FPC80040 - Avoidance and Disclosure: Avoidance: Inflation of production costs
FA06/SCH5/PARA9 & PARA12
The tax relief previously available for production or
acquisition of British films was subject to regular abuse by those
seeking a means to avoid tax. One such abuse was the artificial
inflation of the actual level of production expenditure through the
inclusion of deferred fees or other contingent costs, such as
participations, which might never arise in practice.
The tax regime for films introduced by FA06 includes features
intended to ensure that it does not suffer from similar abuse in
the future.
Recognition of expenditure
There are rules for determining when expenditure on film
production is recognised for the purposes of the film production
company’s (FPC) basic tax computation (i.e. regardless of
whether or not Film Tax Relief (FTR) is available or claimed).
Under these rules,
- expenditure is recognised to the extent to which it is represented in the state of completion of the film
- any amount that has not actually been paid is only recognised where its payment by the FPC in the future is unconditional.
- costs relating to an obligation that is linked to income being earned can only be brought into account to the extent that the relevant income is brought into account
Unpaid amounts
In calculating FTR any costs which remain unpaid four months
after the end of the relevant period of account are excluded,
irrespective of whether there is an unconditional obligation for
them to be paid in the future.
Deferments or contingent fees (unpaid four months after the
end of the period) should be disregarded for the purposes of FTR,
even where such costs are subject to an unconditional obligation to
be paid.
This disregard does
not apply to the basic tax computation.
Example
An FPC is commissioned to produce an FTR-qualifying film.
Production costs (all UK) are £5m. The film is completed
within a single accounting period (Period 1).
The production agreement provides that the FPC will be
paid:
- £4.2m for producing the film, and
- a further £500,000 if box office receipts exceed £20m.
The principal actor has an agreement with the FPC that if box
office receipts exceed £20m he will receive an additional
£400,000 from the FPC.
The contingent receipt of £500,000 is too uncertain to
bring into the calculation of the film’s profit or loss until
box office receipts are known.
Box office receipts exceed £20m towards the end of
Period 2. At that point the additional £500,000 is treated as
earned and brought into the calculation of profit or loss for
Period 2. The obligation to pay the actor will also be recognised
in that period for the purposes of calculating the profits or
losses of the separate trade of film production under FA06/Sch4
[xxxx]
But the FPC does not receive the payment, and does not pay
out the £400,000 due to the principal actor until midway
through Period 3 (i.e. more than four months after the end of
Period 2). So for the purposes of FTR, the £400,000 is ignored
when looking at the Period 2, but is brought in to Period 3.
| Profits or losses of separate trade (FA06/Sch4) | Period 1 | Period 2 | Period 3 |
| Income | £4.2m | £0.5m | nil |
| Expenditure incurred during period (all UK) | £5m | £0.4m | nil |
| Trading profits (losses) | (£0.8m) | £0.1m | nil |
| Calculation of additional deduction and surrenderable loss (FA06/Sch5) | |||
| Expenditure incurred to end of period (all UK) | £5m | £5.0m
(disregarding £0.4m unpaid within 3 months of end of period | £5.4m
(including £0.4m incurred in Period 2 but paid in Period 3) |
| Increase over expenditure incurred over previous period | £5m | nil | £0.4 |
| Enhanceable Expenditure (in this case 80% of total core) | £4m | nil | £0.32m |
| Additional deduction to end of period (100% of enhanceble expenditure) | £4m | £4m | £4.32m |
| Less additional deduction claimed for earlier period(s) | - | (£4m) | (£4m) |
| Additional deduction due for the period | £4m | - | £0.32m |
| Trading (profit) loss for the period after additional deduction | (£4.8m) | £0.1m | (0.32m) |
| Surrenderable loss (lower of trading loss for the period (after additional deduction) and enhanceable expenditure) | (£4m) | - | (£0.32m) |
Summary
Pre-FTR loss: £700,000
Surrenderable losses: £4.32m
