UK Film Partnerships:

Film partnerships provide 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 are particularly useful to people with significant income tax bills; the rules allow 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 allows 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’ is more generous and allows the loss to arise entirely in the first year of the partnership. In either case the loss can be used against income in the year of the loss or in the previous three years. However, film partnerships require a 15-year commitment, and are financially complex. Up to 19 investors put money into a general partnership set up to buy film rights. The minimum investment is usually between £50,000 and £150,000. Of this, the investors puts up only between 15 and 22 per cent, with the rest loaned by a bank.

The partnership then buys the rights to one or more qualifying films from a producer. To qualify, the film must meet criteria laid down by the government about what is and what is not a British film, so it must already exist. The partnership then leases the distribution rights back to the film's producer on a long lease (the maximum is 15 years). The producer pays an annual rental to the partnership that equals the capital and interest repayments on the partnership loan. The lease payments usually increase by 5 per cent a year. The investment is therefore neutral in capital terms, but the benefit is that the whole of the investment qualifies for tax relief in the first year because the partnership can write off 100% of the acquisition costs of the film. So on £100,000 there will be a tax rebate of £40,000 for an outlay of only, say, £15,000.

That tax rebate will then be repaid to the Revenue over the period of the loan, because the capital repayment element of the lease payments will be taxable income for the partnership.

The film partnership scheme attracted about £500m in investment in its first two years, so it is fairly well understood and tested by now. Some variants of the scheme allow investors to trade in and out of film partnerships, thus allowing shorter time horizons - but the Revenue has not yet accepted this principle, and for the time being therefore the variants are risky.

Given that Section 48 relief was due to expire in 2005, further film partnership products were developed which do not rely on specific legislative tax breaks. In addition, the definition of ‘British films’ has been amended to exclude TV films. This has 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 £15 million, 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 stated that the current level of tax relief provided for the British film industry is "absolutely essential" for its long term health, and urged the UK government to preserve the system of tax breaks for film-makers known as Section 48.

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 warns.

Last year, said the Committee, film-making in Britain was worth GBP533.3 million, and since the Section 48 measures were introduced in 1997, some GBP2.59 billion had been spent on production in the UK in total.

Then in October Arts Minister Estelle Morris urged the Treasury to renew the Section 48 tax breaks, although she conceded that the scheme was open to abuse by investors using the system to evade taxes."The evidence is that the tax credit has done what it was meant to do. It was a sound investment and it has proved its worth," Morris announced. "It will be for the Treasury to decide. But I'm quite clear what my role is and...I think (the credit) has got to continue."

Whilst Ms Morris acknowledged that the scheme was open to abuse, particularly by television companies, she said that on balance the case for retaining the tax breaks was overwhelming.

In February 2004 however UK Paymaster General, 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.

Nevertheless, Daniel Taylor of Grosvenor Park, a leading provider of tax based film finance to producers around the world, stated in a Financial Times report that the government's latest move was “literally a death blow” to many film projects which are currently being financed by such partnerships. Taylor predicted that many small independent film-makers will be sent to the wall as a result of losing up to a third of their financing budgets provided through partnership arrangements.

The Inland Revenue meanwhile, insists that the new rules were designed to prevent individuals from "drawing up complex scams to take advantage of the relief and avoid tax".

"This legislation will not prevent film-makers benefiting from film tax relief and it will not hurt legitimate film-makers," added the Revenue.

In May, 2004, the government went further, announcing that it will 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 applies for co-production with the UK will, from 1 July, have to spend 40% of its budget in the UK to qualify. This represents an increase of 10% from the current level.

Explaining the reasoning behind the clampdown, Film Minister 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 have 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 this 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. Other notable projects such as ‘Tulip Fever' featuring British star Jude Law, are still in the process of restructuring their finances and schedules have been set back by about six months.

