First-tier Tribunal (Tax)

(a)           were the LLPs carrying on a trade?

(b)          were they doing so “with a view to profit”?

(c)           did they incur expenditure equal to 100% of the budget of the film or game?

(d)          was their expenditure incurred wholly and exclusively for the purposes of their trade?

(e)           were their losses computed correctly as a matter of generally accepted accounting practice (“GAAP”)?

(a)           for ITP the amendment to its 2002/03 partnership return disallowing in their entirety trading losses of £64,671,573;

(b)          for IFP2 the amendments to its 2005/6, 2006/7, 2007/8 and 2009/10 partnership returns disallowing in their entirety losses of £748,183,712, £76,393,501, £45,850,405, and £444,855 respectively; and

(c)           for IG the amendments to its 2005/6 and 2006/7 partnership returns disallowing in their entirety losses of £25,614,984 and £74,068.

(d)          In the rest of this decision we round amounts to the nearest £m, unless greater accuracy is required for the argument.

(a)           ITP was launched in 2002 and by 5 April 2003 some 140 individuals had invested capital contributions of £26m. 

(b)          IFP2 was launched in 2005. It was the largest LLP and by 5 April 2006, the end of its first accounting period, 1,382 individual investors had made capital contributions totalling £778m. 

(c)           IG was launched in 2005 and by 5 April 2006 individual investors had made capital contributions of  £27m.  

(d)          During the course of this decision we may also refer to another LLP, Ingenious Film Partners LLP (“IFP”), a precursor to IFP2, which was launched in 2004.

2. Summary of the Structure

(a)            30 (35 in the case of ITP) of the budgeted cost was sourced from the subscriptions of individual members of the LLP;

(b)           and 70 (65 in the case of ITP) was sourced from a Commissioning Distributor (the “CD”), which was a Hollywood studio (a “Studio”) or a vehicle formed by independent producers and other financiers;

(c)           the combined 100 was provided to a Production Services Company (a “PSC”), a special purpose vehicle which made the film or game in accordance with an agreed specification. The PSC appeared to have been an associate of the CD: the same lawyers acted for the CD and the PSC;

(d)           when the film or game had been made it was distributed by the CD and the proceeds of distribution divided in accordance with the terms of a “waterfall” which specified who should receive what and in what order, and under which amounts were to be paid to the LLP and paid to, or retained by, the CD.

(a)           by a loan agreement the CD agreed to lend 70 to the CM. The loan was expressed to be repayable only from part (or all, in the case of ITP) of the CM’s drawings from the LLP. The loan was to be made by the payment of 70 (65) directly to the PSC;

(b)          by a Production Services Agreement (the “PSA”) the LLP agreed with the PSC for the making of the film on an Approved Budget of 100 in accordance with a detailed specification, and for payments to the PSC in accordance with an Approved Cash Flow;

(c)           by a Commissioning and Distribution Agreement (the “CDA”) the CD agreed with the LLP that the LLP would make the  film in accordance with the same detailed specification and Approved Budget, and deliver it to the CD. It provided that receipts from the film would be applied in accordance with the waterfall which appeared in schedule 7 of that agreement;

(d)          by a Deed of Acknowledgement the payments expressed to be payable under these three agreements were varied.

(a)           the CD would pay 70 (65) to the PSC, and the LLP would pay 30 (35) to the PSC;

(b)          30% (35%) of the income arising from the film after the deduction of certain costs and fees would be paid to the LLP.

The detail of the provisions which resulted in this cash flow is explained in section 1 of Chapter III.

3. The Parties’ Contentions

(a)            that in computing the accounting profits of the trade, 100 was expended by them on trading stock, namely the film, and that in accordance with GAAP they were required to carry that stock in their accounts at the lower of cost and net realisable value (“NRV”).

(b)          that NRV was equivalent to the virtually certain income which would be derived from the film, and that films were notoriously unpredictable. As a result generally the films, on which they had expended 100, were properly written down to about 20. That write-down gave rise to an accounting loss of about 80 in the accounting period in which the contract for each film was entered into.

(c)           That accounting loss was a loss in the trade for income tax purposes.

These are the losses which the LLPs claim, and HMRC dispute.

4. The Effects for Individual Members and the CM

(i) Individual Members

(a)           in year 1 the member subscribed 35 and had allocated to her a loss of 80. She made a tax claim for the loss and received 40% x 80 = 32 from HMRC;

(b)           in year 2, if the LLP recognised film receipts of 50 and reported a profit of 50 (as might be the case where after the receipt the NRV of the remaining film remained at 20), the 50 would be allocated to the members and drawings of half that amount, 25 would be paid to them. The members would pay tax on that profit of 40% x 50 = 20, and retain 5.

5. The Difference Between ITP and IFP: Non-production Activities

(a)           no profit was made from non-production activities in Year 1;

(b)          the individual members contributed 100 and the CM 100;

(c)           56% x (100+100) = 112 was contracted for film production; and

(d)          the films were written down to 20% of cost,

then a loss of 80% x 112 = 89.6 would arise. 99% of this (it had been 90% in the case of ITP) was allocated to the individual members. They could thus claim loss relief of 99% x 89.6. That was less than their capital subscription and so was not restricted. Thus  in the first year they could make a tax reclaim for repayment of 40% x 99% x 89.6 = 35.5, giving, as was intended to be the case for ITP, a positive return for the individual investor in a matter of months.

6. The Evidence

(a)           Patrick McKenna, the founder and CEO of Ingenious. He is an accountant who was a partner in Deloitte before he left to join Andrew Lloyd Webber at the Really Useful Group in 1990. He has business interests in, and extensive experience of, the business of the film and entertainment industry and understood tax. He was an able witness. He saw difficulties coming and headed them off; he kept what he had said under review to correct any impression he did not want to deliver.

(b)          Duncan Reid, the Commercial Director of Ingenious. Mr Reid joined Ingenious in 1998, and until 2001 had been Finance director. He was the one witness who could give a more detailed account of the activities of IG. Mr Reid was a robust witness who had a tendency to try to be helpful by making up explanations on the hoof rather than to give evidence of what he recalled had happened.

(c)           James Clayton, who until 2014 had been CEO of the Investments division of Ingenious. Mr Clayton had joined Ingenious in April 2003, and had played a pivotal role in Ingenious’ relationship with Fox for IFP and IFP2. Mr Clayton was very careful in what he said and well prepared for what he wanted to recall but  with a sketchy memory of matters for which he had not prepared.

(d)          Nicholas Bower, who until 2014 had been a director of Ingenious’ Investments division. Mr Bower joined Ingenious in 2005 and gave evidence of the activities of Ingenious and the LLPs after that date.

(e)           Neil Forster, the Chief Financial and Chief Operating Officer of Ingenious. Mr Forster joined Ingenious in 2008 and gave evidence of the accounting records of the LLPs, including information as to the performance of the films and games to date, their projected future performance and the accounts of the LLPs.

(a)           Eric Briggs of FTI Consulting Inc, which had acquired the respected Salter Group of which he had been the co-founder. Mr Briggs was an expert in forecasting the future income of films. He provided forecasts of the potential results of a number of films. This included developing a financial model for the “Lifetime Ultimate” for certain films, that is to say the total net income which might arise from the film from all sources over all time.

(In 2010 Ingenious prepared for HMRC their own forecasts of the results of the accounting profit or loss they estimated would arise from each of the films undertaken by the LLPs over the lifetime of the films. These were called the “2010 Ultimates”, and were evaluated by Mr Briggs.)

(b)          Jonathan Olsberg, a management consultant specialising in the film industry, who gave his opinion in relation to three films as to whether those three films would be profitable for their respective LLPs. Mr Olsberg had experience of working as a sales agent.

(c)           Angus Finney, a writer, lecturer and specialist in the film industry who had been a Managing Director of Renaissance Films, a UK film production company between 1999 and 2005.

(d)          Steven Sills of Green Hasson Janks LLP who had extensive experience in the auditing of profit participations from films.

(a)           Jesse Divnich, who until 2014 had been at EEDAR, a large speciality video games research firm. When he appeared before us he was at Tilting Point Media.

(b)          Vincent Scheurer, of Sarassin LLP, an expert in the commercial practices of the video games industry.

(a)           Peter Holgate, a chartered accountant who had until 2013 been senior accounting technical partner at PwC;

(b)          Luke Steadman, a chartered accountant, head of the forensic investigations team at Alvarez & Marsal Global Forensic Dispute Services LLP;

(c)           Richard Cannon, a chartered accountant employed by HMRC.

7. Background: Making a Film

8. Other People and Definitions

(a)           Paula Jalfon who joined as Head of Production in August 2002. She had considerable production experience. She left in April 2007; Mr Bower took over from her.

(b)          Nick Crossley, business development manager. Mr Crossley’s role included financial modelling.

(c)           Kevin Mead, formerly CEO of Ingenious.

(d)          Alison Brister, a legal advisor at Ingenious.

(e)           Mark Fielding, a senior financial analyst at Ingenious.

(f)           James (or Jimmy) Mulville, a member of the Executive Committee of IFP2 and chief executive of Hat Trick Productions.

(g)          David Heyman, a member of the executive committee of IFP2 and the producer of the Harry Potter Films.

(a)           WWBO: worldwide box office receipts: the gross amount received from tickets sold in cinemas. “Theatrical Receipts” is generally used to mean WWBO less the commission taken by the cinemas.

(b)          Domestic BO (or NABO): the gross box office receipts in North America; (it seems that in the film industry North America is domestic).

(c)           International BO: gross box receipts other than in North America.

(d)          P&A: see section 7 above.

(e)           The waterfall: the terms under which income from the film reaches those with an interest in it: some being entitled to income or reimbursement before others.

(f)           GDI: Gross Distributable Income. This is a term used in the waterfalls to describe the income remaining for distribution after the deduction of certain fees and expenses (including P&A). Its calculation is described in Chapter III section 1.

(g)          BR: 50% of the LLP’s share of GDI under the schedule 7 provisions: see Chapter II section 3.

(h)          BDR: a percentage of BR see Chapter II section 3.

