Tax Avoidance Schemes

Written evidence from Future Capital Partners

Tax Avoidance Schemes

I would like to thank the Chair of the Public Accounts Committee (the " Committee "), as well all Committee Members, for inviting me to give evidence before them on 6 December 2012 on tax avoidance schemes. I have received a copy of the transcript from the hearing, which I have reviewed, and I would like to provide the Committee with some further information which I hope will clarify some questions and answers and ultimately be of assistance to the Committee in preparing its report.

Generally throughout this letter I will refer to specific questions asked, and answers given, at the hearing. However, it is important to first set out the background, which I believe requires clarification, and I therefore do so below.

1. Film Tax Relief

A common theme throughout the hearing was the film tax reliefs introduced by Government to encourage growth of the British film industry and the mechanisms by which such reliefs were given and such growth was achieved. In particular the Committee focused on sale and leaseback structures and the acquisition of completed films. There seemed to be some confusion concerning film tax reliefs, especially in relation to the acquisition of a completed film. During the hearing, owing to time constraints, I did not have the opportunity to explain film tax reliefs fully and so would like to take the opportunity to do so now.

Section 42 Finance Act 1992 ("section 42") introduced tax relief which was spread over 36 months for expenditure on the production and/or acquisition of British Qualifying Films. Section 48 Finance Act 1997 ("section 48") accelerated that tax relief to 100% in the period that the production and/or acquisition expenditure was incurred where the film had a cost of production of less than £15 million. The accelerated relief was introduced to encourage investment in and the growth of the British film industry. It is worth noting here that the tax reliefs introduced by both section 42 and section 48, and the mechanisms used to realise that relief, achieved their intended aim of substantially growing investment into the British film industry.

Between 1992 and 1997 banks used finance leases (sale and leaseback) to acquire completed British films and lease them back to the producer – effectively shifting the reliefs from the producer (who was unable to extract any value from the relief) to the acquirer (who was able to use the relief). The producer received the benefit of relatively cheap finance which it could use to make it easier to finance films and consequently grow its business by retaining more rights. These transactions were forerunners to partnership transactions with individuals. When the accelerated tax relief was introduced in 1997 a new market opened up of individuals looking to invest in film structures and access the tax relief – and with a higher marginal rate than corporates, the net economic benefit to the producer (i.e. cash benefit) selling to a partnership was higher than that from a bank.

When section 48 was introduced in 1997 HMRC, in an effort to clarify their practice, issued guidance notes known initially as Statements of Practice and later as Business Income Manuals. These prescriptively laid out, over a number of pages, in great detail, HMRC’s understanding of how leasing transactions (i.e. the sale and leaseback of completed British films) involving individual investors would qualify for the statutory tax relief assuming they were structured in the manner described. They also set out other stipulations regarding the use and availability of these reliefs. Future, other promoters, investors and our respective advisers paid great attention to these guidance notes.

The growth in the popularity of partnerships, initially acquiring and then producing British qualifying films was astonishing. Our estimates were that by 2002, the total size of the market had grown to over £2 billion per annum in expenditure that qualified for either section 48 or section 42 relief (including bank transactions). These individually funded transactions generally followed very closely the form that was prescribed by HMRC in their Business Income Manuals; partners borrowed about 80% of their capital contributed to a partnership on full recourse terms, over a 15 year period; partnerships acquired from film producers completed films and leased them back to the same producer (or a related entity) with lease rentals fixed sufficient to allow the partnership to distribute income to partners that would discharge their loans and interest; the producer would place an amount very similar to that borrowed by partners on deposit with another bank (not the lending bank) that would issue a letter of credit in favour of the partnership, assigned as security to the lending bank. Typically the difference between the purchase price of the film and the amount placed on deposit was called the Net Benefit – and whilst in the early days of bank dominated film leases, this was probably about 2% - 4% of the film’s production cost – by the time the relief came to an end, this was up at 17% - 20% of the production cost from individually funded partnerships. It was through the Net Benefit that film producers benefited, very substantially, from individually funded partnerships, as was intended. The reliefs thus had a material impact on the ability of producers to finance British qualifying films and thus achieved their intended purpose of growing investment into the British film industry. The sale and leaseback structure described above to access the film tax reliefs is explicitly set out in HMRC’s Business Income Manual 56455 (attached).

Partners would benefit from the transaction as they would derive tax relief on almost 100% of their capital contributed to the trade; lease rental income would pay off the loan and interest; income that repaid principal would be taxed – but income used to pay interest would be offset by a deduction available on the interest paid. Cash on cash, over their lifetime, these transactions would be cashflow negative for investors – and absent other changes to commercial circumstances, would require the initial tax relief to generate a return (called a Hurdle Rate) to allow an investor to meet the deferred tax liability. These transactions simply deferred tax. Again, all of this was intended by the film tax relief legislation and recognised by HMRC in their Business Income Manuals.

The above is not intended to be a comprehensive commentary on statutory film reliefs. However, I hope that it assists the Committee in an area that I perceived there could have been some confusion.

