On 13 April 2015, the Supreme Court refused investors in the Eclipse 35 LLP (“Eclipse”) permission to appeal against an earlier decision of the Court of Appeal which concluded that Eclipse was “not commercially trading with a view to make any profit”. Lord Neuberger remarked at the oral hearing that “(w)e have heard nothing that persuades us that the Court of Appeal went wrong in this case.”
In Eclipse Film Partners No. 35 LLP v The Commissioners For HMRC  EWCA Civ 95, the Court of Appeal dismissed the taxpayer’s appeal and affirmed the First Tier Tribunal’s (“FTT”) and Upper Tier Tribunal’s (“UTT”) earlier decisions, on the basis that Eclipse was “not commercially trading with a view to make any profit”.
Eclipse formed part of a distribution scheme set up in 2007 to exploit rights over the films “Enchanted” and “Underdog”. Some 289 investors invested £840m into Eclipse, funded by way of a loan from a Barclays group company for £790m and £50m from their own resources. A licence was granted to Eclipse by Walt Disney Pictures (“Disney”) under which licence fees of £503m were paid. In addition, a consultancy fee of £44m was paid to Future Films Limited. Eclipse paid the investors in aggregate £293m as loans against future income profits which the investors used to prepay in aggregate £293m in interest, as a means of sheltering tax liabilities. Eclipse entered into a sub-licence with a distributor under which the distributor would pay a) annual distributions totalling £1,022m over 20 years, and b) further sums should gross receipts from the exploitation of the films exceed a certain threshold (“contingent receipts”).
On the proper meaning of “trade”, the Court of Appeal affirmed the FTT’s finding that the transactions, although commercially real, and not a “sham” as alleged by HMRC, lacked the speculative nature and element of risk indicative of a trade (the Court of Appeal dismissing that speculation was a requirement of a trade). Of importance was also that Eclipse failed to retain any substantive film rights on termination of the licensing agreement, a factor which led the court to distinguish the current scheme with a sale and leaseback series of transactions. The Court of Appeal dismissed the taxpayer’s submission that the acquisition of film rights and the sub-licencing of those rights inherently points to the carrying on of a trade.
Interestingly, in determining whether Eclipse was carrying on a trade, the Court of Appeal stripped the transactions back to their basic elements while focusing on the activity and enterprise that was carried out as a whole.
At its core, the payment of £503m by Eclipse produced a profit entirely unrelated to the success of the exploitation of the film rights that were sub-licensed, and the Court of Appeal held that this had the character of an investment, not a trade. Although the film rights had a real value, the court agreed with the FTT that the prospect of receiving any contingent receipts was so remote as to be insufficient to confer trading status. The Court of Appeal reiterated that the fact that the contractual documents were heavily negotiated did not in itself point to a trading activity. Indeed, the documents had commercial reality but importantly, the agreements were heavily one-sided in favour of Disney, imposing specific legal conditions on the recoverability of contingent receipts. The distribution agreement gave the distributor full rights over the distribution, marketing, advertising, exploitation or otherwise of the films, and Eclipse’s rights were also subject to prior agreements with the Disney group that Eclipse had not seen. The Court of Appeal agreed with the FTT that this showed an “indifference” on the part of Eclipse about the value of the film rights being acquired, with the right to receive the contingent receipts being more akin to receiving a possible return on an investment.
The Supreme Court’s refusal to hear the appeal affirms the earlier robust decision of the Court of Appeal marks the latest legal setback for the investors in Eclipse, and will have significant implications for investors in other film schemes. It also means that the earlier Court of Appeal decision will set the tone for similar schemes being challenged by HMRC, particularly where the fact-finding tribunal has held that the activity was not trading. It remains to be seen whether HMRC will use this as an opportunity to issue follower notices to other taxpayers who participated in film schemes designed after the statutory rules which permitted sale and leaseback schemes had been withdrawn.
The decision could significantly impact those professionals (and their insurers) that advised investors in such schemes. It does not automatically follow that the failure of an investment or scheme to defer tax means that an adviser has been negligent. Most of the investors in such schemes will have been sophisticated wealthy investors who appreciated the risks. But claims are inevitable given the amounts likely to be at stake.
A link to the earlier Court of Appeal decision can be found here.