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. Would the sale of certain television programs result in them being "excluded productions" within the meaning of draft subsection 1106(1) of the Regulations?

2. If so, can a reassessment be raised using a draft Regulation in order to deny the film tax credit?

3. Were certain television programs sold on the Closing Date, or not, based on the terms of the sales agreement?

PositionS:

1. Yes, based on the present draft wording.

2. It would appear to be a reasonable approach, but the issue of applying proposed legislation is ultimately an Audit/Assessing issue.

3. No.

Reasons:

1. The programs were sold before the expiry of the 25-year holding requirement in the definition of excluded production.

2. The taxpayer claimed and received the film tax credit based on the draft Regulations. It only appears reasonable to allow a reassessment if the requirements were not otherwise met.

3. Appears to be conditions precedent to be met before the sale takes place.

            May 1, 2002

      Natalie Stibernik HEADQUARTERS
      Manager     Allan Nelson, CMA
      Film Industry Services  (613) 443-7253
      344 Slater, 6th Floor

      Attention:  Alain Marchand
            2001-011434

XXXXXXXXXX
Excluded Production - Draft Subsection 1106(1) of the Regulations

We are writing in response to your memorandum to us dated December 6, 2001, wherein you asked for our comments concerning certain tax consequences to XXXXXXXXXX (the "Producer") arising from entering into the XXXXXXXXXX (the "Agreement") with XXXXXXXXXX (the "Purchaser"). Your questions arose from a referral you received from the XXXXXXXXXX TSO.

Background

The Producer entered into the Agreement, dated as of XXXXXXXXXX (the "Closing Date"), with the Purchaser, with respect to the sale of certain television programs produced and owned by the Producer.

The Producer has claimed the Canadian film or video production tax credit (the "film tax credit") on XXXXXXXXXX productions, mentioned in the Agreement (i.e., XXXXXXXXXX " (these XXXXXXXXXX productions are hereafter referred to as the "Productions")). Each of the Productions was certified by the Department of Canadian Heritage as a Canadian film or video production within the meaning of draft subsection 1106(3) of the Regulations.

XXXXXXXXXX (hereafter referred to as the "Excluded Productions") were subject to certain encumbrances. Consequently, under the terms of the Agreement, the Excluded Productions were not transferred to the Purchaser on the Closing Date. Further, the total purchase price to be paid to the Producer on the Closing Date was reduced by a particular amount for each of the Excluded Productions (i.e., XXXXXXXXXX. These amounts are hereafter referred to as the "Price Reductions"). Pursuant to subsection XXXXXXXXXX of the Agreement, the Producer was required, within XXXXXXXXXX years of the Closing Date, to transfer XXXXXXXXXX to the Purchaser, free of encumbrances, in accordance with the terms and conditions of the Agreement. Pursuant to subsection XXXXXXXXXX of the Agreement, Producer agreed to use its reasonable commercial efforts to obtain the requisite consent of the National Film Board to transfer the XXXXXXXXXX to the Purchaser within XXXXXXXXXX years. When any such transfers ultimately took place, the Agreement provided that the aggregate purchase price for the XXXXXXXXXX television programs sold to the Purchaser increased by the applicable portion of the Price Reductions (i.e., XXXXXXXXXX).

The XXXXXXXXXX TSO informed the Producer that the 25-year ownership requirements were not met and therefore the Productions were excluded productions within the meaning of draft subsection 1106(1) of the Regulations. Consequently, the TSO has proposed to reassess the Producer's XXXXXXXXXX taxation years to disallow the film tax credit with respect to the Productions, as well as the additional capital cost allowance under draft paragraph 1100(1)(m) of the Regulations. It was also the TSO's view that the Producer had disposed of the Excluded Productions on XXXXXXXXXX, since there was a clear intention to sell them.

