Spc00695

Income tax – limited liability partnership – whether partnership engaged in trade of exploitation of films – yes – whether film constituted trading stock so as to deny relief under s 42 F(No 2)A 1992 or s 48 F(No 2)A 1997 – no – date of commencement of partnership’s business and basis period applicable – s 40B(3)(b)(ii) F(No 2)A 1992 – date film completed – s 43(3) F(No 2)A 1992 – whether arrangements for exploitation of film a deferred income agreement in respect of a film which is within s 60 FA 2005 – no – whether film consultancy fees incurred deductible – yes 

THE SPECIAL COMMISSIONERS

	MICRO FUSION 2004-1 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, Micro Fusion 2004-1 LLP (“Micro Fusion”).  Micro Fusion contends that it 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 2005 of £12,413,398, being an apportionment of a loss of £15,338,199 which Micro Fusion claims it incurred in its accounting period beginning on 6 April 2004 and ending on 30 June 2005.
2.	That loss of £15,338, 199 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 Future Films Limited (“Future”) for film consultancy services.  In detail:
(1)	Micro Fusion claimed relief on its expenditure of £13,642,547 on commissioning the production of a film entitled Mrs Henderson Presents; of that amount £13,444,455 was claimed under s 48, Finance (No. 2) Act 1997 (“section 48”), and £222,380 was claimed under s 42, Finance (No. 2) Act 1992 (“section 42”); and
(2)	Micro Fusion claimed a trading loss of £1,694,884 of which £1,616,889 was attributable to fees paid to Future.
3.	On 2 February 2007 the Commissioners for Her Majesty’s Revenue and Customs (“HMRC”) issued a closure notice amending Micro Fusion’s return by disallowing its claim to relief under section 48 and section 42, and disallowing all but £188,156 of the loss claimed as a trading loss.  On 8 February 2007 Micro Fusion appealed against that closure notice, and it is that appeal which is now before us.  
4.	Since the closure notice was issued the case has developed, so that in the case as it was argued there are two matters which were not within the scope of the amendments made to the tax return in the closure notice, and this raises certain procedural questions referred to at the end of this decision.  First, in the course of the hearing of the appeal HMRC contended that the whole of the trading loss claimed should be disallowed.  Secondly, HMRC contend that Micro Fusion is liable to tax on a notional receipt under the provisions of s 60, Finance Act 2005, as referred to below in the section of this decision dealing with the Section 60 issue.
5.	As mentioned, this appeal relates to claims made for the tax year ending 5 April 2005.  If, on the facts, we find against Micro Fusion on the matter referred to below as the Completion issue, the consequence is that Micro Fusion’s claims for relief will be made (on directly corresponding terms) for the following tax year.  The parties therefore invited us to determine matters, in this eventuality, by reference to an appeal treated as made by Micro Fusion for the tax year ending 5 April 2006 (notwithstanding that, of course, the processes of a claim, refusal, and appeal have not occurred).  We have agreed to proceed on that basis.
6.	More generally, and having regard to the number of distinct issues in this appeal, the parties asked that we should concern ourselves only with those issues in principle, rather than the detailed figures, leaving it to the parties to resolve the figures so as to give effect to our decisions in principle.  Again, we have agreed to proceed on that basis.
The issues requiring a decision and our decision in summary
7.	The parties identified six issues which require our decision:
(1)	Whether, having regard to the manner in which it sought to make a profit from the film Mrs Henderson Presents, Micro Fusion was carrying on “a trade or business which consists of or includes the exploitation of film” within section 42(1) (the “Nature of Trade issue”).  This issue goes to Micro Fusion’s entitlement to relief under section 42 and section 48 since it is a condition of such relief that such a trade is carried on;
(2)	Whether the film Mrs Henderson Presents constituted trading stock (as defined in s 100(2), Income and Corporation Taxes Act 1988 (“ICTA 1988”)) of Micro Fusion (the “Trading Stock issue”).  This issue, by reason of section 42(8) (which denies relief where the film constitutes trading stock), also goes to Micro Fusion’s entitlement to relief under section 42 and section 48;
(3)	Whether, if Micro Fusion was carrying on a trade or business which consists of or includes the exploitation of film, that trade commenced on 6 April 2004, 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 it incurred on the production of the film Mrs Henderson Presents which can be claimed for relief in the tax year 2004/05 by the application of s 40B(3) F(No 2)A 1992 in the situation where Micro Fusion 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 2004/05;
(4)	Whether, if Micro Fusion was carrying on a trade or business which consists of or includes the exploitation of film, the film Mrs Henderson Presents was “completed” (as defined in s 43(3) F(No 2)A 1992) on or before 30 June 2005 (that is, within the “relevant period” in relation to Micro Fusion, as provided in section 42(3)(a)) (the “Completion issue”).  This issue also goes only to the period in which relief can be claimed (in this case, whether in the tax year ended 5 April 2005 or the tax year ended 5 April 2006);
(5)	Whether, if Micro Fusion was carrying on a trade or business which consists of or includes the exploitation of film, the arrangements Micro Fusion entered into for the exploitation of the film Mrs Henderson Presents comprised a “deferred income agreement in respect of a film” to which the provisions of s 60, Finance Act 2005 (“section 60”) apply (the “Section 60 issue”).  This issue goes to the question of whether Micro Fusion is to be treated as receiving in the relevant period a deemed income receipt for the purposes of its trade; and
(6)	Whether the fees of £1,616,889 incurred by Micro Fusion to Future were properly deductible in the calculation of the profits of Micro Fusion’s trade for the purposes of its tax return for the tax year ended 5 April 2005 (the “Deductibility of Fees issue”).  This issue goes to the quantum of the loss claimed by Micro Fusion for that tax year.
8.	In summary our decision is as follows:
(1)	As to the Nature of Trade issue, in relation to the film Mrs Henderson Presents Micro Fusion was carrying on “a trade or business which consists of or includes the exploitation of film” within section 42(1);
(2)	As to the Trading Stock issue, the film Mrs Henderson Presents did not constitute trading stock (as defined in s 100(2), ICTA 1988), and in consequence Micro Fusion is not precluded by section 42(8) from claiming relief under section 42 and section 48;
(3)	Therefore in principle Micro Fusion is entitled to claim relief under section 42 and section 48, as appropriate, in respect of expenditure incurred by Micro Fusion on the production of the film Mrs Henderson Presents;
(4)	As to the Commencement issue, Micro Fusion’s trade or business which consists of or includes the exploitation of film commenced not on 6 April 2004, but on 20 September 2004.  For the purposes of the proportion of expenditure which can be claimed as relief in the tax year 2004/05 the relevant period as determined by s 40B(3) F(No 2)A 1992 is the period 20 September 2004 to 5 April 2005;
(5)	As to the Completion issue, Micro Fusion completed the film Mrs Henderson Presents after 30 June 2005 (but before 6 April 2006), and hence after the “relevant period” by reference to which Micro Fusion claimed relief under section 42 and section 48 for the tax year ended 5 April 2005.  Its claims for such relief are accordingly made (and are valid in accordance with the terms of this decision) for the tax year ended 5 April 2006;
(6)	As to the Section 60 issue, the arrangements Micro Fusion entered into for the exploitation of the film Mrs Henderson Presents did not comprise a “deferred income agreement in respect of a film” to which the provisions of section 60 apply, and therefore Micro Fusion is not to be treated as receiving in the relevant period a deemed income receipt for the purposes of its trade under those provisions; and
(7)	As to the Deductibility of Fees issue, the fees of £1,616,889 incurred by Micro Fusion to Future were properly deductible in the calculation of the profits of Micro Fusion’s trade for the purposes of its tax return for the tax year ended 5 April 2005.
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 21 below and they serve by way of outline of the factual background to the appeal.  Each of the issues we are required to decide turns largely upon the facts as we found them from the evidence presented to us, and therefore our detailed findings of additional facts relevant to each issue are set out in the respective sections of this decision.
10.	Micro-Fusion was incorporated as a limited liability partnership under the name Micro-Fusion 2003-5 on 9 July 2003.  A Notice of Change of Name of a Limited Liability Partnership was lodged with Companies House on 27 May 2004 and Micro Fusion changed its name to Micro Fusion 2004-1 LLP with effect from 11 June 2004.    
11.	In outline, during the tax year ending 5 April 2005, Micro Fusion acquired from Pathé Productions Limited ("Pathé"), a one picture licence in a screenplay, Mrs Henderson Presents.  Mrs Henderson Presents was released in the United Kingdom on 25 November 2005.  An accountancy firm, Malde & Co., audited the costs of production applicable to the film Mrs Henderson Presents up to and including 21 October 2005.   On 21 September 2005, Micro Fusion completed its tax return for the year ended 5 April 2005 ("the Partnership Tax Return").  The loss arose as a result of:
(1)	fees paid by Micro Fusion, primarily attributable to fees paid to Future under the terms of the Film Consultancy Agreement referred to below; and 
(2)	a deduction under section 48 and a deduction under section 42.  These deductions were claimed on the basis that the relevant amounts represent Micro Fusion's expenditure for the relevant tax year on the production of Mrs Henderson Presents.  
12.	The film Mrs Henderson Presents was directed by Stephen Frears and starred Dame Judi Dench and Bob Hoskins. The film was nominated for two Academy Awards ("Oscars"), four British Academy of Film and Television Arts Awards ("BAFTAs") and sixteen other awards; it won four awards.  Principal photography of the film started on or about 20 September 2004.  
13.	On 8 November 2005, the Department of Culture, Media and Sport (the “DCMS”) issued a Certificate, in accordance with Schedule 1 to the Films Act 1985, in relation to Mrs Henderson Presents, that certified that the master negative, master tape or master disc is "a qualifying film, tape or disc" within the meaning of Schedule 1 to the Films Act 2005 and that the film is a qualifying British Film for the purposes of ss.40B F(No 2)A 1992 and section 42 and section 48.
14.	On 6 April 2004, Micro Fusion entered into a Film Consultancy Agreement (the “FCA”) with Future pursuant to which Future was retained to act as film consultants to Micro Fusion.  Micro Fusion and Future entered into a further Film Consultancy Agreement, dated 28 January 2005 ("the January 2005 FCA") and to a Deed of Amendment to the January 2005 FCA (dated 6 September 2005 but stated to be with effect from 28 January 2005).  The January 2005 FCA provided that Micro Fusion was to pay £1,616,889 to Future.  
15.	On 6 April 2004, Micro Fusion entered into an Exclusive Acquisition Financing Agreement (the “EAFA") with the International Motion Picture Development and Consultancy Limited ("IMPDC").  Pursuant to the EAFA, Micro Fusion acquired certain rights in connection with a screenplay in development which is stated to be for the purpose of financing and distributing the film to which the rights related.  This screenplay was entitled Manson Girls.   
16.	On 1 October 2004, Micro Fusion entered into a One Picture Licence Agreement with Pathé.  Under the terms of the One Picture Licence Agreement (as amended by Deed of Amendment effective from 1 October 2004), and in consideration for the payment of £1 (the receipt of which the Licensor acknowledged) (and subject to the Commissioning and Distribution Agreement and the Production Services Agreement, which are set out below, becoming unconditional), Pathé granted to Micro Fusion a one picture licence of the "Underlying Rights" which is stated to be solely for the purpose of production, exploitation and distribution and delivery of the picture Mrs Henderson Presents.  The Underlying Rights in Mrs Henderson Presents are defined as "the copyright and all other related rights in and to the Screenplay".  The Screenplay is defined as "the final draft screenplay provisionally entitled "Mrs Henderson Presents" written by Martin Sherman.  Pathé also granted Micro Fusion, to the extent necessary to enable Micro Fusion to exercise the rights granted to it under the One Picture Licence, the benefit of all subsisting agreements, representation and warranties in favour of Pathé which were contained in the Underlying Agreements (these Underlying Agreements are listed at Schedule 1 to the One Picture Licence Agreement). 
17.	On 1 October 2004, Micro Fusion entered into the Production Services Agreement ("PSA") with Mrs Henderson Productions Limited ("MHP").  The agreement (Annex A of which is amended by Deed of Amendment dated 28 January 2005 but with effect from 1 October 2004), provided that Micro Fusion engage MHP to produce the film on behalf of Micro Fusion and thereby enable Micro Fusion to produce and complete the film and effect delivery to Pathé.  Principal photography of the film had begun on or about 20 September 2004.    
18.	A Further Deed of Amendment in respect of clause 8.1 of Annex A of the PSA (which made minor amendments) was entered into on 20 September 2005 but with effect from 1 October 2004.   
19.	Pursuant to the terms of the Amended PSA ("APSA"), Micro Fusion was required to advance or procure the advance of a sum equal to the Budget as specified in Schedule III of the APSA, to enable MHP to carry out the Production Services, defined at clause 1.1 as "all goods and services necessary to undertake and complete the principal photography and post production of the Film and deliver the Delivery Materials" to Micro Fusion and Pathé, as Distributor.  
20.	On 1 October 2004, Micro Fusion entered into a Distribution and Commissioning Agreement (as amended by way of Deed of Amendment dated 28 January 2005 but with effect from 1 October 2004) ("the Distribution Agreement") with Pathé whereby Micro Fusion agreed to produce the film and to deliver the same to Pathé in accordance with the terms of Schedule A to the Distribution Agreement. (There is an issue between the parties as to the effective date of these agreements: see the Section 60 issue below.)  
21.	The effect of the above arrangements was that Micro Fusion acquired a one picture licence in the film Mrs Henderson Presents, stated to be for the purpose of producing the same and delivering the completed film to Pathé.  Micro Fusion then entered into the Distribution Agreement with Pathé pursuant to which Micro Fusion transferred the master negative of the film to Pathé and licensed the distribution rights to enable Pathé to exploit the film on a continuing basis (for a period of 21 years) and to market and promote the film in all media all over the world and to earn revenues from doing so. 
The witnesses and the evidence
22.	For Micro Fusion we heard evidence from Mr Timothy Phillip Levy, the Chief Executive of Future Film Group Holdings Limited; 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 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 gave his evidence by video conference link from the offices of DLA Piper in Los Angeles.
23.	Mr Levy was the principal witness for Micro Fusion.  His evidence was wide-ranging and relevant to all the issues we are required to decide:  he dealt with financing of film production 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 production 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 Micro Fusion and its promotion to investing partners; the consultancy arrangements made between Micro Fusion and Future and the services provided by Future to Micro Fusion under those arrangements; the acquisition of certain screenplay rights by Micro Fusion in a film title Manson Girls; the introduction to Micro Fusion of the proposition to finance the production of the film Mrs Henderson Presents and the production arrangements entered into by Micro Fusion in relation to the film; the initial showing of the film Mrs Henderson Presents to potential distributors and its subsequent distribution for public release; the distribution and licensing arrangements entered into by Micro Fusion in relation to the film Mrs Henderson Presents; and the actual and expected commercial success of the film Mrs Henderson Presents. 
24.	Mr Kushner’s evidence dealt with the arrangements whereby Micro Fusion acquired screenplay rights in the film title Manson Girls and the attempts to obtain finance to convert that screenplay into a film.  His evidence is therefore primarily relevant to the Commencement issue.
25.	Mr Malde’s evidence in chief concerned the related tax appeal by the limited liability partnership Halcyon LLP.  However, in cross-examination he gave evidence relating to the application by Micro Fusion to the DCMS for certification of the film Mrs Henderson Presents as a qualifying British film, and that evidence pertains to the Completion issue. 
26.	Mr Back’s evidence, as the partner in his firm responsible for the audit of the financial statements of Micro Fusion, related to the accounting treatment of the fees incurred by Micro Fusion to Future under the consultancy arrangements between those parties.  His evidence is therefore relevant to the Deductibility of Fees issue.
27.	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 Micro Fusion’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 title Manson Girls by Micro Fusion), on which he was cross-examined by Mr Peacock for Micro Fusion.  His evidence therefore primarily relates to the Commencement issue.
28.	In addition to the evidence of the witnesses, we had in evidence extensive documentation comprising eight large files relating to every aspect of the formation, promotion and activities of Micro Fusion as described in the evidence of Mr Levy, including all documentation relating to Micro Fusion’s acquisition of screenplay rights to the film title Manson Girls; the acquisition of the rights to produce the film Mrs Henderson Presents and the production of the film; the licensing and distribution arrangements for the film; and the consultancy arrangements between Micro Fusion and Future.
The relevant legislation – section 42 and section 48
29.	It will be appropriate to set out the terms of the relevant legislation in relation to each issue in turn in the respective sections of this decision.  However, at the heart of this case is the special relief available for expenditure on the production or acquisition of films under the provisions of section 42 and section 48, and it is convenient to set out those provisions at the outset and to explain the scheme and context of the legislation.  The provisions below are as enacted for the tax years relevant to this appeal – tax relief for expenditure on films appears to be subject to regular amendment and change, so that the current scheme for such relief differs substantially from that set out below.
30.	Section 42 provides 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) This subsection applies to any expenditure of a revenue nature incurred by the claimant on the production of a film —
(a)	which was completed in the relevant period to which the claim relates or an earlier relevant period, and
(b)	the master negative of which or any master tape or master disc of which is a qualifying film, tape or disc.
(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) Where any expenditure is deducted by virtue of section 40B above in computing the profits or gains of a trade or business for a relevant period, no deduction shall be made under this section for that relevant period in respect of expenditure incurred on the production or acquisition of the film concerned.
(8) This section does not apply to the profits of a trade in which the film concerned constitutes trading stock, as defined in section 100(2) of the Taxes Act 1988.
(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.
31.	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) …
(5) …
(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.
(6A) …
(7) … 
(8) Subsection (3) of section 43 of the Finance (No 2) Act 1992 (time of completion of a film) shall apply for the purposes of this section as it applies for the purposes of sections 41 and 42 of that Act, but with the omission of paragraph (b) (completion on incurring acquisition expenditure) and the word “or” immediately preceding it.
(9) Subsections (1) to (5) of section 5 of the Capital Allowances Act 2001 (when capital expenditure is incurred) apply for determining when for the purposes of this section any expenditure is incurred as they apply for determining when for the purposes of that Act any capital expenditure is incurred, but as if, in subsection (6) of that section, “at an earlier time” were substituted for “in an earlier chargeable period.
(10) …
(11) This section applies for the making of a deduction for any relevant period ending on or after 2nd July 1997.
32.	In summary the scheme of the legislation is to allow a person carrying on a trade of exploiting films tax relief (in the form of a deduction in computing the profits of that trade) for expenditure he incurs of a revenue nature on the production of a qualifying film (or the acquisition of the master negative of a qualifying film).  Where the total production expenditure on the qualifying film is £15 million or less, the whole of the expenditure qualifies for relief in the relevant period (that is, the claimant’s period of account in which the film was completed – in this case there is a dispute between the parties as to what constitutes the relevant period for Micro Fusion); in all other cases relief for one third of the expenditure can be claimed in the relevant period and for each of the two following years.  By reason of s 40A(1) F(No 2)A 1992 expenditure incurred on the production or acquisition of a master version of a film is to be treated as expenditure of a revenue nature.
33.	Relief under section 42 or section 48 is not available if the film is held as trading stock of the taxpayer’s trade: section 42(8) – this is so because if the film is held as trading stock then under general principles expenditure will be relieved in computing profits and the stock brought in at the appropriate value in the accounts at the year end or on disposal.  For these purposes the special definition of trading stock found in s 100(2) ICTA 1988 is to be used.
34.	This form of relief for production or acquisition expenditure on films sits alongside two other alternative forms of relief for such expenditure – a taxpayer cannot claim production or acquisition expenditure relief if he opts for one of these alternative forms of relief (see section 42(1)(b)):  under s 40B F(No 2)A 1992 the taxpayer can claim relief by matching his expenditure against revenue or other value received from exploiting the film over the lifetime of the film; under s 40(D) F(No 2)A 1992 the taxpayer can elect that the expenditure should not be treated as of a revenue nature so that he is then in a position to claim capital allowances for his expenditure under the capital allowances regime.  These alternative forms of relief are relevant to this appeal only to the extent that production or acquisition expenditure relief “borrows” definitions from their provisions, or that their provisions throw light on disputed matters in the interpretation or application of production or acquisition expenditure relief.
35.	Finally, in this overview of the form of relief for production or acquisition expenditure on films, it should be noted that “qualifying film” is defined by s 43(1) F(No 2)A 1997 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.  The detail of this definition, together with related concepts used in the legislation, is discussed below, as it is a matter of dispute between the parties, but in summary a film is a qualifying film if it is a “British film” (the status of the film Mrs Henderson Presents as a “British film” is not in dispute – see the agreed facts at paragraph 13 above).
The tax basis of Micro Fusion’s investment
36.	Before looking at the specific issues in dispute between the parties it is helpful to understand in general terms the tax basis of Micro Fusion’s investment in the film Mrs Henderson Presents.
37.	In essence, as set out in the agreed facts at paragraphs 11 to 21 above, Micro Fusion incurred expenditure on acquiring from Pathé the screenplay rights and other rights to produce the film Mrs Henderson Presents, and on the production of that film (actual production was sub-contracted to a production company and a third party guaranteed to Micro Fusion that production of the film would be completed).  Such expenditure by Micro Fusion was made out of the capital invested in Micro Fusion by each individual member (i.e. partner) in the limited liability partnership.  The film was a “qualifying film”, and the total production expenditure was less than £15 million.  Micro Fusion, as part of the overall arrangements, agreed to deliver the completed film to Pathé, transferring the master negative of the film to Pathé and granting Pathé by way of licence full distribution rights in respect of the film for 21 years in consideration of Pathé making specified minimum payments to Micro Fusion over that 21 year licence period (the amounts of the payments increase by a margin of five per cent year upon year, but essentially give a fixed return on a compounded basis) together with a percentage of Pathé’s net receipts from the film above a certain threshold (to give Micro Fusion some share in any profit made from the film over the 21 year licence period).  Pathé has the right to acquire Micro Fusion’s interest in the film at the end of the 21 year licence period upon payment of consideration equal to the market value of such interest.
