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1991 (1) TMI 456

..... illett J., who allowed an appeal by the taxpayer company, Ensign Tankers (Leasing) Ltd., against a decision of the special commissioners. The commissioners held that the taxpayer company was not entitled to claim initial allowances under section 41(1) of the Finance Act 1971 in respect of two transactions related to two films (" Escape to Victory " and " Outland "). Section 41 (1) provides : " Subject to the provisions of this chapter, where -(a) a person carrying on a trade incurs capital expenditure on the provision of machinery or plant for the purpose's of the trade, and (b) in consequence of his incurring the expenditure, the machinery or plant belongs to him at some time during the chargeable period related to the incurring of the expenditure, there shall be made to him for that period an allowance (in this chapter referred to as 'a first-year allowance') which shall be of an amount determined in accordance with section 42 below . . . " At the material time, the master negative of a film constituted plant for the purposes of this section. The first year allowance was 100 per cent. The transactions in question were carried out by two l .....

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..... ort-term leasing of plant and machinery and the provision of non-recourse finance in connection with the purchase and leasing of oil drilling rigs. In 1980 the Inland Revenue issued a statement that first-year allowances were to be available for expenditure in connection with the making of films. " Escape to Victory " was a full-length motion picture directed by John Houston and starring Michael Caine, to be shot on location in Hungary. It was to be produced by Lorimar Productions Incorporated (" L. P. I. "), a Californian company engaged in the production of films, and to be distributed by Lorimar Distribution International Incorporated (" L. D. I. I. "), an associated company of L. P. I. By March 1980 L. P. I. had made all the arrangements necessary for the making of the film. The estimated cost of producing the film was just under $ 13m. L. P. I. had secured the necessary finance which was to be provided by means of a revolving credit from Chemical Bank on the security, inter alia, of the film. Principal photography began on 26 May 1980. A Mr. Wilde on behalf of his employer, the merchant bank Guinness Mahon and Co. Ltd., had devised a scheme whereb .....

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..... L. P. I. agreed to lend Victory Partnership the additional $ 9,750,000 (75 per cent. of $ 13m.) it needed to meet the budgeted cost of making the film (" the production loan ") and any further money needed to complete the film in case it ran over budget (" the completion loan "). Both loans were non-recourse loans, that is to say they were repayable exclusively out of the receipts of the film without recourse to Victory Partnership or its general or limited partners or their other assets. (2) Victory Partnership acquired the uncompleted film for $ 4,780,951 being the cost of making it to date. L. P. I agreed to complete the manufacture of the film for and on behalf of Victory Partnership substantially in accordance with the approved budget. Victory Partnership agreed to pay L. P. I. the balance of the approved budget for doing so. Any finance needed in excess of the approved budget would be provided for by L. P. I. in accordance with the terms of the completion loan. L. P. I. assigned to Victory Partnership all its rights in the film, including the ownership of that part of the film which had already been made. (3) Victory Partnership retained the ownership of .....

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..... ds to complete the film if it overran budget. This was an important safeguard to Victory Partnership which effectively insulated it from the risk of budgetary overrun. The second was a payment towards the overhead cost of making the film. L. P. I. was carrying out the work and bearing the overheads : hence the fee for so doing. The commissioners accepted evidence that both the completion fee and the overhead provision were normal incidents of film budgets and that the rates charged were not out of the ordinary. However, although the substance of the transaction in financial terms was that Victory Productions was a 25 per cent. equity participant, that was not the way in which it was structured by the documentation. Victory Partnership did not acquire merely a 25 per cent. interest in the venture but a 100 per cent. Nor, according to the documentation, did Victory Partnership pay only 25 per cent. of the cost : that would not have suited the purpose of the partners. Instead Victory Productions acquired from L. P. I. 100 per cent. of the film and paid 100 per cent. of the total budgeted cost. However out of the total liability for the cost Victory Productions provided 75 per cent. ou .....

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..... ught to achieve (i.e., first-year allowances on 100 per cent. of the cost of the film), like the later fiscal disadvantages which could not be avoided, derived from the " gearing " effect obtained by the use of borrowed money to acquire assets for which first-year allowances were available in the course of a business where expenditure normally preceded the receipt of income by two or three years. " Escape to Victory " ran nearly $ 2m. over budget. The commissioners found that the film was not the financial success for which L. P. I. had hoped. By the end of 1983 Victory Partnership had received from L. D. I. I. and Firrilee a total of $ 11,126,134. Of that amount, Victory Partnership retained 25 per cent. ($ 2,781,533) and paid 75 per cent. ($ 8,344,601) to L. P. I. towards repayment of the production loan. Thus Victory Partnership suffered a loss of $ 468,467 or 14.4 per cent. of its investment. Although further income was to be anticipated, the commissioners found that there was no reasonable prospect of the film making a profit for Victory Partnership or even breaking even. The financial outcome for L. P. I. is more difficult to quantify. It depends on the tr .....

