Court Of Appeal
Ensign Tankers (Leasing) Ltd. vs. Stokes (Inspector Of Taxes)
Section 1971FA 41(1)
Sir Sicolas Browne-Wilkinson V. C., Sturt-Smith & Leggatt, L., JJ.
10th December, 1990 & 30th January, 1991
Counsel Appeared
Christopher McCall Q. C. & Launcelot Henderson, for the Crown : John Gardiner Q. C. & Roger Thomas, for the Taxpayer Company
SIR NICOLAS BROWNE-WILKINSON, V.C. :
This is an appeal by the Crown against the decision of Millett, 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 s. 41(1) of the Finance Act 1971 in respect of two transactions related to two films (” Escape to Victory ” and ” Outland “).
Sec. 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 s. 42 below . . . “
2. 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 limited partnerships-one for each film in each of which the taxpayer company was a partner. It is common ground that, for the purposes of s. 41, the person ” referred to in that section is the partnership. The questions which arise are (a) was the partnership “a person carrying on a trade, ” (b) did the film ” belong ” to the partnership and (c) did the partnership incur expenditure in the purchase of the film ?
3. If the partnerships qualified for first-year allowances under s. 41, under s. 155 of the Income and Corporation Taxes Act, 1970 the partnership is to be treated for tax purposes as though it were a limited company, but in computing its tax liability no deduction is to be allowed for capital allowances. Instead, under s. 155(2), each partner is entitled in computing his or its profit to take into account its share of the partnership capital allowances. Hence, although the claim to the first-year allowances in this case is rightly made by the taxpayer company (both on its own account and in relation to group relief for other companies in the same group) it is of fundamental importance to appreciate that the relevant questions all depend not on the actions and intentions of the taxpayer company alone but on the actions and intentions of the partnership as a body.
4. The case stated by the special commissioners and Millet J.’s judgment are reported at (1989) STC 705 [See (1990) 186 ITR 705]. The judgment is also reported at (1989) 1 WLR 1222. Although there are factual differences between the ” Escape to Victory” and the ” Outland ” transactions, it is common ground that those differences are immaterial for present purposes. I will therefore deal exclusively with the ” Escape to Victory ” transaction, the outline facts of which I gratefully adopt, often verbatim, from the judge’s judgment. The facts :
5. At all material times the taxpayer company was a member of the Thomas Tilling Group of companies, which had substantial group profits. Mr. Whitfield was the managing director of the taxpayer company. He was a chartered accountant and a member of the group’s treasury committee. He was also the group’s tax controller and was principally concerned with the financial and fiscal aspects of the group’s activities. Prior to 1980 the taxpayer company was profitably engaged in the short-term leasing of plant and machinery and the provision of non- recourse finance in connection with the purchase and leasing of oil drilling rigs.
6. 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 26th May, 1980.
7. A Mr. Wilde on behalf of his employer, the merchant bank Guinness Mahon and Co. Ltd., had devised a scheme whereby United Kingdom investors could take advantage of first-year allowances in relation to films. Mr. Wilde had also negotiated with L. P. I. in early 1980 the terms on which his scheme could be used for investment in ” Escape to Victory “. The advantages of the scheme to L. P. I. were that it provided cheaper finance and to investors. that it made available to them first-year allowances which could be used as a tax shelter against other profits. Mr. Wilde marketed his scheme in the United Kingdom as a tax deferral scheme, charging a fee of 7 per cent. payable to Guinness Mahon. Mr. Wilde brought the scheme to Mr. Whitfield, who recommended it to the treasury committee and the group main board. The scheme was implemented all on one day, 14th July, 1980. The basic document was a partnership agreement made between Victory Film Productions Ltd. (” Victory Productions “) as general partner and five other companies, of which the taxpayer company was one. The other companies were not connected with the taxpayer company but, as 1 understand the position, were also purchasers of the scheme from Guinness Mahon. That agreement established the Victory Partnership, the objects of which were : “to engage in the production making and /or acquisition exploitation and distribution of full length cinematographic films and all ancillary rights on a commercial basis and with a view to profit. “
The initial capital of the partnership was $ 3,250,000 (25 per cent. of $ 13m.), all of which was contributed by the limited partners. The taxpayer company’s contribution was $ 2,375,000. The partnership was a limited partnership, Victory Productions alone having the conduct and management of the business. Victory Productions was a company beneficially owned by L. P. I. Its principal director was Mr. Wilde, who had devised the scheme.
