9911796707
TMI Blog1989 (6) TMI 281X X X X Extracts X X X X X X X X Extracts X X X X ..... limited partnerships which entered into various transactions relating to the production and distribution of those two films. Section 41(1) of the Finance Act 1971 provides : "Subject to the provisions of this Chapter, 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: . . . " At the material time, and in the case of expenditure incurred on the provision of new plant, first-year allowances of an amount equal to 100 per cent. of that expenditure were available to be set off against profits chargeable to corporation tax at the rate of 52 per cent. It was common ground before the commissioners that in order to constitute plant the master negative of a film must carry with it the right to distribute and exploit the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ure directed by John Houston and starring Michael Caine to be shot on location in Hungary. It was to be produced by Lorimar Productions Incorporated (" L. P. I "), a company incorporated and resident in California which was engaged in the production of cinematograph and television films, and to be distributed by Lorimar Distribution International Incorporated (" L. D. I. I "), an associated company of L. P. I. concerned with the distribution and exploitation of cinematograph films. By March 1980 L. P. I. had made all the arrangements necessary for the making of the film. It had obtained the screenplay and the copyright, engaged the director and principal actors, selected the location, and prepared a detailed preliminary budget. The estimated cost of producing the film was just under $ 3 million. L. P. I. had secured the necessary finance which was to be provided by means of a revolving credit from Chemical Bank on the security, inter alia, of the film. Principal photography began on 26 May 1980. On 14 July 1980 the taxpayer company entered into a partnership agreement made between Victory Film Productions Ltd. (" Victory Productions "), as general par ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssets. (ii) Victory Partnership acquired the uncompleted film for $ 4,780,951, being the cost of making it to date ; L. P. I. agreed to complete the manufacture of the film for and on behalf of Victory Partnership substantially in accordance with the approved budget, and Victory Partnership agreed to pay L. P. I. the balance of the approved budget for doing so. Any finance needed in excess of the approved budget would be provided by L. P. l. in accordance with the terms of the completion loan. L. P. l. assigned to Victory Partnership all its rights of ownership of and in connection with the film, including the ownership of that part of the film which had already been made. (iii) Victory Partnership retained the ownership of the master negative but granted to L. D. I. I. in perpetuity an exclusive and exhaustive licence to distribute and exploit the film outside the United Kingdom L. D. I. I. was to charge distribution fees-which the commissioners accepted were at " near market rates " and to retain gross receipts until it had recouped its distribution expenses and the shares of profit payable to members of the cast and other participators in the film. Victory Partnership ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... As for the second, Victory Partnership was merely making a financial contribution towards the cost of the film ; L. P. l. was carrying out the work and bearing the overheads. A sleeping partner normally expects the working partners to charge remuneration and overhead expenses before division of the profits. Both items appear, therefore, to be justifiable in principle. The commissioners accepted evidence that (i) a completion fee is to be expected to be included in a film budget and is normally 6 per cent. of the budgeted cost of the film, though this figure is often the subject of negotiation- L. P. I. charged Victory Partnership 4.75 per cent. and (H) overhead provision is included in the budgets of most films by major studios. One witness put normal overhead provision at between 10 per cent. and 25 per cent. of budgeted cost. Another stated that 10 per cent. would be too high for his company, which was " mean on overheads " L. P. I. charged Victory Partnership 8.6 per cent. These items, therefore, cannot be said to be unjustified in principle or excessive in amount, and must be taken to be true costs of the film, properly included in the approved budget, and (as to 75 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ubstantial profits. The main terms of the transaction were negotiated between Mr. Wilde and Lorimar in March 1970. Mr. Wilde was concerned to put together a package which would meet the requirements of Lorimar on the one hand and likely investors in the United Kingdom on the other. At that stage, although Mr. Wilde had some potential investors in mind, the full group had not been assembled and none was committed. Once the package was, assembled, it was marketed in the United Kingdom as a tax deferral scheme. Mr. Whitfield recommended it to the treasury committee and the group main board in these terms. The way in which the scheme was intended to work was as follows. A partnership acts through the partners, or their servants or agents. A limited partnership-and its partners-acts through the general