Eclipse 35 – The Court of Appeal Decision

In the midst of the exceedingly intense pre-election focus on tax avoidance, the Court of Appeal has today handed down its judgment in respect of the widely publicised Eclipse Film Partners No. 35 LLP case. Dismissing the appeal, the Court of Appeal has concluded that the partnership was not ‘trading’ and acknowledged that the implications for those who participated are potentially disastrous.

Eclipse 35 was first successfully challenged by HMRC in April 2012. The decision of the first tier tax tribunal, that Eclipse 35 was not ‘trading’ so as to qualify for the tax relief it claimed, was upheld by the upper tribunal in December 2013. The Court of Appeal has today come to the same conclusion in dismissing the partnership’s appeal.

Eclipse 35 led a two-pronged appeal based on arguments that a) the only possible legally correct outcome of an analysis of the contractual documents and primary facts was that the partnership was ‘trading’, and b) the acquisition of film rights and the sub-licensing of those rights for profit are inherently a ‘trade’. As to the first point, the judgment states that, on stripping the business down, Eclipse 35 bore characteristics of an investment and that the business activities were insufficiently significant to amount to a ‘trade’ for the purposes of the relevant tax legislation. The Court of Appeal were equally unconvinced by the second argument, stating that ‘Eclipse 35 did not pay for the production of the Films’ and agreeing with the FTT which concluded that ‘the reality was that it did not make a significant contribution towards their exploitation’ and so, was not trading.

The Court of Appeal is, of course, entirely right to identify that its decision to dismiss the appeal has ‘very serious fiscal consequences for the members of Eclipse 35. They will be taxed on the income from the arrangements without any relief for the interest they have already paid.’ In fact, the investors never actually received the partnership income and are therefore being taxed on enormous profits which they have never received, known as ‘dry income’. The overall effect on taking part in Eclipse is that having invested, say, £300,000 of their own money, investors are facing income tax bills upwards of £2 million. For some, this will mean bankruptcy.

It must not be forgotten, in my view, that the majority of people who took part in Eclipse 35, and other similar partnerships, were not tax experts. Many took and relied upon professional advice regarding these complex structures which were sold to them as perfectly legitimate and legal tax efficient investments. Whereas politicians and the press have demonised the individual investor, referring to them as immoral ‘tax dodgers’, I firmly believe that the finger has been pointed in the wrong direction. It is those who structured, sold and recommended these vehicles who, in my view, ought to be bearing the brunt of the criticism.

For those that I act for, the potential for tax to be charged on the dry income was never mentioned, explained or quantified. However, it could have been, and indeed ought to have been. It is, of course, incumbent on a professional adviser who is asked to advise upon the merits of a potential course of action to advise of the potential advantages and risks i.e. the upside and downside. Failure to do so may well be negligent. I act for a number of Eclipse investors who are pursuing negligence claims against their advisers. Time is ticking very loudly; other investors should take legal advice immediately as, in the very near future, the passage of time may prevent them from taking any action to recover their losses. They may already be too late.

For further information on this issue please contact Laura Hazell.