Representations

The Purchaser's representatives disagree with the XXXXXXXXXX TSO's proposals and presented, inter alia, the following arguments and comments:

? the Producer did not intend to sell the Productions at the time they were produced. The definition of excluded production in the draft Regulations was never intended to apply to this type of situation where a Canadian producer properly claimed the credit and then at a later date (even though it was within 25 years) sold the productions to another Canadian producer. The 25-year copyright ownership test is not intended to constantly test the qualification of the production, but should be applied at the time the producer completed the production;

? the Department of Finance has been issuing legislation in draft form since 1983 to give an opportunity to the tax community to comment on the proposals. The draft Regulations are presently the subject of a significant on-going dialogue amongst the Department of Finance, Department of Canadian Heritage, the Canadian production industry and the Canadian distribution industry with a view to clarify the investor rules. The 25-year ownership requirement is inappropriate and it is possible that changes will be made to the draft rules prior to their enactment (no indication of any such changes was presented);

? the twenty-five year rule is ineffective beyond the statutory limitation periods imposed by the Act;

? CCRA is precluded from raising an "excluded production" reassessment at this time since the draft Regulations are of no force and effect. They have never been passed by the Governor in Council and have never been published in the Canada Gazette. However, this does not disentitle the Producer to the film tax credit and the additional capital cost allowance already claimed. This is so because the Producer's claims were made in accordance with the objective and intent of the legislation and the draft Regulations; and

? the Excluded Productions were not transferred to the Purchaser on the Closing Date. The conditions precedent to the sale of XXXXXXXXXX were only satisfied in the Producer's XXXXXXXXXX taxation year and the ownership of XXXXXXXXXX have not yet been transferred to the Purchaser. Consequently, it is their view that the CCRA has no basis to deny the film tax credit applied for by the Producer with respect to XXXXXXXXXX, but not currently received.

Your opinion

It is your opinion that the XXXXXXXXXX TSO has correctly administered draft subsection 1106(1) of the Regulations, at the definition of "excluded production", as if the Governor in Council had enabled them. Further, we cannot take two different approaches, e.g., on one hand, issue film tax credit refunds based on the draft Regulations and on the other hand, not use the same draft Regulations when it is time to determine whether or not a production qualifies for the film tax credit. Consequently, you are of the view that the Minister of Canadian Heritage has the ability to revoke the certificates issued with respect to the Productions and the CCRA can reassess the prior taxation years to recover the film tax credits paid. Reference is made to our file #972271, dated September 16, 1997, which supports your opinion.

Our Comments

We will address your questions in the order presented to us.

1. Do you still agree with the interpretation referred to above (file #972271)?

It is our view that if a qualified corporation disposes of any portion of its copyright in a production to a person, other than to a related prescribed taxable Canadian corporation, without having held it for the twenty-five year period referred to in draft clause 1106(1)(a)(ii)(A) of the Regulations, the production would be an "excluded production" within the meaning of that definition. This is based on the assumptions that the production is not a treaty co-production and that the "prescribed taxable Canadian corporation co-producer" exception, or the "prescribed person" exception, in draft clause (A) are not applicable.

Paragraph 125.4(6)(b) of the Act states that the Minister of Canadian Heritage may revoke the Canadian film or video production certificate in respect of a production where the production is not a Canadian film or video production. In such an instance, for the purposes of subparagraph 125.4(3)(a)(i) of the Act, the certificate would be deemed never to have been issued. Draft subsection 1106(3) of the Regulations provides that an excluded production is not a Canadian film or video production. Hence, the Minister of Canadian Heritage could revoke its certificate in a situation where it is later determined that a production is an excluded production. If the certificate was revoked, CCRA could issue a reassessment disallowing the producer's film tax credit claim, since the requirements of subparagraph 125.4(3)(a)(i) of the Act would not be met. Even if the certificate was not revoked, once it is determined that the production is an excluded production, (1) the production would not be a "Canadian film of video production", (2) the producer would not have any "labour expenditure" or "qualified labour expenditure" (defined in subsection 125.4(1) of the Act) in respect of the production, and (3) since the Canadian film or video production tax credit in subsection 125.4(3) of the Act is based on 25% of its qualified labour expenditure, the producer would not have an amount eligible for the credit. Again, CCRA could issue a reassessment disallowing the producer's claim for the credit. We are of the opinion that any such reassessment would be subject to the limitations of section 152 of the Act.

