2001 Ruling 2001-007262C - FILM PARTNERSHIP/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 Department.

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

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.

XXXXXXXXXX 2001-007262

XXXXXXXXXX, 2001

Dear XXXXXXXXXX:

Re: XXXXXXXXXX
Advance Income Tax Ruling Request

This is in reply to your letter dated XXXXXXXXXX and our numerous telephone conversations (XXXXXXXXXX) wherein you requested advance income tax rulings on behalf of the proposed treaty co-production transactions, as described herein.

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 License" means the license agreement entered into by CanCo-Producer and

UK Co-Producer, as described in Paragraph 13;

"Canadian Sublicense" means the sublicense agreement entered into by UK Co-Producer and CanCo-Producer, as described in Paragraph 20;

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

"Co-Production Agreement" means the co-production agreement referred to in Paragraph 7;

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

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

"Dco Leasing" means the joint venture between Eco and Fco, as described in Paragraph 4;

"Eco" means XXXXXXXXXX, as described in Paragraph 4;

"Fco" means XXXXXXXXXX, as described in Paragraph 4;

"Film Partnership" means the general partnership, as described in Paragraph 6;

"Lease Agreement" means the lease agreement entered into by the Film Partnership and UK Co-Producer, as described in Paragraph 18;

"License Agreement" means the license agreement entered into by UK Co-Producer and the Film Partnership, as described in Paragraph 15;

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

"Parentco" means XXXXXXXXXX, as described in Paragraph 1;

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

"Series" means the XXXXXXXXXX;

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

"Wco" means XXXXXXXXXX;

"Xco" means XXXXXXXXXX;

"Yco" means XXXXXXXXXX; and

"Zco" means XXXXXXXXXX.

FACTS

1. CanCo-Producer is a taxable Canadian corporation, within the meaning of subsection 89(1). It is a wholly-owned subsidiary of Xco. Xco is a wholly-owned subsidiary of Parentco. Yco and Zco own XXXXXXXXXX% and XXXXXXXXXX%, respectively of Parentco. Yco is a subsidiary of XXXXXXXXXX owns all of the shares of Zco. 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. 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 . CanCo-Producer's business number 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 in the future, to deduct any amount in respect of the Series (referred to in Paragraph 7) 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

XXXXXXXXX.

4. Dco Leasing is a joint venture between Eco, a corporation incorporated and existing under the laws of XXXXXXXXXX, and Fco, a corporation incorporated and existing under the laws of the United Kingdom. Dco Leasing's principal place of business is situated at XXXXXXXXXX.

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. Dco Leasing will form the Film Partnership under the laws of XXXXXXXXXX. The agent and 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 residents of Canada. The Film Partnership will not be a Canadian partnership as defined in section 102 and the Film Partnership 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 in the future 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.

7. CanCo-Producer and UK Co-Producer have entered into the Co-Production Agreement under 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. Prior to entering into the Co-Production Agreement, CanCo-Producer and UK Co-Producer operate at arm's length with each other and, with respect to the Series, they will be operating as a joint venture and not as a partnership.

8. For the purposes of section 125.4, the Series will be a "treaty co-production" and a "Canadian film or video production". CanCo-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.

9. The aggregate costs for producing the Series will be approximately CND $XXXXXXXXXX. CanCo-Producer will be responsible to pay XXXXXXXXXX% of these total production costs (i.e., approximately CDN $XXXXXXXXXX). CanCo-Producer will finance its share of the production costs mainly from federal and Quebec film tax credits, funding from Telefilm Canada under the Canadian Television Fund [Equity Investment Program and License Fee Program], as well as revenues from pre-sales of Canadian and international distribution rights.

10. The Co-Production Agreement provides that CanCo-Producer shall have the exclusive distribution and exploitation rights to the Series in Canada and UK Co-Producer 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 CanCo-Producer or its affiliated distribution company, Wco, and the revenues earned shall be allocated to CanCo-Producer and the UK Co-Producer in the same percentage as their respective contributions to the financing of the Series.

11. The Co-Production Agreement provides that the UK Co-Producer shall provide financial contributions of approximately CDN $XXXXXXXXXX, which will be funded partly by the UK Sale Leaseback transaction 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.

12. 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.

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 co-production and 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.

13. CanCo-Producer will enter into the Canadian License with UK Co-Producer. Under the terms of the Canadian License, CanCo-Producer will grant to UK Co-Producer a license of its rights, as a co-owner, to copy, rent, license, exhibit, distribute, re-issue, turn to account, derive revenue from and otherwise deal in or with the Series throughout the world, excluding Canada. The term of the Canadian License will be for a period equal to the length of the copyright of the Series. CanCo-Producer will retain (i) ownership of the duplicate copy of the master negative, (ii) ownership of its interest in the underlying copyright to the Series, and (iii) its interest in the right to exploit the Series in Canada. The consideration for the granting of the Canadian License 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.

