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Replies to Queries - 1 - Lights, camera, loss

13 November 2002
Issue: 3883 / Categories:

Mr Film left employment in September 2001 where he had been working in the media through an agency. He has now set up in self employment. By 5 April 2002 he had produced a documentary aimed at United Kingdom audiences and is hoping to sell it to one of the television channels or for a theatre screening.

Mr Film's main expenditure whilst self employed has been in respect of research, production (hire of equipment, transportation, film/video) and post-production (hire of editing equipment). He has also purchased some £5,000 worth of editing equipment.

Mr Film left employment in September 2001 where he had been working in the media through an agency. He has now set up in self employment. By 5 April 2002 he had produced a documentary aimed at United Kingdom audiences and is hoping to sell it to one of the television channels or for a theatre screening.

Mr Film's main expenditure whilst self employed has been in respect of research, production (hire of equipment, transportation, film/video) and post-production (hire of editing equipment). He has also purchased some £5,000 worth of editing equipment.

As the documentary had not been sold by 5 April 2002, Mr Film has, on the face of it, made losses in respect of his self employment which we would like to set off against his income from employment, in order to obtain a refund. But should I be carrying forward the cost of the production, and what other pitfalls should I avoid?

(Query T16,108) - Dim Star.

 

This is going to sound a bit like a double act, but looking at Tim Jarvis's 'Relief in Celluloid' on pages 8 and 9 of the 3 October 2002 edition of Taxation directs us along the right route to advise 'Dim Star'.

We first need to look at the actual tax status of the completed, but not yet sold, documentary. Under section 43(1)(c), Finance (No 2) Act 1992, it sounds as though it is a British film. This definition provides that a British film means a master negative of a film certified by the Secretary of State under Schedule 1 to the Films Act 1995 as a qualifying film. This is:

* where the producer was throughout the time the film was being made a person ordinarily resident in the European Union, or was a company registered in the European Union whose central management and control was throughout the time the film was being made exercised in the European Union;

* where the studios used in making the film were located in the United Kingdom; and

* the associated labour costs represent payments in respect of the labour or services of Commonwealth or European Union citizens.

However, Finance Act 2002, in order to combat possible avoidance, has narrowed the field; in order for a film now to qualify as a British film, it must be genuinely intended for theatrical release. For these purposes 'theatrical release' means exhibition to the paying public at a commercial cinema. The legislation goes on to provide that a film is not regarded as genuinely intended for theatrical release unless it is intended that a significant proportion of the earnings from the film should be obtained by such exhibition. In this case, the wording of sections 99(4) and (5)(b), Finance Act 2002 state that it would not apply to 'a documentary involving the dramatic reconstruction of events if the dramatic content forms 50 per cent or more of the running time'. The object behind this legislation is to exclude from the definition of a British film, any films which are produced primarily for showing on television. In addition, the legislation excludes deferred expenditure from the definition of production expenditure. However, as we are advised that the production of the documentary has been completed, this does not apply here.

Section 40A, Finance (No 2) Act 1992 allows expenditure on a British film to be revenue expenditure and allowed either on an income matching basis which writes the expenditure off in proportion to the film's income as it arises on a 'just and reasonable' basis, or on a cost recovery method allowing the expenditure to be written off against the income as it arises. However, section 42 gives an alternative method allowing the expenditure to be written off over a three-year period. Thus in respect of the completed documentary, one third of the expenses would fall in 2001-02, with one third in 2002-03 and the remaining balance in 2003-04. This thereby accelerates the recognition of the revenue expenditure for tax purposes, and means there would be no connection between the allowing of the expenditure against income.

However, under section 48, Finance (No 2) Act 1997, things get even better! This section amends section 42 and applies to qualifying films completed on or after 2 July 1997 and before 2 July 2005, where the production expenditure on the film is £15 million or less. It allows the producer of the master version of a British film to deduct 100 per cent of the expenditure incurred in the production of the film, for tax purposes, in the period of account in which the film is completed. Where the Secretary of State has certified the film as a qualifying film, then the election would also allow the £5,000 spent on editing equipment to be included.

Therefore because in 2001-02 there has been no self-employed income, then an election can be made under section 380, Taxes Act 1988 to set the loss incurred against Mr Film's other (employment) income in that year. Of course if necessary the carry back rules against 2000-01 income would also apply if needed, with any unused losses carried forward against future trading profits of the business.

Note the Revenue's Statement of Practice 1/98 'Tax treatment of expenditure on films' is definitely a place to visit. - N.K.

 

I fear this response to 'Dim Star's' query may be rather 'B' rated, owing to the limited information provided.

Statement of Practice 1/98 gave an outline of the tax treatment of expenditure on films and a guide as to what should be regarded as production expenditure, which should be identified by reference to normal accountancy principles - and the specific issues considered by the Inland Revenue not so included.

This may be 'Dim Star's' starting point to categorise the various expenditures.

Specific rules apply for certain capital expenditure under paragraph 82 of Schedule 2 to the Capital Allowances Act 2001 with alternative methods of allocating such costs. Under the income matching method, expenditure is written off over the period during which the value of the film is expected to be realised, whilst the cost recovery method effectively means no profit on a film needs to be brought into account for tax purposes until all the costs of production have been recouped (out of such costs).

'Dim Star' should also be aware of section 48, Finance (No 2) Act 1997 which provided for the immediate write-off of expenditure on the production of British qualifying films where expenditure is less than £15 million. (Although this was to have ceased on 1 July 2002, it has now been extended by another three years to 1 July 2005 under section 72, Finance Act 2001.) The documentary may be aimed at United Kingdom audiences, but is it a 'British qualifying film'?

To answer the specific point (i.e. is a claim under section 380 or 381, Taxes Act 1988 in order?), some solace might be obtained from the Inland Revenue's internal Inspector's Manual at paragraph IM3300 in which Inspectors are guided not to fine tune the timing of relief for film production costs where a reasonable attempt has been made to comply with the rules. (This practical approach is then countered by advising referral to head office where amounts are substantial!) Low budget productions would therefore appear to succeed, in loss claims, on that basis. - Jim.

Issue: 3883 / Categories:
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