BIM56385 - Film and audio products: deductions for qualifying films: when production expenditure is incurred: deferments and participations

Time when expenditure is incurred

Until 2 December 2004, F2A92/S42 and ITTOIA/S138 and S138A (‘Section 42’) contained no explicit rule to determine the date when expenditure is incurred (see BIM56330 onwards), so when expenditure is ‘incurred’ in that section took its ordinary meaning following accountancy and tax law principles.

However, F2A97/S48 and ITTOIA/S139 and S140 (‘Section 48) imports the rules from CAA01/S5 to determine the date on which production or acquisition expenditure is incurred (see CA11800). The most important of these rules is that the expenditure is deemed to be incurred as soon as there is an unconditional obligation to pay it. This date is put back to the time when expenditure is required to be paid if that is more than 4 months after the unconditional obligation arises.

Deferments and participations

Deferments and participations are amounts which are sometimes included in the remuneration package of the main participants in the making of a film, such as the executive producer, director and leading actors. These amounts are almost invariably conditional on the success of the film, and do not become due until the film makes certain amounts of income.

A deferment is a fixed sum, some or all of which may become payable at some future date but usually only if the film generates sufficient income. A participation is a sum derived as a percentage of future income or profits, and is therefore always contingent until those profits arise. Insofar as these sums become due and payable, they are deductible as production expenditure. However, they are not an immediate cash cost of production; the reliefs for qualifying films were intended to assist producers in financing their films and so were not directed at these sums which producers have no difficulty in funding as they are payable out of income. Given that these sums require that the producer receives income before they become due, it is likely that they will be deductible immediately under the income matching or cost recovery rules in F2A92/S40B ( BIM56215 and BIM56330).

It has never been possible to include contingent sums in Section 48 relief, either as a deduction for production expenditure incurred or in setting the level of total production expenditure – particularly for fixing the maximum relief for acquisition expenditure (see BIM56380).

Several deferment schemes have been devised, seeking not only to exploit Section 42 relief, but also Section 48 relief – despite the explicit prohibition of contingent sums in that section. Often, these schemes include deferments and participations for everyone involved in a production, not just the leading participants and we have seen schemes where over 90% of the nominal production cost are contingent amounts. In practice, deferments and participations are often wholly unpaid, particularly on small budget films.

Until 2 December 2004, there was no explicit rule to determine when expenditure was incurred for Section 42 relief. However, under generally accepted accountancy principles we would usually expect deferments and participations to be identified as contingencies and in most cases not reflected as actual expenditure incurred. We have seen a number of production company accounts where substantial contingent deferments and participations are not identified on the face of the accounts, but have been written off in the profit and loss account or shown as a fixed asset or work in progress on the balance sheet, balanced by significant amounts of unpaid creditors. Accountancy advice should be sought where the accounts show contingent amounts written off to the profit and loss account or recognised as part of the value of an asset on the balance sheet.

Where unpaid deferments or participations have been claimed as a deduction under Section 48, Section 42 or F2A92/S40B, or used to justify an inflated acquisition price in a sale and lease back deal (see BIM56335), you should refer the case to Anti-Avoidance Group (Films).

FA02/S100

In order to discourage the proliferation of deferment schemes, Section 48 was further strengthened and clarified, for films completed on or after 17 April 2002, to disallow relief for any amounts that, at the time the film is completed:

• have not been paid, and
• are not the subject of an unconditional obligation to pay within 4 months after the date of completion.

In effect this means that even if deferments or participations eventually become payable, they will not be allowed as deductions as production expenditure under Section 48, and will not count in raising the amount of acquisition expenditure that can be claimed under Section 48.

Although this was effective in stopping attempts to use deferment schemes with Section 48 (even though those schemes did not comply with the law before 17 April 2002), it did not prevent Section 42 being abused in the same way. Therefore this rule, and the CAA01/S5 provisions determining when expenditure is incurred were extended to Section 42 relief for claims on or after 2 December 2004 (see BIM56340).

There is one other variety of tax avoidance scheme which has a similar purpose and effect to deferment and participation schemes. This involves ‘ reinvestment’ of expenditure on films and is described at BIM56520.