Norman Bacal is a partner in the law firm of Heenan Blaikie, based in Toronto.

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On July 19, the federal Minister of Finance came out with draft legislation which proposes to create the refundable tax credit for the Canadian film and television industry. The tax credit legislation, corresponds with the proposals previously contained in the discussion paper issued jointly by the Ministers of Finance and Heritage in June 1995 and the 1995 federal budget.

As expected, the credit will be refundable and non-assignable. This means that the production corporation, which is entitled to the credit, will be entitled to a refund of income tax even if none is owing. It will also be available only once the production corporation’s income tax return for the year is filed and assessed by Revenue Canada. No mechanism has been proposed to make the new tax credit bankable.

The credit will be available in respect of a ‘Canadian film or video production’ and may only be claimed by a ‘qualified corporation.’ Neither of these terms have been fully defined as yet.

Stage two of the process, represented by regulations to be drafted, is not expected before the end of September 1995. The third stage will involve the establishment of the administrative process and preparation of forms (probably by the end of the year.)

The tax credit will equal 25% of ‘qualified labor expenditures’ for the year in respect of a production and may only be claimed for a production once principal filming has commenced. Qualified labor expenditures cannot exceed 48% of the cost of a production. As a result, the maximum credit available in relation to a film production will be 12% of the cost.

The credit will only be available to qualified corporations. A qualified corporation means a taxable Canadian corporation, to be further defined by regulation, that in the year carries on through a permanent establishment in Canada, a business that is primarily a Canadian film or video production business.

Consequently, to the extent that the business of a production corporation includes other businesses (including film distribution) or carries on business outside of Canada, it may not qualify for purposes of the credit. For this reason, it is likely that producers will have to take great care to ensure that production corporations qualifying for the credit are single-purpose production companies.

Calculation of credit base

Qualified labor expenditures are based on labor expenditures incurred after 1994 which are attributable to the production. These expenditures must relate to the stages of production from the end of final script stage to the end of post-production. Such expenditures must be paid either in the year or within 60 days of the end of the year and include:

(a) Salary or wages attributable to the production.

(b) Remuneration (other than salary or wages) payable to an individual who is not an employee of the corporation, to the extent that it relates to personal services rendered by the individual for the production and includes the salary or wages of the individual’s employees for services rendered for the production;

Salary, wages and remuneration, for these purposes, exclude any amount determined by reference to profits or revenues. Therefore, deferred or contingent payments will not qualify for the credit.

(c) Payment to a taxable Canadian corporation to the extent that the payment is attributable to and does not exceed salary or wages of the corporation’s employees who render services to the production.

(d) Payment to a personal service (or loan-out) corporation which is a Canadian corporation to the extent that the amount paid is attributable to services rendered personally by the individual for the production.

There is some question as to whether this means that, in the case of a personal service corporation owned by a person rendering services as well as members of his or her family, this provision would not be applicable. In all other cases, in order to access the credit, it will be necessary to trace payments to third-party corporation’s employees.

(e) Payment made by the production corporation to a partnership that is carrying on business in Canada will also qualify to the extent that the amount paid is attributable to services personally rendered by an individual who is a member of the partnership (again without the necessity of actually paying out salary or wages to that person) or is attributable to and does not exceed salary or wages of the partnership’s employees who render services to the production.

For the purposes of post-production, a list of services has been established.

Special provision has been made to deal with inter-corporate charges in the common situation that a corporation will form a subsidiary in order to produce a film. Provided that the production company is a wholly owned subsidiary, the parent and subsidiary may agree that labor expenditures will include any reimbursement made by the production corporation in the year or within 60 days after the end of the year for expenditures of the parent in respect of the production.

Special rules apply where the production company has a different fiscal year-end than its parent. First, we are required to look at the expenditures incurred by the parent in its taxation year in respect of the production, then we are required to assume that the production corporation, for the purposes of these expenditures, has the same taxation year-end as the parent and that the expenditures are incurred by the corporation rather than the parent.

To illustrate, let’s assume that a parent with a Dec. 31 year-end incorporates a wholly owned subsidiary to produce a film with a March 31 year-end. Any expenditures that are incurred and are paid for by the parent by Dec. 31, or within 60 days of Dec. 31, will qualify as labor expenditures of its subsidiary for its fiscal year ended March 31. Expenditures incurred and paid after the 60-day period would be carried forward into the subsidiary’s following taxation year.

It is important to note that, to the extent that the subsidiary is not wholly owned, then any expenditures incurred by the parent corporation would not qualify for the purposes of the credit.