(i)            Ultimate: an estimate of the income from a film which will accrue to the holder of a right in it over the lifetime of the film. (Mr Sills regarded it as relating to the period of 10-15 years after release).

(j)            2010 Ultimates: Ultimate calculations prepared by Ingenious for HMRC in 2010 in relation to many of the LLPs’ films.

(k)          “Sideways loss relief”: the ability of an individual to set trading losses arising in a fiscal year against other taxable income of the year.

(l)            The“Ingenious basis” is the basis on which the LLP’s computed their profits and losses. It assumed that the LLP (i) would incur the full budgeted cost of the film (100 rather than 30), and (ii) would earn income, which included amounts which were retained by the CD in reduction of  the indebtedness of the CM, and was no more than 54.45% of GDI (rather than 30% of GDI).

9. The Structure of the Remainder of the Decision

CHAPTER II. THE CONTRACTUAL RIGHTS AND OBLIGATIONS

1.  The Relevance of the Contractual Rights and Obligations to the Five Issues

(a)           whether the LLPs were trading. Here questions arise as to whether the LLPs owned an asset, the film, which they sold, or whether they laid out monies in return for an income stream; and whether in some way they provided a service or merely invested;

(b)          whether the LLPs’ activities were undertaken with a view of profit. The LLPs computed their profits on a basis which assumed that they had incurred 100% of the cost of the film, and were entitled to the portion of the distributable income described in the schedule 7 waterfall (without reference to other documents). We call that the “Ingenious basis”. Questions arise as to (a) whether on that basis a profit could realistically be expected or hoped for, and (b) whether in fact the LLPs’ profit or loss should be computed by reference to expenditure of 30 (35)% of the budgeted cost and a different income entitlement, and, if that was the case, whether that affected whether the LLPs had a view of profit;

(c)           whether the LLPs incurred 100% of the cost of the films or a lesser amount;

(d)          the legal matrix to which GAAP should be applied to compute the profits or losses of the LLPs; and

(e)           finally, whether the nature of the arrangement between the CD and the LLP was a partnership.

2.The Approach to be Taken to Determining the Rights and Obligations and Their Nature

Ensign Tankers (leasing) Ltd v Stokes [1989] STC 705, [1991] STC 136, [1992] STC 226.

“The parties agree that the 17 documents dated 14 July 1980 were interdependent, and constituted one single composite agreement or transaction, which was a tax avoidance scheme and must be read as a whole.

“If the documents constituting the scheme are read as a whole, the rights of Victory Partnership under the scheme are the rights which were and remain vested in Victory Partnership after all documents had been signed. Similarly the obligations of Victory Partnership under the scheme are the obligations which were and remain enforceable against Victory Partnership after all documents had been signed. 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 final financial consequences.

“When all the documents had been entered into, Victory Partnership was subject to an obligation to pay [25% of the budget] to [Lorimar] and subject to an obligation whereby any money paid by Lorimar into the scheme current account was immediately transferred back to [Lorimar]…When all the documents had been entered into, Victory Partnership had a right to 25% of the net receipts from the exploitation of the film.”

3. The Agreements and the Rights and Obligations Arising

(a) The Agreements in More Detail

(a)           A licence of the screenplay by the CD to the LLP.

(b)          The CDA. This recited that the CD had commissioned the LLP to make the film or game. It included provisions relating to the specification of the film and its delivery to the CD. It dealt with the relationship between the CD and the LLP in relation to decisions about the film or game. In schedule 7 (the waterfall) the gross receipts from the film were divided up. After the payment of certain expenses and distribution fees the balance, termed (in the IFP2 agreements) the Gross Distributable Income (“GDI”), was divided between the LLP and the CD in proportions which varied with the level of GDI.

(c)           The PSA. By this agreement the LLP delegated to the PSC as principal the making of the film in accordance with the specification (mirroring the provisions in the CDA). Payment was to be made to a Production Account in the PSC’s name in accordance with an Agreed Budget and an Approved Cash Flow (which phased the receipts of money over the period of the making of the film). The agreement dealt with the delivery of the film and with rights in the film. It included provisions relating to creative control.

(d)          A Loan Agreement between the CD and the CM. Under this agreement the CD agreed to make a facility available to the CM “to enable it to make [a] capital contribution to the LLP”. By clause 4.1 the loan was to be drawn down in accordance with the Approved Cash Flow, which phased the CD’s contributions over several months (11 in the case of Hot Fuzz), and was directed to be paid directly to the Production Account (or otherwise as the PSC required).

The amount of the facility was 70% (65%) of the Budget for the film. The loan bore no interest.

In the case of ITP the loan was repayable only from Borrower’s Receipts (“BR”) which were defined as 50% of the amount which was stated to accrue to the LLP under schedule 7 of the CDA.

In the case of IFP2 the loan was repayable only from “Borrower’s Distributable Receipts” (“BDR”). This was defined as a percentage of Borrower’s Receipts. That percentage varied, in tandem with the variation of the one of the elements of the CD’s share of GDI (the Studio Participation) under schedule 7 of the CDA.

Clause 5.4 provided that the CM could prepay the loan.

(e)           A Guarantee Agreement (not present in the case of IG). For a fee a Completion Guarantor (in the case of Studio films a member of the Studio group) agreed to complete the film if it ran over budget (or to abandon it and return monies to the parties).

(f)           A Deed of Acknowledgement, which incorporated a Notice of Assignment and Irrevocable Payment Instruction (the “Deed of Acknowledgment etc.”). Each of the Operator, the guarantor, the PSC, the CD and the LLP were parties to the Deed and the CM was the maker of the assignment and payment instruction. Under this combined document monies equal to BDR (BR) which were allocated to the LLP under schedule 7 of the CDA were agreed to be directed to be retained by the CD. It also gave details of the Production Account to which the CD should make payment under the Loan Agreement.

(g)          A Pledgeholder agreement in which the film laboratory which held the master negative of the film undertook to hold it for the CD and the guarantor.

(h)          Security Agreements under which rights in the film were assigned by way of security.

(a)           Under the CDA the LLP was obliged to fund the production of the film, and under the PSA the LLP had to “advance or cause to be advanced" 100 to the Production Account of the PSC;

(b)          The CD was obliged to lend money (70) to the CM;

(c)           The CM was obliged to make a capital contribution of 70 to the LLP;

(d)          The payment of 70 by the Lender to the Production Account satisfied the Lender’s obligation to lend, the CM’s obligation to contribute capital of 70, and part of the LLP’s obligation to pay 100;

(e)           The LLP, having 30 cash from the contributions of ordinary members was obliged to satisfy the remainder of its obligation by paying that cash to the Production Account;

(f)           When the CD began to receive monies from the exploitation of the film, the LLP had the right to receive the amounts set out in schedule 7 of the CDA;

(g)          When that right arose the CM had a related right to drawings; and

(h)          The Lender had a right against the CM for part of those drawings, namely BDR or BR to be retained by it, and the LLP consented to that retention.

(a)            for the Lender, its payment of 70 to the Production Account satisfies its obligation to advance funds under the loan agreement and that as a result the Lender becomes entitled to retain Borrower’s Distributable Receipts (BR);

(b) Capital Contributions and Membership Rights under the LLP Members’ Agreement

(i) The ITP Members’ Agreement

“that the [CM] has entered into contractually binding commitments such that the [CM] will finance its agreed Contribution in respect of that film” in accordance with the agreed cash flow and budget.

(ii) The IFP2 and IG Members’ Agreements

(a)           The CM is entitled to make Capital Contributions at its discretion, but they may not exceed the aggregate of the Ordinary Members’ capital contributions (Cl 8.3).

(a)           in the Loan Agreement (between the Lender and the CM) the recitals contain a statement that the loan is made to enable the CM to make a capital contribution to the LLP (and clause 4.1 provides that “The [CM] hereby irrevocably directs the Lender that all sums drawn down by the Borrower shall be paid to the Production Account for the film)”, and

(b)          recital (B) to the CDA (between the LLP and the CD) is a statement that the CD has agreed to make the loan to enable the CM capital contribution.

(iii) ITP: Rights Arising as a Result of Making a Capital Contribution

(iv) IFP2 and IG: Rights Arising as a Result of Making a Capital Contribution

“Capital Contributions shall be treated as made only when the amount of such Capital Contribution is actually received in freely transferable funds by the [LLP].”

It is clear to us that the LLPs never received any monies in from the CM “in freely transferable funds”. Thus the monies paid by the CD to the PSC did not give rise to a Capital Contribution for the purposes of clause 22. 

 “capital contribution…equal to any difference between the aggregate Capital Contributions made by the [CM] (including for the avoidance of doubt any payment made under this clause 8.4) and the aggregate Capital Contributions made and committed by the [individual] members”. 

(c) Obligation of the LLP to Pay the PSC

(a)           clause 3.1 provides that, subject to:

(a)          other provisions of the agreement,

(b)          the receipt by the CM of funding under the Loan Agreement, and

(c)          the opening of the Production Account,

“The Facility shall be drawn down in accordance with the Approved Cash Flow upon satisfaction of the conditions precedent.”

“The [CM]… directs the Lender that all sums drawn down …shall be paid to the Production Account.”

“ (d) evidence that the [Lender] has advanced a sum equal to seventy per cent (70%) of the Production Funds into the Production Account”,

but under the Loan Agreement the Lender is required to make payments only as required by the Approved Cash Flow. That phases payment over many months. If the loan was drawn down in this manner it would not be until the film had incurred at least 70% of its costs that the LLP would be obliged by clause 3.5 to make the Initial Funding payment of 30.

(d) Rights in Relation to Receipts from the Films or Games

“Until repayment in full of the [CM loan] from the sums directed to the Studio by the CM pursuant to the payment instruction agreed between the [CM, the LLP and the CD], the [CD] shall pay…100% of the remaining Gross Receipts to or at the direction of [the LLP].”

(a)           acknowledges the notice of assignment and undertakes to comply with it,

(b)          consents to the assignment of the right to receive BDR (BR in the case of ITP) to the Lender and agrees that the Lender is “now entitled to receive” BDR “in place of the corporate member”,

(c)           “irrevocably” instructs the CD to make all distribution payments under clause 11 of the CDA in accordance with the payment instructions,

(d)          makes provision for the repayment of the Initial Funding if the Guarantor abandons the film.

