2002 Ruling 2002-0143563 - uk treaty co-production

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues:

(1) Whether there is a disposition of a film in a UK treaty co-production arrangement as a result of a particular licence arrangement.

(2) Whether the investor rules in subsection 125.4(4) apply as a result of the involvement of the UK Co-Producer and UK Film Partnership.

Position:

(1) No.

(2) No.

Reasons:

(1) In spite of entering into the licence agreement, legal and beneficial ownership of master negative and rights (including copyright) were retained. However, a caution was provided concerning the terms of a particular distribution agreement.

(2) Consistent with previous positions; investors will not claim a deduction in Canada.

XXXXXXXXXX 2002-014356

XXXXXXXXXX, 2002

Dear XXXXXXXXXX:

Re: Advance income tax ruling request
XXXXXXXXXX

This is in reply to the letter dated XXXXXXXXXX, wherein you requested advance income tax rulings on behalf of the above named taxpayer. We also acknowledge the additional information provided in your facsimile dated XXXXXXXXXX, and during our numerous telephone conversations (XXXXXXXXXX).

We understand that, to the best of your knowledge and that of the taxpayer involved, none of the issues involved in the ruling request

(i) is in an earlier return of the taxpayer or a related person,

(ii) is being considered by a tax services office or taxation centre in connection with a previously filed tax return of the taxpayer or a related person,

(iii) is under objection by the taxpayer or a related person,

(iv) is before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has not expired, and

(v) is the subject of a ruling previously issued by Revenue Canada or the Canada Customs and Revenue Agency ("CCRA").

In this letter the following definitions are used:

"Act" means the Income Tax Act, R.S.C 1985 (5th Supp.) c.1, as amended to the date hereof, and, unless otherwise stated, every reference herein to a Part, section, subsection, paragraph or subparagraph is a reference to the relevant provision of the Act;

"Canadian Licence" means the licence agreement entered into by Can Co-Producer and UK Co-Producer, as described in Paragraph 11;

"Canadian Sublicence" means the sublicence agreement entered into by UK Co-Producer and Can Co-Producer, as described in 18;

"Can Co-Producer" means XXXXXXXXXX, as described in Paragraph 1;

"Co-producers" means, collectively, Can Co-Producer and UK Co-Producer;

"Co-Production Agreement" means the co-production agreement referred to in Paragraph 5;

"Co-Production Treaty" means the Film Co-Production Agreement between Canada and the United Kingdom;

"Dco" means XXXXXXXXXX, as described in Paragraph 3;

"Fco" means XXXXXXXXXX, as referred to in Paragraph 7;

"Film Partnership" means the limited liability partnership, as described in Paragraph 4;

"Lease Agreement" means the lease agreement entered into by the Film Partnership and UK Co-Producer, as described in Paragraph 16;

"Licence Agreement" means the licence agreement entered into by UK Co-Producer and the Film Partnership, as described in Paragraph 13;

"Paragraph" refers to a numbered paragraph in this letter;

"Purchase Agreement" means the purchase and sale agreement entered into by UK Co-Producer and the Film Partnership, as described in Paragraph 12;

"Series" means XXXXXXXXXX episodes of the television series entitled XXXXXXXXXX, as referred to in Paragraph 5;

"UK Co-Producer" means XXXXXXXXXX, as described in Paragraph 2; and

"Mr. X" means XXXXXXXXXX.

Our understandings of the facts, proposed transactions and purpose of the proposed transactions are as follows:

FACTS

1. Can Co-Producer is a taxable Canadian corporation within the meaning of subsection 89(1) and is wholly owned by Mr. X, a resident of Canada. Can Co-Producer's head office and principal place of business are situated at XXXXXXXXXX. Can Co-Producer is a "qualified corporation" for the purposes of section 125.4. Can Co-Producer deals with the XXXXXXXXXX Tax Services Office and files its income tax returns with the XXXXXXXXXX Tax Centre. Its taxation year ends on XXXXXXXXXX. The business number of Can Co-Producer is XXXXXXXXXX.

