Film industry finance guide

Contents

Introduction 2

The Enterprise Investment Scheme 4

Putting you in the picture – UK film tax credits 10

It’s easier to make decisions when you know what your values are 16

About Grant Thornton 18

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Introduction

Grant Thornton’s Media and Entertainment team is delighted to bring you our latest Film industry finance guide. This booklet provides an overview of some of the key financial issues relevant to the UK film industry and how our team can help you achieve your strategic objectives.

As a leading advisor, we’re proud to work with dynamic companies in the film production and distribution sector, providing a full range of integrated compliance and advisory services to enable our clients to be prepared for the future and unlock their potential for growth.

We hope you find this guide useful. If you would like further information on how we can assist you, please contact one of our sector specialists:

Michael ThorntonPartner, ValuationsT +44 (0)20 7728 2644E michael.j.thornton@uk.gt.com

Steven LeithDirector, AssuranceT +44 (0)20 7728 2868E steven.leith@uk.gt.com

Liz BrionPartner, TaxT +44 (0)20 7728 2326E liz.a.brion@uk.gt.com

Terry BackPartner, AssuranceT +44 (0)20 7728 2343E terry.a.back@uk.gt.com

Christine CornerPartner, AssuranceT +44 (0)20 7728 3171E christine.corner.uk.gt.com

Richard Palmer Senior Manager, TaxT +44 (0)20 7728 2155E richard.palmer@uk.gt.com

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The Enterprise Investment Scheme (EIS) can offer generous income tax and capital gains tax reliefs to investors.

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Over the past few years there has been an increasing use of EIS, and as of last year, Seed Enterprise Investment Scheme (SEIS), to provide financing for film. This involves raising equity finance from private individuals; we have summarised the key points and frequently asked questions in this section.

What are the tax benefits of an EIS investment?30% income tax reliefFor investments made after 5 April 2011, relief is given at 30% of the sum invested subject to there being sufficient tax liability to absorb the relief. In previous years, relief was available at 20%. This relief takes the form of a credit against an individual’s personal tax liability.

No capital gains tax on disposalIf a qualifying individual holds eligible shares for more than three years from the date of issue (or from the date of commencement of trading, if later), then any capital gain on the disposal of the EIS shares after that period will be tax-free, subject to any withdrawal of the relief as mentioned below.

The reliefs are available to ‘qualifying

individuals’ who subscribe for ‘eligible shares’ in ‘qualifying companies’ undertaking ‘a qualifying business activity’.

Further, if a loss arises on the disposal of EIS shares then, subject to adjustment for the income tax relief previously claimed, that loss will be available to the investor. This relief can either be claimed as a capital loss or as a loss for income tax purposes.

Deferral of tax on other capital gainsCGT on a gain from the disposal of any asset can be deferred against an EIS share subscription. The tax on any gain rolled over in this way only becomes due on disposal of the EIS shares or if the individual ceases to be UK resident within three years of issue of the shares. There is no requirement to obtain income tax relief to qualify for capital gains tax deferral and the amount of the gain which can be deferred is unlimited. To qualify for deferral relief the EIS investment must be made during the period commencing one year before the realisation of the gain and ending three years after.

Where a deferred gain becomes chargeable on the disposal of EIS shares, it will be subject to the CGT rate in force at that time (and not at the time the original disposal was made). Therefore,

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any disposals made after 22 June 2010 will be subject to the flat rate of CGT of 28% or 18%, depending upon whether the gain falls within the individual’s unused basic rate band.

What are the investment limits?Individuals may invest any amount in EIS shares, but only the first £1 million invested in any one tax year will qualify for income tax relief and the Capital Gains Tax (CGT) exemption. Thus the maximum tax credit available to an individual in 2013/14 is £300,000 (£1 million x 30%). For these purposes, a husband and wife are treated separately.

Subject to the overriding investment limit in any one tax year, any share subscriptions in the current year can be treated as being made in the previous year for the purpose of EIS income tax relief. For example, an EIS investment made on 1 May 2013 may be ‘carried back’ and income tax relief claimed in the tax year 2012/2013.