On the same day, 14th July, 1980, and in the course of the same meeting, 16 further documents were entered into between eight different parties. The most important of these were a loan agreement made between L. P. I. as lender and Victory Partnership by its general partner, Victory Productions, as borrower, a production services agreement made between the same parties, and a distribution agreement made between Victory Partnership as producer and L. D. I. I. as distributor. The effect of the various transactions was as follows. (1) 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 the master negative, but granted to L. D. I. I. in perpetuity an exclusive licence to distribute and exploit the film outside the United Kingdom. L. D. I. I. was to charge distribution fees at what the commissioners accepted were near market rates and to retain the gross receipts until it had recouped its distribution expenses and the shares of profit payable to members of the cast and other participators in the film. Victory Partnership appointed Firrilee Ltd., another L. P. I. company, its sole and exclusive agent to distribute and exploit the film in the United Kingdom. (4) The net receipts of the film were payable to Victory Partnership and were divisible (a) as to 25 per cent. to Victory Partnership and as to 75 per cent. to L. P. I. in repayment of the production loan until Victory Partnership should have recouped its capital outlay of $ 3,250,000, described as ” the break even point, ” at which time L. P. I. would have recovered a sum equal to the production loan of $ 9,750,000 but without interest ; thereafter (b) as to 100 per cent. to L. P. I. until it should have recovered further sums equal to interest on the production loan together with the completion loan, if any, with interest ; and thereafter (c) as to 25 per cent. to Victory Partnership and as to 75 per cent. to L. D. I. I.
Looking at these arrangements in purely financial, as opposed to legal, terms Victory Partnership was in effect a sleeping partner with a minority interest. It was putting up 25 per cent. of the cost and taking a 25 per cent. equity participation. L. P. I. was putting up the remaining 75 per cent. of the cost and retaining a 75 per cent. participation. In legal terms, however, L. P. I. was not an equity participant. Victory Partnership owned 100 per cent. of the film. L. P. I. was making its contribution by way of loan. A loan creditor would normally expect to be repaid before equity participants recovered any part of their capital. However L. P. L’s advance was recoverable only out of film receipts and was repayable pari passu with Victory Partnership’s capital investment.
The approved budget included two sums payable to L. P. L, a completion fee of $ 618,000 and a supervisory and overhead fee of $ 1,120,000. The first was a charge made by L. P. I. to Victory Partnership as the price of L. P. I. making itself liable to provide the necessary further funds 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. out of loans from L. P. L, whose associated company, L. D. I. I. took a 75 per cent. equity participation. This structure provided Victory Partnership with the element of ” gearing ” necessary to achieve the fiscal advantages that the limited partners were seeking and Mr. Wilde’s scheme was designed to achieve. By borrowing
75 per cent. of the capital cost of the film Victory Partnership was able to spend four times its own capital in the provision of ” plant ” and obtained first-year allowances of an amount equal to that expenditure. As receipts from the film came in, the gearing would have a corresponding but deleterious effect for tax purposes. Until the indebtedness to L. P. I. was repaid, Victory Partnership would be taxed on 100 per cent. of its receipts, although it had to pay over 75 per cent. of such receipts to L. P. I. But since expenditure on the film necessarily precedes the receipt of income, Mr. Whitfield had calculated that the availability of 100 per cent. first-year allowances to be set against group profits made the investment financially attractive whether the film was a complete flop, and produced no income at all, recouped the investment in full, or made substantial profits. According to Mr. Whitfield’s calculations the optimum position between nil receipts for the film and receipts amounting to 300 per cent. of the investment was if the receipts amounted to only 50 per cent. of the investment.
