Ingenious: genuine trading endeavour or MacGuffin?

On 26 July 2019, the Upper Tribunal (UT) issued its judgment in the appeal of the First-tier Tribunal’s decision in Ingenious Games LLP, Inside Track Productions LLP, Ingenious Film Partners 2 LLP v HMRC. In that appeal, the appellant LLPs challenged decisions of the FTT (on 2 August 2016 and then 17 May 2017) that denied income losses which the LLPs had claimed as arising in a film production trade.

Commercial reality

The decisions of the UT and the FTT amount to more than 500 pages but, at heart, they both consider the nature of the LLPs’ activities and whether they amounted to a genuine trade.

Alfred Hitchcock referred to a MacGuffin as a device that has no intrinsic importance but which propels the plot. It does not matter whether it is a Maltese Falcon or a looming meteor; it only matters that it offers a plausible reason for the on-screen adventure. Similarly, the question in this case – perhaps a way of understanding all supposed tax avoidance arrangements – was whether there was an earnestly pursued trade of producing films or whether that was simply a convenient MacGuffin that allowed the LLPs to generate a tax loss.

The LLPs argued that the arrangements reflected a genuine, and successful, involvement in a volatile industry. HMRC argued that the LLPs had no interest in the films being produced; they were just props in the pursuit of a tax loss.


The precise arrangements were complex but, in overview, the LLPs operated film financing arrangements as follows (there were also arrangements involving video games, which were similar):

  • A studio or independent producer (referred to below as the distributor) contracted with an LLP to make the film and the LLP sub-contracted the production to a special purpose vehicle associated with the distributor (referred to below as the PSC);
  • The LLP paid the PSC 30% of the costs which it sourced from members’ capital contributions;
  • The PSC received the remaining 70% directly from the distributor, although it was expressed to be a loan by the distributor to a corporate member of the LLP that was contributed to the LLP;
  • The PSC assigned its rights in the film to the LLP and the LLP licensed or assigned its rights in the film to the distributor; and
  • The completed film was distributed by the distributor and the LLP received a share of the proceeds of distribution under a "waterfall" agreement with the distributor.

The LLPs argued that they had incurred 100% of the expenditure in acquiring films as trading stock. The value of the film was written down given the uncertainty of a successful project, which meant that the trade generated substantial first-year losses. Assuming the LLPs were transparent for tax purposes, those losses could be accessed by the members and set off against other income by way of sideways loss relief (under ICTA 1988 s 380 and, subsequently, ITA 2007 s 64).

The decisions of the FTT and the UT therefore revolved around two key questions:

1. Were the LLPs carrying on a trade in which they incurred a loss (the trading issue)?
2. In order for the LLPs to be treated as transparent so that members could access those losses, was that trade carried on with a view to profit (the view to profit issue)?

Decision of the FTT

The FTT considered that the arrangements could not be characterised as a 100% investment in a film. The fact that part of the expenditure was sourced from a loan was not in itself a problem but, in this case, the agreements were a "single package to be construed as one composite agreement". Under this "composite agreement", the LLPs never had any genuine requirement to pay the 70% that was funded by the distributor. For example, any obligation on the LLPs to make payments to the PSC was contingent on the distributor having already provided funds to the PSC directly. Similarly, the LLPs could only ever receive 30% of the receipts from the films.

The FTT therefore concluded that this "composite agreement" could only be treated, and only made any economic sense, as a 30% investment. This is referred to in the decision of the UT as the "30:30 basis".

Accordingly, the FTT held that the LLPs were trading and were doing so with a view to profit but only on the 30:30 basis.

In fact, the LLPs were not ultimately able to secure losses, even on that 30:30 basis, because in a further decision on 17 May 2017, the FTT held that the expenditure in question was not capable of giving rise to an income loss because it was capital in nature.

Contractual construction

The starting point for the FTT and the UT was to understand the effect of the contractual arrangements.

The FTT relied on Ensign Tankers (Leasing) Ltd v Stokes [1992] 1 AC 655 to justify treating the arrangements, on "normal" principles of construction, as a "composite agreement".

However, as was pointed out in my article following the FTT’s decision, Ensign Tankers did not appear to be applying normal principles of construction. Rather, Ensign Tankers appeared to adopt a Ramsay approach in construing the arrangements against the statute. What the FTT seemed to be doing was applying Ramsay to the construction of contracts (without reference to a statutory context) and that was questionable.

The UT had similar concerns. The UT also considered that Ensign Tankers was adopting an early Ramsay approach and that it was not possible to treat the arrangements as a "composite agreement" on normal principles of contractual construction.

