BIM56545 - Film and audio products: avoidance: partnership loss manipulation: risk free contribution schemes

After the closure of loss manipulation schemes on 10 February 2004 (see BIM56535 and BIM56540), the tax avoidance industry lost little time in devising new schemes in an attempt to achieve the same effect, that is, to obtain sideways loss relief for amounts greater than the contributions to the trade that the partners were actually at risk of losing.

The rules in FA04/S124 limited relief under ICTA88/S380, ICTA88/S381, and FA91/S72 (‘sideways loss relief’) to a partner’s contribution to the trade, and the new schemes attempted to artificially inflate the amount of this contribution. There were a large variety of different schemes; most, but not all, were film related. The majority of film schemes were based on a partnership incurring expenditure on film production, either through a GAAP scheme similar to the example at BIM56535, or by claiming a deduction using the accelerated reliefs for qualifying British films at F2A92/S42 ( BIM56330) or F2A97/S48 ( BIM56380). These schemes were generally followed by a sale and lease back, and were therefore the first part of a double dip ( BIM56360). There were also schemes involving print and advertising expenditure on films produced by large studios (see BIM56555) and on film development expenditure (see BIM56320).

Despite the wide variety, all of the schemes had features in common. All involved a partnership obtaining a large deduction for expenditure in the early years (principally the first) of trading, before any significant income arises, thereby generating a large trading loss. The partners would then claim sideways loss relief on their shares of the loss to generate a tax repayment. The broad structure of most of the schemes was similar to the GAAP scheme described at BIM56535, except that instead of the producer (or other person such as the studio or film developer – for simplicity we will use producer to encompass all such persons on this page) lending money to a corporate partner to invest into the partnership, the money would be lent to the individual partners to invest in the partnership.

The key to these arrangements is the nature of the loans. In all of the arrangements that we have seen the money is not lent directly from the producer to the partner. Instead there will be a complex chain of back to back loans, options and guarantees, typically underpinned by a security deposit made by the producer. The actual loan to the partner will generally be made by a bank, but with arrangements in place for the loan to be assigned or repaid after a few years should the partner have insufficient income from the partnership to do so (which will normally be the case).

There are two principal ways we have seen in which the partner avoids any risk on repaying the loan:

The overall effect of the arrangements is that the producer’s own money is circulated through the partnership in order to boost each partner’s tax repayment. The Exchequer, rather than the partners, bears the risk of the failure of the venture. The partners are guaranteed a positive return.

We have doubts over whether any of these schemes worked under existing legislation, but the Government decided to introduce further legislation to put the point beyond doubt. Measures were announced on 2 December 2004, effective from that date, and are described briefly (in relation to film partnerships) at BIM56550, and in more detail at BIM72600 onwards.

We will continue to challenge schemes in place before 2 December 2004. Cases should be referred to Anti-Avoidance Group (Films) in accordance with BIM56505 where an individual claims sideways loss relief for losses sustained in a partnership where that individual is either:

• a limited partner,
• a member of a limited liability partnership,
• a non-active partner (see BIM56540), and

any arrangements exist or become apparent whereby the partner may or does not have to meet the cost of his contribution to the partnership out of his own income, or any other arrangements where it appears that the loss relief claimed does or could exceed the actual costs sustained by the partner. Some examples (not exhaustive) of cases that should be referred to Anti-Avoidance Group (Films) are shown below.

Example 1. A partner invests money in a partnership, which sustains trading losses. Most of the investment is funded by a loan from a bank. There is an agreement whereby the bank may assign the loan to another party if it is not repaid within a certain period.

Example 2. An individual contributes money to, and becomes a member of, a limited liability partnership (LLP) which sustains losses. Under the membership agreement the member has a right to receive a fixed sum on the winding up of the LLP, irrespective of whether the LLP is successful.

Example 3. An individual is a non-active partner in a partnership. He contributes capital to the partnership, funded primarily by a personal loan from a bank. The partnership sustains trading losses and the partner claims sideways loss relief. After 2 years the loan is repaid by another person (not the partner).