9 July 1998 External T.I. 9817185 - TVC INSURANCE AND INVESTOR RULES

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 Department.

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

Principal Issues:

1. Would subsection 125.4(4) of the Act apply to deny a producer’s claim for the Canadian film or video production tax credit solely because of a loan from a Canadian lender to the Canadian producer in respect of a particular production?

2. Would subsection 125.4(4) of the Act apply to deny a producer’s claim for the Canadian film or video production tax credit solely because the producer acquires what is referred to as time variable contingent insurance (“TVC insurance”) from an arm’s length non-resident insurer that is not taxable in Canada? The insurer receives a fee for guaranteeing the producer’s loan with the lender. The insurer guarantees to pay the lender if the producer defaults on the loan. The insurer would then have full recourse to the producer to collect the amount of any payment made by the insurer to the lender.

3. Would TVC insurance be assistance with a resulting grind to the maximum amount of a producer’s Canadian film or video production tax credit?

PositionS:

1.(a) Where a bona fide loan arrangement exists, that fact alone would not preclude the Canadian producer from qualifying for the Canadian film or video production tax credit in respect of that production.

1.(b) Where the facts indicate that the producer has also transferred an equity interest in the production to the Canadian lender, this will result in the producer being ineligible for the credit in respect of that production (unless the lender is a prescribed person, as defined in proposed subsection 1106(7) of the Regulations, or the lender is actively engaged on a regular, continuous and substantial basis in a business carried on through a permanent establishment in Canada that is a Canadian film or video production business). Such a disposition and acquisition of an equity interest would occur where, for example, the lender’s compensation for the loan includes all of the following: (a) participation payments computed as a percentage of profits from the production, (b) no maximum amount to the participation payments, and (c) clearly no connection between the estimated participation payments and a fair market value interest rate.

2.(a) Acquiring TVC insurance from the insurer will not, in and of itself, result in the application of subsection 125.4(4) to deny the Canadian film or video production tax credit to the producer.

2.(b) In a TVC arrangement, where a 3rd party (the “broker”) receives a percentage share in the net profits of the production, as partial consideration for its services of putting the arrangement together, it is a question of fact whether the broker has acquired an equity interest in the production. If so, it will result in a reduction or elimination of the producer’s available Canadian film or video production tax credit.

3. Not in this scenario where (a) the insurer becomes subrogated to all the rights and remedies of the lender in respect of the defaulted loan, and (b) the insurer does not intend to forgive the obligation.

Reasons:

1.(a) The lender would be an investor, but instead of it possibly being able to deduct an amount in respect of the production, as required for subsection 125.4(4) of the Act to apply, we would view it as being able to deduct an amount in respect of the loan.

1.(b) The lender is an investor, and because of their equity interest in the production they may be able to deduct an amount in respect of the production (for example, bad debt), at some point in time, as required for subsection 125.4(4) of the Act to apply.

2.(a) The TVC insurer is an investor, but since they are not subject to tax in Canada, for Canadian tax purposes they would not be able to deduct an amount in respect of the production, as is required for subsection 125.4(4) of the Act to apply.

2.(b) The broker is an investor, and if they acquire an equity interest in the production they may be able to deduct an amount in respect of the production (for example, bad debt), at some point in time, as required for subsection 125.4(4) of the Act to apply. This involves a question of fact.

3. The conditions in paragraph 12(1)(x) are not met.

981718
XXXXXXXXXX Allan Nelson
(613) 957-9768

Attention: XXXXXXXXXX

July 9, 1998

Dear Sirs:

Re: Canadian film or video production tax credit

This is in reply to our telephone conversations (Nelson/XXXXXXXXXX on June 23 & 25, 1998 and XXXXXXXXXX/Nelson on July 2, 1998) and your letter dated July 2, 1998, wherein you requested our opinions concerning the application of section 125.4 and paragraph 12(1)(x) of the Income Tax Act (Canada) (the “Act”).

Reference is made to what you describe as a common film financing arrangement, where a Canadian film producer finances part of its film production with a commercial loan (the “Loan”) from a Canadian lender. The Loan will be for a two year term with a fair market value interest rate. The lenders will require the producer to obtain time variable contingent (“TVC”) insurance in an amount equal to the principal amount of the Loan. The producer will purchase the TVC insurance from an arm’s length, non-resident insurer that is not taxable in Canada. The producer pays the insurer a fee for guaranteeing the Loan. If the principal amount of the Loan is not repaid out of the normal revenues from the exploitation of the film at the end of the two year repayment period, the lender will make a claim against the TVC insurer to recover the outstanding balance of the Loan. The insurer will then be subrogated in the rights of the lender under the Loan to the extent that it is required to pay any amount to the lender under the TVC insurance policy. For greater certainty, in the event of such a claim against it, the TVC insurer would then have full recourse to the producer to collect the amount of any payment made by the insurer to the lender, and the insurer does not intend to forgive the obligation.