14. The way in which the scheme was intended to work was as follows. A partnership acts through the partners or their servants or agents, in this case through the general partner. If a partnership engages in a trading transaction, that is trading by the partnership (i.e., by all the partners whether active or sleeping). As I have explained, each partner would be entitled under s. 155 to its share of the first year allowances. The availability of first-year allowances would create an immediate allowance for each of the partners. In the inevitable absence of any film receipts during the year in which the expenditure was incurred, the whole amount of the first-year allowance would be available to set against group profits for the year 1980. In later years, as receipts from the film came in, such receipts would be taxable on the basis that I have mentioned. The initial fiscal advantage which Mr.
Whitfield and the scheme sought 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.
15. “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.
16. The financial outcome for L. P. I. is more difficult to quantify. It depends on the treatment of the completion fee, the budgetary overrun and the overhead charge. As to this, there is a disagreement between the commissioners and the judge. In my judgment, the dispute is irrelevant since it is not in question that L. P. I. and its associates entered into the transactions on a genuine commercial basis. The commissioners’ decision:
17. The commissioners started by setting out the common ground between the parties and the issues that they treated as before them. They said : ” It is common ground in these appeals that ( the taxpayer company’s ) investment in films was tax motivated and tax orientated . . . ( the taxpayer company I and the Revenue part company however over the extent to which the fiscal motive has invaded the transactions entered into by ( the taxpayer company ) in relation to the two films ‘Escape to Victory’ and ‘ Outland. ‘ Mr. Thornhill put ( the taxpayer company’s ) position very succinctly on the penultimate day of the hearing, in his reply, when he said that whatever fiscal reasons may have prompted ( the taxpayer company ) to go into films, once it had done so, it did so on a wholly commercial basis. That analysis is rejected by the Inland Revenue, for Mr. Ferris submits that what was done by ( the taxpayer company ) was so moulded by fiscal considerations that the whole character of the transactions relating to the two films was denatured by their fiscal content to such an extent that they ceased to be commercial.”
18. Having considered the expert evidence that the transactions were of a kind, and on terms, normal in the film business and expressing certain reservations about that evidence, they continued : “But even if we were to accept that the transactions considered by the expert witnesses were entirely normal and usual in the film business we do not agree that such evidence must lead us inevitably to the conclusion that the film transactions in these appeals were commercial or that Victory Partnership and Outland Productions or either of them were in consequence engaged in the trade of producing films. In our judgment we must look not only at the component parts of the transactions but at their totality and we must come to a decision as to whether the two limited partnerships were trading, having considered all the evidence adduced before us in these appeals. “
19. They then quoted from the speech of Lord Donovan in Lupton vs. 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. “
20. 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 in documents which predated the formation of Victory Partnership by Guinness Mahon as ” a tax deferral scheme” and by Mr. Black, a senior executive of the Tilling group, as ” a scheme. ” (5) ” Escape to Victory ” was originally budgeted at $ 11.5m., but this budget had increased to $13m. Mr. Whitfield was aware that by 21st June, 1980 the
