UNITED KINGDOM: FILM PARTNERSHIPS

Film partnerships have traditionally provided a means of sheltering income and capital gains from tax, and were introduced in 1997 with the aim of helping to finance the UK film industry. They involve sale-and-leaseback deals on the distribution rights of films that have already been made.

Film partnerships have been particularly useful to people with significant income tax bills; as the rules allowed sheltering of income for up to three years back.

Tax breaks designed to encourage the British film industry have existed for more than 10 years. 'Section 42' relief allowed the cost of producing ‘British' films to generate a loss which can be offset against other income over a 3-year period. ‘Section 48 relief’ was more generous and allows the loss to arise entirely in the first year of the partnership. (but see below for changes to the UK's film tax relief regime.) In either case the loss could be used against income in the year of the loss or in the previous three years.

Film partnerships have traditionally required a 15-year commitment, and have usually been financially complex, but the film partnership scheme attracted about GBP500mn in investment in its first two years.

(However, complex schemes based on Film Partnerships became the subject of anti-avoidance legislation included in the 2006 Finance Act, which largely removed their advantages.)

Given that Section 48 relief was due to expire in 2005, further film partnership products were developed which did not rely on specific legislative tax breaks. In addition, the definition of ‘British films’ was amended to exclude TV films. This greatly reduced the number of qualifying films and increased the cost of sale and lease back schemes.

Changes to the film tax relief regime in the 2002 Finance Act included measures to restrict the main tax relief for British qualifying films with budgets not exceeding GBP15mn, to production expenditure which has been paid at the time the film is completed, or is unconditionally payable within four months of the date the film is completed.

In 2003, legislators began to pressurise the Treasury to ensure continuation of the support scheme. A report from the influential Commons culture committee in September of that year stated that maintaining the level of tax relief provided for the British film industry was "absolutely essential" for its long term health, and urged the UK government to preserve the Section 48 system of tax breaks for film-makers.

Calling the issue a key priority for the government, the committee recommended that "the Government commits to an evolution of Section 48 relief, without further sunset provisions, along the lines proposed by the UK Film Council and the British Screen Advisory Council."

"Lead times for decisions about inward investment are long, therefore the Government must end the current uncertainty plaguing the industry, must do so in a positive manner and needs to do so as quickly as possible," the report warned.

In February 2004, however UK Paymaster General at the time, Dawn Primarolo announced new rules designed to prevent manipulation of trading losses for tax purposes, which commentators said could jeopardise up to twenty films currently in production in the country.

"These schemes exploit tax reliefs that are intended for people who risk their own money in running genuine businesses, but the schemes manipulate tax relief to create claims for losses in excess of the capital at risk,” explained Primarolo. However, the government denied the new legislation was aimed specifically at the film industry.

In May, 2004, the government went further, announcing that it would be introducing tighter rules on film tax breaks in order to ensure more investment in people and facilities. Under the new rules, any film from France, Italy, Denmark or Iceland that applied for co-production with the UK would, from 1 July of that year, have to spend 40% of its budget in the UK to qualify. This represented an increase of 10% from the previous level.

Explaining the reasoning behind the clampdown, Film Minister at the time, Estelle Morris revealed that too many co-productions were seeking to take advantage of the tax incentives on offer in the UK, whilst failing to deliver the right amount of investment in the country's film talent and facilities.

"We have to make sure the co-production system delivers real cultural and economic benefits to both partners," she observed. However, the minister revealed that the move is only intended to be a stop-gap solution, and that a wider review of international film co-production treaties is currently being carried out.

Dire predictions made when the government introduced its new rules were initially not borne out. The UK Film Council reported in August, 2004, that most films that were in production at the time of the change had since managed to reorganize their finances.

"There was a lot of screaming about it because the whole industry was concerned. But actually, five months down the line, I think we're going to be okay," said a Film Council spokesman, adding that the number of films made that year, and those employed in their production, would likely be roughly equal to last year.

One high profile victim of the change however was ‘The Libertine' starring Johnny Depp which was saved by additional funding and the transfer of production to the more tax-friendly Isle of Man.

However, the Film Council representative added that the long term impact of the government's decision was likely to be minimal.

"A few of (the films) were large and it hurt, and it didn't really do them any good, but the industry as a whole continues to work very well - and the majority of productions are under legitimate schemes anyway," he told the BBC.

Finally, in September 2004, Dawn Primarolo unveiled new plans for film tax relief, which were set to replace the old Section 48 relief, due to expire in July 2005.

Launching the new relief, she observed that: “2003 was a record year for film production in the UK and employment in the film and video industries has increased by over 75 per cent in the last decade. We now want to build upon the success of the old Section 48 relief in supporting the production of British films and creating investment and employment opportunities in the industry."

She went on to add that: “This new, more generous relief will ensure that the UK continues to be recognised as one of the best places in the world to make a film.”