38.	The specified minimum payments made by Pathé to Micro Fusion over the 21 year licence period are guaranteed by letters of credit issued by a bank (which takes collateral security for its obligations under those letters of credit from Pathé).  The amount of the specified minimum payments and the guarantee arrangements are related to the way in which the individual members of Micro Fusion finance their investment of capital in the partnership:  the specified minimum payments correlate to the payment of interest on, and repayment of principal of, 70 per cent of their capital invested in Micro Fusion (typically a member will have borrowed up to 70 per cent of the amount he invests as his capital in Micro Fusion (with tax relief for the interest paid on any such borrowing), any such borrowing being on a full recourse basis, but secured by a charge over the stream of specified minimum payments and the benefit of the letters of credit).
39.	Micro Fusion (more strictly, the individual members of Micro Fusion, since for tax purposes the limited liability partnership is “transparent”) claims relief under section 48 for the whole of the expenditure on the production of the film in the accounting period in which the film is completed.  If such relief is available, the individual members are able to set that relief against their other taxable income for the relevant tax year and thereby obtain immediate and full value for that relief.  The specified minimum payments received by Micro Fusion from Pathé under the distributorship arrangements over the 21 year licence period are taxed as income as they fall due; similarly, any share of net receipts over and above the specified minimum payments is taxed as income as such receipts fall due.  In broad terms, therefore, (and taking account of any return which an individual member might be expected to earn on investment of the value of the declining benefit of the tax relief over the 21 year licence period, and taking account also of any tax relief for interest on borrowings by members of their subscribed capital), the arrangements work as a deferral, or shifting, of tax liability (the initial relief being reversed over the 21 year licence period as the income receipts fall due, the timing of that reversal in part depending upon the share, if any, of receipts above the specified minimum payments).  In this appeal the Section 60 issue concerns the question of whether Micro Fusion is subject to amending legislation which, in its broad effect, reduces to 15 years the period of tax deferral.
40.	As with capital allowance-based finance lease structures, the benefit of the tax relief (that is, the benefit of the deferral of the tax liability) is shared between the principal parties (Micro Fusion and Pathé) by means of the amount calculated as the specified minimum payments.  In this way the tax relief indirectly reduces the cost of investment in the film, and thereby serves as an incentive to such investment, which is, of course, the purpose of the broad policy underlying section 42 and section 48 reliefs. 
41.	A feature of the arrangements in this appeal is that Micro Fusion transfers the master negative of the film Mrs Henderson Presents to Pathé for the duration of the 21 year licence period (the nature and consequence of such transfer is at the centre of the dispute between the parties in relation to the Nature of Trade issue and the Trading Stock issue).  This feature in itself is not requisite for either the tax or the commercial objective of the parties.  It does, however, permit another (unrelated) taxpayer to acquire from Pathé that master negative for a period of less than 21 years under what may be broadly described as sale and leaseback arrangements, with that other taxpayer also claiming relief under section 42 for its expenditure in so acquiring the master negative under the “acquisition” head of relief (section 42(3)) rather than the “production” head of relief available to Micro Fusion (section 42(2)).  In the jargon of these things, such arrangements are a “double dip”: as such they confer more tax relief or incentive than perhaps the underlying policy intended and in any event are not acceptable to HMRC (and subsequent legislation has now put an end to such arrangements).  Although we are concerned only with the production expenditure by Micro Fusion and the licensing arrangements it entered into with Pathé, it is the wider arrangements (and the way in which they were facilitated by the transfer of the master negative of the film by Micro Fusion to Pathé) which have attracted the particular interest of HMRC.
The Nature of Trade issue
Introduction
42.	In order to claim relief under section 42 or section 48 for expenditure on the production of a film Micro Fusion must demonstrate that it is carrying on “a trade or business which consists of or includes the exploitation of films”.  HMRC contend that, under the arrangements which Micro Fusion entered into with Pathé, Micro Fusion sold to Pathé the film Mrs Henderson Presents (more particularly, the “physical record” of the film, which they contend is what comprises the film for these purposes) and that accordingly there was no exploitation of the film.  Micro Fusion argues that there was no sale of the film and that in any event the arrangements which Micro Fusion entered into with Pathé (whether or not a sale of the “physical record” of the film) comprised the exploitation of the film.
43.	Section 42(2) (which relates to “production” expenditure) concerns “expenditure of a revenue nature incurred by the claimant on the production of a film…the master negative of which or any master tape or master disc of which is a qualifying film, tape or disc.”  Section 42(3) (which relates to “acquisition” expenditure) is in slightly different terms, concerning “expenditure incurred by the claimant on the acquisition of the master negative of a film or any master tape or master disc of a film where…the master negative, tape or disc is a qualifying film, tape or disc.”
44.	Section 43 F(No 2)A 1992 gives the following definitions:
(1)  In sections 40A to 42 above and this section – 
…
“master negative”, in relation to a film, means the original master negative of the film and its soundtrack (if any)…
“qualifying film” means a master negative of a film certified by the Secretary of State under Schedule 1 to the Films Act 1985 as a qualifying film for the purposes of section 40D above….
(2)  In sections 41 and 42 and this section - 
(a)  any reference to a film shall be construed in accordance with paragraph 1 of Schedule 1 to the Films Act 1985 and
(b)	any reference to the acquisition of a master negative, master tape or master disc of a film includes a reference to the acquisition of any rights in the film (or its soundtrack) that are held or acquired with the master negative, master tape or master audio disc.
45.	Paragraph 1(1) of Schedule 1 to the Films Act 1985 provides:
“film” includes any record, however made, of a sequence of visual images, which is a record capable of being used as a means of showing that sequence as a moving picture;
The Distribution Agreement and other documents
46.	The crucial questions of fact in the Nature of Trade issue relate to the arrangements between Micro Fusion and Pathé, and in particular the agreement termed the Distribution Agreement between those parties dated 1 October 2004 (see paragraph 20 above).  The Distribution Agreement was subsequently amended to insert the detailed financial arrangements between the parties and other matters, but those amendments are not germane to the key provisions relevant to the Nature of Trade issue.  Since the parties dispute the effect of the Distribution Agreement it will be necessary to set out its key provisions (or, rather, those key for this appeal) in some detail.
47.	However, before turning to the Distribution Agreement some preliminary matters should be noted:
(1)	In the Micro Fusion partnership deed (dated 16 December 2004, but expressed to have effect from 1 October 2004) the Business of the partnership is defined as “the trade of the production and/or acquisition and exploitation of Qualifying Films and the other business set out in clause 1.2”.  Clause 1.2 provides: “[Micro Fusion] shall carry on the Business including the production, acquisition and in connection therewith granting rights over and otherwise turning to account Qualifying Films….”
(2)	By the One Picture Licence between Micro Fusion and Pathé dated 1 October 2004 Pathé granted to Micro Fusion “in perpetuity and throughout the universe” an exclusive one picture licence of the copyright and all other related rights in and to the screenplay provisionally entitled “Mrs Henderson Presents” solely for the purpose of the production and delivery of the film with that provisional title.  Pathé acknowledged and agreed that Micro Fusion would be “the sole owner of copyright in and to [the film] throughout the universe in perpetuity”, subject to Pathé’s rights under the Distribution Agreement (see also paragraph 16 above).  Pathé reserved to itself certain rights (including copyright) in the screenplay.
(3)	By the PSA (as amended) (see paragraph 17 above), Micro Fusion engaged MHP to provide “the goods and services necessary to undertake and complete the principal photography and post production of the Film [i.e. Mrs Henderson Presents] and deliver the Delivery Materials” so as to enable Micro Fusion to produce and complete the film and effect delivery to Pathé.  The Delivery Materials comprise, in brief, all materials related to the film derived from principal photography of the film including original exposed negatives of the film.  It is provided that title absolute in respect of all Delivery Material and all other material relating to the film is vested automatically in Micro Fusion, and in particular Micro Fusion is the maker and author of the film and the first owner of copyright in the film.  MHP is to provide its services to deliver the completed film to a detailed specification and casting and to an agreed budget (at the cost of Micro Fusion) and on terms whereby it is to be a “British film” for the purposes of the relevant legislation.  The film is to be delivered by a delivery date of 30 June 2005, and MHP agrees to make an application by that date for a DCMS certificate to the effect that the film is a “British film”.
(4)	The various parties entered into these agreements (including the Distribution Agreement) with the intention that they should be amended (not least, to include detailed schedules relating to the financial terms of the licensing of the film).  Each of the parties had a right to terminate the agreements if such amendments were not made, and those rights themselves were the subject of subsequent variation.  These amendment and termination arrangements and their effect are principally relevant to the Section 60 issue.
48.	The key provisions of the Distribution Agreement for the purposes of this appeal are as follows:
(1)	Clause 1 records that Micro Fusion has agreed to produce the film Mrs Henderson Presents at the request of Pathé to the agreed specification and to deliver it to Pathé on the terms of the Distribution Agreement.
(2)	Clause 4.2 provides that, in any credits appearing in relation to the showing of the film, Micro Fusion is to be shown in the copyright notice on the film as the holder of the copyright in the film (until such time as Pathé exercises its buy-out rights, as described below).
(3)	Clause 7.1 provides that Micro Fusion shall effect delivery of the film conforming to the agreed specifications on or before 30 June 2005. 
(4)	Clause 8.3.1 provides: “[Micro Fusion] hereby sells and [Pathé] hereby purchases all of [Micro Fusion’s] right, title and interest in and to the Delivery Materials (as defined in the Production Services Agreement) and [Pathé] shall become the absolute owner thereof.”  As mentioned above, “Delivery Materials” includes the master negative derived from principal photography of the film Mrs Henderson Presents.  Micro Fusion also agrees to transfer ownership to Pathé of its rights to “Physical Materials”, such as pre-print sound and film material, videotape and audiotape and still photographs.
(5)	Clause 8.3.2 provides: “[Micro Fusion] hereby licenses and assigns solely, exclusively and irrevocably to [Pathé], its successors, licensees and assigns, throughout the Territory and for the Term, the sole, exclusive and irrevocable right, licence and privilege [subject to extant third party rights] and with [Micro Fusion] reserving to itself the copyright…in the [film Mrs Henderson Presents]…to the full extent of [Micro Fusion’s] interest therein all rights to distribute, exhibit, market, exploit, sell, advertise, perform, dispose of, turn to account or otherwise deal with in any and all media whether vested contingent or future and whether now known or in the future created throughout the universe in the [film] (exclusive of [Micro Fusion’s] copyright interest therein….”  By way of particularisation, the rights of exploitation granted to Pathé are expressed to include theatrical, non-theatrical, videogram and television exploitation rights (i.e. rights in all media), and there are further detailed provisions particularising the rights which Pathé as licensee and distributor has to exploit the film.  For the purposes of this clause “the Territory” is the entire universe, and “the Term” commences on 1 October 2004 and ends 21 years from the first theatrical release of the film (or 31 December 2026, if earlier).
(6)	Clause 8.3.3 provides: “The above irrevocable grant of rights shall be without prejudice to [the screenplay rights reserved by Pathé and] [Micro Fusion’s] reservation to itself of the copyright in the [film], it being acknowledged by [Micro Fusion] that all rights of exploitation in the [film] are vested exclusively in [Pathé] further to the grant of rights above, and that [Micro Fusion] shall have no right to control, hinder or otherwise impede any rights of [Pathé] to exploit the [film] pursuant to the terms of this Agreement.”  It should be noted, however, that Micro Fusion is given some rights in relation to Pathé’s exploitation of the film – for example, Pathé can grant sub-licences which extend beyond the 21 year Term only with the consent of Micro Fusion (which consent cannot be unreasonably withheld).
(7)	Clause 8.4 expresses “for the purpose of clarity”, the rights specifically reserved to Micro Fusion, namely, during the Term, the copyright in and to the film (subject to the distribution rights conferred on Pathé by Clause 8.3.2), and, after the Term, all rights in and to the film (unless Pathé has exercised its “Buyout Rights”).
(8)	Pathé’s Buyout Rights are set out in Clause 9: in the final year of the Term Pathé has “the exclusive right to acquire [Micro Fusion’s] copyright interest and any and all other right title and interest of [Micro Fusion] in and to the [film] (and in any material upon which the [film] is based throughout the Territory for a term commencing upon expiry of the Term and continuing thereafter in perpetuity….”.  If it exercises the Buyout Rights Pathé must pay the fair market value of the Buyout Rights, as agreed between the parties, with an arbitration procedure if they cannot agree.
(9)	Clause 9.3 deals with the position if Pathé does not exercise the Buyout Rights: in that eventuality, “upon expiry of the Term [Pathé] shall not destroy any physical materials relating to the [film] but, rather [Pathé shall …return to [Micro Fusion] at [Pathé’s] sole cost and expense such physical materials relating to the [film] as [Micro Fusion] may request….”
(10)	The terms as to the consideration given by Pathé to Micro Fusion for the distribution rights are set out in Clause 11.  They are of some complexity and relate to the different measures of receipts which Pathé expects to earn from distributing the film, but in summary comprise three elements: Micro Fusion receives the first slice of receipts to reimburse it for budget overcosts and similar additional costs it has incurred; Micro Fusion is then entitled to ten per cent of “Adjusted Gross Receipts” earned by Pathé paid annually, but subject to “Minimum Guaranteed Amounts” payable each year as specified (these are the guaranteed payments which give Micro Fusion its fixed return on its investment: see paragraph 38 above); finally, Micro Fusion is entitled to five per cent of “Gross Receipts” earned by Pathé paid annually, and on account of such payments Pathé agrees in any event to pay Micro Fusion five per cent of the approved budget of the film production costs.  In broad terms the effect of these provisions is to give Micro Fusion a guaranteed income, regardless of the commercial success of the film, but also a share of the revenues earned by Pathé from its distribution of the film should the film prove to be successful.
(11)	Clause 15 deals with default and termination.  First, Pathé has the right to terminate the arrangements if the film is not delivered by the agreed delivery date.  In that eventuality all rights in the film remain in Micro Fusion, but Micro Fusion makes a payment equal to 82% of the approved budget of the film to Pathé (that payment being funded by the third party which has guaranteed completion of the film) and Pathé pays the Minimum Guaranteed Amounts due over the 21 year Term.  Secondly, if Micro Fusion fails to approve Pathé’s proposals for sub-licensing or otherwise exploiting the film, Pathé may either continue with those proposals or, by withholding payment of the Minimum Guaranteed Amounts, give Micro Fusion the right to terminate the arrangements, in which case Pathé is released from all its obligations under the Distribution Agreement and all of its rights and interest in the film revert to Micro Fusion (subject to any sub-licences granted by Pathé).  Thirdly, if Pathé fails to pay Micro Fusion the payment equal to five per cent of the approved film production costs, Micro Fusion can terminate the arrangements and all of Pathé’s rights and interest in the film revert to Micro Fusion (again, subject to any sub-licences granted by Pathé).  Fourthly, any other breach of the terms of the Distribution Agreement by Pathé (other than failure by Pathé to pay the Minimum Guaranteed Amounts) gives right to a claim in damages only, with no right of termination or rescission.  It is left as an open matter whether Pathé’s failure to pay the Minimum Guaranteed Amounts gives right to Micro Fusion to terminate or rescind the Distribution Agreement (but if Micro Fusion recovers under the guarantee and security arrangements, that is not to be treated as a failure by Pathé to pay the sums recovered).
49.	We were referred to three other principal documents in the course of the submissions made to us.  The first is the Pre-Release Sale and Purchase Agreement relating to “Mrs Henderson Presents”, dated 1 December 2004 between Pathé and Future Screen Partners no. 1 LLP (defined in that Agreement as the “Purchaser”).  This is the agreement by which the Purchaser acquired the master negative of the film Mrs Henderson Presents in order to claim section 42 relief under the provisions relating to acquisition expenditure under section 42(3), that is, the double dip (see paragraph 41 above).  In this agreement Pathé warrants that it is or will be the sole and exclusive owner of the original master negative of the film and owner or licensee of the distribution rights (being those licensed to it by Micro Fusion under the Distribution Agreement) free from encumbrances and with the unfettered right to sell the master negative and to licence the rights.  By Clause 3 Pathé agrees to sell to the Purchaser the entire legal and beneficial interest in the original master negative of the film and to license the distribution rights it holds in the film for a sum which is the certified cost of the film.  The second document is the Film Lease, also dated 1 December 2004 between the same parties, whereby Future Screen Partners no. 1 LLP leases back to Pathé for a term of 15 years the original master negative of the film and (by way of sub-licence) the distribution rights.  Pathé is appointed sales agent for the disposal of the LLP’s interest in the master negative and the distribution rights at the end of the 15 year term.
50.	The third document is the Inter-party Agreement dated 28 January 2005 (amended 23 May 2005) and made between Micro Fusion, Pathé, Pathé Pictures Limited, MHP, the BBC, the UK Film Council, Film Finances Inc, Future, Barclays Bank plc and Société Générale.  The principal purpose of this agreement was to deal with so-called “financial closing”, dealing with the grants and contributions to the film by the BBC and the UK Film Council, the long-term financing of Pathé (and its repayment of short-term bridging loans and the unwinding of other bridging arrangements involving MHP), the borrowings of funds by the members of Micro Fusion for part of their capital contributions, and the letters of credit and other security arrangements made available by Société Générale.  It is clear from this document that Pathé charged by way of security its right title and interest in the film to Société Générale and that the parties were aware of and took account of the terms and effect of the sale and leaseback entered into between Future Screen Partners no. 1 LLP and Pathé in December 2004.
The parties’ submissions
51.	In relation to the Nature of Trade issue, the question is whether Micro Fusion was carrying on “a trade or business which consists of or includes the exploitation of films”.  The principal point of contention between the parties was whether the exploitation of films is limited to exploiting the “physical record” of a film (its master negative and other physical representation), or whether it comprises some broader concept – and if it is limited to exploitation of the “physical record”, whether the arrangements entered into by Micro Fusion in relation to the film Mrs Henderson Presents were a sale or other outright disposal of the “physical record” of that film and as such were beyond the scope of what comprises “exploitation”.
52.	For Micro Fusion Mr Peacock put forward three submissions in support of Micro Fusion’s contention that it was carrying on “a trade or business which consists of or includes the exploitation of films”.  His first submission was that Micro Fusion, by entering into the Distribution Agreement and the related agreements, was exploiting the film Mrs Henderson Presents by reason of the licence Micro Fusion granted to Pathé under those arrangements: those arrangements did not constitute an outright sale of the “physical record” of the film, as HMRC contended.  In his submission the terms of the Distribution Agreement, when read as a whole, comprise a distribution licence for a term of 21 years with a related transfer of possession of the master negative and other physical representation of the film so as to facilitate the exploitation of that licence with an obligation to transfer back the master negative at the end of that term.  He relied upon the Buyout Rights provisions of the Distribution Agreement which give Pathé the right to acquire for market value at the end of the 21 year term the interest in the film retained by Micro Fusion, and the obligation upon Pathé to transfer back to Micro Fusion (for nil consideration) the “physical record” of the film should the Buyout Rights not be exercised.  He relied on the evidence of Mr Levy that, first, the interest in the film retained by Micro Fusion has substantial value, and this could be so at the end of the 21 year term, and, secondly, the exercise by Pathé of the Buyout Rights is not a commercial inevitability.
53.	Mr Peacock’s second submission was that, even if the arrangements entered into by Micro Fusion were to be properly characterised as a sale of the film, such a sale is in itself “exploitation” of the film for section 42 and section 48 purposes.  “Exploitation” has no special meaning in this context, and therefore if one takes its ordinary meaning, being the steps or method by which an asset is turned to account so as to produce income, that describes what Micro Fusion did in relation to the film Mrs Henderson Presents by virtue of the Distribution Agreement and other agreements.  He referred to provisions in the Finance Act 2006 relating to the taxation of the activities of film production companies where receipts by a company in connection with the exploitation of a film are expressed to include “receipts from the sale of the film or rights in it”: paragraph 6, Schedule 4.  He also argued that the provision (section 42(8)) which excludes section 42 and section 48 relief where the film constitutes trading stock is in itself a recognition that a sale of a film can be a transaction within the scope of a trade consisting of the exploitation of films.
