2002 Ruling 2002-012195A - FILM PARTNERSHIP/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?

Position: 1. No

Reasons: 1. Multi-year lease; certain rights retained, including beneficial ownership of the copyright. Similar to position adopted in file 2000-003885 and 2001-007262.

XXXXXXXXXX 2002-012195

XXXXXXXXXX, 2002

Dear XXXXXXXXXX:

Re: XXXXXXXXXX
Advance Income Tax Ruling Request

This is in reply to your letter dated XXXXXXXXXX, as amended XXXXXXXXXX, and our numerous telephone conversations (XXXXXXXXXX) wherein you requested advance income tax rulings in respect of the proposed transactions described herein. These transactions involve a XXXXXXXXXX series XXXXXXXXXX.

In this letter the following definitions are used:

"Aco" means XXXXXXXXXX;

"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;

"Bco" means XXXXXXXXXX;

"Canadian License" means the license of rights from Aco to Cco described in Paragraph 11;

"Canadian Rights" means those rights described in Paragraph 11;

"Canadian Sublicense" means the sublicense of rights from Cco to Aco described in Paragraph 15;

"Cco" means XXXXXXXXXX;

"Co-Production Agreement" means the agreement between Aco and Cco governing the terms of the co-production as described in Paragraph 6;

"Co-Production Treaty" means the Films Co-Production Agreement between XXXXXXXXXX;

"Dco" means XXXXXXXXXX;

"Eco" means XXXXXXXXXX;

"Fco" means XXXXXXXXXX;

"Lease" means the lease of rights from Purchaser to Cco described in Paragraph 13;

"License Agreement" means the license agreement between Cco and Purchaser described in Paragraph 12;

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

"Purchaser" means XXXXXXXXXX;

"Sale Agreement" means the sale agreement between Cco and Purchaser described in Paragraph 12; and

"Series" means XXXXXXXXXX.

FACTS

1. Aco is a corporation incorporated on XXXXXXXXXX, under the laws of XXXXXXXXXX. Its address is XXXXXXXXXX and its business number is XXXXXXXXXX. Aco deals with the XXXXXXXXXX Tax Services office and files its income tax returns with the XXXXXXXXXX Taxation Centre. Aco is a "qualified corporation" for the purposes of section 125.4 and is an indirect subsidiary of Bco. Bco's head office is at XXXXXXXXXX.

2. Cco was incorporated under the laws of the United Kingdom. Its registered address is XXXXXXXXXX. Cco 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. Cco is an indirect subsidiary of Dco. Dco and its subsidiaries employ in the aggregate over XXXXXXXXXX individuals and are engaged in a broad spectrum of activities in the film industry. These activities are focused on the financing of the production of film and television programs. The activities also extend to the provision of physical post-production facilities to film and television producers.

3. Purchaser is a general partnership formed under the laws of XXXXXXXXXX. The initial partners of Purchaser are Eco and Fco. Both Eco and Fco were incorporated under the laws of XXXXXXXXXX. Eco is an indirect subsidiary of Dco and Fco is unconnected with Dco. It is intended that additional persons will become partners in Purchaser. Such persons will be individuals and/or corporations resident in the United Kingdom. None of the partners of Purchaser will be residents of Canada. At no time will Purchaser carry on a business in Canada or maintain a permanent establishment in Canada. Purchaser will be a non-resident person in accord with paragraph 212(13.1)(b) and none of its members will deduct or will be entitled to deduct any amount in respect of the Series in computing income subject to tax in Canada. Purchaser will not be a "Canadian Partnership" within the meaning of section 102.

4. Cco, Dco, Eco, Fco, Purchaser and each of its members will, at all times, deal at arm's length with Aco and Bco.

5. To the best of your knowledge and that of the taxpayers involved, none of the issues involved in this ruling

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

(iii) is under objection by the taxpayer(s) 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 (the "CCRA").

PROPOSED TRANSACTIONS

6. Aco and Cco have entered into the Co-Production Agreement pursuant to which they will co-produce, exploit and distribute the Series. The co-production will be approved by Telefilm Canada as a treaty co-production under the Co-Production Treaty. With respect to the Series, Aco and Cco will be operating as joint venture participants and not as partners.

7. The Co-Production Agreement provides that Aco shall have the exclusive distribution and exploitation rights to the Series in Canada and Cco shall have the exclusive distribution and exploitation rights to the Series in the United Kingdom. The distribution and exploitation in all other territories shall be the responsibility of Aco or another affiliate of Bco, and the revenues earned shall be allocated to Aco and to Cco in the same percentage as their respective contributions to the financing of the Series.

8. The aggregate costs for producing the Series will be approximately $XXXXXXXXXX. Aco will be responsible for financing XXXXXXXXXX% of the production costs and Cco will be responsible for financing the balance of the production costs. Cco intends to raise a portion of its $XXXXXXXXXX share of production financing by entering into the sale, license and lease transactions with Purchaser, as described below.

9. Upon the completion of the production of the Series, one original master negative of the Series and one duplicate copy of the master negative will be created. Cco will own the original master negative and Aco will own the duplicate copy of the master negative. The production of two copies of the master negative is provided for in paragraph 11 of the Annex to the Co-Production Treaty, 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.

