BIM56605 - Film and audio products: avoidance: individual exit schemes: overview

The main way in which the film tax relief for qualifying British films has been accessed is through tax deferral arrangements, such as sale and lease back, by partnerships of wealthy investors or banks. These arrangements are described at BIM56400 onwards.

In those arrangements, the film reliefs allow expenditure on the production or acquisition of a film to be deducted, in computing the profits and losses of a trade of exploitation of films, before income from exploitation of the film is received. This means that early losses arise which can be used to shelter tax on other income and gains. That sheltered tax is then effectively repaid, through higher tax liabilities in later years, as income arises under the finance lease (or similar agreement). This can lead to tax deferral of up to 15 years for investing partners or banks.

An illustrative example showing how these arrangements work for a partnership of wealthy individuals is shown at BIM56455. If you are not already familiar with this example, you should refer to it now, before reading the rest of this guidance on individual exit schemes.

You will see from the example that once partner W has cashed in his trading loss sustained in the first year, he obtains no additional financial benefit from remaining in the partnership. Future income that he receives is all allocated for repayment of interest and capital on his loan. He will have to pay tax on this; so the longer he remains in the partnership, the greater his cost. Conversely, the Exchequer needs him to stay in the scheme to recover the tax he has been able to defer.

Identifying exit schemes

A number of schemes were devised to avoid an individual having to repay the deferred tax, and these are generally referred to as exit schemes. The aim of these schemes was to enable the individual partners to repay or reassign their loans without having to pay tax on any consideration received. There are a wide variety of different structures used to try to achieve this. The most common schemes involve assigning the income stream – and responsibility for repaying the loan – to someone else, who will not have to pay tax on that income. For example, schemes may use an offshore company in a tax haven, a trust, a company with losses which can be used to shelter the income, or even transfer the income stream to a spouse or minor child with no other income source. However, it is not possible to give a general description of an exit scheme other than that they all involve considerable complexity. Exit schemes do not necessarily involve an individual ceasing to carry on a trade or to be a member of a partnership – but rights to income are generally given up. Exit schemes will normally be identified by their outcome, and this is also the way in which the counter legislation works.

In the tax deferral scheme example described at BIM56455, the net outcome for W is that he has contributed £20,000 and received net tax relief (that is, tax reclaimed less tax paid) of £8,000, so is £12,000 out of pocket. In an exit scheme the net effect is that he will receive tax relief on more than the actual cost to him of making his investment – either by receiving consideration not chargeable to IT or by making a net contribution to the trade less than the amount he has claimed as loss relief. The legislation, which can be found at FA04/S119 to S123 and is effective from 10 December 2003, raises a charge to IT where such non-taxable consideration is received or where losses claimed become greater than the contribution to the trade and there has been any disposal of rights to income from the trade.

The legislation applies to prevent exits by individuals who entered schemes before 10 December 2003, as well as those who did so on or after that date, but only applies where the exits are effected on or after that date (whether or not the arrangements for the exit had been made before then).

Reports to Anti-avoidance Group

A number of schemes where individuals exited from a film scheme before 10 December 2003, or where there was a pre-ordained exit at inception, have been successfully challenged. Anti- avoidance Group (Films), 22 Kingsway, London, WC2B 6NR, would like to know of any schemes where exits appear to have been effected before 10 December 2003.

A great many investors genuinely entered into sale and leaseback schemes in order to benefit from the cash flow incentive offered by the tax deferral and to support the British film industry. However, there is evidence that some investors entered into schemes on the understanding that an early exit would be arranged. We think the counter legislation is effective in preventing exit schemes, and any taxpayers who do exit from schemes will of course need to self assess. However, we are aware that a few schemes have been marketed which try to persuade investors that they can still make a tax free exit. It is therefore important to monitor carefully the returns of individuals who have benefited from film relief, and a report should be made to Anti-avoidance Group if an investor ceases to receive income from a film partnership where insufficient income has been declared to repay loans used to fund his investment.

Although the legislation to counter exit schemes was designed to tackle tax deferral schemes, it also may apply to some loss manipulation schemes (see BIM56535) where expenditure has been deducted under the special rules for expenditure on films, and where schemes were entered into before 10 February 2004. The exit charge does not apply where deductions are made under generally accepted accounting principles; that is, to GAAP schemes.

We have also learnt that schemes are being marketed for non-domiciled individuals which purports to avoid the legislation. If you come across such a scheme a report should be made to Anti-avoidance Group.