Restrictions for assistance

Labor expenditures are reduced by the amounts of the assistance in respect of the expenditure that the corporation or any other person or partnership has received, is entitled to receive or can reasonably be expected to receive. This determination is made each year at the time the corporation files its income tax return for the year.

Generally, the assistance which will reduce labor expenditures includes inducements by way of grant, subsidy, forgivable loan, deduction from tax, allowance or any other form of inducement from a government, municipality or other public authority.

Assistance does not include the acquisition of an interest in the production by any person. As a result, allowances which reduce labor expenditures include Quebec refundable tax credits, ofip rebates, Nova Scotia tax credits, and other grants, to the extent that they are attributable to salary or wages.

Since Quebec’s tax credit is entirely calculable by reference to salary, wages and remuneration, the entire Quebec tax credit will be considered assistance.

In the case of the ofip rebate, however, a calculation will have to be made, dividing the rebate between the portion applicable to salary, wages and remuneration and that related to other budgetary costs.

To a certain degree, therefore, Ontario producers qualifying for ofip will be at a slight advantage to their counterparts in Quebec who qualify for the Quebec tax credit. Such investments, however, will otherwise reduce the cost of the film available for the credit. Cable Fund assistance to broadcasters, which is directed to producers, will not reduce the credit.

Restriction on credit

In order to qualify for the credit, no deductions for tax purposes may be available to anyone other than the production corporation (with certain limited exceptions).

No credit will be available where an ‘investor’ or a partnership has an interest, directly or indirectly in the production. An investor is defined to mean a person who is not actively engaged on a regular, continuous and substantial basis in a business carried on through a permanent establishment in Canada that is primarily a Canadian film or video production business. This means no tax shelters are permitted in respect of any production costs.

It is not clear how to treat foreign investors in a Canadian production. In order to disqualify the production, it is only necessary that an investor ‘may’ claim a deduction in computing income for Canadian tax purposes. It is irrelevant as to whether the deduction is actually claimed. As a result, technically speaking, a foreign investor might be able to claim a deduction for Canadian purposes even though it has no intention to make such a claim.

Given the other changes in tax legislation relating to Canadian productions, it would be unlikely that any foreign entity would be entitled to claim a deduction for Canadian tax purposes since such deductions would only be available to the extent of income from such productions. It is likely, therefore, based on this interpretation, that foreign copyright participation may be permitted.

Obviously, this is all subject to the tabling of the regulations which will define what constitutes a Canadian film or video production.

The case of Canadian investors is a little more difficult. To the extent that a Canadian (including a Canadian broadcaster) purchases a portion of the copyright, the possibility of obtaining the credit would be eliminated except where the investor is engaged on a regular, continuous and substantial basis, in the Canadian film or video production business in Canada.

In this regard, however, the regulations to be tabled may contain particular exceptions to allow persons (whether foreign investors, foreign governments or Canadian broadcasters) to hold an interest.

The new provisions recognize that the tax credit in respect of a production may be spread over one or more years, depending upon when the labor expenditures are paid for.

The definition of a qualified labor expenditure is a formula of additions and subtractions to labor expenditures taking into consideration adjustment for assistance on an annual basis.

Therefore, to determine the qualified labor expenditure, we start with the labor expenditure for the year in respect of the production. If assistance is determined to be payable in a year, in respect of a previous year’s production (and was not factored in previously), then the amount of such assistance would reduce labor expenditures.

It is not clear, as yet, whether assistance for labor expenditures must be segregated on a production-by-production basis or whether a pool is to be formed.

Labor expenditures are increased by repayments of assistance made in the year in respect of the production by the corporation, pursuant to a legal obligation to do so. Again, whether the repayment of assistance is to be calculated on a project-by-project or on a pool basis will determine whether repayment, in fact, increases qualified expenditures when the repayment is made.

Labor expenditures which are incurred in respect of a production in the fiscal year prior to commencement of principal filming are carried forward to the year principal filming does commence and are creditable only in that year.

In order to obtain the credit, the production corporation must file a Canadian income tax return, income tax forms (which have not as yet been created), and must have previously obtained a Canadian film or video production certificate from the minister of heritage, as well as such additional documents that will be announced in the next few months when the new regulations are tabled. It is not clear, at this time, whether the minister’s certificate will be obtainable prior to the completion and final audit of a particular production.

A certificate issued by the minister of heritage may be revoked where an incorrect statement was made for the purposes of obtaining the certificate or the production turns out not to be a Canadian film or video production. In the case of revocation, the certificate is null and void and is treated as never having been issued. Consequently, any tax credit received prior to revocation would be repayable with interest. Penalty provisions have not as yet been drafted.