Modernising film tax credits

The enhancements to the UK Film Tax Relief (FTR) announced in the 2014 budget have now received state aid approval. They will now have retrospective effect from 1 April 2014. The government’s main aim in introducing the changes is to simplify the use of the FTR and to make the UK more attractive to film producers from around the world. The revisions introduce an increase in the rate of relief from 20% to 25% for the first £20 million of qualifying UK expenditure of large-budget films. The changes, which will be introduced by the Finance Bill 2014, also reduce the minimum UK expenditure requirement from 25% to 10% and modernise the cultural test, which has been expanded to allow for European as well as British culture. Following state aid approval the Corporation Tax Act 2009 (CTA) will be amended to reflect the approved changes.

Qualifying companies

FTR is only available for film production companies (FPCs). FPCs are companies that fall within the UK corporation tax net and are responsible for the pre-production, principal photography, post-production and delivery of the completed film. Only FPCs that are actively engaged in planning the production and making decisions at the various stages of the production qualify for FTR and can claim the relief through their corporation tax return. There is no requirement for a FPC to be directly involved in every aspect of the film, nor must the FPC own the master negatives or other film rights. It must not, however, entirely relinquish its involvement in any of the activities.

The requirements to be met by an FPC are simplified in the case of qualifying co-productions, i.e. films that are treated as British by virtue of being produced under an international co-production treaty between the UK and another state. A UK co-producer is only required to make an effective creative, technical and artistic contribution to the film (s 1182(4) CTA), and so a financial-only co-producer would not qualify for the relief.

When is the relief available?

An FPC can rely on the FTR if three requirements are satisfied.

1. The film must be intended for theatrical release

An FPC can rely on the relief if the film is genuinely intended for theatrical release, with a significant proportion of the income from the film obtained by such theatrical exhibition (s 1196 CTA). HMRC has confirmed a significant proportion to be 5% of the film’s income.   An intention for theatrical release is sufficient: a film does not need to be given an actual theatrical release to qualify for FTR.  For the condition to be met, the intention to release the film theatrically must be held at the end of each accounting period of the FPC during which film production activities are carried on.

Guidance published by HMRC outlines the factors that indicate that a film is intended for theatrical release.  These include: (a) the film is a full-length or short feature film of a type generally shown at commercial cinemas; (b) the film is a suitable format to be shown in a cinema; and (c) the FPC can, at the end of each accounting period, demonstrate that there was an intention to seek a contract for a theatrical release of the film.

2.       The film must qualify as a British or EEA film under the cultural test

A film will only qualify for FTR if it qualifies by virtue of an internationally agreed co-production treaty or if it satisfies the cultural test, as set out in Schedule 1 to the Films Act 1985.  Once the revised legislation has gone through Parliament later in the year, FPCs will be able to submit their tax relief claims to HMRC and will be able to do this on expenditure back-dated to 1 April 2014.  Until then, FPCs who are in principal photography on or after the 1 April 2014 may use either the existing cultural test or the revised test to apply.  Qualification is administered by the British Film Institute on behalf of the Department for Culture, Media and Sport.

The UK cultural test is a points-based system that gives each film a score on a number of criteria, grouped into four sections:

1. cultural content;
2. cultural contribution;
3. cultural hubs; and
4. cultural practitioners. 

Until now a film had to be certified as a British film.  The revised cultural test, however, has been expanded to allow for European as well as British culture.  So the main changes are to the cultural content category, in which references to British, UK and English are to be replaced with EEA.  Additionally, the points available for English language and principal photography / special effects / visual effects have been increased.  More weight is to be given to original dialogue in an EEA language (previously four points) and to visual and special effects and shooting if at least 50% of them take place in the UK (previously two points).  The revised cultural test is a 35-point test (previously 31) with a pass mark of 18 (previously 16).

