First-tier Tribunal (Tax)

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Cite as: [2011] UKFTT 401 (TC)

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Eclipse Film Partners No 35 LLP v Revenue & Customs [2011] UKFTT 401 (TC) (22 June 2011)
INCOME TAX/CORPORATION TAX
Other

[2011] UKFTT 401 (TC)

TC01256

Appeal number TC/2009/10762

Expert evidence – application for a direction to exclude expert evidence – whether expert evidence inadmissible on grounds that it is an opinion as to UK tax and therefore trespasses on the special expertise of the Tribunal – whether decision as to admissibility of the evidence should be a case management matter or deferred until the hearing of the appeal – questions as to admissibility and weight to be attributed to evidence admitted to be determined following hearing of the appeal – application refused

FIRST-TIER TRIBUNAL

TAX

ECLIPSE FILM PARTNERS NO 35 LLP Appellant

- and -

THE COMMISSIONERS FOR HER MAJESTY’S

REVENUE AND CUSTOMS Respondents

TRIBUNAL: EDWARD SADLER

JOHN WALTERS, QC

Sitting in public at 45 Bedford Square, London WC1 on 1 June 2011

Jolyon Maugham, counsel, instructed by Freshfields Bruckhaus Deringer for the Appellant

Rajesh Pillai and Rebecca Murray, counsel, instructed by the General Counsel and Solicitor to HM Revenue and Customs, for the Respondents

DECISION

Introduction

1. Eclipse Film Partners No 35 LLP (“E35”) is a limited liability partnership which is appealing against a decision of The Commissioners For Her Majesty’s Revenue and Customs (“the Commissioners”) that, in the tax year ended 5 April 2007, E35 was not carrying on a trade of exploiting film rights, or if it was carrying on such a trade, it was not doing so with a view to profit. That appeal has been listed for hearing before us for thirteen days beginning on 13 July 2011.

2. The principal significance of E35’s appeal relates not to the tax position of E35 itself, but to that of its individual members. Each of the 239 members of E35 borrowed funds to make their respective investments in E35 and made a prepayment of the interest payable on those borrowings for which they have claimed tax relief. The aggregate amount of that tax relief is in the order of £117 million. It is a necessary precondition to a successful claim for such relief on the part of the members that E35 should be carrying on a trade with a view to profit in the tax year in which the members made the interest prepayment. The members wait in the wings, as it were, whilst E35 pursues its appeal against the Commissioners’ decision on the trading issue.

3. Although the issue to be determined at the forthcoming hearing of the appeal is apparently straightforward, the film exploitation and financing arrangements entered into by E35 and it members are complex. The briefest of summaries of those arrangements is given below. The parties are engaged upon a substantial piece of litigation and have twice before brought matters to the Tribunal: in January 2009 E35 applied to a Special Commissioner for a direction that the Commissioners issue a closure notice in relation to the enquiry which they were making into E35’s tax return for the relevant tax year: that direction was given in a decision of Mr Sadler released on 17 February 2009 (SpC 00736). The resulting closure notice comprised the decision against which E35 is now appealing. In August 2010 there was a dispute as to disclosure and certain other case management issues which was heard by Mr Walters, and his directions (with reasons) were given in his decision released on 13 August 2010.

4. The parties are now in dispute about a further case management issue. On 10 April 2011 the Commissioners served on E35 the witness statement of Mr Marcus Stanton in the form of an “Expert Report”. As is explained in more detail below, Mr Stanton claims to be expert in structured finance and banking transactions, and the evidence he offers in his Report, and which the Commissioners wish to adduce in the course of the hearing of the appeal, relates to the financial basis which underlies the transactions entered into by E35 and its members. The analysis he makes leads him to conclude that those transactions were structured so as to secure tax relief for the members of E35 rather than to achieve the commercial prospect of a trading profit.

