Revenue & Customs v Micro Fusion 2004-1 LLP

For film tax relief, exploiting a film requires exploitation of the film’s physical master negative, or—if intellectual property rights form part of the film—of both elements. Retaining bare copyright or a contractual possibility of recovering physical materials does not establish a continuing trade in exploitation where the transaction has substantively transferred the film and its exploitation rights for consideration. An outright disposal is not exploitation because exploitation connotes deriving income from an asset on a continuing basis.

A single sale may constitute trading stock where it occurs in the course of the taxpayer’s trade. A closure notice defines the subject matter of an appeal by its stated conclusion or amendment, but does not generally confine the court to reasons previously advanced where the legal issue causes no unfairness. Relief under section 101 of the Finance Act 2002 restricts relief under section 48 of the Finance (No 2) Act 1997, but does not remove independent relief under section 42 of the Finance (No 2) Act 1992.

HMRC appealed against decisions of the Special Commissioners concerning film-finance tax relief. The appeals concerned Micro Fusion 2004-1 LLP’s claims for production expenditure relief under section 42 of the Finance (No 2) Act 1992 and section 48 of the Finance (No 2) Act 1997, including whether it carried on a trade involving exploitation of films, whether the film was trading stock, and whether section 60 of the Finance Act 2005 applied.

The separate Halcyon appeal concerned whether section 101 of the Finance Act 2002, directed against successive acquisitions, prevented reliance on section 42 as well as section 48. The central questions were the legal effect of the contractual arrangements and the proper construction of the statutory film-relief provisions.

1. Micro Fusion: nature of the trade. HMRC’s appeal succeeded. The phrase exploitation of films in section 42 of the Finance (No 2) Act 1992 was not confined to intellectual property rights. The statutory scheme, including sections 40A–40D, 41, 42 and 43, treated the film as involving a physical master negative or equivalent master version. If intellectual property rights were also included, exploitation of the film would require exploitation of both the physical and intellectual-property elements.
2. Exploitation was not defined and should not be given an abstract judicial gloss. It connoted a transaction designed to derive income from an asset on a continuing basis. A single outright sale was therefore not exploitation for section 42 purposes.
3. Objectively construed, the Distribution and Commissioning Agreement transferred ownership of the master negative and the relevant exploitation rights to Pathé for consideration. The possible return of physical materials after 21 years, and Micro Fusion’s retention of bare copyright, did not alter the substantive reality. The income stream was deferred consideration for the sale, not income from Micro Fusion’s exploitation of the master negative. Micro Fusion therefore did not carry on a trade or business consisting of or including exploitation of films.
4. Trading stock. Although unnecessary to the result, the court held that the film was trading stock within section 42(8). An asset sold in a one-off transaction may be property such as is sold in the ordinary course of trade. The transfer was objectively a sale of the master negative and, if necessary, of the exploitation rights for the 21-year period.
5. Section 60 jurisdiction and application. The court had jurisdiction to entertain HMRC’s section 60 argument. The closure notice stated a conclusion requiring an adjustment to the losses and did not referentially confine the conclusion to particular reasons. The court could entertain a legal argument not previously advanced where the appeal remained within the stated conclusion or amendment and no unfairness arose.
6. The original agreement was entered into before 2 December 2004, but its minimum guaranteed payments were unenforceable while the relevant schedule remained blank. The amending agreement, made on 28 January 2005, supplied the essential payment terms, constituted a deferred income agreement satisfying section 61, and caused the last date of deferral to extend beyond the 15-year period. Section 60 therefore applied.
7. Halcyon. HMRC’s appeal was dismissed. Section 101 of the Finance Act 2002 used relief under section 48 as a statutory shorthand for the enhanced relief available under that provision. It did not prevent a taxpayer who could not obtain section 48 relief from relying on the separate, less generous relief under section 42.
8. The Micro Fusion matter was to be remitted to the Special Commissioners for final disposal on the figures unless agreed. Costs and consequential matters were reserved for further argument.

• High Court (Chancery Division): allowed HMRC’s appeal in the Micro Fusion case and dismissed HMRC’s appeal in the Halcyon case.
• Special Commissioners: had allowed the respondents’ arguments on the nature-of-trade, trading-stock and section 60 issues in Micro Fusion, and had held that section 101 did not preclude Halcyon’s reliance on section 42. Their decision was reviewed on appeal.