Spc00696

Income tax – limited liability partnership – investment in films – expenditure on the acquisition of the master negative of a film – whether deduction under s 42 F(No 2)A 1992 precluded by s 101 FA 2002 – no – date of commencement of partnership’s business and basis period applicable – s 40B(3)(b)(ii) F(No 2)A 1992 – whether any part of acquisition expenditure on films to be disallowed – no – whether film consultancy fees incurred deductible – yes 

THE SPECIAL COMMISSIONERS

	HALCYON FILMS LLP	Appellant

	- and -

	THE COMMISSIONERS FOR HER MAJESTY’S
	REVENUE AND CUSTOMS	Respondents

		Special Commissioners: 	EDWARD SADLER
						JOHN CLARK

Sitting in public in London on 18 – 22 and 25 – 26 February 2008

Jonathan Peacock QC and Jolyon Maugham, instructed by DLA Piper, for the Appellant

Ingrid Simler QC and Andreas Gledhill, instructed by the General Counsel and Solicitor for HM Revenue and Customs, for the Respondents

© CROWN COPYRIGHT 2008

DECISION

Introduction
1.	The appellant in this appeal is the limited liability partnership, Halcyon Films LLP (“Halcyon”).  Halcyon carries on a trade or business which consists of or includes the exploitation of films, and in relation to that trade has claimed a loss in its tax return for the year to 5 April 2004 of £14,021,371, which Halcyon claims it incurred in its accounting period ending on 5 April 2004.
2.	That loss of £14,021,371 comprised a claim for relief under the special provisions relating to expenditure incurred on films and a loss in computing profits arising by reason of the payment of fees to LM Investments Limited (“LMI”) for film consultancy services.  In detail:
(1)	Halcyon claimed relief totalling £12,183,932 in respect of its expenditure on the acquisition of three films entitled Asylum, Method, and Samantha’s Child (together referred to as the “Films”).  Relief for this expenditure on the Films was claimed under section 42 Finance (No 2) Act 1992 (“section 42”); and
(2)	Halcyon claimed a trading loss of £1,837,439 of which £1,805,592 was attributable to fees paid to LMI.
3.	On 18 January 2007 the Commissioners for Her Majesty’s Revenue and Customs (“HMRC”) issued a closure notice (carrying the incorrect date “2006”) amending Halcyon’s return by disallowing its claim to relief under section 42, and disallowing all but £240,760 of the loss claimed as a trading loss.  On 25 January 2007 Halcyon appealed against that closure notice, and it is that appeal which is now before us.  
4.	The case as argued before us by HMRC at the hearing of the appeal is that the whole of the trading loss claimed by Halcyon should be disallowed.  Since this is beyond the scope of the amendments made to Halcyon’s tax return by the closure notice, that raises certain procedural questions referred to at the end of this decision, although in the light of our decision in respect of the trading loss those questions are no longer germane.
5.	This appeal concerns a number of distinct issues for our determination.  The parties asked that we should deal with those issues in principle only, rather than attempt to reach a decision by reference to the detailed figures, leaving it to the parties to resolve the figures so as to give effect to our decisions in principle.  We have agreed to proceed on that basis.
6.	Finally by way of introduction, we should mention that this appeal was heard immediately following an appeal we heard by the limited liability partnership Micro Fusion 2004-1 LLP (“Micro Fusion”), where two of the issues in this appeal (the Commencement issue and the Deductibility of Fees issue, as referred to below) were in substance the same as the corresponding issues in the Micro Fusion appeal and were argued on the same basis (but of course by reference to the different facts applicable to the respective appeals).
The issues requiring a decision and our decision in summary
7.	The parties identified four issues which require our decision:
(1)	Whether Halcyon is precluded from claiming relief under section 42 by reason of s 101 Finance Act 2002 (“section 101”) (the Section 101 issue”).  This issue goes to Halcyon’s entitlement to relief under section 42;
(2)	Whether, if Halcyon is entitled to relief under section 42, it commenced its trade or business which consists of or includes the exploitation of film on 31 March 2003, and if it did not, the date on which that trade did commence.  Related to this is the question of the proportion of the expenditure which Halcyon incurred on the acquisition of the Films which can be claimed for relief in the tax year 2003/04 by the application of s 40B(3) Finance (No 2) Act 1992 (“F(No 2)A 1992”) in the situation where Halcyon commenced its trade part-way through that tax year (these related issues are together the “Commencement issue”).  This issue goes only to the period in which relief can be claimed and the amount of that relief claimable for the tax year 2003/04;
(3)	Whether, if Halcyon is entitled to relief under section 42, the whole of the expenditure which Halcyon claims was incurred on the acquisition of the master negatives of the Films qualifies for relief, or whether part of that expenditure falls to be disallowed on the basis that it is expenditure on matters not comprising the acquisition costs of the Films (the “Disallowance issue”).  This issue goes to the quantum of relief which can be claimed; and
(4)	Whether the fees of £1,805,592 incurred by Halcyon to LMI were properly deductible in the calculation of the profits of Halcyon’s trade for the purposes of its tax return for the tax year ended 5 April 2004 (the “Deductibility of Fees issue”).  This issue goes to the quantum of the loss claimed by Halcyon for that tax year.
8.	In summary our decision is as follows:
(1)	As to the Section 101 issue, Halcyon is not precluded from claiming relief for its acquisition expenditure on the Films under section 42 by reason of section 101, since section 101 applies only to deny relief for the whole of the acquisition expenditure in the year of its expenditure which would otherwise be claimed by reason of s 48 Finance (No. 2) Act 1997 (“section 48”);
(2)	As to the Commencement issue, Halcyon’s trade or business which consists of or includes the exploitation of film commenced not on 31 March 2003, but on 9 December 2003.  For the purposes of the proportion of expenditure which can be claimed as relief in the tax year 2003/04 the relevant period as determined by s 40B(3) F(No 2)A 1992 is the period 9 December 2003 to 5 April 2004;
(3)	As to the Disallowance issue, the whole of the expenditure which Halcyon claims as expenditure on the acquisition of the master negatives of the Films qualifies for relief under section 42 and no part of that expenditure falls to be disallowed for the purposes of such relief; and
(4)	As to the Deductibility of Fees issue, the fees of £1,805,592 incurred by Halcyon to LMI were properly deductible in the calculation of the profits of Halcyon’s trade for the purposes of its tax return for the tax year ended 5 April 2004.
The agreed facts – an outline of the factual background to the appeal
9.	The parties agreed certain facts, which are set out in paragraphs 10 to 26 below and they serve by way of outline of the factual background to the appeal.  Each of the issues we are required to decide (other than the Section 101 issue, which is a matter of statutory construction and therefore of law only) turns largely upon the facts as we found them from the evidence presented to us, and therefore our detailed findings of fact relevant to each issue are set out in the respective sections of this decision.
10.	Halcyon was incorporated as a limited liability partnership on 25 March 2003 under the name Fusion 2003-2 LLP and was renamed Halcyon Films LLP on 24 November 2003.  
11.	In outline, during the tax year ending April 2004, Halcyon acquired three films, Asylum, Method and Samantha's Child, and leased each film back to the relevant vendor in return for minimum lease rentals and a share of the profits. (For the sake of completeness – although the point is not material to the appeal - it should be noted that the lease in respect of Asylum was subsequently novated by the lessee to another entity, Capital Services Limited, under the terms of a Deed of Novation dated 28 July 2004.  Therefore, with effect from 28 July 2004, the lessee of Asylum was an entity other than the relevant vendor). 
12.	The Department for Culture, Media and Sport ("DCMS") issued Certificates, in accordance with Schedule 1 to the Films Act 1985, in relation to (1) Method on 18 May 2004, (2) Samantha's Child on 22 June 2004 and (3) Asylum on 21 July 2004, certifying, in each instance, that the master negative, master tape or master disc of each film is a qualifying British Film for the purposes of s 40B Finance (No.2) Act 1992 and section 42 and section 48.
13.	In March 2003, Halcyon entered into a Film Consultancy Agreement (the “FCA”) with LMI under which LMI agreed to provide consultancy services to Halcyon.  The services to be provided were set out at Schedule 1 to the FCA. 
14.	Clause 7.1 of the FCA provided for LMI to be paid £152,414 in respect of the services provided under the FCA.
15.	LMI submitted four invoices to Halcyon (the following amounts are VAT exclusive):
(1)	an invoice dated 19 June 2003 for £152,414.44;
(2)	an invoice dated 21 June 2004 for £475,309;
(3)	an invoice dated 30 June 2004 for £374,538;
(4)	an invoice dated 2 August 2004 for £803,331. 
16.	On 31 March 2003, Halcyon entered into an Exclusive Acquisition and Financing Agreement ("EAFA") with International Motion Picture Development and Consultancy Limited ("IMPDC"), pursuant to which Halcyon agreed to acquire certain rights from IMPDC for the purpose of financing and distributing the films to which the rights related (under Clause 1 of the EAFA), namely Murders in the Rue Morgue and Grey.  Under Clause 2.1 of the EAFA, Halcyon agreed to use all reasonable efforts to raise finance with a view to commencing production of the films by 31 December 2003.
17.	The film Asylum was directed by David McKenzie, with a script by Patrick Marber and it starred Natasha Richardson, Sir Ian McKellen and Joss Ackland. It was released on 9 September 2005. 
18.	On 9 December 2003, Seven Arts Pictures Inc ("Seven Arts") entered into a sale and purchase agreement ("the Sale Agreement") with Halcyon in relation to Asylum.  Under the terms of the Sale Agreement :
(1)	Seven Arts, as legal and beneficial owner of the original master negative of the film entitled Asylum, its sound track and the Rights (as defined in Schedule 3 to the Sale Agreement), sold the Delivery Material (as defined in Schedule 1 to the Sale Agreement), subject to prior agreements, and licensed the Rights to Halcyon for an amount equal to the Film Acquisition Price; and
(2)	Seven Arts entered into an agreement to hire the right title and interest in the Master Print (this being defined as the Delivery Material and the Rights) from Halcyon under the terms of a leasing agreement (referred to as the "Film Lease").  Seven Arts' rights and obligations under this agreement were novated to Capital Services Limited by Deed of Novation dated 28 July 2004.
19.	On 5 April 2004, a Deed of Amendment relating to the film Asylum was entered into by Seven Arts and Halcyon.  The Deed of Amendment amended the Film Acquisition Price (which was £22,571,647) to "£21,356,853 or such lesser amount as shall be certified by Shipleys [a firm of chartered accountants] as being the Costs of the Film to the Seller in accordance with Clause 2.1(vii) of the Sale Agreement".  Pursuant to Clause 2.1(vii), Seven Arts was obliged to provide Halcyon with, inter alia, a certified statement for the film as stipulated by Shipleys which reflected the total cost in relation to the Film as recorded in the books of Seven Arts as seller, together with written confirmation from Shipleys that such statement had been prepared in accordance with the relevant sections of HMRC’s Business Income Manual on Expenditure on Film and Audio Products and the relevant Statement of Practice issued by HMRC.  A statement to this effect was received from Shipleys on 30 July 2004.  A conditions precedent waiver letter was sent by Halcyon to Seven Arts on 5 April 2004.  This provided that all the conditions precedent set out in Clause 2.1 of the Sale Agreement had been satisfied or waived and that Halcyon agreed to pay the Film Acquisition Price to Seven Arts on or before the Payment Date.  
20.	The film Method was directed by Duncan Roy and it starred Elizabeth Hurley.  It was released on 24 June 2004. 
21.	On 9 December 2003, Pueblo Films Releasing Limited ("Pueblo") entered into a sale and purchase agreement ("the Sale Agreement") with Halcyon in relation to Method.  Under the terms of the agreement:
(1)	Pueblo, as legal and beneficial owner of the original master negative of Method, its sound track and of the Rights (as defined in Schedule 3 to the Sale Agreement), sold the Delivery Material (as defined in Schedule 1 to the Sale Agreement), subject to prior agreement, and licensed the Rights to Halcyon for an amount equal to the Film Acquisition Price; and
(2)	Pueblo hired the right title and interest in the Master Print (this being defined as the Delivery Material and the Rights) from Halcyon under the terms of a leasing agreement (referred to as the "Film Lease").
22.	The Film Acquisition Price means £8,313,417 or such other amount as advised by Malde & Co. [a firm of chartered certified accountants] in writing prior to 1 March 2004.  Pursuant to Clause 2.1.6, Pueblo was obliged to provide Halcyon with, inter alia, a certified statement for the film as stipulated by Malde & Co. which reflected the total cost in relation to the Film as recorded in the books of Pueblo a seller, together with written confirmation from Malde & Co. that such statement had been prepared in accordance with UK Accounting Standards under GAAP.  This confirmation was provided by Malde & Co. on 1 April 2004.  A conditions precedent waiver letter was sent by Halcyon to Pueblo on 16 March 2004.  This provided that all the conditions precedent set out in Clause 2.1 of the Sale Agreement had been satisfied or waived and that Halcyon agreed to pay the Film Acquisition Price to Pueblo on or before the Payment Date.  
23.	The film Samantha's Child (also known as Blessed) was directed by Simon Fellows and starred Heather Graham and James Purefoy.
24.	On 9 December 2003, Pueblo entered into a sale and purchase agreement ("the Sale Agreement") with Halcyon in relation to Samantha's Child.  Under the terms of the Sale Agreement: 
(1)	Pueblo, as legal and beneficial owner of the original master negative of Samantha's Child, its sound track and of the Rights, (as defined in Schedule 3 to the Sale Agreement), sold the Delivery Material (as defined in Schedule 1 to the Sale Agreement), subject to prior agreement, and licensed the Rights (as defined in Schedule 3 to the Sale Agreement), to Halcyon for an amount equal to the Film Acquisition Price; and 
(2)	Pueblo hired the right title and interest in the Master Print (this being defined as the Delivery Material and the Rights) from Halcyon under the terms of a leasing agreement (referred to as the "Film Lease").
25.	The Film Acquisition Price means £6,024,946 or such other amount as advised by Malde & Co. in writing prior to 1 March 2004.  
26.	Pursuant to Clause 2.1.6 of the Sale Agreement, Pueblo was obliged to provide Halcyon with, inter alia, a certified statement for the film as stipulated by Malde & Co. which reflected the total cost in relation to the Film as recorded in the books of Pueblo as seller, together with written confirmation from Malde & Co. that such statement had been prepared in accordance with UK Accounting Standards under GAAP.  This confirmation was provided by Malde & Co. on 1 April 2004.  A conditions precedent waiver letter was sent by Halcyon to Pueblo on 19 March 2004.  This provided that all the conditions precedent set out in Clause 2.1 of or elsewhere in the Sale Agreement had been satisfied or waived and that Halcyon agreed to pay the Film Acquisition Price to Pueblo on or before the Payment Date.
The witnesses and the evidence
27.	For Halcyon we heard evidence from Mr Timothy Phillip Levy, the Chief Executive of Future Film Group Holdings Limited (“Future”) and a shareholder in and director of LMI; Mr Donald S Kushner of Beverly Hills, California, United States of America, who is the President of Junction Films Inc and a producer of motion pictures; Mr Stephen Lewis Joberns, a member of the Institute of Chartered Accountants in England and Wales and a member of the Chartered Institute of Taxation, who is a principal at the firm of Shipleys LLP, Chartered Accountants; Mr Sirishkumar Varadhaman Malde, a fellow of the Association of Chartered Certified Accountants, who is a partner in the firm of Malde & Co, Chartered Certified Accountants; and Mr Terence Alan James Back, a fellow of the Institute of Chartered Accountants in England and Wales, who is a partner in the firm of Grant Thornton UK LLP, Chartered Accountants.  Each witness produced a witness statement as their evidence-in-chief, with (in the case of all but Mr Kushner) documents exhibited to those statements.  Each witness was cross-examined by Miss Simler for HMRC.  Mr Kushner and Mr Joberns gave their evidence by video conference link from the offices of DLA Piper in Los Angeles.