film was already $ 20,000 over the budget of $ 13m., contingency allowance of $ 1 m. having been exhausted, and may have been aware that by 5th July it was $ 0.50m. over budget. Yet this caused the taxpayer company no concern. (6) The Tilling Group had envisaged that, since the completion of the film was dependent on L. P. I. finance, the possibility of L. P. L’s insolvency would be covered by a bank guarantee, but no such guarantee was ever sought. (7) There were certain features of the documents executed on 14th July, which, in their view, ” tended to diminish any faith in their commerciality. ” (8) The partnership did little after 14th July, 1980. (9) Mr. Wilde and Guinness Mahon, as controllers of Victory Productions, did not take very seriously their responsibilities as managing partners, paying little or no regard to cost control of the film. This was inconsistent with ” normal commercial behaviour ” even taking into account the non-recourse basis of the loans from L. P. I. (10) The taxpayer company’s motive and objective in entering into the “Escape to Victory” transactions was to produce for the Tilling Group beneficial tax allowances by means of first-year allowances. (11) The taxpayer company had no commercial motive in entering into the transaction : ” it invested in ‘Escape to Victory’ . . . for fiscal reasons not caring whether they made a profit or not. ” (12) The total uncommerciality of the taxpayer company’s approach was demonstrated when Mr. Black, in the course of his re-examination, was asked whether the ‘ calling Group would have entered into the transaction ” at any cost, ” and replied ” Yes. “
21. The commissioners concluded their decision as follows : ” As we understand the authorities (Coates vs. Arndale Properties Ltd. (1984) 1 W. L. R. 1328 ; Reed vs. Nova Securities Ltd. [(1985) 1 W. L. R. 193 and Lupton vs. F. A. and A. B. Ltd. (1972) 4. C. 634)], transactions which are entered into with fiscal motives 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 See (1990) 186 ITR 666. 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, entered into the arrangements as commercial transactions. The judge took the view that the commissioners had not directed their findings to this point, but had largely concentrated on the ” motives ” of the taxpayer company. The judge also appears to have held that the commissioners were in error in having regard to motive or intention at all : in ascertaining whether the transaction was commercial, he considered that they should have concentrated on the terms of the deal made between Victory Partnership and L. P. I. He described, at p. 1236 [See (1990) 186 ITR 666, 684 685], the crucial question as being ” whether the transactions entered into by the partnerships were on commercial terms with a view to profit. . . He dismissed the commissioners’ findings as to Mr. Wilde’s negotiations as being concerned only with ” Mr. Wilde’s subjective motivation.”
24. Having found that the commissioners had misdirected themselves, the judge held that on the primary facts found by the commissioners there was only one possible conclusion in law, viz., that they were trading transactions. The steps by which he reached this conclusion are illuminating. First he held that the taxpayer company had invested in Victory Partnership as a tax deferral scheme : the taxpayer company’s investment “merely provided the finance necessary to enable trading transactions to be entered into. ” Since this motivation had not been found by the commissioners to have had any adverse effect on the terms offered by L. P. I. the taxpayer company’s motivation “can be laid aside as having no further relevance ; ” p. 1238A-B See (1990) 196 ITR 666.
25. Second he looked at the matter from L. P. l.’s point of view and analysed the deal as an arrangement whereby Victory Partnership put up 25 per cent. of the budgeted finance in return for 25 per cent. of the profit for a film which L. P. I. was making commercially. If the deal had taken this form, says the judge, Victory Partnership would plainly have been trading : p. 1238B-D See (1990) 186 ITR 666. Third the judge extrapolated from his second proposition by inserting into the transaction those factors which the second proposition omitted : the insertion, for purely fiscal reasons, of the provision, whereby Victory Partnership acquired 100 per cent., instead of 25 per cent., of the 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 (Ibid, p. 686).