54.	Mr Peacock’s third submission related to the meaning of “film” for the purposes of section 42 and section 48 – in his view that is a term not limited to the physical record of the film, but wide enough to include the intellectual property rights in a film such as the rights Micro Fusion retained in the film Mrs Henderson Presents.  He accepted that the Films Act definition of “film” refers to the physical record of a sequence of visual images, but the definition is in terms of “film” including the physical record – the definition is not limited to the physical record.  Further, in section 42 itself, “film” must have a wider meaning than simply the physical record, to make sense of the word “film” when used in the expression “master negative of a film” used in the section and related legislation (for example, in section 42(3)).  Thus a distinction is drawn between the physical asset (the “master negative”) and what must be a broader concept (“film”).  This distinction is also found in s 43(2)(b) F(No 2)A 1992, which tells us that for section 42 purposes a reference to the acquisition of the physical asset (the master negative) includes a reference to the acquisition of any rights in the film that are held or acquired with the master negative: not only is the distinction made, but (in the specific area of acquisition only) the physical asset is extended to include any rights in the film, such as intellectual property rights.  Thus “film” in the context of a trade of exploiting films includes intellectual property rights in a film possibly in conjunction with the physical asset, but also possibly standing alone (as would be the case if the trader’s interest in the film were as a sub-distributor).  Accordingly, the disposal by Micro Fusion of the physical record of the film (if such is what occurred) whilst retaining the copyright in the film and receiving payment for that copyright interest is a transaction in the course of carrying on a trade consisting of the exploitation of films.
55.	For HMRC, Miss Simler submitted that since Micro Fusion is seeking the benefit of a relieving provision, it bears the onus of showing that it is has the trade of exploiting films.  She referred in detail to the development of film relief prior to the introduction of section 42: after the decision in Munby v Furlong [1977] Ch. 359 relief for expenditure on films was available under the capital allowances regime, under which it was necessary to identify what comprised “plant”.  In her analysis of the cases which dealt with capital allowances for films (particularly Ensign Tankers (Leasing) Ltd v Stokes [1992] 1 AC 655 (HL) and Barclays Mercantile Industrial Finance Ltd v Melluish [1990] STC 314) she submitted that although it was not decided whether the “plant” comprised the master negative alone or the master negative plus the rights to exploit it commercially, it was clear that the exploitation rights alone were not “plant”.  The form of relief which preceded section 42 (s 72 Finance Act 1982) defined “film” in purely physical terms as the “original master negative of the film and its soundtrack”, and it was the exploitation of the physical film materials which attracted relief.  The approach of section 42 and section 48 is to use the Films Act definition of “film”, with its clear reference to the physical record, and that is consistent with the approach of the earlier legislation.  The Films Act definition itself derives from the Copyright Act 1956 where its function was to describe the physical film materials to which copyright attaches.
56.	Micro Fusion, Miss Simler submitted, did not “exploit” the film Mrs Henderson Presents in that it did not licence its rights in the physical record of the film: as to both form and substance the terms of the Distribution Agreement make it clear that it disposed of the master negative of the film to Pathé outright by way of sale with a contemporaneous licence ancillary to that sale so as to give business efficacy to the sale.  The consideration was unapportioned as between the physical film materials and the licence to exploit the film.  She argued that, contrary to the assertions on behalf of Micro Fusion, the terms of the Distribution Agreement do not as of right re-confer on Micro Fusion property in and title to the physical record at the end of the 21 year Term if Pathé does not exercise the Buyout Rights – Micro Fusion has to take the action of requesting Pathé to return the physical materials.  In this context Miss Simler also drew attention to the Sale and Purchase Agreement dated 1 December 2004 between Pathé and the partnership Future Screen Partners No 1 LLP in which Pathé represents that it is the sole and exclusive owner of the master negative of the film Mrs Henderson Presents with the unfettered right to sell the master negative to that partnership and in which Pathé agrees to sell the entire legal and beneficial interest in the master negative.  This transaction was in the contemplation of the parties throughout, as is evident from the Inter-party Agreement, in order to provide the double dip, and is not consistent with the analysis that Micro Fusion retained an interest of some kind in the master negative.
57.	Miss Simler argued that the copyright in the film retained by Micro Fusion under these arrangements is, by virtue of the provisions of the Copyright, Designs and Patents Act 1988, an asset distinct from the physical record of the film, and although copyright is a species of property, it is essentially not a positive but a negative right, the right to prohibit the exploitation of a protected work without the consent of the copyright owner (see Ashdown v Telegraph Group Ltd. [2002] Ch. 149 at 163): Micro Fusion could not be said to be exploiting the film simply by retaining the right to prohibit others from profiting from it.  The essence of HMRC’s case is that for a person to be in a position lawfully to turn a film to account by exploiting it, he must both have access to the physical record of the film (whether the master negative or a copy) and have the relevant rights to permit him to put the physical record to commercial use.  The rights by themselves cannot be exploited if there is no physical record to generate showings of the film.
Decision on the Nature of Trade issue
58.	It is our decision that, in relation to the film Mrs Henderson Presents, Micro Fusion was carrying on “a trade or business which consists of or includes the exploitation of films” within section 42(1).
59.	We heard a great deal of detailed argument on such matters as the meaning of “film”, the nature of copyright interests and the exact effect of particular provisions of the Distribution Agreement and other documents, and some of these matters we deal with below.  It seems to us, however, that in deciding whether or not Micro Fusion’s activities amounted to the exploitation of the film Mrs Henderson Presents, a broader view gives a sense of perspective.  Taking that broader view we see that Micro Fusion incurred the production expense which resulted in it holding all (or substantially all) of the rights in and to that film (including ownership of the original master negative and the intellectual property or other rights which enabled it to realise the value in the film) and it then proceeded to enter into arrangements which realised for itself some at least of the value in the film over the subsequent 21 years by means of a stream of income (being the guaranteed minimum payments and the share of gross receipts due over that period).  The balance of the value in the film during that 21 year period is available to Pathé to realise through such means (whether by direct showing, sub-licensing or other sub-distribution arrangements) as it decides.  At the end of the 21 year period Micro Fusion is able to realise any value then remaining in the film either by selling its interest in the film to Pathé should Pathé exercise its rights to make that purchase, or (if Pathé walks away without exercising those rights) by whatever other means are then open to Micro Fusion.  Seeing the arrangements in this way, and putting to one side the finer points, we are compelled to reach the view that Micro Fusion is exploiting the film, that is to say, turning it to account for the income which can be derived from it.  It is difficult to see in what other way the arrangements could be characterised consistent with their overall commercial effect.  The question then is whether any of the finer points displace the conclusion reached by taking the broad view.
60.	The first of those finer points, and the one which attracted the most attention of both parties, is the meaning of the word “film” in the expression “the exploitation of films”.  Their respective submissions are summarised above.  Miss Simler focused on the historic position where, in identifying what had to be “plant” for capital allowance purposes, the emphasis was on the master negative or other original physical record of the film as being that which constituted “a film”.  This led to extensive and detailed written submissions in the course of the hearing from both parties as to the relevance of the capital allowances approach and as to what exactly that approach was.  Further, both parties found support for their respective views as to the meaning of “film” in the detail of the drafting in the scheme of legislation relating to films of which section 42 is a part (that is, ss 40A to 43 F(No 2)A 1992).
61.	We consider the capital allowances jurisprudence is of little relevance to a claim for relief under section 42 or section 48, since the question there was not “what is meant by ‘film’?”, but “is a film ‘plant’?”, or perhaps, “what element of a film qualifies as ‘plant’?”.  In looking at the 1992 films legislation, it is instructive that in those provisions which, in one way or another, are related to the capital allowances form of relief for film expenditure (for example, s 40A F(No 2)A 1992 or s 40D F(No 2)A 1992) the draftsman refers to “expenditure incurred on the production or acquisition of a master version of a film”, or expenditure incurred “by a person who carries on a trade or business which consists of or includes the exploitation of master versions of films” (defined to be a master negative of the film and including any rights in the film or its soundtrack that are held or acquired with the master negative: see s 40A(5) F(No 2)A 1992).  However, when it comes to the scheme of relief under section 42 (which was newly introduced in 1992 and has no capital allowance provenance or related antecedents) the draftsman uses the different formulation, namely “the exploitation of films” (importing the Films Act definition of “film”).  Thus there appears to be a conscious decision, at least when describing the trade which must be carried on for the relief to apply, to differentiate the position from that which applies in the capital allowances regime.
62.	This supports Mr Peacock’s argument that “film”, for section 42 purposes, must mean something more than the master negative or other physical record of a film.  We agree with that view, and we do not consider that the definition of “film” in the Films Act precludes that view: in the definitions in Schedule 1 to the Films Act a distinction is made between definitions which “mean” and those (in particular, the definition of “film”) which “include”.  Miss Simler suggested that the definition of “film” as including any record, however made, of a sequence of visual images, used the word “includes” to allow for future developments in technology which might constitute the physical record of a film, but that contingency is allowed for in the expression “any record, however made”.
63.	It seems clear that when the draftsman wished to describe the trade carried on by the person claiming relief under section 42 he chose a wider concept (“the exploitation of films”) rather than a narrower concept (“the exploitation of master versions of films”, as in ss 40B and 40D F(No 2)A 1992).  Indeed, in describing the trade, there is no reason why a narrower concept should be used – the description of the trade does not have the function of defining the scope of the relief for the expenditure, but gives the context: the real gateway to or qualification for the relief for the expenditure is to be found in section 42(2) (in the case of production expenditure) or section 42(3) (in the case of acquisition expenditure) by reference to the nature of the expenditure incurred, and there the expenditure is defined specifically (and in each case with reference to the master negative or other physical record of the film resulting from the production expenditure or acquired by the acquisition expenditure, as the case may be).  It is clear that intellectual property rights may subsist in a film which are distinct from the master negative or other physical record of the film; it may be, as Mr Levy testified, that such rights have greater value than the master negative itself, which, shorn of the right to show or reproduce it without consent, has limited value as celluloid or a computer disk storing digital pulses.  In our view, if a person holds distinct intellectual property rights in a film and exploits those rights by turning them to account, he can be regarded as carrying on a business consisting of the exploitation of films: in the narrow (and we would say, overly-legalistic) sense, he is exploiting intellectual property rights, but applying a common sense approach (which we think is the correct approach in looking at the scope of a trade) he is exploiting the film by means of his interest in it.  
64.	If required, we would therefore be prepared to hold that Micro Fusion is carrying on a trade or business which consists of the exploitation of the film Mrs Henderson Presents even if it holds no interest in or right to the master negative or other physical record of that film.  However, in our judgment the rights which Micro Fusion has under the arrangements it entered into with MHP and Pathé are such as to retain for itself a continuing interest in the physical record of the film, albeit of a residual or reversionary nature, being subject to the distribution and related rights it conferred on Pathé.  That being so, even if the narrower view of the concept of the trade of exploitation of films for which HMRC contend is correct, that is the trade in which Micro Fusion is engaged.
65.	Before commenting on the documents which comprise those arrangements, it is necessary to refer to the evidence we heard from Mr Levy as to the pattern of commercial exploitation of films, and the performance of Mrs Henderson Presents within that pattern.  He stressed the commercial uncertainty and unpredictability of any film.  He mentioned that films have different cycles, or, rather, perform differently across the range of cycles which are available.  Thus the normal sequence is that a film will be exploited first through theatrical (i.e. cinema) showings, then home video (DVD rentals and sales) and pay TV, pay per view, then free TV and other TV rights.  Free TV rights are often not granted until up to two years after cinematic release of the film, and only by that stage is it possible to assess the commercial performance of the film.  A film such as Mrs Henderson Presents is unlikely to have another cinematic release, but the long-term success depends upon the extent of TV exploitation.  As to the performance of Mrs Henderson Presents, it has returned approximately US$30 million in cinema receipts, which is a measure of success, but it has not yet performed well enough to generate additional income for Micro Fusion beyond the guaranteed minimum payments.  In Mr Levy’s view, having regard to the success to date (commercial and critical), the cast and the publicity from award nominations, it is reasonable to anticipate that the film has longevity, with the prospect of long-term repeated showings on TV and continuing sales and rentals of DVDs.  In his view it is a reasonable expectation that the film will generate income for Micro Fusion in the form of a share of gross receipts in addition to the guaranteed minimum payments.  We have no reason to question Mr Levy’s evidence on these matters.
66.	The arrangements Micro Fusion entered into for the production of the film Mrs Henderson Presents gave Micro Fusion the copyright and other rights to the screenplay in the film for the purpose of producing and delivering the film (this is the effect of the One Picture Licence), and as a consequence of the shooting and production of the film, absolute title to the master negative and other physical materials relating to the film, together with copyright in the film, accrued to Micro Fusion (by the terms of the PSA).  Both the One Picture Licence and the PSA were entered into on 1 October 2004, as was the Distribution Agreement whereby Micro Fusion granted to Pathé the licence and distribution rights (including the transfer of title to the master negative and other physical materials), which was during the early stages of principal photography of the film.  We consider that Micro Fusion is properly to be regarded as acquiring all its rights in the film (including the master negative) and then, in sequence, licensing or disposing of them, as was the case in Ensign Tankers (Leasing) Ltd v Stokes [1989] 1 WLR 1222, where a finance partnership acquired the master negative of a film from a production company and simultaneously granted a distributor the licence to distribute and exploit it.
67.	The real point of contention between the parties lies in the terms and effect of the Distribution Agreement, as set out above.  We are clear in our view that, by entering into the Distribution Agreement, Micro Fusion has exploited its interest in the rights it holds in the film (its ownership of the physical record and intellectual property rights).  Micro Fusion has retained an interest not only in the copyright in the film, but also in the master negative and other physical record in the film – as Millet J expressed it in the slightly different context of the case in Ensign Tankers (at 1240G), where the issue was whether the master negative continued to “belong” to the taxpayer, “By entering into the various distributorship agreements, the partnerships did not part with the rights to exploit the films, but exploited them.”  
68.	Micro Fusion granted an exclusive licence for Pathé to distribute and otherwise exploit the film for a term of 21 years in return for periodic payments over that term related to the income (subject to guaranteed minimum amounts) which Pathé derives from its exploitation of the film and in conjunction with that licence transferred title to the master negative and other physical materials relating to the film.  It is clear, however, that Pathé had ownership of the master negative and other materials for that term of 21 years only, and this is so notwithstanding that for that period Pathé is expressed to be the “absolute owner” of them, acquiring its rights by way of purchase (see Clause 8.3.1 of the Distribution Agreement).  That Pathé’s ownership rights are limited as to time is clear from Clauses 8.4 and 9 of the Distribution Agreement:  by Clause 8.4 the parties make it clear that for the duration of the 21 year term Micro Fusion has reserved to itself the copyright in the film (subject to the distribution rights granted to Pathé) and also all rights in and to the film when the term has expired.  Pathé has the right, under Clause 9, to purchase those retained or reserved interests in the film at the expiry of the term for their then market value, and should it fail to exercise those Buyout Rights, it is subject to the obligation to return the physical materials relating to the film to Micro Fusion at that time.  The default and termination provisions in Clause 15 are consistent with this analysis, in that Micro Fusion has a remedy in damages only for most breaches, but has a right to terminate and recover all of Pathé’s right, title and interest in and to the film in a number of specified cases (and in such cases Pathé’s right, title and interest is expressed to “revert” to Micro Fusion).
69.	Furthermore, it cannot be said that Micro Fusion’s rights to the physical materials in the film upon the expiry of the 21 year term are illusory or too remote to be significant or real:  as Mr Levy’s evidence showed, there must be at least some expectation that the film Mrs Henderson Presents will have an income-producing life beyond that period through continuing TV and DVD rights, and to the extent that the value in the film resides in the physical materials rather than the copyright (or arises from the combination of the two) Micro Fusion will be in the position, as owner, to realise that value.  Nor can it be said that there is a commercial inevitability that Micro Fusion will never take back its reversionary interest in the physical record of the film because Pathé will always exercise its option to acquire Micro Fusion’s rights: since Pathé is required to pay market value for such rights when it exercises the Buyout Rights, it will be for its commercial judgment at that time whether it wishes to invest further in the film, and it is possible to foresee many circumstances which could result in it deciding not to do so.
70.	Miss Simler, in a very thorough critique of the terms of the Distribution Agreement and of some of the contemporaneous documents such as email exchanges, argued that there are provisions which point strongly to the analysis that Micro Fusion has made an outright and unreserved disposal by way of sale of the master negative of the film.  She also pointed to the representations given by Pathé to the film partnership which went on to acquire the master negative under the subsequent sale and leaseback transaction (a transaction which, as she pointed out, was in the contemplation of Micro Fusion and Pathé when they entered into the Distribution Agreement), those representations being consistent only with Pathé’s absolute ownership of the master negative.  We agree that the documentation has its ambivalences – were that not the case then no doubt this would not have been a matter for dispute in this appeal.  But looking at the Distribution Agreement as a whole we consider that it has the effect we have set out above, namely that, in conjunction with the distribution licence rights granted to it and for the term of that licence only, Pathé has possession of the master negative as owner subject to its obligation to transfer it back if it fails to exercise the Buyout Rights: there was not an outright disposal by way of sale of the master negative such that Micro Fusion ceased to have any right or interest in the master negative.  The representations which Pathé chose to give in the sale and leaseback documentation are a matter between it and the film partnership concerned, but since the sale and leaseback arrangements were for a period of 15 years only, and therefore expired well before the master negative reverted to Micro Fusion, and since Pathé knew that it could either terminate by exercising its sales agency the interest of the film partnership in the master negative at the end of the 15 years, or acquire Micro Fusion’s reversionary rights by exercising the Buyout Rights after 21 years, that no doubt supported the view it took of the representations it could properly give for the purposes of the sale and leaseback transaction.
71.	For these reasons we decide that, in relation to the film Mrs Henderson Presents, Micro Fusion was carrying on “a trade or business which consists of or includes the exploitation of films” within section 42(1).
The Trading Stock issue
72.	Relief under section 42 or section 48 is not available if the film is held as trading stock of the taxpayer’s trade: section 42(8) provides: 
This section does not apply to the profits of a trade in which the film concerned constitutes trading stock, as defined in section 100(2) of the Taxes Act 1988.
Section 100(2) ICTA 1988 provides, so far as relevant:
For the purposes of this section “trading stock”, in relation to any trade – 
(a)	means property of any description, whether real or personal, being … – 
(i)	property such as is sold in the ordinary course of the trade….
73.	The Trading Stock issue is closely related to the Nature of Trade issue and largely turns on the same facts.  For the section 42(8) exclusion to apply it must be shown that Micro Fusion was carrying on a trade; and that the film Mrs Henderson Presents was property of the kind which Micro Fusion sold in the ordinary course of the trade.
74.	It is common ground that Micro Fusion was carrying on a trade.  The dispute between the parties therefore concerns the question whether or not the film Mrs Henderson Presents was property of the kind which Micro Fusion sold in the ordinary course of the trade it carried on.
75.	In arguing that the trading stock exclusion applied to deny Micro Fusion section 42 and section 48 relief, HMRC were, of necessity, required to argue that the film Mrs Henderson Presents was sold by Micro Fusion since not only was that the property which it contended was trading stock, but it was the only property of which it could possibly be said that it was “such as is sold in the ordinary course of the trade” carried on by Micro Fusion: as Mr Peacock argued, this is because there was no evidence that Micro Fusion had any other history of selling or dealing in films which would otherwise provide the context or benchmark against which to judge whether the film Mrs Henderson Presents was of a kind of property which Micro Fusion sold in the ordinary course of its trade.  If the film Mrs Henderson Presents were sold that would be the transaction which could possibly establish that property of that kind was sold in the ordinary course of Micro Fusion’s trade.  However, if the film Mrs Henderson Presents were not sold it could not be property of the kind sold in the ordinary course of Micro Fusion’s trade since the ordinary course of Micro Fusion’s trade would not encompass a sale of property and therefore it could not constitute trading stock.  
76.	As to whether or not the film was sold, the arguments were those put forward in relation to the Nature of Trade issue.  Thus HMRC argued that “the film” must mean the physical record of the film, such as the master negative, and that on the proper construction of the transactions entered into by Micro Fusion, the film was sold.  Micro Fusion argued that “the film” has a wider meaning which extended to the intellectual property rights alone in the film, which were not sold but simply licensed, and even if “the film” has the narrower meaning of the physical record only, then on the proper construction of the transactions entered into by Micro Fusion, the film was not sold, but, rather, title was transferred in conjunction with the grant of the distribution licence with title reverting to Micro Fusion at the end of the licence period unless at that time Pathé took the further step of exercising the Buyout Rights.
77.	It necessarily follows from our decision in relation to the Nature of Trade issue that we conclude that the film Mrs Henderson Presents was not sold by Micro Fusion, even if HMRC are correct in arguing that “the film” means the physical record of the film.  The transfer of title to the master negative and other physical film material under the terms of the Distribution Agreement was not an outright disposal, nor was it a sale (a transfer of ownership and title for consideration), since title and ownership reverts to Micro Fusion without payment at the end of the 21 year licence period (or earlier in certain events of default) unless Pathé exercises its Buyout Rights.  Nor, as we have mentioned, is it legally or commercially inevitable that Pathé will acquire Micro Fusion’s rights in the film at the end of the licence period, and so it cannot be said that in substance the Distribution Agreement is a sale with a delayed completion.  It follows that the film does not constitute trading stock of Micro Fusion, that is, property such as is sold in the ordinary course of the trade carried on by Micro Fusion and that accordingly Micro Fusion is not denied relief under section 42 and section 48 by reason of section 42(8).