28.	Mr Levy was the principal witness for Halcyon.  His evidence was wide-ranging and relevant to all the issues of fact we are required to decide:  he dealt with financing of film production and acquisition in the United Kingdom; the role of Future in raising such finance, promoting film partnerships and devising structures for such partnerships to invest in the acquisition of films and to exploit films by lease, licence or other means in a manner designed to secure tax reliefs available in the United Kingdom; the formation of Halcyon and its promotion to investing partners; the consultancy arrangements made between Halcyon and LMI and the services provided by LMI to Halcyon under those arrangements; the acquisition of certain screenplay rights by Halcyon in the film titles Murders in the Rue Morgue and Grey; the acquisition by Halcyon of the films Asylum, Method, and Samantha’s Child and the arrangements for determining the price paid by Halcyon for each film; and the leasing arrangements entered into by Halcyon in relation to the Films. 
29.	Mr Kushner’s evidence dealt with the arrangements whereby Halcyon acquired screenplay rights in the film titles Murders in the Rue Morgue and Grey and the attempts to obtain finance to convert those screenplays into films.  His evidence is therefore relevant to the Commencement issue.
30.	Mr Joberns’s evidence concerned the determination of the purchase price paid by Halcyon for the film Asylum, and in particular the role of Shipleys LLP in certifying to Halcyon that the cost to Seven Arts, the seller, of the film Asylum had been accounted for in accordance with Statement of Standard Accounting Practice No. 21: Accounting for Leases and Hire Purchase Contracts (“SSAP 21”), and also in certifying that, for the purposes of a claim under section 42, the cost of the film had been calculated in accordance with HMRC Business Income Manual on Expenditure on Film and Audio Products and the relevant Statement of Practice.  His evidence is therefore relevant to the Disallowance issue.
31.	Mr Malde’s evidence concerned the arrangements whereby the purchase price was determined on Halcyon’s acquisition of the films Method and Samantha’s Child from Pueblo and in particular the role of Malde & Co in certifying to Halcyon the total cost in relation to each film as recorded in Pueblo’s books of account, and that the accounting treatment of the costs of those films respectively in the books of account of Pueblo complied with SSAP 21.  His evidence also is therefore relevant to the Disallowance issue.
32.	Mr Back’s evidence, as the partner in his firm responsible for the audit of the financial statements of Halcyon, related to the accounting treatment of the fees incurred by Halcyon to LMI under the consultancy arrangements between those parties.  His evidence is therefore relevant to the Deductibility of Fees issue.
33.	For HMRC we heard evidence from Mr Michael James McAndrew, an Inspector of Taxes specialising in the investigation of claims for relief on expenditure in the production and acquisition of films, and having the responsibility for the investigation of Halcyon’s affairs in relation to this appeal.  Mr McAndrew produced a witness statement as his evidence-in-chief, and the purpose of his evidence was to introduce in evidence certain documents, and in particular a table relating to the acquisition of screenplay and similar rights by a number of film finance partnerships promoted by Future (including the acquisition of rights to the film titles Murders in the Rue Morgue and Grey by Halcyon), on which he was cross-examined by Mr Peacock for Halcyon.  His evidence therefore primarily relates to the Commencement issue.
34.	In addition to the evidence of the witnesses, we had in evidence extensive documentation in five large files relating to every aspect of the formation, promotion and activities of Halcyon as described in the evidence of Mr Levy, including all documentation relating to Halcyon’s acquisition of screenplay rights to the film titles Murders in the Rue Morgue and Grey; the acquisition of the rights in the films Asylum, Method, and Samantha’s Child and the purchase price paid for those films; the costs incurred by Pueblo and Seven Arts in relation to the production of the films of which they were respectively the sellers; the leasing arrangements for the Films; and the consultancy arrangements between Halcyon and LMI.
The relevant legislation – section 42; section 48; and section 101
35.	The principal legislation relevant to this appeal is found in section 42, section 48 and section 101.  Section 42 provides relief for revenue expenditure on the acquisition of the master negative of a “qualifying film”, and it is common ground that, disregarding the effect of section 101, Halcyon satisfies the requirements of section 42 and therefore qualifies for relief under that provision in principle, although the amount of its expenditure which so qualifies is in dispute.  In general terms section 42 provides relief by allowing one third of the qualifying expenditure on the acquisition of the master negative of a qualifying film to be taken as a deduction in computing the profits of the trade in each accounting period.  “Qualifying film” is defined by s 43(1) F(No 2)A 1992 to mean a master negative of a film certified by the Secretary of State for Culture, Media and Sport under Schedule 1 to the Films Act 1985 as a qualifying film for these purposes: in summary, a film is a qualifying film if it is a “British film”.  It is common ground that each of the Films is for these purposes a “qualifying film”.
36.	A more generous form of relief is available by reason of section 48: in summary, if the total production expenditure on the qualifying film is £15 million or less, the whole of the expenditure qualifies for relief in the relevant accounting period of the claimant.  However, Halcyon was unable to claim relief for its expenditure under section 48 because section 101, as again is common ground, limits relief under section 48 to cases where the acquisition expenditure on a qualifying film is in relation to an acquisition by the producer of the film or directly from such producer and not in relation to any subsequent acquisition.  The point of difference between the parties in the Section 101 issue, which is a point of statutory construction, is whether section 101 (when read having regard to the relationship between section 42 and section 48) applies also to relief claimed under section 42, thereby disentitling Halcyon from claiming any relief for its expenditure on the acquisition of the Films.  It is necessary, therefore, to set out certain of the provisions of section 48, notwithstanding that no claim for relief is made by Halcyon under that section.
37.	Section 42 provides (so far as relevant) as follows:
42 Relief for production or acquisition expenditure
(1) Subject to the following provisions of this section and any other provisions of the Tax Acts, in computing for tax purposes the profits or gains accruing to a person in a relevant period from a trade or business which consists of or includes the exploitation of films, that person shall (on making a claim) be entitled to deduct an amount in respect of any expenditure—
(a)	which is expenditure to which subsection (2) or (3) below applies, and
(b)	in respect of which no deduction has been made by virtue of section 40B above and no election has been made under section 40D above.
(2) ….
(3) This subsection applies to any expenditure of a revenue nature incurred by the claimant on the acquisition of the master negative of a film where—
(a)	the film was completed in the relevant period to which the claim relates or an earlier relevant period, and
(b)	the master negative, tape or disc is a qualifying film, tape or disc.
(4) Any amount deducted for a relevant period under subsection (1) above shall not exceed—
(a)	one third of the total expenditure incurred by the claimant on the production of the film concerned or the acquisition of the master negative or any master tape or master disc of it,
(b)	one third of the sum obtained by deducting from the amount of that total expenditure the amount of so much of that total expenditure as has already been deducted by virtue of section 41 above, or
(c)	so much of that total expenditure as has not already been deducted by virtue of section 40B or 41 above or this section,
whichever is less.
(5) In relation to a relevant period of less than twelve months, the references to one third in subsection (4) above shall be read as references to a proportionately smaller fraction.
(6) A claim under this section shall be made—
(a)	for the purposes of income tax, on or before the first anniversary of the 31st January next following the year of assessment in which ends the relevant period to which the claim relates,
(b)	…
and shall be irrevocable.
(7) ….
(8) ….
(9) This section has effect in relation to expenditure incurred—
(a)	on the production of a film completed on or after 10th March 1992, or
(b)	on the acquisition of the master negative, master tape or master disc of a film completed on or after that date.
38.	Section 48 provides (so far as relevant) as follows:
48 Relief for expenditure on production and acquisition
(1) Subject to subsection (4) below, section 42 of the Finance (No 2) Act 1992 shall have effect in relation to any expenditure to which this section applies as if the following subsection were substituted for subsections (4) and (5) (which for any period limit relief for film production and acquisition expenditure to a third, or a proportionately reduced fraction, of the relievable expenditure)—
“(4) The amount deducted for a relevant period under subsection (1) above shall not exceed so much of the total expenditure incurred by the claimant on 
(a)	the production or acquisition of the film concerned, or
(b)	the acquisition of the master negative or any master tape or master disc of it,
 as has not already been deducted by virtue of section 40B or, section 41 above or this section.”
(2) Subject to subsection (3) below, this section applies to so much of any expenditure falling within paragraphs (a) and (b) of section 42(1) of the Finance (No 2) Act 1992 as is expenditure in relation to which each of the following conditions is satisfied, that is to say—
(a)	the expenditure is expenditure incurred on or after 2nd July 1997 and before 2 July 2005;
 (b)	the film concerned is a film with a total production expenditure of £15 million or less; and
(c)	the film concerned is a film completed on or after 2nd July 1997.
(3) This section does not apply to so much of any expenditure falling within section 42(3) of the Finance (No 2) Act 1992 (acquisition expenditure) as exceeds the amount of the total production expenditure on the film concerned.
(4) Where this section applies to only part of any expenditure to which subsection (2) or (3) of section 42 of the Finance (No 2) Act 1992 applies in the case of any film, the amount deducted by virtue of subsection (1) of that section for a relevant period shall not exceed the sum of the following amounts –
(a)	the maximum amount of expenditure to which this section applies that is deductible for that period in accordance with subsection (1) above; and
(b)	the maximum amount specified in subsection (5) below. 
(5) The amount mentioned in subsection (4) above is the maximum amount which would be deductible for the relevant period in accordance with subsection (4) of section 42 of the Finance (No 2) Act 1992 if – 
(a)	in paragraphs (a) and (b) of that subsection (but not in paragraph (c)) the references to expenditure incurred by the claimant did not include references to any expenditure to which this section applies; and
(b)	the maximum amount mentioned in subsection (4)(a) above had already been deducted by virtue of that section.
(6) In this section “total production expenditure” on a film, in relation to a claim for relief under section 42 of the Finance (No.2) Act 1992, means (subject to subsections (6A) and (7) below) the total of all expenditure on the production of the film, whenever incurred and whether or not incurred by the claimant.
 ….
(11) This section applies for the making of a deduction for any relevant period ending on or after 2nd July 1997.
39.	Section 101 provides as follows:
101 Restriction of relief for successive acquisitions of the same film
(1)  Relief under section 48 of the Finance (No 2) Act 1997 (relief for expenditure on production or acquisition of film with total production expenditure of £15 million or less) in respect of acquisition expenditure is available only in relation to an acquisition - 
	(a)  by the producer, or
(b)	directly from the producer,
and not in relation to any subsequent acquisition (or in relation to any acquisition within paragraph (a) or (b) other than the first).
(2)  For this purpose - 
(a) 	“acquisition expenditure” means expenditure to which subsection (3) of section 42 of the Finance (No 2) Act 1992 (c 48) applies (relief for acquisition expenditure);
(b)	“acquisition” means acquisition of the master negative of a film, or any master tape or master disc of a film, within the meaning of that section; and
(c)	“the producer” means the person who commissions the making of the film and is entitled to control its exploitation.
(3)  This section applies to acquisition expenditure incurred on or after 30th June 2002.
The Section 101 issue
Introduction
40.	As mentioned, the issue between the parties is whether the restriction imposed by section 101 (that relief for qualifying expenditure on the acquisition of a film is available only in relation to expenditure on an acquisition by the producer of the film or directly from such a producer) applies only where relief under section 48 is claimed, or also where relief under section 42 is claimed.  It is common ground as to the facts that Halcyon is not the producer (as defined in section 101) of any of the Films, nor did Halcyon acquire any of the Films directly from such producer: it purchased each of the Films from an intermediary (the distributor of the film in each case), namely Seven Arts in the case of the film Asylum and Pueblo in the case of the films  Method and Samantha’s Child.  The dispute therefore is purely one of law, as to the scope of section 101, and is to be decided by construing the terms of that provision.
41.	The purpose behind section 101 is to counteract so-called “double dipping”, that is, arrangements whereby the producer of the film or some other person obtains relief for production expenditure and a subsequent purchaser of the film obtains relief for his acquisition expenditure.
The parties’ submissions
42.	Mr Peacock looked first at the statutory context of section 101.  He argued that s 99 of the Finance Act 2002 (“FA 2002”) identified relief under section 48 as a separate relief.  Section 48 was also amended by s 100 FA 2002.  The short form summary of section 48 was the same in each of ss 99, 100 and 101 FA 2002.  Thus when looking at section 101, what it was concerned with was that separate relief under s 48.
43.	The original position had been that section 42 gave the taxpayer relief over three years for certain types of expenditure.  Section 48 had then allowed such relief in one year, but only for certain types of expenditure satisfying section 48(2).  Section 101 restricted relief under section 48 and on its face was dealing only with section 48.  Section 101 did not refer to relief under section 42 and one was entitled as a starting proposition to take section 101 at its face value, namely that it was only concerned with section 48.
44.	His second submission was based on the observation that section 101 did not say that section 48 relief was available only in relation to an acquisition by or from the producer: instead, the draftsman had inserted, after the bracketed reference to section 48, and before the words “is available”, the words “in respect of acquisition expenditure”.
45.	The latter words were not mere surplusage: they had a real role, because the draftsman defined them in section 101(2)(a).  The reason for referring especially to acquisition expenditure was that section 48 relief on production expenditure was obviously only available to the producer.  It was an obvious point that one could not obtain production relief in the case of expenditure on the acquisition of a completed film.  What the draftsman only needed or intended was to deal with successive acquisitions in the context of section 48 relief.  However, those words must be doing something else other than merely limiting the effect of section 101 to acquisitions, because the ambit of section 101 could only concern itself with acquisition expenditure and not with production expenditure.
