DAVE MORRISON takes a wide angle look at taxation’s role in the movies.
Tax may not be easily worked into a movie plot but it is essential when plotting a movie. Tax can influence where a movie is made, funding, budget and cost, so here’s a synopsis of some dramas currently showing:
Once upon a time: The Prequel
It may be useful to take a brief retro look back (in sepia of course) to explain the legacy we have today. Back in the days of VHS there were two key pieces of legislation in F(No 2)A 1992, s42 and F(No 2)A 1997, s48 providing for the write off of film production costs against income. Then, in 2001, Limited Liability Partnerships (LLPs) went on general release and some clever tax boffins, appreciating that if LLPs produced / bought films then investors could immediately claim Income Tax losses on their share of the written off production/acquisition costs, embellished the plot. The investor could borrow most of the cash needed, so that tax refunds exceeded their personal cash input, deferring tax until revenues flowed. Revenues were used to repay the loans and cover the tax. These tax deferral schemes, often referred to as either ‘Film Partnerships’, ‘Section 48 Schemes’ or ‘Sale and Leasebacks’ were sometimes linked to non-recourse loans and HM Revenue & Customs sought to rein in what they saw as abusive. Ultimately, in 2007, the Government premiered an attractive alternative in the form of Film Tax Credits and the modern era was born.
Nostalgia is not what it used to be
Unlike their heyday, contemporary film partnerships now tend to be ‘active partnerships’ requiring partners to work at least 10 hours per week, which HMRC will naturally scrutinise for continuity. There are many other film investment opportunities in the marketplace, not all tax driven but the use of EIS, EIS funds, VCTs, UK Film Tax Credits, Pension Schemes all offer opportunities to build in a tax angle.
The opening scenes: Funding
Funding deserves an article all of its own but here we focus on financing independent films rather than commissioned films. Film funding has some wonderful terminology such as ‘gaps’, ‘waterfalls’ and ‘corridors’ but broadly, investment might be directly in the film itself (known as ‘equity’ with provision for recoupment then a share of revenues), through shares in the film production company, by some form of loan finance or so-called ‘soft money’ such as government funding. Loan finance and ‘equity’ is often secured against claims for Film Tax Credit (see below) with tax advisors usually being asked to provide written opinions on the anticipated amounts.
EIS: Essential Investor Seduction
If funding is the filmmaker’s Holy Grail, then we are currently witnessing the EIS crusade. Doing EIS justice could fill several editions of Taxation Magazine, but essentially, individuals can get a 30% tax break based on amounts invested in a company’s shares and can dispose of the shares free of Capital Gains Tax if held for three years (all subject to terms and conditions of course!). Alternatively, if the film flops any losses the individuals make on their shares may be set against income. So, now for the gossip on film’s relationship with EIS.
Information Memorandums offering EIS shares in film production companies often offer seductive ‘glitzy’ investor benefits including visits to sets, WRAP parties, premieres and signed memorabilia. Whilst perhaps ‘priceless’ to film fans, fortunately they are usually relatively insignificant for the purposes of ITA 2007, ss213-223 and the amount of any value received by the investor does not usually have the effect of reducing EIS relief.
Film investment is often perceived as risky, so many investors see it as a small part of a wider portfolio whilst some investors forsake EIS and invest through a pension vehicle. Investment through a company has become less attractive since the expiry of CVS, remember that? The Corporate Venturing Scheme (similar to EIS but for corporate investors) was sadly left on the cutting room floor back in March 2010 and, sadly, there’s no sign of a remake of this classic at this time.
EIS: Eradicating Investor Suspicion
Since April 2012 companies can raise up to £5million in any 12 month period (from £2million previously) under EIS, generating the prospect of funding bigger movies. However, in reality raising film funding remains difficult, primarily because of the perceived risk and difficulty in forecasting a film’s potential performance with no prototype product available to opine on. However, there are certain positive attributes to look out for, such as a prearranged distribution deal ensuring a release. Distribution and P&A (Prints and Advertising) are key to a film’s success, it can sometimes be more important than the quality of the film (you know the ones!). A slate (portfolio) of films may be attractive as a hedge against flops and well known cast and directors help sell films. Genre films can have buoyant niche markets, although the film’s budget should be designed to match the sales estimates rather than the director’s ego. An International Sales Agent may provide sales estimates and may have even arranged pre sales in other territories, which can also be positive.
