Film Partnership Schemes: Eclipse and others
16th March 2015
Investors in the Eclipse film partnerships and other similar film partnerships can expect to face tax bills much in excess of their investment after a recent decision in the Court of Appeal.
There are a number of similar schemes. Generally, the schemes worked as follows:
- The member became a partner by making a capital contribution to the partnership;
- This capital contribution was generally comprised of a 5% contribution from the member’s own fund and a 95% contribution made by way of loan;
- The 95% contribution was paid into a locked account and a letter of credit was issued in order to securitise the loan. On the back of this security, the bank making the loan could then advance sums representing the 95% of his capital contribution.
- The partnership then acquired rights often to Hollywood films and leased those rights back to a film production company, who would then produce the film, with the lease agreement generating a revenue stream for the partnership.
- The purpose of the locked account was to service the member’s debt. The member was charged interest on the loan and payments were nominally made by the partnership into the blocked account.
- It was intended that the member would receive a tax allowance based upon the interest owing, which could be off-set against gains made by members elsewhere. The repayments were generally back-loaded in order to try and maximise the efficiency of the scheme.
However, the Court of Appeal has ruled, in the case of the Eclipse 35 scheme, that it was not commercially trading with a view to making a profit. This means that the members cannot claim tax relief on the interest paid.
The Court of Appeal (Eclipse Film Partners No.35 LLP v Revenue and Customs Commissioners  EWCA Civ 95) has upheld the earlier judgment of the First Tier Tribunal (Eclipse Film Partners No.35 LLP v Revenue and Customs Commissioners  UKFTT 401 (TC)) and concluded that the First-tier Tribunal had been entitled, on the facts before it, to conclude that a partnership’s activities in acquiring film rights and sub-licensing the rights to a distributor did not amount to carrying on a trade.
The partnership’s members were therefore unable to obtain tax relief on interest paid on borrowings they had made to finance the partnership’s activities under the Income and Corporation Taxes Act 1988 s.353 and s.362.
Further, HMRC is now demanding that members are liable for income tax on the income paid by the film production company to the partnership under the lease agreement. This income was, of course, used to repay the loan part of the investment and was never received by the partner.
We expect HMRC to begin using their extensive powers to issue follower notices (FN) for cases of a similar type and the consequent Accelerated Payment Notices (APN) that can be issued by virtue of the FN.
Claims against Advisors and Promoters
Most partners sought advice from IFAs in respect of these schemes. In some cases, advisors failed to appreciate the potential for a tax liability on partnership income and did not warn the investors of this risk. In other cases, advisers did appreciate this risk but recommended that the member participate in the scheme in any event.
However, a recent High Court case (R (on the application of Chancery (UK) LLP) v Financial Ombudsman Service Ltd )  All ER (D) 245 (Feb), has underlined that these products were investments as well as tax avoidance schemes.
Martin Woodford, a Partner at Ward Hadaway who has dealt with several disputes arising from film partnership, is clear on his thoughts on the impact of the case.
He said: ”There has been much focus to date on whether or not members were properly warned as regards the tax risk that they were taking on. They often were not.
“However, these partnerships were also investments and thus regulated by the Financial Services and Market Act 2000 and the regulations made thereunder, in particular the COB/COBS rules.
“Advisers were under a statutory duty to take reasonable steps to ensure that the investment was a suitable investment for the partner.
“Of the cases that I have been instructed on, I am yet to see a case where the investment was suitable. Indeed, much of the advice that I have seen is full of dire warnings of the potential risks of the investment, which somewhat begs the question why members were ever recommended to participate in the first place.”
Given the nature of these schemes as investments, it ought to be remembered that that a member may have open to them the possibility of seeking redress under the Financial Ombudsman Scheme (albeit it has limited jurisdiction to make awards of up to £150,000) as well as potential court action.
Limited time to claim
If claims have not been brought to date, then any claim may face a potential limitation problem.
Generally speaking, it is prudent that a claim against a professional advisor is brought within 6 years of the date of the investment into the scheme. Alternatively, a 3 year period exists which runs, in most cases, from the time at which an investor first discovered that they may have suffered loss.
However, where loss can be properly categorised as truly contingent and there is no immediate loss, time will not start running until this contingency has been fulfilled.
If a court were to accept that any tax loss was truly contingent on subsequent action by HMRC, then partners may therefore still be in time to bring claims.
The headline is clear, though. Partners in any film schemes ought to expect little sympathy from HMRC. They need to take urgent legal advice as regards protecting a claim against third party advisers and promoters both through the courts, and through the Financial Ombudsman Scheme.
Please note that this briefing is designed to be informative, not advisory and represents our understanding of English law and practice as at the date indicated. We would always recommend that you should seek specific guidance on any particular legal issue.
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