Alex Du is a lawyer at the Toronto law firm of McMillan Binch and a member of the firm’s KNOWlaw Group. This article was prepared with the assistance of Albert Luk

The federal government and most of the provincial governments in Canada have implemented tax credit incentives to encourage the development of a healthy film and television industry, but what about the new media industry?

In Canada, only Ontario and Quebec have enacted specific tax credit legislation dealing with the new media industry while other provinces have amended or introduced in their film and television tax credit legislation certain tax incentives for qualifying new media projects.

This column will focus on the Ontario and Quebec new media tax credit programs since they are the only provinces to enact specific tax credit legislation. However, you should check with your provincial agencies to determine whether a new media tax credit program is available to you under their existing film and television tax credit programs. For example, Saskatchewan offers to those qualifying taxpayers under their Film Employment Tax Credit a credit of 35% of eligible employment expenditures in respect of an eligible new media production.

The new media tax credit programs offered by Ontario and Quebec borrow heavily from the film and television production services model. Each tax credit program relies on concepts such as ‘qualifying corporation,’ ‘eligible products,’ eligible multimedia title’ and ‘eligible labor expenditures.’ Both credits are calculated as a percentage of eligible labor expenditures incurred in connection with an eligible product or multimedia title.

Here are some highlights of these tax credit programs:

How much?

The Refundable Tax Credit for the Production of Multimedia Titles is administered by the Bureau de developpement de la nouvelle economie. This organization was set up by the Quebec government to provide companies in the new economy with easy access to available programs and tax credits.

The Ontario Film Development Corporation administers the Ontario Interactive Digital Media Tax Credit. In both Ontario and Quebec there is no limit on the amount of eligible labor expenditures that may qualify and there are no per-project or annual corporate limits on the amount of tax credit which may be claimed.

The Ontario credit is a refundable tax credit and is calculated as 20% of the eligible Ontario labor expenditures incurred by a qualifying corporation to create eligible products in Ontario. This amount can be reduced to 10% if the eligible Ontario labor expenditures are incurred by a subcontractor hired by the qualifying corporation on a fee-for-service basis.

The amount of the Quebec credit is calculated depending on the category into which your multimedia title falls. Category one titles are those intended for mass commercialization. Category two titles are those produced on a made-to-order basis but not intended for mass commercialization. For a category one title, a corporation may claim a 40% credit for Quebec labor expenditures and an additional 10% premium if there is an available French version. For a category two title, a corporation may claim a 35% credit for Quebec labor expenditures but no premium is available if there is a French version of the title.

Qualifying corporations

Both Ontario and Quebec have similar corporate eligibility requirements. Each province requires a qualifying corporation to (i) be a ‘non-tax-exempt’ corporation, (ii) have a permanent establishment in the province in which they are claiming the tax credit, and (iii) develop an eligible product or multimedia title.

It’s also critical to note that both provinces also permit the qualifying corporation to be controlled by a foreign owner.

The similarities end there. In Ontario, a qualifying corporation must have had during the preceding taxation year (on an associated corporations basis) neither annual gross revenues in excess of $20 million nor total assets in excess of $10 million. In addition, the qualifying corporation must own all or substantially all of the qualifying product or multimedia title to apply for the credit. According to the ofdc, ‘all or substantially all’ means 90% ownership in the eligible product.

In Quebec, on the other hand, there are no prescribed thresholds for asset worth or annual revenue nor are there any requirements that the qualifying corporation own the eligible product.

What kind of products

are eligible?

An eligible product for the Ontario credit must be an interactive digital media product whose primary purpose is to educate, inform, or entertain, and that achieves its primary purpose by presenting information in at least two of text, sound and images. This can include games, educational or informational products.

To qualify for the Quebec credit, the multimedia title must be published on a form of electronic media and controlled by interactive software such as a Web browser. The multimedia title must also present information using at least three of text, sound, static images and animated images.

The rules and regulations for each of the two provinces list ineligible products or multimedia titles – including such things as corporate websites, electronic billboards, retail websites or electronic ticket purchasing, products designed to promote or sell a corporation’s products and services, or titles that encourage violence, sexism or discrimination.

In Ontario, the qualifying corporation must develop the product for commercial exploitation. In Quebec, however, there is no such requirement. This allows qualifying corporations in Quebec to apply for a tax credit where a project was produced on a made-to-order basis. This significantly broadens the eligibility of products or titles and allows for a richer incentive to new media companies in Quebec.

Another difference is that the Ontario credit requires that all or substantially all of the product be developed in Ontario by the qualifying corporation, which, according to the ofdc, means the qualifying corporation must own at least 90% of the eligible product. Again, there is no such requirement in Quebec’s program. This also allows a new media corporation to claim a tax credit in respect of a greater number of projects since they don’t actually have to own any of them.