The Deed includes the agreement of the Lender and PSC to this arrangement.

(a)           For reasons we discuss below it was not clear that the CM has a pre-existing right to drawings to assign in whole or part, or that if it had a right to drawings that right would be to an amount which equals or exceeds  BDR (BR). The purported assignment was, to that extent at least, not an assignment of a right of the CD by way of security or at all, and can only have been an assent by the LLP to the method of computation of its right to receipt from the CD;

(b)          The assent and agreement of all the other parties to the Deed indicate that they are agreeing to an alteration in what would otherwise be the rights to the receipt or retention of monies had schedule 7 not been part of the composite agreement, and, if the CM does not have any right to drawings which it can assign, that agreement of itself gives effect to the alteration, not the purported assignment;

(c)           The Loan Agreement provides that the CM has to repay “to the extent it becomes entitled to BDR”, and that the CM’s entitlement be “assigned by way of security…to be applied in repayment of the loan”. The application in repayment of the loan is not ‘security’ for payment, it is payment. Even taking the assignment to be a security to pay the very amounts which arise under it, when a calculation is done and an amount notionally due to the LLP is arrived at, unless the security has been terminated, the amount thereof representing BDR belongs (or continues to belong) thenceforth to the CD/Lender.

(d)          Even if the CM did have a right to an identifiable portion of the LLP’s income from a film as drawings, and even if that portion would always be more than BDR (BR), there is simply no way in which the right of the CD/Lender to retain an amount equal to BDR (BR) can be unwound at the election of the CM. The notice of assignment provides that the instructions cannot be revoked without the consent of the CD. In the Deed the LLP undertakes to the CD/Lender, the guarantor and the PSC to comply with the “irrevocable” instruction and gives its “irrevocable” authority for payment to be made according to Appendix 1. It provides that the CD/Lender “is now entitled to receive” BDR. Appendix 1 says in paragraph 1 that BDR is to be paid at the direction of the CM but in paragraph 3 says that such amounts “shall be retained” by the CD.  The Deed of Acknowledgement etc. affects, not just the position of the CM, but the rights and obligations of the LLP and the CD.

(e)           In Ensign the loan from Lorimar was expressed to be repayable from 75% of the proceeds of distribution of the film. Victory directed the distributor to pay that 75% directly to Lorimar and required the distributor to grant security over the rights granted to Victory under the distribution agreement. Lord Templeman described Victory as being entitled to 25% of the distribution proceeds. 

“[15] Borrowed money belongs to the borrower not lender, and this is so whether the borrower incurs a personal liability to make repayment or not. Depreciation allowances depend upon the taxpayer having incurred the cost of acquiring an asset, not his liability to repay the lender. It does not matter how he came by the money to acquire the asset ...”

“[44] The leverage obtained by the use of a non-recourse loan meant that the investors did not sustain an economic loss after the tax deduction is taken into account [this was a potentially objectionable feature of the scheme] ... the fact that the investment was funded by a non-recourse loan did not alter the fact that the investors had suffered the economic burden of paying the full amount of $x+y. It was not and could not be suggested that either loan was on terms which meant that it was unlikely ever to be repaid. The investors have repaid one of the loans in whole or in part, albeit out of the film receipts ...

[45] The circular movement of money sometimes conceals the fact that there is no underlying activity at all. But each of the payments in the circle must be examined in turn to see whether it discharged a genuine liability of the party making the payment. It does not matter whether external funds were introduced into the circle or whether cheques were handed over and duly honoured. If the money movements did not discharge a genuine liability the introduction of external funds will not save it; if they did, their absence will not affect it. ... subsequent payments in a circle in which the investors were unaware and which they could not control did not alter the fact that they had borrowed y dollars and used it towards the discharge of their liability to the production company, thereby suffering the loss or incurring the relevant expenditure.”

(e) Rights in Relation to a Film

(a)           Clause 2.1 provides that from the Delivery Date (when the film is finished) the LLP assigns to the CD all its rights in the film. It says that, subject to the licence in clause 2.7, nothing in clause 2 shall vest rights in the film in the CD before the Delivery Date.

(b)          By clause 2.4 an undated executed assignment is to be delivered by the LLP to the CD to have the delivery date inserted by the CD to give effect to 2.1.

(c)           Clause 2.5 provides for a back up option for the CD to acquire the rights in the film if a court declares the assignment ineffective, (and the LLP acknowledges that specific performance would be an appropriate remedy if the option is not complied with).

(d)          Clause 2.6 makes Clause 2 subject to the Reserved Copyright under the PSA and provides that the rights to that copyright transfer to the CD only when they move to the LLP from the PSC. (The Reserved Copyright is 5% of the copyright in the film, which under the PSA is reserved by the PSC from the assignment of all present and future copyright in the film to the LLP until the completion of the film when it is “assigned to [the LLP] simultaneously with and included within [the LLP’s] assignment of the copyright to the [CD]”).

(e)           By clause 2.7 the LLP grants to the CD an exclusive and irrevocable licence of the rights in the film in perpetuity or until the date of the assignment (subject to the LLP’s right to produce, complete and deliver the film under the agreement). The carve out of the right to produce and deliver the film indicated that the licence was intended to exclude the LLP from using the film rights as well as prohibiting its granting such rights to others.

(f)           Clause 6.3 gives the CD exclusive control over the distribution and marketing of the film; and clause 6.4 gives it the exclusive right to gross receipts, although it has to pay the LLP under the waterfall.

(g)          In the warranties in clause 7 the LLP warrants that it will not authorise anyone else to exploit the film, create encumbrances over, or otherwise deal with rights to the film, and in clause 9.20 it agrees not to release the film to any third party.

(a)           that the obligation to assign is in the future. It seems to us that Mountney v Treharne shows that this does not prevent a constructive trust arising;

(b)          that because clause 2.1 of the CDA requires the assignments to take place without further formality on that date there is little scope for a constructive trusteeship. We were not persuaded by this argument: the object of equity is to create an immediate interest in the property;

(c)           that the LLP’s obligation was to make a film and then transfer it. It was not an existing asset. We were not convinced by this. The rights in the film accrue as to 95 % to the LLP as they arise. As they arise they may be subject to the constructive trust;

(d)          that in certain circumstances the agreements provide that the rights will be transferred to the Completion Guarantor: they say that makes HMRC’s analysis impossible: the CD cannot be beneficial owner when its entitlement depends upon the contingency, namely the completion of the film as opposed to its abandonment by, and transfer to, the Completion Guarantor.

(f) The CM’s Entitlement to Drawings or to an Amount Equal to BDR/BR

(i) ITP

(a)           “as soon as practicable after the end of each accounting year … an amount equal to the aggregate Receipts received in that year as shown on the Individual Film Accounts for each film shall be allocated for distribution, net of any deductions to be made in accordance with this agreement, by way of drawings between the [individual ] members and the [CM] in the Drawings Proportion for that film”.

(a)           The advance allocation of drawings permitted to be made by clause 9.5 is not an entitlement to such drawings (as is shown by the recovery provisions of clause 9.6(b)). And yet it appears to be an entitlement that the CM purports to assign because what is being assigned is not any right to end of year drawings but to receipts as they accrue;

(b)          “Receipts” are defined as any income of the film “indefeasibly received” by the LLP. By virtue of the Deed of Acknowledgement etc., BR is not indefeasibly received (or receivable) by the LLP because the LLP has irrevocably agreed that its entitlement will be reduced by that amount. Thus under the Members’ Agreement there would be a lesser pot of income to allocate for distribution. If the Operator set a 50:50 Drawings Proportion then the CM would receive half the net income as well as receiving the benefit of any indebtedness it might have to the CD being reduced by BR.

(c)           In the Deed of Acknowledgement etc. the CM purports to assign its right to BR, and yet, absent any determination by the Operator, it appears to have no such entitlement.

 (i) implicitly agreed that it would fix a 50:50 Drawings Proportion for the relevant film until the CM loan indebtedness was discharged, or

(ii) agreed, in the context of the LLP having agreed that an additional amount equal to BR would be retained by the Lender, that what would otherwise have been set as the Drawings Proportion of the CM would be reduced accordingly.

(ii) IFP2 and IG

“10.1 The Ordinary Members (taken as a whole) and the corporate member shall each be entitled to draw 50% respectively of all Partnership Income (defined as the income received by the LLP less operating expenses) … Such drawings shall be paid … from time to time during the course of each accounting period at the direction of the Operator.

10.2 When the Operator has elected to allocate 100% of the profit [to the Ordinary Members] pursuant to clause 9.8, the drawings entitlement set out in clause 10.1 shall be altered such that the Ordinary Members shall be entitled to draw 100% of such Partnership Income …”.

(a)          The right to drawings is to 50% of income received after deducting operating expenses. There is no such deduction in relation to payments of BDR;

(b)          The drawings provision makes the time of payment of such drawings a matter for the Operator. The right to payment therefore may arise after the time of receipt by the LLP, but the right to BDR arises at the same time as the LLP would have acquired, were it not for the Deed, the right to payment;

(c)          The LLP Members’ Agreement envisages that the CM’s right to drawings is defeasible at the election of the Operator, whereas the retentions by the CD are fixed;

(d)         Further, the effect of the agreements is to deprive the LLP of any entitlement to the payments of BDR. Thus the amount of BDR cannot form part of the income of the LLP and cannot be part of the drawings.