26. Having first characterised the transaction as a trading transaction, the judge then identified the relevant question of law, at p. 1239 (Ibid, p. 687) : ” 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 primarily motivated by the hope of obtaining a fiscal advantage rather than a commercial profit and (ii) the transaction itself was deliberately structured in order to secure the fiscal advantage without ceasing to be commercial or jeopardising the prospects of profit ? “
27. He said that the answer to that question was in the affirmative and therefore that the only possible finding was that the transaction was a trading transaction. Commercial purpose:
28. In the ordinary case, the question whether a transaction is a trading transaction will be answered by looking objectively at what was done in order to see if it is similar to transactions of the same nature in the commercial world and carried out in a similar way : per Lord Clyde in Inland Revenue Commissioners vs. Livingston (1926) 11 T. C. 538, 542. But it is established that a transaction which has all the features of trade must also have a commercial purpose: Lupton vs. F. A. and A. B. Ltd. (1972) A. C. 634 ; Coates vs. Arndale Properties Ltd. (1984) 1 W. L. R. 1328, 1333 Overseas Containers (Finance) Ltd. vs. Stoker (1989) 1 W. L. R. 606, 613 (1991) 188 ITR 383. The judge accepted both those propositions of law, but rejected the commissioners’ approach primarily on two grounds. First he held that the purpose of the transaction had to be ascertained objectively and solely by reference to the nature of the transactions themselves, not subjectively by reference to the motive or intentions of the party to the transaction : pp. 1232 G 1233 D See (1990) 186 ITR at p. 679. Second he held that in any event the relevant purpose was the purpose, not of the taxpayer company, but of the Victory Partnership. Subjective intention :
29. The judge rightly held that motive, as such, was irrelevant. In each case the only relevant question is ” what was the purpose or object of the transaction ? ” But it does not follow that, in deciding what was the purpose of the transaction, the motives or intentions of the parties to that transaction are immaterial. A seller of religious tracts who travels from door to door selling his wares, appears to be conducting an ordinary business of sale and purchase. Yet if his object is to engage the customer in religious discussion so as to spread the gospel that intention is decisive and the selling of the tracts does not constitute trading : Religious Tract and Book Society of Scotland vs. Forbes (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 (supra); Coates vs. Arndale Properties Ltd. (supra) and Overseas Containers (Finance) Ltd. vs. Stoker (supra).
30. 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 vs. 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 their implementation. But, in my judgment, other authorities show that evidence of the subjective intention of the parties is admissible and relevant.
31. In Lupton’s case (supra), Viscount Dilhorne held that, in deciding whether a transaction was a trading transaction, regard must be had to the whole transaction. Lord Donovan, at p. 658B, held that it was wrong to regard as irrelevant the fact that fiscal advantage was in view. Lord Simon of Glaisdale said, at p. 660 : ” (3) share-dealings and other business transactions vary almost infinitely ; and to determine whether the transaction is, on the one hand, a share-dealing which is part of the trade of dealing in shares or, on the other, merely a device to secure a fiscal advantage, all the circumstances of the particular case must be considered ; (4) a share-dealing which is palpably part of the trade of dealing in shares will not cease to be so merely because there is inherent in it an intention to obtain a fiscal advantage, or even if that intention conditions the form which such share-dealing takes ; (5) what is in reality merely a device to secure a fiscal advantage will not become part of the trade of dealing in shares just because it is given the trappings normally associated with a share-dealing within the trade of dealing in shares ; (6) 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 . . “
32. In my judgment, Lord Simon’s proposition (6) plainly shows that the ” paramount object ” to which he is referring may be ascertained even though ” the appearance ” of the transaction does not demonstrate what the paramount object of the transaction was.
33. In Iswera vs. Inland Revenue Commissioners (1965) 1 W. L. R. 663 the Privy Council plainly regarded the subjective intention of the taxpayer, i.e., to have a house close to her daughter’s school, as being relevant and admissible in determining whether she was trading. In Reed vs. Nova Securities Ltd. the Crown were criticised in the Court of Appeal (1984) 1 W. L. R. 537 and the House of Lords (1985) 1 W. L. R. 193 for failing to require the taxpayers to prove their case since, if they had been required to do so, the Crown might have elicited in evidence the taxpayers’ intentions in entering into the 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.
34. 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 ?
35. 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, the commissioners were fully entitled to have regard to the motives or intentions of the Victory Partnership in deciding whether the purpose of the transaction was a commercial one. The relevance of the taxpayer company’s intentions:
36. As I have said, the judge criticised the commissioners for having regard to the motives or intentions of the taxpayer company since the question was not whether the taxpayer company had been trading but whether the Victory Partnership was trading. In my judgment, such criticism is justifiable only to the extent that the commissioners were relying on the taxpayer company’s intentions as such, rather than as evidence of the intentions of Victory Partnership. Although the commissioners never spelt this out in so many words, in my judgment it is clear that they were relying on the taxpayer company’s intentions only to the extent that they provided evidence as to the intention of Victory Partnership. The commissioners were in no doubt as to the correct question they had to ask themselves-they twice expressed it correctly” whether the two limited partnerships were trading having considered all the evidence adduced before us ? ” They then considered all the matters in question, including the motives or intentions of the taxpayer company, before reaching their final conclusion that the Victory Partnership was not trading.
