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The reel thing

What are the tax benefits of film sale and leaseback partnerships?

In the last Budget, the Chancellor said the Government would confirm its support for the British film industry by extending the tax benefits available on the purchase of British films from July 2002 to July 2005.

What this means is that private individuals can continue to benefit from the near 100 per cent initial tax relief on the purchase price of films that are bought by partnerships promoting themselves as tax shelter vehicles.

It is important to emphasise that these partnership structures do not rely on the films acquired being commercially successful to derive a benefit for investors.

It should also be pointed out that these partnerships are only suitable for investors with substantial amounts of 40 per cent tax to shelter.

The structure of the arrangement is that a film is bought by a partnership from a film production company and the right to get income from the film is “leased back” to the production company for 15 years.

A bank guarantee is provided by the production company in respect of the lease payments.

The guarantee ensures that a fixed and secure annual income is provided to the partnership, regardless of the commercial success of the films.

The investor gets back from the Inland Revenue an amount equal to 40 per cent of their gross investment. In simple terms, assume an investment of £100,000 is made to shelter either income tax or capital gains tax in this tax year or the last one. (Alternatively, investors can go back three tax years – currently to the 1998/1999 tax year – and reclaim income tax paid in respect of that year or subsequently.)

The investor would make an initial cash contribution of 18 per cent (£18,000) of the gross investment, with a loan being provided for the balance of £82,000.

The partnership uses the investor&#39s money, including the loan, to buy one or more films.

By buying films, the investor is deemed to have made a trading loss and tax relief is obtained on 95 per cent of the gross investment in the first year, with the other 5 per cent of tax relief being claimed over the first three years.

The cash contribution of £18,000 would give rise to tax relief of about £38,000 (95 per cent x 40 per cent x £100,000) in the first year, generating an up-front cash benefit of £20,000 (£38,000 – £18,000).

The sale and leaseback structure is one that simply defers tax. But many tax advisers accept that “tax deferred is tax saved”.

Gradually, over the 15year lease term, the guaranteed income reduces the loan and meets the interest payable on that loan.

The investor is liable to income tax on the capital repayment element of the income from the lease (that is, the total income less the interest) and thus repays the original tax benefit (plus about 4 per cent a year) to the Revenue over the lease term. The majority of this tax liability arises in the last few years. The loan is repaid by the end of 15 years.

The main risks involved are that the guaranteeing bank goes bust (as this is typically AA-rated, God help us all if it does) or that income tax rates increase substantially (leading to a bigger tax liability on the net income from the lease).

Is this a big business? Over £700m was raised for film sale and leaseback partnerships in the 2000/ 2001 tax year.

It is anticipated that this figure will be exceeded in the current tax year. There is no limit to an individual investment and single investments of over £20m have been known.

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