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Session 2005 - 06
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Standing Committee Debates

Draft Partnerships (Restrictions on Contributions to a Trade)Regulations 2006

The Committee consisted of the following Members:

Chairman: Mrs. Janet Dean
Blackman, Liz (Erewash) (Lab)
Breed, Mr. Colin (South-East Cornwall) (LD)
Davidson, Mr. Ian (Glasgow, South-West) (Lab/Co-op)
Fallon, Mr. Michael (Sevenoaks) (Con)
Goldsworthy, Julia (Falmouth and Camborne) (LD)
Gray, Mr. James (North Wiltshire) (Con)
McDonnell, John (Hayes and Harlington) (Lab)
Moffat, Anne (East Lothian) (Lab)
Mudie, Mr. George (Leeds, East) (Lab)
Palmer, Dr. Nick (Broxtowe) (Lab)
Primarolo, Dawn (Paymaster General)
Reed, Mr. Andy (Loughborough) (Lab/Co-op)
Selous, Andrew (South-West Bedfordshire) (Con)
Smith, John (Vale of Glamorgan) (Lab)
Tipping, Paddy (Sherwood) (Lab)
Viggers, Peter (Gosport) (Con)
Villiers, Mrs. Theresa (Chipping Barnet) (Con)
Emily Commander, Committee Clerk
† attended the Committee

Second Standing Committee on Delegated Legislation

Wednesday 14 June 2006

[Mrs. Janet Dean in the Chair]

