Film tax: and (tax) cuts

The way in which high profile individuals choose to invest their money has
attracted a great deal of press comment in recent weeks, much of it sparked by
the reported financial involvement of Wayne Rooney and other professional
footballers in the hit film Avatar. For some time, the tax planning
opportunities offered by film investments made them a popular choice among those
with short-lived but highly paid careers, looking to defer tax receipts until
their more modest, post-retirement years.

However, since HMRC clamped down on perceived abuse by the film partnerships
behind many such schemes, the options are now much more narrow than the
headlines suggest.

Film partnerships typically used contributions from individual investors to
purchase one or more completed films. As a result of tax incentives to encourage
investment in the film industry, the partnership was able to obtain 100% tax
relief for expenditure on the films. The tax relief for the film generated
trading losses for the partnership, which could be used by individual partners
to shelter their income from a variety of sources and, thereby, crystallise
income tax repayments.

The partnership would then lease the film back to its producers, in exchange
for rental payments over a 15-year period. Those receipts would generate profits
for the partnership, which would be taxable on the individual partners over the
15 years. In addition to rental payments, the partnership would also receive
income if the film investments it made were particularly successful at the box
office.

Essentially, the net effect of the investment by individuals was the deferral
of an income tax liability arising in one tax year into a 15-year future period.
As this was prior to the introduction of the 50% rate of income tax, those
individuals would expect to still be subject to tax at 40% in future years. The
investment allowed them to trigger a substantial tax repayment, which could be
reinvested to generate returns greater than the expected tax payments in future
years arising from the film investment.

However, concern that certain structures were abusing the tax rules prompted
HMRC to gradually change the legislation, effectively removing the ability to
invest in television programmes as well as films. Some partnerships were
structured with an exit after an initial short period, so the full 15-year life
of the arrangement and the resulting income stream was cut short. HMRC acted
against these arrangements by imposing exit charges upon them. It also withdrew
the legislation which provided 100% tax relief for film expenditure incurred in
the first year of the partnership’s trade, as well as restricting the ability of
individuals to shelter income with trading losses arising from the film
partnerships.

Despite all of these changes to the legislation, investments in film
partnerships are still possible, although now structured in a different way.
Partners must demonstrate they are involved in the trade of the partnership and
would typically need to spend at least 10 hours per week actively involved in
its trade. This probably rules out the future involvement of Mr Rooney and
plenty of others, so other options must be explored.

For example, Employer Financed Retirement Benefit Schemes (EFRBS) – the more
glamorous sister to pension schemes – are constituted as a discretionary trust,
to provide retirement benefits to employees. As an EFRBS is not a registered
pension scheme, there is no restriction on the amount of contributions that can
be paid by the employer. Employees are not taxed on the contributions made to
the EFRBS on their behalf and National Insurance Contributions are also not
payable. The contributions are invested by the EFRBS and there is flexibility
around the asset classes available for investment.

On retirement, the trust fund is used to provide retirement benefits for the
employee, in the form of a pension, annuity or a lump sum. All such payments
from the EFRBS are taxable on the individual but, if retirement has been
reached, then the individual’s overall level of income is likely to have
reduced, potentially saving him from the 50% tax net. Of course, the individual
may have become non-UK resident after retirement, in which case the EFRBS income
may not be subject to UK tax at all.

Alternatively, property – the traditional investment of choice for those
wishing to spread their tax liability – can still be an attractive option if
handled correctly. Those with existing investments may find the structures
through which they hold property expose them to an increased income tax
liability. They may wish to consider restructuring these, to allow them to
shelter income but continue to benefit from the lower rate of capital gains tax
on capital growth.

Any such activity is often best undertaken as part of a broader portfolio
review, which may include a focus on investment for capital growth, rather than
income. Appropriate professional and investment advice should be taken when
deferring or sheltering income.

Although generally more prosaic than the glamorous world of film investment,
there remain plenty of legitimate ways for high profile or high income
individuals to even out their tax liability over the course of their career.

Gwen Souter is head of the corporate tax team at law firm Maclay Murray
& Spens LLP