FILM TRUST PARTNERSHIP SCHEME
A film partnership scheme is designed to exploit generous tax breaks created by the government (and which have existed for many years) in order to promote investment in the UK film industry. Such schemes come in many flavours, but a typical scheme involves the establishment of a limited liability partnership (LLP) with each investor becoming a partner. The LLP would then acquire the rights from a film production company to exploit and distribute films for a defined period. The LLP would then lease those rights back to a film distributor under a sub-licence which required the distributor to make annual payments to the LLP for the same period. The lease agreement would therefore generate revenue for the LLP.
The original acquisition of the film rights by the LLP would be costly and would be financed in one of two ways. Firstly, by a capital contribution by each partner. Secondly, through each partner taking out a loan. Typically, the value of the loan would be far greater than the capital contributions made. Up to 90% of the acquisition cost of the film rights would be financed by a loan.
The real advantage for investors arose from the interest repayable on the loan. It was believed that this interest could be offset against each investor’s overall tax liability notwithstanding the fact that their main sources of income were completely unrelated to film investment. The cost of the loan repayments would also be financed by the income received under the lease for the film rights. If the scheme worked in accordance with expectations, it was a win, win situation: each investor saw a huge reduction in their income tax liability through a self-financing debt obligation.
Challenges to their Validity
What many people were perhaps unaware of was the fact that the heavy tax reliefs that the scheme relied upon to provide a financial benefit sat on an uncertain legal footing and risked being scrutinised and challenged by HMRC.
Unfortunately for the investors, that is exactly what occurred, and the ability to claim tax relief through film partnership schemes have been dealt a number of body blows this year through legal challenges mounted by HMRC.
The most notable of such challenges, and the most bitterly fought, was to the Eclipse 35 film partnership scheme. Eclipse 35 was first challenged by HMRC in April 2012. It argued that the partnership was not trading and was specifically structured with the simple purpose of creating tax relief for the individual partners. The first-tier tax tribunal agreed and consequently each partner lost their tax relief. The decision was further upheld by the upper tribunal in December 2013. The matter came to the Court of Appeal in “Eclipse Film Partners No 35 LLP v Commissioners for Her Majesty's Revenue and Customs”.
Eclipse sought to argue that the partnership was ‘trading’ and that the acquisition of film rights and their sub-licensing inherently amounted to a trade. (Under the relevant tax legislation, in order for its partners to claim tax relief, Eclipse had to demonstrate that it was carrying on a trade and that the money the partnership borrowed was wholly for the purpose of that trade). The Court of Appeal roundly rejected Eclipse’s argument in a decision handed down in February 2015. Its conclusions on Eclipse’s arguments were stated briefly:
"The proper characterisation of the business of Eclipse 35 depends upon the totality of its activity and enterprise. Stripping the business down to its essential elements, the transactions on which Eclipse 35 was engaged had two aspects. One aspect was that a payment by Eclipse 35 of £503 million would be repaid with interest over a 20-year term and would produce a profit unrelated to the success or otherwise of the exploitation of the Rights sub-licensed. That aspect had the character of an investment."
"The second aspect was the possibility of Eclipse 35 obtaining a share of Contingent Receipts and the activity on the part of Eclipse 35 to secure such a share. The FTT considered that this second aspect was in real and practical terms insufficiently significant in the context of Eclipse 35's business as a whole to lead to a proper characterisation of Eclipse 35's business as one of trade within the meaning of the tax legislation."
The Court of Appeal in Eclipse 35 rightly observed that the consequences of its decision were fiscally calamitous for the investors in the scheme, and for other investors in similar schemes.
Investors are liable to face three serious and unforeseen consequences:
- Income tax will become payable on income which investors sought to shield through film partnership schemes. Tax relief will be transformed into a tax demand.
- Perhaps most disastrously, tax will also be payable on income received by the partnership under the licensing agreement, even though this ‘income’ was used to service the loan obligation and investors did not receive any of it.
The high debt to equity ratio in financing the partnership means that tax payable on partnership income may far exceed tax to be paid as a result of the loss of tax relief on other income. In some cases, an investor’s tax bill may be ten times their original capital contribution. In other words, if a partner invested capital of £100,000, they might expect a tax bill of £1 million. The more that has been invested, the more ruinous the tax bill and this will spell bankruptcy for many.
- Since late 2014, HMRC has issued accelerated payment notices to investors within film partnership schemes. The notices require the upfront payment of outstanding tax before any tax tribunal has ruled against the scheme, with payment having to be made within 3 months of the date of the notice. HMRC will only refund the additional tax paid if the scheme is ruled valid. Investors are therefore presumed guilty, unless proved innocent.
In July of 2015, a judicial review of HMRC’s decision to issue accelerated payment notices to investors in film partnership schemes failed. Investors will therefore be required to pay outstanding tax or else face a bankruptcy petition.
How we can help
Our panel of law firms specialise in banking and financial services related claims and will provide industry leading representation taking you through what is a complex and challenging area. They thoroughly assess all options, can assist you in challenging a HMRC issued APN and take action against the professional adviser who recommended you enter into scheme.