Your Queries

1. Would subsection 125.4(4) of the Act apply to deny the producer’s claim for the Canadian film or video production tax credit solely because of the Loan?

2. Would subsection 125.4(4) of the Act apply to deny the producer’s claim for the Canadian film or video production tax credit solely because the producer acquires the TVC insurance?

3. Would the TVC insurance be assistance, for the purposes of paragraph 12(1)(x) of the Act, with a resulting grind to the maximum amount of the producer’s Canadian film or video production tax credit?

Rulings’ Comments

Your questions appear to relate to a specific factual situation. As noted in Information Circular 70-6R3, we do not provide opinions with respect to proposed factual transactions other than in reply to an advance income tax ruling request. However, we will offer the following general comments that we hope will be of assistance to you. Please note that our views expressed below may change after reviewing all the relevant documents in any particular arrangement.

1. Where a bona fide loan arrangement exists, that fact alone would not preclude a Canadian producer from qualifying for the Canadian film or video production tax credit in respect of that production. The lender would be an investor, as defined in subsection 125.4(1) of the Act. However, instead of it possibly being able to deduct an amount in respect of the production, as required for subsection 125.4(4) of the Act to apply, it would be viewed as being able to deduct an amount in respect of the loan.

Where the facts indicate that the producer has also transferred an equity interest in the production to the Canadian lender, subsection 125.4(4) of the Act will apply, making the producer ineligible for the Canadian film or video production tax credit in respect of that production (unless the lender is a prescribed person, as defined in proposed subsection 1106(7) of the Regulations, or the lender is actively engaged on a regular, continuous and substantial basis in a business carried on through a permanent establishment in Canada that is a Canadian film or video production business). In such an instance, the lender’s equity interest in the production would provide them with the possibility of being able to deduct an amount in respect of the production (for example, C.C.A. or a bad debt deduction), as is required for subsection 125.4(4) of the Act to apply.

Such a disposition and acquisition of an equity interest would occur where, for example, the lender’s compensation for the loan includes all of the following:

(a) participation payments computed as a percentage of profits from the production; (b) no maximum amount to the participation payments; and (c) clearly no connection between the estimated participation payments and a fair market value interest rate.

2. Acquiring TVC insurance from an insurer, such as is described above, will not, in and of itself, result in the application of subsection 125.4(4) of the Act to deny the Canadian film or video production tax credit to the producer. The TVC insurer would be an investor, but since they are not subject to tax in Canada, for Canadian tax purposes they would not be able to deduct an amount in respect of the production, as is required for subsection 125.4(4) of the Act to apply.

In a TVC arrangement, where a 3rd party (the “broker”) receives a percentage share in the net profits of the production, as partial consideration for its services of putting the arrangement together, it is a question of fact whether the broker has acquired an equity interest in the production. If so, it will result in a reduction or elimination of the producer’s available Canadian film or video production tax credit. The broker will be an investor, and if they acquire an equity interest in the production they may be able to deduct an amount in respect of the production (for example, bad debt), at some point in time, as required for subsection 125.4(4) of the Act to apply. This involves a question of fact.

3. The acquisition of TVC insurance, as described above, will not be assistance, for the purposes of paragraph 12(1)(x) of the Act. As stated earlier, our views may change, depending on the actual terms of any particular TVC insurance arrangement.

As discussed during our telephone conversations on June 25, and July 2, 1998, we have also enclosed a copy of our directorate’s draft guidelines for determining the impact that some of the most common film financing arrangements would have on a producer’s eligibility for the Canadian film or video production tax credit. Please feel free to make any submissions on this topic that you wish to have considered before we finalize our positions.

In accordance with paragraph 22 of Information Circular 70-6R3, the above comments are only general expressions of opinion on the application of the Income Tax Act to hypothetical situations, and as such should not be construed as advance income tax rulings, nor are they binding on the Department.

Yours truly,

Manager
Partnerships Section
Resources, Partnerships and
Trusts Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch
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