UK appeal court upholds key film partnership ruling, as HMRC criticised over film industry tax probes

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A UK appeals court on Friday upheld a key ruling against two film scheme partnerships that were marketed as a legal tax avoidance measure designed to encourage the development of the UK’s film industry, agreeing with a tax tribunal’s ruling last year that the schemes had not been found to be genuinely “trading” as claimed, and thus failed to qualify for the receipt of tax relief. 

Among the films that were made as a result of the two financing structures were Roman Polanski’s Oliver Twist, Stephen Frears’s The Queen, and Sam Garbarski’s Irina Palm. 

On Saturday, as news of the decision in the case involving the Samarkand 3 and Proteus 1 film partnerships had yet to become widely known, the BBC reported – without mentioning the latest ruling – that the chairman of the Treasury select committee had criticised HM Revenue & Customs for “its response to the exploitation of tax breaks for the film industry”.

According to the BBC, Tyrie had written to the chancellor, Philip Hammond, after his office had been contacted “by an increasing number of people concerned that HMRC investigations into such schemes were’not always fair nor what anyone could have expected'”.

“Many have said that, when these schemes were being sold, they were not considered to be aggressive avoidance, but just a deferral of tax, and they were often marketed as routine tax management,” Tyrie, a Tory MP, told Hammond, according to the BBC.

“Whether or not these claims are valid, it does appear that many individuals are facing very severe financial distress as a consequence.”

HMRC rejected the criticism, the BBC noted, quoting an HMRC spokesperson as saying, “We have worked hard to tackle abuse in the system on behalf of the vast majority of investors who play by the rules, ensuring they are enforced fairly, and with sensitivity”.

Films ‘included Oliver Twist’

Friday’s Court of Appeal decision, which was written by Lord Justice Henderson, with Lord Justice David Richards and Lady Justice Arden concurring, came to the same conclusion as a tax tribunal did last year, in upholding a 2011 ruling in favour of HMRC, which found that the two film partnerships had not been deemed to be “carrying on a trade”, and thus failed to meet a key pre-requisite for their investors to qualify for tax reliefs.

Like many film financing partnerships schemes that were widely promoted during the earlier years of this century, Samarkand 3  and Proteus 1  followed a “sale and leaseback” model, under which film rights were bought and sub-licensed. (The diagramme, below, is from the court documents published on Friday.)

In December, it was reported that HMRC’s counter-avoidance unit had offered to settle with some of the film partnerships, potentially enabling them to avoid expensive court costs.

HMRC scrutiny seen unavoidable

Gerry Brown, a Scotland-based tax expert and long-time observer of the international taxation landscape, noted that the rationale behind the UK’s tax code on film investment –  that investors receive certain tax advantages, in return for accepting the commercial risks inherent in film production – meant that “schemes designed to eliminate the risk but retain the tax advantages are always going to come under HMRC scrutiny”.

“Last week’s cases could be reduced to an investment of borrowed capital followed by guaranteed returns. The courts came to the conclusion that this type of ‘activity’ didn’t amount to a ‘trade’, and therefor the inevitable losses – production costs always come before revenue generation – could not be set against the investor’s other income.

“The anticipated tax refunds were an integral part of the financing of these investments, and the fact that they will not be forthcoming may cause significant financial embarrassment to some investors.”

‘Catastrophic financial difficulties’

With respect to Andrew Tyrie’s concerns about HMRC’s handling of the film partnership cases, Frank Strachan, partner and head of tax at the London law firm Edwin Coe, said he thought the member of Parliament was “absolutely right” in calling the chancellor’s attention to the matter.

“Many investors were told that such investments were not aggressive, and in some cases I have heard they were advised that the investments were approved by HMRC,” Strachan added.

“Once the Courts find an investment does not work, it is entirely correct that the tax avoided should be repaid, but the use of APNs [Accellerated Payment Notices, which require the payment of disputed tax amounts upfront] is disproportionately weighted in HMRC’s favour. The sums HMRC are levying are, in some cases, many multiples of the amount invested, and can result in catastrophic financial difficulties.

“I suspect in due course, that once APNs and film investment schemes are regarded as a thing of the past, reports will show that HMRC used APNs in too aggressive a manner, and that their use of them should have been brought under control sooner.

“As it currently stands, all legal challenges [with respect] to the legality of APNs have failed.”

To read and download the latest court decision in the Samarkand 3 and Proteus 1 film partnerships matter, click here.