Sideways loss relief - proposed restrictions

HMRC have announced anti-avoidance measures to restrict the use of sideways loss relief by "non-active partners".

The term "non-active partners" refers to limited partners, and partners who spend an average of less than 10 hours a week personally engaged in the partnership's trading activities.

The measures will be contained in the next Finance Bill. Currently, the loss relief available to such partners is based on the amount of capital they have contributed to the partnership. The Finance Bill will provide that, in calculating the amount of relief available, capital contributed by a non-active partner on or after 2 March 2007 (the date of the announcement) will be disregarded, if the main reason, or one of the main reasons, for contributing the capital was to claim loss relief.

The Finance Bill will also introduce an annual limit to the amount of sideways loss relief which a non-active partner may claim. A non-active partner who sustains trading losses on or after 2 March 2007 is restricted to loss relief of £25,000 in respect of all the trading losses for all the partnerships in which he was a non-active partner for the tax year. Of course, if his losses amount to less than £25,000, his claim is restricted to the lower amount. Where sideways loss relief is not available, the losses are carried forward for offset against the the non-active partner's future partnership profits. This measure will scupper tax avoidance schemes in which taxpayers make significant contributions to certain partnerships, thereby generating losses against which they offset their other income or capital gains.

Before the introduction of the latest film tax regime by the 2006 Finance Act, film partnerships were prime candidates for such investment. Certain environmental projects are also good for this kind of investment; partnerships which create carbon credits which they intend to trade for profits tend to suffer losses in the early years, and as such, provide a good opportunity for an investor to claim loss relief. However, once the new loss relief rules come into effect, these too will lose their appeal.

UPDATE (9 March 2007): Following protestations by investors and the film industry that these proposals would damage the British film industry, HMRC backed down and made a few changes to its proposals. The above restrictions will not now apply to 'sale and leaseback' deferral arrangements (see example) made in respect of qualifying 'British' films.

NB. The new films tax regime introduced by the Finance Act of 2006 takes effect for films which commence principal photography on or after 1 January 2007. The rules we have been discussing above apply under the old regime, as they deal with films which commenced principal photography before 1 January 2007. Films which commence principal photography on or after that date are dealt with under another regime, and are outside the scope of the rules above.