UPDATE: The End of Easy Money

HMRC Wins Against EIS Film Partnerships

Updated December 2, 2017

Funds previously available to film and television production companies in the U.K. through the Enterprise Investment Scheme (EIS) and other tax structures are likely to reduce significantly.

UPDATE: In an attempt to summarize complicated legal and tax matters, FilmTake erred by failing to draw the necessary distinctions between recent court rulings and proposed rule changes. For that, we apologize. Below you’ll find a better summary of the issues.

The first issue addresses proposed rule changes by the government affecting EIS investments. The next highlights Ingenious Media and its litigation with Her Majesty’s Revenue and Customs (HMRC). The last issue is about a recent ruling by the United Kingdom Supreme Court (UKSC).

Proposed Rule Changes

According to new rules proposed by the Treasury, producers and taxpayers will no longer be able to use tax structures that solely finance production tax credits, presales, and other guaranteed funds.

Massive international productions, hundreds of independent films, and game developers have banked billions through tax-advantaged investments in the U.K.

The government views the lack of risk for investors in many sophisticated financing structures as pure avoidance and an unintended consequence of specific statues.

Proposals suggest excluding revenues from distribution presales, and income through film tax relief from EIS-eligible investments. The result of these changes will not only affect production finance in the U.K. but globally.

Although the government is trying to reduce the use of the EIS for tax avoidance purposes, it recognizes that presales, tax credits, and other pre-contracted funds contributing to a film’s budget, may still qualify for EIS treatment.

“The government also recognises that within film and media specifically, it is normal commercial practice to secure pre-agreed income (e.g. pre-sales or eligibility for other support). To meet the risk to capital condition investment must be genuinely at risk. Investment that is not covered or protected by pre-agreed income or support (referred to in the media industry as the “gap”) will be eligible. The rule also does not preclude the investment being made to fund costs where a proportion is covered or protected by pre-agreed income or support, provided that the investor remains at significant risk.”

– Treasury Consultation Paper: ‘Financing growth in innovative firms’

According to the consultation paper ‘Financing growth in innovative firms’ [link »»] published by the Treasury, evidence uncovered that £467 million of investment by EIS funds in 2016-17 was focused on capital preservation. This amount accounted for 62% of overall investment by EIS funds.

In essence, the government’s position is that the EIS was designed for investment in high-growth, high-risk startups and small to medium enterprises, not as a mechanism for tax avoidance and capital preservation.

Ingenious Rise

Primarily led by Ingenious Media, the U.K. has long been a mecca for tax structures that provide incentives for financing filmed entertainment. Ingenious has managed investments for over 1,400 investors on hundreds of productions and games. Since launching, they have placed £8 billion in U.K.’s creative sectors.

EIS was launched in 1994 to promote investments in private companies.

Around 2003, production and financial professionals devised tax investment vehicles for high-net-worth individuals to preserve capital while investing in the creative arts.

Since then, investors exploited tax relief structures to place billions across a spectrum of filmed entertainment productions. Through the accumulation of substantial losses, in many instances by design, investors could significantly reduce their taxable income.

Future access to production funds in the U.K. through tax structures will likely be more difficult. It’s also unlikely that Ingenious Media will continue to raise funds at the levels of past years in light of recent rulings, proposed rule changes, and macro forces.

Capital or Revenue

In May 2017, the First-tier tribunal (FTT) ruled in favor of HRMC in litigation against Ingenious Games, Inside Track Productions, and Ingenious Film Partners 2.

The case dealt with the taxable treatment of capital in calculating profit.

The FTT found that “a sum paid by a business to acquire the rights to received future income from the distribution of a film was capital expenditure and was not deductible in computing the business’ taxable profits.” The reason for the decision concerned the lifespan of income generated from film rights exceeding five years that suggested it was capital in nature.

The first part of the litigation, which the FTT ruled on in August 2016, involved several issues including what was meant by “carrying on trade,” “with a view of profit,” and nuances about capital expenditure and accounting principles.

Essentially, the tribunal ruled that investors should only receive tax relief on 30% or 35% not 100% of their investment, which is explored further below.

A spokesperson for Ingenious said they would appeal the entire decision of the tribunal.

Impossible Profit

In the 2016 case, Ingenious computed their profits and losses based on an assumption that they would incur the full budgeted cost of the film or game instead of on the amount they contributed, either 30% or 35%.

The FTT was not persuaded that Ingenious was conducted to make a profit because “the controlling minds and of the activity of the green-lighting committee was not strong enough to convince the tribunal that Ingenious managed the business with a realistic hope of intention of making such a profit.”

The court concluded its discussion into the profit question with by stating, “that if profit is properly to be calculated on the 30:30 basis, the partnership conducted their businesses with a view to such a profit; but if it is calculated on the Ingenious basis, they did not.”

A Technicality in the Supreme Court

On November 15th the UKSC ruled for HMRC and against investors in tax avoidance film partnerships. The decision protected over £1 billion of taxes paid or due to the government.

The case revolved around the ability of HMRC to collect back taxes in certain situations.

The structures used in the partnerships were previously ruled invalid, but those on the hook argued on a technicality that the government’s action against their personal tax filings from pass-through partnership losses was not within the statute of limitations.

The UKSC disagreed and finally put an end the issue that several other parties have watched closely.

The majority of investors and companies have already paid most of their disputed tax bills. If HMRC had lost the case, investors would have reclaimed the funds.

Jim Harra, director general for customer strategy and tax design at HMRC, said: This is another great success in HMRC’s drive against tax avoidance. The Supreme Court’s decision…will ensure that these taxpayers and others waiting behind their case will have to pay what they owe.”

In 2016-2017 U.K. courts made 26 decisions regarding tax avoidance, of which the HMRC only lost three.