The revised cultural test		Points
A	Cultural content
	Film set in the UK or EEA	4
	Lead characters British or EEA citizens or residents	4
	Film based on British or EEA subject matter or underlying material	4
	Original dialogue recorded mainly in English or UK indigenous language or EEA language	6
	Total section A	18
B	Cultural contribution
	The film demonstrates British creativity, heritage and/or diversity	4
	Total section B	4
C	Cultural hubs
C1	(a) At least 50% of the principal photography or SFX takes place in the UK	2
	(b) At least 50% of the VFX takes place in the UK	2
	(c) An extra two points can be awarded if at least 80% of principal photography or VFX or SFX takes place in the UK	2
C2	Music recording / audio post-production / picture post-production	1
	Total section C (maximum 4 points in total in C1)	5
D	Cultural practitioners (UK or EEA citizens or residents)
	Director	1
	Scriptwriter	1
	Producer	1
	Composer	1
	Lead actors	1
	Majority of cast	1
	Key staff (lead cinematographer, lead production designer, lead costume designer, lead editor, lead sound designer, lead visual effects supervisor, lead hair and make-up supervisor)	1
	Majority of crew	1
	Total section D	8
	Total all sections (pass mark 18)	35

If a film scores all of the “cultural hub” and “cultural practitioners” points and all four “EEA language” points in the “cultural content” category, it also has to score either:

1. at least one additional point in one of the first two sections of the “cultural content” category because the film is set in the EEA or because the lead characters are played by EEA citizens or residents; or
2. all four points in the third section of that category because the film is based on EEA subject matter or underlying material.
3. This is referred to as the “golden points” rule.

3.      The minimum UK expenditure requirement must be satisfied

For a film to qualify for FTR, a certain proportion of the FPC’s core expenditure must be UK expenditure. The previous minimum UK expenditure requirement was set at 25%. In order to help UK independent production companies, by encouraging minority co-productions where the UK spend is less than 25%, s 1198(1) CTA will now be amended to reduce the minimum expenditure requirement to 10%.

The relief can only be claimed on core expenditure that is UK expenditure up to a maximum of 80% of the FPC’s core expenditure. UK core expenditure is defined as expenditure incurred on filming activities (pre-production, principal photography and post-production) that take place within the UK, irrespective of the nationality of the persons carrying out the activity.

It excludes any expenditure on development and distribution, as well as the cost of raising finance for the film, but such costs may in certain circumstances fall under the “used and consumed” test (s 1185 CTA). The test concentrates on the recipient or customer of the relevant goods and services as the means of determining UK expenditure. For services that may be used during both development and production (for example, scriptwriting services), expenditure can be apportioned between these activities. Provided that the activities take place in the UK, the expenditure will qualify as UK expenditure, and will qualify for FTR as long as the expenditure is incurred on filming activities.

Tax credit

FTR can increase the amount of expenditure that is allowable as a deduction for tax purposes or, if the company makes a loss, can be surrendered for a payable tax credit. The previous rate of relief was 25% for limited-budget films (i.e. those with an expenditure of up to £20 million) and 20% for all other films.

Following state aid approval, the CTA will be amended so that FTR will be available for surrenderable losses at a rate of 25% for the first £20 million of qualifying core expenditure, and 20% for amounts thereafter, for all eligible film productions, up to a maximum of 80% of the qualifying production core expenditure (s 1202 CTA). The distinction between low-budget films (those with core expenditure of up to £20 million) and other films will be removed. This will make the FTR easier and more attractive to use, as well as eradicate the 20% and 25% schemes. The revised rates of relief will be available to all films on which the principal photography was not completed on 1 April 2014.

Comment

The confirmed changes are expected to have a positive impact on the film industry and significantly improve the UK Film Tax Relief, which in 2009/10 provided around £95 million of support to the British film industry, supporting over £1 billion of investment in 208 films. Introducing changes to this sector-specific tax relief is likely to benefit films at the threshold of the £20 million rate and some larger film productions. FTR allows qualifying companies to claim a payable tax credit, supporting the local production of culturally British/European films. The reduction in the percentage for minimum UK expenditure is intended to encourage further investment in the UK and to benefit visual effects and the film industry as a whole. There are currently between 150 and 200 films a year benefiting from the FTR, and the recent changes should help to create a sustainable British creative sector, particularly benefiting large-budget film producers.

Jonathan Blair, Partner, and Juliane Althoff, Trainee Solicitor, Michael Simkins LLP