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..... d from the speech of Lord Donovan in Lupton v. F. A. and A. B. Ltd. [1972] A. C. 634, 658, and continued: " Bearing this in mind, we proceed to an examination of the evidence, in order to come to a conclusion as to whether the limited partnerships in these appeals were trading. " They then found the facts as follows, inter alia. (1) It was never the intention of the Tilling Group that the taxpayer company should be a commercial success but that its primary purpose was to improve the group's earnings and cash flow by tax deferral. (2) Guinness Mahon (through Mr. Wilde) negotiated the terms of the scheme with L. P. I. as bankers seeking to offer a tax avoidance scheme to investors. As to the commercial terms, Guinness Mahon " took what Lorimar was prepared to give. " (3) In considering the importance to the taxpayer company of making a commercial profit, they held that Mr. Whitfield's calculations demonstrated : " that even the cash flow position of 300 per cent. cost recovery is markedly inferior to that obtaining on a complete flop. The best position by far ... is obtained on 50 per cent. cost recovery. " (4) The transaction was aptly described .....

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..... tives as their paramount object are not . . . trading transactions . . . In our judgment the well known principles established in Lupton's case apply to these appeals and we rely in particular on the oft-quoted speeches of Viscount Dilhorne, at p. 657, and of Lord Simon of Glaisdale, at pp. 659-660. In the circumstances, we find that neither Victory Partnership nor Outland Productions was trading. " The Judgment : I will not attempt to summarise the propositions of law which are stated at [1989] 1 W. L. R. 1222, 1231-1234 [1990] 186 ITR 666, 667 686. As will appear, I do not agree with a number of the judge's propositions, but it is easier to demonstrate this by considering how the judge decided the instant case. He first pointed out, in my judgment correctly, that the commissioners were wrong in holding that, as a matter of law, transactions entered into " with fiscal motives as their paramount object " are not trading transactions. The judge then went on to hold that the commissioners had largely misdirected their inquiries. It was, and is, common ground that the only relevant question is whether Victory Partnership, as opposed to the taxpayer company, ente .....

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..... film by means of the non-recourse loan of the necessary finance from the vendor, L. P. I. He held that the transaction as actually carried through also, prima facie, constituted a trading transaction : since L. P. I. was in it for profit, so prima facie must Victory Partnership have been. The fact that the partnership acquired 100 per cent. instead of 25 per cent. of the film by means of the non-recourse loan repayable out of profits of the film was a different " legal means of achieving the same financial result, " i.e., a 25 per cent. equity interest. If the taxpayer company chooses one legal means of giving effect to the financial result desired, he cannot be taxed as if he had chosen another means of achieving the same result, " even if his choice is dictated exclusively by fiscal considerations. " p. 1238 F+. Having first characterised the transaction as a trading transaction, the judge then identified the relevant question of law, at p. 1239++ : " where a partnership enters into a commercial transaction with a view of profit, can it fairly be regarded as carrying on a trade even if (i) it obtained the necessary finance from investors who were primari .....

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..... s (1896) 33 S. L. R. 289 ; 3 T. C. 415. A dealer in shares who buys and sells shares is engaging in a transaction which, objectively viewed, would be a share trading transaction. Yet such a transaction is not trading if the sole object of the purchase or sale is not to make a commercial profit on such purchase but to obtain a fiscal advantage: Lupton's case [1972] A. C. 634; Coates v. Arndale Properties Ltd. [1984] 1 W. L. R. 1328 and Overseas Containers (Finance) Ltd. v. Stoker [1989] 1 W. L. R. 606 ; [1991] 188 ITR 383. The judge, in holding that the existence of such a non-trading purpose has to be gathered from the transaction itself objectively viewed, relied on certain remarks made by Lord Denning in Newton v. Commissioner of Taxation of Commonwealth of Australia [1958] A. C. 450, 456. But that case was concerned with the interpretation of a taxing statute, not the general law of what constitutes trading. In my judgment, that case provides little assistance. The judge further relied on the fact that in none of the dividend stripping cases to which he referred had the courts relied on, evidence of intention beyond what could be gathered from the transactions themselves and .....