5. On 4 May 2011 Freshfields Bruckhaus Deringer, acting for E35, informed the Commissioners that E35 objected to the admission of Mr Stanton’s evidence in these appeal proceedings. Subsequently E35 applied to the Tribunal for a direction excluding that evidence, or the majority of it, on the grounds that it is inadmissible, since it relates to UK tax matters, which is the province of the Tribunal itself, and since, further, it puts forward a partial version of the facts, dressing as expert evidence matters which properly should be made by way of submission by the Commissioners when they make their case at the hearing.

6. We heard E35’s application on this matter at a lengthy hearing with full arguments from each party.

7. Section 3(1) of the Civil Evidence Act 1972 provides that the opinion evidence of a witness called in any civil proceedings on any relevant matter on which the witness is qualified to give expert evidence shall be admissible in evidence. Section 5(3) of that Act provides that nothing in that Act prejudices a court’s power to exclude evidence at its discretion. It should be noted that for the purposes of the Civil Evidence Act 1972 “civil proceedings” means “civil proceedings, before any tribunal, in relation to which the strict rules of evidence apply (section 5(1)): strictly, therefore, proceedings before this Tribunal are not within the scope of the Civil Evidence Act 1972, but on matters of evidence that Act provides a point of reference for the Tribunal when it exercises its discretion as to the evidence it will admit.

8. As to our particular powers to admit or to refuse to admit expert evidence in proceedings before us, Rule 15 of the Tribunal Procedure (First-tier Tribunal) (Tax Chamber) Rules 2009 provides:

(1) Without restriction on the general powers in rule 5(1) and (2) (case management powers), the Tribunal may give directions as to -

(a) issues on which it requires evidence or submissions;

(b) the nature of the evidence or submissions it requires;

(2) The Tribunal may -

(a) admit evidence whether or not the evidence would be admissible in a civil trial in the United Kingdom; or

(b) exclude evidence that would otherwise be admissible where –

(i) the evidence was not provided within the time allowed by a direction or a practice direction;

(ii) the evidence was otherwise provided in a manner that did not comply with a direction or a practice direction; or

(iii) it would otherwise be unfair to admit the evidence.

Rule 15, as with all other the other Tribunal Procedure Rules, must be applied with regard to the provisions of Rule 2 of the Tribunal Procedure Rules, which states that the overriding objective of those Rules is to enable the Tribunal to deal with cases fairly and justly, and that to do so includes using any special expertise of the Tribunal effectively.

Our decision

9. In view of the urgency of the matter in the context of the preparation by each side of its case for the forthcoming hearing of the appeal we gave our decision orally immediately following the hearing of the application. Our decision is to refuse E35’s present application. We have decided that we should hear the evidence of Mr Stanton at the hearing of the appeal, and also any evidence which E35 adduces in reply to Mr Stanton’s evidence. If it remains E35’s position at the hearing and after the evidence has been heard that all or some identified part of Mr Stanton’s evidence is inadmissible, we will hear submissions on the matter from the parties; if there is a question as to the weight which we should attach to Mr Stanton’s evidence (assuming it is not inadmissible), we will hear submissions on that matter also. We direct accordingly. In giving our decision on the appeal we will then set out our conclusion as to the admissibility of Mr Stanton’s evidence (and, if we admit his evidence, the weight we attach to it in reaching our decision), and our decision on the appeal will then take account of the conclusion we reach as to Mr Stanton’s evidence.

10. E35 asked for our decision on this matter in writing and also for the reasons for our decision. E35 subsequently informed us that it does not intend to apply for permission to appeal against our decision, although of course it remains open for it to do so for the requisite period after the release of this decision.

Summary of the arrangements entered into by E35 and it members

11. In the Special Commissioner’s decision directing the Commissioners to issue a closure notice there was (at paragraph 4) the following brief summary of the facts and the structure of the arrangements entered into by E35 and its members – that summary will also suffice for present purposes:

(1) E35 is a limited liability partnership with approximately 240 members, all, or most, of whom are individuals liable to UK income tax.