78.	The case was further argued before us on behalf of Micro Fusion that even if the arrangements which Micro Fusion entered into comprised a sale of the film, that would not necessarily mean that the film was trading stock for these purposes.  Mr Peacock argued that in s 100(2)(a) ICTA 1988 the reference to property “such as is sold” connotes a scheme or situation of regular or recurrent sales of property of that kind, which is also the connotation of the expression “in the ordinary course of the trade”.  He accepted that a single and unique transaction comprising the sale of property could cause the property to be trading stock within the terms of s 100(2)(a) ICTA 1988, but that would be exceptional.  In the case of Micro Fusion it could not be said that there was a course of conduct which amounted to selling films in the ordinary course of a trade.  Mr Peacock argued that the motive of the taxpayer is relevant (he referred to the case New Angel Court v Adam [2004] STC 799, per Jonathan Parker LJ at 801, whilst acknowledging that that case is dealing with different legislation which is concerned with the acquisition of trading stock) and there was no intention on the part of Micro Fusion to sell the film following production, but simply to exploit it by granting a licence for a stream of income.  Finally, consistent with this was the treatment of the film Mrs Henderson Presents in the audited accounts of Micro Fusion: the film is shown as an asset in the balance sheet, but it is not shown as trading stock of Micro Fusion, and this accounting treatment was not challenged by HMRC in their cross-examination of Mr Back in the course of the hearing.
79.	Miss Simler for HMRC argued that in applying the s 100(2)(a) ICTA 1988 test motive or intent is irrelevant: it is an objective test – is it property such as is sold in the ordinary course of the trade?  This was the approach taken by the Court of Appeal in the case General Motors Acceptance Corporation Ltd v IRC [1987] STC 122, which was concerned with language similar to that in s 100(2)(a) ICTA 1988, where it was held that cars sold by an intermediate finance company were sold in the ordinary course of the taxpayer company’s activities, even though the profit was derived from the finance charge levied rather than from a mark-up on the price of the cars on re-sale.  An asset sold in a one-off transaction can constitute trading stock, and it is not necessary to show that there is a pre-existing trade or a course of conduct of making sales: see Ashborder BV v Green Gas Power Ltd [2005] 1 BCLC 623 at page 661H.
80.	In view of our decision that Micro Fusion did not sell the film Mrs Henderson Presents, we are not required to decide what the position would be if that were not the case and the arrangements Micro Fusion entered into did in fact constitute a sale of the film.  If it were the case that Micro Fusion produced the film and sold it, whilst we agree with Mr Peacock that mere sale of an asset does not make that asset “trading stock” for these purposes, we nevertheless would favour Miss Simler’s argument that in the case of a taxpayer whose only activity is the production and sale of a single film, that sale can fairly be said to be in the ordinary course of that taxpayer’s trade (being the production and sale of films) notwithstanding that it is a one-off transaction, and, further, that the film is property such as is sold in the ordinary course of that trade, and therefore is “trading stock” in relation to that trade.  We agree that the test laid down in s 100(2)(a) ICTA 1988 is an objective one, and should be applied without reference to the motive of the person carrying on the trade.
81.	However, for the reasons given, Micro Fusion succeeds on the Trading Stock issue and is not denied entitlement to relief under section 42 or section 48 by virtue of section 42(8).
The Commencement issue
Introduction
82.	The issue between the parties is whether, as Micro Fusion contends, it commenced its trade on 6 April 2004, or whether, as HMRC contends, it commenced its trade at a later date (HMRC contending that such later date is 28 January 2005, being the date on which Micro Fusion funded the production expenditure on the film Mrs Henderson Presents).  This is largely a question of fact, and turns on the nature and extent of the activities of Micro Fusion in the period before it became involved in the production of the film Mrs Henderson Presents.  Micro Fusion relied upon the evidence of Mr Levy and Mr Kushner in relation to those activities, and their evidence was vigorously challenged by HMRC. 
83.	The date on which Micro Fusion commenced its trade is significant for this reason: Micro Fusion has drawn up its accounts so that its first accounting period begins on the date it claims it commenced its trade (6 April 2004) and ends on 30 June 2005 (Micro Fusion contends that it completed the film on or before this date, but that is the matter in dispute in the Completion issue); Micro Fusion (strictly, its members) realised a loss in that accounting period by reason of the relief for the production costs of the film claimed under section 42 and section 48, and there falls to be determined the proportion of that loss which is treated as falling in the tax year ending 5 April 2005.  There is a dispute between the parties as to the basis on which the amount of that loss for the 2004/05 tax year is calculated in these circumstances.  This matter turns upon the interpretation of the relevant statutory provisions, and is a question of law.
84.	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 30 above.  In summary, section 42(1) provides for a deduction for production or 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 (but where the relief claimed is under section 48, the deduction for the relevant period is for the whole of the expenditure); and by section 42(5), in the case of a relevant period of less than twelve months, the one third portion of expenditure (or full amount in the case of a claim under section 48) 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.
85.	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.
86.	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 Micro Fusion can claim for the tax year ending 5 April 2005 is the loss for the period from commencement of the trade until 5 April 2005).  HMRC contend that the basis period rule applies because Micro Fusion has made up its accounts for a period (6 April 2004 to 30 June 2005) which does not coincide with that period from the commencement of the trade until 5 April 2005.  Micro Fusion contends that the basis period rule is a default rule which can apply only, having regard to the opening words of subsection (b) of s 40B(3) F(No 2)A 1992, if the taxpayer has failed to make up any accounts at all, and that since Micro Fusion 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 2004/05 tax year.
The evidence and the facts
87.	Micro Fusion’s claim that it commenced its trade of the exploitation of films on 6 April 2004 is founded on two documents and on the evidence of Mr Levy and Mr Kushner in relation to those documents and the surrounding circumstances.
88.	The two documents, both of which were entered into on 6 April 2004, are the FCA between Micro Fusion and Future under which Future agreed to provide certain film consultancy services (see paragraph 14 above) and the document referred to as the EAFA (see paragraph 15 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 6 April 2004 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.
89.	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 on 6 April 2004 between Micro Fusion and Future (the parties entered into a subsequent agreement on 28 January 2005 which was amended on 6 September 2005, as referred to in the agreed facts: see paragraph 14 above);
(2)	Future is engaged by Micro Fusion to provide “Film Consultancy Services” for the period which commences on 6 April 2004 and ends when either party terminates the agreement or on the winding up of Micro Fusion.  The “Commencement Date” is expressed to mean “the date on which [Micro Fusion’s] trade commenced, being 6 April 2004”.  In the case of the agreement made on 28 January 2005 there are inconsistent provisions as to whether the term during which the Film Consultancy Services are provided commences on 6 April 2004 or 28 January 2005.
(3)	The Film Consultancy Services include identifying, researching and evaluating films suitable for Micro Fusion; selecting films for the purposes of acquiring and exploiting them on behalf of Micro Fusion; 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 Micro Fusion’s business; entering into and performing all contracts and engaging in all activities and transaction necessary to carry out the foregoing services.
(4)	Micro Fusion has complete discretion to accept or refuse proposals made to it by Future in providing the Film Consultancy Services, and all strategic decisions relating to Micro Fusion’s business are to be made by Micro Fusion in conjunction with Future.
(5)	Micro Fusion agrees to pay Future for the provision of the Film Consultancy Services a fee.  In the 6 April 2004 agreement the fee is expressed as “an initial fee of £100,000 and further fees subject to agreement between [Micro Fusion] and [Future]”.  In the 28 January 2005 FCA the fee is stated as £1,616,889, and by the amending agreement of 6 September 2005 there is provision for Micro Fusion to pay an additional fee by way of a share of any amount of Gross Participation it receives under the terms of the Distribution Agreement.
90.	The provisions of the EAFA are, in summary, as follows:
(1)	The EAFA was entered into on 6 April 2004 between Micro Fusion and IMPDC of Chatsworth, New South Wales, Australia.
(2)	The agreement recites that Micro Fusion has agreed to acquire rights under the agreement from IMPDC for the purpose of financing and distributing the film to which the rights relate.
(3)	IMPDC grants to Micro Fusion the rights to the screenplay Manson Girls written by Mathew Bright in consideration for which Micro Fusion agrees to pay to IMPDC US$150,000 on 30 March 2005 (payment was not made until 12 April 2006, and actual payment was made by Future).
(4)	The rights to the screenplay include the exclusive right throughout the world to exhibit, distribute or deal with the “Film” in any medium and markets.  The Film is defined as “the film or motion picture to be financed by [Micro Fusion] (itself and/or in joint venture or by commissioning other producing entities) based on the screenplay”.
(5)	Micro Fusion agrees to use all reasonable efforts to raise finance for the Film with a view to commencing production by 31 December 2005.  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 Film.  If “financial closing” of the Film has not occurred by 1 October 2005 IMPDC is entitled to reacquire all rights granted to the screenplay on reimbursement of the fee paid by Micro Fusion.
(6)	Micro Fusion 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 screenplay or the Film or in their exploitation will infringe any third party rights.
(8)	By an agreement dated 3 March 2005 the parties amended the EAFA to confer on IMPDC an option whereby, after 6 April 2005, IMPDC could acquire the rights conferred on Micro Fusion under the EAFA for reimbursement of the fee paid by Micro Fusion plus a participation of 25 per cent of all net income to which IMPDC is entitled from its exploitation of those rights.  Further, the EAFA is expressed to be for a term of three years, with Micro Fusion having the option to extend it for a further three years.
91.	Mr Levy’s evidence in chief relevant to the Commencement issue dealt first with the EAFA and the rights to the screenplay for Manson Girls and then with the circumstances relating to the production and financing of the film Mrs Henderson Presents.
92.	His evidence dealing with the EAFA and the Manson Girls screenplay can be summarised as follows:
(1)	An independent producer of a film needs to collate the elements of a film project in order to present it to potential investors (such as distributors) who may be interested in owing the rights to exploit the completed film.  Those elements typically comprise a screenplay (derived from a script, book, or original idea), a director, and key cast members.
(2)	Micro Fusion entered into both the FCA and the EAFA on 6 April 2004.  As to the EAFA, the counterparty, IMPDC, is incorporated in Hong Kong with 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.
(3)	The purchase of scripts or screenplays is high risk, since they are acquired before financing is secured and therefore before film production is likely.  The expectation is that between one in ten and one in twenty screenplays will go on to be made into a film.  The value of a screenplay is determined by negotiation and in the independent production market a price in the range of US$50,000 to US$250,000 might be a going rate for a standard screenplay.
(4)	Future, through Mr Levy, had a close working relationship with Mr Kushner, who has been a prolific producer of British qualifying films, and is very effective and well-connected in the film industry.  Future, and film partnerships promoted by Future, have been involved in about 15 projects resulting in films with Mr Kushner.  One of those films, with the title Snuff-Movie (formerly Man with a Movie Camera) concerns the story of Charles Manson.  Mr Kushner would put projects forward for discussion as to whether Future (through the film partnerships it promoted) could raise investment capital for those projects and create the production vehicles that could produce those projects.
(5)	Mr Kushner proposed the treatment or screenplay of Manson Girls to Future.  It concerns the story of Charles Manson.  Future considered that there was a good chance that Manson Girls would be made into a British qualifying film, and that Micro Fusion would be in an excellent position to produce that film.
(6)	Micro Fusion acquired the screenplay rights under the EAFA for commercial reasons, but the timing of the acquisition was influenced by pragmatic tax reasons in that it was in the interests of Micro Fusion to commence its trade at the earliest point in the tax year to obtain the maximum time-apportionment relief for production expenditure under section 42 and section 48.  The EAFA was a genuine agreement with IMPDC, an unconnected party.
(7)	There is no documentation in relation to the steps taken by Micro Fusion to finance the production of Manson Girls.  Mr Levy recalled that during May 2004, and especially at the Cannes Film Festival that year, he had discussions with representatives of IMPDC and other producers from the USA, Canada and Switzerland with a view to raising finance for the production of Manson Girls.  There were also regular discussions with Mr Kushner, whose contribution was on the creative side of the project, trying to bring together a director, leading cast members, technicians etc.  Mr Levy recalled a tentative finance plan that involved selling rights in the United States to Sony for 60 per cent of the budget, with Micro Fusion contributing 30 per cent, but no-one committed to this.
(8)	Under the EAFA Micro Fusion had acquired a “treatment” of the film and rights to a screenplay.  The first draft of the script of Manson Girls and the preliminary delivery of the screenplay itself did not take place until 22 September 2004, and a revised script was delivered on 14 January 2005.  By that time Micro Fusion was involved in an alternative project, the film Mrs Henderson Presents.  No further action was taken in relation to Manson Girls, and subsequent changes in the tax legislation had a negative impact of the prospect of financing the production of the film.  Micro Fusion retains its rights under the EAFA.
(9)	Payment to IMPDC by Micro Fusion of the fee due under the EAFA was made on 12 April 2006, rather than 30 March 2003, as the agreement provided.  This late payment was an administrative oversight.
93.	Mr Kushner’s evidence also dealt with Micro Fusion’s acquisition of the screenplay rights to Manson Girls.  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)	The writer of the screenplay Manson Girls was known to him and offered it to him.  It concerned Charles Manson and his followers, which was a subject which interested him and which was the basis of the film Snuff-Movie which had been made with a partnership promoted by Future.  From his close contact with Future he knew they were looking for film projects to invest in, and he recommended to IMPDC that they take up the rights and offer them to Future.  He negotiated the price with Mr Levy.
(3)	As to financing attempts to enable the screenplay to be converted into a film, he recalled discussions with Sony and others and with producers and potential directors and cast members.  His recollection is that he and Mr Levy were close to having financing put in place, but it did not happen.  He is still pursuing the possibility of making the film.
94.	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 Micro Fusion’s acquisition of rights to Manson Girls).  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, one (that is the case of Micro Fusion’s acquisition of rights to Manson Girls) 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. 
95.	Mr Levy also gave evidence as to the circumstances in which Micro Fusion acquired the rights to the film Mrs Henderson Presents and proceeded to the financing and production of that film, which is relevant to the Commencement issue.  His evidence in chief on this matter can be summarised as follows:
(1)	The arrangements for the film partnerships promoted by Future (including Micro Fusion) entailed Future issuing a prospectus to potential investors who were seeking to subscribe capital as members of limited liability partnerships for film production investment.  The partnerships were formed with two founding members (entities in the Future group of companies).  Each partnership engaged Future or a related company as a film consultant to seek out suitable films for production and exploitation.  When such a film was found a “Specific Film Offer” would be made to a partnership, and if the potential investors in that partnership were to accept the Specific Film Offer, the film consultant would proceed to negotiate the acquisition of the necessary rights, the production arrangements, and other financing required, and the delivery and distribution arrangements for the completed film.  Once negotiations had been completed the documentation would be entered into, the investors join the partnership as members and contribute their capital (and the partnership deed amended to reflect the enlarged partnership), the film rights would be acquired, and the film produced, delivered and distributed.
(2)	In the case of Micro Fusion, it entered into the FCA and the EADA in relation to the screenplay Manson Girls on 6 April 2004 when the members of the partnership were the two founding members.
(3)	In May 2004 Future, as promoter of the various film partnerships (including Micro Fusion) issued a Proposal (essentially a prospectus) to potential investors for the 2004/05 tax year.  This explained in detail the arrangements whereby investors would have the opportunity to fund a film partnership (as members contributing capital and by loan) as outlined in sub-paragraph (1) above.  The Proposal also detailed the financing and performance guarantee and security arrangements in relation to the production of films to be produced by the partnership and the payment of licence or other sums by the film distributors, and set out the risks undertaken by the investors.  The Proposal explained that the intention was that investors would invest only in British qualifying films, so that the relevant tax relief would be available.  Various safeguards were included to ensure, so far as possible, that films chosen for investment would meet the British qualifying film criteria.
(4)	In early June 2004 Future was approached by Pathé in relation to a project to finance and produce the film Mrs Henderson Presents.  Various sources of finance from the BBC and the UK Film Council were in place, as were the director, the cast and a production company.  Future agreed to pursue the matter to see if sufficiently commercial terms could be agreed with Pathé in its capacity as a distribution company, on the basis that a film partnership promoted by Future would produce the film and deliver a completed film to Pathé for it to distribute under the terms of a 21 year licence.
(5)	There followed lengthy and complex negotiations between Pathé and Future.  It was evident that production of the film would have to begin before the negotiations had been completed and documented.  This is a common circumstance in the film industry.  Negotiations began in mid-June 2004 and were finally completed on “financial closing”, which occurred on 28 January 2005.
(6)	In the course of this process a Specific Film Offer was made to the prospective investors in Micro Fusion in or around August 2004, and a final version shortly before “financial closing”. 
(7)	In September 2004 Micro Fusion committed in principle to produce the film Mrs Henderson Presents, and shooting of principal photography began on 20 September 2004 and was completed on 9 December 2004.
(8)	On 1 October 2004 the parties entered into the One Picture Licence Agreement (see paragraphs 16 and 47 above), the PSA (see paragraphs 17 and 47 above), and the Distributorship Agreement (see paragraphs 20 and 48 above).  These documents were subject to termination rights which, in summary, allowed any party to terminate them if definitive terms and financial closing were not agreed by 31 October 2004.  The parties subsequently agreed not to terminate, but to extend the negotiation period.
(9)	Production costs for the film were met out of bridging finance provided by a third party.
(10)	Definitive terms were agreed on 28 January 2005, when “financial closing” occurred.  The final versions of the principal documents were entered into on that date together with all the security documentation and the Inter-party Agreement (see paragraph 50 above).  On that date, or shortly before, the investors in Micro Fusion joined the partnership as members and contributed their capital and made their loans to Micro Fusion.
The parties’ submissions on the facts
96.	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 those submissions concluded with the submission that we should find that the EAFA, by which Micro Fusion acquired rights to the screenplay to Manson Girls, was a sham, it is necessary to set them out in some detail, as follows:
(1)	IMPDC had a close connection with the Pueblo group of companies, a production and distribution group which, through transactions with other Future-promoted partnerships, was aware of the benefits to be derived if a film partnership began trading at the beginning of a tax year.  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 Manson Girls screenplay.
(2)	The Proposal put to potential investors states that each film partnership will produce or commission the production of a single British qualifying film, and the only Specific Film Offer made to potential investors in Micro Fusion related to Mrs Henderson Presents.  Further, the proposal for Manson Girls did not meet the minimum requirements which, according to the Proposal, had to be met in order for a film project to be eligible for a Future-promoted film partnership to invest in it.  Accordingly, there was no realistic intention that the screenplay for Manson Girls would be made into a film by Micro Fusion.
(3)	There is no documentation produced by Micro Fusion evidencing any negotiations which Mr Levy and Mr Kushner asserted took place to agree the terms of the EAFA, and no evidence of due diligence enquiries as to IMPDC’s entitlement to confer the rights to the Manson Girls screenplay granted by the EAFA.
(4)	There is no evidence that IMPDC demanded payment of the fee of US$150,000 when Micro Fusion failed to pay it on the due date – payment was made over a year late (and by Future, not Micro Fusion itself, but treated as a non-recourse loan to Micro Fusion), and only after HMRC had begun its enquiries.
(5)	There is no documentation produced by Micro Fusion evidencing any negotiations for putting in place financing, production, or other arrangements necessary to convert the screenplay for Manson Girls into a film, although such negotiations were referred to in the evidence of both Mr Levy and Mr Kushner.
(6)	Mr Levy was unable to give a commercial justification for the amendments made to the EAFA in March 2005 whereby IMPDC agreed to pay additional sums to Micro Fusion should IMPDC exercise a right to buy back the screenplay rights in Manson Girls.
(7)	Another Future-promoted film partnership had recently produced the film Snuff-Movie based on the Charles Manson killings involving Sharon Tate, and it was unlikely that a second film about the same distinctive subject would be made so shortly thereafter.
(8)	Having regard to these matters, it cannot be said that the EAFA was genuinely intended to confer on Micro Fusion rights to develop the screenplay for Manson Girls: there was no intention on the part of Micro Fusion 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.
97.	Mr Peacock replied to these submissions in full and in writing, 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 it subsequently transpired that Micro Fusion decided not to pursue its rights to exploit the Manson Girls screenplay, whilst instead pursuing the opportunity to produce Mrs Henderson Presents. 
(3)	Micro Fusion complied with the terms of the Proposal in that it commissioned the production of and then exploited one film only, having found that Mrs Henderson Presents was a more viable project within the timescale within which Micro Fusion wished to make its investment.
(4)	The possibility still exists for Micro Fusion to turn the Manson Girls screenplay into a film, and to that end Micro Fusion received drafts of the screenplay script.  Mr Kusher asserted in his oral evidence that the screenplay for Manson Girls is a valuable property for which there are realistic hopes of converting it into a film, one of the lead roles now having been cast.
(5)	The fact that the fee due under the EAFA was paid (albeit late), and the fact that the parties subsequently amended the EAFA, 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.
(6)	Micro Fusion’s case for having commenced its trade on 6 April 2004 is based not solely on the EAFA: the FCA was also entered into on that date, and its validity, purpose and effect is not questioned.
Decision on the Commencement issue – the date on which Micro Fusion’s trade commenced
98.	The question we have to decide first is the date on which Micro Fusion commenced its trade which consists of or includes the exploitation of films.  We consider that it commenced its trade on 20 September 2004, the date on which there began shooting of principal photography of the film Mrs Henderson Presents, that is, when production of that film began.
99.	Neither of the parties made submissions as to what is required in order that a trade may be regarded as having commenced, but we were referred by Mr Peacock to the decision of the Special Commissioner (Charles Hellier) in the case of Mansell v Revenue and Customs Commissioners SpC 551 SCD 605 (at paragraphs 88 to 94), where there are set out the principles on this question which he derives from the cases.  We are happy to adopt those principles and to apply them in the present case.
