High drama as film tax relief flops

Although investors were offered a settlement opportunity in 2016, many did not see it as an attractive option and decided to continue to fight their corner through the tribunal system. It is likely that many of them are now regretting that decision.

In recent years, (starting well before the opportunity to settle was offered) many of the film partnerships have had their day in court and in every instance have lost their case (or at least a large part of it).

Film partnerships: a brief recap

Film partnerships were originally introduced by the government in 1997 to help finance the UK film industry.

Generally an LLP was established and investors became partners. The partnership then obtained the rights to films and leased them back to the production company to produce the film, with the agreement that this would provide income to the partnership.

Key points

• Film partnerships were introduced to help the film industry
• Many investors are unaware they could be liable for tax
• Many individuals have been issued with notices demanding full payment of the tax HMRC believes is due within 90 days of the issue of the notice

Investment was by way of capital contribution from investors together with the introduction of loan funding taken out by the investors. Loans were usually between 80 per cent and 90 per cent of the total investment. They were repaid on behalf of the investors out of the revenue received by the partnership, creating a partnership loss that could be offset against investors’ tax liabilities.

There were two problems with these arrangements: first, many investors were completely unaware that they would be taxable on the partnership income – a liability which could be much greater than the actual income they received; and second, the structuring of the schemes attracted unwelcome attention when it appeared that its purpose was to attract tax relief for investors rather than helping to finance and promote a film.

HMRC’s view 

Several film partnerships have been through various court hearings hoping to obtain a judgment that allowed the investors to gain the tax relief that they were advised arose from the transaction - but none has been entirely successful. The technical arguments debated in court have varied slightly, but have followed some general themes.

First, the loss relief claimed was dependent on the film partnership carrying on a trade and if it did, whether the trade was undertaken on a commercial basis. In some instances the courts have found that the partnership was not carrying on a trade and that therefore the loss relief under the film acquisition relief provisions could not be claimed.

For example, in Samarkand and Proteus the courts decided that the commercial reality of the transaction was the acquisition of a fixed income stream rather than a speculative trading transaction. In addition it was deemed that if the net present value of the transaction, calculated using the inherent interest rate, was not positive, then the transaction could not be carried on with a view to profit (that is on a commercial basis).

Similarly in Eclipse 35, HMRC argued that the film partnership was an investment rather than a trade and that the borrowed money merely earned interest which could be returned to the investors to pay the cost of their loans. The investors challenged this view, but in successive judgments (which took the case all the way to the Supreme Court) it was found that there was no trade. Members of the scheme will now have to pay larger tax liabilities than if they had never participated in the scheme because they will remain liable for tax on the income received by the partnership.

In Icebreaker, HMRC argued that although the partnerships were trading, the amounts paid by the investors were not used “wholly and exclusively” for the purposes of the trade and that therefore loss relief could not be claimed on the entire amount invested. In fact the courts went further and found that the element of the invested money that was borrowed represented an amount used to artificially inflate the apparent amount paid for the intellectual property rights, meaning that at least that element of the transaction had no commercial but only a tax purpose.

It is therefore questionable whether there was any benefit to the scheme’s participants in making the appeal since the terms outlined in the judgment for arriving at the tax liabilities are remarkably similar to those available to participants before they spent the money going to court.

In the original First Tier Tribunal (FTT) hearing regarding the Ingenious Film Partnership, the Tribunal decided that the partnership was trading with a view to a profit suggesting that investors could obtain tax relief for the amounts of their own cash invested (approximately 30 to 35 per cent of the “total investment”).  Like Icebreaker, amounts borrowed to increase the amount of the investments were not available for loss relief.

Subsequently, the parties were unable to agree the revised tax computations since HMRC argued that the payment for the rights was capital in nature and therefore not allowable for tax purposes.  A supplemental FTT decision confirmed that view.

Since then both Ingenious and HMRC have appealed the FTT decision and an appeal is scheduled to be heard by the Upper Tribunal in March 2019. 

Partnerships

The judgments give rise to two main issues. As mentioned above in relation to Eclipse 35, many participants in film partnerships did not realise they would have to pay tax on the partnership income. This means that they now face huge tax bill dues to the disallowance of the loss claims relating to the investments.

Indeed, many individuals have already been issued with Partner Payment Notices (“PPNs”) demanding full payment of the tax HMRC believes is due within 90 days of the issue of the notice. The introduction of these notices in 2014 allows HMRC in certain circumstances to collect disputed tax from taxpayers in advance of the dispute being settled by an independent tribunal/court. A judicial review of the lawfulness of such PPNs brought by the members of Ingenious failed, leaving thousands of film scheme participants facing huge bills which they are struggling to meet.

What next?

There is nothing inherently wrong with investing in films. Indeed, the British film industry continues to need the funding for which film partnerships were originally designed. The issue is really that investing in film should be like any other investment – something that balances risk and reward. Potential investors therefore must understand precisely what is being offered and the aim of anything they get involved in must be the making of profit from the film production.

Anything which purports to allow huge claims for tax loss relief with comparatively little investment/risk and little or no taxable income should be avoided. As the old saying goes: “If it looks too good to be true – it probably is.”

Fiona Fernie is a partner with the tax dispute resolution team at Blick Rothenberg

*This article has been amended to make clear that the FTT decision is subject to a forthcoming appeal at the Upper Tribunal.