(2) Shortly before 5 April 2007 E35 entered into a complex series of transactions whereby it obtained a licence from a United States corporation, Walt Disney Company, for a period of 20 years of the rights to distribute two films, and sub-licensed the distribution rights in those films to another Walt Disney entity in the United States, WDPT Film Distribution VIII LLC (“WDPT”). E35 paid Walt Disney Company approximately £500 million as consideration for the licence to distribute the films, and under the sub-licence E35 is entitled to receive from WDPT annual fixed royalties and further royalties contingent upon the earnings from the films. The production costs of the two films are, in aggregate, approximately £79 million.

(3) E35 was financed for these purposes by its members, who contributed capital to the partnership. Each member financed his capital contributions in part from his own resources but substantially (as to approximately 94 per cent) by undertaking borrowings for that purpose, borrowing under a 20 year facility made available to him by Eagle Financial and Leasing Services (UK) Limited (“Eagle Financial”). Eagle Financial is a subsidiary company in the Barclays Bank group of companies. In aggregate the members borrowed approximately £790 million from Eagle Financial.

(4) Prior to 5 April 2007 E35 made a payment (expressed to be by way of loan on account of anticipated profits) to the members of an aggregate amount of approximately £292 million. The facility with Eagle Financial includes a term requiring the members to make a payment expressed as a pre-payment in respect of interest accruing over the first ten years of the borrowing, and the members made such payment (of an aggregate amount of approximately £292 million) to Eagle Financial, again, prior to 5 April 2007.

(5) Complex arrangements were put in place to secure the obligations of the various parties. Barclays Bank plc (“Barclays”) issued a letter of credit supporting the payment by WDPT to E35 of the fixed royalties due under the sub-licence, with Walt Disney Company depositing with Barclays approximately £495 million as security for that letter of credit. E35 assigned that letter of credit to Eagle Financial as security for the members’ borrowing.

(6) E35 contracted with a number of other parties for advisory and other services, and in particular with a UK company in the Walt Disney group, WDMSP Limited, which agreed, for a fee, to act as E35’s agent in developing marketing and release plans for the two films in question.

(7) On 11 September 2007 E35 filed its tax return for the tax year ended 5 April 2007. That return shows no profit and no loss.

Mr Stanton’s Evidence and Expert Report

12. The evidence of Mr Stanton to which E35 takes exception is set out in a document entitled “Expert Report of Marcus Stanton” which is dated 8 April 2011 and is signed by Mr Stanton. The Report runs to some ninety pages, and we were told that there were lengthy exhibits to the Report (which we did not read). It is expressed to be Mr Stanton’s professional opinion on the matter in dispute between E35 and the Commissioners, that opinion having been requested by the Commissioners. In preparing the Report Mr Stanton states that he has complied with Part 35 of the Civil Procedural Rules and the accompanying Practice Direction.

13. Mr Stanton begins by setting out his qualifications and experience. In brief, he qualified as a Chartered Accountant and practised at one of the leading firms of chartered accountants, specialising in international and corporate taxation. He then held a series of positions with leading UK merchant and investment banks, including that of Head of Structured Finance and Chief Operating Officer in the Global Capital Markets division of Robert Fleming & Co. Since 2001 he has acted as a banking consultant to banks and various government agencies in the UK and overseas and has also held a number of non-executive directorships in companies in the financial sector.