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, Paymaster General, 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 are that:

The money will be paid direct to film-makers, not through third parties, so it will be less open to abuse;

The relief will cover 20% of production costs compared to the 15% covered by the old Section 48 relief;

Films with budgets of up to £20 million will be able to benefit, compared to a limit of £15 million under Section 48;

For the first time, the relief will include an added incentive for films to be profitable;

The relief applies to all production expenditure, not just that spent in the UK; and The maximum relief which can be claimed on a qualifying film will rise typically to £4 million compared to £2.25 million 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 Section 48 rules.

In December, 2004, the Inland Revenue 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 is not happy that some filmmakers are 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.

However, industry members warn that a clampdown by the UK tax authorities on film finance will lead to confusion over the rules, and the likelihood that many production companies will take their business to other countries.

The pre-Budget report in December 2004 had bad news for film financiers, however. In a statement released following Gordon Brown's delivery of his pre-Budget report on Thursday, 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 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 £117.8 million in 2004 from £269 million the previous year. Moreover, there has also been a reduction in the number of British and American co-productions, from over 100 in 2003 to 81 last year.

The decline in productions choosing to locate in the UK has been largely attributed to the Inland Revenue's move last February to prevent the manipulation of trading losses for tax purposes, shutting off a considerable source of funding for the industry in the process. One high profile victim of the change was ‘The Libertine,' which was saved by additional funding and the transfer of production to the more tax-friendly Isle of Man. However, many film projects, including ‘Tulip Fever,' which starred Jude Law and Kiera Knightly, were forced to suspend production and search for alternative backers.

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. The attractiveness of the UK as a production location is being challenged by the government's decision to tighten up the tax regime relating to the financing of film production which, coupled with an uncertain future over the Section 48 tax breaks and the strong pound had prompted a fall in the number of foreign films being shot in Britain. A decision by the producers of the £67 million project The Watchmen to halt production at the world famous Pinewood Studios attests 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.”

The ongoing uncertainty surrounding the longevity of tax breaks for the film industry in the UK has also sparked speculation that Warner Brothers will switch production of the fifth Harry Potter movie, The Order of the Phoenix, to the Czech Republic from Scotland and Leavesden Studios in Hertfordshire. 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 being 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', reflects the Government's view that more can 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 aims 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. “This consultation signals the Government's continuing recognition of the cultural and economic benefits that film production brings to the UK," stated Paymaster General Dawn Primarolo.

"It provides a real opportunity to maximise the role that tax incentives can play towards Government objectives for film by ensuring greater effectiveness, value for money and a better contribution to the sustainable production of culturally British films in the UK," she added.

In parallel, the Department for Culture, Media and Sport launched a consultation on a proposed objective cultural test for British film. The test aims to better identify culturally British films that might be considered eligible for the new tax incentives. It will offer filmmakers more flexibility by ensuring that a range of measures – personnel, cultural content and facilities – are given more consideration in assessing whether a film qualifies as British. Under the current system, these issues are considered only indirectly as part of the expenditure tests.

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."

It emerged in October 2005 that uncertainty over the tax regime for film production had led to a reduction in interest in the UK as a location, impacting on the profits of Pinewood Shepperton plc, one of the country's leading studios.

Unveiling its results for the six months to June 30, Pinewood revealed that operating profits before exceptional administrative expenses, finance costs and taxation had sunk to £1.9 million, compared to £6.6 million for the same period last year.

Speaking with regard to the disappointing figures, Michael Grade, Chairman, announced that: "As previously indicated, trading conditions for Film Stage Services during the first half of 2005 were challenging as a direct result of outside factors. On 29 July 2005 the Government finally issued its consultation document on the future of UK film fiscal policy."

"We welcome the Government's commitment to continuing fiscal incentives for the UK film sector, and the fact that the issue is now on its way to a positive resolution. Inevitably, some uncertainty will remain while the details are finalised, expected by the Spring of 2006."

"The Board believes the disappointing results for the first half do not indicate any fundamental shift in the film production business as a whole. Our strategy therefore remains unchanged and the Board remains confident in the long term prospects for the group."

In November, 2005, it transpired that the UK Treasury would delay the introduction of the new system of reliefs until April, 2006, in order to gain approval for them from the EU under State Aid rules.

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 combines 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.

Version date: 07.05.06