46.	This led to the question of what those words were designed to do.  Mr Peacock submitted that they were to make clear that there was a further limit on the type of expenditure which could qualify under section 48: to qualify the expenditure must be expenditure on an acquisition by or from the producer.  The draftsman could simply have barred section 48 relief.  Instead, the drafting technique used was to prevent certain expenditure from qualifying from relief.  In other words, the draftsman was not saying that the taxpayer could not have relief; he was saying that only certain expenditure was capable of qualifying for relief.
47.	The reason for the use of the phrase, which then necessitated the definition in section 101(2)(a), was the structure of section 48.  Section 48(1) did not as such amend section 42: it provided an alternative regime which sat alongside section 42 relief, but only for expenditure to which section 48 applied.  Such expenditure was identified in section 48(2), being expenditure falling within section 42(1)(a) and (b), and in addition satisfying section 48(2)(a), (b) and (c).  The effect of section 101 was as if to introduce an additional sub-paragraph (d) into section 48(2), in other words the requirement that the expenditure must be on an acquisition by or directly from the producer.  Such further limitation on the expenditure to which section 48(1) could apply would mean in the present circumstances that section 48 relief would not be available in respect of Halcyon’s expenditure, but section 42 was not amended by section 48(1) in relation to such expenditure.
48.	The significant point was that this did not prevent section 42 relief from being available to Halcyon. To put the point simplistically, section 48 did not apply, but section 42 was still available to give relief for expenditure (including acquisition expenditure) to which section 42 applied.  It was not the case that section 48 applied but no relief was available.
49.	The draftsman was alive to the structure of section 48 and the impact it had on section 42, which was why he went out of his way to add a further condition to the type of expenditure which qualified and did not merely deny the section 48 relief altogether.  This contrasted with HMRC’s view, which was that the taxpayer passed through the gateway of section 48 but could not have any relief and there was no room for section 42.  Halcyon argued that the taxpayer did not pass through the gateway of section 48 because of section 101, but there was still room for section 42 relief, which was unaffected by section 101.  This required a very careful and close analysis of the drafting technique adopted in section 101: was it, as HMRC argued, a simple barrier to relief or was it, as Halcyon argued, a qualification of the expenditure to which section 48 could apply?
50.	Halcyon contended the latter, for three main interrelated reasons.  The first was that section 101 was on its face dealing with section 48 and not section 42.  Secondly, when the draftsman wanted to deal with both section 42 and section 48, he did so expressly, as in s 99 FA 2002.  Thirdly, and most significantly of all, the draftsman had included the words “in respect of acquisition expenditure”.  As already emphasised, these words were not mere surplusage: they were designed to play a role. On HMRC’s view, they would not be needed, but on Halcyon’s view, they were both needed and effective, namely serving to qualify further the type of expenditure as if a further condition (d) were added to section 48(2).
51.	Mr Peacock pointed out that HMRC’s analysis would produce an odd state of affairs.  On that analysis, if a “small” British film (i.e. one with production expenditure of less than £15 million) were involved, and the taxpayer acquired it otherwise than from the producer, section 101 would bar both section 48 relief and section 42 relief, whereas in the case of a British film with total production expenditure exceeding £15 million (where section 101 cannot on any basis apply), there would be no restriction on section 42 relief.  This would produce the anomalous result that “large” films were treated more generously than “small” films, a result for which, in Mr Peacock’s submission, there could be no policy rationale.  
52.	Following the hearing, on 7 March 2008, DLA Piper on behalf of Halcyon wrote to the Tribunal setting out a further argument relating to the relationship between section 101 and, respectively, section 48 and section 42.  This was based on subsequent legislation, the replacement of the latter two sections by the Income Tax (Trading and Other Income) Act 2005 (“ITTOIA 2005”).  We refer to this argument, set out in the following paragraphs, as the “later legislation argument”.
53.	The effect of ITTOIA 2005 was to restate the law, with only minor changes designed in the main to clarify existing provisions, make them consistent or to bring the law into line with well-established practice.
54.	The replacement for section 48 is s 140 ITTOIA 2005.  As demonstrated by s 140(1)(b) and (2), this contained and was subject to the limitation previously set out in section 101.  However, the replacement for section 42, namely s 138 ITTOIA 2005, does not contain and is not subject to any such limitation.  The Explanatory Notes to s 138 ITTOIA 2005 make no reference to section 101.  Annex 1 to the Explanatory Notes (which set out such changes in the law as were made by ITTOIA 2005) do not record this as a change in the law.
55.	It follows that in order for HMRC to be correct in relation to the Section 101 issue, both the preamble to ITTOIA 2005 and the Explanatory Notes must be wrong and ITTOIA 2005 must not merely have restated the law but must have materially and substantially altered it.
56.	For HMRC Miss Simler argued that section 48 was not a separate relieving provision from section 42.  Halcyon had made reference to the summaries in brackets in s 99 and s 100 FA 2002, but all that the draftsman was doing in these sections was to provide a shorthand summary. These could not bear the weight that Halcyon placed on them in asserting that s 48 was a separate relieving provision.
57.	Miss Simler argued that the proper course was to look at section 42 and section 48 to see what reliefs were actually provided: one could then see that section 48 did not provide a separate relief from section 42, but provided a modification of section 42 relief.  It then becomes clear that section 101 must apply to the only relief provided for, namely relief under section 42 in the situation where that relief is modified by section 48.
58.	The position under section 42 was clear: the relief was provided in section 42(1), by entitling the claimant to deduct an amount in respect of expenditure which was either production expenditure or acquisition expenditure, and in respect of which no deduction had been made under ss 40B and 40D F(No 2)A 1992 respectively.  Section 42(8) contained an exclusion for trading stock, which made clear that the trade or business must consist of or include the exploitation of a film.  If the film constituted trading stock, section 42 relief was not available.
59.	Section 48 did not create any separate relief.  There was no separate independent relieving provision in section 48.  It operated parasitically on section 42 and did so by saying that the latter shall have effect in relation to expenditure to which s 48 applies by substituting, for the relief to be given over a three year period, the accelerated relief provisions to be found in section 48.  The absence of separate relief was confirmed by the absence of any trading stock exception in section 48; this was not found or needed there, because section 48 did not operate independently, but operated through section 42 by amending it.
60.	Section 48 operated through section 42 only in relation to expenditure to which section 48 applied, and it defined such expenditure by reference to three conditions in s 48(2).  Two of these were temporal and one related to cost.  None involved any election by the taxpayer.  If the film had production expenditure of £15 million or less, the expenditure was incurred between certain dates, and the film was completed after a certain date, then the expenditure was within section 48 and relief was only available through the modified section 42 route.  There was no independent or parallel relief available.
61.	When section 101 was introduced, it made clear that relief under section 48 in respect only of acquisition expenditure should be limited to expenditure in relation to an acquisition by the producer or directly from the producer.  The reason for the words “in respect of acquisition expenditure” was that section 48 applied both to acquisition expenditure and production expenditure, but section 101 was concerned only with acquisition expenditure.  Section 101 was not, as Halcyon suggested, adding a further condition (d) to section 48(2).  It was a barrier to relief for acquisition expenditure to which section 48 applied.  
62.	Halcyon relied on the references in ss 99(1)(d) and 101(1) FA 2002 to “relief under section 48”. HMRC submitted that these references were pure drafting shorthand, to which no significance attached: they were easier than more cumbersome references to section 42 as amended by section 48(1) in relation to expenditure to which section 48 applied.  The drafting of FA 2002 was no guide to the true interpretation of an enactment passed more than five years previously.  When enacted, section 48 did not admit of the construction for which Halcyon contended: it could not now mean something different in the light of section 101.
63.	HMRC found it difficult to follow Halcyon’s contention based on the words “in respect of acquisition expenditure” in section 101(1).  It seemed to come down to saying that instead of referring to “acquisition expenditure”, the draftsman could simply have framed the section so as to refer to “acquisitions”.  This point was misconceived.  The language of section 101 simply harked back to the relieving provision which it modified, which accorded relief in respect of expenditure on acquisitions, not in respect of acquisitions per se; this was shown by section 42(1)(a) and section 42(3).  
64.	It did not follow, from the fact that section 101 in effect provided that relief was unavailable in defined circumstances, that expenditure otherwise within section 48 suddenly was not within it.  Section 42 relief did not continue to be available in its unamended form in relation to expenditure to which section 48 applied.  If expenditure was within section 48, it was necessary to obtain relief for such expenditure through the modified section 42 relief that was accorded by the amendments in section 48.  There was no separate independent provision.
65.	As for Halcyon’s point that HMRC’s analysis led to anomalous treatment as between “large” and “small” British films, Miss Simler contended that there was nothing to suggest that this result was unintended.  The provisions of s 99 FA 2002, entitled “Restriction of relief to films genuinely intended for theatrical release”, clearly suggested that this was the intention.  Viewed in conjunction with section 101, s 99 evidenced a policy underlying that part of FA 2002 of clamping down on abuses of film relief by low-budget productions, presumably driven by a concern on the part of the legislature that such projects were more likely to lend themselves to abuse than large-budget mainstream productions.
66.	In relation to the later legislation argument, Mr Gledhill wrote to the Tribunal on 19 March 2008 with HMRC’s response to the points made on behalf of Halcyon.  He argued that Halcyon’s submission involved an unsound approach to the issue of statutory construction for the Tribunal, and in any event misconceived the effect of the relevant provisions of ITTOIA 2005.
67.	HMRC had argued that following the passing of the Finance (No 2) Act 1997, relief for expenditure to which section 48 applied was available only pursuant to section 42 as amended by section 48. The consequence was that in cases where section 101 operated to bar relief, the bar could not be circumvented by the taxpayer purporting to claim relief under section 42 rather than section 48.  Halcyon had relied on linguistic points in FA 2002 which were said to show that section 42 and section 48 created distinct reliefs.  In response, HMRC had submitted that if only one relief was available before FA 2002, the position could not have been altered by the language in which that later enactment happened to have been framed.  The effect of an earlier statute could not be different in the light of a later one unless the latter in terms amended the way that the earlier statute took effect.
68.	This same point applied to the reliance in DLA Piper’s letter on ITTOIA 2005.  In interpreting an enactment (here, the Finance (No 2) Act 1997), the Tribunal was entitled, and required, to take into account all materials admissible on ordinary principles to illuminate the aim in the mind of the legislature when passing it.  Those materials did not include subsequently passed enactments.  In support, Mr Gledhill cited Deposit Protection Board v Barclays Bank plc [1994] 2 AC 367 (HL) (Lord Browne-Wilkinson at p 397 D-E).
69.	Halcyon attributed an importance to the preamble and Explanatory Notes to ITTOIA 2005 which these did not bear.  More fundamentally, DLA Piper’s letter failed to take into account the fact that the provisions of ITTOIA 2005 relied upon were never implemented in the form cited.  The Finance Act 2005, passed exactly two weeks after ITTOIA 2005, made various amendments to s 138 ITTOIA 2005.  The effect of the new s 138A(1)(aa) was entirely consistent with HMRC’s analysis of the section 101 point.  The amended enactments showed the legislature to have understood section 42, section 48 and section 101 to interrelate in precisely the manner contended for by HMRC.
Decision on the Section 101 issue
70.	We consider that Halcyon is not precluded by reason of section 101 from claiming relief under section 42 in relation to its expenditure on the acquisition of the Films, since section 101 applies to deny relief for the whole of the acquisition expenditure in the relevant period without affecting relief for that expenditure over three years as provided by section 42.
71.	  In Halcyon’s case each of the Films had total production expenditure of less than £15 million.  The Films were clearly all completed after 2 July 1997.  Similarly, the expenditure was clearly incurred after that date.  All the expenditure was incurred before 2 July 2005.  Thus in principle, disregarding for the present the effects of section 101, the expenditure fell within section 48.
72.	Section 101(2)(c) defines “producer” in terms different from the normal usage of that word, as “the person who commissions the making of the film and is entitled to control its exploitation”.  In terms of that definition, none of the acquisitions in the present case was from the “producer”.
73.	We accept that section 101 is quite specific in its reference to section 48.  It restricts the scope for relief under that section in respect of acquisition expenditure, which section 101(2)(a) defines in terms of relief for acquisition expenditure under section 42(3).
74.	The word “relief” appears once only in section 48, in the description in section 48(1) of the effect of section 42(4) and (5) being substituted by the special version of s 42(4) applied to section 48 expenditure.  (The reference in s 48(1) to “relievable expenditure” follows on from that single reference to “relief”.)  The operative parts of section 48(1) and the remaining sub-sections refer throughout to “expenditure”.
75.	The mechanism adopted is for section 48(1), in respect of the type of expenditure specified, to apply section 42 “as if” it contained that special version of section 42(4).  In section 42 itself there is no reference to “relief”.  The language used throughout section 42 relates to deduction in respect of the expenditure specified.  Consistently with this, the special version of section 42(4) is framed in terms of “deduction” and “expenditure”, and makes no reference to “relief”.
76.	Section 48(1) having set out the operative provision, section 48(2) specifies the expenditure to which the section applies.  It is defined by reference to paragraphs (a) and (b) of section 42(1), but is limited to expenditure fulfilling each of the three conditions set out in section 48(2).
77.	Section 48(3) makes clear that section 48 does not apply to any acquisition expenditure within section 42(3) in excess of the total production expenditure.  Section 48(4) ensures that where section 48 applies to only part of any expenditure falling within section 42(2) or (3), there is a limit on the total that can be deducted under section 42(1).  This is the sum of the maximum expenditure deductible in accordance with section 48, and, to paraphrase section 48(5), the expenditure which would be deductible under section 42(1) if the “section 48 expenditure” were to be ignored.  Thus, by the use of section 48(3), (4) and (5) to separate out expenditure which is in excess of the total production expenditure and ensure that it is brought back within section 42, section 48 preserves the deductibility of certain expenditure under section 42 where that expenditure does not qualify under section 48.  As section 48(4) refers to the respective deductions being made by virtue of section 42(1), this does not appear to us consistent with an argument that section 48 provides a self-standing relief; for Halcyon, Mr Peacock acknowledged that section 48 did not do so.
