Douglas Barrett and Mary-Ann Haney are partners of the Toronto law firm of McMillan Binch. Both are members of the KNOWlaw Group.

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In the last Binchmarks column (Feb. 12, p. 13) we began a review of the new federal tax credit, dealing with some of the specifics which might affect the amount and timing of its availability. This column will deal with more of these technical points.

Before commencing, though, there is news from the front. Four weeks ago, we reported that while cavco was seeking assurances from the government that it could issue content and tax credit certifications under the new rules, it was then of the view that it would be unable to do so until the legislation actually passed. This would have been very disruptive for those producers planning productions during this spring and summer.

We have now been informed by Bob Soucy at cavco that as a result of discussions between officials at Heritage Canada and Revenue Canada, cavco will soon be able to issue what Soucy refers to as an ‘interim letter.’

The letter will not be a form of provisional certificate, but will be designed to give producers and their financial partners some comfort that their productions, if completed in accordance with the approved applications, will comply with the provisions of the draft legislation.

When the legislation is passed, and assuming it is passed in the proposed form, cavco will then issue the appropriate certificate.

Now, on to more technical stuff.

Deferrals

Producers commonly find they have to defer some of their fees in order to make a deal work. As well, during the tax shelter era there was a temptation to pump up producers’ fees in order to maximize the cost of the production and hence the value of the net benefits to the producer. With the tax credit, this is going to be considerably tougher.

The new rules provide that any amount calculated by reference to profits or revenue is excluded from eligibility as a labor expenditure. In order for producers to ensure that their deferrals are not treated as being determined by reference to profits or revenues, they must make sure they are a proper account payable of the production, with payment due within 60 days after the end of the production company.

This means that if deferrals are considered eligible labor costs they will also be treated as income to the producer, whether or not the income is actually received.

One producer from Quebec has said that when the provincial tax credit was introduced there, a number of producers found that they suddenly became more profitable, and had a greater tax burden, without enjoying the benefit of the profitability!

Clearly, the cost of income tax on income not received will be considerably greater than the value of the tax credit on any deferral taken by the producer.

Fringes, benefits

and buyouts

There has been some discussion as to whether the fringes and other benefits paid to performers, writers, directors, etc. qualify as eligible expenditures for the producer. The general view seems to be that they do, if the benefits are taxable in the hands of the person providing the services.

For instance, therefore, if someone is paid an allowance for the purpose of renting a car during the production, the payment is probably eligible. However, if the production provides the car for the person in a manner which is not treated as taxable to that person, it will not be treated as a labor expenditure for the purpose of the credit.

The question of buyouts is an important one since such a large portion of the amounts paid to key talent is for the purpose of buying out their right to receive residual revenue during a specified period.

Arguably, the buyout portion of the payment is not for services rendered for the production, but is an advance against revenue. Despite this, the correct interpretation appears to be that all payments paid under the services contract at the time of production will be treated as eligible labor expenditures.

Post-production costs

For post-production costs, the cavco materials specify, for reference purposes, the labor portion of each type of post-production activity.

For instance, the labor portion of film processing is set at 15%, so if a lab invoice itemizes processing at $10,000, the acceptable labor portion is $1,500. However, only 65% of that amount, or $975, will be treated as an expenditure for the purpose of calculating the credit, since the remaining portion is considered to be markup or profit.

The schedule of rates for post-production services is detailed and extensive, covering seven pages. It was developed for cavco by the apftq, the Quebec producers association, presumably based upon the Quebec experience with the provincial tax credit.

Timing of credit claim

There has been much discussion of the so-called ‘bankability’ of the tax credit. The issue is truly problematic for two reasons.

First, because the credit is treated as a tax refund, no security can be taken by a normal lending institution in the right to receive the credit. This means that only companies which can offer additional forms of security will be of interest to a bank.

Second, for many small productions the credit may not be large enough to justify all of the underlying legal and other work which goes into a commercial loan.

In order to deal with this problem, many producers will incorporate production companies with a financial year end timed to fall at the end of principal photography, when a significant proportion of the production cost will have been incurred. This means that the credit will be claimed over two taxation years of the corporation.

If the financial statements and tax return are prepared and filed immediately after the end of the first taxation year, it is possible that the producer may have the benefit of the major portion of the credit at about the same time as the final cost report for the production is being completed. For these producers, the remaining portion of the credit would be made available a year later, when their next tax return is filed and assessed.

While this approach will be attractive for some, it has its pitfalls. It is well known that the value of government and other ‘assistance’ reduces the portion of production cost which may be used for the calculation of qualifying labor expenditures.

A close examination of the new rules and of the calculation examples which accompany them indicates that all ‘assistance’ must be deducted from the production costs in the first of the two years in which the credit is claimed.

If, as is the case with many Canadian productions, a majority of the financing consists of some form of assistance, the credit available in the first year of a two-year claim could be low or nil.

For these producers, it would be strongly advisable to have the year end of the production company fall after the completion of the production so as to claim all of the credit in one year.

Whichever fiscal year end is selected, active producers will always have a problem with the management of numerous year ends for their production companies.

The Income Tax Act provides that the year end of a company can be changed if the approval of the Minister of Revenue is obtained. While Revenue Canada has issued an Interpretation Bulletin dealing with this topic, it is unknown at this time whether the minister will approve the changing of production company year ends to the common year end of the corporate group, after each production company has taken full advantage of the tax credit.

Timing of recognition

of production costs

For those producers who believe it is advantageous to claim their tax credit over two fiscal years, there is an obvious temptation to ‘load’ as much of the production costs as possible into the first year so as to maximize the value of the credit.

The way the new rules deal with this is to require that the services performed for which a credit is taken must be performed during the applicable fiscal year of the corporation and paid for within the year or within 60 days after the end of the year.

New producer control guidelines

Along with the draft legislation and regulations, the Department of Heritage has issued new producer control guidelines which will become part of the Canadian content certification process for the purpose of administering the tax credit. The purpose of the guidelines is frankly to reduce the access to the credit of some service-type productions which were able to take advantage of the former tax shelter.

In the next Binchmarks column we will review the new guidelines in some detail and comment on their potential impact on the industry.

(This article contains general comments only. It is not intended to be exhaustive and should not be considered as advice on any particular situation.)