10. For the purposes of section 125.4, the Series will be a "treaty co-production" and a "Canadian film or video production". Aco intends to claim a tax credit in accordance with subsection 125.4(3) on its qualified labour expenditure for the year in respect of the Series. Further, Aco's interest in the Series will be a capital property and not a property that is described in its inventory.

11. Aco will enter into the Canadian License with Cco, pursuant to which Aco will grant to Cco a XXXXXXXXXX-year license of its rights, as a co-owner, to rent, lease, licence, exhibit, distribute, derive revenue from and otherwise deal in or with the Series throughout the world, excluding Canada, and its rights under any existing distribution agreements, in respect of the Series, for territories outside of Canada (the "Canadian Rights"). Aco will not license to Cco (or any other party) and will retain for its own account, ownership of the duplicate copy of the master negative, its ownership interest in the underlying copyright to the Series and its right to distribute and exploit the Series in Canada. In consideration for the grant of the Canadian Rights under the Canadian License, Aco will be entitled to a license fee equal in amount to the fair market value of the Canadian Rights as computed on the date that the Canadian License is entered into. In determining the annual amount of the accrued payable, in respect of this license fee, by Cco to Aco (or by Purchaser to Aco, as explained in the last part of this Paragraph), the value of the Canadian Rights will be divided by XXXXXXXXXX, resulting in an accrued amount payable for each year the Canadian License remains effective. On the commencement of each year that the Canadian License remains in force, the entitlement of Aco to the payment in respect of such year will vest. As described in Paragraph 15, accrued amounts payable by Cco to Aco under the Canadian License will not be required to be paid and will not be paid until the earlier of (i) the last day of the term of the Canadian License, and (ii) the last day of the term of the Lease (in this letter "the last day of the term of the Lease" or the "expiry of the term of the Lease" includes any renewals as applicable and described in Paragraph 14(ii)) between Cco and Purchaser (described in Paragraph 13).

In the event that the Lease (referred to in Paragraph 13) terminates prior to the expiration of the Canadian License, the Canadian License will survive the termination of the Lease and will continue in full force between Aco and Purchaser. In lieu of Cco, Purchaser will then be responsible for any additional payments to be made to Aco under the Canadian License, on the same basis and in the same amounts as if the Lease had not terminated. Purchaser will only make such additional payments to Aco upon the termination of the Canadian License.

12. Cco will then enter into the Sale Agreement with Purchaser, pursuant to which Cco will sell to Purchaser all of its interest in the master negative of the Series (together with certain ancillary delivery material) and Cco will also grant rights so that the sole and exclusive right, title and interest in Cco's master negative shall vest in Purchaser. The closing date is expected to be in XXXXXXXXXX and after the date of this letter. There is no provision in the Sale Agreement, the License Agreement or the Lease (described in Paragraph 13), allowing Cco to reacquire the master negative in the Series. Cco will also enter into the License Agreement with Purchaser pursuant to which it will license Purchaser with the sole rights to rent, lease, licence, exhibit, derive revenue from, distribute and otherwise deal in or with the Series throughout the world, excluding Canada. The rights licensed to Purchaser under the License Agreement will include the Canadian Rights licensed from Aco to Cco pursuant to the Canadian License. The term of the License Agreement will be for a period equal to the length of the copyright of the Series (except for the Canadian Rights, which will be for a term of XXXXXXXXXX years). The total consideration payable by Purchaser for the rights acquired under the Sale Agreement and the License Agreement (together referred to as the "Rights Payment") will approximate the total estimated $XXXXXXXXXX production cost of the Series. Approximately XXXXXXXXXX% of the Rights Payment will be paid to Cco up-front (the "Advance") and will be available to Cco for financing its share of the production costs in the Series. At the same time as the Advance is paid, the balance of the Rights Payment will be made by Purchaser to Cco and it will immediately be put on deposit by Cco to fund certain lease payments to be made by Cco to the Purchaser under the Lease described in Paragraph 13. Cco and Aco 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. Aco will not be party to the Sale Agreement or the License Agreement.

13. Immediately after the sale of the master negative under the Sale Agreement and the execution of the License Agreement, Cco will then enter into a XXXXXXXXXX-year lease arrangement (the "Lease") with Purchaser pursuant to which Purchaser will lease to Cco all of the rights acquired by Purchaser from Cco including the license of the Canadian Rights. Under the Lease, Cco will agree to pay to Purchaser XXXXXXXXXX annual lease amounts that will total the aggregate of the funds placed on deposit by Cco (as described in Paragraph 12) together with a market interest rate. In addition, out of its share of the exploitation results from the Series, Cco will agree to pay to Purchaser a negotiated percentage (anticipated to be between XXXXXXXXXX% and XXXXXXXXXX%) of net profits generated from the exploitation of the Series during the term of the Lease. For greater certainty, Aco will not be responsible for any of the lease payments and fees referred to in this Paragraph or Paragraph 14.

