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Tax relief for film production companies

November 2006 - Media, Entertainment & Sport. Legal Developments by Harbottle & Lewis LLP.

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A new tax relief for British films came into force on 19 July 2006 and will apply to films that commence principal photography on or after 1 April 2006.

In the meantime, the existing tax relief (under s48 of the Finance (No2) Act 1997 and s42 of the Finance (No2) Act 1992 - ie the ability to undertake sale and leaseback transactions) will continue to apply to the production of films commencing principal photography on or before 31 March 2006, provided the film is completed before 1 January 2007, and is acquired before 1 October 2007.

The following briefing is intended to provide a summary of the requirements for the new relief and some working examples of how it should operate in practice. Draft guidance on the rules relating to the new film tax credit is also currently being developed on HMRC's website, so further, more detailed information is slowly becoming available.

Conditions for the Film Tax Relief

The relief introduces a new treatment for film production companies (FPCs) that produce qualifying British films. The main features of the new tax relief are as follows:

  • it is provided directly to an FPC and is not available to those whose involvement in film-making is restricted to providing finance;
  • it is available to an FPC making qualifying British films, intended to be shown in cinemas; and
  • it aims to provide FPCs with a maximum benefit of 24% of the total production expenditure for limited-budget films (films with core expenditure of ¬£20m or less) and 19.2% for unlimited-budget films (films with core expenditure of over ¬£20m).

A company will be an FPC in relation to a given film if:

  • it is responsible for:

- the pre-production, principal photography and post-production of the film (ie it must be actively engaged in these activities and involved in planning and decision-making); and

- delivery of the completed film; and

  • it directly negotiates, contracts and pays for rights, goods and services in relation to the film.

There can only be one FPC in relation to a film. However, there is no requirement for the film rights to be owned by the FPC at the time the film is completed.

Broadly, a film will qualify for the relief if:

  • it is intended for theatrical release at cinemas;
  • it is a British film that is certified as such by the Secretary of State (ie the same requirement as existed previously for relief under s42 and s48); and
  • not less than 25% of the core expenditure incurred by the FPC on the film is UK expenditure.

Although the requirement for the film to be a British film remains certification by the Secretary of State, the requirements for such certification have been revised with effect from 1 April 2006 to include a new cultural test. However, a discussion of the new cultural test and the revised rules for the certification of British film is beyond the scope of this briefing.

The term ‚Äėcore expenditure' covers expenditure incurred on pre-production, principal photography and post-production. It specifically excludes any expenditure incurred on development, distribution or other non-production activities.

‚ÄėUK expenditure' is defined as being that incurred on goods and services to be used and consumed in the UK. The nationality of those providing such goods and services has no bearing on whether the expenditure qualifies as UK expenditure. For example, expenditure on cast and crew engaged in filming in the UK will qualify as UK expenditure even where some are based in the UK and others are based elsewhere. Likewise, expenditure on cast and crew engaged in filming outside the UK will not qualify as UK expenditure, even where the services are performed by UK residents or nationals.

Each film is treated as a separate trade for the purposes of the film tax relief.

Summary of the film tax relief

There are effectively two forms of tax relief available to FPCs that were introduced in the Finance Act 2006:

  • a deduction against an FPC's profits for corporation tax; and/or
  • a tax credit.

Corporation tax deduction

Up to 80% of the expenditure incurred on a qualifying film can be deducted from an FPC's profits.

  • For a limited-budget film, the deduction is for the lesser of either 100% of the UK expenditure, or 80% of the total expenditure.
  • For unlimited-budget films, the deduction is restricted to 80% of the lesser of either 100% of the UK expenditure, or 80% of the total expenditure.

For example, an FPC producing a limited-budget film with £10m of expenditure (which is all UK expenditure) will be entitled to a corporation tax deduction of £8m.

The effect of the corporation tax deduction is to increase the level of core expenditure on a film for tax purposes, with the result that the FPC will either make a lower profit, or incur a greater loss than it would have otherwise done. The deduction will be most valuable where the film is profitable and the FPC uses the corporation tax deduction to set against its income. In cases such as this, the deduction can provide FPCs with a maximum tax benefit of 24% of the total production expenditure for limited-budget films and 19.2% for unlimited-budget films (see example e) in ‚ÄėEffect of the corporation tax deduction' box).

See the examples in the ‚ÄėEffect of the corporation tax deduction' boxes, starting below, for further, more detailed examples of how the corporation tax deduction could operate in practice.

Film tax credit

As can be seen by these examples, in many, if not most, circumstances, the corporation tax deduction will result in a net loss for the FPC for tax purposes.

As we have already described, even if the film breaks even, the corporation tax deduction will result in a tax loss of up to 80% of the total expenditure. If the corporation tax deduction does result in a net loss for the FPC, the FPC will be eligible to claim a tax credit (ie a payment from HMRC) for 25% of the loss for a limited-budget film. The tax credit is restricted to 20% for an unlimited-budget film.

