Paletta – Tax Court of Canada denies a film marketing partnership loss on the basis that an alleged option was a sham
A taxpayer used U.S.$82M that had largely been indirectly financed by Twentieth Century Fox to fund, as partner, prints and advertising expenses (“P&A expenses”) respecting a film that Fox allegedly had sold to the partnership for US$128.3M, but with Fox having an alleged option to repurchase the film. The second related taxpayer, engaged in a quite similar transaction.
In denying the claimed losses, Hogan J stated:
[T]he Appellants invested in the … Partnerships solely to avail themselves of the tax savings that the promoters led them to believe they could expect and that they felt secure in the knowledge that Fox had agreed to reacquire the films prior to their commercial release.
Accordingly, I conclude that the options were shams designed to mask the parties’ agreement that Fox would reacquire the films prior to their commercial release.
Consequently, the P&A expenses allegedly borne by the partnerships were not incurred for the purpose of earning income. Likewise, the financing and other expenses incurred by the Appellants with respect to their partnership interests are not deductible.
Hogan J went on to find, in the alternative, that even if his finding on sham was wrong (i.e., the “options” were something less than binding purchase obligations of Fox), s. 231.7(6) of the tax shelter rules precluded the deduction of the losses given inter alia that no tax shelter registration had been made, the P&A expenses had been represented to be deductible and the taxpayers’ expectation of the exercise of those options gave rise to a prescribed benefit under Reg. 231(6).