14. Mr Stanton divides his Report into ten sections, as follows (and adopting his section headings):

(1) The Role of Structured Finance in Tax Driven Transactions: this is a general explanation of the role of arrangers and banks in the context of tax-based products marketed to individuals followed by a description of the funding arrangements entered into by E35 and its members and the tax relief claimed by the members for the prepaid interest;

(2) The Transaction Arrangements: this is an overview of the transaction and a review of the main transaction documents and cashflows, with Mr Stanton expressing his view that the arrangements can be viewed as a combined transaction;

(3) The Profits/Losses of the Eclipse Partnership and the Eclipse Partners: this is an analysis of the likely profits and losses accruing from the transactions to E35 and to its members;

(4) The Derivation of the Transaction Amounts: this is an analysis of the payments made under the transaction documents, with the opinion expressed that such amounts were determined by financial calculations rather than by reference to any film activity;

(5) The Net Profit Calculations Prepared by Future Films: this is an analysis of the profit figures given in the promotional documentation sent to prospective members, relating those figures to the outcome (expressed by Mr Stanton to be a loss) where the members substantially borrow (as they all did) to invest in E35;

(6) The Contingent Receipt Calculations: this is an analysis of the significance in the financial calculations underlying to transaction documents of the right of members to share in “Contingent Receipts” from the films in which the investment is made (that is, earnings from the films over and above the fixed royalties payable to E35);

(7) The Banking Arrangements: this is an analysis of the loan and other facilities provided by members of the Barclays Bank group of companies, the credit risk undertaken by Barclays, and the risk-weighting of the arrangements for Barclays’ capital adequacy purposes;

(8) The Prepaid Interest: this comments on the prepayment of interest on their borrowings by the members and the resulting tax relief claimed by them;

(9) The Risk being borne by the Eclipse Partners: this is an analysis of the nature of the risk to which the members are exposed in the event of default; and

(10) The Role of the Tax Benefits in the Arrangements: this is an opinion that the amount of the investment made by each member was based on the tax shelter sought by that member and that a major factor in determining the size of the E35 partnership was the amount of tax shelter sought by its members collectively, rather than the requirement to finance particular films.

15. In the course of his Report Mr Stanton uses the cashflow and other numbers supplied by Future Films (the promoters of E35) and, by a process he refers to as “reverse engineering”, uses that information to produce his own cashflows and calculations which he claims support his views on the financial and tax basis underlying the transaction as a whole and the individual transaction documents.

The parties’ submissions

E35’s submissions

16. Mr Maugham, for E35, submitted that we should exclude Mr Stanton’s Expert Report, or the majority of it, on the grounds that it is inadmissible. He argued that we should do so at this stage of the proceedings, as a case management matter, and not at the hearing of the appeal or in the course of giving our decision following that hearing.

17. Mr Maugham drew our attention to Part 35 of the Civil Procedure Rules, which provides:

1 Expert evidence shall be restricted to that which is reasonably required to resolve the proceedings.

He acknowledged that those Rules do not govern the procedure of the Tribunal, but submitted that they provided a standard or guide as to the principles which the Tribunal could reasonably apply: see esure Insurance Ltd v Direct Line Insurance Ltd [2008] EWCA Civ 842 at para. 82. He argued that Part 35.1 had been formulated in response to the concerns of the courts that parties were too ready to adduce expert evidence which did not assist the court in reaching a decision – it signalled that a more rigorous approach should be taken in deciding whether or not to admit expert evidence: JP Morgan Chase Bank v Springwell Navigation Corp [2006] EWHC 2755 (Comm).

18. Mr Maugham took us to the cases of United Bank of Kuwait v Prudential Property Services Limited (unreported decision of the Court of Appeal of 27 November 1995) and Barings PLC v Coopers & Lybrand [2001] EWHC 17, which establish that the overriding principle in determining whether expert evidence should be admitted is whether “it is helpful in assisting the court to reach a fully informed decision” (United Bank of Kuwait case), and that expert evidence, even if potentially of value to the court, can still be excluded if it is not helpful because the issue is “one on which the Court is able to come to a fully informed decision without hearing such evidence” (Barings case). The burden of showing that the expert evidence in question meets these requirements and should be admitted is on the party wishing to adduce that evidence (in this case, the Commissioners): Clarke v Marlborough Fine Art [2002] EWHC 11 (Ch).