100.	The first principle is that there must be a fairly specific concept of the type of activity which is to be carried on by way of the trade before a trade can be commenced.  In the present case Micro Fusion was clear that it intended to carry on the trade of exploiting films – this is certainly so by reference to the partnership deed which had effect from 1 October 2004 (see paragraph 47(1) above).  We accept that Micro Fusion had this intention prior to entering into the EAFA and the FCA on 6 April 2004, so that this requirement is satisfied.
101.	The second principle is that “an activity which consists merely of a review of the possibilities in the expectation or hope that information will be obtained to justify going into a business of some kind is not the carrying on of a trade”.
102.	The third principle is that whilst it is not always necessary that a sale is made or a service supplied before it can be said that a trade commences, there nevertheless must be a commencement of operational activities, that is, “dealings with third parties immediately and directly related to the supplies to be made which it is hoped will give rise to the expected profits, and which involve the trader putting money at risk”.  Carrying on negotiations to enter into contracts which will result in operational activities is not itself the commencement of operational activities since no operational risk is thereby undertaken.
103.	Micro Fusion’s case, by reference to these principles, would be that, on entering into the EAFA and the FCA on 6 April 2004 it commenced on that date “operational activities” of the kind referred to in the Mansell case.  HMRC’s case, by reference to these principles, would be that the EAFA is to be disregarded in its entirety as a sham, and that not until the documentation relating to the film Mrs Henderson Presents was finally concluded and entered into at “financial closing” on 28 January 2005 had Micro Fusion undertaken an “operational activity”.
104.	We deal first with the submission made on behalf of HMRC that the EAFA was a sham document.  We do not consider that to be so.  We accept Mr Peacock’s submission as to what is required in order for a document or transaction to constitute a sham.  The EAFA conferred rights on Micro Fusion to exploit a film based on the screenplay Manson Girls for which Micro Fusion became liable to pay a substantial sum (and Micro Fusion did eventually discharge that liability for payment).  There is nothing in the evidence which establishes that those rights and obligations were not genuine or that the parties, in entering into the EAFA, intended that they should not be bound by the rights and obligations which the document creates on its face.  Mr Levy accepted that the EAFA had been entered into at the beginning of the tax year to enable Micro Fusion to establish that it commenced its trade then in order to maximise the apportionment of the loss arising in that year from the tax relief on the production expenditure, and he also acknowledged that Mr Kushner was made aware of the significance to Micro Fusion of entering into the agreement at that time of the year.  However, simply because there is a tax motive for one party to the transaction which the other party is prepared to accommodate does not of itself render it a sham within the proper meaning of that expression.
105.	Of more significance, perhaps, is the allegation that Micro Fusion failed to take action to exploit the screenplay, or even to seek finance to do so.  The evidence of Mr Levy and of Mr Kushner was that discussions were held with various parties about the possibility of financing a film based on the screenplay, but that evidence was not supported by any documentation produced by Micro Fusion for the hearing, which we found strange in circumstances where the documentary evidence in the appeal extended to eight large lever-arch files.  On the other hand, as Mr Kushner made plain in his oral evidence, the film production business rarely proceeds at principal level on the basis of the written word and he expressed his own aversion to dealing with paperwork – deals are struck on the basis of a handshake and the lawyers are left to document them in due course.  In that business context perhaps it is not so surprising that talks about possible deals do not leave a paper trail.
106.	But even if we assume that Micro Fusion failed to take any significant action to exploit the screenplay it does not necessarily follow that the EAFA or the underlying transaction is a sham: it might be that Micro Fusion was unable to take such action, or even chose not to do so (at the possible risk of being in breach of its obligations to the grantor), rather than that it in fact had no rights to the screenplay to exploit, which would be the case if the document were a sham.
107.	Therefore we do not consider that it is established that the EAFA is a sham document, or that the transaction it records is a sham transaction.  In our view Micro Fusion acquired the rights to the Manson Girls screenplay that on the face of it the EAFA conferred.  However, we do not consider that, by so acquiring those rights, Micro Fusion thereby commenced its trade.  The acquisition of those rights was a necessary preparatory action which put Micro Fusion in the position to commence its trade by the exploitation of films, but it was not itself the action of exploiting films.  The same is true of the FCA appointing Future to seek out film projects and their possible financing and production arrangements.  
108.	These matters were, at best, preparatory in that although they were contractual commitments undertaken by Micro Fusion, and in the case of the EAFA resulted in a significant monetary liability, the undoubted weight and sense of the evidence is that little, if anything, was actively pursued – and certainly nothing was achieved - which could in due course have turned the rights acquired to account.  We have the evidence of Mr Levy and Mr Kushner that conversations were held with various people in relation to Manson Girls, and that further work was carried out on the screenplay, but nothing in support of that to indicate action which would give any realistic prospect that profits would flow at some future time from the rights to the Manson Girls screenplay.  Applying the principles set out in Mansell, although at first sight it may appear that by entering into the EAFA and the FCA Micro Fusion engaged in “operational activities”, it is clear that for a trade to be regarded as commenced in advance of any sales or equivalent earning of income, any activities must in fact be “operational” in the sense of undertaken and actively and single-mindedly pursued in a way which is intended to result in a profit earned.  Micro Fusion did not convince us that this was the case in relation to the Manson Girls screenplay.
109.	The point is made clear by the contrast seen once Pathé brought to Future the prospect of financing the production of the film Mrs Henderson Presents in mid-June 2004.  Thereafter there are intensive negotiations extending, in one form or another, until late January 2005 with the various stages evidenced by a plethora of emails and other communications and documented by interim and then final documents of commercial, financial and legal complexity and sophistication.  Matters were finally concluded by what was termed “financial closing” on 28 January 2005.  
110.	Miss Simler urged on us that this date should be regarded as the point at which Micro Fusion commenced its trade, since until that time Micro Fusion and the other parties could resile from the interim agreements entered into on 1 October 2004, and until that time Micro Fusion had not committed its funds to the project.  We think this is too strict a view.  The active negotiations through July and August resulted in a position where the principal parties, Micro Fusion, Pathé and MHP (the production services company which carried out physical production of the film) felt sufficiently committed, as a commercial manner, to permit shooting of the principal photography of the film to begin on 20 September 2004.  By that point Future had put to the prospective investors and members in Micro Fusion a Specific Film Offer in relation to Mrs Henderson Presents which it is presumed was acceptable to them, at least in principle (a revised Specific Film Offer was made to them shortly before their actual investment at the time of “financial closing”).  That commercial commitment was followed by the legal commitment made by the various documents entered into by Micro Fusion and the other parties on 1 October 2004 (see paragraphs 47 and 48 above).  Those documents conferred on Micro Fusion the licence to produce the film, provided for the physical production of the film, provided for the means of financing the film beyond bridging finance, and provided for the distribution of the film and the earning of income from its exploitation by Micro Fusion.  At that point Micro Fusion can certainly be regarded as having set up its business by completing the matters preparatory to commencing trade, and to have begun operational activities.  It is true that the agreements made on 1 October 2004 could possibly have been terminated before the point of “financial closing” was reached, but commercially, with production of the film underway, and with all the parties having a common interest in ensuring that matters proceeded to such a closing, that was unlikely. 
111.	There is a good, case, therefore, for deciding that Micro Fusion commenced its trade comprising the exploitation of films on 1 October 2004.  It seems to us, however, that 20 September 2004 is the better date (in terms of apportioning the tax relief loss, which is the relevance of the commencement date, the difference is not likely to be significant):  accepting Mr Kushner’s general point that in this line of business the lawyers trail behind the handshake commitment, some date in advance of 1 October 2004 would seem reasonable, and for the reasons given the commencement of shooting of principal photography of the film Mrs Henderson Presents seems firm evidence of a commercial commitment to the arrangements documented on 1 October 2004.  There may be a case for a date earlier than 20 September 2004, but Micro Fusion did not make such a case (other than for 6 April 2004, which we reject).
112.	Accordingly it is our decision that Micro Fusion commenced its trade on 20 September 2004.
The basis for determining the amount of relief for tax year 2004/05 – the parties’ submissions
113.	The parties are also in dispute as to the basis for determining the amount of the deduction arising from the production expenditure relief in computing losses for the tax year 2004/05 in the circumstances where Micro Fusion’s trade begins after 6 April 2004 (that is, part-way through the tax year 2004/05) in the situation where its first accounting period runs from 6 April 2004 to 30 June 2005: see paragraphs 83 to 86 above.  
114.	For Micro Fusion Mr Peacock submitted that the position is straightforward.  He argues that there is no dispute that at some point during Micro Fusion’s accounting period Micro Fusion commenced its trade, and so is entitled to relief for its expenditure under section 42 and section 48.  Section 42(1) gives a deduction for production expenditure in computing taxable profits accruing in “a relevant period”, and by section 42(4) the amount deducted for “a relevant period” is one third of the total expenditure (if section 42 applies) or the whole of the expenditure (if section 48 applies).  Section 42(5) applies to reduce that amount proportionately where “a relevant period” is less than twelve months.  By virtue of s 40B(3) F(No 2)A 1992 “relevant period” for these purposes means “a period for which the accounts of the trade or business concerned are made up”: Micro Fusion made up its accounts for the period 6 April 2004 to 30 June 2005, and that is the “relevant period” by reference to which section 42 and section 48 apply in relation to Micro Fusion.  The date on which Micro Fusion commenced its trade is irrelevant for these purposes: it is the period for which the accounts are made up which matters.  The proportionate reduction provided for in section 42(5) is, in consequence, irrelevant, because for Micro Fusion the “relevant period” is not less than twelve months.  He accepted that the basis period used in assessing the income for a tax year may be the “relevant period” (in which case the commencement date of the trade becomes relevant as the start point of that basis period, and a “relevant period” of less than twelve months will occur if the trade is commenced after the start of the tax year), but by reason of s 40B(3)(b) F(No 2)A 1992 that is the default position which occurs “if no accounts of the trade or business concerned are made up for a period”: since Micro Fusion did make up accounts for a period this default position is not germane to its circumstances.
115.	The essence of HMRC’s case, as it was put to us by Miss Simler, is that in order for the concept to have any sensible meaning in the context in which it is applied, “relevant period” must mean the “relevant assessable period”, that is the basis period, the period which is brought into the tax charge for a tax year.  That period is always twelve months or less, and section 42(5) applies to reduce the amount of production expenditure for which relief can be claimed where that period is less than twelve months.  
116.	Miss Simler’s starting point is that the concept “relevant period” has three purposes in terms of the relief given for expenditure qualifying for relief under section 42 or section 48: it determines the period in which the deduction for the expenditure is taken (section 42(1)); it determines when a claim can be made (that is, the period in which the film in question is completed, or an earlier period) (section 42(2)); and it determines the amount of relief which can be claimed (for example, one third of the expenditure with a proportionate reduction for a period of less than twelve months) (section 42(4) and (5)).  
117.	For these different, but related, purposes the definition of “relevant period” in s 40B(3) F(No 2)A 1992 must have a sensible meaning.  Taking first subsection (b) of that section, that is the situation “if no accounts of a trade or business concerned are made up for a period”, this cannot simply mean, as Micro Fusion contends, a situation where no accounts at all are made up for the business, since unless and until accounts are prepared no claim for relief can be made – it is a situation which, in the context in which “relevant period” is used for relief under section 42, could never arise.  Therefore it must mean “if no accounts of the trade or business concerned are made up for an assessable period” – that is the default position which arises when (reading subsection (a) in a consistent manner) it is not the situation where there is “an assessable period for which the accounts of the trade or business concerned are made up”.  This approach explains why section 42(5) deals only with proportionate adjustment of the amount of expenditure qualifying for relief when the “relevant period” is less than twelve months, and does not need to deal with a situation where the “relevant period” is more than twelve months: that can never be the case where the “relevant period” is the assessable period.
118.	Applying this approach to the circumstances of Micro Fusion, if it commenced its trade after 6 April 2004 (say, on 20 September 2004), the assessable period is 20 September 2004 to 5 April 2005.  This is not the period for which the accounts were made up (which was 6 April 2004 to 30 June 2005), and therefore Micro Fusion’s circumstances are not within subsection (a) of s 40B(3) F(No 2)A 1992, but are within the default rule of subsection (b), so that the basis period for the tax year 2004/05 is to be used as the “relevant period”, which , under the normal rules, is the period 20 September 2004 to 5 April 2005, a period of less than twelve months, so that section 42(5) applies to reduce proportionately the amount of qualifying expenditure which can be claimed as a deduction in that tax year.
119.	In reply Mr Peacock argues that not only is HMRC’s interpretation at odds with the actual language of s 40B(3) F(No 2)A 1992, but the gloss of interpreting “period” as “assessable period” in that section cannot be consistently applied since it is meaningless when it comes to be applied to subsection (b)(ii).  Furthermore, if “the relevant period” is to mean the basis period for a year of assessment, there would be no purpose in having section 42(5) (which reduces the amount of relief for a relevant period of less than twelve months) since that is achieved by the normal rules (including the commencement rules) relating to basis periods as found in ss 60 and 61 ICTA 1988, which applied for the tax years in question.
Decision on the basis for determining the amount of relief for tax year 2004/05
120.	We found this to be a point of some difficulty.  We see the force of Mr Peacock’s argument, which is to read s 40B(3) F(No 2)A 1992 simply in terms of what it says.  There do, however, appear to be a number of possible objections to following this course.  The first objection, identified by Miss Simler, is that, on Mr Peacock’s reading the default position of the basis period for the year of assessment provided for in subsection (b) would never apply, since any person wishing to claim the relief would have to draw up accounts for the trade of exploiting films effectively as a pre-condition to make such a claim.  The second objection is that such a reading leaves it open to the taxpayer to manipulate the amount claimed in the tax year in which he begins trading by his choice of accounting period so that (as Miss Simler put it in relation to Micro Fusion, assuming it commenced its trade later than 6 April 2004) the amount of relief which in principle by section 42 is to be apportioned by reference to time is calculated by reference in part to a time before the trade commenced.  The third objection is that if such a reading results in a “relevant period” which exceeds twelve months (as would be the case for Micro Fusion) there seems to be no obvious provision in the section 42 scheme which deals with apportionment when the “relevant period” does so exceed twelve months – although perhaps it would be said that in such a case a third of the expenditure qualifies (assuming section 42 relief only) and no apportionment of the expenditure is required.
121.	On balance we prefer Miss Simler’s reading of s 40B(3) F(No 2)A which admittedly requires a gloss on the language used, but we think a permissible one in a provision which, in context, is clearly concerned with relating periods of account to tax years.  It gives a consistent result within the scheme of section 42 which is fair in the circumstances and apportions the relief by reference to what has happened rather than the arbitrary choice of accounting periods.  The objections which Mr Peacock raised are not unreasonable in themselves, but do not, it seems to us, amount to objections of principle or challenge the fairness or reasonableness of the view for which HMRC contends.
122.	Therefore we decide this matter in favour of HMRC to the effect that for the tax year 2004/05 the “relevant period” for the purposes of section 42 is the basis period for that tax year, which, as we understand it, and taking account of our decision as to commencement of the trade, is the period from 20 September 2004 to 5 April 2005.
The Completion issue
Introduction
123.	The issue here for determination is whether, within the terms of section 42, the film Mrs Henderson Presents was “completed” in the “relevant period”.  As the point was argued before us, the question is whether the film was completed on or before 30 June 2005 on the assumption, it would seem, that the “relevant period” was the first accounting period of Micro Fusion, which began on 6 April 2004 and ended on 30 June 2005.  The significance of this issue, as it was explained to us, is that if the film was completed after 30 June 2005 Micro Fusion would not be able to claim relief for its expenditure under section 42 or section 48 for the tax year 2004/05, but instead would have to make its claim for the subsequent tax year (in which case, as was common ground, the other issues dealt with in this appeal, and our decision in relation to them, would be taken as relevant and applicable to the claim it would make for that subsequent tax year).
124.	Although the matter was not referred to at the hearing, it would seem that if HMRC’s view as to the meaning of “relevant period” in the context of the Commencement issue is correct, as we hold it to be, so that the “relevant period” (or, rather, Micro Fusion’s first “relevant period”) ends on 5 April 2005, then, at least in relation to the tax year 2004/05 the question is whether the film Mrs Henderson Presents was completed on or before 5 April 2005.  No evidence was adduced by Micro Fusion by reference to the state of the film on this date.  In any event, since it is our decision that the film was not completed on or before 30 June 2005, the matter is determined against Micro Fusion even if the “relevant period” is the first accounting period of Micro Fusion, as it has contended.
125.	The date on which the film Mrs Henderson Presents was completed is a question of fact to be decided by reference to the relevant statutory provisions.  The effect of section 42(1) and (2) is that relief is available for expenditure on a qualifying film incurred by a person carrying of a trade of exploiting films where the expenditure was incurred “on the production of a film which was completed in the relevant period to which the claim relates or an earlier period”.  Section 43(3) F(No 2)A 1992 provides that for the purposes of section 42 “a film is completed at the time when it is first in a form in which it can reasonably be regarded as ready for copies of it to be made and distributed for presentation to the general public”.
126.	Micro Fusion’s case is that the film Mrs Henderson Presents was in this state by 30 June 2005 as evidenced by communications with Pathé and by the fact that it was screened to potential distributors at an event, London UK Film Focus (“LUFF”) on 30 June 2005, and that although subsequent editing changes were made to certain aspects of the film after this date, they were minor in character and made after Pathé had taken delivery of the film.  HMRC’s case is that the post-production work to the film was material in the context of the film as eventually screened to the public, and that other evidence, including the information given in the application to the DCMS for certification of the film as a British qualifying film, shows that the film was not completed until September 2005 at the earliest.
The evidence and the facts
127.	The evidence before us on this issue comprised the oral evidence of Mr Levy, Mr Kushner and Mr Malde (all in cross-examination by Miss Simler – the evidence in chief of Mr Levy made a brief reference only to this issue, and it did not feature in the evidence in chief of Mr Kushner or Mr Malde), and a range of documents.
128.	The following relevant facts were established from the evidence:
(1)	Shooting of principal photography of the film Mrs Henderson Presents commenced on 20 September 2004 and was completed on 9 December 2004.  This was followed by the normal post-production work.
(2)	On 30 June 2005 the film Mrs Henderson Presents was screened at LUFF.  This was not a screening for the public, but for potential distributors of the film.  For the purposes of this screening, on 22 June 2005 Pathé ordered a 35mm print from the original negative.
(3)	On 1 July 2005 Pathé sent an email to Future stating (in the context of an exchange of emails about the completion date to be shown in the application to the DCMS for qualifying film certification), “the completion date would be 29 June”.  (Mr Levy stated that his recollection that there was other correspondence on the point with Pathé to similar effect, but copies could not be found.)
(4)	In early July 2005 there is email correspondence between, variously, Pathé, the film’s director, Mrs Heyman of MHP (the production services company), and Framestore, the special effects company engaged for the production of the film, concerning two scenes in the film on the roof-top of a building during the Blitz, where it was agreed that the computer-generated imagery used in the film required to be re-worked.
(5)	On 11 July 2005 Pathé emailed Framestore in these terms, referring to various exhibitor screenings of the film scheduled for later in July and in August, and to the proposed screening of the film at the Venice Film Festival on 5 September: “We cannot screen with the roof-top shots as they currently stand – they’re simply not acceptable.  The fact that the London Film Festival committee have just said that they’ll need to re-screen the film once the CGI is complete before deciding, is testimony to this.  We now inevitably have to cancel the exhibitors screening on the 27th [July] (for which invitation have been issued) at a huge cost to our distribution department.”
(6)	On 18 July 2005 the BBC (which contributed funding to the film) approved various matters (already by then approved by Pathé) necessary for inclusion in the credits shown at the end of the film.
(7)	These requests for changes were made by Pathé.  It was agreed that changes would be made, but there is no evidence as to when those changes were regarded as completed.
(8)	Production cost reports for August show that during that month expenses were being incurred on post-production expenses, and film and sound editing expenses in relation to the film, within the scope of the film’s original budget.
(9)	On 17 August 2005 Pathé arranged a special screening of the film Mrs Henderson Presents for a number of journalists, who were invited to comment on the film.  Several commented on the absence of special effects, and comments included the following: “I’m sure [the film] will be even better when the special effects are finished.”  “I think once the special effects are added the film will do very well.”  “Thoroughly enjoyed the film, finished or not it looks wonderful.”  “The stage productions were fun but not made as much of as they could have been, and obviously without the finished computer-generated imagery at the end it’s hard to know how that will all play out when it’s done.”
(10)	On 9 September 2005 the film Mrs Henderson Presents was screened at the Toronto Film Festival.
(11)	On 21 September 2005 Pathé ordered from Technicolour 12 “feature prints” from the internegative of the film.
(12)	On 20 October 2005 application was made to the DCMS for certification of the film Mrs Henderson Presents as a British qualifying film.  The application was submitted by Mrs Heyman of MHP, who as part of the application made a statutory declaration that the information and documents she supplied in connection with the application were to the best of her knowledge true and complete in all respects.  The application form included the following in the definitions pertaining to the form: “Completion of film: for the purposes of applications the production of a film is completed when the film is first in a form in which it can reasonably be regarded as ready for copies of it to be made and distributed for presentation to the general public.”  The application form contained the following entry: “Date on which production of the film was completed – that is, when it was ready for copies to be made for presentation to the general public” and the date given against this entry is 20 September 2005.  The DCMS certificate issued on 8 November 2005 in relation to the film Mrs Henderson Presents refers to this date as the date when the film was first completed as reported by the applicant.