78.	While section 48 specifically provides in the case of acquisition expenditure which exceeds the total production expenditure that such excess falls back into section 42, section 48 does not indicate whether that provision is an illustration of a general principle, that expenditure which for any reason fails to qualify as deductible pursuant to section 48 automatically reverts to being deductible under section 42.  However, it would appear odd that expenditure on a film which failed to qualify for deduction pursuant to section 48 because, for example, the total production expenditure turned out to be in excess of £15 million, should be denied deductibility relief both under section 48 and section 42.  We think that it must follow from such an example that there is a general principle as mentioned above.
79.	This does not mean that the deductibility relief under section 48 is separate from that under section 42.  The mechanism used is for expenditure falling within section 48 to continue to be deductible under section 42(1) but to be treated under the special version of section 42(4) as wholly deductible in the relevant period rather than being deductible over three relevant periods: there is a special regime of relief for expenditure to which section 48 applies, and that is a modified version of the basic section 42 regime.
80.	Expenditure qualifies as expenditure to which section 48 applies if it meets all the relevant conditions.  Expenditure which for some reason is expenditure to which section 48 does not apply is expenditure which, in our view, falls back into (or always remains eligible for) the basic section 42 regime (assuming, of course, it satisfies the conditions of that regime).
81.	We do not think that section 48 can be regarded as an amending section.  It is time-limited, since under section 48(2)(a) the expenditure must be incurred on or after 2 July 1997 and before 2 July 2005.  Thus we interpret it as more in the nature of a modification for special limited purposes.  This accords with the argument on behalf of Halcyon at paragraph 47 above.
82.	The result of section 101 is that deductibility pursuant to the special regime effected by section 48 (that is, the modified section 42 regime) is not available in respect of acquisition expenditure other than on an acquisition by or directly from the “producer” as defined.  HMRC contended that it did not follow, from what amounted to the denial of relief in defined circumstances, that expenditure otherwise within section 48 ceased to be within it.  We think that this is answered by the use in section 101(1) of the words “in respect of acquisition expenditure”.  As we have indicated above, the structure of section 48 and section 42 is based on the concept of “deduction” in respect of “expenditure”, and the references to “relief” are incidental.  The effect of section 101 is to treat acquisition expenditure relating to “non-original” acquisitions as falling outside the special section 42 regime provided by section 48.  Although this does not amount to failure of one of the three conditions set out in section 48(2), the effect is the same: the expenditure falls outside section 48 and, as a result, comes back into (or remains within) the basic section 42 regime.  This is in accordance with the construction of the provisions, and it gives a result which makes sense within the overall scheme of this legislation.
83.	We have arrived at our view on the effect of section 101 without reference to the later legislation argument, which we do not consider necessary to that view.  Although on its face the initial version of the legislation contained in ss 138 and 140 ITTOIA 2005 appears to be consistent with our view, we are reluctant in the present circumstances to use the later legislation, which is intended broadly to be a form of consolidating Act, to interpret the effect of earlier legislation.  We accept that in principle later legislation can be used as an aid in construing the earlier version where this is “in pari materia”, as indicated in Bennion’s Statutory Interpretation (4th edition) Part XIV Section 234.  However, the differences between the relevant sections in ITTOIA 2005 as originally enacted and as amended and supplemented by the Finance Act 2005 are such as to raise the question whether the draftsman of the relevant amending provisions in the latter took the same view as to the interpretation of ss 138 and 140 ITTOIA 2005 and their predecessors as those responsible for the drafting of the rewritten legislation in ITTOIA 2005.  We do not think it appropriate to engage in a detailed comparison of the respective versions when we are satisfied, without looking at the subsequent history, as to the effect of the legislation directly in question.
84.	For these reasons we decide the Section 101 issue in favour of Halcyon.
The Commencement issue
Introduction
85.	The issue between the parties is whether, as Halcyon contends, it commenced its trade on 31 March 2003, or whether, as HMRC contends, it commenced its trade at the later date when it acquired its interest in the master negatives of the Films (that is, 9 December 2003).  This is largely a question of fact, and turns on the nature and extent of the activities of Halcyon in the period before it purchased the master negatives of the Films.  A similar issue of fact arose in the related appeal by Micro Fusion, and Halcyon, as did Micro Fusion in its appeal, relied upon the evidence of Mr Levy and Mr Kushner in relation to those activities.  Again, as in the Micro Fusion appeal, their evidence was vigorously challenged by HMRC in this appeal.
86.	The date on which Halcyon commenced its trade is significant for this reason: Halcyon has drawn up its accounts so that its first accounting period begins on the date it was incorporated (25 March 2003, and therefore shortly before it claims it commenced its trade on 31 March 2003) and ends on 5 April 2004; Halcyon (strictly, its members) realised a loss in that accounting period by reason of the relief for its expenditure on the acquisition of the master negatives of the Films claimed under section 42, and there falls to be determined the proportion of that loss which is treated as falling in the tax year ending 5 April 2004, having regard in particular to the provisions of section 42(5) which proportionately reduce the relief which can be claimed in cases where the “relevant period” is less than twelve months.  There is a dispute between the parties as to the basis on which the amount of that loss for the 2003/04 tax year is calculated in these circumstances.  This matter turns upon the interpretation of the relevant statutory provisions, and is a question of law.
87.	The statutory provisions in question are section 42 and s 40B(3) F(No 2)A 1992, and the issue is what is meant by the expression “relevant period” in those provisions, and in particular the definition of that term.  Section 42 is set out at paragraph 37 above.  In summary, section 42(1) provides for a deduction for acquisition expenditure on a film “in computing for tax purposes the profits or gains accruing to a person in a relevant period” from the trade of exploiting films; by section 42(4) the amount deducted for a relevant period is not to exceed one third of the production or acquisition expenditure; and by section 42(5), in the case of a relevant period of less than twelve months, the one third portion of expenditure which can be deducted is to be reduced “to a proportionately smaller fraction”.  Section 43(1) F(No 2)A 1992 provides that relevant period has the meaning that term is given in s 40B(3) F(No 2)A 1992.
88.	Section 40B(3) F(No 2)A 1992 provides:
In this section “relevant period” means – 
(a)	a period for which the accounts of the trade or business concerned are made up, or
(b)	if no accounts of the trade or business concerned are made up for a period – 
(i)	 if the profits or gains accrue to a company within the charge to corporation tax, the accounting period of the company;
(ii)	in any other case, the period the profits or gains of which are taken into account in assessing the income of the trade or business for a year of assessment.
89.	The dispute between the parties on the meaning and effect of the statutory provisions can be summarised as follows.  The effect of s 40B(3)(b)(ii) F(No 2)A 1992 is to invoke the basis period rule (which, if applicable would have effect so that, broadly, the loss which Halcyon can claim for the tax year ending 5 April 2004 is the loss for the period from commencement of the trade until 5 April 2004).  HMRC contend that the basis period rule applies because Halcyon has made up its accounts for a period (25 March 2003 to 5 April 2004) which does not coincide with the basis period from the commencement of the trade until 5 April 2004.  Halcyon contends that the basis period rule is a default rule which can only apply, having regard to the opening words of subsection (b) of s 40B(3) F(No 2)A, if the taxpayer has failed to make up any accounts at all, and that since Halcyon did make up accounts for a period, the default basis period rule cannot apply and accordingly there is no basis for proportionately reducing the amount of the relief claimed for the 2003/04 tax year.
The evidence and the facts
90.	Halcyon’s claim that it commenced its trade of the exploitation of films on 31 March 2003 is founded on two documents and on the evidence of Mr Levy and Mr Kushner in relation to those documents and the surrounding circumstances.
91.	The two documents are the FCA between Halcyon and LMI under which LMI agreed to provide certain film consultancy services to Halcyon and the EAFA between Halcyon and IMPDC under which Halcyon acquired certain rights to the screenplays of two film titles (see paragraph 16 above).  HMRC contend that the EAFA is a sham, entered into only to give a semblance of a commercial transaction in order to represent for tax purposes that the trade commenced on 31 March 2003 and that in any event no substantive actions were taken to exercise or exploit the rights purportedly acquired by the EAFA.  They challenge the evidence in chief given by Mr Levy and Mr Kushner.
92.	The provisions of the FCA are also relevant to the Deductibility of Fees issue (see below), but in summary its terms as relevant to the Commencement issue are as follows:
(1)	The FCA was entered into in March 2003 between Halcyon and LMI (the copy of the document submitted in evidence was signed, but not dated other than “March 2003”: the date is assumed to be 31 March 2003 – certainly after 25 March 2003, which is the date of incorporation of Halcyon).  The parties entered into a subsequent agreement on 23 February 2004 which essentially reproduced the terms of the first agreement, but made further provision as to the calculation of the fees to be paid by Halcyon to LMI for its services;
(2)	LMI is engaged by Halcyon to provide “Film Consultancy Services” for the period which commences on 31 March 2003 and ends when either party terminates the agreement or on the winding up of Halcyon.  The “Commencement Date” is expressed to mean “the date on which [Halcyon’s] trade commenced, being 31 March 2003”.  
(3)	The Film Consultancy Services include identifying, researching and evaluating films suitable for Halcyon; selecting films for the purposes of acquiring and exploiting them on behalf of Halcyon; purchasing and taking options over screenplays and other rights and interests necessary for the reproduction or distribution of films; procuring the purchase of films and master negatives for the purpose of exploitation; exploiting or procuring the exploitation of all film rights with a view to maximising the scope and profitability of Halcyon’s business; entering into and performing all contracts and engaging in all activities and transaction necessary to carry out the foregoing services.
(4)	Halcyon has complete discretion to accept or refuse proposals made to it by LMI in providing the Film Consultancy Services, and all strategic decisions relating to Halcyon’s business are to be made by Halcyon in conjunction with LMI.
(5)	Halcyon agrees to pay LMI for the provision of the Film Consultancy Services a fee.  In the 31 March 2003 FCA the fee is £152,414.  In the 23 February 2004 FCA the fee is in two parts, each determined by a formula: first it comprises “not more than 5.5% of the aggregate moneys subscribed to [Halcyon’s] capital by Members pursuant to the Partnership Deed”; secondly it comprises “20% of [Halcyon’s] entitlement to Additional Rentals from the Films” – for these purposes “Films” means films acquired and exploited by Halcyon, and “Additional Rentals” means those rentals received by Halcyon in addition to the minimum rental income paid under film leases it enters into.
93.	The provisions of the EAFA are, in summary, as follows:
(1)	The EAFA was entered into between Halcyon and IMPDC “as of March 31, 2003”, and is expressed to be the document recording the terms of an agreement reached between the parties on that date whereby Halcyon has agreed to acquire rights from IMPDC for the purpose of financing and distributing the film to which the rights relate.
(2)	IMPDC grants to Halcyon the rights to the two original film screenplays, one for the project Grey, written by Kathy Fettig, based on the Oscar Wilde novel The Picture of Dorian Gray, and the other entitled Murders in the Rue Morgue written by Bob Boris, inspired by an Edgar Allan Poe story.
(3)	Halcyon agrees to pay to IMPDC US$50,100 no later than 31 January 2004 (payment was not made until 29 November 2004, and actual payment was made by Future).
(4)	The rights to the screenplays include the exclusive right throughout the world to exhibit, distribute or deal with the “Films” in any medium and markets.  The Films are defined as “the films or motion pictures to be financed by [Halcyon] (itself and/or in joint venture or by commissioning other producing entities) based on the screenplays”.
(5)	Halcyon agrees to use all reasonable efforts to raise finance for the Films with a view to commencing production by 31 December 2003.  The parties agree to negotiate in good faith with a view to finalising all principal agreements for development, pre-production, financing, production and distribution of the Films.  If “financial closing” of the first Film has not occurred by 28 February 2004 IMPDC is entitled to reacquire all rights granted to the screenplay on reimbursement of the fee paid by Halcyon plus any development and pre-production funding advanced by Halcyon.
(6)	Halcyon agrees not to encumber or dispose of the rights to the screenplay until financial closing.
(7)	IMPDC gives certain warranties, including a warranty that nothing in the screenplays or the Films or in their exploitation will infringe any third party rights.
94.	Mr Levy’s evidence in chief relevant to the Commencement issue dealt first with the EAFA and the rights to the screenplays for Grey and Murders in the Rue Morgue and then with the circumstances relating to the acquisition in December 2003 by Halcyon of the films Asylum, Method, and Samantha’s Child.
95.	His evidence dealing with the EAFA and the rights to the screenplays for Grey and Murders in the Rue Morgue can be summarised as follows:
(1)	Halcyon was incorporated in March 2003 for the purpose of carrying on the trade of investment, acquisition and exploitation of films.  In March 2003 it entered into the FCA whose terms were effective from 31 March 2003, and it also entered into the EAFA, also effective from 31 March 2003.  The other contracting party to the EAFA is a Hong Kong company, IMPDC, which has its place of business in Australia.  Mr Levy was introduced to IMPDC through Mr Kushner, who is a consultant to IMPDC and a film producer.
(2)	Halcyon’s purpose in entering into the EAFA was to acquire film rights that had a real commercial prospect of becoming successful films, but this has to be seen in the context of a market in which the expectation is that only between one in ten and one in twenty screenplays will be made into films.  Future, through Mr Levy, had a close working relationship with Mr Kushner, who had been a prolific producer of British qualifying films, and is very effective and well-connected in the film industry.  Mr Levy’s experience was that projects originated by Mr Kushner were likely to have a greater than normal prospect of being produced.
(3)	Halcyon, in common with several other partnerships established by Future, acquired screenplay rights for commercial reasons, but the timing of the acquisition of the rights was influenced by the tax benefits which arise from commencing the trade early in the tax year.  The EAFA was a genuine agreement made with an unconnected party under which Halcyon acquired valuable commercial rights: it chose to acquire those rights shortly before the commencement of a tax year to maximize the tax benefits of that acquisition.
