BIM56550 - Film and audio products: avoidance: partnership loss manipulation: risk free contribution: legislation

Legislation was announced on 2 December 2004 to prevent avoidance schemes where partners sought to inflate claims to trading loss relief by attribution of contributions to the partnership on which they do not bear the financial risk ( BIM56545). The legislation is not specific to film partnerships, and detailed 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 for film partnerships.

The legislation is at FA05/S73 to S78 and in the Partnerships (Restrictions on Contributions to a Trade) Regulations 2005. These regulations were also applied to the film exit charge, for individuals benefited by film relief, by FA05/S79 which inserted a new section in FA04 at FA04/S122A (see BIM56635).

The provisions apply to individual partners who are:

• limited partners,
• members of limited liability partnerships,
• non-active partners ( BIM56540) in general partnerships in the first 4 years of assessment that they carry on the trade.

For all of these partners the amount of trading loss relief that can be claimed under ICTA88/S380, ICTA88/S381, or FA91/S72 (‘sideways loss relief’) is capped by the partner’s contribution to the trade (that is, the amount which the partner invests as capital in the partnership). The regulations apply restrictions on the amount that is treated as being an individual’s contribution to the trade so as to:

• restrict sideways loss relief claims, and
• deem a receipt of taxable non-trading income (or income taxable under Case VI Schedule D for 2004/05) where sideways loss relief has already been claimed and the contribution to the trade is reduced below the amount of loss relief claimed.

The restrictions apply to all trading losses of a partner who starts trading on or after 2 December 2004. Where a partner is part of a partnership trading both before and on or after 2 December 2004, then the partnership losses are computed as if there was an accounting date on 1 December 2004 – and the new restrictions only apply to the partner’s share of the losses sustained after that date (a partner’s allocation of losses has to be based on the partnership sharing arrangements in place throughout – a partner can’t be allocated just pre-announcement losses).

The restrictions

The key to this legislation is in the restrictions on what is deemed to be a contribution to a trade, and this is contained in the regulations. Although generally the schemes we have seen involve loans, the legislation also caters for reimbursed contributions which are not loans. The restrictions apply to arrangements in place when the contribution is made, and also arrangements made subsequently which result in the partner not having met the cost of his contribution himself.

Where a partner’s capital contribution is financed in part or whole by a loan, the contribution is reduced to the extent that:

1. an agreement or arrangement exists whereby the cost of repaying the loan will or may be borne, or ultimately borne, by another person; or
   
2. the cost of repaying the loan is borne, or ultimately borne, by another person; or
   
3. the liability to repay the loan is assumed by someone else, or is released (written off); or
   
4. if the cost incurred in repaying the loan, taken over any period of 5 years beginning after 2 December 2004, is substantially less than it would be under arm’s length repayment terms with a bank, by the entire amount of the capital outstanding on the loan.

A loan includes not just the immediate loan to finance the contribution, but also any replacement loan or loans.

There are a few points to note here.

It is sufficient if any kind of arrangements are in place where someone else may bear the cost of repayment. This is because many schemes merely have options or guarantees that may be exercised or come into play in certain circumstances (albeit in practice the exercise may be certain). This does not mean that a normal commercial arrangement where a person takes out commercial insurance to cover loan repayments in the event of an unlikely or unforeseen event (such as long term illness) would be caught. There the person taking out the insurance is in effect covering the risk and cost himself (in most instances insurance will not lead to repayment). However, if the terms of the insurance were uncommercial in that the costs would almost inevitably be borne by the ‘insurer’ then the rules may apply. It will generally be obvious which circumstance applies.

The second and third tests are simple factual tests – there is no need to establish any arrangements or agreements. Assumption or release of a loan here do not require formal legal documentation – the test is a practical one of what has actually happened.

The fourth test is to prevent those schemes where a loan is said to be repayable on full recourse terms, but in practice never is. Terms of loans can vary significantly. All of the terms of a loan should be considered including rates of interest and the period of the loan, but remembering that the main focus is on the actual repayment terms.

The regulations stipulate that the cost incurred in repaying the loan must be substantially less than it would be under arm’s length repayment terms. Generally, cases where this type of avoidance occurs will be obvious. Factors such as perpetual or very long term roll up of interest, and loans from non-commercial (particularly off-shore entities or trusts) need careful attention. Although the test is over 5 years, the terms over a longer period may also be relevant.

The restrictions also apply where a capital contribution is not financed by a loan, but is or may be subsequently reimbursed. The contribution is reduced to the extent that:

1. there is at any time an agreement or arrangement whereby any part of the financial cost of making the contribution will or may be reimbursed, directly or indirectly, to the partner by another person; or
   
2. at any time the financial cost of making the contribution is, directly or indirectly, reimbursed to the partner by another person.
   

In all cases, ‘another person’ can be a partnership, and includes the partnership to which the contribution is made and of which the individual is a partner. A particular form of scheme caught by this is one where a partner has a right to receive an amount on the winding up of a partnership, or the sale of his partnership interest, irrespective of the success of the partnership and the share he has contributed to it (that is, where the cost is ultimately borne by someone else).

Exemptions

These regulations are intentionally wide ranging, and specific exemptions are required to ensure that acceptable situations in which partners’ may not have to bear the finance cost of their capital contributions are not caught unintentionally. In particular, an individual’s contribution is not restricted where:

1. the financial cost is borne or reimbursed by another individual in the normal course of the partner’s domestic, family or personal relationships; or
   
2. the individual is financially unable to repay a loan following events outside of his control occurring after the loan was taken out; or
   
3. the amount reimbursed or borne by someone else is chargeable to IT on the partner as his share of profits of the partnership trade.
   

The first prevents situations where friends or family contribute. For example, a person may borrow money secured on his home (that is, a mortgage) for which both he and his spouse/partner may be jointly liable. Although, someone else may be liable to repay the loan, the restriction does not apply because this is in the normal course of a family relationship.

The second ensures someone who cannot pay and therefore has a loan written off, for example, through insolvency, is not caught. However, if the person initially could not have possibly repaid the loan when it was made, then the repayment, assumption or release of the loan by someone else will trigger the restriction.

The final exemption is primarily directed at film sale and lease back partnerships (but may exceptionally apply in some other circumstances). Under accountancy practice (see BIM56410), the finance lease rentals received by the partnership are treated as part repayments of capital and part of interest on a loan. Withdrawal of the full rental payments may therefore be shown in the accounts as reimbursement or withdrawal of partnership capital. However, these lease rentals are fully taxable on the partner as income of the trade – so the regulations exclude these sums from the restrictions.

Points to look out for

Most film partnerships are tax deferral schemes, primarily sale and lease back (see BIM56400 onwards). Attempts to avoid the tax deferral are prevented by the exit charge ( BIM56600 onwards). There are schemes where investors in film partnerships do so on the basis of a genuine speculative risk investment in films. However, we have also seen many partnerships, principally production partnerships, print and advertising/marketing, and film development partnerships, which are tax avoidance schemes.

Particular care is needed in examining and monitoring these partnerships. Where avoidance is present, this will usually be apparent at the outset through arrangements to repay loans. However, in some schemes arrangements may not be fully apparent from the information memorandum prepared by the scheme organisers, particularly schemes in which the loan is not repayable.

Any case where you suspect information is being concealed or misrepresented, or where there is any evidence of tax evasion, should be referred immediately to Anti-Avoidance Group (Films) in accordance with BIM56505.