Thousands of City workers have had their plans to shelter bonuses from tax capsized just weeks before the end of the tax year, as the Revenue has watered down a crucial benefit of widely- used partnership schemes.
Such schemes, which invest predominantly in films, but also in wind farms, medical research and technology, have been used to mitigate or defer hundreds of millions of pounds worth of tax each year. They work by generating trading losses in the first year, which high net worth individuals have been able to offset against their earned income for tax purposes using a process called “sideways loss relief”.
But the Revenue last week introduced a £25,000 annual limit on losses that can be used to offset income sourced from outside the partnership. Tax advisers say this is low enough to effectively kill off investment into these schemes as costs can be high.
Martin Churchill, editor of the Tax-Efficient Review, says: “Snipping the sideways loss relief has really choked up these schemes.”
He believes £2bn would have been poured into these schemes between now and April 5, with around 75 per cent of that going into film production schemes offered by companies such as Ingenious Media, Future Films, Scion and Invicta Capital.
“Everybody was gearing up to put significant amounts of money into these schemes. Bonuses get paid in February and people don’t tend to do anything until the run-up to the end of the tax year,” says Churchill.
He believes there are currently around 2,000 investors in these schemes, with a total of £5bn wrapped up in them.
The Revenue’s crackdown is the latest in a string of hard-hitting anti-avoidance measures that have significantly stifled the choice investors have to protect their income from tax. The Revenue has also taken action to close popular schemes that allowed investors to avoid tax by investing in and then chartering out yachts and light aircraft.
The Revenue did soften the blow to film schemes with a fast U-turn that introduced an exemption for more complicated “sale and leaseback” schemes, after warnings that more than 100 films, including the latest James Bond, Casino Royale, would have had their funding frozen. Sale and leaseback schemes essentially allow investors to defer tax and are considered more restrictive to investors as they are limited to British films.
The schemes that have been capsized by the new rules are those that rely on a style of accounting known as a “Generally Accepted Accounting Principles” or GAAP. Under the GAAP system, trading losses in the first year could be offset against income earned from other sources in the last three years.
These schemes gave investors more freedom – they could put money into Hollywood films, for example, and there was no maximum investment. Also they offered investors immediate tax relief (see box) and the chance to make money from the film – or other venture’s – future success.
Film scheme providers say the schemes were not tools for tax avoidance but genuine investment opportunities for investors interested in making money from films. But without the bonus of tax relief in the first year, these would be a big gamble for any investor as there is no guarantee a film will be successful. Partnerships will now only be able to offset losses against future profits generated by the venture itself.
Andy Gadd, head of research at Lighthouse Group, a firm of financial advisers that was promoting several film schemes to clients, says: “This is a clampdown on a perfectly legitimate tax planning tool. It is another example of the government coming out with legislation without thinking it through.”
The rule change may also have profound consequences for the British film industry.
Patrick McKenna, chairman of Ingenious Media, which was this year planning to finance at least 20 films, says: “This has blown up the film industry in this country. I have never seen such draconian rules affecting the industry.”
He points out that had sideways loss relief not existed, then neither would films such as Notes On A Scandal, Night At The Museum and Hot Fuzz.
“[The Revenue] has taken a very blunt instrument to deal with this. It has not discriminated between bona fide investment and tax abuse,” says McKenna.
He says investors were piling into these schemes to benefit from the returns generated by the films. The initial costs of Ingenious’s schemes, which were granted approval by the Revenue, typically eat into the tax rebate. “There was no money to be made from the tax relief,” says McKenna.
Gadd says the changes have also intensified the confusion among investors as to where they can invest.
“This worsens the feeling of uncertainty for investors. Advisers are trying to give advice and people don’t want to follow it as they are worried the investments could be closed down,” he says.
Investors who have recently put money into these schemes run the risk of losing their funds. Schemes can no longer source new funding, and if they do not reach minimum funding levels they could collapse. People who put money into schemes a year ago should be safe, although there is still some degree of risk as the Revenue has never shown one of these schemes a green light and therefore could recoup tax in the future.
Essentially the only options still available to wealthy investors are permitted schemes – pensions, venture capital trusts (VCTs) and enterprise investment schemes (EISs) – which all have fairly strict investment limits.
Octopus Investments says the clampdown on partnership schemes will boost VCT and EIS investment by £50m-£60m over the next few weeks.
Richard Rhys, chief executive of MNFA, a financial adviser, expects a wave of new tax schemes to emerge within days to mop up the excess demand from high earners. “The avoidance industry has a voracious appetite. There are so many people looking to shelter or defer tax that other opportunities will not be far away.”