(g) The Loan Agreement

(h) Summary: The Rights and Obligations Arising Under the Relevant Agreements

(a)           The Members Agreements did not in the circumstances confer an obligation on the CM to make any capital contribution. Further:

(a)          the provisions of the LLP Members’ Agreements were such that whether or not the CM made, or was obliged to make, a capital contribution to the LLP, the CM’s rights to profits and drawings and on a winding up were unaffected; and

(b)          we doubt whether the payment by the Lender of 70 to the PSC’s Production Account constituted the making of a capital contribution to the LLP by the CM in accordance with the Members’ Agreement;

(b)          No obligation was conferred by the agreements on the LLP to pay or cause to be paid any more than 30 to the Production Account (and as we later conclude, no cost was incurred by the LLP by reason of the CD’s payment of 70). Further, in any event that liability to pay 30 arose only once the whole of the 70 was paid, but the payment of the 70 was required to be made in accordance with the Approved Cash Flow and not all at once. Thus the liability to pay arose only at the end of production of the film;

(c)           The agreements conferred on the LLP a right to receive from the CD only the schedule 7 amounts as reduced by BDR (or BR). In the next Chapter we show that the amount of this entitlement was 30% (35%) of GDI;

 (d) The rights the agreements conferred on the LLP in relation to a film between signing and completion of the film were, or were in their incidents, those, or equivalent to those, of a mere trustee for the CD, and those (negligible) rights were the only rights transferred to the CD by the LLP on completion of the film; and

(e) Whilst the agreements confer on the CD the right to retain BDR (BR) in computing the amount payable to the LLP, it is not completely clear that the CM had a right to payments of that (or any) amount by way of drawings, but any such right was relinquished to the extent of BDR (BR).

(i) The LLP was obliged to pay 30, suffered no other cost, and became entitled to 30% of GDI;

(ii) The CD was obliged to pay 70 and became entitled to retain 70% of GDI;

(iii) The PSC was obliged to make the film; once made its ownership transferred to the CD; while it was being made the CD had (apart for 5% held by the PSC) rights in the film equivalent to those of a beneficial owner;

(iv) In ITP the CM had no right to drawings in relation to the film unless the Operator decreed; in IFP2 it had a right, defeasible at the election of the Operator, to drawings equal to half the net receipts from the film less BDR.

“[367] Therefore whilst the cash flows … can be said to be fundamental to Eclipse 35’s participation in the arrangements entered into … it does not follow that the arrangements do not have the commercial purpose of effect which on their face they purport to have.”

4. Control Over Making the Film

CHAPTER III. THE FINANCIAL EFFECTS OF THE AGREEMENTS, THE IFP2 “TAP” AND ELEMENTS OF THE APPROVED BUDGET

1. Cash Movements

(a)           in the ITP structure, the CM, a non-UK-resident orphan company which was not part of the Ingenious group, received almost none of the cash which flowed to the LLP. It benefited only to the extent of the repayment of the CM loan (to the extent that may be called a benefit);

(b)          in the IFP2 structure, where the CM was a UK-resident member of the Ingenious group, the CM received from the cash which flowed to the LLP sufficient to enable it to retain, after the payment of corporation tax, at least 5% of GDI whatever the level of GDI, and also benefitted from  repayments of the CM loan;

(c)           in the IFP2 structure, the cash received by the LLP was 30% of GDI and the cash retained by the CD was 70%  of GDI, whatever the level of GDI. In the ITP structure the CD retained 65% until loan repayment and thereafter kept 79% (being a commission of 30% plus 70% of the balance).

(a)           In the IFP2 structure the CD’s concern was to ensure that it was entitled to retain 70% of GDI, and it was not concerned with the description attached to the retention: it was equally happy to be entitled to the cash as a part repayment of the CM loan as it was to be entitled to it as a “participation” or a commission.

(b)          The 70:30 (65:35) ratio of cash retained by the CD to that received by the LLP reflected their respective cash contributions to the making of the film when there was no shortfall financing.

As we explain elsewhere, where there was shortfall financing under which the CD (or Shortfall Financier) provided additional finance over and above the 70% (65%) which flowed through the CM loan, the ratio of cash receipts by the LLP to receipts by the CD was the ratio of cash investment by the CD (and if different the Shortfall Financier) to the cash investment deriving from the LLP’s ordinary members; and thus would be less than 30:70 (35:65).

Thus the sharing of GDI represented the CD’s proportionate investment in the film.

(c)           Because the IFP2 CM was not obliged by the agreements to make any repayments (other than by the ‘assignment’ of BDR) of the CM loan, it would retain for its sole benefit any drawings paid or payable directly to it by the LLP. Thus, in the case of IFP2 the 5% (or more) of GDI retained after tax by the CM was in the nature of a real economic profit obtained by it.

(d)          The additional complexity of the steps in the IFP2 waterfalls existed solely for the purpose of providing this after-tax economic benefit for a member of the Ingenious group.

(e)           One of the objects of IFP2 in entering into this format for the agreements for films was therefore to secure a benefit for the CM.

(a) ITP

(a)           A Distribution Fee of 20% (kept by the CD)

(b)           Distribution Costs (P&A and video/DVD costs etc.)

(c)           Contingent participations of third parties such as actors, and

(d)          The amounts payable to the Completion Guarantor to reimburse it for payments it made if the film went over budget.

(a)           The CD would retain a Distribution Commission of 30%,

(b)          Then the CD “shall pay” ITP 100% of the balance until the CM Loan was repaid,

(c)           After that the remaining amount if any was to be divided 70% to the CD and 30% to the LLP “which [the CD] shall pay to [the LLP]”.

(There are other provisions in the waterfall which relate, for example, to unused contingency in the Budget, which are irrelevant for present purposes.)

(b) IFP2

(a)           a Distribution Fee of 15% of gross receipts to be kept by the CD,  

(b)          then, until Distribution Costs had been recouped, 16.67% of gross receipts to be applied as GDI (the “gross corridor”),

(c)            then, Distribution Costs (P&A and video/DVD costs and contingent participations of third parties such as actors),

(d)          and then, the amounts payable to the Completion Guarantor to reimburse it for payments it made if the film went over budget (in some agreements this was limited to the amount of the Sale and Leaseback Proceeds where a sale and leaseback of the film had also been arranged).

(a)           The CD would retain a Distribution Commission of 30%,

(b)          The CD would also retain a “Studio Participation” of

 “(i) 15.45% of GDI until GDI exceeds 165% of approved production budget,

(ii) 34.71% of GDI until GDI exceeds 204% of approved production budget, then

(iii) 27.14% of GDI thereafter”

(words taken from the Hot Fuzz/Universal agreements).

(c)           Then until GDI was equal to the budget, the CD “shall pay” 100% of the balance to or at the direction of the LLP;

(d)          After that the Completion Guarantor would recoup any unrecovered completion costs;

(e)           Then the CD “shall pay” to or at the direction of the LLP 100% of the balance until the CM Loan shall have been repaid “from the sums directed to the Studio by the [CM] pursuant to the payment instructions agreed between the [LLP, CD and CM]”;

(f)           After that, the remaining amount, if any, was to be divided 70% to the CD and 30% to the LLP “which [the CD] shall pay to [the LLP]”.

“(i) 90% … until GDI ... totals in aggregate 165% of the Approved Production Budget ...

(ii) 30% … until GDI totals in aggregate 204% of the Approved Production Budget, thereafter

(iii) 60% ...” until the loan is repaid [ex Hot Fuzz/Universal documents].

In other words, as shown in the table below, 45%, 15% and 30% of GDI remaining after the Distributor Commission and Studio Participation.

** The calculation of these figures is explained in Appendix 4, which also contains references to Mr Bower’s evidence on the subject.

*** Comparison prior to loan repayment

2. The Importance of GDI

(a)            Mr Olsberg indicated that for Independent films distribution fees would be in the order of 15-25 %.

(b)          We were told that Ingenious had managed to negotiate lower fees for the IFP2 deals, normally at 15%, than for the ITP deals – normally 20%.

(c)           Mr Clayton, when speaking of negotiation with Fox over the waterfall about the level of the distribution fee said that at that time “the market rate was more like 15%”.

(d)          Mr Reid said a 15% distribution fee was about a right arms-length fee and that the CD’s distribution fee was “for the job of distributing” (although there was some profit in that).

(e)           Mr McKenna described the Studios as having profit centres to each of which was ascribed part of the monies retained by the CD. A distribution fee of 15-20 was a reasonable fee for the distribution activity (or profit centre).

3. Items in the Budget

(a) The Studio Overhead

(b) The Completion Bond Fee

(c) The Contingency

(d) The Executive Producer Fee

“services of a nature generally and usually rendered by Executive Producers as shall be mutually agreed and shall be rendered (to the extent mutually agreed) in the manner customary in the production of feature films including ... cooperating with and advising the [PSC] with respect to the finalisation of the production budget and the financing arrangements for the film (the  “Services”)”;

a somewhat vague description of the services to be rendered, and encompassing activities – the financing of the film – which had already taken place.

CHAPTER IV. THE LLPS’ FILMS – the Films, the Move to Studio Films, Shortfall Financing, Co-production and The Avatar Hedge

1. The Films and the Move to Studio Films

2. Shortfall Financing

4. The Avatar Hedge

(a)           for new budgets for Life of Pi and Die Hard 4;

(b)          for IFP2 to pay the (27.37% x £92.59m =) £25.32m to the Production Accounts of the three films;

(c)           for Fox to allocate the whole of the additional expenditure to Avatar and to direct that the 27.37% x £92.59m = £25.32m be paid to the Avatar Production account;

(d)          but for the purpose of the determination of rights to Receipts from the three films the additional monies should be treated as if they had been applied:

(a)          54.58% for Avatar,

(b)          4.07% for Life of Pi,

(c)          41.35% for Die Hard 4;

(so that, as we understand it, the shortfall in the funding IFP2 had thitherto provided in respect of those films would be reduced by the additional contribution,  and accordingly so that the Shortfall Percentage, by which rights to GDI was reduced, should be correspondingly smaller in respect of each of those films);

(e)           for schedule 7 of the CDA for each film (the waterfall provision) to be divided into a Budget A and a Budget B, and for the Shortfall under Budget A to be nil and to arise only under Budget B. The division of the Gross Receipts between the A Receipts waterfall and the B Receipts waterfall was specified as:

(a)          Avatar: A: 49.17%; B 50.83%,

(b)          Life of Pi: A: 84.97%; B: 15.03%,

(c)          Die Hard 4: A: 22.45%; B: 77.55%;

(f)           and for the Shortfall to be allocated only to the B Receipts calculation.