Although it rejected the composite agreement approach, the UT did consider that where a number of contracts are entered into together, the other contracts form part of the "factual matrix" in construing any one of them (the term used by Lord Neuberger in Wood v Capita). The court’s role was to identify the intention of the parties by reference to all the background knowledge – that is, the full "factual matrix" – available to the parties (see Arnold v Britton [2015] AC 1619 at para 15). Where there is in truth a single transaction, the court is entitled to read the contracts together for the purpose of determining their legal effect.

Arguably, that is not much of a difference. Both the FTT and the UT focus on similar aspects of the arrangements: whether the LLPs ever had a real payment obligation (not beyond 30%) or ever held any rights in the films (it had no more than a shell of ownership).

Crucially, however, the UT’s analysis of the arrangements meant that it reached a different position on both the trading issue and the view to profit issue.

The trading issue

The FTT had concluded that the LLPs were trading on the 30:30 basis. The UT did not agree that this was justified. The arrangements, properly construed, showed that film production was largely irrelevant. If (as the FTT had in fact found) the LLPs were largely just acquiring an income stream and were not producers of films, then there was no justification for coming to a different conclusion on the 30:30 basis. That was not the basis on which the parties had actually transacted.

For the UT, on normal principles of construction, the LLPs had little or no involvement in a film venture that had effectively been used to dress up the acquisition of a potential income stream.

The UT considered that the FTT had made other errors. In particular, the FTT’s reliance on the traditional "badges of trade" was misleading. The fact that activities were organised, repetitive and complex did not necessarily mean there was a trade. In particular, the UT noted that the complexity of the LLPs’ arrangements in respect of independent films "tipped the balance" towards a trading activity, but the UT disagreed that complexity made any difference.

One area that caused the UT some difficulties, as it did the FTT, was Ensign Tankers, in which an apparently similar arrangement was treated as a trading transaction. In the end, the UT seemed largely to decide that the judgment in Ensign Tankers depended on the fact that the partnership had acquired and owned the master negative to the film. By contrast, the LLPs never really had any film ownership rights.

Although the decisions of the FTT and the UT are otherwise closely argued, that is not an especially convincing conclusion. It is difficult to believe the partnership in Ensign Tankers could do anything (or, frankly, had any interest in doing anything) with the master negative to the film.

The view to profit issue

Even though the finding on the trading question was determinative, the UT went on to consider whether the LLPs were acting with a view to profit, such that they were treated as transparent for income tax purposes under ITTOIA 2005 s 863(1).

The FTT had considered that this was a subjective test but with an objective element. Even if the LLPs had no conscious profit motive, one might be assumed if there was a realistic prospect of profits arising.

In practice, this comes back to the FTT’s view of the arrangements on the 30:30 basis. The FTT could see no prospect of a profit on the basis of a 100% investment, but it accepted that profits were realistic assuming a 30% investment.

The UT disagreed. Profit did not need to be the predominant motive, but it did need to be subjectively intended. It could not be derived from an objective calculation of whether profit was realistic.

Of course, objective evidence may provide a reality check. Profit may be so inevitable that it must be treated as a purpose or, conversely, claims for a subjective profit motive may not be supportable by reference to the wider commercial context.

In this case, the UT saw no evidence of a subjective motive. The controlling minds of the LLPs had given little thought to the profitability of the arrangements. The LLPs might have been interested in revenue and would certainly have welcomed profit, but there was nothing to suggest it was a material consideration.

The fact that the arrangements might realistically be profitable on the 30:30 basis was irrelevant. The LLPs had engaged on the basis of a 100% investment. The LLPs might have known they could only make a profit on the 30:30 basis, but that is irrelevant to whether there was a view to profit on the terms that were actually entered into.

What next?

For all the UT’s concerns with the FTT’s decision, there is little disagreement as to how the arrangements should be characterised. The UT’s conclusions depended on the meticulous analysis carried out by the FTT.

The real difference is that the UT did not agree that because the LLPs understood the commercial deal on a 30:30 basis, the arrangements could therefore be rewritten as a genuine trading deal on those terms.

For the UT, this was an investment in a potential income stream in order to realise a tax relief. The film production activities provided an eye-catching reason for asserting that there was a trade, but there was no genuine involvement of the LLPs in any trade.

The LLPs and its investors might complain that the position taken on the trading issue and the view to profit issue goes much further than has ever been considered previously. They might be right. Neither the FTT nor the UT dealt convincingly with Ensign Tankers.

Given the factual findings of the FTT (as repurposed by the UT), achieving a different outcome in a higher court may well be a struggle.

The lesson for others involved in similar arrangements is to understand whether the apparent commercial objective of the arrangements is a genuine endeavour of the taxpayer or just a MacGuffin that props up a claim for tax relief.

This article was first published by Tax Journal.