29 August 1994 GST/HST Interpretation 1994-08-29[2] - Allowances Paid to Self-employed Staff

This is further to your memorandum of December 17, 1993 to XXXXX at Headquarters, requesting a technical review of two contentious issues related to an audit performed on a GST registrant, XXXXX, in connection with the production of XXXXX[.] Reference is also made to telephone conversations between yourself and Mr. Gunar Ozols of this office.

It is our understanding that the issue of input tax credits claimed by XXXXX on per diem allowances paid to self-employed staff has been resolved. We have no further comment on that issue.

You submitted copies of various audit memorandums and audit reports arising out of the audit, copies of correspondence from XXXXX to the Department as well as to other parties, and copies of numerous contracts between XXXXX and various third parties. Based on the memorandums and audit documents (and ignoring for the moment the contracts), we understand your view of the situation to be as follows:

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7. During the course of the audit, it was determined that GST was neither collected nor remitted on XXXXX of the XXXXX of funds received through private investment. It is your position that these funds represent consideration for the sale of rights by XXXXX to exploit the completed film produced by the co-producers.

8. XXXXX position is that GST on XXXXX of the XXXXX has been remitted by XXXXX or its parent company. However, you have determined that GST has not been remitted by any party. Your proposed assessment of XXXXX is 7/107ths of XXXXX[.]

XXXXX also contends that although it is a party to the funding contracts that give rise to the GST, it is not selling anything. It is merely the person co-producing the film with XXXXX Title to the film never rested with XXXXX and could therefore never give rise to a taxable sale. The parent of XXXXX holds the distribution rights and proceeds from the sale of distribution rights flowed through to XXXXX as an advance guarantee.

9. Your rationale for assessing XXXXX is that, given it claims all input tax credits associated with the film production, it should collect and remit all the GST associated with the supply of the completed film production. The co-producers jointly own or control all rights to the film production under common law. The funds received from XXXXX represent consideration for the sale of rights to the exploitation of the completed film and it therefore a taxable supply.

The ownership of a film is largely represented by the copyright. The law of copyright in Canada is governed by the Copyright Act. The owner of a copyright is the author of the work and, although not specifically provided for, the Copyright Act implies that a work may have joint authorship. Thus, in the absence of any evidence to the contrary, the co-producers of a film would have equal and joint ownership of the film and associated rights as represented in the copyright.

However, the documentation submitted with your referral, particularly the various contractual arrangements, are not consistent with your description, as outlined in paragraphs 1 to 9 above, of the transactions undertaken XXXXX and various third parties. Part of the difficulty may be that the documents are not all consistent with each other. Other documents are not entirely clear in their result.

On the question of the ownership of the film, and therefore the supplier of the distribution rights and license to the film, we do not have a copy of any contract between XXXXX and XXXXX[.] You indicated that you did not have such a contract and did not know whether one exists. However, there is a letter of agreement, dated sometime in September, 1991, between XXXXX which sets out the terms and conditions for the production of XXXXX. XXXXX is a party to the agreement on behalf of a corporation to be constituted. This proposed corporation would appear to be XXXXX and we have substituted XXXXX. However, it should be verified that in fact this is the case, particularly if there is no other agreement between XXXXX[.]

Pursuant to article 9(a) of the letter of agreement, XXXXX owns 100 per cent of the copyright, subject to grants of partial ownership to other equity investors, such as XXXXX etc. Article 9(b) provides that XXXXX will grant to XXXXX an undivided 50 per cent copyright interest in any copyright interest remaining with XXXXX after the grants of copyright interest to the parties named in article 9(a). Thus, it would appear that, notwithstanding the Copyright Act, XXXXX copyright interest in the film arises not from its co-production of the film, but as a grant from XXXXX[.]

A distribution right or a license, such as those granted to XXXXX is not a grant of a copyright interest. The granting of these rights are supplies by the copyright owners, that is, XXXXX[.] The other equity investors can be ignored for purposes of the distribution and licensing agreements because, first, they are not parties to those agreements and second, the equity investors have "re-assigned" their distribution rights back to XXXXX (see for example, article 4.03 of the Telefilm Agreement and article 6.1 of the OFDC Agreement). Furthermore, the licensing agreement with the XXXXX (wherein XXXXX acquires its license to broadcast The XXXXX from XXXXX states that XXXXX has acquired its distribution rights from the XXXXX[.] The agreement defines the "producer" as XXXXX and XXXXX[.]