(a)           before March 2006 IFP2 had deployed £84m in Avatar (including therein the CD’s contribution via the CM), being 45.6% of the budget;

(b)          by March 2007 IFP2 had raised additional capital of which £65m (calculated to include the CD/CM element) was to be spent on film production;

(c)           IFP2 agreed to deploy all of that on Avatar;

(d)          but it was agreed that it would receive income as if it had deployed it in agreed proportions between the three films.

(a)           had IFP2 not entered into the Funding Side Letter, it would, on the basis of the figures in the Appendix 6, by 30 April  2013 have recognised £20m of additional income, and the Ingenious lifetime  projections for IFP2 (the ‘2010 Ultimates’) would have been £132m greater.

(b)          IFP2 entered into the Hedge because the green-light committee put its foot down. It was not toothless or moribund.

(c)           It was not inimical to the LLP’s business models not to provide or procure the provision of all the finance for a film:

(i) IFP2 and IFP3 were the initial co producers of Avatar. Their liabilities were stated to be joint and several but each was clearly to provide some of the finance;

(ii) Shortfall finance was an element of the November 2006 and the March 2007 Avatar agreements and of the Die Hard 4 and Life of Pi agreements. The shortfall financier obtained an income stream calculated on the same principles as the LLP’s entitlement and in proportion to the amount financed (but without the 70% loan mechanics or the Studio deductions).

(d)          By entering into the Hedge, IFP2 was in effect buying interests in the income streams from the films rather than the right or obligation to produce them.

(e)           It was not essential to IFP2’s business model that the completed films be delivered to it for onward delivery to the CD: para (c) of the Funding Side Letter provides that the delivery of the completed film by the PSC to any one of IFP, IFP3, IFP2 satisfied the PSC’s obligation to deliver to each of them.

(f)           It was acceptable for any creative influence over the production of the film residing in the LLPs to be exercised jointly with one or more other LLPs (see (a) of the Funding Side Letter).

(g)          The negotiation of these agreements would not have been a simple process. They are complex arrangements. It was not analogous to buying an investment.

(h)          The funding provided by IFP for some of the films, even after including the CM’s loan contribution, was less than 50% (see Die Hard 4).

The transaction provides an indication of the financial nature of the LLPs’ businesses. These conclusions are referred to later in particular in Chapter VII: With a View of Profit, and Chapter VI: Trading.

CHAPTER V.  INGENIOUS GAMES – Special Considerations

CHAPTER VI: TRADING

1. What Did the LLPs Do?

(a)           By entering into the Hedge, IFP2 was in effect buying interests in the income streams from the films rather than the right or obligation to produce them.

(b)          It was acceptable for any creative influence over the production of the film residing in the LLPs to be exercised jointly with one or more other LLPs.

(c)           The negotiation of these agreements would not have been a simple process. They were complex arrangements. It was not analogous to buying an investment.

(a)           Considering for green-lighting films proposed by Ingenious entities. In that context we note here that we do not regard the LLPs as having gone out to search for new films save perhaps in the discussions Mr Clayton had with Fox close to 5 April when new films were sought to mop up subscribed capacity, or a “valve” operated to cope with situations in which subscriptions were insufficient;

(b)          Complex, serious and detailed negotiation of the commercial terms of agreements for the making of films;

(c)           Entering into contracts for the making of films and in relation to their exploitation under which substantial sums were put at risk;

(d)          Keeping an eye on what was going on in the making of the films and in particular paying some attention to the costs of production but without any significant involvement in the creation of the films.

(e)           Receiving revenue and reviewing revenue statements from films;

(f)           Accounting and administration.

 2. Legal Principles

(a)           he said that whatever the financial substance, the legal structure was that the Victory Partnership acquired a 100% interest in the film, not a 25% one, and paid 100% of the cost, not 25%, although it did so with the assistance of the non-recourse loan (759G);

(b)          “The production of a film, or the completion of an uncompleted film (or, I might add the purchase of a completed film), in each case with a view to its distribution and exploitation for profit, are all typical (though highly speculative) commercial transactions in the nature of trade”;

(c)           at (762D), he set out nine propositions of which the following is a summary:

(i) in order to be trading a transaction “must possess not only the outward badges of trade, but also a genuine commercial purpose”;

(ii) the presence of a collateral fiscal purpose does not denature a commercial transaction;

(iii) but if the sole purpose of the transaction (not the taxpayer’s motive) is fiscal it cannot have a commercial purpose (by definition);

(iv) the purpose of the transaction is to be objectively determined considering it as a whole in the light of all the circumstances;

(v) a transaction whose purpose is to make a profit does not cease to be commercial because those who provide the finance may have a fiscal purpose;

(vi) in some cases the shape and character of the transaction is so affected by fiscal considerations that it ceases to be a commercial transaction;.

(d)          he said that the Special Commissioners:

(a)          were wrong in treating the distinguishing criterion as being whether there was a “paramount” rather than a sole fiscal objective (764E);

(b)          based their decision on features which threw no light on the question namely:

(aa) the motive of Ensign rather than that of the partnership, and

(bb) the lack of evidence of activity after the agreement was signed, the lack of interest in controlling expenditure and odd provisions in   the agreements. These were merely “footling” considerations;

(e)           he said that in his judgement the only possible conclusion was that Victory Partnership was trading. If Lorimar had, as must have been the case (767F) a commercial hope of profit, so would Victory Partnership. (Effectively as to 25% of the total.) The only conclusion could be that the transaction entered into by Victory Partnership was a commercial transaction;

(f)           at 768C, he said that the facts that a person obtained financing from investors who were motivated by fiscal considerations and that the transaction was structured to achieve a fiscal advantage “without ceasing to be commercial or jeopardising the prospects of profit” did not prevent a commercial transaction entered into with a view of profit from being a trading transaction;

(g)          the transaction had all the characteristics of a typical though speculative trading transaction and none of those of investment – he mentioned the purchase of an uncompleted film, the arrangement for its completion with a view to exploitation, and the uncertain profit and negligible residual value (768J).

“The Crown on the other hand argues that a tax avoidance scheme is ineffective and taints the transaction involved in the scheme. In the present case Victory Partnership entered into a scheme with the object of avoiding tax and not with the object of trading. In the course of the scheme Victory Partnership contributed [25%] to the cost of the film and became entitled to 25% of the net receipts; that transaction in isolation would admittedly constitute trading in the making and exploiting of films. But the transaction was only part of a tax avoidance scheme. It follows that the conditions of section 41 of the 1971 Act are not fulfilled. ... Victory Partnership did not carry on trade and did not incur capital expenditure for the purposes of trade ...

“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 Crown on the other hand appears to look upon tax avoidance as a corporate cancer which infects and destroys any fiscal effects advantageous to the taxpayer.”

 “My Lords I do not consider that the commissioners or the courts are competent or obliged to decide whether there was a sole object or paramount intention nor to weigh fiscal intentions against non fiscal elements. The task of the commissioners is to find the facts and to apply the law, ... the facts are undisputed and the law is clear. Victory Partnership expended capital of [25%] for the purposes of producing and exploiting a commercial film. The production and exploitation of the film is a trading activity. By section 41 of the 1971 Act capital expenditure for a trading purpose generates a first-year allowance. The section is not concerned with the purpose of the transaction but the purpose of the expenditure. It is true that Victory Partnership only engaged in the film for the fiscal purpose of obtaining a first-year allowance but that does not alter the purpose of the expenditure. The principles of Ramsay and subsequent authorities do not apply to the expenditure of 25% because that was real and not magical expenditure by Victory Partnership.

3. Comparison with Eclipse 35, Samarkand and Degorce

5. The Relevant Factors

(1) A Customer

(2) Organisation

(3) Repetition

(4) Is the transaction related to an existing trade?

(5) The nature of the subject matter: was the subject matter the kind of thing which is normally the subject matter of trade or can only be turned to advantage by realisation?

(6) The way in which the transactions were carried through: was it done in a way typical of a trading in that subject matter?

(7) The source of finance. Borrowing to buy may point to resale in the short term.

(8) Was work done on the object? Work done may point to a trade.

(9) Breaking down into lots may suggest trade.

(10) Whether the purchaser intended to sell at the time of purchase “if before the contract of purchase is in place a contract for sale is already in place that is a very strong indicator of a trading deal rather than an investment.”(per Browne-Wilkinson V-C at 471 in Ensign).

(11) Did the asset provide enjoyment or an income pending resale? If so it would be more likely to be an investment.

(12) Speculation: the possibility of profit; the undertaking of risk.

Overall

Taking all this together we conclude, on balance, that the LLPs were trading: the Operator did more than act as an investment manager of a portfolio of investments: through its actions and those of its agents the LLPs engaged in speculative, organised, repeated transactions in a way which involved work beyond that which would have been involved in the mere making of an investment.

6. Fiscal Motive

(a)           the model is shown in two facets of its actual use not to require the LLP to be responsible for 100% of the cost. Those facets are: (i) the shortfall financing when, because the LLP could not raise the full 30%, additional finance was provided by a Shortfall Financier who took a proportionate share of GDI as a result (see Chapter IV section 2); and (ii) the occasion, such as happened in the case of Avatar where another Ingenious LLP “co-produced” the film, each provided part of the funds;

(b)          the desire to be at the heart of production could have been achieved by having the same rights and obligations in relation to production but having the CD and the LLP being obliged to fund the PSC separately and directly without the arrangement for the CM loan. There was nothing in the evidence which indicated that those rights and obligations could not have been the same in the relevant agreements if the funding obligation had been changed.

(c)           the aspects of the model which limited development risk, financing risk, and distribution risk would have been unaffected by a change in the expressed funding obligation; and

(d)          in fact a proper construction of the rights and obligations imposed by the contractual structure reveals that in law and in practice the LLP was only obliged to fund 30% (35%).

.

CHAPTER VII. WITH A VIEW TO PROFIT – Part 1: The Law and the Arguments

1. The Legal Principles

“carries on a trade, profession or business with a view to profit”.

We call this the “with-a-view-to-profit condition”. As we have noted HMRC say that it was not satisfied.

Issues of Construction

“those [purposes] are not limited to the conscious motives which were in mind at the time. Some consequences are so inevitable that they must be taken to be the purpose for which the payment was made.”