Investors’ bad experiences related to the old pre 2007 era (described above) remain a bit of an obstacle. This thorny legacy was revisited recently in some newspaper articles about tax avoidance and with some of these old cases likely to reach tribunal soon we have probably not heard the last. This negative publicity regarding pre 2007 arrangements is unhelpful for filmmakers, as are investors’ tales of prolonged HMRC enquires delaying tax repayments thereby negating the tax deferral. Settlements with HMRC may have also affected the value of some pre 2007 investments. Cultured ‘luvvies’ also complain that so much money was sunk into these schemes that some poor movies were made that should not have been, giving the UK film industry a bad image. Overcoming these legacies requires reminding investors that the current Government has pledged to retain the Film Tax Credit (at least until December 2015 when it comes up for review by the EU) and has expanded EIS, so it is effectively endorsing film EIS.
EIS: Ending Is Sweet, a three year affair
Film and EIS really are made for each other, but they weren’t conceived for each other, so why is this seemingly illicit affair so hot? Primarily, because production, distribution and sales suits a three year cycle and an EIS investor needs to hold the EIS shares for three years, a harmonised running time.
Dividends received on EIS shares are taxable, so dividends are not attractive over the first 3 years so capital growth in the share value, which can be disposed of tax free, makes sense in a three year window. Remember though that there is a rule about no ‘pre-arranged exits’ (ITA 2007, s257CD) so the exit strategy cannot be declared at the outset.
EIS: Expect Intellectual Scenarios
Whether or not movies are intellectual entertainment, all films are regarded as Intellectual Property (IP) for EIS purposes. Keen EIS specialists will know that amongst the ‘excluded activities’ included within ITA 2007, s192(1) lies the potential ‘booby trap’ of ‘receiving royalties or licence fees’ and a film’s income falls within that definition. However, fast forwarding to ITA 2007, s195 reveals that this is acceptable where the company created the greater part of the underlying IP. Consequently companies which are junior co-producers could have problems, although this may depend on how their co-productions are structured.
EIS: Eerie International Situations
Co-productions could be seen as partnerships in certain circumstances, which can lead to falling foul of ITA 2007, s183 and this has been a problem for some co-productions. However, where there is a genuine co-production, particularly under one of the UK’s Official Film Co-production Treaties or the European Convention on Cinematographic Co-Production (ECCC) it is likely to be accepted as EIS compliant.
EIS: Even International Shooting
EIS companies no longer need a UK trade but do need a UK Permanent Establishment, widening the opportunity for foreign films to be made by UK EIS funded companies. However, this can mitigate UK Film Tax Credits (see below).
EIS: Ending ‘Iffy’ Schemes
If there is one horror story that has caused some howling and screaming recently, it is the new Anti-Avoidance legislation known as ‘Disqualifying Arrangements’ aimed at stopping contrived EIS businesses and embedded as ITA 2007, s178A.
The film industry (amongst others) protested loudly about a rather prescriptive and precise set of proposals published in mid 2011. By the end of the year HMRC had, rightly, heeded the complaints and issued a rather more vague alternative instead. Unfortunately it is so vague that uncertainty reigns and without comprehensive guidelines there is always the danger that in a different future climate, HMRC could, potentially, apply it differently. HMRC are about to finalise the guidelines, which are unlikely to be much further ‘tweaked’ and there may well be a ‘trial and error’ learning curve for practitioners as to how these are applied over the forthcoming months.
Essentially HMRC wants to block contrived trades, for example where part of a large company’s trade is spun out into an EIS vehicle or where money goes full circle whilst picking up EIS benefits along the way. Whatever the uncertainties, the film industry should recognise that EIS is important to independent filmmakers and a clean image is important given the experiences and legacy of the old Film Partnership schemes.
SEIS: Sensational Extra Incentive Scheme
The Seed Enterprise Investment Scheme (SEIS) is the new kid on the block, a sort of baby EIS with a cute 50% Income Tax Relief on investment and a ‘new baby’ gift of a CGT holiday for anyone with a CGT liability in 2012/13 who invests their gain in SEIS shares.
This fairy tale (read Part 5A of ITA 2007 for the full story) can end up with an investor gaining 100.5% tax relief and so living happily ever after. If that sounds too good to be true, here’s how it works:
The investor receives an initial income tax reduction of 50% of their investment. If they have a CGT liability in 2012/13, then up to 28% of the amount invested can be wiped off permanently. Supposing after 3 years the film has flopped and the shares are worthless, the investor can then claim income tax relief on the loss at, say, 45%. The loss is calculated as the amounted invested minus the 50% initial relief, but takes no account of the CGT relief. So, 45% of the 50% loss results in another 22.5% of relief, bringing the total up to 100.5%
With SEIS raises being limited to £150,000 it is unlikely that many movies will be funded entirely by SEIS, but it could fund the early development stage of a film. The developed project could then be sold on to a film producer or a subsequent EIS raise could follow to fund production.