Based on the above, it would appear that XXXXX did in fact make a supply of its share of the distribution rights to XXXXX[.] However, the documentation provided raises questions as to the exact nature of the various arrangements. There is no document granting distribution rights to XXXXX from XXXXX[.] There is a Distribution Agreement dated February 5, 1992 between XXXXX. This agreement grants the distribution rights to XXXXX from XXXXX. There is an amended Distribution Agreement between XXXXX and XXXXX which provides that the copyright notice shall be in the name of XXXXX[.] How did XXXXX acquire the copyright to the film? Did it acquire the copyright from XXXXX and XXXXX, or did XXXXX and XXXXX form a partnership to produce the film? The existence of the agreement between XXXXX and XXXXX is acknowledged in some, but not all, of the other agreements.

It is interesting to note that there is a Consent attached to the loan agreement between XXXXX and XXXXX[.] The Consent refers to a "Partnership Purchase Agreement" between XXXXX and XXXXX (different from the Distribution Agreement between XXXXX and XXXXX and also refers to "the transfer of Rights, as defined in the Partnership Agreement, from XXXXX to XXXXX.

We note that the Distribution Agreement states that XXXXX is a limited partnership formed under the laws of XXXXX[.] If in fact the distribution rights were sold to XXXXX which then sold them to XXXXX it is important that the residency status of XXXXX be determined.

The Distribution Agreement is also ignored in the response by XXXXX dated July 5, 1993, to the preliminary Statement of Audit Adjustments. In this letter, XXXXX states that XXXXX acquired its rights to XXXXX from XXXXX[.]

Based on the contradictory evidence presented by the documentation submitted, it is not possible to say with certainty who supplied XXXXX with the distribution rights. However, it would seem likely that even if XXXXX received the distribution rights from XXXXX would previously have received those rights from XXXXX and XXXXX[.] The remainder of this memorandum assumes that XXXXX did supply its interest in the distribution rights to someone, even if not directly to XXXXX.

Part of the rationale for the assessment for unremitted GST against XXXXX is that it was responsible for accounting for the revenues and expenses of the film production and claimed all input tax credits associated with the production of XXXXX. This by itself is not sufficient to support the assessment. It must be established that XXXXX made a supply for which GST was not remitted. You have taken the position that XXXXX did indeed make a supply of the distribution rights. However, our concern is that we do not have sufficient documentation to establish that this is in fact the case. As we noted above, there is the letter of agreement between XXXXX and XXXXX which provides that XXXXX (i.e., XXXXX) was to receive a 50 per cent copyright interest in the film after certain other parties purchased equity investments. However, documentation of the "chain of title" to the distribution rights is not complete, in that we have no documentation showing how XXXXX received those rights which it sold to XXXXX.

Our other concern is that if XXXXX did make a supply of distribution rights to someone, it would only be to the extent of their ownership interest as co-producer. In other words, XXXXX would also have made a supply of its share of the distribution rights. The result is that both XXXXX and XXXXX are the suppliers of distribution rights and XXXXX could argue that it is responsible only for the GST on its portion of the sale of those rights. Even if XXXXX claimed all the input tax credits on the production of the film, it would be entitled to do so if it was in fact the recipient, as defined in subsection 123(1), of those inputs.

The Department has a policy entitled "Tax Liability of Purchases and Supplies Made by a Joint Venture Participant on behalf of Non-Electing Joint Venture Participants", Policy Number P-139. It provides that the correct tax treatment in situations dealing with joint ventures where the joint venture election has not been made will depend on whether the "operator" of the joint venture is an agent of the other joint venture participants. There is some similarity between the co-production of the film and a joint venture. However, it is doubtful the policy should apply in this case. It does not appear that there was the intent to create a joint venture, even though XXXXX was responsible for accounting for the expenses and revenues of the production. A joint venture is an arrangement whereby two or more persons work together in a limited and defined business undertaking, which does not constitute a partnership, a trust or a corporation, the expenses and revenues of which will be distributed in mutually agreed portions. The requirement that the expenses be distributed in mutually agreed portions is frequently satisfied by each of the participants in the joint venture agreeing to reimburse the participant who incurs the joint venture expense for a specified percentage of the expense. Furthermore, the participants in a joint venture normally have a joint interest in the product of the joint venture. Therefore, the participants frequently authorize one participant to sell all of the joint venture product and to distribute the sales revenue to the other participants based on their interests in the joint venture product as determined by the agreement.