(a)            It does not mean whatever the taxpayer thinks it means but has an independent meaning. Thus, for example, a taxpayer who considers herself to make a profit equal to the proceeds of sale of goods, would not, by intending to sell, necessarily have a view of profit. As Lord Templeman said in Street v Mountford,  

“The manufacture of a five pronged implement for manual digging results in a fork even if the manufacturer, unfamiliar with the English language, insists that he intended to make and has made a spade.”

(b)          It means the excess of the business’s income over its expenditure:  Partnership, Lindley & Banks 19 Ed 2 - 07 states that by profit is meant the net amount remaining after paying out of the receipts of the business all the expenses incurred in obtaining those receipts; and section 2(2) of the Partnership Act 1891 makes clear that gross returns are not profits by providing that the sharing of gross returns does not itself create a partnership.

“amounts ... reserved in the accounts of an employer, or held by an intermediary [who, in that case were the trustees], with a view to their becoming relevant emoluments.”

(a)           it is less specific than “for the sole purpose of” or “with the principal or dominant intention of”; and suggests a degree of flexibility of meaning and application although it plainly connoted some undefined element of purpose intention or contemplation;

This was confirmed by the fact that “with a view to” was applied by the Act to two quite different situations: to both the sums in the accounts of the employer where the only party concerned was the employer, so that any element of intention referred to the employer’s “view”; and also to the amounts held by the trustee, where the “view” could be ascertained only by the terms of the settlement;

(b)          in the context of the relevant Act, it was looking to the future: the “view” was to potential emoluments becoming relevant emoluments;

(c)            the word “potential” indicated that the event was one which had the potential to occur.

“17. The Court of Appeal therefore decided that the funds were held with a view to becoming relevant emoluments if they were held on terms which allowed a realistic possibility that they would become relevant emoluments.

18. I agree with the Court of the Appeal, largely for the reasons given by Jonathan Parker LJ. In the ordinary use of language the whole of the funds were potential emoluments. They could be used to pay emoluments. It is true that ... potential emoluments is a defined term ... [but] if the terms of the definition are ambiguous, the choice of the term to be defined may throw some light on what they mean.”

(a)           The statutory context of section 863 is different from that which was considered in Dextra. Indeed in Dextra neither Jonathan Parker LJ nor Lord Hoffmann found any help in ascertaining the meaning of the words from other statutory contexts (such as section 44 Bankruptcy Act 1914 or section 595 TA 88). On the other hand the parallel between the language of the Partnership Act 1890 and that in section 863 indicates a common understanding of the word “view”. Dextra was concerned with whether sums were “potential emoluments”, and the label “potential” threw light on what was meant (an event which could not realistically happen did not have potential). In section 863(1) this light is not present and there is no replacement for the glow it sheds;

(b)          Jonathan Parker LJ accepted that the words had a degree of flexibility and connoted some element of purpose, intention or contemplation: “[67] ... it is not possible to lay down any hard and fast rule as to how the expression ... is intended to apply to any given set of facts. Each case will turn on its own facts in this regard.”;

(c)           the clear parallel with section 1 Partnership Act 1890 indicates that the interpretation of that section is relevant and, as Mr Gammie noted, in that context intention is material. In Newstead v Frost 1981 WLR 135 the Special Commissioners accepted that there was a partnership between Mr Frost and a company. Viscount Dilhorne who gave the leading speech in the House of Lords dismissed an argument by the Revenue that the business carried on in common was simply that of avoiding tax. He said “while it is clear that the partnership was formed with [the tax avoidance object] it must have been formed with a view of profit. It was intended that profits should be made ...”, therein equating a view of profit with an intention to make profit.

“[371]. In essence the difference between the parties can be resolved only by an analysis of the evidence in order to determine whether the making of trading profits ... was a genuine, meaning real and earnestly pursued, objective, or, even though there was a hope and potential for trading profits, any profit which did result would be little or nothing more than a potential incidental benefit of an activity in reality pursued for other reasons.”

(a)           a mere hope of profit, and

(b)          a profit which is simply a potential incidental benefit,

(c)           being indifferent or ambivalent about profit,

(d)          not being interested in profit,

(e)           not being averse to profit,

(f)           carrying out an activity which is genuinely thought to be capable of profit,

(g)          even welcoming a profit or thinking there was a realistic possibility of profit.

(a)           the test requires some element of purpose, intention or contemplation. That is apparent from the word “view” and the approach to it by other courts and tribunals;

(b)          whether or not a taxpayer has a subjective intention depends on all the evidence: a mere assertion of intention may not be enough;

(c)           The test does not require an overriding objective of making profit or its pursuit to be the main or predominant purpose of the activity. As Lord Hoffmann said in Dextra, had that been intended Parliament would no doubt have used such expressions “which are by no means unfamiliar in tax legislation”.

(d)          Thus the existence of other hopes or intentions in the conduct of the business need not prevent the carrying on of the business having a view of profit.

(e)           Having an intention to make profit is not enough; the taxpayer must conduct the business with a view to profit. The nature of the conduct of the business is relevant. The test is about how the trade is carried on and how the taxpayer intends to carry it on. That focuses on the activities of the business and their possible future income, and that focus is a counterweight to a purely subjective analysis of the taxpayer’s motives or hopes.

(f)           A “view” looks to the future – to the intentions as to the conduct of the business and the results which will flow from it. The taxpayer’s intentions as to the conduct of the business are part of the subjective elements of the test. 

(g)          Dextra indicates that there may be some objective element in “with a view to” although in a different statutory context. In the present context “profit” has a meaning independent of what the taxpayer considers it to be: that indicates an objective element in the test: an assessment of whether the intended conduct of the business has a realistic possibility of delivering a profit.

In Vodafone Millett LJ said (742J) that the determination of purpose in section 74 TA 88: “… does not involve an enquiry of the taxpayer whether he consciously intended to obtain a trade or personal advantage by the payment. The primary enquiry is to ascertain what was the primary object of the taxpayer in making the payment. Once ascertained, its characterisation as a trade or private purpose is a matter for the commissioners, not the taxpayer”. The same principle applies in relation to the question of whether something is done with a view to profit. The enquiry as to the object of the activity is not into the way in which that object is described at the time or later by the taxpayer.

(h)          As a result, if the conduct or intended conduct of the business is such that there is no realistic possibility of profit, the business cannot be said to be carried on with a view to profit, no matter what the subjective intentions of the taxpayer as to profit are.

(i)            That objective test is, however, about whether the conduct is such as to give a realistic possibility of profit, not about whether it is businesslike or commercial.

(j)            If the conduct of the business is such that it is inevitable or almost certain that a profit will be made that will be the carrying on of the business with a view of profit. We accept Mr Milne’s submission that Lord Millett’s dictum that purpose is not limited to conscious purpose and that some consequences are so inevitable that they must be taken as a purpose applies here. If it is true for “purpose” it seems to us that it must also apply to “view”. If Miss Mallalieu had bought her black clothes with a view to satisfying the court dress rules, it seems inevitable that she must also have bought them with a view to decency and warmth. If a person intends to travel in an aeroplane from London to New York it is inevitable that they will travel with a “view” to crossing the Atlantic Ocean whether or not they consciously considered it when buying a ticket.

(k)          Between the two extremes, no realistic possibility of profit and almost inevitable profit, there is a hinterland in which the hopes and expectations of the taxpayer will be a significant factor and where the flexibility of the phrase “with a view to” permits the weighing of the subjective intentions of the taxpayer as to the financial results (not the “profit”) of the business and the likelihood of the intended conduct and so those results yielding a profit.

Whose View?

2. The Arguments

(a)           the CD model provided a structure which was more likely to produce profits than the traditional structure. The use of the model demonstrated the intention to make profit. The negotiation of lower distributor fees and the gross corridor showed the perseverance of that intention;

(b)          the selection and approach to films by the green-lighting committee and the criteria it applied evidenced the choice of commercially attractive films. In particular Mr Olsberg’s evidence was that it would not have been unreasonable to expect the selected films to be profitable;

(c)           the evidence of Mr Briggs and Mr Divnich, and the exercise in which Notting Hill was substituted for Wimbledon showed that the financial elements of the model were such that it was capable of delivering profitable LLPs.

(a)           the individuals’ evidence is equivocal. It must be tested against a background that what mattered to investors and to Ingenious were losses and receipts, not profits;

(b)          the only evidence that the LLPs conducted any assessment of the likelihood of profitability was in the illustrative figures shown in the IFP and IFP2 Information Memoranda. But examination of the underlying computations showed that these had been prepared on erroneous assumptions which, if corrected, delivered a loss, or required unrealistically good film performance for LLP profit. At the time IFP2 was promoted, Ingenious would have known, from its own track record with ITP, that its selection of films did not deliver such profits.

(c)           The nature of the waterfalls for which the LLPs contracted were such as meant that profit for a film or for an LLP was unrealistic.

(d)          The projection that IFP2 would be profitable depended upon an unsound projection for Avatar. If participation in the highest grossing film of all time did not make IFP2 profitable, profit cannot have been intended or realistically expected.

CHAPTER VIII WITH A VIEW TO PROFIT – Part 2: The Evidence

1. The LLPs’ Actual and Projected Film Profits and Losses

(a)           9 were forecast to be profitable,

(b)          56 were forecast to be loss-making of which:

(a)          12 were projected to recover 50 to 75% of cost,

(b)          13 were projected to recover 25 to 50% of cost,

(c)          29 were projected to recover 1 to 25% of cost, and

(d)         one did not generate income.

(a)           16 would have been forecast to be profitable;

(b)          49 would have been forecast to be loss-making with various levels of recovery.

2. Third-party Evidence of Film Profitability

(i) Independent Films

Budget Percentage Profitable

£0.5 – 2m 4.1%

£2 – 5m 4.6%

£5 –10m 12.1%

>£10m 17.4%

We saw no indication of how “profit” had been calculated but we assumed that it meant that production costs had been recouped. Most of the LLPs’ Independent films had budgets of over £5m.

Budget Percentage Films Released Achieved 2x

£2 – 5m 3.2

£5 – 10m 10%

>£10m 20%

and that only about half (44.6%) the films made were theatrically released.