14. The terms of the Lease will further provide for the following:

(i) Cco may, with the consent of Purchaser, enter into licenses with respect to the distribution or other exploitation of the Series that extend beyond XXXXXXXXXX years. Any such arrangements will survive the termination of the Lease and will continue in full force and effect between the licensee and Purchaser (or its assignee);

(ii) after the end of the initial XXXXXXXXXX year term of the Lease, if Cco has not provided timely notice of termination to Purchaser, paragraph 3.3 of the Lease provides for automatic renewals of the Lease for one or more successive annual periods up to a maximum aggregate of XXXXXXXXXX years. The consideration to be paid for any such lease renewal periods will be a fair market value rental amount, yet to be negotiated;

(iii) Cco will be appointed as the agent of the Purchaser and will be authorized, at any time after the expiry of the term of the Lease, to dispose of all of Purchaser's right, title and interest in the Series (including, but not limited to, the master negative obtained under the Sale Agreement and its rights granted under the License Agreement, but subject to the rights granted in the Canadian Sublicense) to a third party on terms reasonably satisfactory to the Purchaser, as evidenced in writing. Purchaser will refund to Cco, as a rental rebate, an amount equal to XXXXXXXXXX% of the net proceeds of any such disposition. For greater certainty, pursuant to the terms of the Co-Production Agreement, Aco will not be entitled to receive any portion of the proceeds of such a disposition, nor will it be entitled to receive any portion of such a rental rebate paid to Cco.

15. Immediately after the granting of the Lease, Cco will then enter into the Canadian Sublicense with Aco, pursuant to which Cco will license the Canadian Rights to Aco for a period of XXXXXXXXXX years. The rights licensed under the Canadian Sublicense from Cco to Aco will be the same as the rights licensed by Aco to Cco under the Canadian License and will be for the same XXXXXXXXXX year period. Consideration payable by Aco under the Canadian Sublicense will be a license fee equal in amount to the license fee payable under the Canadian License.

On the commencement of each year that the Canadian Sublicense remains in force, the entitlement of Cco to the accrued amount payable from Aco in respect of such year (i.e., XXXXXXXXXX of the license fee) will vest. Amounts payable by Aco to Cco under the Canadian Sublicense will not be required to be paid and will not be paid until the earlier of (i) the last day of the term of the Canadian Sublicense, and (ii) the last day of the term of the Lease.

As contemplated in Paragraph 14(i), as part of the terms of the Lease, Purchaser will consent to the Canadian Sublicense and, as a result, to the extent that the Lease terminates prior to the expiration of the Canadian Sublicense, the Canadian Sublicense will survive the termination of the Lease and will continue in full force between Aco and Purchaser. In lieu of Cco, Purchaser will then be entitled to receive any additional payments to be made by Aco under the Canadian Sublicense, on the same basis and in the same amounts as if the Lease had not terminated. Aco will only make such additional payments to Purchaser upon the termination of the Canadian Sublicense.

Any monetary obligations described in this Paragraph and in Paragraph 11 between Aco and Cco, under the Canadian License and the Canadian Sublicense will be extinguished by way of set-off, also on the earlier of (i) the last day of the term of the Canadian License and the Canadian Sublicense, and (ii) the last day of the term of the Lease.

If the context applies, any monetary obligations described in this Paragraph and in Paragraph 11 between Aco and Purchaser under the Canadian License and the Canadian Sublicense, will be extinguished by way of set-off on the last day of the term of the Canadian License and the Canadian Sublicense.

16. For greater certainty, the Canadian License, the Sale Agreement, the License Agreement, the Lease and the Canadian Sublicense will all be entered into on the same day.

17. The Purchaser will claim a deduction under the tax laws of the United Kingdom in respect of the Rights Payment paid to Cco (referred to in Paragraph 12).

PURPOSE OF THE PROPOSED TRANSACTIONS

Aco is proposing to enter into the Canadian License and Canadian Sublicense with Cco in order to facilitate Cco's completion of the sale, license and lease transactions with the Purchaser. Pursuant to such transactions, Cco will receive certain payments from Purchaser that will assist Cco in financing its portion of the production costs of the Series.

RULINGS

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and purpose of the proposed transactions, and provided that the proposed transactions are completed in the manner described above, we confirm the following:

A. The carrying out of the proposed transactions described above, including the license of the Canadian Rights by Aco pursuant to the Canadian License, will not result in Aco being considered to have disposed of an ownership interest in its portion of the Series, for the purposes of section 125.4 and paragraph 20(1)(a).

B. Since Cco and Purchaser and each of the partners of Purchaser 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 Cco and Purchaser 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 Aco under subsection 125.4(3).

COMMENTS

These rulings are given subject to the general limitations and qualifications set forth in Information Circular 70-6R4, issued by the CCRA on January 29, 2001, and are binding provided the proposed transactions are entered into on or 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 expenditures 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, or whether Aco's interest in the Series is capital property to Aco;

(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 Purchaser and is subject to income taxation in Canada;

(iv) any income tax consequences to any person if the Series is distributed or exploited by an affiliate of Bco, other than Aco, as is contemplated in Paragraph 7; and

(v) except as expressly stated above in Rulings A. and B., the entitlement of Aco to any federal or provincial film tax credits.

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

Yours truly,

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