expended by the taxpayer. However on further consideration I am satisfied that there are no dicta in Lupton v. F. A. and A. B. Ltd. which force me to conclude that the investment of $3¼ m. by Victory Productions was not expenditure for the purposes of trade. Lupton v. F. A. and A. B. Ltd. was an all or nothing case in which the only question was whether or not the relevant transactions formed part of the trading activities of a dealer in stocks and shares. This House did not in Lupton v. F. A. and A. B. Ltd., require to address itself to a situation where what would otherwise be a trading transaction producing financial and fiscal con ..... X X X X Extracts X X X X X X X X Extracts X X X X
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