14. Under the terms of the Purchase Agreement, UK Co-Producer will sell its master negative 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 negative shall vest in the Film Partnership. The closing date is expected to be XXXXXXXXXX. CanCo-Producer will not be a party to the Purchase Agreement.

15. UK Co-Producer will also enter into the License Agreement with the Film Partnership, whereby the UK Co-Producer will grant to the Film Partnership the sole and exclusive right to copy, rent, license, exhibit, distribute, re-issue, turn to account, derive revenue from and otherwise deal in or with the Series throughout the world, excluding Canada. For greater certainty, under the License Agreement the UK Co-Producer will, inter alia, grant to the Film Partnership the rights the UK Co- Producer acquired under the Canadian License referred to in Paragraph 13. The term of the License Agreement will be for a period equal to the length of the copyright of the Series. UK Co-Producer and CanCo-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. CanCo-Producer will not be a party to the License Agreement.

16. The Film Partnership will pay in total approximately CDN $XXXXXXXXXX (the "Rights Payment") to the UK Co-Producer for the rights acquired by the Film Partnership under the Purchase Agreement and the License Agreement.

17. 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 19(i).

18. Immediately after the sale of the master negative under the Purchase Agreement and the execution of the License 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 negative acquired under the Purchase Agreement and license all of the Film Partnership's rights in the Series acquired under the License Agreement for a period of XXXXXXXXXX years. The Lease Agreement will provide that the UK Co-Producer will have the general right to license, distribute, advertise and exploit the Series worldwide, except in Canada. The terms of the Lease Agreement will also provide that the rights in the Series to be granted to CanCo-Producer under the Canadian Sublicense (refer to Paragraph 20) will survive the termination of the Lease Agreement, with the result that the rights granted to CanCo-Producer under the Canadian Sublicense will remain validly in existence for the term of the copyright of the Series.

19. 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 increase by XXXXXXXXXX% a year with one additional rental being paid in XXXXXXXXXX. The total of the Lease Payments over XXXXXXXXXX years will approximate the amount of the Rights Payment plus a fair market value interest factor. 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.

(ii) In addition to the Lease Payments, the UK Co-Producer will also pay 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 (pursuant to CanCo-Producer's rights and obligations under the Co-Production Agreement [e.g., refer to Paragraph 10 which indicates that under the Co-Production Agreement, CanCo-Producer is responsible for most of the distribution and exploitation of the Series], CanCo-Producer will in fact act as exclusive agent of the Film Partnership) and will be authorized at any time after the term of the Lease Agreement to sell all of the Film Partnership's right, title and interest in the Series (including, but not limited to, the master negative and its rights granted under the License Agreement, but subject to the rights granted in the Canadian Sublicense) to a third party and the UK Co-Producer will be entitled to receive XXXXXXXXXX% of the net proceeds of such sale. In the event of such a sale, the terms of the Co-Production Agreement would apply to the total revenues derived from the sale and consequently, the portions payable to CanCo-Producer and UK Co-Producer would be XXXXXXXXXX% and XXXXXXXXXX%, respectively.

(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 License Agreement, to renew the term of the Lease Agreement for one or more years. The annual rental amount will be £XXXXXXXXXX . Pursuant to CanCo-Producer's rights and obligations under the Co-Production Agreement, CanCo-Producer will in fact be responsible for the decisions concerning Lease Agreement renewals.

These provisions will in effect allow CanCo-Producer the option, at the end of the initial lease period, either to dispose of the Series to a third party or to continue the commercial exploitation of the Series themselves.

20. Immediately after the granting of the lease by the Film Partnership to the UK Co-Producer, as described in Paragraph 18 and 19, UK Co-Producer will enter into the Canadian Sublicense with CanCo-Producer to license to CanCo-Producer the same rights licensed by CanCo-Producer to UK Co-Producer under the Canadian License, on the same terms and conditions. The date of payment and the consideration payable to the UK Co-Producer under the Canadian Sublicense will be the same as provided for in the Canadian License and these monetary obligations will be extinguished by way of set-off at the end of XXXXXXXXXX years. The Canadian Sublicense will survive the termination of the Lease Agreement, with the result that the rights granted to CanCo-Producer under the Canadian Sublicense will remain validly in existence for the length of the copyright of the Series.

21. 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 Series and the rights under the License 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 17) will apply to reduce the UK Co-Producer's costs of production of the Series 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 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 granting of the rights under the Canadian License by the CanCo-Producer to the UK Co-Producer will not be considered a disposition of the copyright in the Series by the CanCo-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 the CanCo-Producer 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;

(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; and

(iv) except as expressly stated above in Rulings A. and B., the entitlement of CanCo-Producer 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 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 $XXXXXXXXXX Series production costs, and, in particular, nothing in this letter should be construed as implying that CanCo-Producer has entered into a sale-leaseback transaction with respect to its interest in the Series.

Yours truly,

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