Shadow Cast over future of Film Schemes
US broadcaster Walter Kronkite famously said at the end of the US involvement in the Vietnam War “we have reached the end of the tunnel and it turns out there is no light”. Investors in the Eclipse 35 film partnership must be feeling similarly black as April saw HMRC win the final victory with the Supreme Court’s dismissal of an appeal by the film partnership investors. Eclipse 35 traded distribution rights in Disney films including Enchanted and Underdog and lost in its attempt to claim tax relief, a defeat that will cost its 300 scheme partners around £117m in tax as well as hefty legal costs.
The partnership had entered into a complex series of transactions for the acquisition, distribution and marketing of film rights. The members had borrowed money to contribute to the capital of the partnership. They could only claim tax relief in respect of interest if the loan was used wholly for the purpose of a trade carried on by Eclipse 35. The UT upheld a decision by FTT that the partnership had not played a meaningful part in the marketing and distribution of the films – it had therefore not carried on a trade.
The Court of Appeal noted that a payment by Eclipse 35 of £503m would be repaid with interest over a 20 year term and would produce a profit unrelated to the success of the exploitation of film rights. That aspect therefore had the character of an investment. Further the possibility that the partnership would receive contingent receipts was considered too remote for this aspect to be significant. The Court of Appeal accepted that the transactions were not ‘shams’ but that eclipse had acquired an investment rather than carried on a trade.
Victory for HMRC
This could prove to be a significant victory for HMRC both for its precedent effect and because of the amounts involved – tax relief of £293m was at stake. There were 31 Eclipse partnerships designed to run for between 11 and 20 years from 2005/6. Eclipse 35 is the first of the partnerships to be taken to litigation. This could be significant to the appellants in the other cases where trade is an issue, which are working their way through the courts. Attempts are being made to re-characterise the arrangements of the other LLPs but it is difficult to see how they will succeed given the precedent set here.
However, a similar case (Patrick Degorce v HMRC) had the same result in August last year as the UT found that the taxpayer had not been trading so the scheme he had implemented did not work. Mr Degorce had implemented a tax avoidance scheme known as the ‘Goldcrest Film Scheme. The scheme involved the purchase and immediate assignment of intellectual property rights in two films. The UT accepted the FTT’s finding that it was clear before Mr Degorce entered into the transactions, that at the end of them, he would only be left with one possible outcome which was a known income stream. In a similar way to Eclipse the contingent income Mr Degorce could receive based on unknown future performance was not sufficient to make this a trading transaction.
HMRC’s current approach (with the ‘Court of Public Opinion’ firmly behind them) has been tackling avoidance through the courts, attacking deemed artificial structures and demanding APN’s for good measure. APN’s are Accelerated Payment Notices which require participants in tax avoidance schemes to pay the tax liability ahead of investigation only being repaid if their appeal is successful. These notices have so far raised £2bn and, more importantly, deterred new schemes from being created and from investors putting their money into any schemes that have been designed. The success of HMRC in both the Degorce and Eclipse cases will provide them with more confidence in targeting other schemes where there is a question over the genuine commerciality of transactions.
Film industry benefits/other schemes
Cases such as Eclipse, and others, continue to paint the film industry as a vehicle for tax avoidance and make it increasingly more difficult for producers to raise funds for their films. More news coverage of HMRC successes perpetuates this perception and is at risk of derailing further a struggling sector. The vast majority of producers are seeking funding are genuine films with structures only complicated by the number of parties now required to get a film fully financed.
The industry has had a history of tax incentives introduced by the governments that have only served to provide opportunities for promoters to create schemes for tax avoidance without enhancing the film industry in any material way. The current mechanism of film tax credit, however, has finally created a structure which significantly enhances the industry. As highlighted in a previous article the tax benefit is paid to the producer to assist in funding the production costs of the film rather than to investors by means of a tax shelter. This has led to significant foreign investment in the UK where foreign film makers (especially from the US) have come to the UK to make their films enhancing the UK economy and generating tax revenue for the Treasury.
This success for HMRC in the long run is also a success for the UK and its taxpayers as it deters and penalises artificial tax avoidance schemes but they need to be careful not further damage the film industry with too much fist pumping perpetuating its perceived reputation.