We conclude that investing in an Independent film with a budget of £5m or more and which has some backing from others with commercial expertise in films may give rise to a reasonable hope that WWBO will exceed 2x budget, and, if the investor is appropriately placed in the waterfall, his chance of recouping his investment may not be fanciful.

(ii) Studio Films

3. The Commissioning Distributor Model

(a)           It was not inimical to the LLP’s business models not to provide or procure the provision of all the finance for a film:

(i) IFP2 and IFP3 were the initial co-producers of Avatar. Their liabilities were stated to be joint and several but each was clearly to provide some of the finance;

(ii) Shortfall finance was an element of the November 2006 and the March 2007 Avatar agreements and of the Die Hard 4 and Life of Pi agreements. The shortfall financier obtained an income stream calculated on the same principles as the LLP’s entitlement and in proportion to the amount financed (but without the 70% loan mechanics or the Studio deductions).

(b)          It was not essential to IFP2’s business model that the completed films be delivered to it for onward delivery to the CD: para (c) of the Funding Side Letter provided that the delivery of the completed film by the PSC to any one of IFP, IFP3, IFP2 satisfied the PSC’s obligation to deliver to each of them.

(c)           It was acceptable for any creative influence over the production of the film residing in the LLPs to be exercised jointly with one or more other LLPs.

(d)          The funding provided by IFP for some of the films, even after including the CM’s loan contribution, was less than 50% (see Die Hard 4).

The  benefits of the CD Model claimed by the Appellants:

(i) There was no requirement to invest time or money in development: the LLPs benefited from the risks already taken by others.

(ii) there was less financing risk since the LLPs committed only to projects where (at least) 70%/65% of the finance came from the CD.

(iii) The risk of the film not finding a route to market was mitigated because commitments were made only where a Studio was attached or there was a market-leading agent and key territory presales in place. The LLPs point to the fact that 98% of the Ingenious films were made and distributed in cinemas and that the BFI average was 44.6% (2003-2010).

(iv) IFP2 recouped, through the gross corridor, in an elevated position.

 (v) The LLPs shared in gross income in perpetuity, and in particular in gross video/DVD rentals rather than sharing in income on a royalty basis. Mr McKenna said that in their experience video/DVD rentals less the associated costs exceeded typical royalty income.

(vi) With sufficient capital each LLP could adopt a “slate approach” and increase their chances of a hit. The 2005/6 slate of IFP2 consisted of 22 films. In later years it added a further 5 films to its stable. Mr Milne says that if you get a hit it will make up for many losses.

 (vii) That it put the LLPs at the heart of production.

(viii) That it ensured the alignment of the interests of the CD and the LLP.

The Commissioning Distributor Model: Conclusions

4. Green-lighting

(a)           a producer and a director with a successful record;

(b)          attractive cast preferred;

(c)           for Independent films, a recognised satisfactory sales agent;

(d)          again for Independent films, one significant major territory presold.

(a)           some flexibility was given to Fox to allocate IFP2’s capital between films. This may have resulted in Fox allocating the LLP’s monies to those films they considered would be less profitable – and gave no weight to any view IFP2 might have had about potential profitability;

(b)          there was likely to have been some prioritising of the investment of members’ subscriptions before 5 April over the assessment of the likely possible profitability of the films and the LLP;

(c)           there was some leaning towards high visibility Studio films;

(d)          whereas Independent films were generally not profitable, Studio films were less risky.

(a)            the film had to satisfy a qualitative test;

(b)          there had to be available funds; and

(c)           the film had to have been evaluated by Ingenious staff and, broadly,  found to meet the criteria in the Information Memorandum.

Green-lighting: Conclusions

5. The Evidence Given by the Controlling Minds of the LLP’s

Mr McKenna

(a)           films which produced a substantial return for their backers were like hen’s teeth. British films rarely recouped their budget;

(b)          one of the objects of having a slate of films was to increase the likelihood of securing a hit, and to mitigate the effects of disasters. For an LLP to make a profit the hits had to make good all the losses;

(c)           in the case of IFP, but not ITP, the “first dollar corridor” from gross receipts increased the likelihood that a film which did not make a profit for the LLP would provide some contribution to the LLP even if its performance was dire;

(d)          the first dollar corridor and presales would mean that investors would receive some return of their investment even if a film did not make a profit for the LLP;

(e)           the Ingenious film personnel knew that unless an LLP was managed with a view to profit it would not deliver to the investors the tax benefits advertised in the Information Memoranda. As a result the LLPs were managed with a view to profit;

(f)           Ingenious’ rule of thumb was that a film was likely to be profitable for an LLP if, in the case of a Studio film WWBO > 2x budget, and in the case of an Independent film, collected gross receipts > 2x budget.

“1. One big film in the slate doesn't pay for the others when you don’t participate in the first 70% of income arising from the other films, and 2. You can still make a full recovery of the slate budget and a handsome profit/return when you get one hit and participation in income arising at different levels from other films in the slate.”

Mr Reid

(a)           the developer had failed to attract the 70% finance required for Ingenious’ involvement;

(b)          doubts over the quality of the proposed financial commitments of others;

(c)           failure to attract a sales agent;

(d)          failing to sign the star or director needed.

(a)           commercial viability (by which he meant that the project involved well-known actors or directors);

(b)          an experienced day-to-day producer;

(c)           market validation (in the form of presales or other market finance);

(d)          a sales agent for Independent films.

Mr Clayton

HMRC’s Criticisms

(a)           in the IFP2 Information Memorandum it was said that “IFP2 will only produce films where … it is able to secure participation in sales receipts, not just profits.” That was a recognition that sales receipts – income – would be more important for an investor than the LLP achieving a profit. Aiming for receipts is part of aiming for profit but only if the aim is to obtain receipts which cover costs;

(b)          the IG Information Memorandum spoke of “maximising the return through participation in revenues arising from games exploitation receipts rather than profits”: a recognition of the comparative importance of receipts;

(c)           the reply suggested to the investor’s e-mail about the possibility of profit recorded at para [628] above;

(d)          Mr Clayton’s description of his hopes for the results of his own investment in an LLP and his answer to Mr Stafford’s question recorded in section 5 of this Chapter;

(e)           an e-mail from Mr McKenna to a Richard Harris about the advantages of investing in Inside Track. Mr McKenna said that it represented “an opportunity to participate in the gross sales income (not, non-existent profit!) arising from a portfolio of films with a minimum net of tax return of 6% and with the investment being returned within 6 months.” The words in parentheses are those of Mr McKenna;

(f)           the negotiation of the gross receipts corridor. Not only was there some suggestion that later benefit (and thus a greater possibility of profit for the LLP) could be given up for participation in earlier receipts, but the effect was to provide receipts for the benefit of investors even if a film did badly. It evidences an aim of income even if it also mitigated losses and could assist in LLP profits (after all, all income assists in the path to profit).

Conclusions: Controlling Minds’ Evidence

6. The IFP/IFP2 Information Memoranda

(a)           the number of films on the slate and the split between Studio and Independent films,

(b)          the ratio of gross receipts to budget,

(c)           the ratio of box office to budget,

(d)          variations in the timing of receipts and expenses.

(a)           that the DVD cost ratio was too low;

(b)          that the P&A ratio was too low;

(c)           that the effects of the waterfall were not properly modelled;

(d)          that other assumptions were made which were inconsistent with data which was held by Ingenious; and

(e)           that even if the illustrations did not suffer from these defects, the performance they required from the LLP’s films in order to make the modest profit was unrealistic, and ignores Ingenious’ own data in relation to the performance of films previously undertaken by ITP.

(1) The DVD/Video Cost Ratio

“video costs @ 20% of domestic revenue & 25% of foreign revenue”.

(i) it is the result of a particular ratio of overseas to domestic income which may not be reflected in the films which the LLP was to make. In particular we note that LS202 uses 23.1% for both domestic and foreign DVD costs;

(ii) it is a result in part (because some of the figures for DVD costs in the table were not plainly derived from the application of Focus’ 20% or 25% formula) of actual figures (or possibly figures determined in some other way) for three films released between 1999 and 2004, all of which were made by Chuck Roven/Atlas and distributed by Warner Bros, and in part of figures based on Focus’ 20/25% applied in the context of films released between 1992 and 1998, all of which were also made by Chuck Roven/Atlas, and three out of four of which were distributed by Warner Bros. That does not look like a representative sample;

(iii) it is unclear whether Focus’ use of 20/25% was geared to the period 1992 to 1998. In that period DVD was in its infancy and so may not have been the ratio Focus would have used after 2004;

(iv) elsewhere in the Mosaic material are some forecasts for income and expenses for proposed films. There are six such forecasts and all infer or use a DVD cost ratio of nearly 28%. This material bears the Focus’ imprimatur;

(v) 35% continued to be used after the preparation of the IFP2 Information Memorandum in calculating NRV figures including those for IFP2. Mr Crossley though had used the 23.1% ratio in some other work he had done at the time in relation to Mamma Mia;

(vi) Mr Bower, when explaining to us the workings of the waterfall, said that “DVD costs at 35% of revenue is, broadly speaking, the ratio one usually observes, something in that ballpark”; and

(vii) Mr Stanford’s advice was that the DVD cost ratio was 33% both domestically and internationally.

(2)  A Contingency

(3) Use of Other Mosaic/Focus Ratios

(a)           Theatrical Rentals: US and international box office

(b)          Pay Per View: US and international box office

(c)           Other: US and international box office

(d)          Print Expense: US and international box office

(e)           Advertising Expense:  US and international box office

(f)           Other Expenditure: US and international box office

(4) P&A Assumptions

Conclusion: P&A Ratios: In 2005/6 it seems to us that the fixed estimate for the P&A/GBO ratio of 37.5% was not realistic and that the lowest realistic estimate at that time was 40% (the Base case Focus average).

(5) Modelling the Waterfall

15.45% of GDI until GDI exceeded 165% of budget,

increased to 34.71% when GDI  fell between 165% and 204% of budget,

and thereafter 27.14%.

{15.5%x165 +34.71%x(204-165) +27.14% x(247-204)}/(165+39+43) = 20.6%.

