On Saturday, The Times published a page 1 article about how the UK’s tax authority, HM Revenue & Customs, was planning to come after some 780 investors in a type of tax avoidance scheme that ostensibly invested in film productions, “demanding” that they pay “up to 20 times the amount they invested”. The headline was “Stars face ruin over tax bill”, and among the celebrity investors named were former Manchester United manager Sir Alex Ferguson, former England managers Sven-Göran Eriksson and Glenn Hoddle, and former Sainsbury’s chairman Sir Peter Davis. One observer told the paper that the scale of the demands was such that he thought there could be “people potentially jumping off bridges”. Here, Gerry Brown, an Edinburgh-based chartered accountant and tax commentator who began his professional career as an Inland Revenue Inspector of Taxes, considers the matter, and how we ended up here…
According to The Times, “hundreds of bankers, celebrities and businessmen have claimed they face bankruptcy after the taxman demanded they repay up to 20 times the amount invested in a huge avoidance scheme”. Some of these investors in the so-called Eclipse tax avoidance scheme were, the paper said, facing bankruptcy.
How did we arrive at this sad state of affairs?
It all began back in the 1990s, when the UK government introduced a tax code for film production, designed to assist the British film industry.
Expenditure on the production or acquisition of a film could be deducted in computing the profits and losses of a trade of exploitation of films, before any income was received. This meant that early losses arose which could be used to shelter tax on other income and gains.
That sheltered tax was then effectively repaid, through higher tax liabilities in later years, as income arose from leasing the film. This offered a tax deferral of up to 15 years for investors.
The investment was usually funded by cash and a secured loan. The investor obtained a cash flow benefit after claiming loss relief, but had to pay tax on the income stream from leasing, which also had to be used to repay the loan.
Investment schemes were set up which used these reliefs as intended. Here’s how it worked:
1. A typical scheme involved an investor acquiring the rights to a film, and leasing those same rights back to a film production company. This company then would proceed to produce the film, with the lease agreement generating a revenue stream for the investor.
2. In practice, investors in such films were usually “grouped” into limited liability partnerships (LLPs).
An investor in such a project would provide capital from his/her own resources, and this would then be “geared up” with a loan. These loans usually represented in excess of 90% of the total funding of the LLP.
3. The income received by the LLP from the production company repaid the loans on behalf of the investors. The arrangement created a “loss”, which then would be used to offset against the investors’ own taxable income.
Government and HMRC were happy with this; tax relief was the honey that attracted the investors to the British film industry.
However, tax avoidance schemes soon followed, devised to exploit the reliefs in ways contrary to the government’s intention. These (including the Eclipse schemes) were challenged by HMRC, which argued that the schemes were structured to create a tax relief for the investors, rather than to produce films.
In most (but not all) of the cases heard by the tax tribunals and the courts, the HMRC view prevailed, and investors were accordingly denied tax relief.
There are outstanding appeals in relation to some schemes and these will be heard in due course.
The consequences for those investors whose schemes have been successfully challenged by HMRC are now becoming clear. Investors will lose the ability to offset the “loss” against their taxable income.
The tax the investors sought to defer or shelter will then fall due. In most cases, loss relief claims will have been processed, and tax repayments made under the “process first, review later” approach adopted by the UK’s self-assessment code.
Investors will also become liable for income tax on the lease income used to repay the bank loans that supported (typically) 90% of the investment.
This lease income will be taxable, even though it goes straight to the bank, and is never actually received by the investor.
The “gearing”, essential to generate enough cash to purchase expensive film rights, will now work against the investor.
It is widely accepted that the additional tax demands will reach about 10 times the level of the cash investment provided by the investor. It is these demands which could lead to bankruptcy.
The lending banks are presumably still happy with the stream of lease payments, which will gradually reduce the loans.
HMRC is turning the screw by issuing Accelerated Payment Notices (APNs), which means that the tax in dispute must be paid before any tribunal or court hearing on the merits of a particular case. (There is no right of appeal against an APN.)
The major London-based law firm, Withers, has begun a class action against promoters of tax avoidance schemes, on behalf of professional footballers and other celebrities. It is alleging that the investors were victims of mis-selling by advisers who specifically targeted young and financially-inexperienced footballers.
Other law firms are investigating possible claims. It should be borne in mind that many claims could be “time barred”.
For some investors, this sorry saga has been running for 10 years, and seems set to run for a few more – particularly if the class action proceeds to full-blown court hearings.
Meanwhile, the time taken to resolve these tax disputes, and others, is fast becoming a scandal, and the government should be taking steps to clear the huge backlog of tax appeals. Nearly 30,000 tax appeals were “open” as at 6 April 2015, and it is believed that the number has increased since then.
All we can do for now is to hope, while all of this is dragging on, that no one actually does jump off a bridge.