BIM56560 - Film and audio products: avoidance: partnerships: losses derived from exploiting a licence: legislation

The counter measure to the type of scheme described at BIM56555 was announced on 10 February 2004, and the legislation can be found at FA04/S126 to S130. 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 relevant to film partnerships.

Broadly, the provisions are designed to apply a charge to IT on non-active partners who seek to obtain a tax advantage by ‘exiting’ from a partnership, whose trade involves the exploitation of a licence, having claimed relief for losses incurred in that trade.

Persons affected

Like the rules to counter loss manipulation which were also announced on 10 February 2004, these measures only apply to an individual non-active partner who claims loss relief under ICTA88/S380, ICTA88/S381 or FA91/S72 (‘sideways loss relief’) in respect of a licence related loss sustained by a trade carried on in partnership in any of the first 4 years of assessment that the partner carries on the trade, irrespective of whether the trade itself has been carried on for a longer period by others. See BIM56540 for what is meant by a non-active partner.

The provisions apply to any non-active partner, including a limited partner as well as partners in general partnerships and limited liability partnerships.

Meaning of ‘licence related loss’

A licence related loss means a loss that derives to any extent from expenditure incurred in the trade in exploiting the licence. Generally licence has a very broad meaning, being the ability to do something under any kind of contract or agreement. For the avoidance of doubt the legislation makes it explicit that a licence includes an obligation to do something as well as the freedom or ability to do so. Licence also encompasses any agreements related to a licence, defined as any agreements entered into in pursuance of the same arrangement. See FA04/S126.

Where losses derive in part from the exploitation of a licence and in part from expenditure incurred in relation to an entirely different matter, a just and reasonable apportionment may be made (FA04/S128).

Charge to tax

The legislation imposes a charge to IT where an individual claims sideways loss relief for a licence related loss and also receives any form of consideration for which the individual is not chargeable to IT in respect of the disposal either of the licence or of any rights to income arising from the licence. For years of assessment up to and including 2004/05 the charge to IT is under Case VI of Schedule D ( BIM80000). For years of assessment 2005/06 onwards the individual is deemed to have an additional amount (see below) of income chargeable to tax which is not to be treated as trading income.

The charge arises irrespective of whether consideration for the disposal is received before or after the sideways loss relief is claimed. This is to prevent someone side-stepping the rule by delaying their claim to loss relief until after consideration is received.

The amount of the charge is capped at the amount of sideways loss relief (given in respect of losses incurred in the first 4 years of assessment that the individual carries on the trade) less the amount of any trading profits arising from the trade of exploitation of the licence on which the individual has been subject to IT. If consideration is received over more than one year (for example, for part disposals) then any earlier consideration which is subject to IT by virtue of these provisions is treated as profits arising from the exploitation of the licence.

The balance of any consideration received above this amount is not taxed under these rules, but may be subject to another charge, most likely to CGT.

This measure does not apply to any consideration for a disposal to which the film exit charge applies (individuals benefited by film relief – FA04/S119 to S123 – see BIM56600 onwards). The film exit charge always takes priority, but only applies where losses have arisen through deductions made under the special rules for expenditure on the master versions of films at F2A92/S40A to S43, F2A97/S48 and ITTOIA/S130 to S144.

Meaning of ‘disposal’

A disposal of a licence or rights to income under a licence is construed very widely. It includes, (but is not limited to):

(a) the revocation of the licence;

(b) the disposal, giving up or loss by the individual, or by a partnership of which he is a member, of any right under the licence;

(c) any disposal, giving up or loss by the individual, or by a partnership of which he is a member, of any right to any income (or any part of any income) under an agreement that is related to or contains the licence (‘a licence-related agreement’);

(d) any default in the payment of income to which the individual, or a partnership of which he is a member, has a right under a licence-related agreement;

(e) a change in the individual's entitlement to any profits deriving to any extent from such income, such that his share of the profits is reduced or extinguished;

(f) a change in the individual's entitlement to any losses deriving to any extent from expenditure incurred in exploiting the licence, such that he becomes entitled to a share, or a greater share, of the losses without becoming entitled to a corresponding share of profits;

(g) the disposal, giving up or loss of the individual's interest in a partnership that has the licence or a right to income under a licence-related agreement, including the dissolution of the partnership.

It also includes any disposal which is part of a larger disposal.

Although this definition is very wide, it will not have effect against any outright loss of rights, as the charge only applies where the individual receives consideration for the disposal. It should be noted that the consideration could be received by the partnership and the partner receive a share, or may be paid directly to the individual. This will include consideration by way of assumption or payment of a partner’s liabilities under a loan taken out to invest in the partnership. Any case where a partner appears to have received consideration related to a disposal and it is argued that the consideration is not for the disposal should be referred, with the relevant facts, to CT&VAT (Technical).

Commencement

These measures apply to all losses sustained on or after 10 February 2004. Losses should be computed as if 9 February were the accounting date for this purpose. The measures also apply to all licence related losses of any partner who joins a partnership on or after 26 March 2004, even if he is allocated a share of losses sustained by the partnership before 10 February 2004.

This mismatch in commencement arises from the problem with the original technical note, issued on 10 February, which also countered partnership loss manipulation schemes. The problem is described in more detail at BIM56542. As explained at BIM56542 it is unlikely that a partnership would have been able to incur expenditure before partners joined a partnership as it would not have had the funds to do so. Any claims that a partner joining on or after 10 February 2004 is exempted from this measure, by reason that the losses were sustained by the partnership before that date, should be examined very carefully and referred, with the full facts, to Anti-Avoidance Group (Films) in accordance with BIM56505.

This measure applies only where the consideration for the disposal was received on or after 10 February 2004.

Example

Mr A joins a partnership on 1 January 2004. The partnership starts trading on that date and incurs expenditure in marketing films under an agreement with a film studio. Mr A’s share of partnership losses is £30,000 in the period up to 9 February 2004, and £70,000 in the period from 10 February 2004 to 5 April 2004. Mr A claims sideways loss relief of £100,000 for 2003/04.

In the period from 6 February 2004 to 5 April 2005 Mr A receives income from the partnership of £5,000, on which he is taxed.

No income is received in the year to 5 April 2006, but the partnership sells its rights under the agreement back to the studio on 2 January 2006. Mr A’s share of the consideration is £90,000.

For the purposes of this example we assume that the partnership is trading, and that the sale of the rights under the agreement gives rise to a capital receipt (these assumptions may not be valid based on actual facts of a case).

Mr A has lost his rights to income under the agreement, and has received consideration of £90,000 for these rights. Relevant licence related losses are only the £70,000 sustained on or after 10 February 2004. Net licence related losses are reduced by the £5,000 received from the trade of exploiting the licence to £65,000.

As Mr A has received more than this, he is taxed on additional income, which is not to be treated as trading income, of £65,000 in 2005/06. The balance of the consideration (£90,000 - £65,000) may be taxed as a CG, see CG12700 onwards.