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Tax Relief on Films
Eyes Wide Open
HARRY HICKS looks at the new tax relief for British films.
Tax Relief on Films
Eyes Wide Open
HARRY HICKS looks at the new tax relief for British films.
ON 21 SEPTEMBER the Treasury announced the long awaited proposals for the replacement of F (No 2) A 1997, s 48 which is due to expire on 1 July 2005. The detail of the new relief and transitional arrangements regarding s 48 are contained in the Inland Revenue note of the same day entitled 'Tax relief for the production of low budget British films'. The purpose of this article is to set out how it is envisaged that the new relief will operate and to explore the possibilities going forward for individuals to access tax relief in respect of film investment.
The new relief
The key features of the relief (as proposed) are:
It is available on production of British qualifying films costing up to £20 million.
It is available to UK companies as a relief or credit against corporation tax.
It is available as a deduction of 150% of production spend to be claimed in the period that the film is completed.
Up to two-thirds of the relief (i.e 100% of production cost) can be surrendered in that period for payment of a 20% tax credit which is itself exempt from tax.
Of the total 150% relief, one-third can only be used as a deduction against income arising from the film.
It will not affect the entitlement of investors in film production companies to claim relief under the venture capital schemes (EIS, VCT and CVS), provided the other conditions of these reliefs are met.
Relief under F (No 2) A 1992, s 42 is to remain but is to be available only for qualifying films costing more than £20 million.
Transitional rules will extend the availability of s 48 relief for a period in order to provide a smooth transition.
There are a number of apparent anomalies within the Treasury press release and the Inland Revenue technical note. For example:
The Treasury states that the relief will cover 20% of production costs compared to the 15% covered by s 48 relief (which in itself is not quite correct as the 15% was provided by way of sale and leaseback arrangements accessing s 48 relief and there have been other arrangements providing an additional 20 to 25%). However, the Inland Revenue note makes it clear that not all expenditure incurred in connection with a production (for instance financing costs) will qualify for the 20% credit so that the relief could be significantly less than 20%.
The Treasury states that the new relief applies to all production expenditure, not just that spent in the UK. However, the Inland Revenue note in para 19 states that the claimant of the new relief will normally be the special purpose vehicle company that makes the film and that the relief will apply to the production expenditure incurred by that company and claimed in its tax return. The writer is at pains to understand how in an international co-production situation, where expenditure will be incurred by the co-producing overseas partner(s) and possibly claimed by them in their own tax returns, the UK company can claim relief for the whole cost of the film when it will not have incurred all of the expenditure.
The Treasury note states that 'for the first time, the relief will include an added incentive for films to be profitable'. However, a detailed analysis of the tax impact of various levels of income from a film suggests that as the relief is currently drafted it might be best for the claimant to simply claim his 20% relief on expenditure and then make no sales at all.
The writer understands that these and any other anomalies will have been ironed out in time for next year's Budget statement and subsequent Finance Bill. However, it is not expected that the new relief will depart in any significant way from what is outlined above.
Individuals and film investment
The press release from the Treasury which announced the new relief listed as its first key feature that 'the money will be paid direct to film-makers, not through third parties, so it will be less open to abuse'. This makes clear the Treasury's motivation in introducing the new relief: that it is to help the film production industry and not to line the pockets of tax-based film financing intermediaries. It is also, of course, another example of the Treasury's fight against perceived tax avoidance.
By way of background to this, s 48 provides immediate write-off of expenditure on the production or acquisition of the master version of a British qualifying film whose total production expenditure does not exceed £15 million. In practice, independent film producers generally have far greater expenditure than income in the year the film is completed. Consequently, producers normally access s 48 relief indirectly through leaseback or co-production arrangements with (usually) partnerships of high net worth individuals. Inevitably the intermediaries who introduce the wealthy individuals to the producers and structure the arrangements look to take a fee for their services. There have also been some 'creative' structures using s 48 (and other sections of the Taxes Acts relating to film) which the Government has regarded as 'abusive' and has stopped by enacting various anti-avoidance rules.
In the light of this, is there any scope in the future for film financing structures which provide tax relief for individual investors? Based on the legislation as it currently stands and on the new relief as outlined, it would appear there may be a number of options.
S 42 partnerships
S 42 relief provides a write-off over 36 months of expenditure incurred on the production or acquisition of the master version of a British qualifying film. It is proposed, as mentioned above, that it will apply only to films costing more than £20 million.
S 42 relief has been accessed by producers in much the same way as has s 48 relief, i.e. by way of leaseback or co-production arrangements with either partnerships of high net worth individuals or UK banks. One assumes that it is to remain so as to continue to encourage the Hollywood studios to produce films such as Harry Potter in the UK.
Despite the 36-month rather than one-year write-off, the s 42 based leaseback arrangements can offer terms to wealthy individuals as attractive as those offered under the one-year write off under s 48 by reducing the benefit to the producers. The s 42 co-production arrangements are essentially tax-incentivised investments into bigger budget films and generally work for the investor only if the film produced makes certain levels of income.
Other film relief partnerships
The sections of the Taxes Acts setting out the reliefs available for film (F (No 2) A 1992, ss 40A-D, 41, 42 and 43) assume that the film produced or acquired is not trading stock in the hands of the producer/acquirer. If a master version does constitute trading stock, then the special film relief sections do not apply and it would appear that normal Sch D, Case I principles go along with the need to address generally accepted accounting principles (GAAP) in accordance with FA 1998, s 42.
The Inland Revenue guidance notes on the film reliefs in its Business Income Manual make clear in para 56255 that the Revenue will only regard a film as trading stock if it is not 'held for the purpose of exploitation by the granting of rights out of it or for the purpose of producing copies for sale'. In other words, there is not a choice: it is a matter of commercial and legal fact as to which films constitute stock and which do not.
The writer is aware of a number of partnership schemes being offered in the market at the moment which are based on treatment of the films produced or acquired as trading stock. It remains to be seen how the Inland Revenue will respond to these schemes.
Venture capital schemes
As noted above, it is proposed that the new relief will be compatible with relief under EIS, VCT or CVS. This is useful, as this would appear to limit the downside for those parties who genuinely desire to invest in films and are prepared to take a risk. It is generally acknowledged that the downside of investment into an EIS company is limited to 48% of an investment (up to £200,000, assuming no other EIS investment in the same fiscal year) due to the upfront 20% relief and income tax loss relief (assumed to be at the 40% rate) on the remaining 80% of the investment if it is all lost after the three-year qualifying period. By combining the new relief with EIS relief, this downside could in certain circumstances be reduced to 36%: 20% upfront relief, 20% credit paid to the company if 100% is used to produce a film and the film produces no income, and income tax loss relief (at 40%) on the balance of 60% after the three-year period. It will of course be necessary to see the detail of the legislation to confirm this, but this seems a possibility based on what is in the Inland Revenue note.
The question of whether there might be film-specific VCTs which combine the advantage of the new tax credit with the enhanced upfront income tax relief at 40% remains to be seen. This is an interesting thought from a tax point of view, but an altogether more complex one from a regulatory and pragmatic view.
Welcome news?
The new relief for film as currently outlined would appear to be welcome news for film producers. However, the opportunities for individuals to use film investment for tax planning purposes seem more limited in the future than they have been in the recent past. We await with interest the detail of the legislation and how film investment via EIS and VCTs might expand in the future.
Harry Hicks is head of film and television at Chilterns.
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