2. UK Co-Producer is a corporation incorporated and existing under the laws of the United Kingdom. Its principal place of business is situated at XXXXXXXXXX. UK Co-Producer does not carry on a business in Canada, nor will it be entitled, at any time, to deduct any amount in respect of the Series in computing income subject to tax in Canada.

3. Dco is a corporation incorporated and existing under the laws of England. Its UK principal place of business is situated at XXXXXXXXXX.

PROPOSED TRANSACTIONS

4. Dco will form the Film Partnership under the laws of XXXXXXXXXX . The manager of the Film Partnership will be Dco. The Film Partnership and all of its members will deal at arm's length with Can Co-Producer and UK Co-Producer. The members of the Film Partnership will be resident in the United Kingdom and none of the members of the Film Partnership will be resident of Canada. The Film Partnership will not be a Canadian partnership as defined in section 102 and will be deemed to be a non-resident person for the purposes of certain payments under Part XIII, in accordance with paragraph 212(13.1)(b). The Film Partnership will at no time either carry on a business in Canada or maintain a permanent establishment in Canada. The Film Partnership, or any of its members, will not deduct, nor will they be entitled to deduct, any amount in respect of the Series in computing income subject to tax in Canada.

5. The Co-producers have entered into the Co-Production Agreement, dated XXXXXXXXXX, to co-produce, exploit and distribute the Series. The co-production (as described in this letter) has received preliminary approval and will be fully approved by Telefilm Canada and the Department of Cultural Media and Sports (i.e., the United Kingdom authorities) as a treaty co-production under the Co-Production Treaty between Canada and the United Kingdom, based on the terms of the agreements provided to us with your application for this advance income tax ruling. Prior to entering into the Co-Production Agreement, the Co-producers operated at arm's length with each other and, with respect to the Series, they will not be operating as a partnership.

6. For the purposes of section 125.4, the Series will be a "treaty co-production" and qualify as a "Canadian film or video production". Can Co-Producer will claim a tax credit in accordance with subsection 125.4(3) on its qualified labour expenditure for the year in respect of the Series.

7. The Co-Production Agreement provides that Can Co-Producer shall have the exclusive distribution and exploitation rights to the Series in Canada (the "Canadian Rights"), and that the UK Co-Producer shall have the exclusive distribution and exploitation rights to the Series in the United Kingdom. The rights to distribute and exploit the Series in all other territories (the "Other Exploitation Rights") are shared between the Co-producers. The Other Exploitation Rights are the subject of an agreement (the "Broadcast and Distribution Agreement") dated XXXXXXXXXX , between the Co-producers and Fco. The initial term of the Broadcast and Distribution Agreement is for XXXXXXXXXX years, with XXXXXXXXXX automatically renewable terms of XXXXXXXXXX years each. Under this agreement, Fco agreed to pay the Co-producers US$XXXXXXXXXX per episode in the Series in consideration for the Other Exploitation Rights. In return Fco is entitled to receive a distribution fee, reimbursement of certain distribution advances and expenses, and interest in respect of certain distribution advances. Under the same agreement, the Co-producers are entitled to the residual amount of certain gross receipts derived by Fco in respect of the Other Exploitation Rights. After payment of any profit participations, this residual shall be allocated XXXXXXXXXX% to the Can Co-Producer and XXXXXXXXXX% to the UK Co-Producer. The Broadcast and Distribution Agreement reflects normal commercial arrangements for such services and will not result in a disposition by the Co-producers of any portion of their respective beneficial ownership interests in the Series to Fco or to each other.

8. The budgeted aggregate costs for producing the Series will be approximately CDN $XXXXXXXXXX. Can Co-Producer's share of the production costs will be XXXXXXXXXX% of the of the total production costs (i.e., approximately $XXXXXXXXXX). Can Co-Producer will finance its share of the production costs mainly from federal and XXXXXXXXXX film tax credits, as well as revenues from pre-sales of Canadian and international distribution rights.