The Paparazzi: Information Memorandums
Whilst EIS may be a headline act, finding investors can be a tricky casting exercise and a polished script is needed for any promotion. Care must be taken to observe the rules contained in the Financial Services and Markets Act 2000 and subsidiary regulations. For example, a raise of £5 million will fall within the Prospectus Regulations as it will exceed €5 million and may need FSA approval. Lower raises are likely to fall within the Financial Promotions Regulations and Information Memorandums may need authorisation by an Authorised Person. Exemptions exist, but care is needed. Depending on the distribution strategy a PLC may be necessary. Advisors should screen the tax sections of Information Memorandums rigorously to ensure they reflect current law.
The Star Attraction: Film Tax Credits
In 2007 UK Film Tax Credits were released nationwide and now have a supporting role in CTA 2009, Part 15. Unlike the previous era, the benefits (cash of up to 20% of the film’s budget or 16% where core production expenditure exceeds £20million) go to the production companies rather than investors. A number of provisions were installed to counter manipulation, for example only companies qualify and only one company must produce the film (unless an international co-production under a UK treaty).
Generically similar to R&D Tax Credits, qualifying costs are enhanced (up to 80% or 64% for £20million plus films) and then part of the company’s loss is sacrificed for the cash. Where there is a profit (not common during the production phase) the enhancement reduces any tax liability. Indeed, the way the computation is structured may be slightly alien to many practitioners whose usual starting point is the traditional ‘Profit per the Accounts’. The rules on utilisation of losses then get really radical so we’ll leave them for now. Suffice to say that each film is treated as a separate trade, losses are calculated using principles similar to long term work in progress (ie some anticipated income may need to be recognised) and losses may only realistically be used against other income once a film is complete. HMRC cover the subject well in its Film Production Company Manual (FPC10000 onwards) with minimal shades of grey and is recommended reading.
So, why should the taxpayer fund up to 20% of a film’s budget? The logic is that the knock-on benefit to the economy from film activity attracted to the UK pays for the tax credit. So why isn’t it State Aid to Industry and prohibited by the EU? Well it is cultural aid, so for a film to qualify it must pass a UK cultural test monitored by the British Film Institute or qualify as a co-production under a UK treaty. Films need to score 16 out of 31 points to pass the cultural test and, depending on the points claimed, may require an accountant’s report signed by an accountant qualified to sign company audit reports. Points may be claimed for all sorts of cultural reasons from the writer, the characters, the setting and even the production hub and personnel (ordinarily resident persons in any EEA state are deemed British for this test). If too many points are needed based hub and personnel, rather than cultural matters, then there is an, often avoidable, Golden Points rule to overcome.
At least 25% of the Core Production Expenditure must be in the UK. Certain expenses aren’t considered core production expenditure, such as development costs, finance costs, marketing, deliverables (only the cost of the master copy counts) for example, and the 20% tax credit will be impaired to the extent that expenditure doesn’t qualify. Furthermore, the costs must be consumed in the UK, which may seem unconventional. Foreign goods used during UK filming count, UK goods taken to foreign locations do not. It is not where the money is spent, but where the film making activity takes place that qualifies a cost. A music score written abroad but recorded in the UK, for example, is consumed in the UK.
To avoid funding certain TV productions the Government limited the UK Tax Credits to films by requiring that they are intended for theatrical release. Note the word ‘intention’, so long as the intention remains the film qualifies, but if that changes it no longer does. To prove an intention it is best to keep records of correspondence with film festivals, sales agents and distributors.
However, fast forward and there are now proposals to introduce a similar tax credit for ‘high end’ TV drama costing more than £1 million per hour and animations from April 2013. Presumably, ‘low end’ TV, will remain a casualty?
Incidentally, companies are entitled to opt out of these rules (CTA2009 s1182 (7)) making them ineligible for Film Tax Credit. This might be useful where not all of the criteria have been met but a GAAP write down of film costs may be appropriate. Because Income Tax is not relevant to this legislation, sole traders or partnerships making films would fall within normal accounting and tax protocols. Meanwhile, there is also film tax legislation for non-trading film businesses at ITTOIA 2005, s609 – 613.
World Cinema – Tax Credit Shopping
Unsurprisingly the UK is not the only country with tax incentives designed to attract film making activity. Indeed, a number of European countries have imitated the UK’s EU compatible model, although some have limited the annual funds available and other small differences may exist. For example Germany allows costs of crew located abroad where they are subject to German payroll taxes.