(13)	Mr Malde was involved with the preparation of the application to the DCMS, and the form was completed after checking the details as to the film’s completion with a person at Pathé looking after post-production matters.
The parties’ submissions on the Completion issue
129.	Mr Peacock made the following submissions on behalf of Micro Fusion:
(1)	The statutory test in s 43(3) F(No 2)A 1992 looks to the question of when the film is first in a form in which it can reasonably be regarded as ready for copies of it to be made, which recognises the possibility that the film may be altered at a later stage but still satisfy the statutory test.
(2)	The statutory test looks to the question of when the film can reasonably be regarded as ready for copies of it to be made, which is a test of when it might be or is capable of being regarded as ready for copies to be made, which is further recognition that a film is to be treated as complete for the purposes of the test notwithstanding later changes.  It is a recognition that in the final stages a film proceeds through a series of “cuts”, the first, or an earlier one of which might satisfy the statutory test.
(3)	It is common ground that work was carried out resulting in changes to the film Mrs Henderson Presents after 30 June 2005, but the nature and extent of those changes, to some of the special effects used in the film, was not such as to lead to the conclusion that the film was not first in a form in which it could reasonably be regarded as ready for copies of it to be made for public showing before those changes were made, that is, at the time of the screening at LUFF on 30 June 2005.  The screening at LUFF was to the potential distributors, and it is reasonable to assume, as Mr Levy asserted, that the film would be in a final form for that important audience.
(4)	Micro Fusion delivered the film to Pathé on 30 June 2005, Pathé having confirmed that the film had been completed and delivered to them by Micro Fusion.  Subsequent changes to the computer-generated imagery were made to satisfy Pathé’s requirements.  In the opinion of Mr Levy the changes made after the film was screened at LUFF were changes that a normal film-goer would not notice.
(5)	The production of the internegative (which is prepared from the original negative to protect the original negative) relates to the process of making copies of the film for public screenings, and does not relate to the completion of the film, other than that it is a process which occurs after such completion.
130.	For HMRC Miss Simler made the following submissions:
(1)	There is no evidence that Micro Fusion delivered the film to Pathé before 30 June 2005, but even if this were the case that in itself does not satisfy the statutory test, which looks to the form of the film.
(2)	The LUFF screening was not a screening to the general public.  The version eventually distributed for presentation to the public was undoubtedly different, and the events of July and August 2005 show that the changes made were regarded as material to the film’s preparedness for public screening.
(3)	The production of the internegative is a step in the process which indicates that the film is ready for distribution.  It is not apparent from the evidence when that occurred, but it was not before 30 June 2005 since a special print from the original negative was used for the LUFF screening.
(4)	Mrs Heyman, the actual producer of the film, declared in the application to the DCMS, upon the advice of Mr Malde, that the film was completed on 20 September 2005.  Mrs Heyman is expert in matters relating to the production of films, and Mr Malde is expert in matters of film financing and tax relief for expenditure on films: both would have understood the significance of the statement made in the application, where the same concept is used as to the completion of a film as is found in s 43(3) F(No 2)A 1992.
Decision on the Completion issue
131.	The burden is on Micro Fusion in this appeal to show that the film Mrs Henderson Presents was completed, in the statutory meaning of that expression, on or before 30 June 2005.  We do not consider that Micro Fusion demonstrated that this was indeed the case – rather, the preponderance of evidence is that the film required, and received, material post-production work before Pathé was prepared to offer it for public screening.
132.	We accept Mr Peacock’s argument that the definition in s 43(3) F(No 2)A 1992 of when a film is completed has within its terms a degree of flexibility or latitude, no doubt in recognition of the great variety of ways in which a film will move from the post-production stage to its readiness for public screening, and Mr Kushner gave us some insight into these processes in his description of the different “cuts” which might be made of a film (director’s cut, producer’s cut, etc) before it arrives at the version shown to the public.  Mr Kushner also cautioned against too much emphasis on the different stages or types of negative copying, since digital processes may create different paths.  Therefore we recognise that a film may be “completed” for these purposes before it reaches the stage where copies are actually available for distribution for public screening, and we recognise, too, that a film may be “completed” before it is in its absolutely final form.
133.	However, in this case there was, so it appears from the evidence, a real concern expressed in July 2005 that the film was not in an acceptable form for screening even to an audience of potential exhibitors.  This concern was expressed by Pathé, who of all the parties had the most direct commercial interest in the public success of the film, and therefore, it is fair to assume, a sensitivity to whether the film was in the state which would most likely ensure that success.  It was a concern which caused them to state that they would have to cancel the exhibitors’ screening.  Mr Levy referred to the computer-generated imagery which was at the heart of this concern as relating to two shots only, and he expressed the view that a member of the public would not notice the changes which were subsequently made.  Against this we have not only the concerns expressed by Pathé, but also (and perhaps more relevantly to the question of likely public perception) the comments of the journalists made after the special showing to them in August 2005 (these were not film critic or specialist journalists, it would seem, but journalists from periodicals who might be expected to give publicity to the film in their respective magazines), from which it is quite apparent that the film was not in the form which they expected it to be in when it would be publicly released: whether or not there were only two scenes, they were material enough for their incomplete state to be noted in the limited comments they made about the film as a whole.
134.	Micro Fusion seeks to rely on the LUFF screening on 30 June 2005, which was obviously a showcase event for this and other British films by way of private screening for the benefit of potential distributors, but the fact of such a screening tells us no more than that a version of the film was then available – it does not tell us that either Pathé as the exhibitor of the film or that particular specialist audience regarded the film in that version as ready for copies to be made and distributed for public screening.  Such evidence as we had (a draft programme of the LUFF event) indicated the contrary, since the running time stated for the film Mrs Henderson Presents was significantly longer than the running time stated in the application to the DCMS (no final programme was produced, so we could not see whether the running time had been reduced by the time of the LUFF screening – indeed, Micro Fusion had to be prompted at the hearing to provide evidence that the LUFF screening actually took place). 
135.	Micro Fusion also relies on the fact that Pathé confirmed on 1 July 2005 that it was then of the view that 29 June 2005 would be the completion date shown in the application to the DCMS for qualifying film certification.  Against this we have the evidence of Pathé’s concerns expressed shortly thereafter about the readiness of the film for a forthcoming exhibitors’ screening.  More significant is the evidence concerning the actual application to the DCMS for the film to be certified as a British qualifying film: that contains a statement made under oath by Mrs Heyman, the person perhaps most closely involved in all aspects of the production of the film, that the film was completed on 20 September 2005.  It is clearly set out in the application form what is meant by the date of completion, and what is meant is the s 43(3) F(No 2)A 1992 definition of when a film is to be regarded as completed.  It transpired from Mr Malde’s evidence at the hearing that he had advised Mrs Heyman as to the date to be specified as the completion date in the application, having been provided with information as to the point by someone at Pathé who was looking after the post-production stages of the film.  Both Mrs Heyman and Mr Malde can be regarded as having a full – even expert – understanding of these matters and of their significance.
136.	For these reasons we consider that Micro Fusion fails to prove that the film Mrs Henderson Presents was completed for section 42 and section 48 purposes on or before 30 June 2005.  We are not required to reach a decision as to the date on which it was so completed, merely that it was on a date after 30 June 2005, which is our decision on this issue, with the consequences that entails for the claim Micro Fusion seeks to make.  Should it be material for the relief which Micro Fusion will claim for the tax year 2005/06, we are prepared to find that the film Mrs Henderson Presents was completed for these purposes before the end of that tax year.
The Section 60 issue
Introduction
137.	With effect from 2 December 2004 legislation was introduced which applies in cases where section 42 relief is claimed for expenditure on a film and relates to what is described in that legislation as “deferred income agreements in respect of a film”, that is to say an agreement which produces income from the exploitation of a film over a period exceeding 15 years.  The broad effect of the legislation in question (section 60 and following provisions) is to accelerate the income from the exploitation of the film as though it arose over a 15 year period rather than the actual (longer) period.  Such acceleration is achieved by applying a formula to determine what is referred to as the “amount of excess relief”, and that amount is treated as received as income in the tax year in which section 42 relief is claimed for the expenditure on the film.
138.	The question we are required to determine is whether Micro Fusion is within the scope of that legislation: it claims relief under section 42 and section 48 for its expenditure on the film Mrs Henderson Presents, and by the terms of the Distribution Agreement it had the benefit of a “deferred income agreement in respect of a film”, since the licence it granted to Pathé ensured that it received income payments for a term of 21 years.  However, the DCA was entered into on 1 October 2004, and Micro Fusion therefore claims it is not subject to the section 60 provisions, which apply only where the “deferred income agreement in respect of a film” was entered into on or after 2 December 2004.  HMRC contend that the DCA did not become binding until after 2 December 2004, and, further, that an amending agreement (entered into on 28 January 2005) was itself a “deferred income agreement in respect of a film” and that accordingly Micro Fusion had entered into such an agreement within the scope of section 60.
139.	For the relevant year, and so far a relevant for the question we have to determine, section 60 and its related sections provide as follows:
60 Deferred income agreements which exist when relief claimed
(1)  This section applies where – 
	(a)  in relation to a trade or business (“the relevant trade”), a 	company (“C”) makes a claim on or after 2nd December 2004 under 	section 42 of F(No 2)A 1992 for a deduction for a relevant period in 	respect of expenditure relating to a film (“the claim”), and
	(b)  when the claim is made, one or more deferred income 	agreements in respect of the film exist to which C is or has been a 	party and which C entered into on or after 2nd December 2004.
(2)  C is to be treated for corporation tax purposes as receiving, in the relevant period in respect of which the claim is made, an amount of income from the relevant trade equal to the amount of excess relief
…
(4)  [provisions for the calculation of the “amount of excess relief” by reference to the “15 year period”, the “operative date”, and the “final deferral date”]
(5)  The “15 year period” means the period of 15 years which begins with the operative date.
(6)  The “operative date” means –
	(a)  where the claim is only in respect of expenditure incurred on the 	acquisition of the original master version of the film, the date of that 	acquisition, and
	(b)  in any other case, the date upon which the film is completed.
(7)  The “final deferral date” means - 
(a)  the last date of deferral in relation to the deferred income agreement mentioned in subsection (1)(b) (see section 61), or
(b)	where thee is more than one such agreement, the date which is the latest of the last dates of deferral in relation to those agreements.
…
(10)  This section is deemed to have come into force on 2nd December 2004.
61 Meaning of “deferred income agreement in respect of a film”
(1)	For the purposes of section 60, a “deferred income agreement in respect of a film” means an agreement which satisfies condition A or condition B.  
(2)	Condition A is that the agreement (whether or not it supplements or varies another agreement) –
	(a)  guarantees to any person an amount of income arising from the 	exploitation of the film, and 
	(b)  has the effect that the last date of deferral is a date after the end 	of the 15 year period.
(3)	Condition B is that the agreement –
	(a) supplements or varies another agreement (“the earlier 	agreement”) which guarantees to any person an amount of income 	arising from the exploitation of the film, and
	(b) has the effect that the last date of deferral is a date which is 	after the end of the 15 year period and after the last date of deferral 	(if any) in relation to the earlier agreement.
(4)	The “last date of deferral” means the last date upon which an amount of the guaranteed income will or may arise.
(5)	It does not matter whether any of the agreements mentioned in subsection (2) or (3) existed before 2nd December 2004.
(6)	For the purposes of this section – 
	(a)  “agreement” means an agreement or series of agreements, and
	(b)  an agreement “guarantees” an amount of income if the 	agreement, or any part of it, is designed to secure the receipt of that 	amount (or at least that amount) of income.
(7)	This section is deemed to have come into force on 2nd December 2004.
64 Transitional provision for years of assessment before the year 2005-06
(1)  Section 60 has effect, for income tax purposes, for the year 2004-05 and earlier years of assessment as if –
	(a)  in paragraph (a) of subsection (1), for “company” there were 	substituted “person”, and
	(b)  in subsection (2) for “corporation tax” there were substituted 	“income tax”.
The relevant documentation by way of evidence
140.	As to the facts, the evidence in relation to the Section 60 issue comprises the terms of the relevant documents which Micro Fusion entered into in relation to the licensing of the film Mrs Henderson Presents to Pathé and the surrounding correspondence.
141.	On 1 October 2004, Micro Fusion entered into the Distribution Agreement with Pathé (see paragraph 48).  The Distribution Agreement was executed as a Deed.  The format of the Distribution Agreement is a one-page agreement, the operative provision of which is as follows:
“In consideration of the mutual covenants and agreements herein contained and for other good and valuable consideration, [Micro Fusion} has, at the request of [Pathé], agreed to produce the Picture [Mrs Henderson Presents] (conforming to the specification set forth in Exhibit H to Schedule A hereto) and to deliver the Picture to [Pathé] on and in accordance with the terms of Schedule A hereto (which Schedule and all exhibits attached thereto are included herein by reference).”
Schedule A sets out all the substantive terms relating to the licence, and comprises (including its Exhibits) 34 pages.
142.	Certain additional documentation was entered into both before and after execution of the Distribution Agreement.  Some documentation took the form of side letters, and some was more formal.  On 17 September 2004 Micro Fusion wrote to Pathé agreeing to finance the film, but subject to termination of the agreement in the absence of financial closing by 31 October 2004.  This letter stated that the approved budget for the Film was £12,240,230: this figure was subsequently increased.  The termination provision was as follows:
“This letter agreement shall automatically terminate and be deemed void ab initio if financial closing had not occurred by 31 October 2004, (time to be of the essence) and neither party shall have any further obligation to the other thereafter save that both parties and Mrs Henderson Productions Limited undertake to promptly sign all such documentation and do all such things as you may require to evidence such termination and reversion of all and any rights to you.”
143.	 On 29 September 2004, in anticipation of execution of the Distribution Agreement and the picture licence, Pathé wrote to Micro Fusion (this letter was subsequently referred to as the “Pathé Unwind Letter) stating that:
“to the extent that the Distribution Agreement and the Licence Agreement have not been modified, supplemented or amended by 31 October 2004 to Pathé's and/or the Partnership’s satisfaction, either party shall have the right to immediately terminate the Transaction Documents upon written notice to the other, such notice to be given within ten (10) days from such date .  .  .  ”
144.	On 1 October 2004 Micro Fusion wrote to MHP (the production company) stating that the PSA had been executed on the understanding that financial closing (to include execution of an Interparty Agreement) would take place by 31 October 2004, pending which Micro Fusion undertook that it would take no action under the PSA which might be damaging to MHP unless such action was authorised by the existing arrangements between MHP and Pathé.
145.	On 7 October 2004 an e-mail was sent by Geraldine Attlee at the BBC to a number of individuals including a BBC colleague referring to the possibility that the “Micro Fusion deal” might not close.  A schedule attached to that email showed that by that date Pathé had funded just under £3.2 million of production costs.
146.	In the event, financial closing was not achieved by 31 October 2004.  On 2 November 2004, the possible amendment of the PSA was the subject of discussions between SJ Berwin (the solicitors acting for Micro Fusion) and Pathé.  On 8 November 2004 Pathé, MHP and Micro Fusion executed a Variation Agreement dealing with the consequences of the failure to close by 31 October 2004.  This took the form of a letter from Pathé to MHP and Micro Fusion referring to the Transaction Documents, and included the following operative provisions:
“1.  Notwithstanding that the various Transaction Documents were not modified, supplemented and/or amended to the satisfaction of the respective parties thereto by 31 October 2004 (“Original Date”), and have, as at the date hereof, not been modified, supplemented and/or amended to the satisfaction of the parties herein and, notwithstanding that the terms of the Pathé Unwind Letter require notice to be given within ten days of the Original Date if the parties are not satisfied that the Transaction Documents have been modified, supplemented and/or amended to their satisfaction by the Original Date, the parties hereto wish to continue negotiating the Transaction Documents on the original terms of such negotiation as if no notice period applied in such Pathé Unwind Letter.
2.  Without prejudice to the foregoing, and for the avoidance of doubt (i) Pathé, MHPL and the Partnership hereby confirm that the Transaction Documents will not be considered binding on the relevant parties thereto in the event that such parties have not provided notice (that such documents remain unacceptable to such party) as at the date hereof (and in the case of Pathé and the Partnership, within ten days of the Original Date); and (ii) Pathé, MHPL and the Partnership will continue to negotiate the Transaction Documents in good faith but without prejudice to each party’s right to declare (“Termination Notice”) that the Transaction Documents (or any of them) are not in an acceptable form to such party, in which case the parties hereto shall each be released of their respective obligations under such Transaction Documents and all rights granted to the Partnership pursuant to the Transaction Documents (or any of them) shall automatically and irrevocably revert to Pathé from the date of such Termination Notice.
3.  [This deals with the parties’ obligations following a Termination Notice.]
4.  Save as varied hereby, the terms of the MHPL Unwind Letter and the Pathé Unwind Letter remain in full force and effect.”
147.	An e-mail dated 16 November 2004 from SJ Berwin to Pathé, Future and others, and entries contained in a schedule attached to that e-mail, showed that the PSA and the Distribution Agreement were still under revision as at that date.
148.	On 28 January 2005 (the date of “financial closing” of the entire transaction) Pathé and Micro Fusion entered into a Deed of Amendment relating to the Distribution Agreement (the “Distribution Amending Agreement”).  Under the heading “Operative Provisions”, this provided:
“1  Amendments to Commissioning Agreement
[Pathé] and [Micro Fusion] agree that the Commissioning Agreement is hereby amended by deleting Schedule A to the Agreement [i.e. the Distribution Agreement] and replacing it with the Schedule A attached hereto with effect from the date of the Commissioning Agreement.
2  Continuing obligations
Save as expressly amended hereby, the Commissioning Agreement and, in particular, all terms in Schedule A which are identical to those in Schedule A attached hereto, shall continue in full force and effect.  For the avoidance of doubt, all payment dates in the Commissioning Agreement, including but not limited to the date of payment of the Minimum Guaranteed Amounts, shall be unaffected by this Deed of Amendment.”
149.	The document Schedule A attached to the Distribution Amending Agreement was in substantially the same form as Schedule A to the Distribution Agreement when that document was signed.  In particular all provisions relating to the 21 year Term of the licence were identical.  The consideration provisions in Clause 11.2 in both versions of Schedule A (both as to calculation of amounts due and the dates for payment) were also in identical terms: once budget overcosts have been reimbursed in full, Pathé pays a portion of “Adjusted Gross Receipts” at the end of each accounting period during the term, paying on account of, and as a guaranteed amount of, the Adjusted Gross Receipts the Minimum Guaranteed Amounts “in each twelve month period, commencing with the twelve month period ending in 2006 and continuing until the twelve month period ending in 2025 (in each case on the dates set forth in Exhibit D)”, such payment to be made of the Minimum Guaranteed Amount within thirty days of the end of such twelve month period.  However, whereas in the Schedule A to the Distribution Agreement when it was signed Exhibit D (setting out the Guaranteed Minimum Amounts payable during the Term) was left blank, in the substituted Schedule A attached to the Distribution Amending Agreement Exhibit D was completed by the inclusion of those Guaranteed Minimum Amounts and the annual dates on which they were to be paid, those dates being consistent with the terms set out in Clause 11.2.
150.	The document Schedule A attached to the Distribution Amending Agreement contained the following provision (in terms identical to the corresponding Clause 18.3 in the Schedule A to the Distribution Agreement when it was signed):
“18.3 ….This agreement expresses the entire understanding of the parties hereto and replaces any and all former agreements, understandings or representation relating in any way to the subject matter hereof and contains all of the terms, conditions, understandings and promises of the parties hereto in the premises….”
151.	Micro Fusion’s claim under section 42 was made in September or October 2005, but in any event after 2 December 2004.
The parties’ submissions
152.	Mr Peacock for Micro Fusion argued that the Distribution Agreement was a binding agreement entered into on 1 October 2004 and therefore before 2 December 2004, and therefore was not subject to the provisions of section 60, notwithstanding that it is a “deferred income agreement in respect of a film” by virtue of its 21 year term.  As to the Distribution Amending Agreement, if HMRC’s case was that it was an agreement satisfying Condition A in s 61(2) Finance Act 2005 (that is, it gives rise to income from the exploitation of a film and that income continues to arise beyond the 15 year period) and was thus a “deferred income agreement in respect of a film” entered into on or after 2 December 2004, that argument was defective in that it ignored the existence and effect of the Distribution Agreement.  
153.	In relation to the Distribution Amending Agreement, it was accepted that it supplemented or varied another agreement as referred to in s 61(2) Finance Act 2005.  It was also true that the Distribution Amending Agreement varied another agreement (the Distribution Agreement) which guaranteed an amount of income, so falling within s 61(2)(a) Finance Act 2005.  However, it did not meet the second requirement of Condition A in s 61(2)(b) Finance Act 2005: the Distribution Amending Agreement did not have the effect that the last date of deferral was a date which was after the end of the15 year period, because that had been provided for in the Distribution Agreement.  The Distribution Amending Agreement confirmed existing obligations – it was not a new agreement.
154.	In relation to Condition B in s 61 Finance Act 2005, the Distribution Amending Agreement did supplement or vary another agreement (the Distribution Agreement), which guaranteed an amount of income arising from the exploitation of the film, but it did not meet the second requirement of Condition B, partly for the same reason as it failed to meet the second requirement of Condition A: it did not have the effect that the last date of deferral was a date which was after the end of the15 year period, because that had been provided for in the Distribution Agreement.  The other reason it failed to meet the second requirement of Condition B was that it did not alter the last date of deferral as had been provided for in the Distribution Agreement – the date was the same under both agreements.  The intention of the legislation had been to “grandfather” existing agreements.  Thus if non-material amendments (i.e. those which did not elongate beyond 15 years the term during which income from the film arose) were made after December 2004 to an agreement made before December 2004, the parties would not expect to be caught by the section 60 provisions.