9. The Co-Production Agreement provides that the UK Co-Producer shall provide financial contributions of approximately CDN $XXXXXXXXXX (XXXXXXXXXX% of the total production costs), which will be funded partly by the UK sale, license and lease transactions with the Film Partnership, as described below in subsequent Paragraphs. Each co-producer agrees to execute any documents or perform any act that is reasonably necessary to carry out the provisions of the Co-Production Agreement.

10. Upon the completion of the production of each episode of the Series, one original negative and/or master videotape (the "master tape") of the episode and one duplicate copy of the master tape will be created. UK Co-Producer will own each of the master tapes, which will be kept in a laboratory in XXXXXXXXXX, England. Can Co-Producer will own each duplicate copy of the master tapes. The production of two copies of the master tapes is typical of a treaty co-production and is contemplated in paragraph XXXXXXXXXX of the Annex to the Co-Production Treaty between Canada and the UK, which provides that each co-producer shall be the owner of a copy of the protection and reproduction material and shall be entitled to use it to make the necessary reproductions.

11. Can Co-Producer will enter into the Canadian Licence with the UK Co-Producer. Under the terms of the Canadian Licence, Can Co-Producer will grant to the UK Co-Producer a licence of its rights, as a co-owner, to copy, rent, licence, exhibit, distribute, re-issue, turn to account, derive revenue from and otherwise deal in or with the Series throughout the world, excluding the Canadian Rights. The term of the Canadian Licence will be for a period equal to the length of the copyright of the Series and will be subject to the Broadcast and Distribution Agreement described in Paragraph 7 and any other existing distribution agreements. Can Co-Producer will retain: (i) ownership of the duplicate copy of the master tape of each episode of the Series; (ii) ownership of its interest in the underlying copyright to the Series and (iii) its interest in the Canadian Rights. The amount of consideration to be received by Can Co-Producer from UK Co-Producer for the granting of the Canadian Licence will be equal in amount to the value of the rights granted to the UK Co-Producer at the date that the Canadian Licence is entered into and shall be payable at the end of XXXXXXXXXX years.

12. Under the Purchase Agreement, UK Co-Producer will sell its master tapes of each episode of the Series to the Film Partnership and grant rights so that the sole and exclusive right, title and interest in UK Co-Producer's master tapes shall vest in the Film Partnership. The initial conditional closing date (when agreements are signed that are subject to certain listed conditions precedent) is expected to be before XXXXXXXXXX. Financial and final closing will be no later than XXXXXXXXXX days following receipt by Dco, in its capacity as manager of the Film Partnership, of a Department of Cultural Media and Sports certificate (from the United Kingdom authorities) pursuant to an audit of the Series' production costs, and is expected to be no later than XXXXXXXXXX. Can Co-Producer will not be a party to the Purchase Agreement.

13. UK Co-Producer will also enter into the Licence Agreement with the Film Partnership, whereby it will grant to the Film Partnership the sole and exclusive right to copy, rent, licence, exhibit, distribute, re-issue, turn to account, derive revenue from and otherwise deal in or with the Series throughout the world, excluding the Canadian Rights. For greater certainty, under the Licence Agreement the UK Co-Producer will, inter alia, grant to the Film Partnership the rights the UK Co-Producer acquired under the Canadian Licence referred to in Paragraph 11. The term of the Licence Agreement will be for a period equal to the length of the copyright of the Series. UK Co-Producer and Can Co-Producer will retain co-ownership of the copyright for the Series and all of the rights and benefits of such legal ownership in accordance with the Co-Production Agreement. Can Co-Producer will not be a party to this Licence Agreement.

14. A total amount of approximately CDN $XXXXXXXXXX (being XXXXXXXXXX % of the budgeted production costs for the Series, calculated after deducting XXXXXXXXXX % from the budgeted production costs for the Canadian Rights, which are retained by Can Co-Producer) will be paid by the Film Partnership to the UK Co-Producer for the master tapes and the rights acquired by the Film Partnership under the Purchase Agreement and the Licence Agreement (the "Rights Payment").

