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HMRC Offers Film Production Partnership Settlement Opportunity

by Robert Lee,, London

23 January 2013

HM Revenue and Customs has written to investors in film production partnerships with details of a "settlement opportunity," following a number of tax tribunal cases in which HMRC successfully argued that particular schemes existed primarily to avoid tax.

The move is part of a crackdown on schemes that, in HMRC's judgment, "fail to provide the relief claimed either because the majority of the funds employed in the business are not used for relevant expenditure or because the schemes do not meet the requirements for sideways loss relief so that the full relief claimed is not available to the participants."

Film partnerships were introduced in 1997 to help with the financing of the UK film industry. Such partnerships involve sale-and-leaseback deals on the distribution rights on films that have already been made, and they have been used as tax shelters for some years. In the case of a scheme called Eclipse 35, 289 partners contributed GBP50m (USD79m) to a partnership, to which a bank loan of GBP790m was added. More than GBP500m was then used to purchase two films from Disney, which were then leased back for 20 years, while GBP293m was given back to the bank to pay off 10 years of interest.

This payout to the bank ought to have generated GBP404,000 of tax relief per investor – but a tribunal in April 2012 found that the transactions, while genuine, did not have the attributes of real trade. Eclipse 35 did not undertake any commercial risk, and the partnership in no way enhanced the film rights which they leased back or played any meaningful role in the marketing of the films. Other cases cited by HMRC include Icebreaker 1 LLP, Samarkand Film Partnership No 3, and Alchemist (Devil's Gate) Film Partnership.

According to HMRC, the tribunal's findings means that loss relief is allowable only to an amount equivalent to the contribution made to the partnership by the taxpayer as a cash contribution, less fees spent on tax advice or on circular funding arrangements. Loan interest is allowable only to the extent that it represents the allowable expenditure paid out of the initial cash contribution. HMRC's settlement opportunity also specifies that the balance of the loss claim will not be allowable, and that tax is payable on any share of income attributable to the cash element of expenditure and on any share of income attributable to the loan financed element that represents investment income over and above the return of the initial capital.

In June 2012, the Manchester law firm Pannone noted that tribunal's judgment in the case of Eclipse 35 would leave investors with much higher tax liabilities than they were expecting. Kit Sorrell, the firm's Senior Professional Negligence Partner, said that: "Typically an investor may invest perhaps GBP100,000 to GBP500,000 of their own money into the scheme. They will also take out substantial loans of many millions of pounds which will also be invested into the partnership. What many investors don't realize is their potential liability for the income of the partnership itself." That income, which is received from the lease agreement, is used to pay back the loan, which means that partners face paying income tax on income they have never received.

Those affected by the Eclipse 35 decision included a number of prominent individuals from the world of sport, as well as financiers and City traders.

HMRC announced its settlement opportunity scheme in December, and it warned those who failed to comply that they would face litigation that may lead to "additional costs and potential reputational damage," as well as "a worse tax result than they would obtain under the settlement opportunity."

TAGS: court | compliance | tax | film finance | tax compliance | tax avoidance | United Kingdom | enforcement

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