The main features of the new tax relief scheme were that:

• The money would be paid direct to film-makers, not through third parties, so it will be less open to abuse;
• The relief would cover 20% of production costs compared to the 15% covered by the old Section 48 relief;
• Films with budgets of up to GBP20mn would be able to benefit, compared to a limit of GBP15mn under Section 48;
• For the first time, the relief would include an added incentive for films to be profitable;
• The relief would apply to all production expenditure, not just that spent in the UK; and
• The maximum relief which could be claimed on a qualifying film would rise typically to GBP4mn, compared to GBP2.25mn under Section 48.

The new regime was due to come into effect from July 2005, but subsequent Treasury announcements cast doubt over the usefulness of some aspects of the new rules.

In December, 2004, the Inland Revenue (as it then was -- it has since become HM Revenue & Customs) accused some members of the British filmmaking industry of abusing tax reliefs designed to encourage growth in the industry. Twenty representatives from the film industry met with Revenue officials and were told in no uncertain terms that they will be punished if they do not immediately cease the “exploitation” of the tax system.

In particular, the Revenue was not happy that some filmmakers were said to be stretching tax rules by “double dipping,” or claiming twice for the same expense – a practice which is not technically illegal, but one that the Revenue argues goes against the spirit of the legislation and has become ingrained in the industry.

"The government remains committed to encouraging film production in the UK through use of the reliefs in the way in which the legislation allows - but this does not extend to deliberate exploitation of those reliefs," the Inland Revenue commented.

The pre-Budget report in December 2004 had bad news for film financiers. In a statement released following Gordon Brown's delivery of his pre-Budget report, Harry Hicks, head of the Film and TV department of professional services group, Chiltern Plc expressed disappointment at the tax measures affecting film financing unveiled by the then Chancellor, likening them to using a "sledgehammer to crack a nut".

Mr Hicks announced that he was particularly surprised at the decision to clamp down on double claims for tax relief on the same film, observing that although the government recently expressed its displeasure at illegitimate 'double dipping': "the Revenue confirmed that they have no objection to two claims for relief so long as there is a recognition of income within the transactions".

Other new measures contained within the pre-Budget report included the restriction of film tax deferral to 15 years, the extension of sale and leaseback anti-exit rules for companies that have accessed film tax relief, and the restriction of loss relief for individuals in partnership. All of the changes in film financing tax law unveiled by the Chancellor were effective from December 2, 2004.

Figures issued in January, 2005, seemed to bear out the forebodings of the doom-sayers. The number of films made in the United Kingdom during 2004 fell by almost half, and the number of British film projects started fell to 27, 44% less than the 44 film projects which began production in 2003. The total spent declined to GBP117.8mn in 2004 from GBP269mn the previous year. Moreover, there was a reduction in the number of British and American co-productions, from over 100 in 2003 to 81 in 2004.

The decline in productions choosing to locate in the UK was largely attributed to the Inland Revenue's move to prevent the manipulation of trading losses for tax purposes, shutting off a considerable source of funding for the industry in the process.

In April, 2005, reports suggested that the ongoing uncertainty surrounding tax breaks for film productions staged in the United Kingdom could result in many big-budget productions moving abroad.

A decision by the producers of the GBP67mn project, The Watchmen to halt production at the world famous Pinewood Studios attested to the increasingly unfavourable tax and cost climate. Producer Lloyd Levin said that the “loss of certain rebates” in the UK along with the weak dollar in relation to the pound had forced Paramount to explore alternative “shooting scenarios.”

In August, 2005, following the UK Treasury's announcement of a review of film tax reliefs in Budget 2005, a consultation document was published setting out proposals for new tax incentives for the production of films which make a cultural contribution to Britain, a move which was welcomed by members of the British film industry.

The new proposals were viewed as a lifeline for the film industry in Britain, which had faced mounting uncertainty after the Treasury decided to scrap the system of tax incentives known as Section 48 because it felt that they were too readily abused by film financiers.

The consultation, known as 'Reform of Film Tax Incentives: Promoting the sustainable production of culturally British films', reflected the Government's view that more could be done to encourage effective and sustained investment, while providing better value for money for the British taxpayer and the film-going public.

The proposed new relief aimed to achieve the following:

• Direct and easier access to support for film producers ensuring better value for money for taxpayers;
• Better targeting of support towards culturally British films, including more generous levels of benefit for those British films in need of greater support;
• Greater flexibility for film-makers in light of the increasingly global nature of film-making - balanced with incentives that support the sustainability of UK infrastructure and human and technical resources, to ensure the ongoing production of culturally British films; and
• Ensuring that the cinematic successes of today can help support the successes of tomorrow by providing producers the most generous level of benefit where they are committed to medium-term investment in UK film productions.

In parallel, the Department for Culture, Media and Sport launched a consultation on a proposed objective cultural test for British film.

Welcoming the Treasury's announcement, UK Film Council Chief Executive Officer John Woodward commented that the new approach to film tax incentives would encourage investment in multiple production projects.

"The consultation proposals represent a totally new approach to tax relief for film," Mr Woodward observed.

