BIM56575 - Film and audio products: avoidance: guaranteed income schemes: exempt expenditure

The measures introduced by FA04/S125 prevent investors in a partnership whose trade includes the exploitation of films from obtaining a tax deferral (see BIM56570). However, the accelerated reliefs for qualifying British films are most commonly accessed indirectly by producers through sale and leaseback or similar arrangements with partnerships of wealthy individuals (see BIM56400 onwards). The value of these reliefs would be severely diminished if these arrangements were prevented. FA04/S125 (ICTA88/S118ZL) therefore exempts certain losses, or parts of losses, from the restrictions.

Losses are exempted, and may therefore be set against an individual’s other income or CG under ICTA88/S380, ICTA88/S381 or FA91/S72, to the extent that those losses derive from exempt expenditure.

Exempt expenditure

Expenditure is exempt expenditure if it is:

• expenditure deductible in computing the profits of the partnership under F2A92/S41 (‘Section 41’ - BIM56320), F2A92/S42 (‘Section 42’ - BIM56330) or F2A92/S42 as amended by F2A97/S48 ( BIM56380);
• incidental expenditure which, although not deductible under any of those sections, is incurred in connection with the production or acquisition of a film for which a deduction is given under those sections; and
• incurred before 26 March 2004 and the partner was carrying on the trade in partnership before that date (this is a commencement rule – see BIM56570).

Incidental expenditure is expenditure on management, administration or obtaining finance. It will generally be a very small amount in comparison to the expenditure deductible under Section 41 or Section 42. This expenditure was included in exempted expenditure so that partnerships involved solely in a sale and lease back or a similar tax deferral arrangement would not be disadvantaged.

The extent to which incidental expenditure is connected to the production or acquisition of a qualifying film is to be determined on a just and reasonable basis.

Example. A film sale and lease back partnership spends £10m on acquiring the master versions of qualifying British films in 2005/06. In the same year it also incurs £100,000 in interest charges on bridging loans to buy the film, £50,000 in legal fees to draw up finance leases and £6,000 in administrative costs of drawing up accounts, submitting tax returns and so on.

The £10m spent on the films is exempt expenditure as it is deductible under Section 42.

The £100,000 spent on interest charges is also exempt.

The £50,000 incurred in drawing up the finance leases is not connected to the acquisition of the film, so is not exempt.

A proportion, on a just and reasonable basis, of the £6,000 will be exempt expenditure as the accounts cover not just the film acquisition but also the leaseback. Let’s say this is split 50:50.

Therefore the total amount of losses which the partners may set against their other income and gains is £10,103,000. The balance of £53,000 may be carried forward and set against future profits from the trade (for example, lease rentals).

Losses derived from expenditure incurred

Where a partnership incurs mixed expenditure, some of which is exempt and some of which is not, the amount of losses derived from exempt and non-exempt expenditure is to be determined on a just and reasonable basis (ICTA88/S118ZM).

Where expenditure is exempt solely on the basis that it was incurred before 26 March 2004, a just and reasonable basis of determining losses derived from exempt expenditure would be to deem an accounting date at 25 March 2004 – computing exempt losses on the basis of income arising and expenditure incurred up to that date.

Where there is mixed expenditure on or after 26 March 2004, the basis of calculation of the exempt and non-exempt losses will depend on the particular facts of the case. In most practical situations this will be relatively straightforward as tax deferral schemes generally have clearly delineated sources of income, and in the early years, when losses arise, there is likely to be little or no income. Cases of difficulty, or where the allocation of losses cannot be agreed, should be referred to CT&VAT (Technical).

Example

In 2004/05 a partnership incurs £10m on the acquisition of the master versions of qualifying British films, which are leased back to a film studio under a finance lease. It also incurs £15m on print and advertising expenditure on the same films through a film marketing company. In the same year it receives £200,000 in lease rentals, and £100,000 specified as a share of exploitation income from the film marketing company.

A finance lease is a guaranteed income agreement, so the provisions will apply. This example does not specify whether the distribution income received from the marketing company is paid under an agreement which guarantees an amount of income. While this is likely, it is not relevant as the finance lease already ensures application of the rules.

The total loss allocated to the partners is £24.7m.

The losses derived from the exempt expenditure are £9.8m (£10m less income of £200k). This amount may be relieved against other income and gains of the partners. That is, each partner may obtain relief for 9.8 / 24.7 = 39.7% of his total loss allocation in this way.

The losses derived from the non-exempt expenditure is £14.9m (£15m less income of £100k), equivalent to 60.3% of each partner’s loss allocation. These losses may only be used against future profits from the trade.