The partners in a film tax scheme, Gala Film Partners LLP, have lost a dispute with HMRC over whether its losses of £110m were a true interpretation of the trading position
Members of the Gala Film Partners LLP went to the First Tier Tribunal (FTT) to reject amendments made by HMRC to its partnership tax return for the 2003/04 tax year related to film schemes offered to high net worth investors for involvement in the distribution of Sony Corporation films.
The case took years to be get to the tribunal and it was heard eventually over a four-week period in November to December 2021, however a decision has only just been released after 20 months.
The main points at stake were that in a closure notice dated 28 August 2015, HMRC asserted that Gala did not, as it had claimed, incur a loss in that tax year of £110,755,060 in the course of carrying on a trade of film distribution and that it had taxable profits of £552,570.
Gala was set up by Invicta Capital Limited on 7 May 2003 and was run by CEO and chair, Mohammed Yusef as a vehicle for high net worth individuals to invest in arrangements devised by Invicta. The scheme related to the distribution of films produced by entities linked to Sony Corporation.
Under licence agreements, Gala would acquire the rights in the films for 21 years, including cinema release, DVD, subscription TV and a terrestrial TV window.
Each scheme participant had to invest £10m in the partnership, the majority of which could be loaned back to the individual with a limit of £7.75m through a bank loan from Société Générale. The tribunal documents indicate that initially there were 35 investors.
Long running deals with the studios meant that annual royalties would be paid to the partnership and from year eight, the participators’ loans would be repaid.
As it was expected that no distribution income would be received by the partnership until its second period of trading the partner’s share of the first year’s trading loss would be £10m.
By utilising section 380 and 381 of Income Tax Act (ICTA) the partner would be able to claim tax relief at 40%, assuming the income they were setting the trading loss against was taxable at 40%, the scheme details suggested.
The distribution deal with Sony only lasted three years which meant that the members received a net benefit purely from tax relief of approximately £1m, described as the ‘tax benefit’ by HMRC. If the scheme had run for eight years, the investors would have made a loss as the original proposal outlined.
HMRC argued that it was inevitable from the outset that the call option would be exercised at the first opportunity (as it was) so that the members would suffer only a capital gains tax (CGT) charge on the option price and thereby obtain the tax benefit. In their view, that was ‘the only realistic way of the members making a return from their investment in Gala’.
‘It was an inherent feature of the scheme that it would be wound up in a manner which attracted a CGT charge, on the price paid on the exercise of the call option, rather than an income tax charge (as would apply to the final “minimum amount”) thereby ensuring that the individual investors would (if the scheme worked as intended) be able to make a profit on their cash contributions purely from tax relief,’ HMRC stated.
Gala disputed that they could not have known Sony would wind up the distribution deal early so that the tax benefit would be realised.
The tribunal ruled that ‘Gala did not carry on any trade and if, contrary to our view, it did carry on a trade, it did not do so with a view to profit’.
HMRC has accordingly sought to disallow the loss and considers that Gala’s turnover for the 2003/04 tax year is taxable under Case VI of schedule D.
In one of the longest judgments released this year, at 364 pages, the tribunal reviewed relevant cases before determining its ruling.
The tribunal found that ‘the members are not entitled under s353 ICTA to claim relief for interest paid on the Société Générale loans on the basis that a necessary condition for relief to apply is not met. The monies borrowed by the members and contributed to Gala were not “used wholly for the purposes of the trade” as required for relief to apply under s 362(1)(b)’.
They also said that Gala did not account for losses incurred due to expenditure and transactions correctly under GAAP accounting rules.
The appellants have the right to appeal.