BIM56540 - Film and audio products: avoidance: partnership loss manipulation: restriction of relief for non-active partners

Legislation was announced on 10 February 2004 to prevent excessive claims to trading loss relief through partnership loss manipulation schemes ( BIM56535). The legislation is not specific to film partnerships, and more guidance on the new rules is contained at BIM72600 onwards. This page gives only a brief overview of the rules with regard to specific points of application for film partnerships.

The legislation is at FA04/S124 and inserts new sections into ICTA88 at ICTA88/S118ZE to S118ZK.

Restriction on sideways loss relief to capital contribution

The purpose of the legislation is to restrict the amount of trading losses (see BIM75000 onwards) that an individual partner can claim against his other income and gains under ICTA88/S380, ICTA88/S381, and FA91/S72 (this is generally known as ‘ sideways loss relief’). Total sideways loss relief is restricted to the amount of the individual’s ‘capital contribution to the trade’. Broadly, this is:

• the amount of a partner’s actual capital subscription to the partnership; plus
• any amount of undrawn profits from the partnership; less
• any amount of capital withdrawn or reimbursed by someone else (unless the capital withdrawn is taxed as trading income of the partner, as might occur in a film lessor partnership where the accountancy treatment might show part of the finance lease rentals withdrawn as withdrawals of capital).

Losses can, however, be carried forward and set against future trading profits under ICTA88/S385 – but this would remove any tax advantage from the scheme.

In applying the restriction both losses claimed and capital contributions are aggregated. The effect of this is to prevent the type of scheme described at BIM56335, which depends upon partners claiming more loss relief than they actually contribute as capital.

In practice, partners investing in film partnerships obtain loans to finance part of their investment. These loans are usually secured on a guaranteed income stream from the partnership (for example, from lease rentals) – see BIM56425. Where loans are made to finance a contribution these loans must always be full recourse on the partner. For example, if the partnership does not receive lease rental income in a film sale and leaseback partnership, perhaps because the lessee has defaulted, then the partner himself must still bear the cost of loan repayment. See BIM56545 for schemes where the partner funds his contribution with amounts for which he is not personally at risk.

Some schemes have been seen where the partnership takes on the joint liability for the partner’s loans. Even if the individual partners guarantee parts of these loans, the partnership loan does not count towards the individual partner’s contribution.

Example

A film production partnership is set up to finance the production of a film costing £10m. There are 10 individual partners and they each contribute £200,000 of their own money. The partnership borrows £8m, and each partner is said to be liable for up to £800,000 of this loan in the event that the partnership has insufficient income to repay it. The partnership subcontracts production of the film to a production services company, which it pays £10m. When the film is completed the partnership claims a deduction for the £10m spent under F2A97/S48, generating a loss of £10m shared equally between the partners.

Each partner can claim sideways loss relief of only £200,000; the balance of £800,000 of each partner’s losses can be carried forward and set against their future income from the trade.

Partners affected

The legislation only applies to individual general partners in general partnerships (including Scottish partnerships) and to individual members of limited liability partnerships. It does not apply to limited partners in general partnerships and limited partnerships, as these partners were already subject to similar restrictions under ICTA88/S117.

Partners affected are only those who are non-active partners. A non-active partner is someone who spends less than 10 hours per week on average personally engaged in activities carried on for the purposes of the trade. The average is taken over the entire basis period for a year of assessment, except where that basis period is less than 6 months at the commencement or cessation of the trade, in which case the average is over the first or last 6 months respectively.

Investors in film partnerships are generally passive partners, with no active involvement in running the partnership trade. We have heard of some schemes being promoted on the premise that partners will be able to get around these restrictions by spending 10 hours each week reviewing videos or films, or similar pastimes. This is not actively and personally carrying on the trade. Any cases where it is argued that the restrictions do not apply to an individual in a film partnership, because they spend more than 10 hours per week on average actively carrying on the trade, should be referred to CT&VAT (Technical).

The restrictions only apply to losses sustained in the first 4 years of assessment that a person is carrying on the trade. This test relates to the individual and not to the partnership. Where an individual joins a partnership after the trade has commenced, the first year of assessment will be that in which he joins the partnership; otherwise, it will begin in the year of assessment in which the partnership starts trading.

Commencement

The commencement provisions are quite complicated, and raise particular issues where care is required in examining returns. These are described at BIM56542.

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