19. He also referred to the case of Woodford & Ackroyd v Burgess [1999] EWCA Civ 620, where the Court of Appeal indicated that it is desirable, where possible, for the question of the admissibility of expert evidence to be determined prior to the trial.

20. Turning to the particularities of Mr Stanton’s Expert Report, Mr Maugham argued that it is essentially the evidence of a tax practitioner expert in certain types of transactions who offers a partial and limited comment on the transaction documents and then speculates as to the tax conclusions which can be drawn from his analysis. The nature and tax consequences of the transactions entered into are matters on which the Tribunal has to form a view in order to reach a decision as to whether or not E35 was carrying on a trade with a view to a profit. Since it is the function of the Tribunal to make that decision, and to use its specialist expertise to do so (see Rule 2(2) of the Tribunal’s Procedure Rules), it is evidence which should be excluded since the Tribunal “is able to come to a fully informed decision without hearing such evidence” (Barings case). In stating his view as to matters of fact and as to the tax analysis of the transactions, Mr Stanton is, at best, offering as evidence matters which should properly be the subject of examination of the witnesses of fact and then submission by the Commissioners and, at worst, usurping the decision-making function of the Tribunal.

21. Mr Maugham also argued that much of Mr Stanton’s evidence relates to the issue of the prepayment of interest by the members of E35 and their consequent claim for tax relief, but that is not the issue which the Tribunal has to decide – the issue for the Tribunal is whether or not E35 is carrying on a trade with a view to a profit.

The Commissioners’ submission

22. For the Commissioners Mr Pillai opposed E35’s application to exclude Mr Stanton’s evidence on two grounds: on the procedural ground that it is consistent with the modern approach of the English courts that the Tribunal hearing the appeal should hear the evidence and deal with admissibility in its decision by giving the appropriate weight to that evidence; and on the substantive ground that the evidence is admissible since it will assist the Tribunal at the hearing to reach a fully informed decision on the matters relevant to the appeal.

23. As to the procedural ground, Mr Pillai referred to the case of Re M & R (Minors) [1996] 4 All ER 239 at 254a (CA) and to the textbook authority, Expert Evidence: Law & Practice (3^rd Edition 2010) at 1-030 as authority for his submission that, in all but those cases where the issue is clear-cut, the assessment as to whether or not evidence should be admitted should be made after that evidence has been heard, so that the court can attribute appropriate weight to the evidence when it reaches its decision.

24. He argued that that is the correct approach in the instance of Mr Stanton’s evidence, since, first, the question of admissibility has arisen only shortly before the hearing is due to occur, and, secondly, the extent and nature of the evidence is such that the Tribunal needs to have considered all the issues, and the case as fully argued by each side, before it can fairly judge whether the evidence assists the Tribunal to reach an informed decision, and the weight which should be attributed to that evidence.

25. As to the substantive ground, he argued that the evidence of Mr Stanton should be admitted because it meets the test set out in the Australian case of R v Bonython (a test applied by the English courts, as in the JP Morgan Chase case and also in Zeid v Credit Suisse [2011] EWHC 716 (Comm)): the witness is expert in the matters on which he gives evidence, and the subject matter of the opinion expressed by the witness is one upon which expert evidence is permissible. The Tribunal will require an understanding of the nature of the arrangements entered into by E35 and it members, which can be informed by expertise and knowledge in the field of banking and structured finance, which is expertise and knowledge which Mr Stanton has at a high level. The structured finance nature of the arrangements is acknowledged by E35’s own evidence, so that specialist evidence on that subject is clearly relevant to the proceedings, and is evidence on specialist matters which is likely to assist the Tribunal in reaching its decision.

26. Finally, if Mr Stanton’s evidence were excluded, he submitted that that would deprive the Commissioners of the opportunity to advance their own factual analysis of the information which E35 relies on in presenting its case. Mr Stanton’s evidence is in support of the Commissioners’ case as that has been pleaded in the proceedings.