155.	It was accepted that Exhibit D to the version of Schedule A attached to the Distribution Agreement (dealing with the Guaranteed Minimum Amounts paid over the course of the 21 year term) had been left blank, whereas Schedule A to the Distribution Amending Agreement had contained a completed version.  However, the blank version of Exhibit D did not prevent the Distribution Agreement from having effect.  The Distribution Agreement had identified the last date of deferral, and nothing in the Distribution Amending Agreement affected that since the corresponding provisions in the substituted Schedule A relevant to the last date of deferral were identical to those in the original Schedule A.
156.	Mr Peacock rejected any suggestion that the Distribution Agreement was not binding as from the date it was signed by the parties, 1 October 2004.  He referred to the various side letters between the parties, including the Pathé Unwind Letter and also to the Variation Agreement of 8 November 2004.  In his submission those later documents clearly demonstrated that the Distribution Agreement was binding as from its signing, since they made provision for rights of termination in certain circumstances.  The intention and effect of the Variation Agreement was to keep the Distribution Agreement in force and binding on the parties notwithstanding that matters had not been concluded by 31 October 2004.  There was thus no period during which the Distribution Agreement had ceased to be binding, and the Distribution Amending Agreement could not be regarded as a subsequent agreement creating afresh rights and obligations which had expired.
157.	For HMRC Miss Simler referred to the Distribution Amending Agreement, pointing out that by its terms it deleted the version of Schedule A contained in the Distribution Agreement and substituted a new version.  Clause 2 of the Distribution Amending Agreement provided for continuation.  She referred to the “entire agreement” provision at Clause 18.3 in Schedule A to the Distribution Amending Agreement.  HMRC’s principal argument was that this Clause 18.3 provision brought Micro Fusion within section 60, on the basis that it expressly stated that the Distribution Amending Agreement replaced all former agreements relating to the same subject matter, and was said to express the entire understanding of the parties.  As a result, the Distribution Amending Agreement had the effect that the last date of deferral within s 61(4) Finance Act 2005 was after the end of the 15 year period within the meaning of s 61(2) Finance Act 2005.
158.	If that argument was not accepted, HMRC’s second argument was that Exhibit D (dealing with the crucial matter of the amounts of income Micro Fusion was to receive for licensing the film) had been left blank in the Distribution Agreement, so that the first time that the agreement between the parties had been complete and had had the effect that payments were to be made and deferrals provided for was in the Distribution Amending Agreement, which brought into effect the substituted Schedule A with the completed Exhibit D.
159.	HMRC’s third argument was based on the various side letters and the Variation Agreement.  Micro Fusion had written on 17 September 2004 to Pathé agreeing to finance the film, but subject to termination if there was no financial closing by 31 October 2004.  On 29 September 2004 Pathé had written to say that if the Distribution Agreement and the Licence Agreement had not been modified, supplemented or amended by 31 October 2004 to the parties’ satisfaction, each party had the right to terminate the Transaction Documents.  Miss Simler also referred to the 1 October 2004 side letter from Micro Fusion to MHP, and to the side letter from Pathé to Micro Fusion, presumably written on the same date.  The latter provided that in the event of termination of the Distribution Agreement for failure to achieve closing by 31 October 2004, Pathé and Micro Fusion were to be released from their mutual obligations.  She also referred to the Variation Agreement.  
160.	In Miss Simler’s submission this documentation, viewed as a whole, had the effect that the principal documents (and in particular the Distribution Agreement) were not binding on the parties until financial closing had been achieved in January 2005.  There were other contemporaneous documents which showed that the parties themselves regarded the position as non-binding: Miss Simler referred to the BBC e-mail dated 7 October 2004 referring to the possibility that the Micro Fusion deal with Pathé might not close.  This being so, the “deferred income agreement in respect of the film” was in fact entered into on or after 2 December 2004 (namely, on 28 January 2005), the date on which it could be said that either the Distribution Agreement became a binding document, or the parties entered into the conclusive agreement comprised in the Distribution Amending Agreement. 
Decision on the Section 60 issue
161.	It is our decision that, although a deferred income agreement in respect of the film Mrs Henderson Presents for the purposes of section 60 did exist (being the Distribution Agreement), and that Micro Fusion was a party to that agreement, Micro Fusion did not enter into that agreement on or after 2 December 2004.  Accordingly, Micro Fusion is not within the scope of section 60 and is therefore not to be treated for tax purposes as receiving an amount of excess relief.
162.	The first question which we consider is whether the Distribution Agreement was binding before 2 December 2004, the date on which section 60 came into effect.  It was an agreed fact that Micro Fusion had entered into the Distribution Agreement on 1 October 2004.  
163.	In relation to the binding nature of the Distribution Agreement Miss Simler first questioned whether the Distribution Agreement could be effective in the absence of a completed version of Exhibit D, dealing with the Minimum Guaranteed Amounts: she contended that these payments were central to the transaction, not least from Micro Fusion’s perspective.  
164.	We do not consider that the blank Exhibit D affected the validity of the Distribution Agreement.  The parties were bound by all the terms of the Distribution Agreement, which included the consideration provisions in Clauses 11.1, 11.2 and 11.3.  These Clauses set out in detail the complex calculation of the amounts Pathé is to pay Micro Fusion as consideration for the licence and distribution rights (see paragraph 48(10) above), with the “floor” of the Minimum Guaranteed Amounts; the implementation of these Clauses, which would eventually require insertion of the relevant details of the Minimum Guaranteed Amounts in Exhibit D, was simply part of the overall transaction, and it is fair to infer that it was implicit that the parties were obliged to insert the details of the Minimum Guaranteed Amounts when the relevant financial information became available to them.  The absence of these details did not go to the root of the contract between the parties, and so did not prevent them from being bound by the terms of the Distribution Agreement.  
165.	It is also the case that the key matter, for section 60 purposes, namely the length of the period during which income arises from the exploitation of the film, was a matter agreed upon in the Distribution Agreement and which was unaffected by any variations effected by the Distribution Amending Agreement or other documentation.  Clause 8 of Schedule A to the Distribution Agreement as executed dealt with the grant of rights.  It specified that the “Term” commenced on signature and would end on the earlier of (a) 21 years from first theatrical release, and (b) 31 December 2026.  It referred to the sale of “Delivery Materials” to Pathé, and gave Pathé a licence for the Term; during the Term Micro Fusion reserved copyright, and thereafter reserved all rights.  Thus from the execution of the Distribution Agreement, the Term was specifically provided for.  
166.	Miss Simler’s further argument in relation to the binding nature of the Distribution Agreement was based on the various side letters and the Variation Agreement.  She contended, on the basis of these documents, the parties regarded the Distribution Agreement and the related principal documents as non-binding until financial closing was achieved.
167.	We do not accept that contention.  In our view, the side letters and the Variation Agreement show that the parties intended to keep themselves bound despite their lack of success in meeting various negotiation “deadline dates” for elements of the documentation to be finalised.  The various options to terminate do not imply that the respective agreements were not binding: on the contrary, they show that the parties accepted that they continued to be bound by the terms of the documents unless and until one of the parties opted to exercise its termination rights.  The same is true of the arrangements to extend the deadlines: the agreements of the parties were not extinguished even where extensions were agreed after a deadline had expired since no party had taken the opportunity of the expired deadline to serve a termination notice.
168.	In this context we mention that there was a mistake in the drafting of the Variation Agreement.  In our view, the first “not” in Clause 2(i) of that Agreement was inserted in error as the remainder of Clause 2 would make no sense if the Transaction Documents were not considered binding.  Accordingly, in arriving at our general conclusion expressed in the previous paragraph, we have construed the Variation Agreement as providing for the parties to remain bound by the Transaction Documents unless they opt otherwise under any of the provisions permitting termination and release from the relevant obligations.
169.	This brings us to what was Miss Simler’s primary argument, which we consider in the light of our conclusion that the Distribution Agreement was validly entered into on 1 October 2004 and that it remained binding on the parties thereafter, albeit, as from 28 January 2005, amended by the terms of the Distribution Amending Agreement.
170.	That primary argument was based on the “Entire Agreement” provision in Clause 18.3 of Schedule A to the execution copy of the Distribution Amending Agreement (see paragraph 150 above).  Before considering that argument, we review the effects of the “Entire Agreement” provision in the context of the remaining provisions of the Distribution Amending Agreement.
171.	The Operative Provisions of the Distribution Amending Agreement start by deleting Schedule A to the Distribution Agreement and replacing it with the Schedule A attached to the Distribution Amending Agreement; this is expressed to be effective from the date of the Distribution Agreement.  However, the effect of Clause 1 is qualified by Clause 2.  This provides that the Distribution Agreement, and in particular all terms in Schedule A to that agreement which are identical to those in Schedule A attached to the Distribution Amending Agreement, shall continue in full force and effect.  It is therefore clear that, except in relation to any new terms introduced by the replacement Schedule A, the existing rights and obligations under the Distribution Agreement are to continue.  In relation to payment dates, this continuation is emphasised by the second sentence of Clause 2: “For the avoidance of doubt, all payments in the [Distribution] Agreement, including but not limited to the dates of payment of the Minimum Guaranteed Amounts, shall be unaffected by this Deed of Amendment.”
172.	The “Entire Agreement” provision in Schedule A to the Distribution Amending Agreement replicates the corresponding provision in Schedule A to the earlier document, the Distribution Agreement.  We conclude that its inclusion in the Distribution Amending Agreement was intended to continue its effect, and not to change the position.  It perhaps sits uncomfortably with the continuation provisions of Clause 2, which clearly contemplate that the Distribution Amending Agreement is to be read together with the Distribution Agreement to determine which terms of the Distribution Agreement are to continue in operation.  We accept Mr Peacock’s description of the “Entire Agreement” provision as “boilerplate” drafting reproduced word for word from the original Schedule A: as we have mentioned previously, the replacement Schedule A was substantially in the same form as the original Schedule A, with most of its 34 pages in identical form.  It seems most likely that those responsible for drafting the Distribution Amending Agreement did not address their minds carefully to the difference in circumstances resulting from the drafting approach which sought to combine the effects of the two documents, but instead concentrated their attention on making the changes required in the replacement Schedule A to give effect to the commercial agreement then attained.  Given the “Operative Provisions” of the Distribution Amending Agreement, with its clear statement as to the continuing effect of the Distribution Agreement, we do not consider that, by reason of an “Entire Agreement” provision replicated unamended by likely oversight from the original document, the Distribution Amending Agreement can or should simply be read as a new “stand-alone” agreement replacing the Distribution Agreement.  
173.	We therefore conclude that the “Entire Agreement” provision at Clause 18.3 of Schedule A to the Distribution Amending Agreement was not intended to result in the putting aside of the Distribution Agreement, or to treat the Distribution Amending Agreement as the only agreement relating to the subject matter originally covered by the Distribution Agreement.  The latter was intended to stand, and the Distribution Amending Agreement was a supplementary document dealing with those matters only which were changed by virtue of the Distribution Amending Agreement.  It follows that the Section 60 issue requires examination of both these documents, and cannot, as Miss Simler argued, be limited to the Distribution Amending Agreement, which was entered into on 28 January 2005, after the date on which section 60 came into effect.
174.	On the basis of the above findings, we consider the effects of the legislation.  It is clear that Micro Fusion fulfils the condition in section 60(1)(a), as its claim for section 42 relief was made after 2 December 2004.  The other condition which has to be fulfilled in order for section 60 to apply to Micro Fusion is that in section 60(1)(b): when the section 42 claim was made (September or October 2005), did one or more “deferred income agreements in respect of the film” exist to which Micro Fusion was or had been a party and which Micro Fusion entered into on or after 2 December 2004?
175.	The definition of a “deferred income agreement in respect of a film” is contained in s 61 Finance Act 2005.  An agreement will fall within the definition if it satisfies either Condition A or Condition B set out in s 61 Finance Act 2005.
176.	For Condition A to apply, the agreement in question must fulfil two tests, whether or not it supplements or varies another agreement.  The first requirement is that the agreement guarantees to some person an amount of income arising from the exploitation of the film.  The second is that the agreement has the effect that the last date of deferral (that is, the last date on which such income will or may arise) is a date after the 15 year period.
177.	For Condition B to apply, the agreement in question must supplement or vary another earlier agreement which guarantees to some person an amount of income arising from the exploitation of the film.  The agreement in question must also meet two further tests: it must have the effect that the last date of deferral is a date which is after the end of the 15 year period, and also have the effect that this is a date which is later than that provided for under the earlier agreement.
178.	The Distribution Agreement satisfies Condition A, and is therefore a “deferred income agreement in respect of a film” for the purposes of section 60.  However, as we have found, it was entered into before 2 December 2004.  It therefore falls outside the condition set out in section 60(1)(b), and in consequence is not an agreement to which section 60 applies.  
179.	By contrast, the Distribution Amending Agreement was entered into on 28 January 2005, and therefore falls within the condition set out in section 60(1)(b), so that it is necessary to determine whether or not it is a “deferred income agreement in respect of a film”, that is, whether or not either Condition A or Condition B of s 61 Finance Act 2005 are satisfied.
180.	In relation to Condition A, the Distribution Amending Agreement does guarantee to some person, i.e. to Micro Fusion, an amount of income arising from the exploitation of the film.  Did it have the effect that the last date of deferral was a date after the 15 year period?  If the Distribution Amending Agreement is examined on its own, it reads as if it has this effect.  However, as we have found, the Distribution Amending Agreement cannot be treated as a “stand-alone” agreement: it has to be read with, and as a document which amends, the Distribution Agreement.  In matters that relate to the term or duration of the licence during which Micro Fusion receives income and the final date on which a payment is made in respect of that licence, the Distribution Agreement stands unamended by the Distribution Amending Agreement; further, Clause 2 of the Distribution Amending Agreement expressly states that it does not affect the payment dates under the Distribution Agreement.  It is true that in one respect, namely the amount due each year as Minimum Guaranteed Amounts, the Distribution Amending Agreement was the operative agreement, because it provided for the insertion of a completed Exhibit D to Schedule A; but the provision which set out the last date upon which an amount of the income from licensing the film may or will arise (i.e. the last date of deferral) is provided for by Clause 11.2 of the original Schedule A to the Distribution Agreement, which sets out the payment framework or scheme, and is not changed by the replacement Schedule A inserted by the Distribution Amending Agreement, where that provision is in identical terms.  For these reasons, we do not consider that the Distribution Amending Agreement meets the test in section 61(2)(b) – it does not have the effect that the last date of deferral is a date after the end of the 15 year period.  As Condition A requires that both tests in section 61(2) must be met, the Distribution Amending Agreement does not fall within Condition A.
181.	In relation to Condition B, the Distribution Amending Agreement does meet the first test in section 61(3)(a), as it supplements an earlier agreement, the Distribution Agreement, which guarantees to Micro Fusion an amount of income arising from the exploitation of the film.  However, it does not meet the second test, for two reasons.  The first reason is the same as we have found for Condition A: the Distribution Amending Agreement did not “have the effect that” the last date of deferral was a date after the 15 year period, as this was what had already been provided by the Distribution Agreement, which in this respect was expressly required to remain unaltered.  The second, related, reason is that the Distribution Amending Agreement did not have the effect of making the last date of deferral later than that provided for under the Distribution Agreement.
182.	Thus neither Condition A nor Condition B is fulfilled in relation to the Distribution Amending Agreement.  The consequence is that, in terms of section 60(1)(b), the Distribution Amending Agreement is not a “deferred income agreement in respect of the film” as defined in s 61 Finance Act 2005.  
183.	For these reasons neither the Distribution Agreement nor the Distribution Amending Agreement brings Micro Fusion within the scope of section 60 with the result that section 60 does not apply to treat Micro Fusion as receiving an amount of income from its trade equal to an amount of excess relief.
The Deductibility of Fees issue
Introduction
184.	Micro Fusion paid fees totalling £1,616,889 to Future for consultancy services pursuant to the various film consultancy agreements and amendment agreements entered into between Micro Fusion and Future over the period 6 April 2004 to 6 September 2005.  Micro Fusion has claimed those fees as an expense in computing the profits of its trade for tax purposes so as to give rise to a trading loss for the year to 5 April 2005.  HMRC challenge the deductibility of those fees in their entirety.
The evidence and the facts
185.	On 6 April 2004, Micro Fusion entered into the FCA with Future pursuant to which Future was retained to act as film consultants to Micro Fusion.  The fee payable by Micro Fusion to Future under that agreement as consideration for those services was £100,000.  A further Film Consultancy Agreement was entered into between Micro Fusion and Future: that was dated 28 January 2005 (the “January 2005 FCA").  Subsequently the parties entered into a Deed of Amendment to the January 2005 FCA.  That Deed of Amendment was dated 6 September 2005 but was stated to be with effect from 28 January 2005.   The January 2005 FCA provided that Micro Fusion was to pay Future a fee of £1,616,889 for the services provided by Future to Micro Fusion.  We refer to this as the “Film Consultancy Fee”.
186.	The services to be provided by Future under the FCA and those under the January 2005 FCA were the same.  The sole difference between the terms of the two agreements was the increased level of the Film Consultancy Fee under the January 2005 FCA.  The purpose of the subsequent Deed of Amendment was to insert a clause which, through an oversight, had been omitted from the January 2005 FCA.  This clause provided that Micro Fusion was liable to pay Future 15 per cent of any “Gross Participation Fee” which became due to Micro Fusion under the Distribution Agreement.
187.	The services which Future agreed to provide to Micro Fusion were listed in Schedule 1 to both the FCA and the January 2005 FCA, as follows:
“1.  Identifying, researching and evaluating films suitable for the Partnership [i.e. Micro Fusion];
2.  Selecting films for the purposes of acquiring and exploiting the same on behalf of the Partnership;
3.  Purchasing, taking options over, or otherwise acquiring and obtaining and holding or disposing of all copyrights and underlying rights (including rights in literary works and screenplays), and other rights and interests necessary for the reproduction, exhibition, distribution, licensing, leasing, representation and sale of any Film;
4.  Procuring the purchase of Films and /or any master negative master tape or master disc in respect thereof including any description of rights therein for the purpose of exploitation;
5.  Exploiting or procuring the exploitation of all such rights and assets as are required in respect of Films including by way of leasing, licence and distribution agreements and disposal;
6.  Carrying on all or any of the activities and transactions concerned with, related to or ancillary to the purchase, leasing and exploitation or sale (by all means and methods) of Films and all or any activities and dealing with literary agents, consultants, financiers, lessees, distributors, sales agents, producers, importers, exporters, hirers of, dealers in and agents or representatives for Films;
7.  Using all reasonable efforts to monitor and manage the exploitation of Films, including the activities of all persons having rights in or over Films acquired by the Partnership, including effecting any necessary insurances and security arrangements, within the terms of the acquisition and exploitation agreements;
8.  Entering into agreements with other persons in order to acquire and exploit the Films where necessary or desirable, to maximise the scope and profitability of the Partnership’s business;
9.  Subject to approval by the Members, arranging the exploitation of the library of Films, in lieu of a third-party selling agent, including disposals;
10.  Executing, delivering and performing all contracts, deeds and other undertakings and engaging in all activities and transactions necessary or advisable in order to carry out the foregoing for the benefit of the Partnership, subject to and in accordance with the provisions of the Film Consultancy Agreement.”
188.	Although the FCA provided for the payment of a fee of £100,000, it appears probable from Mr Levy’s evidence that this sum was never paid, and that the fee payable under the January 2005 FCA was regarded as replacing it.  There was no evidence of any claim to treat the sum of £100,000 as a deduction in computing Micro Fusion’s profits.
189.	In Micro Fusion’s financial statements for the accounting period ending 30 June 2005 the sum of £1,619,889 paid by way of the Film Consultancy Fee was included as an operating cost which, with other costs, resulted in a loss on ordinary activities before and after taxation of £1,694,884.  In the relevant partnership tax return Micro Fusion claimed this amount as a trading loss.
190.	On 17 November 2005 HMRC issued a notice of enquiry covering the whole of that partnership tax return.  Following its enquiry HMRC issued a closure notice on 2 February 2007.  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.
191.	At the hearing, HMRC contended that none of the Film Consultancy Fee was deductible in computing Micro Fusion’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 the Film Consultancy Fee which is alleged to be non-deductible.
192.	The Audit Partner at Grant Thornton UK LLP responsible for the audit certificate for Micro Fusion’s financial statements for the period to 30 June 2005 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 external Audit Partner determined that it was correct and proper for the Film Consultancy Fee paid by Micro Fusion to Future during the period to 30 June 2005 to be treated as deductible in Micro Fusion’s profit computation for that period.
193.	Mr Back described Micro Fusion’s business as that of acquiring rights to produce films and then exploit the completed films.  The part of the business involving the acquisition of films was in his view better characterised as the acquisition of intellectual property rights for the purpose of making films.  The services which Future was engaged to provide in relation to the acquisition of films were the first four listed in Schedule 1 to both the Film Consultancy Agreements.  As Micro Fusion had sub-contracted all exploitation to an entity which it had engaged to act as a commissioning distributor (namely, Pathé), Mr Back considered that the other services listed in Schedule 1 were not material when compared with the first four.  Thus the element of the services not related to the acquisition of the film rights was not material to determining the accountancy treatment of the fees paid by Micro Fusion to Future.
