Inferno Films Limited v The Commissioners for HMRC

This appeal concerns the availability of relief under the Enterprise Investment Scheme (“EIS”) in respect of an issue of shares in the Appellant, a company involved in film production. Essentially, HMRC had refused to issue their compliance certificate EIS3 to the Appellant pursuant to section 2014 Income Tax Act 2007 (“ITA07”), on the basis that they considered it did not comply with the “risk to capital” test set out in s157A ITA07 because it did not have objectives to grow and develop its trade in the long term, nor was there a significant risk that there would be a loss of capital by investors of an amount greater than the net investment return.

The appeal was therefore concerned with these two issues, though most of the argument revolved around the first of them. HMRC effectively maintained that the Appellant’s business was intended to comprise the financing of one or more individual films on a project by project basis, rather than to develop a meaningful business infrastructure and reputation of its own.

With the consent of the parties, the hearing was conducted by video link, using the Tribunal’s Video Hearing System. A face to face hearing was not held because of the difficulty of ensuring the safety of all participants. The documents to which I was referred comprised a bundle consisting of 310 pages, an Appellant’s additional bundle consisting of 56 pages and a separate bundle of authorities.

Prior notice of the hearing had been published on the gov.uk website, with information about how representatives of the media or members of the public could apply to join the hearing remotely in order to observe the proceedings. As such, the hearing was held in public.

In addition to the two bundles of documents referred to above (and one additional important email from February 2019 referred to below), I heard oral testimony from Philip Palmer (the founder and a director of the Appellant and shareholder in it, his background being as a writer and creative producer in film and television), Michael Riley (a film producer with his own business Sterling Pictures Limited, through which he provided his services as producer of the Appellant’s film “The Ballad of Billy McCrae”) and Kieron Wilkinson (an external investor in the Appellant, who also acted as its chairman).

I find the following facts.

The Appellant was incorporated on 1 April 2015. It commenced business as a film production company on 12 July 2015. On 21 July and 17 August 2015 and 29 February 2016 it issued shares under the Seed Enterprise Investment Scheme (with HMRC’s approval on each occasion), raising £100,000 in total. It had found “business angel” investors through a Welsh business angel network. These were experienced business people who provided the Appellant with their expertise and experience (Mr Palmer being experienced only on the “creative” side), they were not passive investors just looking for a tax break with minimal risk.

On 1 February 2016 the Appellant acquired from Mr Palmer and a company called Afan Films Limited (of which Mr Palmer was described as “co-owner”) all the rights in the unpublished script written by Mr Palmer for the film which has subsequently been made under the name “The Ballad of Billy McCrae” (“BBM”) (there had been previous working titles for the film, namely “Inferno”, “Blood and Stone” and “Red Mist”). It was agreed that Mr Palmer would be paid an initial £10,000 by the Appellant, and when filming started he and Afan would be paid further amounts, depending on the size of the external investment required to make the film.

Information about the Appellant’s business activities from early 2016 to early 2019 was sketchy. From the evidence available, however, it appears that the bulk of its energies was taken up with attempting to get its project BBM off the ground, indeed the Appellant confirmed as much in its investment memorandum issued in early 2019 (see [16] below). On 18 April 2016 a “Crew Agreement” was signed between the Appellant and Mr Riley, recording that Mr Riley was being engaged as “Producer” for BBM, with his appointment expected to last until the film was “delivered”. He was to be paid a fixed fee of £350 per day (subject to a total cap of £45,000) and was to receive a 5% share of “net profits”. He was to receive a credit as producer of BBM, alongside a similar credit for Mr Palmer, and “In Association with Sterling Pictures” was also to appear in the opening credits. Mr Riley was a very experienced producer, with the knowledge and contacts to deal with or arrange all stages of the production process. He had been attracted to join forces with the Appellant because of Mr Palmer’s ambition to create a sustainable business and because he valued the Welsh connection it was intended to nurture. At the time of the hearing, he had produced 27 films and was about to start on his 28^th.

The Appellant’s accounts for the two years ended 30 April 2017 and 2018 disclosed little, being small company accounts with no profit and loss accounts or informative notes. All they showed were reductions in the Appellant’s shareholders’ funds from £48,128 (at 30 April 2016) to £44,261 and £42,203 (for the two following years). I infer that this time was taken up largely with efforts to find further funding and progress the production of BBM.

At some point after its initial share issues (possibly as late as early 2019) the Appellant invested £10,000 of its cash into a film called “Sideshow”; the bulk of finance for that film had already been raised but the Appellant’s investment provided the final piece of funding that enabled the film to be made. Sideshow was produced by Michael Riley, and both Mr Riley’s company Sterling Pictures Limited and the Appellant (under its trading name of “Cymru Films”) were credited as production companies for the film. The terms of the Appellant’s investment in Sideshow were not explained to me, beyond a statement in the Appellant’s documents that it could “yield significant returns… and assists us considerably in branding Cymru Films as a company with two completed movies with distribution deals and imminent UK cinema releases”.