(4)	At the time Halcyon entered into the EAFA there was no finance in place for the production of either Grey or Murders in the Rue Morgue, but it was hoped to find finance through the skills of Mr Kushner and the expertise of Future in the UK tax-based film finance market.  On 30 January 2004 Future issued a prospectus in relation to Halcyon, which refers to Halcyon’s acquisition of rights to these two film titles and to discussions with banks, equity film funds and other finance providers “in order to progress the financing of these films”.  There is no documentation as to any such discussions relating to finance for the films.
(5)	Neither Murders in the Rue Morgue nor Grey has yet been made into a film.  Attempts are still being made to finance Grey.
(6)	Payment to IMPDC by Halcyon of the consideration for the film rights for the two films of US$50,100 was made on 29 November 2004, rather than on 31 January 2004, as the agreement provided.  Mr Levy was not aware of the reason for the late payment.  The payment was made by Future through the company which was the Designated Member of the Halcyon partnership, effectively as a capital contribution to Halcyon.
96.	Mr Levy’s evidence in relation to the acquisition by Halcyon of the films Asylum, Method, and Samantha’s Child can be summarised as follows:
(1)	The Films were acquired as completed films under sale and leaseback transactions which were conventional in form for the UK film industry where tax incentives are part of the financing arrangements.
(2)	Under such arrangements the production of the film is financed and completed and the owner of the film sells the master negative of the film and also grants a licence in respect of the distribution rights in the film (together with the benefit of any distribution agreements already in place) to the person (in this case Halcyon) investing in the film, who then leases back all the economic rights in the film (the distribution rights and the ability to exploit the intellectual property rights) to the original seller or a related party of the original seller.  Under the leaseback terms the lessee makes regular annual fixed payments to the investor/lessor by way of primary rental payments together with a share in the net profits earned by the lessee from the film.
(3)	Specifically in relation to Halcyon, it acquired the master negatives in the Films by sale and purchase agreements entered into on 9 December 2003, and by those agreements leased the Films back to the seller, as set out in the agreed facts (see paragraphs 17 to 26 above).  There were various other ancillary documents (such as a laboratory agreement, whereby Halcyon as owner of the master negative gave the lessee access to make copies etc), but the sale and leaseback structure was essentially a simple and straightforward commercial transaction.  Halcyon received primary rental payments and additional rentals (more generous to Halcyon than was common in such deals) giving it a share of 4 per cent of the lessee’s gross revenues from the Films once those gross revenues exceeded one half of the film acquisition price and 8 per cent once they exceeded the film acquisition price.
(4)	Each of the sale and purchase agreements relating to the respective Films contained terms relating to the calculation of the price to be paid by Halcyon, and the certification of that price in relation to the expenditure on production costs: these matters principally relate to the Disallowance issue, and are referred to below.
97.	Mr Kushner’s evidence related to Halcyon’s acquisition of the screenplay and rights to the film titles Grey and Murders in the Rue Morgue.  His evidence in chief can be summarised as follows:
(1)	He is an experienced producer of films based in Beverly Hills, California, and he has been involved with the production of over one hundred films in the last twenty-five years.  He acts as a consultant to IMPDC.  He has worked with Mr Levy on film projects for a number of years, and in particular since 2002 in relation to British qualifying films.  He has been involved with fifteen co-productions involving Future and the partnerships it has promoted.
(2)	Mr Kushner worked on the development of the screenplay for Grey with a writer he had worked with on other screenplays where IMPDC had supplied funds for their development and production into films, including the film Method, which Halcyon acquired as a completed film.  Since Future had agreed to finance a script by this writer, it was a natural fit to offer Grey, a screenplay by the same writer.  No significant cast members had been signed up for Grey (unlike Method).
(3)	Mr Kushner recommended to IMPDC that it should invest in the two screenplays and offer them to Future, and he then negotiated with Mr Levy for the acquisition by Halcyon of the two screenplays.
(4)	It has always been the intention to make a film out of the screenplays, and in the case of Mr Kushner’s collaboration with Future and the partnerships it has promoted, the track record of turning screenplays into films is good by the standards of the industry.  
(5)	In the case of Grey there has been active pursuit of finance and production possibilities over a number of years.  A director has been identified, and there have been conversations with possible cast members.  At one point a possible co-financier was identified and in 2002 there were efforts to interest two German funds.  In 2004/05 there was further work on the script and discussions with possible investors, requiring preparation of budgets and finance plans.  It is still the intention to produce a film based on the Grey screenplay, but current conditions of the dollar/sterling exchange rate and the lack of tax incentives for film investment in the UK make this difficult.
(6)	As to Murders in the Rue Morgue, not much headway has been made in converting the screenplay into a film, largely because of difficulties with the script which have not yet been resolved.
98.	For HMRC Mr McAndrew gave evidence in the form of a schedule prepared under his supervision of screenplay and similar rights acquired by various film partnerships promoted by Future (including Halcyon’s acquisition of rights to Grey  and Murders in the Rue Morgue).  The schedule shows eight cases of such partnerships acquiring an interest in screenplays or scripts where such acquisition is claimed as the event whereby the trade of that partnership is commenced.  Of these, three scripts are acquired at the end of the tax year (two of which are the screenplays acquired by Halcyon), one at the start of the tax year, and four at various times during the tax year.  The schedule also shows that of the eight screenplays or scripts two have been made into films, but not by the film partnerships which first acquired the interest in the scripts. 
The parties’ submissions on the facts
99.	As in the case of the related Micro Fusion appeal, Miss Simler conducted an extensive cross-examination of both Mr Levy and Mr Kushner in relation to the Commencement issue, following which she and Mr Gledhill produced a lengthy set of written submissions on the facts.  Since (as in the Micro Fusion appeal) those submissions concluded with the submission that we should find that the EAFA, by which Halcyon acquired rights to the screenplay to the film titles Grey and Murders in the Rue Morgue was a sham, it is necessary to set them out in some detail, as follows:
(1)	IMPDC had a close connection (for example, executive officers in common) with the Pueblo group of companies, a production and distribution group which, through other transactions with Halcyon (as seller and lessee under the sale and leaseback transactions for the films Method and Samantha’s Child) was not only aware of the benefits to be derived if a film partnership began trading at the beginning of a tax year, but received a direct advantage of such benefits by means of the more favourable leaseback terms which were secured to reflect those benefits.  Further, the relationship between Mr Kushner and IMPDC was unclear – although he claimed to be a consultant to IMPDC in his evidence he spoke as though he were the principal in relationship to the rights in the screenplays.
(2)	The original partnership deed of Halcyon (current at the time it entered into the EAFA) states that the partnership will “carry on the Business including the acquisition, investment in and exploitation of Films…”, and there is no reference to the production of films (in contrast to the stated business of the partnership in the case of the Micro Fusion partnership, which was involved with film production).  Accordingly, there was never any valid commercial reason for Halcyon to acquire screenplay rights with a view to producing films (as it purported to do in the case of Grey and Murders in the Rue Morgue).
(3)	There is virtually no documentation produced by Halcyon evidencing any negotiations which Mr Levy and Mr Kushner asserted took place to agree the terms of the EAFA, and no documentary evidence of due diligence enquiries by Future as to IMPDC’s entitlement to confer the rights to the Grey and Murders in the Rue Morgue screenplays granted by the EAFA.
(4)	There is no evidence that IMPDC demanded payment of the fee of US$50,100 when Halcyon failed to pay it on the due date – payment was made 10 months later (without any explanation as to why it should be made at that date), and was funded by Future.
(5)	There is no documentation produced by Halcyon evidencing any negotiations for putting in place financing, production, or other arrangements necessary to convert the screenplays for Grey and Murders in the Rue Morgue into films, although such negotiations were referred to in the evidence of both Mr Levy and Mr Kushner, and are referred to in the prospectus issued to potential investors in Halcyon.  That prospectus also says that proposals for the financing of these films will be put to members shortly after the closing of the offer, but Mr Levy accepted in cross-examination that no such proposals were put to the members of Halcyon.
(6)	There is no evidence as to when the parties entered into the EAFA: it does not bear an execution date, but is expressed to be “as of 31 March 2003”.  Mr Kushner in his evidence in chief mentioned that Grey was introduced to Future because they were familiar with the writer’s work on the film Method, but since Halcyon purchased the master negative of Method in December 2003, and Mr Levy could not show evidence of any involvement in Method prior to mid-November 2003, it is possible that the EAFA was not entered into until as late as November 2003.
(7)	In conclusion, therefore, and having regard to these matters, it cannot be said that the EAFA was genuinely intended to confer on Halcyon rights to finance the production of the screenplays for Grey and Murders in the Rue Morgue: there was no intention on the part of Halcyon that the rights ostensibly granted by the EAFA were to be exercisable according to their terms.  The EAFA was entered into as dishonest window-dressing for tax purposes.
100.	Mr Peacock replied to these submissions in full and in writing.  His submissions were essentially as made in relation to Micro Fusion’s case, as follows:
(1)	Sham is a serious allegation tantamount to fraud, and the burden of proving sham rests on HMRC as the party alleging it.  That burden is not discharged in the present case.  An allegation that a step was taken solely to achieve a tax benefit is not an allegation of sham.
(2)	For a document or transaction to be a sham, there must be a subjective and a common intention between the parties to the document or transaction to create different rights or obligations from those which the document or transaction give the appearance of creating: Snook v London and West Riding Investments Ltd [1967] 2 QB 786 (CA) and Hitch v Stone [2001] STC 214 (CA).  In the present case the EAFA created the rights and obligations stated in it – this is so even if Halcyon has not yet pursued its rights to exploit the Grey and Murders in the Rue Morgue screenplays.  Those rights remain valuable and available to Halcyon, and the evidence of Mr Kushner is that, in relation to Grey at least, there has been, and continues to be, active pursuit of the possibility of financing and producing the film. 
(3)	The allegations of a connection between IMPDC and Pueblo (a UK company) made by HMRC are not substantiated.
(4)	The fact that the fee due under the EAFA was paid (albeit late), rather than supporting HMRC’s contention that this was evidence of the sham nature of the EAFA, is evidence that the parties were exercising or complying with their rights and obligations created by that document.
(5)	Halcyon’s case for having commenced its trade on 31 March 2003 is based not solely on the EAFA: the FCA was also entered into so as to take effect from that date, and its validity, purpose and effect is not questioned.
Decision on the Commencement issue – the date on which Halcyon’s trade commenced
101.	The first question we have to decide to determine the Commencement issue is the date on which Halcyon commenced its trade which consists of or includes the exploitation of films.  We consider that it commenced its trade on 9 December 2003, when it entered into sale and leaseback transactions in relation to the master negatives of the films Method, Asylum and Samantha’s Child.
102.	As mentioned, Halcyon’s case in relation to the Commencement issue was argued alongside that of Micro Fusion in relation to the same issue – in both cases the taxpayer argued that its trade commenced by virtue of rights and obligations arising under documents entered into at, or shortly before, the beginning of the relevant tax year, and those documents (a film consultancy agreement for the provision of film services and the acquisition of film screenplays and the rights to turn them into films) were in very similar form in both cases and, also in both cases, were entered into some time in advance of the different transactions which became the substantive business activities of the respective partnerships.  The parties advanced the same arguments in relation to both cases, allowing only for the obvious differences of fact (the different screenplays, the different partnerships and their different businesses, the different timescales and so forth).  It will come as no surprise, therefore, that we reach our decision in this appeal for substantially the same reasons as we reached our similar decision in the Micro Fusion appeal.  It will suffice, therefore, in this appeal to summarise those reasons and to identify any points of material difference from the reasons we have set out in full in our decision in the Micro Fusion appeal.
103.	In this case we adopt and apply the principles set out in Mansell v Revenue and Customs Commissioners SpC 551 SCD 605 (at paragraphs 88 to 94) as to what is required in order that a trade may be regarded as having commenced for tax purposes.
104.	HMRC’s principal contention was that the EAFA should be disregarded as a sham document and in any event may not have been entered into until a date much later than its “as of” date of 31 March 2003.  We do not consider that HMRC established its case on this point, having regard to the proper meaning of sham (as to that meaning, we accept the submissions of Mr Peacock).  We consider that the EAFA created the rights and obligations it purported to create, so that the screenplay rights and the rights to produce a film in respect of the titles Grey and Murders in the Rue Morgue were genuine.  They created an obligation on Halcyon to pay US$50,100 for the rights it obtained, and that obligation was discharged.  The fact that Halcyon entered into these arrangements at a time which was intended to confer maximum tax benefits (a point readily acknowledged by Mr Levy in his evidence in chief) does not of itself render them a sham.  Further, even if there were some relationship between IMPDC and Pueblo (a fact which was not established by HMRC), so that it could be said that IMPDC had some motive in acting in a way which maximised that tax benefit, that again does not necessarily result in the document being a sham.  Finally, Halcyon’s failure to exploit the screenplay rights (notwithstanding certain contractual obligations to do so in the EAFA) is again not necessarily proof that those rights did not exist.  
105.	As to the point that the EAFA was entered into on a date significantly later than 31 March 2003 (HMRC argued for a date in November 2003, on the basis of some comment by Mr Kushner relating the screenplay Grey to the film Method), we conclude that we have no evidence which enables us to determine the date on which the EAFA was executed.  Mr Kushner made the point generally in cross-examination that in the film industry commitments are given on the basis of personal and commercial relationships with legal documentation following at a later point and that in any event it is the personal commitment which has the real commercial significance.  We can understand that to be the case.  The “as of” dating of the EAFA indicates that the document was in fact executed after that date, but (unless the document was a sham and fraudulent, which we reject) it also indicates that the parties intended it to reflect a commitment of some commercial significance made at that date, which is what is recited in the EAFA.
