If we accept that ‘tax schemes’ are probably not a good idea to invest in as a general rule, then we have to ask ourselves ‘What are the alternatives for those who have a large income or capital gains in a particular tax year and want to have some method of deferring or sheltering that income or capital gain?’
Well, there are a number of options available and in the second part of this four part special report I will look at some tax shelters and an exciting tax shelter known as a Film Partnership.
When the disclosure rules came into force in December 2004, some of the promoters of the more adventurous tax schemes did have the sense to realize that those tax schemes were probably no longer viable and they started to look at a class of tax shelter that have been broadly called Capital Allowance Schemes.
Environmentally Friendly Tax Shelters – Fancy a Mercedes?
Now a capital allowance is an allowance that any business would get for investing in equipment that it needs to carry on its business, so for instance, if you’re an office and you need computers to run your office and you buy computers, you will get what’s called a capital allowance. This means you can offset a portion of the cost of that equipment against your tax bill.
Also, in recent years in order to promote environment efficient energy use, the government has introduced accelerated capital allowances of up to 100% of the cost for certain types of equipment that are kinder to the environment. Equipment that promotes energy efficiency for your business and also surprisingly cars, which have very low emissions, so for instance a diesel ‘A’ Class Mercedes car can actually benefit from 100% capital allowance. This means that if a business buys such a car with very low emissions then it provides a significant tax benefit. And that’s just a very simple example.
A number of tax shelters were created that were directly related to carbon emissions. These were devised to help limit the impact of global warming. There is currently a scheme whereby you can invest in a partnership buying these carbon emission credits.
Another energy efficient shelter uses windmills. These are modern type windmills that generate electricity. It is also possible to obtain a 100% allowance on these.
Now, as I write this article, these types of shelters, (which are far less aggressive than other tax schemes), are currently all being investigated by the Revenue and Customs. Some of these Capital Allowance Partnerships appear to be genuine businesses and therefore it is possible that Revenue and Customs will accept some of them and taxpayers will be able to invest in them. However, until the Revenue and Customs clarifies its stance on such Capital Allowance Partnerships, nobody should invest in them as this will bring involvement in a tax enquiry, rather than tax savings!
What does that leave us with?
Film Partnerships – A Great Way to Defer Tax
There are several government approved tax shelters which you can still use. The largest and most exciting of these for high earners, those with at least £100,000 of income to shelter, are what are called Film Partnerships. These were introduced a few years ago by the government to encourage investment in British films. They are divided into Section 48 relief, giving 100% relief for films costing up to £15million and Section 42 relief, giving relief over 3 years for films costing over that amount. The objective was to encourage and promote the British film industry. This meant that anybody investing in a qualifying British film could benefit from the capital allowance.
These reliefs though are being replaced for films that have not started production before April 1st 2005 and completed by January 1st 2007. There are, however, a number of films still available for these deals including the Da Vinci Code that offers relief under Section 42 over 3 years.
There are also 2 ways of accessing these films. You can invest in a risk free sale and leaseback, where the film partnership buys a completed film and leases it back to the producers. The investor loans approximately 80% of the investment and the income covers the interest on the loan. The Actual investment is paid back after 15 years when the tax saved comes back in to charge. So, it is actually a 15 year tax deferral, rather than a total tax shelter. Another way of investing is in a production partnership, where the returns maybe higher but so is the risk. Again, a loan is used, but if the film fails, there are no guarantees that the loan will be repaid. Production partnerships are therefore very risky and should be avoided.
The financial reality against such shelters is that they are offering a fifteen-year tax deferral. This means that only after fifteen years will you get back the money that you have invested into the film partnership. Therefore, if, for example, your tax liability is 40% of £100,000, then it means that you would be liable to pay £40,000 in tax. However, because you will only invest £20,000 of your money into the film partnership (£80,000 is invested via in the way of a loan) you will make an immediate tax saving of £20,000.There will be profits or income coming through the film partnership that will cover the cost of your loan repayments. In fifteen years time all the money that you have invested will come back to you by way of income. Therefore, in effect, in fifteen years time, you will get a large ‘deferred’ income tax liability.
That is why a film partnership can be seen as a good tax shelter, not a perfect one because after fifteen years you are effectively getting that income back and it will be taxable then. However, fifteen years is a very long time in anyone’s life or career and it gives you plenty of time to use that money to good effect. There are no limits on the amount of money you can invest in a film partnership scheme, subject to there being available qualifying film partnerships.
One of the difficulties this year is that so few films are available and the Da Vinci code maybe one of the few on the market this tax year. I expect more sale and leasebacks to appear in the next few months. In fact, you can carry the capital allowance loss it generates back for up to three tax years. This means that if you have income tax that you paid in up to three tax years earlier, you can claim that back by investing in a film partnership. You could also use it against any capital gains, providing that it has offset against your income in that year. Once it has offset against the income in either the current year or the previous year, you can use it to offset any capital gains that you have realized either in the previous year and paid tax on, or in the current year and are about to pay tax on. It is quite a flexible shelter in that respect.
Although film partnerships are an excellent way to defer tax, there are also other tax shelters that exist. I will discuss the next of these, Venture Capital Trusts (VCTs) in next month’s issue.
Personal Tax TipDo you have more than one job, or are you an employee with a self-employed sideline? If so, don’t forget you may be able to apply for “deferment” of some of your National Insurance Contributions; better than paying too much and having to wait until the end of the tax year to claim a repayment!