Investing in films – has HMRC moved the goalposts?

Investment in the UK film industry was boosted by tax relief prior to 2007 but investors in formerly government-backed film schemes are now under the scrutiny of HMRC. Media and entertainment lawyer Laurie Cooke reports.

Background

Between 1997 and 2006 hundreds of British films and television programmes were financed by private investors using a form of tax relief known as ‘sale and leaseback’. Designed to boost low budget film making in the UK, ‘section 48 relief’ allowed individuals investing in qualifying films to set 100% of their investment against other income.

HMRC issued guidance notes in relation to section 48 relief and gave their express approval of the sale and leaseback structure, which was a deferment model that did not ultimately deprive the Treasury of tax income.

With their investments leveraged by bank loans, sale and leaseback investors purchased a finished film and obtained tax relief on their investment. The film was then leased back to the producer to be exploited in the normal way. The producer would receive part of the purchase price, the rest was kept on deposit to make lease payments back to the investors over a 15 year period. So the tax relief received by the investor was, by the end of 15 years, balanced out by tax payments on the lease income.

This legislation helped generate a boom time for the British production industry. Although sale and leaseback provided only part of the budget of the film, it was a sizeable chunk and one that did not require anyone taking a risk on the film’s performance. In addition, inward investment from co-productions with foreign producers (whose films could also qualify) helped boost London’s post-production industry and kept British creative talent in regular work for a decade.

Tightening the rules

But the boom was not to last.Whilst ‘vanilla’ sale and leaseback continued to be available, certain sale and leaseback sponsors devised more financially inviting structures that stretched the rules.

HMRC responded by closing loopholes and tightening the rules, but the alleged abuse continued. In 2006 the government removed section 48 relief altogether. It was replaced with a tax credit that the film producer could obtain directly, without the involvement of private investors.

HMRC challenges

In 2010 HMRC won its first victory in what has become a crusade against film investment schemes, successfully challenging the trading status of two sale and leaseback partnerships, Proteus and Samakand. These partnerships had invested in the films The Queen and Oliver Twist.

A further case involves the successful challenge of the Eclipse 35 film partnership (this time not a sale and leaseback structure) on the same grounds, i.e. that the partnership was not conducting a trade.

Appeals of each of these judgments will be heard this year. But if the decisions are upheld the investors will have to repay the tax relief they have received.

Such high profile cases, as well as media interest in certain celebrities who were among the schemes’ investors, has turned public opinion against all forms of tax planning and the line between tax evasion and avoidance has become distinctly blurred.

HMRC has been granted additional funding to continue its crackdown on tax avoidance, which extends to challenging schemes that did not operate in the ‘spirit’ of the legislation. Litigation remains the preferred strategy. However, HMRC has also written to investors in sale and leaseback schemes, even those not under investigation, inviting them to accept a ‘settlement’ along the lines that if they pay back the tax relief obtained from the leveraged portion of their investment (i.e. the bank borrowing), they can escape future challenges.

These investors are now looking to their accountants and advisors for guidance. In some instances, they are launching their own investigations into whether they were mis-sold an investment product that they believed had been approved by the Revenue.

Some such challenges may win, however the sponsors of film sale and leaseback structures will say they cannot be responsible for HMRC moving the goal posts. As with all investment schemes, the sponsors will rely on published risk warnings designed to protect them from liability if a change of law has a retrospective effect on the function or legality of their scheme. Many will have backed this up with opinions acquired from tax counsel that their scheme would qualify for the advertised tax relief.

A retrospective change in the law?

Do these challenges to film investment schemes amount to a retrospective change of law?Not perhaps as such. But, the resolve of HMRC to challenge schemes regardless of whether they complied with the law of the time and their own extensive guidance notes, and the seeming willingness of the first tier tax tribunal to support them, is having a retrospective impact.