106.	However, although we consider that Halcyon acquired the rights which the EAFA purported to confer on Halcyon, and incurred the obligations which the EAFA purported to impose on Halcyon, we do not consider that Halcyon commenced its trade by reason of entering into the EAFA and the FCA.  As with Micro Fusion, by entering into those arrangements Halcyon put itself into the position whereby it could commence its trade of exploiting films, but it did not establish to our satisfaction that it took action to pursue in any realistic way the exploitation of the rights it had acquired.  The only evidence on the point was given by Mr Levy and Mr Kushner, but that was only in the most unspecific terms (and in the case of Mr Kushner, he referred only to the difficulties of getting together a working script for Murders in the Rue Morgue, and in the case of Grey most of his comments as to possible sources of finance related to periods before or after the year 2003).  No documentary evidence of any activity of this kind was available to us.  We also note that Halcyon was established (and promoted in its prospectus) as a partnership with a business intended for exploiting completed films by sale and leaseback transactions (so that, as the prospectus mentions, any decision to raise further capital to finance the production of the films Grey and Murders in the Rue Morgue would require the unanimous consent of all partners), and that reinforces the view that there was no realistic pursuit of any trading activity in relation to those rights it had acquired.  In terms of the principles set out in the Mansell case, Halcyon did not in truth engage in “operational activities” by entering into the EAFA and the FCA.
107.	Instead, Halcyon’s trade began when it acquired the master negatives of the films Method, Asylum and Samantha’s Child: that is the point at which Halcyon first engaged in the “operational activities” which resulted in or comprised its profit-making business.
108.	Accordingly it is our decision that Halcyon commenced its trade on 9 December 2003.
Decision on the basis for determining the amount of relief for tax year 2003/04
109.	The second question we are required to decide in relation to the Commencement issue concerns the rules which determine the period for which expenditure qualifying for section 42 relief is apportioned.  As referred to in paragraphs 86 to 89 above, there is a dispute between the parties on a matter of statutory interpretation of the provisions of s 40B(3)(b)(ii) F(No 2)A 1992 relating to the meaning of “relevant period” which determines the amount of relief available to Halcyon under section 42 in the tax year in which its trade commenced.
110.	The same point of statutory interpretation arose in the Micro Fusion appeal, and we refer to our decision in that case for the detailed submissions of the parties on the point and the reasons for our decision.  As in that case, we decide the matter in Halcyon’s appeal in favour of the interpretation advanced by HMRC to the effect that for the tax year 2003/04 for Halcyon the “relevant period” for the purposes of section 42 is the basis period for that tax year which, on the basis of our decision on the facts, is the period from 9 December 2003 to 5 April 2004.
The Disallowance issue
Introduction
111.	The next question we are required to determine relates to the amount of expenditure which Halcyon incurred on the acquisition of each of the Films for which it is entitled to claim relief under section 42.  Halcyon’s case is that the whole of the expenditure it so incurred qualifies for such relief.  HMRC’s case is that part of that expenditure falls to be disallowed on the basis that Halcyon’s expenditure reflects matters not comprising the seller’s acquisition costs of the Films.  Neither the validity of the Sale Agreement for each Film nor the amount which Halcyon paid pursuant to the Sale Agreement for each Film (£21,356,853 in relation to Asylum; £7,848,356 in relation to Method; and £6,183,134 in relation to Samantha’s Child) is in dispute: the matter in contention is whether Halcyon is entitled to claim section 42 relief for the whole of those amounts which Halcyon paid.  
112.	Halcyon argues that each Sale Agreement was negotiated on arm’s length terms and therefore it is entitled to relief by reason of section 42(3) for the expenditure it incurred on the acquisition of the master negative of each of the Films, which is the amount paid under each relevant Sale Agreement, and that is the beginning and the end of the matter.  HMRC argues that the acquisition price for each of the Films was not negotiated at arm’s length on a true commercial basis, and therefore to determine the amounts qualifying for section 42 relief Halcyon must rely on the concessionary approach permitted by HMRC and set out in the relevant HMRC Business Income Manual.  This being the case, it is necessary to look behind the amounts paid under the relevant Sale Agreements to the costs incurred by the seller to determine the true production costs of the respective Films, and since certain costs reflected in the price paid for the Films cannot be substantiated as production costs or other costs of the Films, the amount of those costs must be disallowed in quantifying the amount qualifying for section 42 relief.  Halcyon replies that even if the underlying costs of the seller of the film can be scrutinised in this way in order to ascertain the amount of qualifying section 42 expenditure, on the facts there is nothing which falls to be disallowed, as is evidenced by the various accountants’ certificates by reference to which the price paid for the respective Films was ascertained.
113.	As to the matters which HMRC argue are not production costs and therefore give rise to a disallowance, they are (i) certain finance costs incurred by the distributor (that is, the seller of the relevant Film to Halcyon) in the period which it owned the master negatives prior to the sale to Halcyon (for the Films together totalling £1,821,823); (ii) certain consultancy fees payable by the producers of the Films to LMI (for the Films together totalling £5,967,971); and (iii) amounts described as “deferrals”, being contingent bonuses payable to leading actors in the Films and/or the directors of the Films dependent upon, in each case, the relevant Film achieving target gross takings (for the films together totalling £2,647,667).  These sums together total £10,437,461.
The evidence and the facts
114.	The relevant terms of the Sale Agreement for each of the Films are set out in the agreed facts (see paragraphs 17 to 26 above).
115.	The evidence in chief of Mr Levy on this issue was limited to describing the purchase of the Films by Halcyon (and the immediate lease back to the distributor) as being a simple and straightforward commercial transaction, and he referred briefly to the terms of the Sale Agreements, deferring to the evidence of Mr Joberns and Mr Malde as to the way in which they had respectively certified the Film Acquisition Price under each Sale Agreement.  Mr Levy was cross-examined at length by Miss Simler about the process for the negotiation of the Sale Agreements and in particular the terms as to price.  We find the following facts from Mr Levy’s evidence:
(1)	Halcyon, as buyer of the Films, was unrelated to the sellers of the Films (Seven Arts, in the case of Asylum, and Pueblo, in the case of Method and Samantha’s Child).
(2)	The sellers of the Films, in their capacity as distributors/lessees of the Films, have a share in the section 42 tax relief in relation to the expenditure on the films by reason of the structuring of the financial terms of the leaseback.  They therefore have an indirect interest in the amount of expenditure for which Halcyon can validly claim section 42 relief.
(3)	As a commercial matter, the interest of each of the sellers of the Films was to achieve the highest price it could negotiate for the relevant Film, and in any event a price which at least equalled its costs in relation to its acquisition of that Film.  The price they were prepared to agree was also arrived at taking into account the terms of the leaseback, and in particular the share of gross receipts which they agreed to offer to Halcyon in addition to the fixed rental payments.
(4)	Halcyon’s interest was to pay a price which qualified in full for section 42 relief and which also recognised the commercial requirement of the seller that it must recover its costs in relation to its acquisition of the relevant Film.  To that end it took advice from Malde & Co in general terms as to what expenditure would qualify for such relief.  The price certification process agreed with the sellers and set out in each Sale Agreement was designed to achieve Halcyon’s objective of paying a price which would be section 42 qualifying expenditure whilst meeting the sellers’ requirements as to recovery of costs.  The certification process used accountants to verify the costs which the sellers/distributors claimed they had incurred on the films.
(5)	In relation to the film Asylum the Film Acquisition Price was originally negotiated at £22,571,647 as agreed in the Sale Agreement, and this was amended to £21,356,853 or such lesser sum as Shipleys should specify in the certification process.  When that process was carried out the figure certified was the higher figure of £21,985,288.  The price paid was the contractual amount of £21,356,853.
(6)	In relation to the film Method the Film Acquisition Price was agreed as £8,313,417 or such other amount as advised by Malde & Co under the certification process.  When that process was carried out the figure certified was £7,848,356, which was the price paid by Halcyon under the Sale Agreement for that film.
(7)	In relation to the film Samantha’s Child the Film Acquisition Price was agreed as £6,024,946 or such other amount as advised by Malde & Co under the certification process.  When that process was carried out the figure certified was £6,183,134, which was the price paid by Halcyon under the Sale Agreement for that film.
116.	Mr Joberns gave evidence as to the certification process which he carried out in relation to the Film Acquisition Price for the film Asylum.  Mr Joberns has extensive experience in the film and film finance industries.  His evidence in chief by way of his witness statement included a copy of Shipleys’ letter (under his reference) dated 30 July 2004 prepared pursuant to the Sale Agreement certifying the costs incurred by Seven Arts, the seller/distributor, as costs in connection with its acquisition of Asylum, and certain of the documents on which he relied in giving such certification.  He was cross-examined by Miss Simler.  We find the following facts from the evidence of Mr Joberns:
(1)	Shipleys was engaged by Halcyon to advise on the costs that had been incurred by Seven Arts in acquiring Asylum from the co-producers together with any further costs incurred directly by Seven Arts in relation to the film.  Under the terms of the Sale Agreement Shipleys were engaged to certify that the costs had been so incurred and had been capitalised in its books of account, that is, accounted for in accordance with SSAP 21.  Shipleys had been separately engaged by Seven Arts to audit production costs of the film for other purposes, and relied on their work to determine production costs of the film.  Shipleys relied on written representations made to it on behalf of Seven Arts by third parties engaged to prepare and verify certain of the underlying accounting records and procedures for the film, including information as to finance costs incurred by Seven Arts.  In relation to the likelihood of the “deferrals” (the bonuses due to actors and director contingent on achieving gross revenue targets) becoming payable and the amounts due if they became payable, Shipleys relied on the forecasts given by an independent film sales evaluator.
(2)	Shipleys’ statement as to the costs incurred by Seven Arts on the film (totalling £21,985,288) comprised:
(a)	Audited costs of production incurred by the producer of £15,603,452;
(b)	Fees of £3,030,984 payable by the film production partnership to LMI and charged as a cost by Seven Arts in its accounts as part of the value of the film (Seven Arts having paid a price for the film to the film production partnership which reflected this fee);
(c)	Interest costs of £1,735,811 incurred by Seven Arts on loan finance funding of the film.  All such interest was paid to third party financiers;
(d)	Deferral costs of £1,615,041: this figure represents a reasonable expectation (as at the time of the certification) of the amount of the actor and director bonuses which would become payable, based on the estimate of the independent sales evaluator as to the likely US cinema box office revenues that the film Asylum will generate within the first fifteen years of the film’s exploitation.
(3)	As to the fees paid to LMI by the production partnership, those fees took into account a fee of £1,264,414 which was payable (or had been paid) by LMI to Seven Arts (as distributor) by way of an introductory fee.  The amount of the fees was considered to be “unusually large” by the Department of Culture Media and Sport (“DCMS”) when the film Asylum came to be certified by the DCMS as a UK/Irish co-production and in consequence was left out of their analysis for the purposes of their certification.  In the view of Mr Joberns the amount of the fees paid to LMI was not out of line with the level of consultancy fees seen in the film industry.
117.	Mr Malde gave evidence as to the certification process which he carried out in relation to the Film Acquisition Price for the films Method and Samantha’s Child.  Mr Malde has substantial experience in advising clients in the film industry in relation to British qualifying film certification and the accounting and UK tax treatment of films and film finance, his firm having advised in relation to over 500 films.  His evidence in chief by way of his witness statement included a copy of Malde & Co’s letters (under his reference and both dated 1 April 2004 2004) prepared pursuant to the respective Sale Agreements certifying the total film costs and expenditure in relation to the films for the purposes of section 42 as applied by the HMRC Business Income Manual – Expenditure on Film and Audio Product, being the amounts of capitalised costs of the respective films which Pueblo showed in its books of account.  Attached as an appendix to each letter was an audited statement of the total cost of production of the relevant film.  Mr Malde was cross-examined by Miss Simler.  We find the following facts from the evidence of Mr Malde:
(1)	Malde & Co was engaged by Pueblo to provide to Halcyon, as provided in the relevant Sale Agreements, a certified statement showing the total cost of the relevant film as recorded in Pueblo’s books of account and confirmation that such statement had been prepared in accordance with UK Generally Accepted Accounting Principles (“UK GAAP”).
(2)	The costs recorded in the accounting records of Pueblo in relation to each film were recognised in accordance with SSAP 21 by reference to the fair value of the films.
(3)	In relation to the film Method, the total cost of the film as recorded in Pueblo’s books amounted to £7,848,356, which was the Film Acquisition Price as determined by the Sale Agreement.  Its component parts were as follows:
(a)	Direct production costs incurred by the co-producers of £5,586,893, as audited by Malde & Co;
(b)	Producers’ film advisory costs of £1,468,630, being fees paid to LMI by the film production partnership and charged as a cost by Pueblo in its accounts as part of the value of the film (Pueblo having paid a price for the film to the film production partnership which reflected this fee).  Pueblo received no introductory fee from LMI;
(c)	Deferral costs of £728,540, being deferred amounts due to lead actors and the director contingent upon the film achieving certain target gross revenues.  The obligation to pay these amounts was assumed by Pueblo from the production partnership, and the note to the audited cost of production statements states that “the producers consider that the above sums are likely to be paid in the future, based on their estimates for future revenues of the film”, and on the basis of this statement Pueblo brought the amounts into account as deferred expenditure in making the fair value calculation of the film.  The producers included this statement in their sworn application to the DCMS for co-production certification;
(d)	Direct costs incurred by Pueblo of £64,293 relating to legal and finance costs for its acquisition of the film.
