Eclipse 35 – the final death knell
The members of the Eclipse 35 partnership heard on 14 April that the Supreme Court had refused their request for leave to appeal against the Court of Appeal’s decision that their activities did not amount to trading. Having lost at both the First Tier and Upper Tribunals before losing again in the Court of Appeal, their defeat was comprehensive. To add to their disappointment, they also lost a separate appeal on the matter of the costs of preparing bundles of documents for the First Tier Tribunal hearing.
To quote from the Court of Appeal’s decision, ‘…the proper characterisation of the business of Eclipse 35 depends upon the totality of its activity and enterprise. Stripping the business down to its essential elements, the transactions on which Eclipse 35 was engaged had two aspects. One aspect was that a payment by Eclipse 35 of £503m would be repaid with interest over a 20 year term and would produce a profit unrelated to the success or otherwise of the exploitation of the Rights sub-licensed. That aspect had the character of an investment. Mr Aaronson (Eclipse’s counsel) did not argue to the contrary. The second aspect was the possibility of Eclipse 35 obtaining a share of contingent receipts and the activity on the part of Eclipse 35 to secure such a share. The FTT considered that this second aspect was in real and practical terms insufficiently significant in the context of Eclipse 35’s business as a whole to lead to a proper characterisation of Eclipse 35’s business as one of trade within the meaning of the tax legislation. In our judgment, that was a conclusion which the FTT were entitled to reach and, indeed, with which we agree.’
Essentially, the Upper Tribunal and the Court of Appeal upheld the First Tier Tribunal’s finding of fact that those elements of the transactions which might have had the characteristics of a trading venture were too small a part of the overall arrangements to justify the conclusion that Eclipse 35 was trading. Furthermore, there was “no discernible customer” and, following the reasoning of Lord Wilberforde in Ransom v Higgs, this suggested there was no trade. The Supreme Court also declined to interfere with that judgement.
In the reporting of this case in the Press, much has been made of the supposed tax avoidance aspect of the partnership. In this astonishingly ill-informed and partisan piece in The Guardian, tax avoidance is mentioned some 6 times in the course of less than 350 words; interestingly the phrase is not used even once in the Court of Appeal’s 31-page judgement despite The Guardian claiming that the former’s decision was that “the scheme amounted to tax avoidance on the grounds that there was no trade being carried out” – a travesty of the truth and evidence that the level of discourse on this subject in the Press has reached yet another new low. In fact, tax avoidance is only mentioned in the original First Tier Tribunal judgement to make it abundantly clear that the existence of a tax avoidance motive would be utterly irrelevant to the point at issue in the case, namely whether the Eclipse partnership was trading.
The outcome is potentially disastrous for the members of Eclipse 35 and the numerous other partnerships that were established along similar lines. In essence, the scheme was a tax deferral rather than a tax avoidance mechanism: the loss which generated the tax relief in the year of claim was matched and potentially exceeded by taxable income in succeeding years which the members of the partnership did not actually receive as it was used to pay interest on their borrowings.
The Court of Appeal’s decision meant that, while no relief was given for the original contribution and associated borrowings, the income that arose in subsequent years was and still is taxable in full, even though the members received no cash payments. The consequence for many participators will be that they will be subject to tax on up to 10 times their original contributions to the scheme with no matching income, leading to crippling debt and bankruptcy for some. Many of the members of this and similar partnerships were by no means sophisticated investors and were relying on professional advice. However, according to Jennie Granger, HMRC director general of enforcement and compliance, as quoted on the CCH Daily website, “This is a fantastic victory for HMRC.” I am sure that those who will now be paying tax on income they have never seen and will never see will not necessarily share her delight at the outcome.