2. If yes, do you agree that upon entering the Agreement, the Producer lost its entitlement to the film tax credit with respect to the Productions?

3. If no, what is your current view on this issue?

If we apply the wording in draft section 1106 of the Regulations, as if it was enacted, and if we assume that the Producer was the sole owner of the Productions from the first time they were completed and were commercially exploitable, it is our view that any of the Productions that were disposed of by the Producer to the Purchaser under the terms of the Agreement became excluded productions. Consequently, the Producer would no longer be entitled to the film tax credit in respect of those productions. Refer to our response to Question 1, above and Question 5, below.

4. How should we deal with the proposed section 1106 of the Regulations?

In the past, where draft amendments to the Act and/or Regulations have effective dates that arrived before the legislation was passed by Parliament, the Department of National Revenue and the CCRA has suggested that taxpayers complete their returns in accordance with the proposed amendments in order to improve administrative efficiency and avoid public confusion. Taxpayers were usually advised that, if they follow this procedure, any changes made to the draft legislation before enactment will result in adjustments to tax returns filed in accordance with the original proposal. This procedure avoids the necessity of processing returns without taking the proposed changes into account and having to deal with the likelihood of amendments to numerous returns when the legislation passes. At the same time, suggesting that returns be filed in accordance with the proposals and indicating that adjustments will be made if Parliament alters the proposals, respects the role of Parliament in the legislative process.

As explained in response to Question 1, above, in order to qualify for the film tax credit in section 125.4 of the Act, there must, inter alia, be a "Canadian film or video production". Without the relevant definition in draft subsection 1106(3) of the Regulations, there would be no Canadian film or video production and no eligibility for the film tax credit. Notwithstanding this argument, as you point out, our Department has been issuing film tax credits since section 125.4 of the Act was enacted in 1996, presumably on the basis that the draft Regulations would be passed as proposed [Note: Generally, if enacted as proposed, draft section 1106 of the Regulations will apply to 1995 and subsequent taxation years. The 25-year ownership requirement will be effective for productions for which a Canadian film or video production certificate is obtained after 1996].

While we recognize that proposed legislation is not binding until it has been proclaimed into force, we concur with your view that we should not be taking two different approaches to the application of the draft Regulations, e.g., on one hand, issue film tax credit refunds based on the draft Regulations and on the other hand, not use the same draft Regulations when it is time to determine whether or not a production is an excluded production which would not qualify for the film tax credit.

Having stated our view, it is ultimately the role and responsibility of Audit and Assessing to decide how to proceed on these types of assessing issues involving administration of proposed legislation.

5. Based on the Agreement, did the Producer dispose of the Excluded Productions on XXXXXXXXXX?

It does not appear that the Producer disposed of the Excluded Productions on XXXXXXXXXX. In our view it seems that the parties agreed to sell the Excluded Productions only after certain conditions were dealt with (see subsections XXXXXXXXXX of the Agreement) and those conditions had not been dealt with on XXXXXXXXXX.

Section XXXXXXXXXX of the Agreement contemplates the sale of the Productions, including the Excluded Productions, to the Purchaser. However, the sale is subject to section XXXXXXXXXX of the Agreement and therein adjustments are made to the purchase price reflecting the fact that ownership of the Excluded Productions will not be passed to the Purchaser on XXXXXXXXXX. The Agreement is silent on what happens if the conditions allowing for the sale of the Excluded Productions are not met within the stipulated time periods.

XXXXXXXXXX

Finally, we note that, contrary to representations made on behalf of the Producer,

Schedule XXXXXXXXXX of the Agreement appears to indicate the Producer did not own all of the copyright in the Productions prior to the sale to the Purchaser. If this is the case, then it raises the question of whether there was an investor rule problem or an excluded production problem, prior to the sale referred to in your memorandum to us. We do not have sufficient information to comment further on this point, but just raise the question for your consideration.

We hope the above will be of assistance to you.

If you have any additional queries on this matter please feel free to contact us.

Milled Azzi, CA
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
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