New tax relief in the UK – Incentives for the creative sector

The UK Government defends the country’s pole position in high-quality productions.
One thing we do really well in the UK is producing high-end television programmes like Downton Abbey, animation programmes such as Wallace & Gromit, and blockbuster video games such as the “Need for Speed” series. So when recently a number of high-profile and ostensibly “British” television programmes, such as “Titanic” and “Ripper Street”, were produced in other jurisdictions, notably the Republic of Ireland, the UK Government got worried!

The Film Tax Relief (“FTR”) system, introduced in 2006, has been very successful. The UK film industry now contributes over £5bn a year to UK GDP and there has been a 70% increase in the UK film production workforce since 2007. Not only this, but FTR, just like the new patent box rules and R&D tax credits, has also resulted in an increased overall tax take to the Treasury through enhanced VAT and PAYE receipts.

Not surprisingly, the new rules are based on the FTR model and, given that it is the Chancellor’s avowed intention that the new relief should be “the most generous available in the world”, it was no surprise that the proposed tax relief for the creative sector (released on 11 December 2012) was well received.

How does the relief work?
Just as with FTR, the tax relief will only be available to UK companies which fall within the charge to corporation tax (note that LLP’s will not be eligible but co-productions will) where “core expenditure” is at least £1m per programme hour and at least 25% of this core expenditure is UK based. There are no minimum expenditure limits for animation or games, by the way.

Companies for this purpose are deemed small or large depending on whether core expenditure is more or less than £20m. Small companies can claim an additional deduction worth 100% of the lower of either UK expenditure or 80% of total core expenditure. Large companies are restricted to 80% of this figure. If a company is loss-making it can surrender the additional losses for a cash credit.

In summary, a small company will be able to claim an additional 20p on every pound of core expenditure, besides the tax relief it would normally obtain on the expenditure, and a large company can claim 12.8p.

Definitions
As with all legislation, “the devil is in the detail”, and not all the terminology has an obvious meaning. Here are some of the key definitions:

• “Core expenditure” is expenditure on pre-production, principal photography and post-production of the programme. Certain development, distribution and finance costs are not eligible. Production fees will qualify towards the £1m threshold, provided they are less than 10% of the pre-production budget. For animation the cost of relevant quality assurance should qualify, but not service maintenance costs.
• The Cultural Test
  Sixteen points out of the same 31 in the original test are still needed. Points will be awarded for British locations, characters, dialogue, demonstrating British heritage or creativity, developing activity taking place in the UK and use of British developers.  The main difference to the film Cultural Test is the expansion of the “cultural content” section to include the EEA (European Economic Area), not just the UK.

What programmes are eligible?

• dramas, documentaries and comedies with a slot length of more than 30mins and core expenditure of at least £1m of direct production cost per hour.
• Programmes must be intended for broadcast on TV and also the internet and for digital distribution via mobile phones. Games must be available for “commercial release”.
• Dramas and documentaries are treated as animations if animation is at least 51%.
• Several programmes commissioned together will be treated as one, but the relief will be applied separately to each commissioned programme.

Non-eligible programmes include advertisements, news, current affairs and discussion programmes, quiz, game and chat shows, competitions, live events and training programmes. Game producers will be required to self-certify during the claims process that video games do not contain pornographic or other extreme material.

What is our view?

• There are still problems to overcome before the relief is finalised, such as the decisions concerning the cultural test and state aid approval from the European Commission. Much will depend on how flexible HMRC are in interpreting the rules. Nevertheless we like what we have read and it seems that HM Treasury really has listened carefully.
• The relief is generous and at least as much as most of us expected. The rate of 25% at which the losses can be encashed favours smaller businesses which would normally pay corporation tax at only 20%. This is better than the R&D tax relief where repayment can only be made at a discount to the value of the losses if they were carried forward. Whether it will stay “the most generous in the world” for much longer remains to be seen as the Republic of Ireland is currently reviewing its “section 481” creative tax relief.
• However the one big criticism is that the hurdle of £1m core expenditure per hour has been set too high for most small production companies. Whilst the Government may well have succeeded in persuading the likes of HBO and Disney to shoot over here, the smaller production companies fear that UK production costs will be driven up by their larger competitors and that they will reap no benefit from the relief.
• The relief is simple and relatively easy to understand because it is based on the FTR model. However the introduction of relief for the game industry is bound to be more complicated, given the fact that production expenditure follows a different pattern to TV and film. The model is nevertheless suitably flexible in its adaption to animation and games where for example production costs are often incurred after the game has been released.
• It is also good news that any losses arising from the new relief (which are not surrendered for the cash tax credit) may be carried forward and treated as a current year loss in the following period, maximising, for example, group relief opportunities.

For more information and discussion, do get in touch with Peter Owen (peter.owen@ecovis.com) or Christopher Jenkins (christopher.jenkings@ecovis.com)

USEFUL SOURCES OF INFORMATION

• http://www.niassembly.gov.uk/Documents/CAL/5812.pdf
  A comparison of film tax relief across 14 countries, produced by the Northern Ireland Assembly Jan 2012
• http://www.hm-treasury.gov.uk/consult_creative_sector_tax_reliefs.htm
  HM Treasury summary of June consultation paper