The introduction of the UK tax credit in 2006 was meant to end the war between the film financiers and the UK’s Inland Revenue. So why is the battle still raging over Section 48?

“Stars face massive payback demands” trumpeted the headlines in a Sunday newspaper last month when the story broke that the UK’s HM Revenue and Customs (HMRC) was investigating Ingenious Media’s  Inside Track Fund, a 2003/4 scheme that it believes might have been  used for tax avoidance rather than for genuine investment in the British film industry.

During the days of Section 42 and Section 48 tax relief for British film, there were many other similar film partnership schemes based on what accountants call sideways loss relief. Famous footballers  and media personalities are among the high net worth individuals who invested substantial amounts into such funds.  “The loopholes which allowed the tax relief to be abused with no benefit to the film industry have been closed. If we find evidence of abuse we will take steps to put things right,” a spokesperson for HMRC commented. “Generally, the Revenue are investigating all of these old schemes,”  suggests accountant Christine Corner, a partner at Grant Thornton UK  LLP. “There are a number waiting for the Revenue to say  what their case  is or to agree the tax losses.”

The financiers themselves have insisted that their schemes are  legitimate. “As a matter of routine, all of our businesses are subject  to rigorous scrutiny and have been found to have been operated in the proper manner. In particular, we have consistently demonstrated that investors have claimed correctly for any losses that they have  incurred,” an Ingenious spokesperson commented.Many think Ingenious will soon be vindicated. “As far as we’re aware, Ingenious are confident that the HMRC enquiry will ultimately be unsuccessful as they strongly maintain that their film partnerships are  not tax management schemes but bona fide investment businesses,” says Abigail Payne, a partner in the Film and Television Group at lawyers  Harbottle & Lewis.

Nonetheless, in the current straitened economic climate, the Revenue is determined to claw back money wherever it can. There is little public sympathy for wealthy investors who may have avoided taxes - or, in some  cases, even have profited from the tax - by making a show of backing  British movies.

If HMRC outlaws the old schemes, the investors will have to repay the tax along with interest and - possibly - a penalty fee. In other words,  as one well-placed observer puts it, they’re in for “a big hit.”

Setting a worrying precedent for the financiers, HMRC recently won a case against Icebreaker LLP, a partnership involved in sideways loss relief. However, the Revenue subsequently lost a similar case against  Tower MCashback.

Questions remain too about the long-term future of “sole trader”  schemes (that’s to say, schemes with investors actively involved in  film production who work at least 10 hours a week on the movies they back.)  In a recent memo about tax avoidance, the Revenue pointedly  noted that in its eyes, “reading scripts” did not constitute  meaningful commercial activity. However, those who run sole trader schemes seem sanguine about  their  prospects.  “You need to look at the intention of the trader. If they are doing  this just to pad out some diary they submit to HMRC with the intention of claiming sideways loss relief, you can  imagine that HMRC will look  at that very closely. If, however, this  is a genuine trade and individuals are undertaking script reports, script reading, with the intention of furthering their trade and increasing their profit, then  that I think is the kind of activity HMRC will be quite happy to see sole traders undertaking,” says Adam Betteridge, Chief Operating  Officer of Premiere Picture which runs  the Sovereign sole trader structure.

To many, it can’t help but seem a little disorienting that the Revenue  is still poring over the activities of the film business in such  forensic detail. Since the so-called “tax bombshell” of February 2004, when HMRC first clamped down on tax partnerships thereby unravelling  the financing of some high profile films (Tulip Fever among them),  there have been frequent interventions from the Revenue. The assumption  was that the introduction of the UK film tax credit in 2006 would end the war of attrition between financiers and HMRC. “The tax breaks for investment in British films have been significantly reformed so that  the relief goes where it was always intended to go - those who produce films and employ talent,” a spokesperson for HMRC comments.

But is the HMRC turning a blind eye to the complexity of film financing? Producers remain as reliant as ever on  the so-called “middlemen” to finance their films. For British producers, the ongoing battle between the Revenue and the financiers doesn’t  immediately seem such a burning issue. It relates to funds and movies from several years in the past, before the  introduction of the tax credit. The producers are too busy trying to finance their current movies to worry about schemes from so long ago.  Nonetheless, the danger is that investors may lose faith in the British  film industry.

As Christine Corner puts it: “In terms of investors, they’re starting now to get fed up with always being under investigation by the Revenue.”  Others argue that the investors already realise that backing British  movies isn’t simply a short-cut to a tax advantage. “It (film) is  absolutely a commercial business. It needs to be looked at on a commercial basis,” states Adam Betteridge. “Any tax relief available is really just a by-product in the event that some of the films they might  go into don’t do as well as they hope.”