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.
J.F. Oulton Tel. 995-1787
November 3, 1983
XXXX
This is in reply to your letter dated September 29, 1983 wherein you requested our review of seven different scenarios in relation to the revenue guarantee provisions for certified productions under the Income Tax Regulation (the Regulations). These scenarios each describe a type of arm's length agreement between a producer of a film and a distributor/broadcaster (the distributor) in connection with the distribution thereof. These are the aspects which we will specifically discuss in regard to these scenarios:
(1) General comments applicable to all scenarios.
(2) Specific comments on the scenarios and in particular whether or not
(a) there is a revenue guarantee in these distribution
agreements within the meaning of paragraph
1104(10)(c.1) of the Regulations;
and where the answer to (a) is positive (Scenarios 2 to 4, 6 and 7)
(b) Whether there will be a reduction in an investor's
capital cost allowance (CCA) claim pursuant to
paragraph 1100(21)(b) of the Regulations as a result
of the distribution agreement being entered into.
Of particular concern to you in this regard, is our interpretation of the phrase "whereby it may reasonably be considered certain, having regarding to all the circumstances", in paragraph 1100(21) (b) of the Regulations, in light of the conditions which a producer must fulfill prior to a final commitment for distribution being obtained from the distributor.
Before dealing with the specific scenarios, we emphasize the following:
(i) The revenue guarantee definition in the
Regulations refers to "a contract or other
arrangement". Our comments will be based on the
assumption that there are no relevant
arrangements, written, verbal or tacit, other than
as described in the scenarios. (ii) Our comments are based on the presumption that the
scenarios reflect bona fide business arrangements
and thus are not shams or artificial transactions
without any real business purposes. (iii) Whether or not "it may reasonably be considered
certain, having regard to all the circumstances"
is a question of fact in each case so that our
review of an investor's CCA claim is not limited
to the terms of a particular distribution
agreement. For example, an investor may have
reasonable certainty of receiving revenue as a
result of a verbal commitment from the distributor
and/or producer. Therefore each actual case will
be judged on its own merits based on the specific
fact situations. (iv) It is presumed that the distributor has not
accepted the final product nor has the
distribution agreement been fully consumated at
any time before the later of (a) the date the principal photography of the film
is completed, and (b) the date the investor acquired his interest in
the film, so that there remains a reasonable risk at such
later time that an investor will receive a fixed
or minimum amount of revenue under the agreement.
Comments on the Scenarios
(A) General
(1) Under each of scenarios 2 to 7 the distribution
rights are licensed. This may encompass a particular
number of showings in a particular media,
geographical area and/or for a particular time.
Generally, this is not offensive, since the investor
will "own" those rights even though they will be
licensed to a distributor if the conditions of the
agreement are fulfilled. This will be known to the
investor when he buys in. However, the comments in
paragraph 4 of IT-441
must always be borne in mind. (2) Under item 2 of each of scenarios 1 through 6 and
item 3 of scenario 7 the final product produced is
subject to the fulfillment of a number of conditions
by the producer and to the requirements of the
distributor being satisfied. It is our opinion that
these are typical examples of conditions which, in
and by themselves, would create doubts such that it
may not reasonably be considered certain that the
investor will get revenue under the contract.
Generally the reason is that such contractual
conditions will leave a reasonable degree of risk or
uncertainty that the conditions can, in fact, be
fulfilled. This aspect was emphasized in the second
paragraph of your News Release of October 26, 1983
and of particular significance is the fact that ". .
each situation will be of necessity judged on its
own merits". (3) In each of the scenarios, the distributor is granted
the rights to monitor the production process, to act
as an observer or as a consultant, without any right
of veto. This provision does not in any way compel
the distributor to accept the finished product. As a
matter of fact, the contract will be entirely
dependent on acceptance of the finished product by
the distributor. It is our opinion that the inherent
risk will still be intact notwithstanding that the
monitoring, observing and consulting rights have
been granted to the distributor. The above interpretation is correctly reflected in
the second paragraph of page 2 of the News Release. (4) In each of the scenarios, it is contemplated that an
investor may acquire his interest at various times
e.g. either at the third production stage, at the
fourth, fifth or sixth of the eight production
stages. This will generally not be a concern
provided the inherent risk is still in place at the
later of the date on which principal photography is
completed and the date in which the investor
acquires his interest. However, investing towards
the end of the production may reduce some of the
risks in some cases. Consequently, caution should be
exercised since in a particular situation, we can
perceive that the risk may be reduced to the point
where it may reasonably be considered certain that
the investor will get revenue. (5) Each of the scenarios contains an item which states
that "it is evident ... that the producer will need
the funds from the licence for the
broadcasting/distribution rights to cover part of
his production costs". It is our opinion that this
aspect, in and by itself, is not sufficiently
offensive to reduce the overall risk to an investor.
