Case Comment: Eclipse Film Partners No 35 LLP v Commissioners for Her Majesty’s Revenue and Customs  UKSC 24
21 Tuesday Jun 2016
On 13 April 2016, the Supreme Court declined Eclipse Film Partners No 35 LLP permission to appeal in relation to the issue of whether it was trading within the definition of relevant tax legislation for the purposes of tax relief.
The Supreme Court granted permission to hear an appeal from Eclipse concerning the powers of the First Tier Tribunal in awarding costs relating to bundle preparation.
Eclipse is a UK limited liability partnership (LLP) involved in the business of production, distribution, financing and exploitation of films. The members of Eclipse borrowed money (approximately £840 million) to contribute towards its capital, paid interest (approximately £293 million) on the money borrowed and intended to receive tax relief on that interest. In October 2006, following a complex set of financial transactions, Eclipse paid £503 million for a 20 year licence to acquire specified rights to distribute and exploit two films from Walt Disney Pictures: Enchanted and Underdog. On the same day, Eclipse sub-licensed the rights to WDPT Distribution VIII LLC (another member of the Disney group). WDPT was required to exploit and distribute the films and pay Eclipse annual amounts over the 20 year period, variable distributions and contingent receipts (calculations were based on the success of the films).
Tax legislation and HMRC Assessment
The Income Tax (Trading and Other Income) 2005, s 609 (which derives from the Income and Corporation Taxes Act 1998, s 18) imposes a charge to income tax on the income of a business involving the exploitation of films that does not amount to a trade. However, Eclipse relied on preferable tax treatment of LLPs. Under s 863 of the 2005 Act, if a LLP carries on a “trade or business” with “a view to profit”, the activities of the LLP are treated as being carried on in partnership by its members and not by the LLP as a separate entity. In practice, an LLP has to submit a partnership tax return but does not pay tax. Individual partners of a LLP are treated as sole traders and taxed separately on their shares of LLP profits. As prescribed under s 362 of the 1988 Act, (subsequently rewritten as the Income Tax Act 2007, s 398), individuals who borrow money to invest in a partnership (including an LLP) are entitled to tax relief on interest payments if, during the relevant period, the following are satisfied:
- the individual is a member of the partnership (which is not a limited partnership or an investment LLP); and
- no capital is returned to the individual.
The partners of Eclipse who were liable to UK income tax would have been able to claim tax relief on interest paid on borrowed money contributed to the partnership. However, HMRC issued a closure notice for the year ending 5 April 2007 concluding that the partnership was not carrying on a trade or, if it was, it was not doing so with a view to profit in accordance with the 2005 Act. Eclipse appealed to the First Tier Tribunal (FTT).
The FTT concluded that Eclipse was not carrying out a trade in accordance with the 2005 Act. The FTT found that the activities of Eclipse did not amount to a trade but to a business involving the exploitation of films and found it to be a non-trading business within s 609 of the 2005 Act.
The FTT also made costs directions relating to the preparation of bundles. They directed that bundles should be agreed but where they could not be agreed each party should prepare its own bundles and serve three copies on the other party and the FTT. As no agreement was reached, oral directions were given for Eclipse to prepare the bundle and costs to be shared. Eclipse prepared the bundles which ran to 700 pages, due in part to requests from HMRC for various documents to be included. Eclipse then sent HMRC an invoice for half the cost, totalling £108,395.48. HMRC refused to pay the invoice on the grounds that the FTT had no jurisdiction to make the cost sharing order. Eclipse appealed the decision.
The Upper Tribunal (UT) dismissed Eclipse’s appeal on the substantive issue, stating that the FTT had been entitled to hold that Eclipse was carrying on a non-trading business. The UT held that the FTT did not err in law by finding that an element of speculation is a significant (although not determinative) characteristic of the concept of trade. They held that a film partnership, which does not engage in any meaningful way in the marketing and release of the film, was not trading simply because there was a remote possibility that it might receive variable distributions.
The UT set aside the oral direction relating to costs on the grounds that the FTT had no jurisdiction to give such a direction. Eclipse appealed the decision.
Court of Appeal
The Court of Appeal held that the FTT (and the UT) had not erred in law in finding that Eclipse had not been trading for the purposes of the 2005 Act. The court stated that Eclipse’s business depended on “the totality of its activity and enterprise” and highlighted that its business consisted of a loan (which was characteristic of an investment) and the possibility of contingent receipts (which were not significant enough to lead Eclipse to be considered as trading).
The Court of Appeal held that the FTT did not have jurisdiction to make an order that the costs of preparing hearing bundles for a substantive appeal by Eclipse. Lord Justice Moses concluded “I share the view of the Upper Tribunal, for the reasons it gives, that there was no power to make an express order that the costs be shared”. Eclipse appealed the decision.
The Supreme Court
On 13 April 2016, the Supreme Court heard submissions as to whether permission should be granted for Eclipse to argue the following two issues:
1. Did the Upper Tribunal err in law in treating Edwards v Bairstow as delineating the scope of its appeal jurisdiction?
2. Did the First-tier Tribunal (and subsequently the Upper Tribunal and Court of Appeal) err in law by not concluding that the appellant’s acquisition (by licence in) and disposal (by licence out) of specified rights to distribute and/or exploit two films produced by Disney was inherently trading?
The Supreme Court refused Eclipse permission to appeal in relation to the substantive issue of whether they were trading for the purposes of the tax relief.
The Supreme Court allowed permission in relation to the costs issue and heard submissions in relation to the proper construction of the FTT (Tax Chambers) Rules (the FTT Rules), governing the practice and procedure to be followed by the First Tier Tribunal and, in particular, rules 2 (Overriding objective and parties’ obligation to co-operate with the Tribunal), 5 (Case management powers) and 10 (Orders for costs), in relation to the power to make orders in respect of costs.
Lord Neuberger gave the only judgment. He dismissed the argument that the FTT had made an order as to sharing of costs instead of paying costs because HMRC would in effect be paying Eclipse half its costs if the order did stand. He also dismissed the argument that the FTT had inherent powers to make orders as to costs under rule 5 which deals with bundle preparation as part of case management. He concluded with the proposition that Eclipse may have “a claim against the Revenue for £108,395.48 based on restitution, in the same way that a restitutionary claim may be made where services are performed under a contract which is for some reason unenforceable or void.” This comment, obiter dicta, confirms that Eclipse could pursue HMRC for these costs in a different forum.
This case has received significant media attention due to the involvement of high profile celebrities and the current tabloid focus on tax avoidance. The consequences of the Supreme Court decision to refuse permission to appeal on the substantive issue will be significant for those involved in the film finance scheme and others in similar schemes. The relevant members of Eclipse will now be taxed on income earned from the scheme without any relief for interest already paid. Participants in similar schemes will be left to decide whether to pursue the basis of challenge and suffer potential financial penalties or to seek settlement.