Mallowdale Enterprises Limited v CIR (2011) 25 NZTC 20-024
The taxpayer company was one of a number which invested through partnerships in a West End production based on the movie “Jailhouse Rock”. The production was not a success and although substantial revenues were generated they were not enough to cover production costs let alone deliver a return to investors.
Investors deducted the losses they incurred against other income and the Commissioner denied those deductions arguing that the expenditure, whether it was regarded as production expenditure or running costs of the show, was capital in nature and therefore non-deductible.
The High Court found against the Commissioner and in the process revisited the well known indicia related to the capital/revenue distinction.
Importantly the Court found that the investment by the taxpayers was directly into the production and that it was effectively being managed and applied in trust by the producer company. In short the investment was applied towards realizing an income stream from the successful production and promotion of the show.
Few of the expenses incurred were outlaid once and for al and most were recurring. The expenditure could fairly be characterized as circulating capital until it had been recouped from revenues and the arrangements for recoupment which saw investors receiving a “take-out” before profit sharing began did not mean that the investment was capital. Had it been, the Court suggested that it would have been expensed over the expected life of the production. Finally the Court decided that the use of the word “capital” in documents that regulated the relationship of investors did not determine the nature of the expense for tax purposes.
This is probably a close run case for the taxpayers. It is not difficult to see why the IRD might have considered the investment as capital and had the investment been made though a corporate structure it may well have been treated that way. After all, one had to set up the production as an income earning structure before it could earn income and so at least that element of investment that went to the establishment of the show as a working production might well have been seen as capital in nature.
The Court was prepared in this case, however, to examine the way the investment was made and to observe that little of the expenditure actually went into set-up in the classic sense. The structure adopted gave the investors a direct involvement (albeit in trust and/or agency) in the “on the ground” outlay of funds so that the character of the funds as outlaid could be called in aid of a determination of the nature of the investment, when that might not otherwise have been possible.
© G D Clews 2011