37. Given that subjective intention was material, the relevant intention must be that of the Victory Partnership itself as the party which entered into the transactions. The taxpayer company and the four other enterprises who joined in the scheme were all partners in the Victory Partnership and their intentions, together with that of the fifth
partner, Victory Productions, must together constitute the intentions of the partnership. The partnership itself did not come into existence until the same day, 14th July,, as that on which the allegedly trading transactions took place. The taxpayer company and the four other companies had acquired the tax deferral scheme from Guinness Mahon. In the absence of other evidence as to the intentions of the other sleeping partners, the commissioners were fully entitled to infer that their intentions were the same as those of the taxpayer company. As to the sixth partner, Victory Productions, its management was controlled by Guinness Mahon and Mr. Wilde and the commissioners 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.
38. 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 :
39. 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. vs. Stoker (supra). 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 a question of fact for the commissioners, not a question of law ; (3) if the commissioners find as a fact that the sole object of the transaction was fiscal advantage, that finding can in law only lead to one conclusion, viz., that it was not a trading transaction. Since a fiscal advantage was the sole purpose there is no place for there being any commercial purpose ; (4) if the commissioners find as a fact only that the paramount intention was fiscal advantage, as a matter of law that is not decisive since it postulates the existence of some other purpose, albeit not paramount, which may be commercial. In such a case, the commissioners have to weigh the paramount fiscal intention against the non-fiscal elements and decide as a question of fact whether in essence the transaction constitutes trading for commercial purposes. Therefore, on its face, the commissioners’ decision purporting to reach their conclusion as one of law is erroneous.
40. The Crown, however, submitted that whatever words the commissioners used they were not misdirecting themselves in law but were reaching an overall decision of fact after weighing the various elements. I am unable to accept this. There is substance in the judge’s criticism that in the long section of their decision headed “conclusion” they are dealing almost exclusively with the subjective intentions of the parties and do not expressly refer to those factors which might point the other way, e.g., the possibility that if the film were a major “hit” a commercial profit to Victory Partnership would have accrued and the fact that a large sum of money had been invested by the partners in the transaction. Since the decision does not clearly show that the misdirection was only verbal but may have represented a misunderstanding as to the basic law, in my judgment the case must be remitted to the commissioners.
41. Since the case is far from straightforward, it may be helpful to the commissioners if we give some guidance as to how they should approach this case, especially as there are other points beyond those I have already dealt with which have been dealt with by the judge and have been argued before us. What is the ultimate question ?
42. When a transaction contains some element of trade but also a paramount fiscal objective, how should the commissioners approach the question ” was this a trading transaction ? ” 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 (supra), (” 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 vs. 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 the transaction was not trading despite the possibility of profit. So, in the present case, the mere fact that there was a possibility that Victory Partnership might make a truly commercial profit if the film, were a great success does not preclude a finding that it was not a trading transaction.
43. In my judgment, the relevant questions (adapted from propositions (4) and (5) of Lord Simon’s speech in Lupton’s case (supra) are these : was this a transaction which was palpably part of the trade of engaging in film production ? If so, it will not cease to be so because there was an intention to obtain a fiscal advantage, even if that intention conditioned the -form of the agreements. Or was it in reality merely a device to secure first-year allowances on 100 per cent. of the film ? If so, it will not be trading notwithstanding that the documents and terms were normal in commercial transactions of the same kind. If the matter is in doubt, the intentions of the Victory Partnership will be relevant and may be decisive. I must emphasise that it is the intentions of the Victory Partnership, not those of L. P. I. which are relevant. Although it is right to take into account the position of a third party, the relevant question is whether the transactions constituted trading by the partnership. In relation to the same transaction, one of the parties may be trading but the other not. Where a private individual sells his investments to a share dealer, he is not trading but the share dealer is. It is the nature of the transaction viewed from the position of the taxpayer (or in this case the partnership) that is relevant: see Lupton’s case, per Viscount Dilhorne, at p. 654C, and Thomson vs. Gurneville Securities Ltd. (1972) AC 661, 678B, per Lord Simon of Glaisdale.
