Icebreaker 2: What Matters is what really happens

The recent Icebreaker 2 decision received considerable press attention. The case concerned claims for loss relief by the members of several LLPs. It highlights that it doesn’t matter what documentation says, if what really happened is different.

There was no challenge as regards the validity of  the documentation: “the various agreements all did precisely what they purported to do”. Whilst HMRC will seek to find weaknesses in documentation, if they standup to this scrutiny they cannot be disregarded. 

The members of the LLPs were required to meet regularly and at least six times a year. However, although the tribunal accepted the members did not merely “rubber stamp” whatever was put before them, there was nevertheless no evidence that are commendation by the scheme promoter was ever rejected. The partnership agreement required members to devote a necessary part of their time to duties under the LLP agreement. The aim was to avoid loss relief being limited to £25,000 for individuals who are “non-active partners” under ITA 2007 s 103Band C. In order to escape this limitation, the members needed to devote an average of at least 10 hours per week to being personally involved in a trade being carried on on a commercial basis and with a view to profit. The members listened to music sent to them by the promoter etc. and undertook certain research, but the Tribunal held that this activity was not carried on for the purposes of the trade, was not on a commercial basis or with a view to realisation of profit, all being requirements of the legislation - ‘the research, such as it was, undertaken by the members could not have had any material impact on the trade of the partnership and correspondingly was not “for the purposes of the trade”. 

The Icebreaker scheme geared up the tax losses of the individuals by borrowings. Knowing that the Courts had taken a tough stance on non-recourse borrowing, Icebreaker used full recourse loans. However the scheme involved the LLPs making a bank deposit sufficient to give full security to the bank for repayment of the borrowings. The Tribunal did not accept that the purported gross figures “can be regarded as reliable or even approximate yardsticks of the true cost of production or the value of the rights in the finished product.” And “the difference between the gross and net fee (the cash invested by the participants) was never truly available for the exploitation of the relevant intellectual property rights”. The money went round in a closed circle entirely controlled by the bank and in the majority of cases not even circulated.

The agreements stated that money would be used to exploit IP. The Tribunal observed that this“requires us to disregard the reality that all those concerned knew and intended that a relatively modest part of the total fee would actually be used in the exploitation of those rights while the greater part would not” and that“the arrangement by which the principal exploitation company supposedly made a payment to the production company offset by a payment for a share of there venues was a pretence, designed […] to confer some plausibility on the claim that the borrowed money was available for use in the exploitation of intellectual property rights”. 

The LLP accounts showed expense for the exploitation of IP. However, the Tribunal decided the accounts did not accord with GAAP and the payments were to acquire income streams, the P&L debits were not sustainable.

In conclusion, it does not matter what arrangements purport to do if the reality is different. It is not sufficient merely to put a requirement in an agreement; the actual testing of whether requirements are met is based on substance, not form. The Tribunal will take account of the reality of what actually happened where this is at variance to the documentation. It is what happens in reality which matters: book entries on their own do not establish facts.