The document bundle did include an investment memorandum issued by the Appellant in late 2018 or early 2019, in which it was seeking to raise £400,000 by way of external investment. This, it was said, would enable it to make, sell and distribute BBM. The proposal was that the holders of the new shares would, between them, own 50% of the Appellant.

The Appellant was not able to achieve its objective with this proposal, as a result of which it returned in early 2019 with a scaled back proposal, seeking to raise a minimum of £50,000 from investors which, with the investment of £30,000 of the Appellant’s own funds and agreement for “deferred fees” totalling £300,000 (i.e. fees to be paid out of proceeds from the film once released), would enable the Appellant to make, sell and distribute BBM. As part of this proposal, it appears the identify of the proposed director of BBM was changed.

This revised investment memorandum (which described BBM as “the flagship production of Cymru Films”) included the following statements:

It is important to remember that the investment memorandum was not a professionally written document with specialist input from lawyers, accountants and financial advisers. It was a story-teller’s attempt to capture the vision that Mr Palmer had for the next stage of the Appellant’s development. Some speculative financial return figures were given in it, the detail of which is not relevant, except for the statement that “a proportion of distributable reserves will require to be maintained within Cymru Films to fund future growth from further film projects.”

Finally, under the heading “The journey and next steps”, the following text appeared:

There then followed a short list of “Potential future films”, giving short details of three further Wales-themed films under consideration.

As part of his role as chairman (and a “business angel” investor), Mr Wilkinson was in communication with a contact who was a potential new investor. On 25 February 2019, he emailed him, obviously picking up on earlier contact between them in relation to BBM/the Appellant. After confirming that the film should be starting to shoot in the next few months, he said this:

In response, on 8 March 2019, the recipient of this email emailed back to confirm that his wife would make a £20,000 investment in the Appellant.

On 3 April 2019 the Appellant issued a further 450 shares to 8 investors (including the above new investor in addition to previous shareholders) for a total issue price of £50,000.

This successful limited round of fundraising enabled the Appellant to make BBM, using Mr Riley/Sterling Pictures to produce it, whilst retaining all the intellectual property rights in the film itself. It was subsequently released through sales agents in the UK and the USA, having a limited UK cinema release and also being available through various streaming services.

As part of the scaled back budget and generally straitened financial situation of the Appellant, further loans of £20,000 were required from some of the investors in order to bring BBM to market, and many of the fees to be paid to those who worked on the film were agreed to be deferred, so as to be paid out of the expected receipts following release of BBM.

On 10 June 2019 the Appellant submitted its form EIS1 compliance statement to HMRC in respect of the issue of shares on 3 April 2019, seeking HMRC’s authority to issue certificates to the investors under section 204 Income Tax Act 2007 (“ITA07”), entitling them to EIS relief in respect of their share subscriptions. After raising some questions on the information supplied, and seeking further material, HMRC ultimately issued a decision dated 24 January 2020 refusing to give the relevant authority. The stated reason was because the Appellant “fails the requirement of Section 157A (ITA07)”. This was because HMRC were not satisfied that the Appellant had “objectives to grow and develop its trade in the long term” due to a number of factors, the key ones being the Appellant’s lack of employees (or plans to hire any) and the extent of its subcontracting (leading them to the conclusion that the Appellant was merely acting as the financier of Sterling Pictures for the purposes of a single film project).

The Appellant appealed and in their “view of the matter” letter dated 5 June 2020, HMRC confirmed their decision, referring to the use of subcontractors instead of employees as being “against the requirements and intentions of the Risk to Capital Condition”.

The Appellant asked for a statutory review of HMRC’s decision, which was concluded on 28 August 2020. In their review conclusion letter, as well as upholding the original decision on essentially the same grounds, HMRC also expressed the view that the fundraising had been intended to finance one single project (the making of BBM) and accordingly they would also have considered the business of the Appellant not to amount to a “qualifying trade” for EIS purposes on the basis that it amounted to “other financial activities” under section 192 ITA07. This latter argument, though repeated in their statement of case, was not pursued by HMRC at the hearing (correctly, in my view).

HMRC maintain that the Appellant does not meet the “risk to capital” condition contained in section 157A ITA07 which provides, in respect of any issue of shares made on or after 15 March 2018, so far as relevant, as follows:

Section 206 ITA07 provides that “[f]or the purpose of the provisions of TMA 1970 relating to appeals, the refusal of an officer to Revenue and Customs to authorise the issue of a compliance certificate is taken to be a decision disallowing a claim issued by the issuing company”. Accordingly, the appeal having been notified to the Tribunal, TMA 1970 provides that the Tribunal “is to determine the matter in question”, namely whether HMRC were entitled to refuse their authority for the issue by the Appellant of the relevant compliance certificates. In order to do so, the Tribunal must therefore form its own view as to whether the “risk to capital” requirements of section 157A ITA07 were satisfied.

It is not necessary to set out any further legislation for the purposes of this decision and a broad understanding of the Enterprise Investment Scheme as a whole on the part of the reader is assumed.