Eligible expenditures

Each of the two provinces calculates the tax credit based on a percentage of eligible labor expenditures for a taxation year. In Ontario, eligible expenditures include 100% of salaries and wages for employees incurred after June 30, 1998 and 50% of remuneration incurred after May 4, 1999 and paid to arm’s-length persons who are not employees.

Expenditures must be (i) paid to individual residents of Ontario, (ii) directly attributable to the development of the eligible product, (iii) incurred in the taxation year and paid in the taxation year or within 60 days after the end of the taxation year, and (iv) paid for services rendered at a permanent establishment in Ontario.

In Quebec, the credit is calculated as a percentage of the ‘eligible labor expenditures’ of a producer for a taxation year. Eligible labor expenditures include the salaries incurred in the year with persons who are employed by the producer in one of its establishments located in Quebec and who work directly on the production of the eligible multimedia title. Salaries paid to employees of subcontractors in Quebec are also eligible but are deemed to be 50% of the amount invoiced when the subcontractor is at arm’s length from the production corporation.

Neither credit permits as eligible expenditures salaries incurred for the multiplication of its information media, such as cd-rom multiplication or website hosting services once the product is launched. Under the Quebec credit, salaries incurred for mastering a title, promotion, or distribution are not eligible expenditures.

The Ontario budget 2000 announced that the Ontario credit would be extended to include certain expenditures incurred after May 2, 2000 relating to the qualifying marketing and distribution expenses up to $100,000 per eligible product. Some of these eligible costs would be attending trade shows where the product is being promoted and advertising the product in print and electronic media.

Unfortunately, this is not presently law and amendments to the credit are required before a qualifying corporation can claim this expenditure.

The Ontario credit:

Is it for you?

As a matter of policy, the Ministry of Finance has decided to limit the eligibility criteria for its new media tax credit to those smaller to midsize corporations. The threshold of $20 million in annual gross revenues and $10 million in assets (on an associated corporations basis) will not, for the most part, pose a problem for small to medium-sized new media companies engaged in developing their own projects. However, it will effect those new media companies which are focusing on convergence with film and television studios or producers, particularly those which want to leverage market and brand awareness of existing film and television properties.

Some new media producers have entered into arrangements with film or television producers to create original Internet content based on traditional media properties. Naturally, many of these property owners insist on retaining control over the finished new media property and are unwilling to give the new media producer any ownership interest in the finished product. In these cases, the Ontario credit would be available only to the film or television producer and not the new media producer.

The Ontario credit will also not be available to those film or television corporations that have a new media division or subsidiary if those producers exceed the asset or revenue test. This is because the asset and revenue test is determined on an ‘associated corporations’ basis.

The definition is somewhat complicated, but without getting into too much detail, a corporation is associated with another if one of the corporations controlled, directly or indirectly, the other, or if both of the corporations were controlled by the same person or group of persons.

The meaning of control is not simply one of how many shares you own but who has actual or de facto control over the corporation. There are subtleties to the meaning of ‘associated corporations’ and you should review the legislation or consult with the ofdc to determine whether or not or to what extent your corporation may be associated with another.

A film or television producer who meets the asset and revenue test can qualify for the credit by retaining a new media corporation to produce the eligible product on a fee-for-services basis. The amount of the tax credit, however, is reduced to 10% of those eligible labor expenditures incurred by the new media corporation. While this would still encourage some growth in the new media convergence industry, it will be modest and the benefit will be reduced to those types of new media corporations.

At some point, the ofdc and the Ministry of Finance will have to examine whether this segment of the new media industry should benefit from a larger tax credit.

Banking the credit

Each of the credits has the potential to be borrowed against. If you plan on banking the Ontario credit, the ofdc will issue to a lender for a fee an Interim Estimate Letter to facilitate the use of the credit as security for a loan. The Interim Estimate Letter will provide a preliminary assessment of eligibility and an estimate of the amount of the Ontario credit based on projections. It does not, however, entitle the qualifying corporation to receive a refund from the Ministry of Finance. You must still file your return and a full assessment will be conducted to determine eligibility for the Ontario credit.

This should be good news for new media companies since they should be able to obtain interim financing from a bank for a particular project based on a percentage of the total estimated tax credit. This type of financing is commonplace in the high-technology, biotechnology and film and television industries.

However, only time will tell whether lenders will have an appetite to make these kinds of loans. There are several factors which will play a role: What is the total amount of the tax credit? When will it be payable? What other banking services can they provide to you besides this loan? What kind of fees can be charged?

You should be concerned with fees, legal costs and the internal costs of reporting and tying up your company with security to a lender. If you are not an established new media producer, you should be aware that lenders will more than likely insist on a personal guarantee.

This column is intended to provide you with a brief overview of Ontario and Quebec’s new media tax credit programs. You should contact the Ontario Film Development Corporation or the Bureau de developpement de la nouvelle economie, for further information about their tax credit programs before you apply. They can be reached by Internet at www.ofdc.on.ca and //www.bdne.gouv.qc.ca.

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