partner. If it engages in a trading transaction, that is trading by the partnership (i.e., by all the other partners as well, whether or not they have done anything at all beyond putting up capital). Where a partnership includes one or more companies, each corporate partner's share of the profits or losses of the partnership constitutes, by force of section 155 of the Income and Corp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... have reduced the loss, but the-commissioners found that there was no reasonable prospect of the film making a profit for Victory Partnership or even breaking even. The outcome for L. P. I. is more difficult to quantify, since it depends on the treatment of the completion fee, the budgetary overrun, and the overhead charge. Chemical Bank was still financing the major part of the budgeted cost of the film originally on the security of the film and it may well have required a completion guarantee to be procured from a third party at the cost of L. P. l. If so, then both the completion fee and the budgetary overrun should be excluded from the calculations, the one because it was not retained by L. P. l. and the other because it was not borne by it. Unfortunately the commissioners made no finding in this respect. If these items are excluded and if the overhead fee is also excluded on the ground that it truly reflected overhead and similar costs of the film borne by L. P. l., then L. P. l. lost a similar proportion of its investment or three times the amount of the loss suffered by Victory Partnership ($ 9,750,000 less $ 8,344,601 equalling $ 1,405,399). . This is in fact the most favo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to 25.5. The film was to be distributed by Ladd G. B., a Californian joint venture and an associate of Ladd G. B., under an exclusive and exhaustive licence granted by Outland Productions, which retained the ownership of the master negative. Under the terms of the Outland distribution agreement, Outland Productions was entitled to a " gross override " of 2 per cent. of the gross receipts of the film or 3 per cent. once it had recouped its outlay on the film with interest. The documents-30 in all-were executed in the course of a single meeting on 5 November 1980. By that time principal photography had been completed and the film was in its post-production stage. The transaction had been negotiated between Mr. Whitfield on the one hand and a Mr. Inglis and a Mr. Heyman on the other. The additional one per cent. gross override, once Outland Productions had recouped its capital outlay with interest, was payable to one of Mr. Heyman's companies as an introduction fee. He presumably expected the film to make a profit for Outland Productions since he was content to allow his introduction fee to be dependent on its doing so. Like the earlier film. " Outland " also ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ole 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 lie was trading, but whether he was trading. If the sole purpose of it trailsaction is to obtain a fiscal advantage, it is logically impossible to postulate the existence of any commercial purpose. But it is perfectly possible to predict 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. In Newton v. Commissioner of Taxation of Commonwealth of Australia [1958] A. C. 450, Lord Denning said ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pon 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 he 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 Lupton v. F. A. and A. B. Ltd. [1972] A. C. 634, 647, Lord Morris of Borth-y-Gest said : 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 fairiy 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 o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Tilling group in investing in the partnerships instead of on the purpose or object of the transactions into which the partnerships entered. This is the more surprising because the commissioners recorded at the outset not only the taxpayer company's inevitable admission that its investment was tax motivated and the Crown's concession that the question was not whether the taxpayer company was carrying on a trade but whether the limited partnerships were doing so, but also the crucial issue as lying between the parties' rival contentions : (i) that of the taxpayer company, that whatever fiscal motives may have induced it to go into films, once it had done so everything that was done was done on a proper commercial basis ; and (ii) that of the Crown, that what was done was so moulded by fiscal considerations that the whole character of the transactions relating to the films was denatured to such an extent that they ceased to be commercial. Despite this, by far the greater part of the commissioners' decision is concerned with establishing the obvious and admitted fact that the tax- payer company's motivation was fiscal rather than commercial or in drawing adverse i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... financial terms on which the partnerships contracted were not unfavourable, though they did not agree that such evidence led inevitably to the conclusion that the transactions themselves were commercial. The commissioners' conclusion that the transactions were not trading transactions was not, therefore, based on any finding that their financial terms