Who are ‘qualifying individuals’?This is any individual who has subscribed for shares wholly in cash in the company. However, an individual will not qualify if they are connected with that company at any time within the two years prior to the share issue and the three years after the share issue date (or the date

on which trading commences, if later). This ‘connection’ can be by way of employment, partnership, or by being an associate (eg a spouse or child; but not a brother or sister) of another connected person. An individual will also be connected if they own or are entitled to acquire, directly or indirectly, more than 30% of the issued ordinary share capital, issued share capital or voting power of the company or a subsidiary. These connection conditions do not apply to the CGT deferral mentioned below.

What are ‘eligible shares’?Eligible shares are any new ordinary shares issued in the EIS company for bona fide commercial reasons, which, throughout the period of three years beginning with the date on which they are issued, carry no preferential rights to dividends (other than a fixed dividend in some cases) or assets on liquidation of the company. The shares must be fully paid up at the time of issue and they cannot be redeemable.

What are ‘qualifying companies’?A qualifying company need not be UK resident. However, from 6 April 2011, the company issuing the shares must have a ‘permanent establishment’ (PE) in the UK. Different rules

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apply for investments made up to and including 5 April 2011. These rules were changed in order to ensure compliance with EU state aid rules.

Qualifying companies must be unquoted and the funds raised must be used by the issuing company or by a qualifying 90% subsidiary in carrying out qualifying business activities. Companies listed on the Alternative Investment Market are treated as unquoted for these purposes.

Where a parent company is raising funds, it must only have 51% subsidiaries to be a

qualifying company, with the exception of property management subsidiaries which must be held 90%. However, the funds can only be used by qualifying 90% subsidiaries.

A qualifying company must have fewer than 250 employees and cannot have raised more than £5 million from the EIS or Venture Capital Trusts (VCT) regimes in the last year. In addition, the gross assets of a standalone company, or aggregate gross assets of a group, must not exceed £15 million prior to investment, nor £16 million post investment.

A new condition was introduced, with effect from 6 April 2011, excluding companies from qualifying where they are in difficulty. The ‘financial health requirement’ will disqualify a company if it would generally be regarded as being in difficulty as defined in the EC’s official journal, ‘Community Guidelines on State Aid for Rescuing and Restructuring Firms in Difficulty’.

From 6 April 2012 a ‘disqualifying arrangements’ test will disqualify activities where companies are set up for the purpose of accessing the relief, with little or no commercial purpose other than tax avoidance.

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What is a UK ‘PE’?As stated above, from 6 April 2011, a qualifying EIS company must have a ‘permanent establishment’ in the UK. Broadly, a UK PE is defined as a fixed place of business, such as a place of management, a branch, office, factory or workshop, through which the business is wholly or partly carried on. However, this requirement will not be met if the business activities carried on in the UK are merely preparatory or auxiliary to a non-UK based trade.

Alternatively, the definition also extends to a company for whom an acting agent exercises their authority in the UK on a regular basis.

What is a ‘qualifying business activity’?Broadly speaking, a qualifying business activity means the carrying on of a qualifying trade during the three years from the date the shares are issued or, if later, three years from the date the company commenced trading. Any research and development undertaken with the intention of starting a trade is also treated as a qualifying business activity.

Qualifying trades encompass all forms of trading except for certain prohibited businesses including dealing in land, financial activities, legal/accountancy services, property backed

activities, shipbuilding, as well as coal and steel production.

What if I sell the shares early?A disposal of EIS shares within three years of issue could result in a restriction of the EIS reliefs previously given and, if so, the relief will be clawed back. In addition, the CGT exemption may also be lost, however, any capital loss arising as a result may be set against either income or capital gains in the same or the preceding tax year.

Can I oversee my investment?Yes, to a certain extent. The EIS rules allow investors to become directors of companies into which they have invested, so long as they become directors after the issue of the shares. Such a position may be executive in nature and the individual may be remunerated accordingly.