15. Depending upon the status of British certification process for the Series (see Paragraph 12), the UK Co-Producer will receive an advance (the "Advance") from the Film Partnership, either on initial closing or upon financial and final closing (see Paragraph 12), representing approximately XXXXXXXXXX% of the Rights Payment. The balance of the Rights Payment will be paid to the UK Co-Producer on financial and final closing and will be put on deposit by the UK Co-Producer to obtain a bank guarantee and to fund its Lease Payment obligations under the Lease Agreement referred to in Paragraph 17(i).

16. Immediately after the sale of the master tapes of the Series under the Purchase Agreement and the execution of the Licence Agreement, the Film Partnership will enter into the Lease Agreement with the UK Co-Producer. Under the terms of the Lease Agreement the Film Partnership will lease to the UK Co-Producer the master tapes acquired under the Purchase Agreement and licence all of the Film Partnership's rights in the Series acquired under the Licence Agreement for a period of XXXXXXXXXX years (renewable as explained in Paragraph 17(iv)). The Lease Agreement will provide that the UK Co-Producer will have the general right to licence, distribute, advertise and exploit the Series worldwide except the Canadian Rights. The terms of the Lease Agreement will also provide that the rights in the Series to be granted to Can Co-Producer under the Canadian Sublicence (refer to Paragraph 18) will survive the termination of the Lease Agreement, and will continue in full force and effect between Can Co-Producer and the Film Partnership with the result that the rights granted to Can Co-Producer under the Canadian Sublicence will remain validly in existence for the term of the copyright of the Series.

17. The Lease Agreement will further provide for the following:

(i) A minimum rental schedule will be agreed between the Film Partnership and the UK Co-Producer, which will detail the lease payments over XXXXXXXXXX years (the "Lease Payments"). The Lease Payments will be on account of rights to distribute and exploit the Series outside of Canada and will be the sole responsibility of the UK Co-Producer. The Lease Payments will total the aggregate funds placed on deposit by UK Co-Producer (as described in Paragraph 15), together with a market interest rate.

(ii) In addition to the Lease Payments, the UK Co-Producer will also pay (out of its share of revenues from the Series) to the Film Partnership a profit participation equal in amount to XXXXXXXXXX% of the net profits from the exploitation of the Series.

(iii) The UK Co-Producer will be appointed the exclusive agent of the Film Partnership, subject to Can Co-Producer's rights and obligations under the Co-Production Agreement and subject to the Broadcast and Distribution Agreement.

(iv) Following the end of the initial XXXXXXXXXX-year term of the Lease Agreement, the UK Co-producer will have the right, up to the end of the term of the Licence Agreement, to renew the term of the Lease Agreement for XXXXXXXXXX years. The annual rental amount will be a minimal amount.

These provisions will allow the UK Co-Producer, at the end of the initial lease period, the option of continuing the commercial exploitation of the Series, or as agent of the Film Partnership, to dispose of the Film Partnership's rights to the Series (including, but not limited to, the master tapes obtained under the Purchase Agreement and its rights granted under the License Agreement, but subject to the rights granted in the Canadian Sublicense and any existing distribution agreements, and in accordance with the Co-Production Agreement) to a third party. In the event of such a sale, the Film Partnership will refund to the Co-producers the total revenues derived from the sale, including but not limited to the proceeds of disposition, to be allocated between Can Co-Producer (XXXXXXXXXX%) and UK Co-Producer (XXXXXXXXXX%).

18. Immediately after the granting of the lease from the Film Partnership to the UK Co-Producer, as described in Paragraphs 16 and 17, UK Co-Producer will enter into the Canadian Sublicence with Can Co-Producer to licence to Can Co-Producer the same rights licenced by Can Co-Producer under the Canadian Licence on the same terms and conditions, and for the same period. The date of payment and the consideration payable to the UK Co-Producer under the Canadian Sublicence will be the same as provided for in the Canadian Licence and these monetary obligations will be extinguished by way of set-off at the end of XXXXXXXXXX years. As noted in Paragraph 16, the Canadian Sublicence will survive the termination of the Lease Agreement, with the result that the rights granted to Can Co-Producer under the Canadian Sublicence will remain validly in existence for the length of the copyright of the Series.