2. Specific questions

Question 118 and 122

The Chair asked that I talk the Committee through a sale and leaseback model (as described above) and referred to a partnership named Terra Nova. Terra Nova is not a sale and leaseback partnership and did not utilise the statutory film tax reliefs referred to above. Terra Nova provided film production services to a major US studio.

The Chair stated (question 122), and I will paraphrase, that Terra Nova exploited an important Government initiative to encourage more films to be created in the UK to get a tax advantage that Parliament never intended. That is not correct as Terra Nova did not utilise the statutory film reliefs introduced by Parliament. If the Chair was inferring that sale and leaseback transactions exploited the statutory film relief legislation in a way that Parliament never intended that is equally incorrect, and i refer to my fuller explanation above of these reliefs.

Question 118 and 119

The Chair asked whether Terra Nova had been "closed down" by HMRC. Terra Nova was not specifically "closed down" in the sense that that phrase might be taken to mean. Legislation was introduced in March 2007 that limited sideways loss relief for non-active partners i.e. partners who do not spend a significant amount of time carrying out activities for the purpose of the partnerships trade. The amendment to the legislation was not specifically directed at Terra Nova and was applicable to all partnerships which had non-active partners. Terra Nova itself was not affected by that legislation as it was a transaction that had been implemented in the previous year. However, the transaction could not have operated in the same way were it implemented after March 2007.

If the Chair was referring to the fact that HMRC have closed their enquiry, we made an application to the Special Commissioners (now the First-tier Tribunal) to direct HMRC to close their enquiry and issue a closure notice, because it was our view that HMRC were unnecessarily delaying the progress of the enquiry. The case is now being litigated with a hearing expected in the second half of 2013.

Question 129, 130, 131, 132, 133

This set of questions related to the acquisition of completed films. Specifically at question 132, Mr Bacon states "If the purpose of the legislation was to encourage the making of British films, as I understand it to have been, it sounds like within it there was the capacity to use the scheme to do things other than finance the making of British films." Please refer to my background comments regarding the statutory film reliefs above (i.e. section 1.). As stated, accessing statutory film reliefs through the acquisition of completed films via sale and leaseback transactions was a very important source of finance for British film production companies. Ultimately this enabled investment in the British film industry and allowed the production of many British films as was the intention of the legislation.

Question 140, 141, 142, 143

These were questions that all related to Jersey general partnerships. Specifically the Committee wanted to know why Jersey general partnerships were used. The Committee were concerned that in using a Jersey general partnership partners were not declaring all information to HMRC. This is not the case. The partnership tax returns that were submitted to HMRC contain the name, address, UTR and NI number for each partner. Furthermore, as I said at the hearing, the partners income tax returns would contain all of the details of their participation in the transaction. No information was disguised or withheld from HMRC. We provide HMRC, as a matter of course, with all the transaction documents in any transaction we promote. In the course of any HMRC enquiry we will also provide HMRC with thousands of e-mails and other correspondence. We are very open with HMRC and provide them with all the information they might need (often before there is any legal requirement for us to do so).

If the partnership is registered at Companies House, the partner’s name and address would be available to the public and it is for this reason that partners want to preserve confidentiality.

Question 175

At question 175 the Chair mentioned what she termed "exit schemes" in reference to sale and leaseback transactions. During the hearing I tried to explain the commercial reasons that partners may want to leave partnerships such as their credit exposure to financial institutions such as Bank of Ireland. Other reasons include:

· films have performed badly in some cases and generated insufficient income to repay loans, for which investors are fully at risk;

· tax rates have increased from 40% to 52% (including NI);

· investment returns have plummeted making it a struggle to generate the Hurdle Rate;

· HMRC has taken a revisionist approach to these old transactions, even structures based entirely and solely on their own Business Income Manuals;

· laws have been changed retrospectively that affect, in some cases, these businesses or their partners;

· a growing number of partners have left the UK, introducing risk to the non payment of tax by non UK resident partners – and HMRC’s stated attempts to pursue the remaining members for that tax.

A number of these considerations can influence partners’ behaviour and result in them wanting to take appropriate commercial steps to manage their risks.

Question 238

At question 238 the Chair says that the sole purpose of Eclipse Film Partners No.35 LLP ("Eclipse 35") was to avoid tax. With respect the Chair’s statement is completely incorrect. The First-tier Tribunal found at paragraph 412 of its decision that Eclipse 35’s paramount objective was not to procure a tax advantage; rather Eclipse 35’s paramount objective was to obtain the returns inherent in the Distribution Agreement and what Eclipse 35 did is not to be characterised as a mere device to secure a tax advantage. As this case is subject to ongoing litigation, it is not appropriate to comment further.

Question 241

We currently have 255 investment vehicles (i.e. partnerships and companies) that we have promoted or are responsible for. These 255 investment vehicles fall within 12 types of structure including film sale and leaseback partnerships and enterprise investment schemes, etc.

I trust that this letter will be of assistance to the Committee when it writes its report. I also hope that it clarifies some issues where I perceived there could have been confusion.

Tim Levy


13 December 2012

Prepared 31st December 2012