BIM56535 - Film and audio products: avoidance: partnership loss manipulation schemes

Background

Following the changes to the film relief rules in FA02, and in particular the rules in FA02/S99 which stopped TV programmes being used in tax deferral schemes, there were insufficient qualifying British films to meet the demand of wealthy individuals looking to shelter their income from tax. This led to a number of complex and artificial avoidance schemes, many of which did not directly use the film reliefs at all, although most (but not all) of these schemes were based on films. The largest type of scheme was one based on treating a film as trading stock and generating a loss by writing down the value of the film under GAAP. However, it should be noted that many schemes which accessed the film reliefs for qualifying British films also used loss manipulation arrangements.

Schemes using GAAP rather than the film reliefs are generally referred to as GAAP schemes, and there are a number of different varieties of these. The example below illustrates some of the key elements of partnership loss manipulation schemes, and is based on a particular type of scheme in which the film is treated as trading stock. Other GAAP schemes are described at BIM56545, BIM56555 and BIM56565. This page outlines the scheme, and BIM56540 gives a brief overview of the legislation introduced to counter it (and other loss manipulation schemes) and guidance on what to do if you come across a similar scheme. This is a general partnership measure, and you should refer to BIM72600 onwards for more guidance on how the anti- avoidance rules work.

Loss manipulation scheme example

The precise details of each scheme will vary – this example gives a broad overview of how the schemes were intended to work (the inclusion of the various steps below does not imply that we necessarily accept that the steps work as the scheme organisers intended). It should be noted that this type of scheme is not particularly new, and we have successfully countered similar schemes in the past, most notably in Ensign Tankers (Leasing) Ltd v Stokes 64TC617, but also in other cases which were not litigated. The new schemes build in intervening steps in an attempt to distance themselves from the circular money flows in Ensign Tankers.

• The commissioning producer of a film (see BIM56530) needs £10m to make his film, but only has £7.5m (some of this is likely to be from a planned sale and lease back arrangement – see BIM56400 onwards).
• The producer enters into an arrangement with a partnership of wealthy individuals to provide the balance of £2.5m.
• The partnership is set up to trade in the production of films – to produce films as requested by commissioning producers and to sell the films back to the commissioning producer when they are completed (but see note after this example).
• The films are trading stock of the partnership – and therefore the special rules for films do not apply (see BIM56255).
• The producer lends the £7.5m to a company which will also become a partner in the partnership (the ‘corporate partner’ – usually based in an offshore tax haven).
• This loan is limited recourse – only repayable should the corporate partner receive sufficient profits from the partnership. Commonly, the loan may be made through a series of back to back arrangements with banks – primarily in an attempt to distance the scheme from Ensign Tankers.
• The partnership is funded by a capital contribution of £7.5m from the corporate partner (in some schemes the corporate partner may simply lend the money to the partnership, on limited recourse terms), and the balance of £2.5m out of cash from the individual partners (the individual partners will probably pay at least £3m in total - £0.5m, or more, is paid to the avoidance scheme operators).
• The partnership then sub-contracts the actual production of the film to a production services company, and passes funds to that company to make the film. The partnership will normally take ownership of the work done throughout production, although its role is wholly passive. The production services company will normally be owned by, or affiliated to, the commissioning producer.
• When the film is completed, the partnership ‘sells’ the film back to the commissioning producer (often referred to in schemes as a commissioning distributor) in return for a right to a share in future profits from exploitation of the film.
• Owing to the speculative nature of film production (see BIM56450) the value of this right is likely to be, under GAAP, negligible or zero. In most schemes the producer will take most or all of any income up to the £7.5m before sharing the balance with the partnership.
• The partnership has then spent £10m on the production of a film which it sells for a right valued at zero under GAAP, and records a loss of £10m (it claims that it is trading with a view to profit on the basis that it will receive income if the film is very successful – which is unlikely – see BIM56450).
• All, or almost all, of the profits and losses of the partnership are initially allocated to the individual partners – usually until the partnership income is approximately equal to the cost of the film (in most schemes the partnership is unlikely to receive any, or any significant, income).
• The individual partners now have allocated trading losses of about £10m which they claim to set against their other income and gains under ICTA88/S380 and ICTA88/S381, and FA91/S72 (see BIM75000 onwards). This generates a tax repayment of £4m – a considerable profit on their cash contribution of £2.5m plus the amount going to the scheme organisers.
• The net effect of this arrangement would be £2.5m to the film producer, £1m profit to the wealthy investor and £0.5m to the scheme organiser. This is funded by £4m from the Exchequer. The Exchequer may recoup some of this if the partnership receives income from the film, however in most schemes this is unlikely, and even where there is some income, the Exchequer is effectively the only party at risk on the investment.

In practice, where the film is a qualifying British film, the partnership will usually transfer the completed film to an offshore company in a tax haven. That company will then carry out a sale and leaseback transaction with another partnership (or possibly a bank). An offshore company is used because that company will make a profit having acquired the film for nothing and sold it back for full production cost. In this situation it is possible that the provisions of FA02/S101 ( BIM56530) may apply to prevent relief being given to the lessor partnership. Any sale and leaseback partnerships that acquire a film that has been produced using a loss manipulation scheme in this way should be referred to Anti-Avoidance Group (Films) – see BIM56505.

The scheme described above uses GAAP and treats the film as trading stock. Similar schemes (that is, where the film is sold for a right to future income, or in some cases licensed) have also been seen where the film reliefs under F2A92/S42 ( BIM56330) or F2A92/S48 ( BIM56380) are claimed to write off the expenditure on production of the film. These schemes are usually part of double dipping arrangements ( BIM56360).

All cases where loss manipulation is found and which precede the anti-avoidance measures in FA04 (announced on 10 February 2004) should be referred to Anti-Avoidance Group (Films) for advice.