2002 Ruling 2002-0130983 - FILM TAX CREDIT-UK TREATY

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 ss. 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) Legal and beneficial ownership of master negative and rights (including copyright) retained. (2) Consistent with previous positions; investors will not claim a deduction in Canada.

XXXXXXXXXX 2002-013098

XXXXXXXXXX, 2002

Dear XXXXXXXXXX:

Re: Advance income tax ruling request
XXXXXXXXXX

This is in reply to the letter of XXXXXXXXXX submitted by XXXXXXXXXX in which he requested an advance income tax ruling on behalf of the above named taxpayer. We also acknowledge the additional information provided in the correspondence of XXXXXXXXXX, and during our various telephone conversations in connection with your request (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 CanCo-Producer and UK Co-Producer, as described in Paragraph 12;

"Canadian Sublicence" means the sublicence agreement entered into by UK Co-Producer and CanCo-Producer, as described in 19;

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

"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 described in Paragraph 8;

"Film" means the film entitled entitled "XXXXXXXXXX", as described in Paragraph 5;

"Film Partnership" means the general 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 17;

"Licence Agreement" means the licence agreement entered into by UK Co-Producer and the Film Partnership, as described in Paragraph 14;

"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 13;

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

"Xco" means XXXXXXXXXX.

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

FACTS

1. CanCo-Producer is a taxable Canadian corporation within the meaning of subsection 89(1) of the Act and a wholly owned subsidiary of Xco. Xco is wholly owned by XXXXXXXXXX, a resident of Canada. CanCo-Producer's head office and principal place of business are situated at XXXXXXXXXX. CanCo-Producer is a "qualified corporation" for the purposes of section 125.4 of the Act. CanCo-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 CanCo-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 Film in computing income subject to tax in Canada.

3. Dco is a corporation incorporated and existing under the laws of XXXXXXXXXX. 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 CanCo-Producer and the 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 of the Act 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) of the Act. 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 Film in computing income subject to tax in Canada.

5. CanCo-Producer and the UK Co-Producer have entered into a co-production agreement (the "Co-Production Agreement") to co-produce, exploit and distribute the Film. The co-production has been pre-approved by Telefilm Canada as a treaty co-production under the Co-Production Treaty between Canada and the United Kingdom. Prior to entering into the Co-Production Agreement, CanCo-Producer and the UK Co-Producer operate at arm's length with each other and, with respect to the Film, they will not be operating as a partnership.

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

7. The aggregate costs for producing the Film will be approximately CDN $XXXXXXXXXX. CanCo-Producer's share of the production costs will be XXXXXXXXXX% of the total production costs (i.e. approximately $XXXXXXXXXX). CanCo-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.

8. The Co-Production Agreement provides that CanCo-Producer shall have the exclusive distribution and exploitation rights to the Film in Canada, and that the UK Co-Producer shall have the exclusive distribution and exploitation rights to the Film in the United Kingdom, XXXXXXXXXX. The distribution and exploitation in all other territories shall be the responsibility of CanCo-Producer, the UK Co-Producer and their international sales agent, in accordance with the terms of a sales agency agreement (the "Sales Agency Agreement") to be negotiated, and the revenues earned shall be collected and divided according to a collection agreement (the "Collection Agreement") to be negotiated by CanCo-Producer, the UK Co-Producer, a collection agent, a sales agent and all other beneficiaries. The Sales Agency Agreement will be for an initial term of XXXXXXXXXX years. CanCo-Producer has entered into a distribution agreement with Fco, granting it the exclusive licence to distribute the Film in Canada. The initial term of the agreement is for a period of XXXXXXXXXX years and the distributor will have the right to renew the agreement for an additional period of XXXXXXXXXX years. These agreements will reflect normal commercial arrangements for such services and will not affect the beneficial ownership of CanCo-Producer's rights in the Film.

9. The co-producers will not modify their rights in the negotiation of the Sales Agency Agreement and the Collection Agreement and the allocation of revenues between the co-producers will not be altered from the terms of the Co-Production Agreement which is to allocate the revenues from non-exclusive territories in a proportion of XXXXXXXXXX% to CanCo-Producer and XXXXXXXXXX% to the UK Co-Producer.

10. 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 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.

11. Upon the completion of the production of the Film, one original master negative of the Film and one duplicate copy of the master negative will be created. UK Co-Producer will own the original master negative and CanCo-Producer will own the duplicate copy of the master negative. The production of two copies of the master negative is typical of a treaty co-production and is contemplated in paragraph 11 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.