In this case, it does not appear that either party could be said to have "reimbursed" the other for expenses. Rather, funding flowed directly to XXXXX as per the various agreements entered into between XXXXX and the various third parties. Nor could XXXXX be said to have sold the distribution rights on behalf of XXXXX since XXXXX was a party to the sale of those rights.

However, even if the policy does not apply directly to this case, it does provide some guidance as to the correct tax treatment of the sale of distribution rights. First, it is necessary to establish whether XXXXX was acting as agent for XXXXX when it received payment for the sale of the distribution rights. In our view, it was not. As noted earlier, XXXXX appears to have been a party to the contracts which sold the distribution rights. The joint venture policy states that

"Where, however, an agency relationship does not exist when the non-electing participant's share of the joint venture product is sold the non-electing participant would be considered to be making a supply to the recipient of the product equal to its interest in the product as determined by the joint venture agreement."

This suggests that XXXXX and XXXXX should have remitted GST on the sale of the distribution rights based on the proportion of their interest in the film.

The Department also has a policy on "Remittance of Tax by a Third Party", Policy Number P-131. It provides that the Department will accept third party remittances, for example, where a creditor attorns the rent of a debtor and remits to the Department the GST owing to the debtor. The creditor will report the GST on its account and the debtor will not be required to account for the GST which it otherwise would be required to remit as the supplier.

However, the policy does not address the situation where the third party does not remit the GST, even though it has collected or accounted for the consideration for a supply made by another party. In other words, although XXXXX maintained the bank account in which the funds raised by the sale of the distribution rights were deposited, the policy would not support an assessment against XXXXX for the GST owing on the sale of XXXXX share of the distribution rights.

With respect to input tax credits claimed by XXXXX for all expenses of the film production, the joint venture policy provides as follows:

"Where ... an agency relationship does not exist when these goods and services are acquired [i.e., inputs into the joint venture production], and the participant acquiring the good or service is reimbursed for the purchases, the participant will charge tax."

In other words, if XXXXX is seen as having reimbursed XXXXX for the acquisition of goods and services in the production of the film, XXXXX should collect GST from XXXXX[.] However, as was noted earlier, we do not believe that there was a reimbursement by XXXXX to XXXXX, but rather a flowing of all funds to XXXXX, which operated the bank account out of which goods and services were purchased. Since it appears that XXXXX was the only recipient of these inputs, it was entitled to claim the input tax credits.

Finally, we note that the assessment is for 7/107ths of XXXXX. It is not clear as to why the assessment is on a tax-included basis. Pursuant to Policy Number P-118, Assessments on a Tax-Extra or Tax-Included Basis, it is a question of fact in each situation as to whether the consideration paid included tax. However, there must be evidence, as outlined in the policy, that the consideration did in fact include tax and that a tax-included assessment is appropriate.

In conclusion, our comments can be summarized in the following points:

1. There is a need for further documentation or additional information on how XXXXX acquired its ownership share of the film and exactly to whom the distribution rights were sold, given the terms of the letter of agreement between XXXXX and XXXXX and the existence of the Distribution Agreement between XXXXX and XXXXX[.] The residency status of XXXXX may be relevant, and

2. Even if it can be established with certainty that XXXXX did supply a share of the distribution rights, it is likely that XXXXX also made a supply of its share of the distribution rights and that XXXXXcannot be assessed for the GST that is owing on XXXXX share of the sale of the distribution rights.

If you have any further questions, please contact Gunar Ozols at (613) 952-9589.

H.L. Jones
Director
General Tax Policy
Policy and Legislation

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