The UK has a popular film tax credit and newly boosted investment schemes. But are controversial tax avoidance stories hurting film finance? Geoffrey Macnab reports

A recent statement issued by Manchester law firm Pannone is headlined: “Investors in film partnership schemes face financial ruin.” This is just the latest in a drip feed of stories, allegations and counter-allegations around recent reports in the UK media about film finance and tax avoidance.

In April, in what was described as a landmark victory for Her Majesty’s Revenue and Customs (HMRC), a tax tribunal ruled that investors in the Eclipse Film Partners No 35 LLP scheme will not be entitled to tax relief, reportedly worth £117m (around $184m), because the scheme was concerned with tax avoidance rather than genuine trading.

The Eclipse case followed the earlier decision by a tribunal in favour of HMRC in September 2011 in a case against two film partnerships promoted by Future Capital Partners (Samarkand Film Partnership No 3 and Proteus Film Partnership No 1).

Then, in late June as part of its overall investigations into tax avoidance, The Times newspaper quoted a source from HMRC as saying that it had 600 film schemes under investigation and that such “schemes are a £5bn [$7.86bn] risk for us at least”.

‘Some of our investors are refugees from the sketchier schemes, which don’t seem to have had much benefit for the investors’

Nigel Thomas, Matador Pictures

While most financiers cried foul against HMRC, some in the industry suggested the film partnership schemes were indeed abusive and deserved to be “outed” in the press.

Now there is the prospect of legal action on many fronts. The financiers are pitted against HMRC and the media, while investors blame the financial advisers who drew them into the partnership schemes in the first place.

Critics of the partnership schemes have long expressed outrage at the way the schemes generated artificial losses and gave investors the opportunity to claim tax relief on far higher sums than they actually invested.

Now, however, the argument has turned full circle. Kit Sorrell, senior professional negligence partner at Pannone, recently commented that investors may be required to “pay income tax on ‘income’ they never received”. Their liability, he suggested, could be 10 times their original capital investment, adding: “For many investors, this enormous liability will come as an absolute shock and could lead to financial ruin.”

Taking action

Leading UK film financier Ingenious has begun legal action against both The Times and HMRC. Ingenious protested fiercely that it was not, and never had been, in the business of tax avoidance.

Even venerable pop star Elton John weighed into the debate. The Times had claimed incorrectly that Ingenious chief executive Patrick McKenna was the UK musician’s former accountant. Though the newspaper printed a clarification, John sued for libel on the grounds the newspaper had falsely linked him to “immoral tax avoidance”.

Given the amounts of money involved and the high profile of many of the protagonists, it has been inevitable the story has continued to generate plentiful coverage in the UK press. Premiership football managers and players and various celebrities are among the high-net-worth individuals who have invested in partnership schemes.

However, many observers within the film industry doubt whether the feuding between HMRC and the film partnership schemes any longer has anything to do with them or with the long-term health of the British film industry. After all, this was all ancient history - the article in The Times called into question investments mostly in the late 1990s.

The disputes re-awakened memories of the bad old days of sale and leaseback and the alleged abuses under Section 42 and 48 tax relief.

Since its introduction in 2007, the UK film tax credit has worked smoothly and the stables had been cleaned - or so the industry thought. Amid much fanfare, prime minister David Cameron announced last year that this targeted tax break for the film industry would be extended until the end of 2015 - a clear sign the tax relief had further received official blessing. The extension of the tax credit to high-end TV drama, animation and video games in the March 2012 Budget was more evidence the government was ready to support the creative industries with fiscal breaks.

Endorsing EIS

European Union approval was given earlier this summer to the new UK Enterprise Investment Scheme (EIS) rules. The annual investment limit for qualifying companies under EIS can now be raised to £5m ($7.85m) - up from £2m ($3.1m) - which makes it more attractive as a vehicle for investing in film.

“Our investors perceive [EIS] as something that is very much endorsed by HMRC,” said Nigel Thomas [pictured] of producer/financier and EIS specialist Matador Pictures. “Quite clearly, HMRC is encouraging film investment to go through EIS with the tax credit.

‘A lot of the partnerships used legislation introduced to incentivise investment in film. It was seen as a good thing’

Christine Corner, Grant Thornton

“Certainly, some of our investors are refugees from some of the sketchier schemes that have been around, which honestly don’t seem to have had much benefit for the investors… The benefit seems to have accrued to the promoters.” On the face of it, then, the film-financing landscape in 2012 seemed stable and transparent. The bad blood between HMRC and film-finance schemes was something from another time. Dave Morrison from accountancy firm Nyman Libson Paul said: “If there was a war with the Revenue [and the film industry], there was a ceasefire in 2007. There might be a few rogue groups carrying it on, on both sides.”

Other film financiers have struck a less sanguine note. One prominent figure in the sale-and-leaseback era and still active today suggested HMRC has been leaking details to the media in a strategic way.

“What has been developed is legislation by the media,” he suggested. “What the Revenue is doing right now is a war of attrition. They’re fighting cases that I think are very straightforward and should not be fought.”

He added that, thanks to the controversy, “investors have walked out the door. They just do not want to be involved in this sector any more.”

HMRC had no comment to make about the allegations it had been briefing the media but one Revenue source denied emphatically that anything had been done to compromise taxpayer confidentiality.

Another expert was angry at the statement from the British Film Institute (BFI) distinguishing between “government-approved tax reliefs… and tax schemes which have nothing to do with those statutory reliefs and just happen to use film as a vehicle for minimising the tax contributions of individuals.”

The attitude among some financiers is that the BFI should recognise that “actually, these outlandish tax deals most probably were legal and ultimately will be proved so”.

“A lot of the partnerships were using legislation which was introduced to incentivise people to invest in film,” said Christine Corner, a partner in the media and entertainment group at accountancy firm Grant Thornton. “The government at the time saw them as a good thing.”

The cases that are being fought in the courts now relate to partnership schemes or the later GAAP schemes set up several years ago that were dependent on something called sideways loss relief. Such schemes worked by generating trading losses that high-net-worth individuals were able to offset against their earned income.

Morrison argued that most of the mature investors the film industry is now targeting are sophisticated and well-informed enough to know what they are doing, but that the stories in The Times and elsewhere are not helping investor confidence.

An added concern is the continuing uncertainty over whether EIS is going to work as a source of funding for British film. The latest draft guidance issued by HMRC earlier this summer provoked further disquiet. Experts attacked this guidance as “opaque at best”.

Grasping complexity

An Ingenious spokesperson said: “The key worry is that HMRC does not seem to understand the film and TV sectors in all their funding complexity and appears to entertain certain prejudices about the nature of abusive behaviour within them which, if not challenged, could severely limit the inflow of funds through the EIS.”

To the outsider, it is a thoroughly confusing picture. These seem halcyon times for British film. The tax credit is in place, Lottery funding for film is set to increase after the Olympics, the industry has given a warm welcome to the Film Policy Review, US studios are increasingly active in the UK and box-office successes from The Inbetweeners Movie to The King’s Speech have bolstered confidence. However, the counter argument is that the ongoing feud between HMRC and the financiers - and its prominent coverage in the media - cannot help but damage confidence in the sector as a whole.

“A shrivelled-up industry even more desperately short of risk capital,” is what one observer said the UK will be left with if investors are discouraged from putting their money into film.