The film tax credit does not form part of the FPC's taxable income.

If the film tax credit is not claimed then the FPC will be able to carry forward the corporation tax deduction and set it against future income from the film in the same way as other losses.

Combining deduction and credit

As explained above, the FPC will be entitled to both a corporation tax deduction and a film tax credit where the corporation tax deduction reduces gross profits to result in a net loss.

The film tax credit will be limited to 25% or 20% (for limited- and unlimited-budget films respectively) of the lesser of either the amount of the net loss, or the available qualifying expenditure (which is a maximum of 80% of the expenditure on the film).

For limited-budget films, the maximum overall tax credit that can be claimed is 20% of the total qualifying expenditure on the film (ie 25% of 80% of the expenditure on the film). It will only be possible to claim the maximum tax credit in cases where the total qualifying expenditure on the limited-budget film is equal to or more than the income generated from the film (ie in cases where the film either breaks even or makes a loss before taking account of the corporation tax deduction - see examples a) and b) in the ‚ÄėCombined effect of the deduction and the film tax credit' box).

For unlimited-budget films, the maximum overall tax credit that can be claimed is 16% of the total qualifying expenditure on the film (ie 20% of 80% of the expenditure on the film). It will only be possible to claim this maximum tax credit in cases where the total qualifying expenditure exceeds the income generated from the unlimited-budget film by at least 19.2%.

The combination of the corporation tax deduction and the film tax credit operates in such a way that it will be possible for the expenditure on a limited-budget film to exceed the income from that film by up to 20%, and the FPC will be able to recoup the whole of this excess by claiming a tax credit. It is expected that this ability to recoup 20% of the cost of film production will prove a useful tool for FPCs to finance up to 20% of their film production costs (see example c) in the ‚ÄėCombined effect of the deduction and the film tax credit' box).

As we have described, the film tax relief is at its most valuable when the FPC makes sufficient profits to be fully absorbed by the available corporation tax deduction (ie to reduce profits to zero without producing a loss), as this gives a tax benefit of up to 24% or 19.2% of total expenditure (depending on whether the film has a limited or unlimited budget). However, if the FPC is not able to fully absorb the corporation tax deduction with its profits, the combined effect of the tax deduction and tax credit will be most valuable where the film is profitable and the FPC uses the corporation tax deduction to set against income from the film, while claiming a tax credit in respect of the loss created by such deduction (see example d) in the ‚ÄėCombined effect of the deduction and the film tax credit' box).

Film production spanning more than one accounting period

Where the production of a film covers more than one accounting period, the film relief operates on a cumulative basis as follows:

a) with respect to the corporation tax deduction:

  1. in the first accounting period, the level of the FPC's available qualifying expenditure is determined by the amount of total core expenditure incurred within that period (and where such expenditure was incurred); and
  2. in subsequent periods, including the final period, the level of the available qualifying expenditure is calculated by reference to total expenditure incurred by the FPC to date, less any corporation tax deductions claimed in previous accounting periods;

b) as with the corporation tax deduction, the calculation of the tax credit operates cumulatively, taking into account any previous tax credits claimed.

The overall effect of the cumulative system is to produce the same result that would have arisen if the film had been produced in a single year. However, one of its benefits is that it allows FPCs to claim the film tax relief in each accounting period which spans production time, rather than having to wait until the film is completed.

This briefing does not constitute legal advice and is intended as general guidance only. If you have any queries relating to any of the contents of this briefing, please contact a member of the film group or the tax group.

Effect of the corporation tax deduction

a) Limited-budget film with £10m expenditure, all of which is UK expenditure

Income from the film: £10m (ie the film breaks even, making zero profit)

Corporation tax deduction: £8m (ie 80% of total expenditure as this is less than 100% of UK expenditure)

Post-deduction: loss of £8m

b) Limited-budget film with £10m expenditure, £5m of which is UK expenditure

Income from the film: £10m (ie the film breaks even making zero profit)

Corporation tax deduction: £5m (ie 100% of UK expenditure as this is less than 80% of total expenditure)

Post-deduction: loss of £5m

c) Limited-budget film with £10m expenditure, all of which is UK expenditure

Income from the film: £7m

Actual trading loss: £3m

Corporation tax deduction: £8m (ie 80% of total expenditure as this is less than 100% of UK expenditure)

Post-deduction: loss of £11m (ie the £3m trading loss, less the deduction)

d) Limited-budget film with £10m expenditure, all of which is UK expenditure

Income from the film: £13m

Actual trading profit: £3m

Corporation tax deduction: £8m (ie 80% of total expenditure)

Post-deduction: loss of £5m (ie the £3m trading profit less the deduction)