It is not legitimate to argue, as did the judge, (a) that if Victory Partnership had bought a 25 per cent. equity share in the film, that would have been trading and therefore (b) since the actual transaction effected merely recast that financial transaction in a different, fiscally advantageous, structure the recast transaction must itself constitute trading. As I understand the commissioners’ findings, Victory Partnership would never have entered into a transaction to buy only a 25 per cent. equity share. It was an essential ingredient of the scheme devised by Guinness Mahon that 100 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 vs. 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 (supra) 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 in the commercial world and carried out in a similar way. (2) In addition to the outward badges of trade, in order to be a trading transaction its purpose must be commercial. (3) The question ” was it trading ? ” is a question of fact for the commissioners. (4) In deciding that question, the commissioners must look at the transactions as a whole including the steps taken for its implementation. (5) The commissioners must decide whether the transaction was in reality merely a device to secure a fiscal advantage or a genuine trading activity. (6) The ultimate question always remains ” what was the purpose of the transaction ? ” That question will normally be answered by an objective analysis of the transactions viewed as a whole. (7) If the appearance of the matter, as shown by an objective analysis of the transactions, is equivocal, the subjective intention of the taxpayer is relevant in determining the purpose of the transaction and will generally be decisive. (8) A transaction can be equivocal and therefore evidence of subjective intention relevant even if there was a possibility of the transaction producing a commercial profit-as opposed to a tax benefit-to the taxpayer. (9) Although the purpose of the other party or parties to the transactions, being part of the circumstances, is relevant, the question in each case is whether the taxpayer was trading. Just because the other party to the transaction in question may have no fiscal object and viewed from his angle the transaction is one by way of trade, it does not follow that the taxpayer as a party to the same transaction is also engaged in trade. (10) If the sole purpose of the transaction is to gain a fiscal advantage, in law that cannot amount to trade. (11) If the transaction has some commercial features but also an element of fiscal advantage, it is for the commissioners to weigh the conflicting elements to decide whether the transaction was entered into by the taxpayer for essentially commercial purposes but in a fiscally advantageous form or essentially for the purpose of obtaining a fiscal advantage under the guise of a commercial transaction. In the former case, the transaction would constitute trading; in the latter it will not.
48. For these reasons I would allow the appeal and remit the case to the commissioners to reconsider their decision in the light of our judgments.
49. That is 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 :
50. The judge held that the principle in W. T. Ramsay Lid. vs. 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 for the resons which he has given this appeal should be allowed and the case remitted to the special CITs. I add only one comment of my own It seems to me helpful to keep two questions separate : (1) whether the transaction was a trading transaction : and (2) whether in entering into it Victory Partnership was “carrying on a trade.” The first question naturally comes first, because unless the transaction was a trading transaction, the second question cannot arise. The first question must, if possible, be determined objectively, and the motives of the parties are initially irrelevant. If the true nature of the transaction cannot be determined, its paramount object must be examined. For my past, I should be thought that the ascertainment of the paramount object of the transaction is also an objective process. But it is at this stage, when other features of the case are taken into account, and the paramount object of the transaction may not prove decisive, that the second question falls to be considered. In answering it, evidence, that the second question falls to be considered. In answering it, evidence of subjective intention should be obviously play its part : Iswara vs. IRCs (1965) 1 WLR 663 and Reed vs. Nova Securities Ltd. (1985) 1 WLR 193. The fact that a person entered into a transaction with a predominantly fiscal intention may assist of the transaction, to determine whether by engaging in it that person can properly be said to have been “carrying on a trade”. That is the question which the CITs must answer here.
[Citation : 191 ITR 419]