(4)	In relation to the film Samantha’s Child, the total cost of the film as recorded in Pueblo’s books amounted to £6,183,134, which was the Film Acquisition Price as determined by the Sale Agreement.  The component parts of this cost were comprised of the same items (each ascertained on the same basis) as for the film Method, being direct production costs of £4,388,972; producers’ film advisory costs of £1,468,357; deferral costs of £304,086; and direct costs of £21,719.
The parties’ submissions
118.	Mr Peacock’s main submission for Halcyon was the simple proposition that in a transaction between unconnected parties which is freely negotiated, the only relevant question in determining the section 42 relief to which Halcyon is entitled in relation to the Films is: What did Halcyon pay for the Films?  The amount it paid for each of the Films, the Film Acquisition Price, is an agreed fact, and not in dispute, and that is the amount for which it is entitled to the relief.  This follows from the provisions of section 42(3), which is simply in terms of “…expenditure of a revenue nature incurred by the claimant on the acquisition of the master negative of a film….”.  The evidence shows that the price was negotiated between the parties, with each party mindful of its own interests, the seller looking for the highest price and Halcyon, as buyer, mindful that the seller needed to recoup its costs, but also mindful that the price paid had to be justified by reference to the fair value of the film in the books of the seller as established according to UK accounting standards so that the price could be justified on that basis to HMRC.  To that end the parties arrived at the mechanism of using experienced accountants to certify the costs to the sellers of the relevant Films and that those costs had been properly accounted for.  In the case of the film Method the agreed price was actually lower than the certified figure: in the case of the other two films the certified figure was the price paid.
119.	Mr Peacock pointed out that in 2005 the law was changed to limit the amount of qualifying acquisition expenditure to production expenditure only, but those provisions were not in force in relation to Halcyon’s acquisition of the Films.  He characterised HMRC’s endeavours to look behind the actual acquisition price as an attempt to impose on Halcyon that later, more restricted, regime.
120.	Secondly, Mr Peacock submitted that even if it is permitted to look beyond the actual price paid, the evidence shows that each component part of the price is justified as a cost which was properly capitalised in the accounts of the seller, applying UK accounting standards, and, moreover, satisfied the terms of HMRC’s relevant Business Income Manual as being either production expenditure or other incidental expenditure incurred on completing the film: the certifying accountants were required to confirm that this was the case, and that is what they did.
121.	As to those component parts, there was no dispute about the actual production costs themselves.  In their pleadings HMRC challenged the seller’s finance costs, but the matter was not pursued in cross-examination beyond some questions to Mr Joberns, who remained of the view that all the interest was paid to third party financiers and no part was an internal notional charge.  The matters which were challenged at length in cross-examination were the deferrals (the amounts due as contingent payments to lead actors and the directors of the Films, dependant upon the amount of gross revenues) and the advisory fees paid to LMI.
122.	As to the deferrals, in cross-examination there was a challenge as to whether they should have been included as part of the seller’s costs of the Film, given their contingent nature, but the respective accountants took the view that they should, having regard to an expert valuer’s opinion as to the likelihood of the triggering targets being achieved in the case of Method, and the producers’ opinions (which they were prepared to swear to in the application to the DCMS) to the same effect in the case of Asylum and Samantha’s Child.  There was also a challenge in cross examination as to whether, in the case of the deferrals due in relation to Method, some or all of the rights of the actors and director to those contingent bonuses had been assigned to the seller as distributor, so that they no longer subsisted as contingent obligations of the seller.  Mr Joberns did not recognise this to be the case, and Mr Levy could not recall that this had occurred, but admitted the possibility that there may have been a security assignment to support interim financing taken by the distributor, but not an outright assignment so as to extinguish the obligation.  
123.	As to the advisory fees, these were a cost incurred by the producers to LMI and as such were an incidental cost which, so it was certified, was properly capitalised in the accounts of the seller in determining the fair value of the relevant film.  There was a challenge to those fees in the case of Method on two counts: first that they were excessive, and secondly that LMI had itself paid an amount to Seven Arts, the seller/distributor.  The evidence of Mr Joberns was that the amount of the fee was in line with what he had seen in other cases, and although the DCMS challenged the amount of the fees in the course of the co-production certification process, this was disputed by Seven Arts and the matter was not pursued by them in order not to delay the certification process, for which the fees point was not a determining factor.  As to the fact that LMI had paid an introductory fee to the distributor, that is irrelevant to the question of what comprises the cost of the film in the hands of the seller, even where the seller and the distributor are the same person – the fee which the production partnership paid to LMI was a cost of the film, regardless of any payments which LMI might have made or of the identity of the payee of such payments.  In the case of the films Asylum and Samantha’s Child there was no challenge to the quantum of the advisory fees paid to LMI, and although it was suggested that LMI had made payments to Pueblo, the evidence of Mr Malde was that this was not so.
124.	Miss Simler, for HMRC, pointed out that as section 42 is a relieving provision, it is for Halcyon to show that the expenditure for which it claims it is entitled to relief is in fact expenditure which qualifies for relief.  In the present case there was no arm’s length negotiation of the price, but instead the price was fixed by reference to the tax reliefs available, with Halcyon imposing a price on the seller/distributor.  Both Halcyon and the seller/distributor had an interest in maximising the amount of section 42 relief and this resulted in a price inflated to take advantage of such relief, and accordingly the price paid in the Sales Agreement for each of the Films should be disregarded and instead the component parts of the seller’s costs should be analysed.
125.	As to those component parts of the price, there is no challenge to the production costs.  There is no challenge to any interest or finance costs to the extent they are genuine and not internal or notional.
126.	There is a challenge by HMRC as to the fees paid to LMI in the case of each of the Films: the services for which LMI was remunerated by each production partnership included such matters as promoting, setting up and financing the production partnership, which are matters that do not relate to the production of the film, so that the fees paid to LMI by the production partnership (and shown as a part of its cost of the film by the seller in each case) cannot be justified as forming part of the acquisition costs of the film – they are neither production costs nor incidental costs of completing the film.  Further, in the case of Asylum, the amount paid by the production partnership reflected an introductory fee which LMI paid to Seven Arts, so that the amount shown as a cost of the film in the books of Seven Arts was inflated by an amount it had actually received.  The DCMS raised serious concerns about the size of the fees paid by the production partnership to LMI in the case of Asylum, which throws further doubt on the validity of those fees as a proper cost of the film to the seller. 
127.	HMRC challenges the deferral items within the costs of the Films on the grounds that they were not costs actually incurred, but were contingent costs only.  In the case of the films Method and Samantha’s Child the accountants, in accepting those contingent costs as deferred costs of the film, relied only on the estimates of the producers of likely gross revenues without reference to independent evidence.  In the case of Asylum there is evidence from contemporaneous email correspondence that some or all of the parties entitled to the deferrals assigned their rights to those deferrals to the distributors, in which case the obligation to pay was cancelled as a matter of law.  That being so the contingent liability could not be reflected as a cost of the film.
128.	Miss Simler referred to the relevant part of the Business Income Manual which sets out HMRC’s views at the time relevant to this appeal as to the amount of expenditure for which section 42 relief can be claimed (BIM 56435 as at April 2003).  She described it as a concession made in circumstances where it is difficult to put a market value on a film before its public release because of the uncertainty of its commercial success or otherwise.  It is in the following terms:
“A film may be sold prior to general public release for a sum equal to production expenditure plus other incidental expenditure incurred on completing the film.  The other expenditure may include things that do not qualify as production expenditure, such as interest, insurance premiums, commitment fees, etc.  Where this happens a challenge should not be made on the grounds that a proper appreciation of the film’s prospects would have led to a lower figure.”
The certification process shows that Halcyon was seeking to rely on this guidance.  HMRC argues that the items of cost it challenges cannot be said to be “incidental expenditure incurred on completing the film”, and so cannot come within the terms of the concession.
Decision on the Disallowance issue
129.	We consider that the amount of expenditure which Halcyon incurred on the acquisition of the master negative of each of the Films was the amount it paid under each respective Sale Agreement, so that it is entitled to section 42 relief on such amount, and no part of the amount claimed for relief is to be disallowed.
130.	We accept the case made by Mr Peacock for Halcyon.  The terms of section 42(3) are clear and without ambiguity or qualification:  the amount which the taxpayer can claim as relief by way of deduction is his expenditure on the acquisition of the master negative of the film.  In the present case Halcyon acquired the master negative of each of the Films by the terms of a Sale Agreement and the price it paid for the master negative was determined as provided by those terms.  Those terms have not been challenged – they are agreed between the parties.  Halcyon’s expenditure on the acquisition of the master negative in the case of each Film was the price it paid, the Film Acquisition Price, as provided for in each Sale Agreement.
131.	It might be possible to disregard the terms of any Sale Agreement if it could be shown that the price purportedly paid was to any extent consideration given for something other than the acquisition of the master negative – if, for example, in reality the substance of the agreement was that the purchaser was paying, in part at least, for something other than the master negative by way of an ancillary or collateral contract.  This, as we understand it, was not the case argued by HMRC.  Instead, HMRC argued that the Sale Agreement, although made between independent parties, was not commercially negotiated so as to arrive at a price representing the value of the master negative, since both parties had an interest in fixing the highest price possible.  Accordingly the price paid should be disregarded and instead the seller’s costs should be analysed to determine what comprised true production costs and costs properly incidental to production of the Films.
132.	However, we were not taken to any provision in the legislation relating to section 42 relief which, in determining qualifying expenditure, substitutes a different amount from acquisition expenditure – for example, there appears to be no provision, common enough in other parts of tax legislation, which substitutes a market value where parties are not acting at arm’s length.  We cannot see, therefore, on what basis HMRC can argue that we are required to look beyond the price Halcyon paid for the master negatives.  This is not a case where the Sale Agreement can be set aside as a sham document which fails to give effect to the true intentions of the parties, nor, as we have said, is it argued that in encompasses some collateral contract.  Furthermore, we cannot agree that the terms of each Sale Agreement were not commercially negotiated.  Mr Levy, in his evidence in cross-examination, set out fairly the interests of the parties as they negotiated the price, as we have set out above – the seller needed to recoup the costs to it of the film (that is, the costs as it had accounted for them in its books of account) and Halcyon as buyer had an eye to the practice of HMRC as to qualifying acquisition expenditure as that practice was set out in their Business Income Manual.  The parties resorted to expert accountants – and both Shipleys and Malde & Co were highly experienced in this field – to certify that the price paid by Halcyon did not exceed the cost of the film to the sellers as shown in their books, and that such cost had been accounted for in accordance with UK accounting standards and practice.
133.	In our view, therefore, Halcyon is entitled to claim section 42 relief for the amount it paid under the terms of the relevant Sale Agreement for the master negative of each of the Films, and there is no basis for looking beyond those terms.  That determines the matter.  However, a great deal of detailed forensic enquiry was made by Miss Simler and Mr Gledhill by reference to the documentation at the hearing as well as in cross-examination, on the basis that it is legitimate to look to the production costs and incidental costs of the Films in determining the amount of qualifying expenditure and we need to deal with the conclusions they asked us to accept in the light of that enquiry.
134.	We were taken to the production costs and incidental costs of each of the Films as shown in the books of account of Seven Arts and Pueblo respectively and as certified as costs capitalised in accordance with UK accounting standards by the two firms of accountants, as set out in the evidence and findings of fact above.  As mentioned, HMRC have no argument with the amounts shown as production costs.
135.	In relation to the incidental costs (finance costs, deferrals, and fees to LMI) which are challenged in whole or in part by HMRC, these are costs which, first, the directors of the sellers consider should properly be accounted for as costs of the respective Films or otherwise reflected in the value of the Films, and secondly which the expert accountants then certify to be such costs properly accounted for by the sellers.  In our view these sums can be challenged as costs of the Films only where the directors of the sellers have acted in breach of the duties imposed on them by law and, further, the accountants have been negligent or have acted in bad faith.  We did not find this to be the case.  
136.	In her cross-examination of Mr Joberns Miss Simler first tried to establish that part of the costs shown as relating to Seven Arts’ financing of the film Asylum were an internal or notional charge, but this was not accepted by Mr Joberns, who pointed out that the email exchange suggesting this might be the case was dealing with the point in advance as a matter of speculation or enquiry, and that the matter was not pursued.  We accept his evidence that the finance costs as shown, totalling £1,735,811, were costs of the seller in connection with its acquisition of the film Asylum.
137.	In relation to the amount shown as a cost by way of deferrals in the case of Seven Arts’ costs for the film Asylum, Mr Joberns held to his view that the amounts shown in the accounts were based on estimated future gross revenues as determined by a specialist in such matters, and were therefore properly shown as a deferred cost of the film in accounting terms, notwithstanding their contingent nature.  He did not accept Miss Simler’s assertion that there had been an assignment for no consideration by the actors and director concerned of their contingent interest to Seven Arts and in consequence its contingent liability had been extinguished.  We accept his evidence that the deferred costs as shown, totalling £1,615,041, were costs of the seller in connection with its acquisition of the film Asylum.