The producer may feel compelled to do his work to
please the distributor or the agreement wouldn't
have been entered into, but there is still a
reasonable degree of risk or uncertainty present in
the agreement. Notwithstanding that risk is not necessarily
reduced, however, we fail to see the significance of
this aspect in all of the scenarios. For example, in
scenarios 2 and 7, the distributor does not start to
pay until the final product is accepted so that the
arrangement provides no financial assistance
throughout the production when the producer will
need the money.
(B) Specific
The following 2 scenarios do not constitute revenue guarantees as defined in paragraph 1104(10)(c.1) of the Regulations:
Scenario 1.
This scenario grants the distributor a first option
to obtain a licence for the distribution rights. The
granting of a bona fide option by its very nature is
not sufficient to conclude that a licencing
arrangement will in fact be entered into even if the
conditions are fulfilled. If the distributor is
happy with the film, he has the first right to enter
into an agreement to distribute the product. Scenario 5.
There will not be a revenue guarantee until the
parameters on which the amount to be paid will be
based, are established.
The above interpretations of Scenarios 1 and 5 are correctly reflected in the first paragraph of page 2 of the News Release.
In the discussion of the scenarios that follows, there is a revenue guarantee by definition in each one.
Scenario 2.
All significant comments on this scenario are
covered by the general comments above. Scenario 3.
In addition to the right to monitor or supervise the
production, the distributor has a right to examine
certain specified financial data under item 4. This
aspect does not change the above general views
expressed as to the right to monitor or supervise. Under item 5, the distributor will advance money
with a right to reimbursement and also reserves the
right not to require reimbursement in which case he
automatically becomes an investor. It is our view
that this provides financial protection to the
distributor in respect of the advances, but does not
in and by itself, otherwise reduce the inherent risk
in respect of the revenue guarantee. Furthermore it
is presumed that to the extent investors have
participated that their "ownership" rights will not
be otherwise affected should the distributor also
become an investor. Scenario 4.
Item 6 of this scenario is much like that of item 5
of Scenario 3 since each provide for repayable
advances or conversion of the advances into an
equity in the film. This feature does not reduce the
risk in respect of the revenue guarantee, but where
the producer has pledged all of the ownership rights
as security, a concern may arise as to whether or
not other investors will "own" interests in the film
for CCA purposes.
The above interpretation of Scenarios 3 and 4 is correctly reflected in the third paragraph of page 2 of the News Release.
Scenarios 6 and 7
In light of the other conditions discussed above, it
is our opinion that an investment of money and/or
technical services and goods should not reduce the
inherent risk in respect of the revenue guarantee.
If, however, it may be construed through such
investing that the distributor is also a co-
producer, then the comments we made on page 3 of our
letter of June 14 to Mr. Goura will still apply. The
fact that the distributor has a right to withdraw at
any time, probably enhances an investor's risk.
As discussed, we were alarmed with the impression given in the October 27 Globe & Mail article by Dan Westell entitled: "Fox offers new tax changes to lure broadcast investment". It is emphasized that there are no new tax changes with respect to revenue guarantees and furthermore as you know, there is not "a major new interpretation of the rules". The rules have not changed nor has their interpretation. The development of these scenarios is only to be viewed as an effort to fit within the law as it reads. The implication in that article is that there no longer need be as much risk, which is completely fallacious.
We return herewith the document defining quality standards in force at XXXX
ORIGINAL SIGNED BY ORIGINAL SIGNÉ PAR
D.B. MORPHY
for Director Specialty Corporations Rulings Division Corporate Rulings Directorate Legislation Branch
Attachments
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