12. CanCo-Producer will enter into the Canadian Licence with the UK Co-Producer. Under the terms of the Canadian Licence, CanCo-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 Film throughout the world, excluding Canada. The term of the Canadian Licence will be for a period equal to the length of the copyright of the Film and will be subject to existing distribution agreements as well as the Sales Agency Agreement and the Collection Agreement described in Paragraph 8. CanCo-Producer will retain: (i) ownership of the duplicate copy of the master negative of the Film; (ii) ownership of its interest in the underlying copyright to the Film and (iii) its interest in the right to exploit the Film in Canada. The consideration for the granting of the Canadian Licence will be equal to the value of the rights granted to the UK Co-Producer, which shall be payable at the end of XXXXXXXXXX years.

13. Under the Purchase Agreement, UK Co-Producer will sell its master negative of the Film to the Film Partnership and grant rights so that the sole and exclusive right, title and interest in UK Co-Producer's master negative shall vest in the Film Partnership. The closing date is expected to be before the XXXXXXXXXX. CanCo-Producer will not be a party to the Purchase Agreement.

14. 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 Film throughout the world, excluding Canada. 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 12. The term of the Licence Agreement will be for a period equal to the length of the copyright of the Film. UK Co-Producer and CanCo-Producer will retain co-ownership of the copyright for the Film and all of the rights and benefits of such legal ownership in accordance with the Co-Production Agreement. CanCo-Producer will not be a party to this Licence Agreement.

15. A total amount of approximately CDN $XXXXXXXXXX will be paid by the Film Partnership to the UK Co-Producer for the rights acquired by the Film Partnership under the Purchase Agreement and the Licence Agreement (the "Rights Payment").

16. The UK Co-Producer will receive an up-front advance (the "Advance") from the Film Partnership, representing approximately XXXXXXXXXX% of the Rights Payment. The balance of the Rights Payment will be paid to the UK Co-Producer on 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 18.

17. Immediately after the sale of the master negative of the Film under the Purchase Agreement and the execution of the Licence Agreement, the Film Partnership will enter into a lease agreement with the UK Co-Producer (the "Lease Agreement"). Under the terms of the Lease Agreement the Film Partnership will lease to the UK Co-Producer the master negative acquired under the Purchase Agreement and licence all of the Film Partnership's rights in the Film acquired under the Licence Agreement for a period of XXXXXXXXXX years. The Lease Agreement will provide that the UK Co-Producer will have the general right to licence, distribute, advertise and exploit the Film worldwide except in Canada. The terms of the Lease Agreement will also provide that the rights in the Film to be granted to CanCo-Producer under the Canadian Sublicence (refer to Paragraph19) will survive the termination of the Lease Agreement, and will continue in full force and effect between CanCo-Producer and the Film Partnership with the result that the rights granted to CanCo-Producer under the Canadian Sublicence will remain validly in existence for the term of the copyright of the Film (unless the Film is sold as explained in Paragraph18).

18. 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 Payment"). The Lease Payments will be on account of rights to distribute and exploit the Film outside of Canada and will be the sole responsibility of the UK Co-Producer.

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

(iii) The UK Co-Producer will be appointed the exclusive agent of the Film Partnership, subject to CanCo-Producer's rights and obligations under the Co-Production Agreement, the Sales Agency Agreement and the Collection 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 in effect allow the co-producers the option, at the end of the initial lease period, either to dispose of the Film to a third party or to continue the commercial exploitation of the Film. In the event of such a sale, the total revenues derived from the sale, including but not limited to the proceeds of disposition, would be allocated between CanCo-Producer and UK Co-Producer in the same percentage as their respective contributions to the production of the Film.

19. Immediately after the granting of the lease from the Film Partnership to the UK Co-Producer, as described in Paragraphs 17 and 18, UK Co-Producer will enter into the Canadian Sublicence Agreement with CanCo-Producer to licence to CanCo-Producer the same rights licenced by CanCo-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 Paragraph17, the Canadian Sublicence will survive the termination of the Lease Agreement, with the result that the rights granted to CanCo-Producer under the Canadian Sublicence will remain validly in existence for the length of the copyright of the Film.

20. The Film Partnership will claim a deduction under the tax laws of the United Kingdom for 100% of the amount of the Rights Payment paid to acquire the master negative for the Film 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 16) 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 Film by taking advantage of provisions of U.K.'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 CanCo-Producer to the UK Co-Producer will not be considered a disposition of the copyright in the Film by CanCo-Producer for the purposes of section 125.4 of the Act.

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 Film 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 CanCo-Producer under subsection 125.4(3).

COMMENTS

These rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R4, dated January 29, 2001 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) any income tax consequences of the Sales Agency Agreement, the Collection Agreement or the distribution agreement with Fco, referred to in Paragraph 8, and

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

Nothing in this letter should be construed as implying whether or not any of the transactions entered into by CanCo-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 Film production costs, and, in particular, nothing in this letter should be construed as implying that CanCo-Producer or the UK Co-Producer has entered into a sale-leaseback transaction with respect to any interest it may have in the Film.

Yours truly,

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

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