19. The Film Partnership will claim a deduction under the tax laws of the United Kingdom for XXXXXXXXXX% of the amount of the Rights Payment paid to acquire the master tapes for the Series and the rights under the Licence Agreement. The net amount of the Rights Payment that is received by the UK Co-Producer (which will be approximately equal to the amount of the Advance referred to in Paragraph 15) will apply to reduce the UK Co-Producer's costs of production in the United Kingdom.

PURPOSE OF THE PROPOSED TRANSACTIONS

The purpose of the proposed transactions is to generate additional financing to reduce the production costs for the Series by taking advantage of provisions of the United Kingdom's tax legislation which are designed to encourage the production of film and television activity in the United Kingdom.

RULINGS

Provided that the preceding statements constitute a complete and accurate disclosure of all the relevant facts, proposed transactions, and purpose of the proposed transactions and provided that the proposed transactions are carried out as described above, and further provided that there are no other transactions which may be relevant to the rulings requested, we confirm the following:

A. The granting of the rights under the Canadian Licence by Can Co-Producer to the UK Co-Producer will not be considered a disposition of the copyright in the Series by Can Co-Producer, for the purposes of section 125.4.

B. Since the UK Co-Producer and the Film Partnership and each of the partners of the Film Partnership will not deduct, nor will they be entitled to deduct, any amount in respect of the Series in computing income subject to tax in Canada, the involvement of the UK Co-Producer and the Film Partnership in the proposed transactions described above will not, in and of itself, result in the application of subsection 125.4(4) to deny a tax credit to Can Co-Producer under subsection 125.4(3).

COMMENTS

These rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R5, dated May 17, 2002, and are binding on the CCRA provided that the proposed transactions are completed before XXXXXXXXXX.

These rulings are based on the Act in its present form and do not take into account the effect of any proposed amendments. Except as expressly stated, our rulings do not imply acceptance, approval or confirmation of any income tax implications of the facts or proposed transactions. In particular, nothing in this letter should be interpreted as confirming, either expressly or implicitly that the CCRA has agreed to or accepted:

(i) the reasonableness of any expenditure referred to in this letter, or the determination of fair market value, adjusted cost base or undepreciated capital cost of any property referred to in this letter;

(ii) the GST implications of any of the proposed transactions;

(iii) any income tax consequences relating to any person who may have an interest in the Film Partnership and is subject to income taxation in Canada;

(iv) the entitlement of Can Co-Producer to any federal or provincial film tax credits, except as expressly stated above in Rulings A and B; and

(v) any income tax consequences of entering into the Broadcast and Distribution Agreement with Fco, referred to in Paragraph 7. We note, that under the terms of this agreement, Fco has become entitled to share in a significant amount of the revenue from the Series (XXXXXXXXXX). Notwithstanding the stated fact in Paragraph 7 concerning the commerciality of the terms of the Broadcast and Distribution Agreement, we are not commenting on whether this agreement has resulted in a disposition by Can Co-Producer of any portion of its beneficial ownership interest in the Series to Fco or to UK Co-Producer. This matter involves a question of fact and of valuation. We do not have sufficient information to comment further at this time, except to state that Can Co-Producer's eligibility to claim a tax credit under subsection 125.4(3) in respect of the Series could be reduced or eliminated if, for instance, any or all of the following conditions are met:

(1) Fco did acquire an ownership interest in the Series;

(2) Fco is an "investor" as defined in subsection 125.4(1); and

(3) Fco, directly or indirectly, may deduct an amount in respect of the Series in computing income subject to tax in Canada for any taxation year.

Nothing in this letter should be construed as implying whether or not any of the transactions entered into by Can Co-Producer will directly or indirectly enable the Film Partnership to have access to any deductions for UK tax purposes with respect to any or all of the Series production costs, and, in particular, nothing in this letter should be construed as implying that Can Co-Producer or the UK Co-Producer has entered into a sale-leaseback transaction with respect to any interest it may have in the Series.

Yours truly,

XXXXXXXXXX
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Legislation Branch

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