Public Accounts CommitteeSupplementary written evidence from Ingenious
1. Introductory Statement
The Committee’s Oral Evidence session was prompted by the publication of the NAO’s report on Tax avoidance: tackling marketed avoidance schemes (HC 730). We reject the contextual premise that lies behind the invitation to us to give oral evidence: we do not market “tax avoidance schemes”.
The report cites the HMRC “working definition” for tax avoidance of “using the tax law to get a tax advantage that Parliament never intended”. Everything Ingenious does has a commercial profit motive attached to it and is designed to deliver trading profits.
It is true that our investors have been able set off early stage losses in our production partnerships against other income but this is not unique to film and is done in precisely the way Parliament intended—that is to say through sideways loss relief (“SLR”) in general accounting principles, to encourage investment and enterprise (these provisions were effective in law between 1960 and 2007). More often than not, the losses incurred in the early years are offset by the profits arising in later years, which are taxable.
Unfortunately, the Committee’s discussion of these issues was at key moments confused. The Chair appears to mix up two different legal bases (see especially Q 223). It is therefore useful to provide a short overview of the relevant statutory framework. It is not possible to understand film financing during the period in question, or to understand the role played by tax incentives within the film industry, without fully comprehending this legislative framework.
This supplementary memorandum therefore comprises: (a) a short account of the relevant legislative framework; (b) an account of Aries Film Partners, which, with respect to the Chair, is not “an exit scheme”; and (c) detailed comments on specific numbered Questions.
2. The Legislative Framework
Under section 48 of the Finance Act (No. 2) 1997, the Labour government introduced a provision allowing acquirers of British qualifying films to claim a 100% deduction for the cost of those films in the year of acquisition. This legislation manifested itself in a mechanism called “ sale and leaseback” which provided private investors with the ability to reduce their income tax liabilities by joining UK partnerships set up to undertake the sale and leaseback trade. This was fully supported by HMRC through a statement of practice, SP1/98. A similar piece of legislation (section 42 of the Finance Act (No. 2) 1992) was already on the statute book but the deduction could only be claimed on a straight line basis over three years. The new section 48 allowed the deduction to be claimed in year one (but only on films below £15 million).
This stimulated a wave of private investment into the UK film business, but was ultimately unsatisfactory in its consequences. Notwithstanding the considerable benefit to the film services sector from increased levels of production, the sale and leaseback mechanism was open to abuse.
Moreover, investors did not take performance risk on the films. Commercial success or failure was irrelevant because investors simply received a tax deferral, to be paid back over the life of the film lease irrespective of film performance, while the producer used his benefit from the transaction to help defray the cost of production. It was a purely financial arrangement which largely failed to achieve the original policy aim of creating sustainable film production businesses.
However it did set the scene for investors to move further up the risk curve. The next generation of film partnerships did take performance risk, while using SLR for any losses realised to protect the downside. This was done under general accounting principles: SLR was available to individual investors in partnerships from 1960 onwards and was not confined to the film industry.
The quid pro quo was that partnerships’ income from film exploitation was taxable in the UK, so that in the event of commercial success HMRC would be better off because the tax paid on income would exceed the initial tax relief.
Unfortunately these arrangements were similarly open to abuse. As a result, and notwithstanding our attempts during Standing Committee proceedings on the Finance Bill 2007 to persuade Parliament to preserve SLR by introducing a purpose test and a pre-clearance procedure so as to eliminate abuse, SLR was eventually restricted to “active” investors.
Finally, in 2007, the film tax credit (FPTC) was introduced by the Labour government in place of s.42 and s48. Ingenious advised the Film Tax Unit at HMRC during consultations on this new credit.
3. Aries Film Partners (“Aries”)
Aries is not an “exit scheme”, as repeatedly claimed by the Chair in the oral evidence proceedings.
Aries was established in 2003 under the sale and leaseback provisions referred to above. Investors received tax relief on the cost of the acquisition of a film and were then subject to tax on the income arising from the subsequent lease of the film, creating a tax deferral.
Partners in Aries have recently been presented with an opportunity for the partnership to acquire a new film for leasing exploitation, in continuation of its existing trade. We, Ingenious, propose to provide around 82% of the additional capital required with the remainder coming from the other partners. The proposed profit share allocation for any income generated by this further trading activity would be 95% to our client and 5% to the other partners. This is a necessary adjustment to reflect the fact that the capital allowances arising on the new acquisition are effectively allocated by law to the partners who contributed capital towards the acquisition of the partnership’s films and accordingly receive a proportionate share of any annual income from those films. Income arising from the original films and the new film is effectively pooled in the partnership and the capital allowances available by reason of the acquisition of the new film are, as a matter of law, set against the totality of the income.
Because the new films do not, initially, generate income, the allowances are claimed only in respect of the original income and are as a consequence of capital allowance legislation allocated to the partners who have an income share in the original films. Therefore, as Ingenious does not receive a share of original film income, in order to balance out the benefits received by the other partners from the availability of capital allowances, we seek to receive more of the income generated by the new film. This is simply an equitable arrangement to reflect the fact that we do not benefit from the capital allowances.
When the new film begins to generate income, the partners will be taxed at their usual rate of income tax and we will pay corporation tax at 24%. With the addition of dividend tax of 36.1% on the balance the effective rate of tax on us is 52%. Accordingly, all of the income generated by the new film acquired by Aries will be taxed at a significant rate: there is no income which escapes taxation in the UK. The same partners in the same partnership are carrying on the same trade, with all income still subject to UK tax.
If a partner chooses not to make a further investment he will continue to be allocated the same net taxable profits as always envisaged and will continue to pay tax on those profits. All income arising from the new film is fully subject to UK tax. If the film fails commercially, the partners will have lost some or all of their further capital contributions but will also have received tax relief from the capital allowances. Again, this is precisely the intention of the overall scheme of capital allowance legislation and is applied on a purely mechanical basis.
It is thus demonstrably clear that Aries is not an “exit” scheme as erroneously stated by the Chair.
4. Detailed Comments on Numbered Questions
Q 199: insert after “we have not bought films” the words “through our production partnerships”.
Q200: insert after “The only buying of a film…” “occurs in relation to sale and leaseback. In recent years we have acquired some American films. We acquire them to invest in their future commercial performance.”
Q202/3: The Chair is mistaken. Sale and leaseback provisions were not “closed down”: on the contrary, they were extended by the government in 2005. They subsequently expired in 2007.
Q216: “there are film partnerships”…
Q218: the “film tax credit” was introduced in 2007.
Q223: this exchange is very confusing. The Chair talks about amending “the film tax” but the only provisions amended in 2007 were the SLR provisions of general finance legislation: this took place, or so we were advised by HMRC at the time, for reasons that had nothing to do with film.
Q245: Insert after “Yes”, the words “we produced a detailed written account of our conversations with HMRC”.
Q246: Avatar is just one of the films financed through our production partnerships. All of our films have been financed “properly”.
Q248: the Chair makes repeated reference to “my note”. If this is a note supplied by HMRC and the note denies the commerciality of our production financing arrangements we categorically reject what is said in the “note”.
Q255: insert after “I agree, totally” the words “as a matter of law”.
Q258 et seq: the references to Jersey here amount to a red herring. These companies were trading in the UK and subject to full UK tax.
13 December 2012