Can the tax relief be taken away?Yes. The main conditions for retaining relief are:• ThemoneyraisedbytheissueofEISshares

must be wholly applied in qualifying business activities and must be applied in that business within two years of the share issue, or where it is a new trade, within two years of commencing the trade

• Thecompanymustnotceasetobeaqualifying company during the three year period from the date of issue of the shares or the start of trading, if later

• Theremustbenoarrangementsatthestartofthe relevant period for the company to become quoted during the three year period

• Sharesmustbefullypaidupwhenissued• Thecompanymustnotbecontrolledby

another company or companies, although for shares issued on or after 21 March 2000 this should not prevent financial institutions having a stake in the form of preference shares as the test is based on the number of shares or voting power. This restriction applies to any arrangements for another company to acquire control at some time in the future (such as share options)

• Iftheindividualinvestorbecomesconnectedwith the company during the relevant period, relief is withdrawn

• Problemsmayariseandcausearestrictionorwithdrawal of the EIS relief if companies redeem or repurchase non-EIS shares during the period commencing two years before and ending three years after an EIS issue

• Investorswhoreceiveanyvaluefromthecompany within a period commencing two

years prior to the issue of the EIS shares and three years after may find their relief being adjusted or withdrawn. This restriction does not apply to normal salaries for new directors, nor does it apply to interest given at a commercial rate on monies lent by the investor, dividends representing a normal return on investment or other normal commercial arrangements between the investor and the company

Seed Enterprise Investment Scheme (SEIS)A new relief, SEIS, was introduced from 6 April 2012. It is similar to EIS, but providing for 50% initial income tax relief on share investment, as well as reduced capital gains tax on reinvested gains, and ultimately an exemption from capital gains tax on a disposal of the SEIS shares after three years.

The investment limits are considerably lower than for EIS;• theinvestorlimitsis£100,000perannum• thecompanycannotraisemorethan£150,000

through SEIS• atthetimeoftheshareissuethecompany’s

asset’s must be less than £200,000 and have fewer than 25 employees.

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Who should I contact?This information is intended only as a broad outline of the schemes. Investment in EIS or SEIS is high risk and both investors and issuers should seek professional advice before undertaking such investments. If you need guidance on this subject or other matters please contact:

Liz BrionT +44 (0)20 7728 2326E liz.a.brion@uk.gt.com

Richard PalmerT +44 (0)20 7728 2155E richard.palmer@uk.gt.com

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What is a film tax credit?For many years, UK governments have sought to encourage the film industry with tax incentives. In 2007 an entirely new tax regime was introduced for film production companies (FPCs). This was to replace the previous tax reliefs for film costs, which had been seen as placing too much emphasis on tax breaks for individuals at the cost of real investment in UK films.

The tax rules allow FPCs to claim an enhanced tax relief on qualifying film production costs, depending on the size of the film. This additional relief can then be ‘surrendered’ in exchange for a payment, the amount again depending on the size of the film, for up to 25% of the amount surrendered. The relief will continue until at least the end of December 2015.

Who qualifies for the film tax credit?Only FPCs qualify (and not, for example, partnerships). FPCs are companies that are responsible for pre-production, principal photography, post-production and delivery of the completed film. A FPC must be actively engaged in production planning and decision making during these periods, as well as directly negotiating, contracting and paying for rights, goods and services in relation to the film. It does not have to have been

involved in development of the film before pre-production.

Note there can only be one FPC in respect of each film; if more than one company could qualify, the company that is most directly engaged in the activities above is the FPC. In the case of qualifying co-productions (see below) a company that makes an effective creative, technical and artistic contribution to the film is the FPC.

What films qualify for the film tax credit?To qualify for film tax credits, the film must be intended for theatrical release at a paying public commercial cinema with a significant proportion (HM Revenue & Customs will accept at least 5% as meeting this test) of the intended earnings from

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Putting you in the picture – UK film tax credits

the film to be obtained from the exhibition. It is the intention that is important; the film does not subsequently need to have a theatrical release. This condition must be met at the end of each accounting period of film making activities by the FPC. Once the condition is failed, it cannot be qualifying in that or any later period. The film must also be certified by the Secretary of State for Culture, Media and Sport as a British film. Certification of films is currently administered by the British Film Institute.

In addition, at least 25% of the core expenditure (see below) must be incurred in the UK. In the case of qualifying co-productions this condition must be met by the co-producers.

How are FPCs taxed?The FPC’s activities in respect of a film are treated separately from any other activity for tax purposes, commencing at pre-production or, if earlier, when income from the film is received. The notes below look at the position of one film only.

