BIM56450 - Film and audio products: tax deferral schemes for qualifying films: sales at market value

Until the changes announced on 2 December 2004 ( BIM56340 onwards) it was possible to obtain relief under F2A92/S42 for acquisition expenditure in excess of the actual costs of production of a film ( BIM56335). However, there are very few films where a price in excess of the actual costs of production can be justified. There are a number of reasons for this.

Most films are highly speculative ventures, and a large proportion never achieve general release at the cinema. Some films, originally intended for cinematic release (see BIM56115), are released straight to video or DVD. Even then, half of all films – principally small budget films – are never released.

Even where a film is released, the great majority (even of relatively successful films) make little or no net return for the producer beyond amounts received for pre-sales. This is because of the way that films are marketed. Exhibitors (for example, cinemas and video rental outlets) are likely to take at least half of gross sales. Film distributors then take the lions share of the remainder. Distributors incur significant costs on ‘prints and advertising’ (producing prints of the film and advertising it). These costs can equal or exceed the actual costs of producing the film, and distributors almost invariably insist on covering these costs and taking a profit margin before giving any return to the producer.

Most film producers will also appoint a sales agent, responsible for marketing the film at festivals, and so on, and selling to distributors across the world. The sales agent will usually provide estimates forecasting likely sales (by the producer) of the film across the world – normally in the form of a minimum, medium and maximum amount of sales, all based on the assumption that the film will be released and will be successful. Commercially, these estimates are often presented to banks in order to obtain additional borrowing (‘gap finance’). Commonly, banks, if they think that the film is likely to be successful, may lend up to 50% of the minimum sales estimate.

Frequently, sales estimates are also used for tax purposes to attempt to justify sales at above actual production cost – most commonly in avoidance schemes with significant amounts of deferments and participations ( BIM56385). Sales estimates should be examined critically. They are notoriously unreliable and we have seen numerous examples where the estimates on low budget films predict sales commensurate with blockbuster levels of success. In particular, where sales estimates are used to justify a value above actual production cost or provisions for deferments and participations, you should not only compare the estimates with actual performance of the film (which is the least relevant as it benefits from hindsight), but ascertain whether the estimates have been presented to a bank to obtain finance, and seek examples of similar estimates by the agent on films previously released.

A sales agent may take a relatively small fee if the producer has to meet actual marketing costs, or a larger fee if the agent bears the risk of incurring these costs.

Producers will often also have to share some of any income that is left with investors – for example, lottery ‘grants’ from the UK Film Council are normally repayable to the extent that the film is profitable, but not otherwise, which will reduce the net value of the film for the producer. Any deferments and participations due on the film will also act to reduce the value.

As a result of this, and although successful films can be very profitable, it is generally rare to be able to value a film at above actual cost of production – particularly for low budget films. Some large budget (‘big ticket’) films may be an exception to this, but normally only where the film is part of a series of films with a proven track record. Very large budget films (for example, with production costs over £100m) are more likely to be successful, but even at this level of expenditure, success is far from guaranteed.

Any cases where it is argued that a price above actual production cost (plus minor incidental costs) is justified, and you are unable to agree the valuation, should be referred to CT&VAT (Technical).