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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Confusion abounds about the new federal refundable tax credit. When is it really going to be available? What do you have to do to get it? What are the hidden traps that might jeopardize its availability?

This is the first of several Binchmarks columns which will focus on aspects of the tax credit that producers and creators will be required to learn. It’s going to be a little like the introduction of the gst: while there will certainly be a bumpy transition period, the kinks will eventually be worked out.

The important point on the tax credit, and the one we will deal with first, is to avoid doing something which would eliminate or reduce the credit on your 1996 productions.

Here is a selective list of issues you will need to understand.

Timing of introduction

The credit is based on draft amendments to the Income Tax Act which were introduced in last year’s budget. In December, draft regulations followed. Because the amendments to the Act have not yet been passed by Parliament, the government does not yet have the legal authority to pay out the credits. It might have the ability, however, to reduce tax payment obligations of a producer.

While we wait for the legislation to pass, cavco will seek to obtain assurances from the government that it can issue tax credit certificates and certify productions as Canadian under the new rules. In the meantime, it is prepared to certify under the existing rules, and in doing so, remind the applicant that if it wishes access to the tax credit it will have to apply again once the new law comes into force.

Many producers are therefore applying to cavco or the crtc for ‘interim’ certification (in order to qualify for Telefilm, the Cable Production Fund or for broadcast purposes).

For several months now new producer control guidelines have been in circulation throughout the industry and have been the subject of ongoing consultations. The authority to make these new guidelines is given to the Minister of Heritage under the draft amendments to the Income Tax Act.

The overall effect of the guidelines will be to make it significantly more difficult to certify what has come to be known as a service production for the purposes of the tax credit.

While a further Binchmarks column will go over the new guidelines in some detail, a quick glance at them reveals that some series might have difficulty in obtaining certification in the event they are renewed. To deal with this, cavco has indicated that case-by-case consideration will be given to grandfathering series which are renewed on the same terms as in previous years, provided that movement is made towards qualifying with the new rules in subsequent seasons. Effectively, therefore, cavco’s intention is to permit complete grandfathering for one renewal only.

Eligibility of writing costs

There has been much talk that the language of the new rules would preclude as eligible labor costs the costs of engaging writers. cavco has now confirmed that this was not the intention, and that the rules will permit a claim based on all costs incurred after the acquisition of the underlying property.

Payments to non-Canadian companies

It is common knowledge that payments for the services of key creative personnel are often made to their personal services corporations. Under the new rules, remuneration paid to non-Canadian companies will not be an eligible labor expenditure – even if the person providing the services through the ‘loan-out’ company is a Canadian and qualifies for Canadian points. Discussions with officials at cavco have confirmed that this was the intention of the Department of Finance in drafting the new rules.

This means that you can engage personnel (Canadian or otherwise) who wish to use a Canadian incorporated company to offer their services, but if you wish to get the tax credit on remuneration paid to foreign personnel, they will have to contract personally and not through their services companies.

Because of the tax consequences of doing this, the success of negotiations for expensive foreign personnel may well hinge on their personal tax situations.

Services companies owned by a team

Remuneration paid to a services company owned by more than one person will only qualify as a labor expenditure if this remuneration immediately becomes part of the salary paid to the individual providing the services. This will not be the case if the services company is exclusively owned by the individual providing the services.

We are aware of a number of services companies owned by more than one person. In order to maintain the advantages of incorporation and qualify for the tax credit, these individuals will now have to incorporate separately.

From a producer’s perspective, it will likely become a standard contract term to require a warranty of every services company that it is solely owned by the person providing the services, or an undertaking that all of the remuneration paid to the company will be immediately paid out to the individual whose services it is providing as salary.

Reimbursement of development costs

Reimbursement of script development and other labor costs incurred by an affiliated company would not appear to be eligible unless the affiliated company is a 100% parent of the reimbursing company. It is common knowledge that a significant proportion of productions are produced by single-purpose companies which are co-owned by producing partners.

In most cases, one of the companies has developed the underlying property and agrees to sell it into the ‘joint venture’ company in return for the reimbursement of development costs. The new rule would not permit these costs to be eligible for the tax credit.

In order to address this situation, producers will have to form wholly owned subsidiary companies and cause them to enter into coproduction partnerships or joint ventures. The resulting coproduction agreements would allocate the applicable resources to the subsidiary companies and they would in turn make reimbursement to their parent companies for the costs each has incurred.

Companies developing properties and wishing their costs to be repaid out of the budget in a manner which qualifies for the tax credit should seek appropriate legal or accounting advice before structuring the production vehicle.

Certification of coproductions

On international coproductions, the tax credit will only be available on Canadian costs. This was to be expected.

On internal Canadian coproductions, it is cavco’s current intention to issue one certificate for the production, rather than one to each of the coproducers. Revenue Canada will then examine the tax returns filed by the two coproducers to ensure that the tax credit taken by both of them does not exceed the estimate of eligible labor costs issued by cavco.

The coproducers will therefore apparently be completely free to negotiate among themselves how to share the value of the credit. No doubt this will create some interesting discussions!

The points raised in this column are the result of an initial review of the new legislation and draft regulations, and discussions with cavco. This is a significant period of transition with much to be learned by both industry and government. Future Binchmarks will cover the inevitable developments.

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