were uncommercial, but in the absence of any commercial motive on the part of the taxpayer company coupled with three further findings, (i) that there was no evidence of any significant activity by Victory Partnership after 14 July 1980 ; the events of that date had no impact on the actual production and distribution of the film ; (ii) the partnerships made no attempt to control expenditure on the films and Mr. Whitfield showed no concern when they ran over budget ; and (iii) the documentation contained several curious provisions which the commissioners described as " almost unreal and which " tended to diminish any faith in their commerciality. " They gave three examples. With respect to the commissioners, none of these features throws any light on the question they were called on to decide. Thus : (i) Victory P ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Victory Productions' services agreement-indicates nothing more than second thoughts resulting in a last-minute amendment of little practical importance (and none at all so far as the fiscal element is concerned) which reflected the minority role and lack of technical expertise of Victory Partnership. Their third criticism-of the Victory Productions' distribution agreement-is of a typical example, common in everyday commercial agreements lacking any fiscal element, of surplus provisions inadvertently left in a lengthy document which has undergone progressive revision. The error had no practical consequence of any kind. The commissioners even criticised Victory Partnership for taking no action to guard against the possibility of L. P. l. or L. D. I. I. becoming insolvent. They made no similar criticism in relation to Warner Bros., for obvious reasons. The criticism is misplaced. Mr. Whitfield made inquiries into Lorimar's financial standing and ascertained that it had a $ 67 million revolving credit from Chemical Bank of which $ 54 million had been drawn down, and that Chemical Bank thought " very highly of them both financially and technically and would recommend ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hether the financial terms which Lorimar offered were so unfavourable to Victory Partnership that the transactions which resulted cannot fairly be described as commercial. It does not inexorably follow that unfair advantage was taken of Mr. Wilde's motivation. The fact mentioned in the last part of the penultimate sentence is not significant ; it is not even relevant. Every statement in the last sentence is wrong. Victory Partnership cannot fairly be said to have made a " considerable " loss in " Escape to Victory " when it recovered nearly 86 per cent. of its investment. L. P. l. lost at least the same proportion of its own investment, that is to say, three times as much ; and Warner Bros. lost a very much larger amount in " Outland. " The commissioners' attitude to the taxpayer company was extremely hostile. They clearly regarded it as having participated in an outrageous tax avoidance scheme. It is difficult not to sympathise with this view. But it does not follow, either in law or in fact, that the scheme did not involve the limited partnerships entering into trading transactions. The commissioners' reasoning and conclusions cannot be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a minority interest. For purely fiscal reasons, the transactions were so structured that, instead of acquiring a 25 per cent. interest in the venture, Victory Partnership borrowed 75 per cent. of the budgeted cost and acquired a 100 per cent. interest. The loan was made without recourse, and Victory Partnership had to concede a 75 per cent. interest in any ultimate profits in consequence. That is why the arrangements can be described as being in substance the acquisition of a 25 per cent. interest. But there is often more than one legal means of achieving the same financial result. If the taxpayer chooses one, he cannot be taxed as if he had chosen the other, even if his choice is dictated exclusively by fiscal considerations. The arrangements actually adopted, like the acquisition of a minority stake in a trading venture, also prima facie constitute a transaction in the nature of trade. The only financial disadvantage suffered by Victory Partnership by reason of the structure actually adopted lay in the fact that L. P. l. would recover the whole of the interest on its loan after Victory Partnership had recovered its capital but before it recovered notional interest on its invest ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nt of " gearing " which inflated the amount of the first-year allowances beyond the sums which the partnerships had to finance out of their own resources, and allowed them to enjoy the firstyear allowances which would have been available to L. P. I. if it had been a United Kingdom taxpayer. But that was the result of the use by the partnerships of borrowed money to finance their activities, not of anything uncommercial in the nature of those activities. The Crown's attack was illtargeted. If successful, it would have denied the partnerships any first-year allowance at all. Yet had they confined their claim to an amount equal to the expenditure of their own initial capital, the Crown would never have dreamed of challenging it. 5. Investment At one stage of the argument before me the Crown submitted that the