BIM56335 - Film and audio products: deductions for qualifying films: write-off over three years: practice before FA05

Anti-avoidance measures were introduced to stop abuse of F2A92/S42 (Section 42) on 2 December 2004 (see BIM56340 onwards). However, transitional rules ( BIM56350, BIM56365 and BIM56370) mean that not all expenditure incurred on the production or acquisition of a qualifying film on or after that date will be subject to the new restrictions.

Although ITTOIA did not come into force until 6 April 2005, some films may also be subject to the rules in Section 138 before this was amended and Section 138A inserted. Unless the context otherwise requires, ‘Section 42’ and ‘Section 48’ (F2A97/S48) here refer also to their equivalent provisions, ITTOIA/S138 to S140.

Production expenditure

For films unaffected by FA05, relief under Section 42 is available for production expenditure, whenever that expenditure is incurred or payable (providing the film was completed after 10 March 1992). However the expenditure must have been incurred by the person seeking the deduction. Incurred here takes its ordinary meaning, and would not include wholly contingent sums such as deferments and participations payable only if income arises from the film until such time as the obligation to pay those sums becomes certain (see BIM56515).

Example 1

A company produces a film and completes production on 1 July 2004. The film is subsequently certified as a qualifying film. At completion the company has paid out £20m in production costs. In addition, the company has contracted to pay the director a further £1m in the event that the net proceeds received by the company from exploiting the film exceed £22m. The additional payment to the director is uncertain and contingent on achieving the necessary level of income. It will not be incurred until that level has been reached.

Acquisition expenditure

Before FA05, Section 42 imposed no limit on the amount of acquisition expenditure relievable under the section, other than the expenditure had to be incurred on the acquisition of the master version of the film.

Most films are highly speculative ventures and difficult to value. As a result production companies often write off much of the expenditure on a film, so that the value shown on the balance sheet is substantially below cost (or even zero). It might therefore be argued that a payment to acquire a film at full production cost is excessive and is not expenditure incurred to acquire the film, but for another purpose (such as obtaining a tax advantage). Restriction of the acquisition price in this way would defeat the purpose of the relief, which is to assist producers in financing their films. Also, most acquisitions occur before a film has been released and it is rarely possible to make a judgement that a film is worth less than its actual cost of production at that stage. So, in practice you should not challenge a pre-release acquisition price set at the actual costs of production (see BIM56435).

Film producers also often incur a relatively small amount of overheads and incidental expenditure such as company running costs, financing costs and the completion bond. Although these are not direct costs of producing the film, before 2 December 2004 you should accept an acquisition price set at the cost of production plus these incidental costs.

Exceptionally, the value of a film may be demonstrably greater than its production cost plus incidental overheads. This is only likely to apply to films which are one of a series with a proven track record, and usually these will be big budget films. In such circumstances you can accept an acquisition price at the greater value of the film, providing the value appears realistic.

These guidelines only apply where the master version of the film is acquired with all of its intellectual property rights (e.g., distribution rights, copyright) attached, see BIM56440.

Avoidance – inflated acquisition price

Before FA05 there was widespread abuse of Section 42 through artificially inflating the acquisition price of a film well above production cost or market value. This commonly occurs in three ways:

• the cost of production of the film is inflated by including contingent sums payable only if the film is successful;
• addition of substantial overheads and other costs wholly unrelated to the production of the film (particularly common with large budget films);
• over valuation of the film.

Any contentious cases where the acquisition price appears to be significantly above the greater of actual production (plus incidental) costs and market value should be referred to CT&VAT (Technical).

Interaction between Section 42 and Section 48

Before the changes made by FA05 and after the introduction of Section 48 in 1997, the three year write off rules ( BIM56330) in Section 42 applied to all expenditure on the production or acquisition of the master version of qualifying films costing more than £15m to produce, but also to some expenditure on films costing £15m or less to produce. This expenditure is:

• any expenditure incurred on the acquisition of the film where that exceeds the total production expenditure ( BIM56380) on the film,
• for any film completed after 16 April 2002 any production expenditure incurred after the film is completed (e.g., deferments or participations which only become payable when the film generates certain levels of income – see BIM56385),
• for any film completed after 16 April 2002 any expenditure incurred on the production of the film before the film is completed which is neither paid before completion nor unconditionally payable within 4 months of completion.

Where Section 42 applies to some of the expenditure on a qualifying film, that part of the expenditure can be written off using the 3 year rule. Relief can be given under both Section 42 and Section 48 in the same relevant period ( BIM56210).

Example 2

A company produces a film and completes production of that film on 1 July 2004. The film is subsequently certified as a qualifying film. It immediately starts a trade of exploitation of the master version of films. It draws up accounts to 31 December 2004 and annually thereafter. The film costs £10.6m to produce, but £0.6m is payable more than 4 months after the film is completed. The maximum amount of its expenditure that the company may deduct in each relevant period is as follows.

Example 3

A partnership has been carrying on a trade of exploitation of the master version of films for a number of years. It draws up its accounts to 31 December each year. It buys a film for £10.6m on 1 July 2004. The film cost £10m to produce, all of which was paid before the film was completed. The maximum amount of its expenditure that the partnership may deduct in each relevant period is as follows.