Beyond EU constraints, global incentives can be less restricted. Tax credits in some countries, really are, ‘as it says on the tin’, ‘tax credits’! The recipient gets a voucher valid for settling local tax, which often involves selling it to a local taxpayer at a discount as the film production company is unable to use it. In the USA incentives can be obtained at State level and vary from state to state. Canada offers interesting incentives across its provinces and has a co-production treaty with the UK enabling a ‘pick n’ mix’ approach.
PAYE – People and your expenses
The August 2012 remake of the Film and TV Production PAYE Guidance Notes are available on your screens now (http://www.hmrc.gov.uk/specialist/fi-notes-2012.pdf) and Guidelines on the Special NIC Rules for Entertainers are available on demand at http://www.hmrc.gov.uk/guidance/nicrules-ents.pdf. The former deals with self-employment and when PAYE should be applied whilst the latter deals with the peculiarity of entertainers being categorised as employed for National Insurance purposes whilst self-employed for tax.
Producers naturally prefer as many of the crew as possible to be deemed self-employed or be paid through a limited company thereby limiting their Employer’s NIC cost.
It’s all about celebrities: Actors, ITV Services and IR35
Actors’ status goes back to some renowned old cases including Fall v Hitchen (1972) 49TC433 and McCowen v West (1993) (unreported) with the current legislation relating to NI categorisation now showing in the Social Security (Categorisation of Earners) Regulations 1978/1689 Sch 1Part I 5A
A stunning special effect involved top celebrity actors being designated ‘Key Talent’ and, unlike most actors, being treated as self-employed for both Tax and NICs. However, as a bi-product of ITV Services Ltd v HMRC (2011) TC836 this practice appears no longer tenable. Legally, the Key Talent exclusion probably never existed and this is now a hot topic for practitioners with thespian clients.
Both cast and crew using limited companies (loan outs) should always consider the Personal Service Companies rules (known as IR 35 on the street) but self employed actors may have previously overlooked the National Insurance implications There is also a question over retrospective application by HMRC with the possibility of a test case looming.
The Demibourne Legacy
The cost implications of Employer’s NICs categorisation can be critical to filmmakers and HMRC cross check every UK Film Tax Credits claim for PAYE operation. The cost of getting it wrong could blow a budget and any additional PAYE paid out may be difficult to recover from crew who have long since moved on.
Crew members should have declared the relevant income on their tax returns as self employed earnings so, by exploiting a sequel, HMRC could risk collecting tax twice / double dipping / unjust enrichment as noted in the celebrated case of Demibourne Ltd v HMRC SpC 486. Consequently Regulations 72E – G were added to the PAYE Regulations SI 2003 / 2682 and, subject to conditions, employers may now request that HMRC reduce the total PAYE due from an enquiry by the amount of any consequent refunds due to the relevant individuals
A letter of consent from each individual is required, but HMRC might not disclose the amount offset for each individual, only the collective amount. There is little room for appeal if HMRC appear to come back with a low number and refuse to disclose how they calculated that figure. This is a topic for another occasion, but is something that probably warrants a review with a view to enabling the advisor being able to work with the individuals’ advisors to cross check the HMRC responses on each individual.
Tax must be deducted at 20% from foreign entertainers appearing in UK films, this withholding being payment on account before a tax return filing. It is possible to negotiate a lower withholding rate to reflect deductible expenses and the final outcome, but advisors should consider whether the cost of the required negotiations are justifiable where the actor can offset UK tax in their country of residence. Remember too that the UK-US Tax Treaty Article 16 exempts entertainers with income below $20,000.
What may be an interesting question is, (subject to relevant NI treaties) whether deductions should incorporate National Insurance Contributions if the Key Talent exemption no longer applies?
Certificates of UK residence can mitigate withholding taxes which overseas distributors may wish to edit from payments to producers and this, territory by territory, exercise and may need to be repeated annually providing plenty of international action for advisors.
Naturally, tax advisors want to attend the films and even cinema buildings can take a starring role with their potential for Capital Allowance claims. 1971’s legendary Odeon Associated Theatres Ltd v Jones 48TC257 remains classic cinema from a golden age of tax. Have you ever wondered whether there’s VAT on warm popcorn or whether cinema staff uniforms are a benefit in kind? Film tax simply oozes fiscal thrillers, so standby, …….LETTERS, CALCULATOR…..ACTION!
Dave Morrison is a partner Nyman Libson Paul specialising in Entertainment Industry matters and also chairs the ICAEW’s Entertainment and Media Group. He can be contacted on 02074332448 or firstname.lastname@example.org