Degorce v HMRC – film partnership did not amount to a trade

Mon 14 Sep 2015

The Upper Tribunal (UT) has released its decision on the case of Degorce v HMRC, upholding in full the earlier decision of the First-tier Tribunal (FTT).

The case concerns a film scheme (known as the ‘Goldcrest film scheme’) which Mr Degorce entered into shortly before 5 April 2007 and in particular, the deductibility of a loss for income tax purposes.

In board terms, under the scheme, Mr Degorce acquired rights in two films (partly financed by limited or non-recourse loans, which were only to be repaid if sufficient profits were made from the scheme) which he immediately assigned. On the assignment of these rights, he received a ‘right to future income’ and crystallised a loss of circa £20 million, which was claimed as a trading loss and set off against his other income in that, and the subsequent, tax year.

The issues originally considered by the FTT were whether:

• Mr Degorce carried on a trade during the year ended 5 April 2007 (the ‘trade issue’), and if so whether:
• the trade was carried on on a commercial basis (the ‘commercial basis issue’);
• the trade was carried on with a view to realising a profit (the ‘view to profits issue’);
• the profit / loss for the year of assessment had been calculated in accordance with GAAP (the ‘GAAP issue’); and

the expenditure incurred by Mr Degorce was wholly and exclusively for the purpose of that trade (the ‘expenditure issue’).

The FTT found against Mr Degorce on the basis of the first issue, that he had not in fact been carrying on a trade. However, they continued to consider the remaining issues on the assumption that he had in fact been carrying on a trade, but found against him on each of these too.

The jurisdiction of the UT was to consider whether the evidence before the FTT was sufficient to support their conclusions, rather than to consider whether on the same evidence they themselves would have come to a different conclusion. They considered each of the factors in turn.

The trade issue

The discussions focussed on the FTT’s consideration of the badges of trade, and although the UT agreed with the appellant that various parts of the FTT’s decision on this matter could be criticised (in particular, the fact that they disregarded evidence of similar activities because the tax consequences of those activities were under investigation), they concluded that there was no evidence before the FTT which could lead them to the conclusion that a trade was in fact being carried on, and upheld their decision on this matter.

In particular, UT commented on the fact that the pre-ordained nature of the transactions led to only one possible outcome – although the overall exercise was somewhat speculative (with regards to the level of income, if any, which would be received from the rights) there was no speculation in the transactions themselves, in that Mr Degorce acquired nothing but an income stream. The UT also commented that ‘as a general rule a trading transaction should be recognisable as such without close analysis of its detail.  It does not seem to us that the informed observer, standing back from the detail, would necessarily conclude that what Mr Degorce did amounted to a trading activity’ or conversely that the ‘conclusion that this was not trading could not be regarded as perverse’.

The commercial basis issue and the view to profit issue

The consideration of these issues overlapped somewhat with that of the trade issue, however the FTT had found that when looking at the transaction (including the timing of it, the anticipated result and Mr Degorce’s understanding of it) they could see no commercial basis for it other than the potential tax relief which could be achieved.  The rationale for this was that the FTT had found no basis upon which Mr Degorce could be satisfied that the price paid was commercial.  There was no detailed independent valuation prior to his signing the agreements and making the payments.  When rights were later sold, this was also without independent valuation.  As such, the entire focus of the transaction was on the potential tax relief.

The UT upheld the decision of the FTT, concluding that the FTT had considerable evidence before them and that there was nothing to indicate that their decision was inconsistent with or unsupported by that evidence.

The GAAP issue

Although the FTT had considered a number of accounting issues in connection with the case, the only issue in question here related to the presentation in the accounts of the asset (i.e. the right to future income) and the loan.

On this issue, the FTT had concluded that the accounts did not show a true and fair view of Mr Degorce’s affairs and had not been prepared in accordance with GAAP, claiming that the asset and loan should have been presented as a linked presentation on the balance sheet, the result of which would have been to limit the maximum deduction which could have been charged to the accounts (and therefore the potential loss).

The UT held that the FTT’s conclusion was one that it was open to it and which could not be challenged by the UT.

The expenditure issue

The FTT had concluded that the expenditure incurred by Mr Degorce on the acquisition of the film rights was not incurred wholly and exclusively for the benefit of the trade and hence not tax deductible Although the UT commented that the reason for the decision of the FTT had not been expressed clearly, they upheld their decision.

In particular, they accepted HMRC’s arguments that the loan financing entered into was no more than a device to produce a higher asset cost which could then be written down in the accounts to produce a loss.  The money went round in a closed loop.  The UT stated that as in the Ensign Tankers case, there was both ‘real expenditure’ on the film rights, and ‘artificial’ expenditure arising out of the self-cancelling transactions involving the loan.  Thus, the UT suggested that the result was that relief would be available for the real expenditure but not for the amount which was artificially inflated. 

Comments

This was the lead case, with the result impacting upon 11 other taxpayers. It is yet to be seen whether an appeal will be made to the High Court, although it is worth noting that the case is similar to that of Film Partners v HMRC, which was held in favour of HMRC in the Court of Appeal earlier this year.

The fact that Mr Degorce had engaged in a number of similar schemes did not alter the outcome: repeating similar transactions a number of times did not help in making it a trading activity.