(6) LS202: The Combination of the Factors Discussed Above

(a)           we reduced the international distribution fee to 15% (a conservative reduction given our conclusions in relation to the contingency in (2) above) to eliminate the contingency (varying cell Film Prodn Income tab C48);

(b)          we increased the DVD cost ratio to 28% (Film Prodn Income tab C27 and C54);

(c)           we reduced the US advertising ratio to 36% and increased the International advertising ratio to 36% (Film Prodn Income tab C25 and C52) so that the sum of advertising and prints was 40%;

(d)          We carried the resultant ratio of total gross receipts (89%) to total box office income arising in D64 of the Film Prodn Income tab to R14 of the Film Production tab.

(e)           We adjusted the distribution commission to 30% and the gross participation to 20.6% (R17 and R19 Film Production tab). The increase in GDI which resulted from step (d) meant that this figure should have been somewhat higher (and thus calculated profit somewhat lower).

Our Conclusions on LS202

(7) Ingenious’ Own Data on Film Performance

(8) WWBO to Budget Ratios Required for the LLP to be Profitable

(a)           the assumption in LS202 was that all three Studio films achieved 2.9 x budget. That was unrealistic;

(b)          the treatment of Independent films was incorrect;

(c)           the  reference to The Blair Witch Project was misleading.

(a) 2.9 Times Budget

(b) Independent films

(c) The Blair Witch Project

(9) A Five Year Vehicle

Our Conclusions on the IFP2 Information Memorandum

(10) LS101

7. The 2.2x WWBO Multiple

(a)           Night at the Museum (3.4x). This film was not profitable for the LLP, but on the basis of the 2010 Ultimates was projected to be profitable;

(b)           Hot Fuzz (3.7x). This was profitable for the LLP;

(c)           Die Hard 4 (2.2x). On Mr Forster’s evidence this was not profitable nor projected to be profitable (in the LLP’s reporting currency);

(d)          Notes on a Scandal (2.3x). This was neither profitable nor projected to be profitable;

(e)           Shaun of the Dead (3.6x). Profit of £3m at 5 April 2013, projected Ultimate £8m; budget £5m;

(f)           Closer (2.5x). No material income at all (due to high P&A expenses and absence of a gross corridor).

Hairspray with a 2.1x multiple was projected to lose £4m.

8. The Waterfall

9. The Expert Evidence of Mr Sills, Mr Briggs and Mr Olsberg

Mr Sills

(a)           sufficient cash receipts by the LLP to equal 30% (35%) of the budget of the film. (In the Appendix we call this the joint-venture basis: considering the LLPs as having put in 30% (35%) of the budget and as recovering 30% (35%) of GDI);

(b)          when the sum of (i) the payments actually made to the LLP and (ii) the amounts of BDR/BR retained by the CD would equal 100% of the budget. This is the point at which, on the Ingenious basis of calculation of profit, the LLP would break even;

(c)           when the total payments of BDR/BR would be equal to the CM loan.

(a)           in relation to the 30:30 basis (the joint-venture basis), Mr Sills’ evidence suggests a conclusion that, at the time those films were contracted, it would not have been unreasonable to expect the films to have been profitable on this basis;

(b)          in relation to the Ingenious basis of profit calculation (the 100%: 54.45% basis) Mr Sills’ evidence permits (but does not require) a conclusion that, at a time when the films were contracted, it would have been very optimistic to have expected this target to have been met for more than a small proportion of those films;

(c)           Mr Sills’ evidence permits a conclusion that, at the time the film was contracted, it would have been unrealistic to expect that the CM loan would be repaid at any time.

Mr Briggs

Mr Olsberg

10. Wimbledon-as-Notting Hill  

(a)           first we recast Mr Forster’s tables on that basis (working to the nearest £5m):

(b)          then we recast the Briggs’ Wimbledon-as-Notting Hill, and the tribunal’s crude adjustment thereto on the same basis.

11. Avatar

(a)           By the Completion Guarantor as to $149m, i.e. as to some 40%;

(b)          By the Shortfall Financier as to some 37%;

(c)           Under the CD Model as to the remaining amounts (70% of which were financed by Fox).

(a)           WWBO ($2.78bn) was more than 2.2 x budget ($286m), and more than 2.2 x or even 2.9 x the eventual cost (being some 6 x the eventual cost);

(b)          Gross income was $2bn by August 2013: that was more than 4 x final cost ($450m); the Information Memorandum states the assumption that IFPs’ films will produce gross income on average of 4.2 x budget;

(c)           Theatrical net revenue was about 43% of WWBO; LS202 works on an average of 44% of budget;

(d)          Home video (DVD) revenue was about 40% of WWBO; LS202 worked on 110%;

(e)           Pay TV revenue was about 2% of WWBO; LS202 worked on 16%;

(f)           Free TV revenue was 35% of WWBO; LS202 worked on 19%;

(g)          Other income was 1% of WWBO; LS202 used 2%;

(h)          The ratio of distribution costs to gross income was about 50%; LS202 used ratios which delivered an average of about 40%.

(a)           Ingenious’ 2010 Ultimate indicates an eventual profit of £536m, but that was based on further box office and DVD income which neither Mr Briggs nor Mr Sills could support;

(b)           Mr Briggs’ Avatar Ultimate (on the basis of Titanic) gave a lifetime profit of $33m (£22m). If that profit was used to replace the profit derived from the 2010 Ultimates in Mr Forster’s report for Avatar of £536m, IFP2 would make a projected lifetime loss of £308m;

(c)           From Mr Sills’ report, if WWBO was $4.16bn, IFP2’s receipts on the Ingenious basis from Budget B would have been $72m and if WWBO was $3.6bn, IFP2’s receipts from Budget A would have been $154m. Thus to the nearest $50m, if WWBO had been $4bn, IPF2’s receipts would have been about $250m or about £150m (to the nearest £50m) which is some £130m more than Mr Briggs’ figure. That would therefore reduce the Briggs lifetime loss by £130m. Thus, on the Ingenious basis, even if Avatar’s WWBO was $4bn, IFP2’s net aggregate result (within similar limits of accuracy) for films would have been a loss of £175m.

(a)           Without Avatar the projected lifetime profit of IFP2 would be £85m (using the Ultimates adopted in Mr Forster’s schedule),

(i) that there was no magic in GDI because the same eventual take could be engineered by flexing the Distributor’s fee and the Distributor’s commission;

(ii) that a 70:30 division did not reflect the shares in Gross Receipts, but of GDI, and

 (iii) that although Ingenious personnel used “70:30” in some of their correspondence this was no more than a convenient shorthand for one aspect of a traditional Studio deal.

We have addressed the first two of these points in Chapter III section 2 above. So far as the last point is concerned, it seems to us that 70:30 reflects the economic and commercial substance of the deal: it is not shorthand, but reality.

(a)           In March 2005 Mr Ulman, writing on behalf of Fox to Mr Clayton in relation to an IFP deal had said: “I understand this is essentially to be a 70/30 deal”;

(b)          Ingenious personnel knew that when a Shortfall Financier was involved it would contribute x% of budget and take x% of GDI;

(c)           At the end of the Approved Budget in the Hot Fuzz CDA there are set out the direct costs of the film and their augmentation by the bond fee, the Studio overheads, the executive producer fee and the contingency. It then sets out a Grand total which it divides:

“Ingenious Contribution 30% $6,621[k]

[CD] Contribution 70% $15,449[k]”

That indicates that the LLP knew that even the formal documentation evidenced that its contribution to the film was 30% only.

(d)          In the Completion Guarantee Agreement clause 8 provides that:

“subject to the [LLP] not being in default of its obligation to deposit funds in the amount of thirty per cent (30%) of the Approved Budget ... into the production account”,

the Guarantor guarantees delivery of the film. The guarantee is not conditional on the CD’s 70% being transferred, and in the words above expressly acknowledges the Ingenious contribution as being 30%.

(e)           Spreadsheets and figures produced by Nick Crossley in February 2005 for Mr Reid describe “Ingenious’ share of GDI” as being 30%, and speaks of Distribution Income being split 70/30 throughout. Three possibilities are discussed for the detail of the gross corridor, and it is noted that one is a better deal for Ingenious (the LLP) since it recoups “more than its pro rata share”.

 Mr Reid described this as being shorthand: the figures were prepared ahead of a negotiation with the Studio – he said you could use verbose terms and be exact when analysing the situation against the contract, but when you were “going in to deal with the person who is providing the rest of the capital you can go to a shortcut”. That in our view is a shortcut to the commercial and economic effect of the structure.

(f)           In his oral evidence in relation to the step variations in Studio Participation and BDR discussed in section 1 of Chapter III, Mr Reid said that Mr McKenna had argued that IFP2 should negotiate with the Studios so that the Studios would get less than 70% of GDI. That indicated an understanding that the economic interest of the LLP was 30% – even though we doubted Mr Reid’s particular recollection.

(g)          In an e-mail of 7 October 2004 Mr Clayton outlines to a possible partner the principle terms of IFP’s business. The first bullet point is:

“30% equity contribution to budget”,

with a recoupment corridor of 35% on all distributable income. Although Mr Clayton said that this was shorthand it clearly reflected the commercial or economic deal he was offering: the legal documents would “conform the underlying economics to the model we are operating.” In another e-mail of 20 October 2004 Mr Clayton says that “IFP can offer 30% of a film’s gross budget in equity”.

(h)          The Green-light papers spell out the 70:30 deal. The LLP’s share of income as 30% and that of Fox 70%.

(i)            Mr Bower said that “some of the spreadsheets talk about “retained by the partnership” because they are talking about the partnership’s members being the ordinary members and the CM versus the Studio”.

(a)           HMRC expressly say that Ingenious' view of profit is wrong. In other words it that the figure produced by the Ingenious’ basis was not, or would not have been, “profit” within the meaning of that word in the statute. It cannot be right that “profit” is a word of independent meaning, but “a view to profit” carries a subjective personal meaning of profit;

(b)          if Mr Gammie is correct then a person who mistakenly thinks that the amount of his turnover is profit (despite expenses) could satisfy, and a person who thinks she is not making a profit because she calculates her profit after deducting capital expenses  could fail to satisfy, the subjective test of  a view of profit.

13. Conclusions: With a View to Profit