For each period of account, the FPC brings in as income a proportion of the estimated total income from the film, less the costs of the film incurred (and represented in work done) to date. The proportion of income brought in is the costs of the film incurred to date as a proportion of the estimated total costs of

the film. Income for this purpose is any receipts from the making or exploitation of the film treated as earned at the end of the period.

Costs are those in respect of film making activities in connection with the film, or with a view to exploiting the film. No deduction is available in respect of expenditure that would not be allowed for tax purposes (eg entertaining), but expenditure is not regarded as being of a capital nature because it is creating an asset (the film).

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When is expenditure incurred?To be a cost of an accounting period, it must have been incurred in the period. Generally this will be when it is reflected in work in progress. However the following should be noted:• Advancepaymentsareonlyrecognisedwhenthe

work is carried out• Deferredpaymentsarerecognisedwhenthe

work is recognised in the state of completion of the film

• Theremusthavebeenanunconditionalobligation to pay

• Ifpaymentislinkedtoincomefromthefilm,thecost is only recognised when the income is earned

• Pre-tradingexpenditureisrecognisedwhenthetrade commences

No claim can be made in respect of any amount which has not been paid within four months of the end of the accounting period.

What costs qualify for an additional deduction?Some of the FPC’s expenditure will qualify for an additional tax deduction. The amount depends on the FPC’s ‘core expenditure’. Core expenditure is film making expenditure on pre-production, principal photography and post-production. It does not include development expenditure, marketing

and distribution costs, or financing costs. Where costs relate to both core and non-core expenditure, an apportionment on an appropriate basis will be necessary, an example being writer’s fees.

The additional deduction is calculated as the applicable rate multiplied by the lower of:• UKexpenditurewithinthecoreexpenditure,and• 80%ofcoreexpenditure.

For limited budget films (see below), the applicable rate is 100%. For other films, the applicable rate is 80%. As the calculation is cumulative for each accounting period, additional deductions given in previous periods are deducted.

What counts as UK expenditure?This is expenditure on goods or services which are used or consumed in the UK. For example a US director, paid in dollars by the FPC for the time he is filming in the UK, is regarded as UK expenditure.

Film production company’s surrenderable lossFrom the film income and costs calculated as above, the FPC can set off the additional deduction. If this produces a loss for the accounting period, this can be surrendered for a film tax credit. However the surrendered amount cannot exceed the available core expenditure for the period (effectively capping the

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surrender to the additional deduction for the period for limited budget films).

How much tax credit is payable?For limited budget films, the payable credit rate is 25% of the amount surrendered, for other films it is 20%. A limited budget film is a film whose total core expenditure is £20 million or less.

Claims for film tax creditsThe FPC makes the claim as part of its corporation tax return and computation. Interim claims can be made during the film production period, but claims must be accompanied by a certified copy of the certification as a British film (either interim or final as appropriate). Claims must also state the planned UK core expenditure and confirm that the 25% condition regarding this will be met. The tax return for the film completion period must state the final amount of core expenditure that is UK expenditure.

Qualifying co-productionsFor film tax purposes a qualifying co-production is a film that falls to be treated as a national film in the UK as a result of the UK’s official co-production agreements or the European Convention on Cinematographic Co-production.

Planning pointsThe choice of the FPC’s accounting period is important as it will determine the period of expenditure which will form the FPC’s claim for film tax credits. Terminating accounting periods early will speed up claims, but has to be balanced against how much expenditure will then fall into the next accounting period. The tax rules regarding the timing of expenditure referred to above will also be important to consider. The Companies Act rules regarding changing accounting dates should be borne in mind.Particular care should be taken with co-productions. For international films, other countries have their own film tax incentives and where expenditure is incurred and by whom will be important. Note that if the co-production is not a qualifying co-production, there could be issues about whether the UK co-producer is a qualifying FPC.

The FPC should ensure that its PAYE/NIC obligations and payments are up to date and that it has complied with the ‘foreign entertainers’ withholding tax obligations, as the tax legislation

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allows for the set off of amounts outstanding for payment periods ending in the accounting period of the film tax credit claim. It will also delay repayment of the film tax credit. Anti-avoidance rules prevent artificially inflated claims for additional deductions or film tax credits.

