Patrick Degorce, chief investment officer at Theleme Partners, lost his original case at a First Tier Tax (FTT) tribunal last year. [Patrick Degorce v the Commissioners for Her Majesty’s Revenue and Customs, [2013] UKFTT 178 (TC), TC02593, Appeal number: TC/2010/01916].

At the time, the FTT heard that the argument turned on a complex set of transactions in relation to the acquisition and assignment of film rights by Degorce from Goldcrest Pictures Ltd and also in relation to the financing of that acquisition.

At Degorce’s appeal, which opened this week in the Upper Tribunal, his barrister, Jolyon Maugham, said: ‘This is not a case involving financial engineering masquerading as a trade, this is not Icebreaker, not Eclipse.’

There are 11 cases standing behind the Degorce appeal which has been set down until Friday.

The hedge fund manager’s legal team said Degorce undertook commercial due diligence on the film deals through his own agent, as well as taking advice on the independent valuation of the income streams from a media specialist called Christopher Petzel, according to a report in the Financial Times.

Degorce’s legal representative argued that the FTT had made several errors of law and failed to take into account that Degorce had actively investigated the market for film projects before and after the April 2007 tax year in dispute.

This is in contrast to the FTT’s conclusion which stated: ‘We accepted that Mr Degorce may well have explored opportunities in the film sector, but in our view the contemplation of any such activities is distinguishable from the reality of actually entering into such transactions.’

In this case, Degorce’s self assessment return for the year ended 5 April 2007 showed a net loss for tax purposes of just over £20m. He claimed loss relief in respect of his sole trader film distribution activity and set £18.8m of that loss against income from his hedge fund activities.

Unlike other tax avoidance schemes, HMRC did not argue that the transactions entered into by Degorce were a sham, but claimed that Degorce could not be said to be carrying on a trade and so was not entitled to Case 1 trade losses.

HMRC contended that the transactions were designed to generate losses for the individual participants by ensuring that the film rights were acquired at a price which would far exceed the value of the future net income stream received in return for the onward sale of the film rights.

The original tribunal hearing heard evidence from HMRC that Degorce had bought the rights to two feature films – Tropic Thunder, produced by Ben Stiller, and Love Guru, written by Mike Myers – for an artificially inflated figure of £21.9m, but only paid in £4.8m of his own money. It claimed he then sold the rights back to Goldcrest for a fraction of the inflated price, saying the difference was a trading ‘loss’.  

The FTT found in HMRC’s favour and said Degorce was not carrying on a trade and so could not offset any apparent losses. The judgement also raised issues over the way in which profits/losses of the trade had been calculated, saying that these were not in accordance with GAAP.

It found that Degorce had purchased film rights for £20,299,495, which he then sold on the same day at a loss of £19,417,698, which it argued suggested he had little long term interest in the film business.

The tribunal said: ‘It seemed to us that the only logical inference was that the films, individually, were of little importance but rather the aim was to provide Mr Degorce with an asset or assets by which Mr Degorce could shelter the amount of income as advised.’

In one instance, Degorce negotiated with Goldcrest to obtain a reduction in the price of the film of The Lovely Bones directed by Peter Jackson from £10.12m to £6.38m. In written evidence to the latest appeal, his legal team argued this action showed he was not motivated solely by the tax relief because if that was the case he would want to increase rather than decrease the price paid.

He also bought the rights to the highly successful vampire film Twilight for £7.5m and his receipts were £19.7m, with more taking due in future, which his lawyers say is an indication that he was making a long term investment in a trading activity.

HMRC said it had no comment while the case was proceeding. A ruling is expected in a few months.

If either party is still unsatisfied with the ruling and opts to appeal, the matter will next be heard in the Court of Appeal.

The FTT decision is here: http://www.financeandtaxtribunals.gov.uk/judgmentfiles/j7095/TC02593.pdf