Sara Morton is a lawyer in the Entertainment Law Group of the Toronto law firm of Lang Michener.

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The Globe & Mail stated that the federal budget introduced on March 6 ‘contains scant good news for culture.’ One positive note overlooked by most media reports was the announcement of a proposed amendment to the Income Tax Act permitting a producer to assign the Canadian Film or Video Production Tax Credit.

This announcement was good news to both producers and lenders to the film and television industry because if the proposed amendment becomes law it will open the door to producers using the tax credit as collateral for loans.

Since the release last year of the draft legislation and regulations establishing the federal tax credit program, producers and lenders had been frustrated by the fact that the draft legislation and regulations did not permit the assignment of the tax credit to a lender as collateral to secure a loan (assignment of certain government debts is prohibited by federal statute and recent caselaw).

Enforce credit

The validity of an assignment of the tax credit means that a lender to whom a credit has been assigned will be able to enforce its rights to receive the credit against a producer and a trustee in bankruptcy should the producer go bankrupt before the credit is paid to the lender.

The tax credit is an ideal receivable for producers to finance because it will be payable some time after completion and delivery of the production. From a lender’s perspective, the federal tax credit is potentially a good receivable to lend against because it is payable by a creditworthy party; subject, however, to the limitations below.

The Department of Finance has stated that the proposed amendment will be contained in the legislation implementing the changes announced in the budget, a draft of which is not expected until the fall. However, if enacted in its proposed form, the amendment will make valid any assignment of the tax credit made after March 5, 1996.

The anticipated retroactive effect of the amendment may encourage lenders to begin accepting the tax credit immediately as collateral for loans. However, producers should anticipate that most lenders will be cautious in doing so, for the following reasons.

First and foremost is the fact that the legislation and regulations establishing the tax credit program have not yet been passed by Parliament, although the Department of Finance expects them to be passed in June. As a result, while Revenue Canada may, as a practical matter, reduce a producer’s tax payable by the amount of the tax credit, it does not yet have authority to pay out the tax credit, which is essential in order for a lender to lend against it.

Secondly, cavco has not yet begun issuing tax credit certificates under the tax credit program, although it has stated that, as of the date of publication of this article, it may have begun issuing an ‘interim letter’ which, although not a certificate, will provide some comfort to lenders intending to lend against the credit.

Once the legislation and regulations are passed, cavco will begin issuing tax credit certificates. The tax credit certificates will certify that the production is ‘Canadian’ and will contain an estimate of the amount of ‘qualified labor expenditures’ to be used in the calculation of the tax credit. Such estimates will not be binding and will be subject to audit by Revenue Canada.

Lenders are unlikely to lend against the tax credit before an interim letter or tax credit certificate is issued by cavco as lenders will be relying on these documents to provide them with information on which to base their lending decision.

Even after the passage of the legislation and regulations, in view of the non-binding nature of the tax credit certificate, producers can expect lenders to discount the anticipated amount of a tax credit, the calculation of which is based upon the estimate contained in such certificates. As experience with the tax credit accumulates, however, the amount of such discounting may decrease.

Even after the legislation and regulations have been passed by Parliament, lenders may still have concerns about lending against the tax credit. This is because the proposed assignability of the tax credit is subject to two limitations which make the tax credit less attractive as collateral to a lender: first, such assignment is not binding on the government, and second, a lender’s right to the tax credit is subject to all defences, counterclaims and rights of set-off which the government has against the producer in question.

Payable to producer

The first limitation means that Revenue Canada is not obligated to recognize the assignment or to pay the tax credit to the lender to whom it has been assigned. The Department of Finance has stated that refund cheques will continue to be payable only to the producer.

This is a disadvantage from a lender’s perspective because in production financing lenders usually give notice of an assignment to the party by whom a receivable is payable and direct them to pay the receivable to the lender.

As the ability to direct payment of the tax credit by Revenue Canada to a lender is not permitted by the proposed amendment, lenders must take other steps to achieve this, such as, for example, having the producer designate the lender’s address (or that of a third party) as the address to which the tax credit should be sent and the lender (or a third party) obtaining a power of attorney from the producer permitting it to receive and cash the tax credit cheque and pay it to the lender in satisfaction of the loan.

Although it seems likely that the producer’s designation of another address will be permitted, this has not yet been confirmed by Revenue Canada. If the above method is not acceptable to Revenue Canada, the tax credit could be paid to the producer, who would be required by the lender to hold it in trust until it is paid to the lender.

The second limitation is that the lender’s right to receive the tax credit is expressly made subject to various rights of the government which could have reduced the amount of the tax credit payable to the producer.

Such rights include defences or counterclaims which the government has against the producer and the right to offset against any amounts owing by the government to the producer any amounts the producer owes to the government, such as unpaid income taxes and source deductions. This is clearly problematic for the lender.

The lender can make enquiries to Revenue Canada (with the necessary authorization from the producer) to determine the amount of any liabilities of a producer which could reduce the amount of the tax credit payable. However, such enquiries can be time-consuming, and the tax position of the producer may have changed between the time the lender makes such enquiries and when the tax credit becomes payable.

Producers can therefore expect lenders financing the tax credit to require them to incorporate a new corporation which does not have any such liabilities to borrow the loan, to require them to pay all such liabilities as they become due, and for lenders to reduce the amount of the loan on account of any such actual or potential liabilities.

Despite these limitations, if the announced amendment is enacted in its proposed form, it marks a substantial improvement in the climate for lending to film and video producers in Canada and should result in an increase in the availability of loans, particularly to producers who do not have an established track record or other security to offer to a lender.