Draft Partnerships (Restrictionson Contributions to a Trade)Regulations 2006

2.30 pm
The Paymaster General (Dawn Primarolo): I beg to move,
That the Committee has considered the draft Partnerships (Restrictions on Contributions to a Trade) Regulations 2006.
Good afternoon, Mrs. Dean. What a pleasure it is to see you in the Chair. It is the first time that you have chaired a Committee in which I am the Minister and I am looking forward to a successful debate this afternoon.
The regulations are made under powers introduced in the Finance Act 2005 and provide detailed rules to tackle tax avoidance schemes used by wealthy individuals investing in partnerships. The schemes were a direct attempt to sidestep the anti-avoidance rules under the Finance Act 2004, which prevented individuals exiting from film partnerships free of tax. That was an outright tax avoidance measure.
The regulations, together with the legislation under the Finance Acts 2004 and 2005, bring that practice to an end and ensure that the abuse cannot take place. They exclude certain amounts from an individual’s contribution to a partnership when calculating the amount of a film exit charge under the anti-avoidance rules in the Finance Act 2004, particularly when an individual’s share of future partnership profits is reduced after a new partner has been admitted into the partnership. The regulations exclude from the individual’s contributions an amount based on the capital contribution made by the new partner. When individuals have claimed tax relief for film-related losses in excess of the amount of their capital contribution to the partnership, an exit charge will arise under the anti-avoidance rules in the FinanceAct 2004.
I shall now explain the background to the regulations and say what they will achieve. Generally speaking, film partnerships obtain tax benefits from the previous reliefs for film production by means of a sale and leaseback structure. The partnership buys a film from a producer who then immediately leases it back in return for a series of rental payments, usually over a period of 15 years. In the early years of the lease period, the initial cost of buying the film creates losses that the members of the partnership can use to offset against their income and gains, thereby reducing the amount of tax that they have to pay. However, when the loss has been used up, the share of lease rental payments that the partner receives in later years constitutes income on which the tax is due. In other words, the benefit of a sale and leaseback structure delivers a tax deferral whereby investors can postpone their tax liability to a future date, but there is still a tax liability.
The mischief that the regulations are aimed at dealing with is those schemes that seek to transform the deferrals into an outright tax advantage by allowing the individual investors effectively to exit from the partnership at the point at which the taxable income starts to arise. We have seen schemes that sought the same outcome, and legislation was introduced under the Finance Act 2004 to ensure that individuals could not simply walk away from their tax liability once they had taken advantage of the up-front tax benefit of a sale and leaseback arrangement. Further legislation under the Finance Act 2005 also stopped corporate investors exiting from agreements at the point at which they would have to start paying tax. As I said, that is outright avoidance.
The schemes were a direct attempt to get around the existing anti-avoidance rules that stop that sort of exit. They did so by means of a totally artificial structure in which an existing film partnership is restructured to admit a new partner. That new partner is based offshore and contributes capital that the partnership uses to purchase additional film rights. That expenditure is offset against the income from the lease payments on which the United Kingdom partners would otherwise have been taxed.
The income arising from the new film rights is allocated to the new partner. The UK partners receive taxable income only if there are further profits realised much further into the future—if at all. In that way, the UK partners can avoid paying tax on their income from the original lease payments as they arise. In theory, there is no limit on the number of times that their liability to tax can be postponed. The effect is to transform the simple tax deferral, which is in the system, into a permanent tax advantage. Needless to say, the Government rejected the suggestion that that was a legitimate form of tax planning and the regulations specifically aim to prevent it.
The regulations are effective from 20 December 2005—the date on which they were announced. They build on the current exit rules and impose a charge to income tax on the individuals in a film partnership if a new partner is admitted into the partnership and contributes capital to it, if changes are made to the arrangements for sharing profits and losses in the partnership or if the rights of the existing partners to share in future profits from the partnership are reduced. Where those conditions are met, the amount that the new partner introduces into the partnership is apportioned between each of the existing partners, in line with the arrangements that were in place for sharing profits and losses before the new partner was admitted.
The regulations stipulate that the amounts apportioned to each of the existing partners should be excluded when determining whether the restructuring of the partnership constitutes an exit event for the purposes of the 2004 anti-avoidance rule and, if so, what amount is chargeable to income.
The regulations only affect partnerships that sought to avoid the tax charge that arises in the deferral income arrangements by introducing a new partner into the partnership in the circumstances that I have described. They have no impact on the straightforward sale and leaseback structures in which tax liabilities are merely deferred.
On this occasion, with this type of tax avoidance, we can be specific about what we are seeking to prevent with straight objective tests, so clear is this arrangement. Unfortunately, this is not the first time that the Government have had to act to end deliberate abuses of tax reliefs put in place for film production. The reliefs are in place until 1 April 2006. The Government have made clear statements on numerous occasions that they will continue to monitor the use of the reliefs and take firm action to stop avoidance where it occurs. The schemes that I have mentioned are a perfect illustration of the type of abuse at which those statements are directed. They also demonstrate why the Government were entirely right to replace the old film reliefs with the new regime, which is only available to film production companies and cannot be claimed by investment partnerships whose only involvement in film making is arranging or providing finance.
Although the Government are committed to supporting the British film industry and have been generous in doing so over the years, we are equally committed to tackling avoidance wherever it happens—in the film industry or anywhere else. We hope that the tax avoidance industry has now got the message, but it can rest assured that the Government will act decisively to stop any attempt at future abuse. I commend the regulations to the Committee.
2.39 pm
Mrs. Theresa Villiers (Chipping Barnet) (Con): The Opposition share many of the Government’s concerns about the extent to which the film tax relief regime has been used for aggressive and artificial tax avoidance purposes. Therefore, we have no objection to a statutory instrument that is focused on one such aggressive attempt to get round the existing anti-avoidance legislation for film-related partnerships.
The statutory instrument seems to be in line with the approach that the Government have taken with other such legislation. As we have heard, it targets attempts to transform a deferral of tax into a permanent outright tax reduction. Hence, we are broadly supportive of the approach taken.
We are concerned that the costs of sections 42 and 48 film tax relief have spiralled from £10 million in 1997-98 to £520 million in 2004-05 and a staggering £560 million in 2005-06, according to the Paymaster General’s response to a recent parliamentary question. Those are huge sums when one takes into accountthe fact that the UK’s entire cinema sales were only £770 million last year.
The Opposition remain concerned about the continued avoidance problems with film tax relief and that those have necessitated more or less continuous change in the structure of the tax system. The tax break scheme for film has been revised by the Finance Acts 2000, 2002, 2004 and 2005 and radically by the Finance Act 2006. We hope that the scheme set out in this year’s Finance Bill will prove a more stable structure—one that is less open to abuse, yields better value for money for the taxpayer and is more directly targeted on the people who are producing the films.
The jury is out on the way in which the new film tax structure will work. We hope that it will achieve all those goals and be a significant improvement on the current regime. As we have heard from the Paymaster General this afternoon, the regime has significant flaws that have created opportunities for its use for avoidance purposes, which were never intended by the Exchequer when it was adopted.
2.42 pm
Mr. Colin Breed (South-East Cornwall) (LD): I, too, have no problem with the regulations, as they will prevent a clear abuse of the system that should be stopped as soon as possible. One has to marvel at the ingenuity of people who can utilise relatively sensible and innocent proposals designed to assist a valuable part of the UK economy for such nefarious purposes. That is a shame because, as has been demonstrated, the film tax credits have been targeted in a way that is wholly unhelpful to the film industry.
The tax avoidance industry, as the Paymaster General calls it—accountants and lawyers—might begin to understand that their continual seeming to undermine such things will only harden people’s views about providing assistance to genuine parts of the UK economy. I hope that the message goes out to the appropriate people. I am therefore pleased to support the regulations.
2.43 pm
Dawn Primarolo: Given that acceptance, there isnot much to add. I want to take the opportunity to thank the hon. Member for South-East Cornwall(Mr. Breed). I think that the hon. Member for Chipping Barnet (Mrs. Villiers) made the same point, but the hon. Gentleman made it clearly: there are lots of good reasons to have reliefs in a tax system, and sale and leaseback is one example. If they are persistently abused or used in ways that were never intended by the House, legitimate business and enterprise will be damaged in the end, because Her Majesty’s Revenue and Customs will inevitably take steps, through legislation as well as enforcement, to protect the revenue and prevent such activity. That makes things more complex and more difficult for everyone. I am grateful to the hon. Gentleman for reinforcing that strong message, which is a clear one that the House should send out.
On reliefs in film, sale and leaseback is a general relief in the tax system, in the sense that it can and does apply in lots of places. Film has been targeted by such schemes, but the new tax credit, which is paid to the producer rather than through financiers, will take us a long way towards protecting the film industry, by ensuring that those involved are committed to films, as opposed to trying to find tax avoidance schemes. With those closing comments, I commend the regulations to the Committee.
Question put and agreed to.
Committee rose at fourteen minutes to Three o’clock.

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