HMRC argued that the Appellant did not satisfy the “risk to capital” condition on two grounds:

The key question before me is whether, having regard to all the circumstances existing as at 3 April 2019, it would be reasonable to conclude that both (a) the Appellant had “objectives to grow and develop its trade in the long-term”, and (b) there was a significant risk that there would be a “loss of capital of an amount greater than the net investment return”.

I agree with Mr Fallon that, for the appeal to succeed, the burden lies on the Appellant to satisfy me as to both points.

I can dispose of the second point quite briefly. As at 3 April 2019, the prospects of any net investment return to the investors generally (whether by way of income or capital growth) were extremely speculative. Those prospects depended entirely upon the commercial success of BBM and the subsequent successful use by the Appellant of the resultant proceeds in pursuing its stated aim of developing its business. It was (and remains) perfectly possible that the investors would lose all of the amounts subscribed by them for their shares. This view is unaffected by the availability of film tax credit. I have no hesitation in finding the requirement of s. 157A(1)(b) ITA07 to have been met.

The first point (“objectives to grow and develop the trade in the long-term”) requires closer examination.

Mr Fallon argued that there were many aspects of the Appellant’s organisation of its business that pointed towards it either being a “single project” company or, at best, a vehicle through which finance was to be provided for a series of individual projects. The clearest evidence of this was contained in the various versions of the investment memorandum, which essentially focused heavily on BBM and had very little of significance to say about plans to develop the business of the company in the longer term. Looking at the specific circumstances identified by way of illustration in s. 157A(3), he submitted the Appellant did not appear to have any intention of taking on employees, acquiring tangible assets for film production (such as camera equipment, production facilities or studio space), the company itself was little more than a shell which sub-contracted all of the activities necessary to produce and distribute BBM, and in his submission the opportunity for investment was marketed as being in respect of BBM rather than the long-term development of the Appellant’s trade.

Mr Palmer argued that HMRC were approaching the matter in an entirely uncommercial way, treating the Appellant as if it were a “tyre manufacturer”. For a small newly-founded film production company with very limited financial resources, the only way to build a long-term business was from small beginnings. The Appellant simply did not have (and could not sensibly raise) the money to make more than one film at a time. It was therefore unrealistic to characterise it as a “single project” venture simply because that was the only realistic starting point for it. There was ample evidence before the Tribunal to show that the Appellant did not simply intend to shut up shop and distribute any profits from BBM once it had been made and sold; it had a mission to develop Welsh filmmaking and a number of ideas for its next project down that path if the success of BBM allowed it to move forward, and that was the basis upon which the investors had subscribed for their shares. He referred to the success George Lucas had with his second film “American Graffiti”, which had enabled him to make his next film “Star Wars”; he was not suggesting that the Appellant could follow a similar trajectory, just illustrating that a small initial success in the film world could lead onto much greater things.

Equally, he argued that the Appellant’s subcontracting of all the actual film making activity on BBM was a perfectly standard approach in the film industry and, for a company of its size, the only realistic course to follow (indeed, he named at least one very well-known producer who, he said, operated on exactly the same basis). He made reference to the comments made in CHF Pip! plc v HMRC [2021] UKFTT 0383 (TC) at [85]: “as a matter of principle it is my view that a company can trade by outsourcing its activities to a third party”, having considered the extensive outsourcing arrangements in place in that case (involving a children’s entertainment TV series). Whilst that appeal had failed on other grounds, he argued that the approach of the Tribunal in that case on the outsourcing point supported the Appellant’s case here.

I agree with Mr Palmer, for essentially the reasons he advanced. From the evidence I have seen and heard, I am satisfied that having regard to all the circumstances existing at 3 April 2019 (including those referred to in s. 157A(3) ITA07), it would be reasonable to conclude that the Appellant had at that time objectives to grow and develop its trade in the long term. This is apparent both from the contemporaneous documents, read as a whole, and from the evidence I head from Mr Palmer, Mr Riley and Mr Wilkinson. Furthermore, from their evidence I am satisfied that the Appellant has been doing its best to transform those objectives into reality in the period since 3 April 2019. There was a perfectly natural focus in the fundraising document on the immediate project which the Appellant was seeking to bring to fruition, but it is perfectly clear to me that this focus did not detract from the Appellant’s intended long term objectives to grow and develop its film production trade by making and releasing a series of further films, as finance allowed, building on the specifically Welsh theme which it was intended to promote.

The appeal is therefore ALLOWED. HMRC must accordingly give their authority for the Appellant to issue certificates under s. 204 ITA07 in respect of the shares issued on 3 April 2019 to its investors.

This document contains full findings of fact and reasons for the decision. Any party dissatisfied with this decision has a right to apply for permission to appeal against it pursuant to Rule 39 of the Tribunal Procedure (First-tier Tribunal) (Tax Chamber) Rules 2009. The application must be received by this Tribunal not later than 56 days after this decision is sent to that party. The parties are referred to “Guidance to accompany a Decision from the First-tier Tribunal (Tax Chamber)” which accompanies and forms part of this decision notice.