He added that: “The precise value of the new relief will be determined by the way in which filmmakers choose to use it. Where they continue to structure their films in the same way as they do now, the level of benefit will broadly be the same. However, the new reliefs will deliver a bigger benefit when the income from a film is reinvested against future film production."“This marks a totally new beginning for film tax relief and the coming months of the consultation period will be crucial as the detail of the proposal are worked through."

In November, 2005, it transpired that the UK Treasury would be delaying the introduction of the new system of reliefs, in order to gain approval for them from the EU under State Aid rules. (Approval was subsequently granted in April 2006.)

Then in March, 2006, the government announced that new legislation was being introduced into the 2006 Finance Bill to shut down a complex tax avoidance scheme exploiting the tax relief intended for film production in the UK.

The scheme in question combined a film sale and leaseback partnership with a separate but parallel investment partnership. It provides individuals using the scheme with a tax advantage greater than the amount invested whilst avoiding any taxable income at a later date.

"This is a particularly aggressive attempt to exploit the current tax reliefs intended to support the British film industry. As we made clear in December's Pre-Budget Report, the Government will take swift and appropriate action to counter such abuses of the tax system. We will continue to monitor the use of the existing tax reliefs as long as they are in place," explained Primarolo.

In September 2006, the head of the UK's Pinewood Shepperton studios predicted a brighter future for the British film industry now that the new set of tax incentives had been established.

Commenting on the company's first half financial results, Ivan Dunleavy, chief executive, said that he expected more big budget productions to come to Britain in the years ahead after a period when uncertainty surrounding the industry's tax regime saw production companies using more foreign studios.

"With the passing of the legislation to implement the new UK film tax relief and clarity over UK film fiscal policy, we expect to see a return to a more normal film production environment by the end of 2006 with larger film productions once again committing to filming in the UK for the future," he stated.

Pinewood Shepperton, one of Europe's largest and most popular studio complexes, reported an improved operating profit of GBP3.6 million (US$6.8 million) for the first six months of 2006, up from GBP1.4 million in the same period last year.

In November, 2006, it transpired that the UK's new film finance tax credit scheme was attracting investors too, with a new hedge fund planning to raise GBP150mn to finance films in expectation that they will make enhanced profits due to the tax credits.

In July 2007, a new report suggested that the UK government’s new film tax relief was working well, keeping the UK competitive and supporting the growth of a thriving film sector.

As a result of the tax incentives, the UK was expected to attract around 11% of global film production over the period to 2010 with inward investment rising to about GBP800 million by then, the report by Oxford Economics predicted.

Commenting on the findings, John Woodward, Chief Executive Officer of the UK Film Council, stated: “This new report shows that the UK film industry is a major contributor to the UK economy making films that UK and international audiences want to see and generating financial and cultural benefits. Thanks to our world class film facilities and phenomenal skills and talent, backed by Government and industry investment, the British film industry is strong and primed for further growth."

However, a March 2008 announcement regarding the restriction of tax relief on film investment schemes caused concern.

Commenting on the announcement by HM Revenue & Customs, Lucy Elwes, senior tax manager KPMG’s UK media practice, explained that the new measures would mean that it will no longer be possible for individuals to offset losses from their film investments against their other income, unless they played an active part in the management of the film business.

“Similar legislation was introduced in last year’s budget to close down tax relief on losses incurred by partnership film businesses. The new legislation targets individuals seeking to shelter otherwise taxable income," Elwes stated.

“The UK film industry has benefited a great deal in recent years from the flow of investment through tax-driven structures. While today’s announcement won’t come as a surprise to the industry given HMRC has made no secret of their dislike of these types of arrangement, it will undoubtedly have a negative effect on the funding of the British film industry," she concluded

However, figures published in November 2008 by Financial Secretary to the Treasury, Stephen Timms were showcased by the government as evidence of the success of the UK film industry, thanks to the new film tax reliefs.

The figures, which were the first to be published since the scheme began in January 2007, showed that GBP104 million in tax relief had been provided to support the production of around 100 new UK films.

The figures showed that 110 claims received tax relief to the end of March 2008, totalling GBP104mn, and covering around 100 new films. Overall 155 claims had been made over that time, for a total of GBP126mn, although a number of the claims were more recent and therefore still being processed at the time that the figures were compiled.

Stephen Timms said: "These figures reinforce the role film tax relief is playing in strengthening the British film industry and encouraging the production of high quality home-grown films. This is a dynamic industry that has continued to be resilient in the face of difficult economic times. The UK's share of the global theatrical market was USD3.3 billion in 2007, with the top 10 performing UK films worldwide grossing around USD2.5 million, up 26% on the previous year."

Culture Minister Barbara Follett added: "The importance of film tax relief in supporting one of our most successful and culturally important creative industries should not be underestimated. UK-made films provide entertainment, employment and a cultural commentary that I think is vital and the tax relief scheme is an indication of just how committed the government is to this vibrant and diverse sector."