BIM56542 - Film and audio products: avoidance: partnership loss manipulation: restriction of relief for non active partners: commencement

The commencement provisions for the restriction of loss relief for non active partners described at BIM56540 are quite complex, and need to be applied carefully. Because of the large amounts of money pouring into these schemes and the large Exchequer risk, the Government announced its intention to introduce these restrictions in a press release and technical note on 10 February 2004.

The press release made it clear that the new rules applied to any losses sustained after 9 February 2004 or to any partners joining a partnership after that date, but the technical note, which contained the details of the proposed restrictions, only explicitly mentioned losses sustained. Some individuals might therefore have continued to join partnerships which had sustained losses before 10 February in the belief that they could obtain a share of those losses without restriction to their capital contribution. When it was realised that this might be happening, the Government reissued the technical note (on 26 March 2004) making it explicit that new partners joining on or after 26 March 2004 could not benefit excessively from losses sustained by the partnership before 10 February 2004.

In summary:

• the restrictions apply to all losses sustained on or after 10 February 2004. To calculate losses sustained before that date, there is a deemed accounting date at 9 February, and losses must be computed with regard to income earned and expenditure incurred before that date;
• the new rules do not apply to restrict sideways loss relief on an individual’s share of losses sustained by the partnership before 10 February 2004, provided the partner joined the partnership before 26 March 2004 (there may however be restrictions under pre- existing rules);
• if a partner’s share of losses sustained before 10 February 2004 are greater than or equal to their capital contribution, then there can be no further sideways loss relief for losses sustained on or after that date;
• if a partner’s share of losses sustained before 10 February is less than their capital contribution, then total sideways loss relief (that is, including their share of losses sustained on or after that date) cannot exceed their capital contribution;
• a partner joining on or after 26 March 2004 cannot claim sideways loss relief in excess of their capital contribution for any trading losses, whenever they were sustained by the partnership.

There are a number of particular points to look out for. Most partners do not join, and contribute money to, a film partnership until close to 5 April. This is to minimise the time between their cash investment and the receipt of their repayment of tax, which cannot be claimed until the following year of assessment. Recruitment of partners/investors therefore tends to take place largely towards the fiscal year end, and there is considerable competition between scheme organisers to attract investors.

In order for a partner joining on or after 10 February 2004 to benefit from losses sustained by the partnership before that date, the partnership would also need to have incurred the expenditure before that date. It is doubtful whether many partnerships would have been able to incur expenditure before they had the funds, or even knew whether they would have the funds, to do so. Entering an agreement to incur expenditure on film production at some point in the future is not the same as having already incurred the expenditure, and thereby having sustained a loss.

You should therefore examine very carefully any claims that losses were sustained by a partnership before 10 February 2004 where the partnership had insufficient funds to meet this expenditure until a later date. Many loss manipulation schemes sought relief under F2A97/S48, which has specific rules specifying when expenditure is incurred: these rules may be in point when considering whether a loss had been sustained before 10 February 2004. You should also consider the film exit charge (see BIM56600) in loss manipulation schemes where expenditure is deducted under the special rules for films (F2A92/S40A to S42 and F2A97/S48).

We also received several reports that some investors were being encouraged to backdate agreements to enter partnerships. Where you have reason to think that any documents have been backdated, make an immediate report to Anti-Avoidance Group (Films) – BIM56505.

Pre-announcement expenditure deductible over more than one year

Where expenditure was incurred on the master version of a film before 10 February 2004, that expenditure may not be deductible until some time after that date. For example, the expenditure may be deductible under the three year rule in F2A92/S42 ( BIM56330). (A similar point arises with capital expenditure on plant and machinery subject to writing down allowances, but this is unlikely to be relevant to film partnerships.)

Where an amount of expenditure incurred is deductible by virtue of F2A92/S42, but cannot be deducted until a later period, any losses attributable to that deduction are not subject to the restrictions. The losses attributable to that deduction are to be determined on a just and reasonable basis.