BIM56455 - Film and audio products: tax deferral schemes for qualifying films: partnership example

This example is illustrative of a sale and leaseback arrangement which accesses relief for qualifying British films to obtain a tax deferral. The example is for a partnership using films costing less than £15m to produce to which F2A97/S48 or ITTOIA/S140 (‘Section 48’ – see BIM56380) applies, although partnerships can and do fund more expensive films to which F2A92/S42 or ITTOIA/S138A (‘Section 42’ – see BIM56330) applies. There is an example of a similar arrangement for a bank subsidiary, based on a more expensive film at BIM56460.

The example is simplified to show the key elements of what is often described as a ‘plain vanilla’ sale and leaseback scheme, although particular details and amounts may vary on a case to case basis. We do not give pre-clearance on any film schemes, and, owing to the high prevalence of tax avoidance involving film schemes, each case should be examined carefully on its own facts. The experience of Anti-Avoidance Group is that schemes that depart radically from the structure described, and in particular are more complex, are likely to carry a high risk of tax avoidance.

1. A film production company (C) spends £10m on making a film, which is then certified as a qualifying British film ( BIM56105).
2. C sells the master version of the film to a partnership of wealthy individuals (P) for £10m.
3. P immediately leases all the rights in the film back to C for a period of 15 years.
4. Lease rentals are payable by C to P over the period of the lease on an annual basis. C may taper these lease rentals slightly so that less is payable in the early years, and more towards the end of the lease, provided the rentals increase by no more than 5% each year (see BIM56430).
5. In order to secure the lease rentals, C places about 82% of the £10m it has received for the sale of the film on deposit with a bank. It keeps about 14% (which is usually used to pay off loans taken out to make the film) and gives about 4% to the scheme organiser.
6. C has a taxable receipt from sale of the film of £10m. However, under section F2A92/S40B it is able to set off all the costs of production against this disposal – generating neither a profit nor a loss (see BIM56420). It should be noted that the treatment in the accounts of C may be radically different from the tax treatment ( BIM56410) and full tax computations to reflect this are required.
7. C is able to set the lease rentals that it must pay as a deduction against any income it receives from exploitation of the film. It is important to note that any grants or subsidies received by C towards the cost of making the film will be taxable receipts, as will any pre-sales received.
8. P is able to fund its purchase of the film through capital contributions made by the partners. The partners are usually wealthy individuals, paying tax at the top rate of 40%, who have substantial taxable income that they wish to shelter. There may also be a managing partner – normally a company – that does not contribute capital, but administers the scheme.
9. P is carrying on a trade of exploitation of the master versions of films. It has negligible overheads (that is, no costs to set against the lease rentals which it receives), so the partnership profits effectively equate to the lease rentals. The partnership profits and losses are shared between the partners in proportion to their capital contributions to the partnership and are taxable on them as profits of their trade (see section ICTA88/S111).
10. Each of the partners’ contributions is funded 80% by a loan from a bank and 20% by cash from the partners’ own resources.
11. The partners’ loans are secured on their share of income from the partnership, that is, the lease rentals, which are in turn secured by the deposit made by C.
12. When P acquires the film it is able to claim an immediate deduction under section 48 of the £10m it has spent on buying the master version of the film to set against income from its trade. As P has no income at this point, it generates a trading loss of £10m which it allocates to the individual partners in proportion to their capital contributions to the trade.
13. Consider an individual partner, ‘W’, who contributes £100,000 to the partnership. W funds this contribution through £20,000 of his personal cash and a personal loan (secured against his future income from the partnership) of £80,000.
14. W’s share of the partnership loss in the first year is £100,000. This is a trading loss which he is able to claim against his other income and gains under ICTA88/S380 or S381. This generates a tax repayment of £40,000 (£100,000 at 40%).
15. As a result, W has received a tax repayment which is £20,000 greater than his cash contribution of £20,000 – that is he has a net cash benefit of £20,000.
16. In later years, W will receive his share of P’s profits (arising from the lease rental stream) on which he will be taxed. However, the full amount of this income has to be used by W to pay off interest and capital on his loan.
17. W can claim relief under ICTA88/S353 (by virtue of ICTA88/S362 – loans to buy into a partnership) equal to the amount of his income from P which is used to repay interest on his loan. However, he can obtain no relief for the amount which is used to repay capital on the loan.
18. As a result, W pays additional tax each year on the amount of his income from the partnership which is used to repay capital on his loan. Eventually, when the loan is fully repaid, he will have paid additional tax of £32,000 (40% of £80,000).
19. From W’s perspective, the overall effect of this is that in year 1 he has received a cash benefit of £20,000 but after year 15 he is out of pocket overall by £12,000 (£20,000 less the £32,000 in additional tax he has paid).
20. This is equivalent to W obtaining a loan of £20,000 for 15 years and paying - in total - £12,000 of interest on it - roughly equivalent to a loan at 5% interest per annum.
21. If W is to profit overall from the scheme he needs to invest his net benefit of £20,000 in year 1 so as to recover £12,000 or more by year 15 - that is, to invest the net benefit to give a return greater than the 5% notional interest rate. This rate, at which the net benefit needs to be invested, is called the ’hurdle rate’.
22. From a tax perspective (that is, from the perspective of the Exchequer) after 15 years W has been given tax relief of £8,000 on his actual cash investment of £20,000 – leaving him out of pocket by £12,000. In effect, as an incentive to invest in films, the Exchequer has given W a deferral of tax of £32,000 spread over 15 years.

Variations and practical points

Until the changes announced on 2 December 2004 the sale price was commonly set at the cost of the film plus minor incidental costs incurred by the producer which were relievable under Section 42 (see BIM56335 and BIM56435).

The scheme administrator fees referred to at point 5 above are often paid by the partnership rather than the production company. Some or all of these fees may not be allowable revenue deductions. Normal Case I trading rules apply.

The above example produces the same result for investing partners whether or not the film is successful. Some schemes, usually with a slightly higher initial cash contribution from the partner (say 75%), guarantee only sufficient rentals to repay a 75% loan, but supplement these rentals with a small profit share should the film prove to be successful.

A number of schemes have also been devised in which the partnership purports to be the producer/licensor of a film with a similar tax deferral structure as sale and leaseback schemes (see BIM56405). Many of these schemes have been associated with tax avoidance, and any such schemes should be referred to CT&VAT (Technical) for advice.