Taxation of film production companiesWhile film tax credits are the most important part of the tax regime for FPCs, they are not the only part. As indicated above, the profit or loss of each film is considered separately and is based on a cumulative position of income and expenditure in respect of the film.

To the extent that in an accounting period there is a loss in respect of the film, this is carried forward to set off against profits in the future from the same film by the FPC.

At the time of the film either being completed or abandoned, the FPC may elect that, so much of the loss that does not relate to the additional deduction, is set it off against profits of another trade the FPC carries on, or to carry the loss back to a previous accounting period (in accordance with the normal tax rules), or to carry it forward as if it were in connection with another film the FPC is producing, or finally it may surrender the loss to another company in the same tax group for set off against

that company’s profits for the period.When the trade of the FPC is terminated, any

remaining losses of the FPC (including in respect of the additional deduction not surrendered) may be transferred for use in respect of another film production of the FPC or transferred to another FPC, which is producing a film, in the same tax group.

Because any loss carried forward relating to the additional deduction can only be set against profits from the same film (until the trade of the FPC is terminated), it will usually be advantageous to surrender the maximum amount of the additional deduction.

New high-end TV, documentary and animation tax creditsThe 2013 Finance Bill includes tax relief for high-end television, documentary and animation productions.

The relief is subject to potential change, but is intended to come into effect from 1 April 2013. Transitional rules will apply to productions straddling that date.

The relief is similar to the existing film tax legislation, providing for a payable net tax credit to the production company of up to 20% of production costs.

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Unlike for the film relief there is no reduction in the credit available if the production costs exceed £20 million.

Other points to note are:• theremustbeaqualifyingprogrammeproduced

by a qualifying production company• theprogrammemustbeintendedforbroadcast

to the general public on television or the internet

• theprogrammemustpassa‘culturaltest’whichwill be administered by the BFI

• atleast25%ofthequalifyingexpendituremustbe UK expenditure.

There are two additional conditions if the production is not an animation production:• theprogrammemustbegreaterthan30minutes

in ‘slot length’, and• theprogrammemusthaveaveragequalifying

expenditure per hour of slot length (including commercial breaks) of not less than £1million.

An animation programme is one where the majority of expenditure on the programme relates to animation.

Who to contactChristine CornerT +44 (0)20 7728 3171E christine.corner@uk.gt.com

Richard PalmerT +44 (0)20 7728 2155E richard.palmer@uk.gt.com

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Focused valuation expertiseWhether you are about to go through a merger, acquisition, fundraising or a restructuring of your business, are involved in a dispute or needing to understand tax implications – the values involved are likely to be an important commercial consideration.

Grant Thornton’s valuations team provides expert support and advice in disputes, for transactions or lending and in support of financial reporting and tax matters – valuing businesses, shares, or intangible assets such as film titles, music libraries and IP rights.

Using our experience and expertise to benefit clients in the media sectorThe range of our clients in the media sector means that we can apply real expertise and experience in providing valuation advice. A selection of recent credentials is set out opposite.

It’s easier to make decisions when you know what your values are

International coverageValuations increasingly have a global dimension, which adds another element of complexity. Therefore you need an advisor with a good international network. The UK team is a core part of the Grant Thornton International valuation network which comprises over 500 specialist staff located in 60 countries. We work regularly on international assignments, ensuring that we provide you with advice that reflects your international needs.

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Credentials

…an independent distribution company specialising in music programming and independent films. Grant Thornton was engaged to assess the value of our client’s media library to assist with capital funding.

…a group of television, film and new media production companies. Grant Thornton has provided valuation services for a range of purposes.

…a leading producer for factual and drama content for major broadcasters worldwide. Grant Thornton was engaged to assess the value of IP rights owned by our client’s to assist in financing negotiations.

…a distributor of independent films for international audiences. Grant Thornton provided valuation advice to the shareholders.

For more information, please contact

Mike ThorntonPartnerT +44 (0)20 7728 2644E michael.j.thornton@uk.gt.com

Chris WestDirectorT +44 (0)20 7865 2491E chris.west@uk.gt.com

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