138.	In relation to the amount shown in the accounts of Seven Arts as a cost of the film Asylum by way of fees paid to LMI, Mr Joberns again maintained his view that he had correctly certified these amounts as proper costs to Seven Arts of the film.  He said that they had been paid by the partnership producing the film in consideration of the services supplied by LMI, and that the amount, although questioned in a different context by the DCMS, was not unusual, in his experience, for a film with a budget such as this.  He said it was not relevant that LMI itself had, as a distinct matter, paid an introductory fee to Seven Arts as distributor – for the accounting purposes of Seven Arts as seller the question was whether the production partnership had paid the fees to LMI in relation to the production of the film, and this was the case.  We accept the evidence of Mr Joberns that the LMI fees as shown, totalling £3,030,984, were costs of the seller in connection with its acquisition of the film Asylum.
139.	As to the films Method and Samantha’s Child, neither the production costs nor the finance costs as certified by Malde & Co were challenged in cross-examination.  In the case of the costs by way of deferrals, there was no suggestion that the rights to the contingent amounts had been assigned to the distributor, but Miss Simler put it to Mr Malde that he had seen no evidence as to likely future gross revenues which might trigger the payments.  Mr Malde said he relied on the considered views of the producers, which were the views they included in their application for DCMS certification.  Miss Simler suggested that there was a degree of circularity in that the producers in turn used the accounts of Pueblo audited by Malde & Co.  We accept Mr Malde’s evidence.  He is expert in matters relating to the accounting treatment of films and in certifying that these items were costs of the films properly accounted for as such he was expressing his professional opinion which he gave upon making enquiry for that purpose.  We conclude, therefore that the deferral sums (£728,540 in respect of Method, and £304,086 in respect of Samantha’s Child) were costs of the respective films in the accounts of the seller.
140.	In the case of the fees paid to LMI by the partnerships which produced Method and Samantha’s Child, we accept the evidence of Mr Malde that no part of the fees paid reflected any introductory fee or other payment made by LMI to Pueblo as distributor.  We also accept his evidence that such fees, totalling £1,468,630 and £1,468,357 respectively, are properly accounted for by Pueblo as costs of the respective films in Pueblo’s books of account.
141.	Therefore, even if we follow the line of enquiry into the production costs and incidental costs of the Films, as Miss Simler considers we should in this case, we conclude that all the costs accounted for by the respective sellers as acquisition costs in relation to the respective Films are properly shown as such.  Those who are experienced in determining the nature of such costs for the purposes of drawing up the accounts of the sellers, and who were required to verify and certify that such costs were accounted for as costs in connection with the acquisition of the respective Films in accordance with UK GAAP and the relevant accounting standards, reached that conclusion and nothing in the evidence we saw led us to consider that they had reached the wrong conclusion.
142.	For these reasons we reach our decision that no part of the expenditure which Halcyon incurred on the acquisition of the Films under the respective Sale Agreements should be disallowed.
The Deductibility of Fees issue
Introduction
143.	Halcyon paid fees totalling £1,805,592 to LMI for consultancy services pursuant to the FCA entered into by Halcyon and LMI in March 2003.  Halcyon has claimed those fees as an expense in computing the profits of its trade for its accounting period ended 5 April 2004, giving rise to a trading loss for tax purposes for the tax year ended on that date.  HMRC challenge the deductibility of those fees in their entirety.
144.	The matters arising in this issue arose also in the related Micro Fusion appeal, where the factual circumstances were very similar and the parties put forward the same arguments as in Halcyon’s appeal.
145.	The agreed facts relevant to this issue are set out in paragraphs 10 to 15 above.  We set out below the other relevant facts.
Further facts relevant to the Deductibility of Fees issue
146.	The terms of Schedule 1 to the FCA (which set out the consultancy services to be provided by LMI) were similar to those contained in the film consultancy agreement entered into between Micro Fusion and Future Films Limited as set out in our decision in the related Micro Fusion appeal.
147.	On 23 February 2004 Halcyon entered into a further Film Consultancy Agreement with LMI (the “February 2004 FCA”). This was intended to be a more detailed agreement than the original FCA. Clause 7 of the February 2004 FCA provided for the payment of fees to LMI (referred to as “the Film Consultant”) in the following terms:
“7.1 The Film Consultant shall be paid the following amounts in respect of the performance of its obligations hereunder in relation to the Films where the Film Consultant provides the Film Consultancy Services:
	7.1.1 Not more than 5.5% of the aggregate moneys subscribed to the 	LLP Capital by Members pursuant to the Partnership Deed (“Film 	Consultant’s Closing Fee”).  The Film Consultant agrees that, out of 	such fixed sum, it shall bear all expenses and third party charges 	associated with the provision of the Film Consultancy Services, 	being fees due to the Partnership’s solicitors, accountants and tax 	counsel in connection with advices [sic] provided and in connection 	with the drafting, completing and closing of all agreements; 	commissions due to independent financial advisers and other 	intermediaries and introducers in connection with the Partnership’s 	capital raising; closing fees, margin and pre-paid interest (if any) to 	the LLP Members Bank and the fees due to both the Promoter and 	Operator; and
	7.1.2 As an ongoing entitlement for the Film Consultant in return for 	the Film Consultant involvement in structuring the Partnership, the 	Partnership agrees to pay to the Film Consultant 20% of the 	Partnership’s entitlement to Additional Rentals from the Films. The 	fees pursuant to this clause 7.1.2 shall be known as the “Film 	Consultant’s Net Proceeds Fees”;
......”
148.	On 13 January 2005 the partnership tax return for Halcyon was submitted in respect of the tax year ending 5 April 2004.  HMRC carried out an enquiry into that return.  Following that enquiry, HMRC issued a closure notice, and in relation to the Deductibility of Fees issue the effect of the closure notice was that HMRC allowed 6 per cent of the Film Consultancy Fee and disallowed the balance of 94 per cent.  The fees payable to LMI by Halcyon for which it claimed a deduction in relation to its period of account ending 5 April 2004 amounted to £1,805,592.  Those fees were invoiced by LMI over the period from June 2003 to August 2004 on the dates and for the amounts set out in paragraph 15 above.
149.	At the hearing, HMRC contended that none of the fees paid to LMI was deductible in computing Halcyon’s profits for tax purposes.  We return below to the implications of this change of view, but initially we consider the question of deductibility without looking at the question whether it is the whole or a large percentage of that fee which is alleged to be non-deductible.
150.	The Audit Partner at Grant Thornton responsible for the audit certificate for Halcyon’s financial statements for the period to 5 April 2004 was Mr Terry Back.  He appeared as a witness before us.  His role was as a witness of fact, and not as an expert witness.  His evidence was given for the purpose of stating the basis on which he as Audit Partner determined that it was correct and proper for the fees as invoiced by LMI to Halcyon to be treated as deductible in Halcyon’s profit computation for the period to 5 April 2004.
151.	Mr Back described Halcyon’s business as that of acquiring and leasing films through what were termed sale and leaseback transactions.  As such, Halcyon’s primary activities were accounted for in the relevant financial statements in accordance with SSAP 21.  Under the FCA and the February 2004 FCA Halcyon had engaged LMI to provide it with, inter alia, assistance in acquiring and leasing films.
152.	The services listed at paragraphs 1 to 4 of Schedule 1 to the two FCAs related to the acquisition of films.  The services listed at paragraphs 5 to 9 related to the exploitation of films.  Under a normal sale and leaseback agreement, the lessor (here, Halcyon) would pass on the work of exploitation to the lessee as part of the leaseback agreement.  In the light of this, Mr Back’s opinion was that the services which LMI was required to carry out under paragraphs 5 to 9 were insubstantial when compared with those listed at paragraphs 1 to 4.  His view as to the remainder of the paragraphs in Schedule 1 was similar.  In his opinion, the element of the services under the FCA and the February 2004 FCA that did not relate to the acquisition of the films was not material in determining the accountancy treatment that should be applied to the costs paid by Halcyon to LMI.
153.	Mr Back explained that under UK GAAP any business incurring costs for services in connection with its business would write off the costs in its profit and loss account as they were incurred.  Halcyon had incurred the liability to pay the consultancy fees to LMI under the terms of the FCA and the February 2004 FCA.  The subject of costs was dealt with in the body of SSAP 21.  Paragraph 30 of SSAP 21 defined “initial direct costs”.
154.	Sale and leaseback transactions (or in the case of a lessor, more properly “purchase and leaseback” transactions) were dealt with for accounting purposes as composite transactions.  In the books of the lessor, the original purchase from the lessee was not treated as the purchase of a fixed asset, but rather as the acquisition of a debtor.  Paragraph 48 of SSAP 21 stated: “A buyer/lessor should account for a sale and leaseback in the same way as he accounts for other leases, that is, using methods set out in paragraphs 38 to 45 above”.
155.	In the section of SSAP 21 covering accounting by lessors, as for Halcyon, paragraph 44 stated that: “Initial direct costs incurred by a lessor in arranging a lease may be apportioned over the period of the lease on a systematic and rational basis.”
156.	Thus, under SSAP 21, the default position for Halcyon (that is, applying the general rule under UK GAAP) was to write off the costs incurred under the FCA and the February 2004 FCA as an expense in the period in which the services were performed and the costs thereby incurred.  The effect of paragraph 44 of SSAP 21 was to give Halcyon the option of writing off the expense over the period of the lease if it wished to do so, as the wording “may be apportioned” clearly provided an option to spread the cost.  There had not been any requirement to spread the cost, nor had any such requirement since been imposed.
157.	Applying SSAP 21 Halcyon had chosen to write off the LMI fees as an expense of the trade in the period ended 5 April 2004, the period in which the Films had been acquired and in which the contracted services had been performed by LMI.  When auditing the accounts for that period, Grant Thornton had concurred with that treatment.
The parties’ submissions
158.	As Halcyon’s appeal was heard at the same time as that of Micro Fusion, each party’s arguments in both appeals on the Deductibility of Fees issue were put to us at the same time.  Both parties acknowledged that the arguments put in the Micro Fusion appeal were equally applicable to Halcyon, and so did not address us separately in relation to Halcyon.  As we have recorded those arguments in detail in our decision in the Micro Fusion appeal, we do not repeat them here.  However, there was one respect in which the parties’ submissions related specifically to Halcyon rather than to Micro Fusion.
159.	It was argued for HMRC that clause 7.1.1 of the February 2004 FCA expressly provided that the fees payable to third parties (such as the fees due to lawyers for work done for Halcyon) were payable out of the Film Consultant’s Closing Fee, thus supporting the contention that the whole of that fee should be disallowed.
160.	For Halcyon, Mr Peacock argued that clause 7.1.1 made provision for calculating the fee as a percentage of the capital raised in the partnership; this was simply a method of computation.  LMI was not the agent of Halcyon, so although there was a difference in language between this Halcyon document and the corresponding Micro Fusion document in the computation of the fee payable, there was no difference in the analysis of the nature and status of that fee.  Clause 7.1.2 made reference to a fee for structuring, but this was a separate fee and not that in question in Halcyon’s present appeal.
Decision on the Deductibility of Fees issue
161.	Our decision on this issue is the same as our decision in the Micro Fusion appeal.  As the only difference between the submissions in the two appeals was based on the wording of clause 7.1.1 of the February 2004 FCA, we confine our comments to this point.
162.	We accept Mr Peacock’s argument that clause 7.1.1 does not make LMI the agent of Halcyon in relation to the expenses mentioned.  The liability to pay the expenses listed arises under the various contracts between LMI and third parties.  There were no contracts between Halcyon and those third parties.  We can see no basis for imputing the existence of direct contracts between Halcyon and those parties.  The possibility that Halcyon might have entered into direct relationships with those parties does not justify an assumption that it did so.  The analysis of the contractual relationships must be based on facts and not on hypotheses.
163.	Accordingly, as in the Micro Fusion appeal, it is our decision that the Film Consultant’s Closing Fee is deductible in computing Halcyon’s profits for tax purposes for the period ending 5 April 2004.  We note that the greater part of the fees were invoiced by LMI after 5 April 2004, but accepting the evidence of Mr Back that Halcyon, in accordance with UK GAAP, wrote off the fees in the period in which the Films were acquired (and the consultancy services rendered) we conclude that the date of invoicing is not relevant in determining the period in which the deduction should be taken, and no point in relation to this was taken by either party.
164.	As we have determined the Deductibility of Fees issue in favour of Halcyon, we do not need to address the question of establishing the basis on which HMRC originally identified the 6 per cent which was regarded as deductible and distinguished it from the remaining 94 per cent considered not to be deductible.
Concluding procedural matters
165.	At the hearing Mr Peacock raised a procedural point in relation to the Deductibility of Fees issue: as mentioned above, the closure notice under appeal allowed a sum equal to 6 per cent of the Film Consultant’s Closing Fee as deductible, but at the hearing HMRC argued that no part of that fee was deductible.  He questioned whether, under the rules as they now apply to the self-assessment regime, we have jurisdiction to determine matters so as to disallow the whole amount when the closure notice disallows only part of the amount giving rise to the trading loss.  The matter falls away in the light of our decision on the Deductibility of Fees issue in favour of Halcyon, and as the jurisdiction point was not fully argued before us at the hearing we are reluctant to express a view on a procedural matter which could be of some importance beyond this particular appeal.  Should our decision on the Deductibility of Fees issue be appealed, and the jurisdiction point become relevant, the parties are at liberty to return to argue the point before us and we will then reach our decision.
166.	As mentioned at the outset, the parties asked us to reach our decisions on the various issues in dispute as decisions in principle.  This we are entitled to do under the powers of regulation 18(5) of The Special Commissioners (Jurisdiction and Procedure) Regulations 1994 as amended.  Under those powers we adjourn the making of the final determination so that the parties may agree the figures and any other matters arising from our decision, and should they fail to do so we will make our determination of any outstanding matters after further representations by the parties.

          EDWARD SADLER				JOHN CLARK

SPECIAL COMMISSIONERS

RELEASE DATE: 30 June 2008

SC/3066/2007 

Authorities referred to in skeletons and not referred to in the decision:

Elliss v BP Oil Northern Ireland Refinery Ltd  [1985] STC 722
Elliss v BP Oil Northern Ireland Refinery Ltd  [1987] STC 52 (CA)
Ben-Odeco Ltd v Powlson [1978] 1 WLR 1093 (HL)
R v HM Customs & Excise, ex parte Greenwich Property Ltd [2001] STC 618
McNicholas Construction Co Ltd v CCE [2000] STC 553
HM Revenue & Customs v Dempster [2008] EWHC 63 (Ch)