Corporation tax saving: £0.9m

Assuming a corporation tax rate of 30%, the corporation tax saving of £0.9m represents 30% of the £3m actual pre-deduction trading profit which, in the absence of the tax deduction, would have been taxable.

e) Limited-budget film with £10m expenditure, all of which is UK expenditure

Income from the film: £18m

Actual trading profit: £8m

Corporation tax deduction: £8m (ie 80% of total expenditure as this is less than 100% of UK expenditure)

Post-deduction: £0 profit (therefore no corporation tax to pay)

Corporation tax saving: £2.4m

Assuming a corporation tax rate of 30%, the corporation tax saving of £2.4m represents 30% of the £8m actual pre-deduction trading profit which, in the absence of the tax deduction, would have been taxable. This represents the maximum benefit of the film tax relief - ie 24% of the total production expenditure.

f) Unlimited-budget film with £25m expenditure, all of which is UK expenditure

Income from the film: £25m (ie the film breaks even, making zero profit)

Corporation tax deduction: £16m (ie 80% of 80% of total expenditure)

Post-deduction: loss of £16

g) Unlimited budget film with £25m expenditure, £15m of which is UK expenditure

Income from the film: £25m (ie the film breaks even, making zero profit)

Corporation tax deduction: £12m (ie 80% of UK expenditure as this is less than 80% of 80% of the total expenditure of £25m)

Post-deduction: loss of £12m

h) Unlimited budget film with £25m expenditure, all of which is UK expenditure

Income from the film: £30m

Actual trading profit: £5m

Corporation tax deduction: £16m (ie 80% of 80% of total expenditure)

Post-deduction: loss of £11m (ie the £5m trading profit less the £16m deduction)

Corporation tax benefit: £1.5m

Assuming a corporation tax rate of 30%, the corporation tax saving of £1.5m represents 30% of the £5m actual pre-deduction trading profit which, in the absence of the tax deduction, would have been taxable.

Combined effect of the deduction and the film tax credit

a) Limited budget film with £10m expenditure, all of which is UK expenditure

Income from the film: £10m (ie the film breaks even making zero profit)

Corporation tax deduction: £8m (ie 80% of total expenditure)

Post-deduction: loss of £8m

Tax credit: £2m (ie 25% of net loss of £8m)

Total tax benefit: £2m (ie 20% of total expenditure)

b) Limited budget film with £10m expenditure, all of which is UK expenditure

Income from the film: £7.5m

Actual trading loss: £2.5m

Corporation tax deduction: £8m (ie 80% of total expenditure)

Post-deduction: loss of £10.5m (ie £2.5m trading loss less the £8m deduction)

Tax credit: £2m (ie 25% of the available qualifying expenditure of £8m as this is less than the post-deduction loss of £10m)

Total tax benefit: £2m (ie 20% of total expenditure)

c) Limited budget film with £12.5m expenditure, all of which is UK expenditure

Income from the film: £10m

Actual trading loss: £2.5m

Corporation tax deduction: £10m (ie 80% of total expenditure)

Post-deduction: loss of £12.5m (ie £2.5m trading loss less the £10m deduction)

Tax credit: £2.5m (ie 25% of the available qualifying expenditure of £10m as this is less than the post-deduction loss)

Total tax benefit: £2.5m (ie 20% of total expenditure)

d) Limited budget film with £10m expenditure, all of which is UK expenditure

Income from the film: £12.5m

Actual trading profit: £2.5m

Corporation tax deduction: £8m (ie 80% of total expenditure)

Post-deduction: loss of £5.5m (ie £2.5m trading profit less £8m deduction)

Corporation tax benefit: £0.75m (ie 30% of £2.5m actual trading profit which would otherwise have been taxable)

Tax credit: £1.375m (25% of the post-deduction loss of £5.5m)

Total tax benefit: £2.125m (ie £0.75m plus £1.375m)

e) Unlimited budget film with £20m expenditure, all of which is UK expenditure

Income from the film: £20m (ie the film breaks even making zero profit)

Corporation tax deduction: £12.8m (ie 80% of 80% of total expenditure)

Post-deduction: loss of £12.8m

Tax credit: £2.56m (ie 20% of net loss of £12.8m as this is less than the qualifying expenditure of £16m)

Total tax benefit: £2.56m

f) Unlimited budget film with £20m expenditure, all of which is UK expenditure

Income from the film: £15m

Actual trading loss: £5m

Corporation tax deduction: £12.8m (ie 80% of 80% of total expenditure)

Post-deduction: loss of £17.8m

Tax credit: £3.2m (ie 20% of the available qualifying expenditure of £16m as this is less than the post-deduction loss of £17.8m)

Total tax benefit: £3.2m

By Louise Gordon, assistant solicitor, Harbottle & Lewis LLP.

For more information please visit www.harbottle.com.