194.	He 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 incurred.  Micro Fusion had incurred the liability to pay the consultancy fees when it signed the January 2005 FCA.  At that time Future had carried out the substantial majority of its obligations, having assisted Micro Fusion in acquiring the rights to the film Mrs Henderson Presents during the latter part of 2004.
195.	From his review of the Film Consultancy Agreements, he did not consider that there was anything to suggest that the payment of the Film Consultancy Fee was conditional on the acquisition of the film.  The ability to capitalise costs under paragraph 9(b) of FRS [Financial Reporting Standard] 15 thus fell away and the costs were accounted for under FRS 10.  Micro Fusion had not sought to capitalise the Film Consultancy Fee by reference to FRS 15: had they wished to do so, Mr Back would have needed to see proof that payment of the Film Consultancy Fee was conditional on the acquisition of the film.  Instead, Micro Fusion chose to write off the Film Consultancy Fee in accordance with UK GAAP and in line with FRS 10 in the period ended 30 June 2005, the period in which the film was acquired.  When auditing the accounts for that period, Grant Thornton UK LLP had concurred with this treatment.  
The parties’ submissions
196.	Mr Peacock for Micro Fusion referred to s 42(1) Finance Act 1998, which provides: 
“For the purposes of Case I or II of Schedule D the profits of a trade, profession or vocation must be computed in accordance with generally accepted accounting practice, subject to any adjustment required or authorised by law in computing profits for those purposes.”
He argued that in the light of Mr Back’s evidence that the Film Consultancy Fee was properly written off to Micro Fusion’s profit and loss account in accordance with UK GAAP, the Film Consultancy Fee was properly deductible in calculating Micro Fusion’s loss for the period for tax purposes, subject only to any adjustment required or authorised by law.
197.	Quite apart from Mr Back’s evidence, it was clear that the services under the respective Schedules to the FCA and the January 2005 FCA were services on which expenditure was both revenue in nature and wholly and exclusively for the purposes of Micro Fusion’s trade.  This contention was supported by Mr Levy’s evidence as to the services supplied by Future and as to the basis on which it calculated the fees which it charged under the Film Consultancy Agreements.
198.	On the basis of Mr Levy’s evidence, Mr Peacock maintained that there had been no recharging of expenditure incurred by Future on making commission payments to independent financial advisers of partners in Micro Fusion.  It was a novel proposition of law that the nature of expenditure incurred by party A should be dictated by the nature of expenditure incurred by an arm’s length third party B.
199.	HMRC asserted that certain of the expenditure was capital expenditure because it related to the provision to Micro Fusion by Future of its specialised know-how, contacts, experience and personnel.  This argument suffered from two deficiencies.  The first was that it ignored the accountancy evidence that the payments by Micro Fusion to Future were revenue in nature.  Secondly, and in any event, payments for such services were revenue in nature: in support, Mr Peacock cited Vodafone Cellular Ltd v Shaw [1997] STC 734 at 741c (Millett LJ).
200.	HMRC had agreed that 6 per cent of the Film Consultancy Fee was deductible.  However, they had offered no evidence as to the basis on which they had sought to apportion the fees between those which were, and those which they contended were not, deductible.
201.	In the course of his cross-examination, Mr Back had agreed that certain of the monies expended by Future were monies which, had they been expended by Micro Fusion, may have been capital for tax purposes and thus not deductible.  However, the relationship between Future and Micro Fusion under the Film Consultancy Agreements was one of principal to principal and not one whereby Future was Micro Fusion’s agent.  This was shown by Clause 11.3 of each agreement, which provided:
“This Agreement shall not constitute or be construed as constituting the Film Consultant a partner or joint venture of the Partnership or vice versa and, further, does not appoint the Film Consultant as the agent of the Partnership.”
 There was no evidence that Future acting under either of the Film Consultancy Agreements was able to, or did, incur expenditure as a disbursement on behalf of Micro Fusion.
202.	In his cross-examination, Mr Levy had provided details of the nature of the services provided by Future to Micro Fusion.  He had also indicated the commerciality of the fees charged by Future.  Mr Peacock argued that to such extent as expenditure incurred by Future was relevant, much of that expenditure was not referable to services provided to any particular partnership which it promoted.  It was referable to the setting up by Future of its own profit-making enterprise, and not that of the partnerships.  Mr Peacock referred to Mr Levy’s evidence on setting up the structure and working with banks, on expenditure on the tax treatment of the transactions, and the respective activities of Future in providing film advisory services and “maintaining excellent relations with financial advisers”.
203.	There was no legal basis for characterising expenditure incurred by Future in establishing partnerships, which it knew would later contract for services from Future, as capital expenditure of those partnerships.  This was in effect what HMRC were seeking to do.
204.	For HMRC Miss Simler referred to the provisions of the FCA concerning the services to be provided by Future and the initial fee of £100,000.  In May 2004 Future had issued a “Film Partnership Proposal for the 2004/2005 tax year”.  This Proposal – essentially a prospectus – had offered investors the opportunity to become members of Micro Fusion, the proposed nature of the latter’s business being specified.  The Proposal set out the terms on which Future would pay commission to introducing independent financial advisers, and stated that Future was to “be responsible for paying legal fees relating to the Closing, and banking fees”.  The Proposal contained a warning that “the Inland Revenue may argue that, contrary to the terms of the agreement, some of this fee is related to negotiating the arrangements for the making of the Film and therefore, at least to that extend, is capital in nature”.
205.	Miss Simler listed the actions taken by Future between May 2004 and financial closing in respect of the Film on 28 January 2005.  These actions were taken both pursuant to the FCA and as anticipated by the Film Partnership Proposal.  It had been argued for Micro Fusion that it was irrelevant that Future had defrayed fees which might or might not be seen as capital expenditure by Future.  Irrespective of this, HMRC contended that Micro Fusion’s fee expenditure was preliminary expenditure intended to set up a specialised trade in film production, from which its members hoped to secure tax benefits by virtue of section 42 and section 48.  Under the two Film Consultancy Agreements, Micro Fusion effectively gained access to the specialised know-how, contacts and experience of Future and its personnel.  Expenditure for that purpose was properly accounted for as capital expenditure.  An example of preliminary expenditure treated as capital was to be found in the case ECC Quarries Ltd v Watkis [1975] 3 All ER 843, [1975] STC 578.  Viewed substantively, Micro Fusion was purely a legal shelf vehicle until after the bulk of the real services provided by Future had already been supplied.
206.	It was necessary to look at the true nature of the services being provided by Future.  The services being provided were not services provided simply to identify a film.  They were services provided to set up the whole structure of the partnership’s activity.  They were laid out to secure the organisation of the partnership, and to provide the means for capital raising and finance, and to ensure that the partnership had legal advice in relation to the structuring and financing of its activity.
207.	What Micro Fusion obtained from its association with Future was an enduring benefit which was indispensable to its intended trade in films, in the absence of any relevant experience of the film industry on the part of its investor members.  In return, it had paid a substantial lump sum to Future.  These were indicia of capital expenditure: Miss Simler referred to Van den Berghs Ltd v Clark [1935] AC 431, and Inland Revenue Commissioners v John Lewis Properties plc [2003] Ch 513 (CA), [2003] STC 117, at [80]-[90].
208.	HMRC further contended that the expenditure of the Film Consultancy Fee was not in any event wholly and exclusively referable to Micro Fusion’s trade within s 74(1)(a) ICTA.  HMRC was entitled to disallow the sums ostensibly incurred by Micro Fusion on film consultancy, but in fact referable to payments of commission to independent financial advisers, partners’ borrowing costs, and the costs of professional advisers attributable to work and advice on tax structuring.  Although the Inspector had disallowed 94 per cent, HMRC contended that the entirety of the fee should be disallowed.
209.	The ordinary way to ascertain the profits or losses of a business was to apply accepted principles of commercial accountancy (Gallagher v Jones [1994] Ch 107 at 134D, [1993] STC 37 at 555).  However, in any given case, a generally accepted rule of commercial accountancy was inapplicable if its application was shown to be inconsistent with the true facts.  For this reason the Tribunal was entitled to enquire into and judge whether the accountancy treatment of Future’ fees was based on a correct appreciation of the nature of the fees, and whether the tax treatment claimed in fact followed.  The way in which the parties characterised the expenditure was not determinative: the substance should be examined (as, for example, in Ainley v Edens (1935) 19 TC 303).  As a general rule, preliminary expenditure and allied items were generally in the nature of capital expenditure.  Furthermore, where the expenditure was incurred once and for all with a view to bringing into existence an asset or advantage (which need not be a material asset) for the enduring benefit of the trade, such expenditure was a capital expense (Van den Berghs Ltd v Clark).  Money laid out to secure the organisation of Micro Fusion’s activities was accordingly a capital expense.
210.	The Film Consultancy Agreements provided at clause 8.2 that in the event of termination of such agreement, Future would be entitled to payment of its fees and reimbursement of the expenses identified in clause 7:
“8.2  If this Agreement is terminated due to breach by or insolvency of the Partnership, notwithstanding such termination, the Film Consultant shall be entitled to payment of its fees and reimbursement of its expenses as provided in Clause 7.”
211.	In addition to carrying out the audit of Micro Fusion’s accounts, Mr Back had given Future and Mr Levy generic advice on the Micro Fusion structure.  His advice had been reflected in the Film Proposal for Micro Fusion.  It was clear that SJ Berwin had advised on this Proposal and would be responsible for producing, managing and negotiating documentation involved in the formation of Micro Fusion, the commissioning and production of the Film, banking agreements and so on.  SJ Berwin did in fact become so involved.
212.	Future incurred fees to a range of third parties whose services benefited Micro Fusion, including professional advisers acting on establishing and financing the Micro Fusion structure.  Future also incurred fees by way of commission to independent financial advisers for introducing investors to the Micro Fusion partnership.  Future recouped these fees from the Film Consultancy Fee.  In cross-examination, Mr Back had agreed that all such fees paid by Future, which Miss Simler argued were paid on behalf of Micro Fusion, were expended to put Micro Fusion in a position to acquire the rights to produce or acquire films.  He had agreed that they were fees paid by Future out of the Film Consultancy Fee and expended for setting up and securing the organisation of Micro Fusion’s activities.  He had accepted that in substance those payments related to the whole structure of Micro Fusion’s profit making apparatus and were designed to set up its structure so that it was in a position to start trading.
213.	Miss Simler argued that the Film Partnership Proposal made it clear that Micro Fusion would remain liable to discharge all the fees and costs payable by Future if Future failed to pay them:
“9a.  As described on page 18 LMI [this was the Film Consultant named in the Proposal, but the role was ultimately taken by Future] has agreed to pay the costs of the Offer and has agreed to pay all the ordinary administrative costs of the LLP.  If LMI does not pay those costs (for which there is a contractual obligation) the LLP will be liable to pay them and will have to pursue LMI to enforce its contractual obligations.”
214.	Mr Back had made no reference in his witness statement to those services to be paid by Future from the Film Consultancy Fee, and they appeared to have played no part in his audit consideration.  Miss Simler contended that, had Mr Back considered those services, it was inevitable that his view of the proper accountancy treatment would have been different.
(1)	For these various reasons HMRC argued that the Film Consultancy Fee was not deductible in computing Micro Fusion’s profits for tax purposes, and since the Film Consultancy Fee was a single undifferentiated sum, it fell to be disallowed in its entirety. 
Decision on the Deductibility of Fees issue
215.	Our decision is that the fees of £1,616,889 incurred by Micro Fusion to Future pursuant to the Film Consultancy Agreements were properly deductible in full in the computation of the profits of Micro Fusion’s trade for the purposes of its tax return for the year ended 5 April 2005.
216.	Although Miss Simler referred to Gallagher v Jones, we accept Mr Peacock’s argument that for the period in question, to 30 June 2005, the position was governed by s 42 Finance Act 1998, as set out above.  Mr Back’s evidence was that Micro Fusion’s accounts had been computed in accordance with UK GAAP, given Micro Fusion’s decision that it should not capitalise the consultancy costs by reference to FRS 15 but should instead write off the fees in accordance with UK GAAP and in line with FRS10 in the period ended 30 June 2005.  Miss Simler sought to challenge the basis on which Mr Back had arrived at his view.  However, there was no expert evidence to suggest that Mr Back’s approach had been incorrect.  We do not consider that we have any basis for questioning his view.
217.	Having accepted that the accounts were prepared in accordance with UK GAAP, it remains open to us to consider whether the profit or loss established by those accounts should for tax purposes be subjected to “any adjustment required or authorised by law in computing profits for those purposes”.  The only statutory provisions referred to as possibly requiring an adjustment to be made in the present case are s 74(1)(a) and s 74(1)(f) ICTA 1988.  We also need to consider whether there is any other possible basis for making such an adjustment.
218.	Section 74(1) ICTA, so far as relevant in this instance, is as follows:
“Subject to the provisions of the Tax Acts, in computing the amount of the profits to be charged under Case I or Case II of Schedule D, no sum shall be deducted in respect of – 
(a)  any disbursements or expenses, not being money wholly and exclusively laid out or expended for the purposes of the trade, profession or vocation;
…
(f)  any capital withdrawn from, or any sum employed or intended to be employed as capital in, the trade, profession or vocation, but so that this paragraph shall not be treated as disallowing the deduction of any interest…”
219.	Mr Back’s approval of Micro Fusion’s accounts was clearly based on an acceptance of the status of the legal relationship created between Micro Fusion and Future as a result of entering into the January 2005 FCA.  This provided for the various services listed in Schedule 1 to be performed as appropriate by Future, the consideration under that agreement being the Film Consultancy Fee.  We can find nothing in the January 2005 FCA which suggests that Future was to act as Micro Fusion’s agent in providing the various other services listed by Miss Simler relating to the structure of Micro Fusion’s business.  On its face, the January 2005 FCA appears to be limited to the provision by Future of the Schedule 1 services and the payment by Micro Fusion of the Film Consultancy Fee as the consideration for those services.
220.	In relation to the financing costs, Mr Levy referred to the bank fees, commissions paid to independent financial advisers and the professional advisory costs incurred by Future.  Those costs were incurred by Future to raise funds for the generic Micro Fusion structure, in other words to provide for the establishment of a number of similar partnerships, and were not charged on directly to any particular partnership.
221.	We accept that a relationship recorded in a contract between parties apparently acting at arm’s length can be affected by the terms of other arrangements between those parties, so that it may well be necessary in the present case to consider the totality of the relationship between Micro Fusion and Future.  However, before doing so, the January 2005 FCA must first be examined to establish whether it appears to be on an arm’s length basis.  In relation to the services to be provided by Future, we accept Mr Back’s view that the most relevant paragraphs of Schedule 1 are the first four dealing with acquisitions of films.  It is clear that Micro Fusion required the provision of such services in order to carry on what Mr Back described as its business of acquiring rights to produce films and then exploit the completed films.
222.	In return for the provision of those services by Future, Micro Fusion agreed to pay the Film Consultancy Fee.  Was the level of this fee arrived at on an arm’s length basis?  HMRC did not seek to question the level of this fee: the argument was directed at what it was intended to cover.  Mr Levy indicated that Future determined its fees by reference to what it had seen and learned in the film business over several years.  His evidence, which was not challenged, was that companies and individuals providing services to film production businesses, by helping them identify opportunities and facilitate the bringing together of all the elements of a transaction and making it happen, typically charged fees for their services somewhere in the region of 7.5 per cent to 15 per cent of the budget of a film.  As this was the market means of determining fees, Future set its fees by reference to that level.  (The Film Consultancy Fee was about 12 per cent of Micro Fusion’s expenditure on the film Mrs Henderson Presents.)  Future also took into account a calculation of the likely expenses that it would incur in relation both to fixed third party costs and internal costs, and thus the profit which it expected to make from acting as Film Consultant to Micro Fusion.  Mr Levy’s evidence was that Future’s net profit from the transaction, after internal cost allocation and amortisation of the generic Micro Fusion structure, would be around 1 per cent of the film’s budget.
223.	Our conclusion on the evidence is that the “structuring” costs were paid by Future and not by Micro Fusion.  In the absence of any evidence to suggest that the level of the Film Consultancy Fee was not arrived at on a commercial basis having regard to the services to be provided under the January 2005 FCA, we do not consider that this Fee can be characterised as payment by Micro Fusion for the structuring costs.  We accept that those costs were brought into account by Future both to establish at what point within the normal band of production service charges it should set the level of the fee which it should charge and to arrive at the calculation of its net profit from the transaction.  However, these are entirely separate questions from that of the treatment of the Film Consultancy Fee by Micro Fusion.
224.	We accept Mr Peacock’s argument that it is not appropriate for the nature of expenditure incurred by one party, Micro Fusion, to be dictated by the nature of expenditure incurred by an arm’s length third party, Future.  Mr Levy’s comment that the finance costs were “not charged on directly to any particular Partnership” indicates the distinction which needs to be made.  The structuring costs were a cost component in Future’ profit calculation, and therefore relevant to the setting of the level of the fees which it decided to charge.  They were not a cost component so far as Micro Fusion was concerned.  Micro Fusion paid the Film Consultancy Fee and in return received the relevant services provided for under Schedule 1 to the January 2005 FCA.  In our view, the Film Consultancy Fee was arrived at on an arm’s length basis, and no part of it can be characterised as payment for the structuring costs, even though Micro Fusion made no separate payment to Future for the setting up of the structure.
225.	We acknowledge that the economic effect of the arrangements between Future and Micro Fusion was that Future bore the cost of items relating to the structure.  We also accept that, if Micro Fusion had contracted for and paid for those items, its expenditure might well have fallen to be disallowed for tax purposes as capital or under s 74(1)(a) ICTA 1988 as disbursements or expenses not being money wholly and exclusively laid out or expended for the purpose of the trade.  However, we see no basis on the evidence for Micro Fusion to be treated as having entered into contracts relating to the structuring, whether directly or through Future in some form of agency capacity.  Micro Fusion did not have to pay for the structuring of the arrangements – it merely paid the Film Consultancy Fee.  The provision in the Film Partnership Proposal to which Miss Simler referred did not necessarily carry the inference that Future, in dealing with third parties, was Micro Fusion’s agent – it related only to the costs of the Offer and to Micro Fusion’s administrative costs, and Micro Fusion could have been made contingently liable in the event of Future’s default by reason of indemnity or guarantee, rather than by reason of an agency relationship.  
226.	Although the overall effect of the arrangements was that Micro Fusion had the benefit of the structure, no part of the consideration which it gave to Future was attributed to the structuring costs.  In the absence of any evidence to suggest that the Film Consultancy Fee might somehow have been inflated in order to cover those costs, we see no reason to depart from the treatment of the Film Consultancy Fee in Micro Fusion’s accounts as a deduction in computing its trading profits.  In respect of the Film Consultancy Fee neither s 74(1)(a) nor s 74(1)(f) ICTA 1988 requires any adjustment to be made to that accounting computation in order to compute the profits of Micro Fusion’s trade for tax purposes.
227.	As we have determined the Deductibility of Fees issue in favour of Micro Fusion, 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
228.	At the hearing Mr Peacock raised a procedural point in relation to the Section 60 issue and also the Deductibility of Fees issue.
229.	In relation to the Section 60 issue, no reference to the issue or to a possible liability to any amount of income by way of an amount of excess relief was made in the closure notice issued by HMRC which had given rise to the appeal.  The matter had arisen as an issue only when (without leave of the Tribunal) HMRC had amended their Statement of Case prepared pursuant to the directions of the Tribunal for the management of the pre-hearing process.  Mr Peacock questioned whether, under the rules as they now apply to the self-assessment regime, we have jurisdiction to determine matters that are not the subject of the closure notice under appeal.
230.	Similarly in relation to the Deductibility of Fees issue, and as mentioned above, the closure notice under appeal allowed a sum equal to 6 per cent of the Film Consultancy Fee as deductible, but at the hearing HMRC argued that no part of that fee was deductible.  Mr Peacock questioned whether 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.  
231.	In both instances the matter falls away in the light of our decision in favour of Micro Fusion in both the Section 60 issue and the Deductibility of Fees issue, 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 either or both of the Section 60 issue and the Deductibility of Fees issue be appealed, and the jurisdiction point thereupon become relevant, the parties are at liberty to return to argue the point before us and we will then reach our decision.
232.	Finally, and 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/3067/2007 

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

Re Isitt and Railway Passengers Assurance (1889) LR 22 QBD 504
John Smith & Son v Moore [1935] 2 AC 13 (HL)
Gladstone v Catena [1948] OR 182 (Ontario CA)
Noddy Subsidiary Rights v IRC (1966) 43 TC 458
Moore v R J Mackenzie & Sons Ltd [1972] 1 WLR 359
Ben-Odeco Ltd v Powlson [1978] 1 WLR 1093 (HL)
Simmons v IRC [1980] 1 WLR 1196 (HL)
Reed v Nova Securities Ltd [1982] STC 724 (HC) and 1 WLR 193 (HL)
Van Tien v Staatssecretaris van Financien [1993] STC 91 (ECJ)
Johnston v Britannia Airways Ltd [1994] STC 763
IRC v Wattie [1999] 1 WLR 873 (PC)
Khan v Miah [2000] 1 WLR 2123 (HL)
TowerMcashback LLP 1 v HMRC [2008] STC (SCD) 1
HMRC v Dempster [2008] EWHC 63 (Ch)