limited partnerships were not trading at all but merely investing in films to be made and distributed by others. This was not an argument which was addressed to, or considered by, the commissioners and if there were any substance in it the case would have to be remitted to them. The submission appears promising at first sight, but as an independent point it breaks ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of a prearranged transaction, or that it is not known in what order they were executed. As Sir Raymond Evershed M. R. said in that case, at p. 561 : " It is no doubt true to say that in one sense the transaction was one transaction ; but it is equally true to say that it consists necessarily of certain defined steps which must take place in a certain defined order, if the result intended is eventually to be achieved. That seems to me not an artificiality, but a necessary result of the law and of the conveyancing practice which was involved. " The fact is that the distributor's right to distribute the film depended on that right having first belonged to the partnership, in the same way that the title of a purchaser's mortgagee depends on the legal estate having momentarily been vested in the purchaser. For reasons which will become apparent, the Crown's submission is not improved by reliance on the principle laid down in Furniss v. Dawson [1984] A. C. 474. But in my judgment the question does not depend on conveyancing niceties. The application of section 41 to a film negative cannot depend on whether the film is to be distributed by the agent of the taxpay ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on 5 November 1980 ... (ii) " In our judgment the creation of the two limited partnerships, Victory Partnership and Outland Productions, served no commercial or business purpose. As soon as each was brought into existence it was launched on a prescribed course of action over which it had almost no control. Partnership meetings were few, and on the evidence before us served no business purpose. Each was brought into existence as part of a tax deferral scheme designed to produce significant tax shelter for [the taxpayer company I and the 'calling group. In these appeals there is nowhere any evidence of any significant action being taken by the partnerships. Where action was taken it was at the instigation or prompting of Ensign, usually in the person of Mr. Whitfield, dealing direct with other parties. " The first of those findings is unexceptionable, at least if it means only that the transactions were interdependent and intended to be entered into simultaneously. That does not, of course, make them artificial or uncommercial ; complicated commercial transactions frequently involve numerous parties and require large numbers of separate but interlocking documents to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is to be treated not as having an independent effect but as merely an element in a different and larger whole. If so, then a question of statutory construction arises, for it is still necessary to apply the terms of the taxing Act to the composite whole. In Furniss v. Dawson the transfer to an intermediate transferee was not disregarded ; it was treated for what it was, a. step in the disposal to the ultimate purchaser. The question that then arose was whether that first step came within the words of a statutory exemption. I am unable to comprehend how the creation of the two limited partnerships can be treated as a step in some other and larger transaction without any independent effect of its own. What other transaction ? It can only be the production and distribution of the films. The commissioners' finding appears to lead to a conclusion that the taxpayer company had a direct partnership in the film transactions. But this does not help the Crown. It means only that the taxpayer company, instead of the partnerships, incurred the relevant expenditure (all of it ?, or only its share % and what of the other limited partners in Victory Partnership ?) and is entitled to the corr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ctory Partnership. Victory Partnership cannot simply be treated as if it played the part of Greenjacket in Furniss v. Dawson. Greenjacket was merely a conduit pipe for the receipt and disposal of shares at a predetermined price and a receptacle for the receipt of the purchase money. It was incapable of making a profit from the transaction and to Lord Oliver of Aylmerton this was essential to the decision : see Craven v. White [1989] A. C. 398, 514, Victory Partnership, by contrast, is the taxable entity. It acquired an unfinished film-that is to say an asset incapable of commercial exploitation in its existing state-arranged for it to be completed and undertook to deliver it to the distributors in its finished state with a view to its commercial exploitation. That is a typical adventure in the nature of trade. This difference between its outlay, which was known in advance, and its receipts, which were impossible to forecast, would represent the profit or loss on the venture. Leaving aside its borrowings, it put up $ 3.25 million of its own money and stood to lose the lot. In fact, it lost $ 468.469. Had the film been successful, it would have made money and possibly a lot of Its a ..... X X X X Extracts X X X X X X X X Extracts X X X X
|
