The clampdown on Enterprise Investment Schemes (EIS) is expected to have an immediate impact on UK film financiers, with mid-budget films set to be the worst hit.

The changes to EIS, announced by HM Revenue & Customs (HMRC) in the pre-budget speech last week, mean it will no longer be possible for several different EIS companies (each capped at $3.3m (£2m) to contribute to  the same film via a partnership or limited liability partnership (LLP). This practice, referred to by some as “daisychaining,” has now been outlawed.

While mid-budget films, in the $3.3m to 16.4m (£2m to £10m) range, are expected to be worst affected, some big budget features will be also be stymied.

Goldcrest Film Production LLP, set up earlier this year to support British films in the $3.3m - $13.m (£2m to £8m) ranget will be unable to raise further funding under the EIS. The fund, which has an advisory board  including such industry heavyweights as Michael Kuhn, David Parfitt and Graham Broadbent, aims to provide 20% of a film’s budget. Goldcrest has provided post-production services on several independent British films already including Centurion (pictured), St Trinian’s 2: The Legend Of Fritton’s Gold (pictured) and Ken Loach’s forthcoming, Route Irish.

Adam Kulick, a partner at Goldcrest, said: “Films in the £2m to £10 million range are cobbled together from a variety of different sources many of which have been drying up recently due to the collapsing debt markets and the lack of liquidity for equity. These EISs were playing an enabling role in order to help a producer close financing and were geared toward British production.”

Kulick pointed out that HMRC clampdown is not “retrospective” and so will not affect any EIS fund raising completed prior to the pre-budget report (or funds raised under the auspices of an HMRC advance assurances) as was the case with Goldcrest Film Production LLP. “We will therefore be able to proceed with a slate of mid-budget range of British films.”

He added that Goldcrest’s overall strategy of building a company covering post-production, sales, financing and production would remain the same. “However, we have to re-evaluate the method by which we finance the making of British films following the changes.”

The changes will not affect financiers using individual EIS funds such as financier and production company Matador Pictures.  Founder Nigel Thomas, said: “We welcome the changes because it takes out of the system some of the people who are pushing the envelope. Overall, that is damaging to everyone. There comes a point when the Government just gets so fed up with the abuses that they close the whole thing down. I am glad that they (HMRC) are focusing attention on EIS as it is supposed to be operated.”

Thomas added that the idea of using EIS to fund very big budget, star-driven movies does not make sense. “It shouldn’t have to rely on wheezes like daisychaining EIS’s together. Such films should be possible to finance out of the marketplace in a conventional manner.”

Christine Corner, a partner at accountants Grant Thornton, pointed out that EIS daisychaining was a relatively new practice, which she believes will limit the impact of the changes.  “It was at the margins but it was something that probably would have taken off a bit more,” she added.

“Generally, producers are struggling because there isn’t much finance out there at all. There is a lot less gap finance, banks have pulled out - it is getting harder to get films financed.”

What does it mean for film financing?

What has HMRC announced?

It has announced a change to their interpretation of what constitutes an EIS qualifying trade. Previously an EIS company could raise money from individual investors (a maximum of $3.3m (£2m) could be raised by each company in a 12m period – i.e. not enough for most films to be made from a single company). Then several EIS companies would contribute the funds to a partnership which may have say £10m of funds to make a film (e.g. 5 x £2m per company contributed to the partnership).

The partnership is transparent for tax purposes so the five companies who have put £2m each are all deemed to be carrying on a proportion of the partnership trade and share a proportion of the partnership losses.

HMRC are changing their interpretation so that a company trading through a partnership will now not be deemed to be carrying on a qualifying trade and the company won’t be an EIS company. In turn, investors won’t have the tax reliefs they used to benefit from.

How did it work before?

Previously there were structures in place raising tens of millions of pounds from high net worth individuals allowing them to benefit from EIS relief if the film(s) were successful (i.e. 20% tax relief on the initial share subscription and a CGT free disposal of the shares after three years). Also, in the event that the film was not a success the investor could make a s131 election (share loss relief) allowing them to treat the capital loss on the shares as an income tax loss to set against other income taxed at 40%.

What prompted HMRC to make these changes?

HMRC have not objected to companies trading through partnerships for a long period but the trigger point which appears to have upset them is the loss claims under s131 (which is linked to EIS relief).

Say an investor borrowed £114, 508 (£70,000) on a non-recourse basis and also used $49,088 (£30,000) of their own money - subscribing $163,602  (£100,000) in total. If the film was not a success then they would have a capital loss of $163,602 (£100,000) which could be set against other income taxed at 40%.Their $49,088 (£30,000) investment would generate $65,451 (£40,000) in tax relief and their non-recourse loan would be written off.

Some of the structures are quite complex to explain but HMRC clearly did not like it and preventing an EIS company operating through a partnership was an easy way for them to stop it.

What will this mean for film funding going forward?

In the short term, a lot of funding was coming from these sources for both UK and international projects. It mainly impacts larger budget films.

Smaller budget films using EIS finance with no underlying partnership are better off after the pre-budget report because the rules that stated a company need to trade wholly or mainly in the UK have been relaxed. Now a company only needs to have a “permanent establishment” in the UK?

What do film companies need to be aware of?

Smaller film companies with smaller budget projects can still raise EIS funding but larger budget films are likely to find funding from film funds will be significantly reduced.

If the funding of larger studio films is impacted this could have a knock on effect on the UK film business generally e.g. pre and post production work.

Q&A supplied by David Brook, a tax partner at accountants BDO, who specialises in film financing.