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..... transactions : see per Fox L. J. [1984] 1 W. L. R. 537, 554, whose decision was affirmed by the House of Lords and also per Lord Bridge of Harwich [1985] 1 W. L. R. 193,195. In my judgment, these authorities demonstrate that, at least where the transaction is equivocal and the purpose may or may not have been commercial, the commissioners are entitled to look at evidence of the subjective intention or motives of the relevant party. That is not because the legally relevant question is " with what motive did the parties enter into the transaction, " but because such motive is evidence, sometimes compelling, on which to decide the legally relevant question, viz., was the purpose of the transaction a trading purpose ? In the present case the circumstances were plainly equivocal : quite apart from the fact that the motive of the taxpayer company (as one of the partners in the Victory Partnership) was fiscal, the provisions involving the vendor of the film, L. P. I. lending on a non-recourse basis 75 per cent. of the purchase price, such loan being repaid out of profits of the film, raises immediate questions as to the true nature of the transaction. Therefore, in my judgment, .....

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..... oners formed the view that they were merely implementing the tax deferral scheme. Therefore, although the commissioners do not expressly spell out the route whereby they reached the conclusion, on a fair reading they were finding that the subjective intention of the Victory Partnership in entering into the transactions was not commercial. In my judgment, therefore, the grounds on which the judge decided that the commissioners were wrong in law in reaching their conclusion and the grounds on which he based his own decision that there was only one possible result, viz., that these were trading transactions, were incorrect. Paramount or sole object of fiscal advantage : It will be remembered that the commissioners expressed their conclusion by holding that, as a matter of law, this was not a trading transaction since the paramount intention was to obtain a fiscal advantage. In my judgment, this constitutes an error of law : Overseas Containers (Finance) Ltd. v. Stoker [1989] 1 W. L. R. 606; [1991] 188 ITR 383. In the summary, that case decides : (1) trade involves not only the badges of trade but a commercial purpose ; (2) the question whether a transaction is a trading transaction is .....

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..... ion ? " The judge appears to have considered that if there was some element of commercial trading that was enough. The taxpayer company has argued that since there was some possibility of profit and therefore some element of commercial trade, that was decisive. I reject both those views. First, Lord Simon of Glaisdale's proposition (6) in Lupton's case [1972] AC 634, 660, (" if the appearance of the transaction leaves the matter in doubt, an examination of its paramount object will always be relevant and will generally be decisive " ) shows that there are cases where, notwithstanding commercial features, the fact that the object is fiscal is decisive. The mere possibility of profit is not decisive. In Reed v. Nova Securities Ltd. [1985] 1 W. L. R. 193, the fact that the debts might have realised a profit was enough to justify a finding by the commissioners that it was a trading transaction. Yet it is manifest that both the Court of Appeal [1984] 1 W. L. R. 537 and the House of Lords [1985] 1 W. L. R. 193 considered that, if there had been a finding that the objective was primarily to obtain a fiscal advantage, the commissioners could properly have found that .....

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..... per cent. of the first-year allowances would be obtained in return for only 25 per cent. investment. The commissioners must look at the actual transaction entered into, not another transaction that was never under consideration at all. Finally the judge relied on a dictum of Lord Morris of Borth-y-Gest in Lupton's case, at p. 647. In Lupton's case the majority regarded Griffiths v. J. P. Harrison (Watford) Ltd. [1963] A. C. 1 as either being wrongly decided or, per Lord Simon of Glaisdale, as establishing such a narrow proposition as to be irrelevant. The minority, Lord Morris of Borth-y-Gest and Lord Guest, had been parties to the Harrison decision and regarded it as still being good law. In my judgment, it is not safe to rely on the views of the minority in Lupton's case [1972] A. C. 634 since they were not taking the same view as the majority. To summarise my views on the law in this case the position, in my judgment, is as follows : (1) Whether a transaction is to be classified as commercial normally falls to be determined objectively by reference to the nature of the transaction itself, i.e., is it a transaction of a kind similar to transactions of the same nature .....

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..... s enough to dispose of the matter in this court but the judge, on the view he took, had to decide three other points. The remaining points : The judge held that the principle in W. T. Ramsay Lid. v. Inland Revenue Commissioners [1982] A. C. 300 did not enable the creation and existence of the limited partnership to be ignored for tax purposes. The Crown has not appealed against that decision, which, in my judgment, was plainly right. Second, the judge held that the plant " belonged " to Victory Partnership. The Crown has appealed against that decision. I have heard nothing which makes me think the judge was wrong. Third the judge held that, notwithstanding the fact that the purchase of 75 per cent. of plant was financed by the non-recourse loan from L. P. I., Victory Partnership had " incurred " the expense of purchasing 100 per cent. of the plant. The Crown has appealed against this decision. Although I think there is much force in the judge's reasoning, I prefer to express no concluded view on this point since it is not necessary for the decision in this court. STUART-SMITH L. J. I agree. Leggatt L. J. I agree with Sir Nicolas Browne-Wilkinson V.-C. that f .....

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