Consulting on tax relief for animation, high-end television and video games - International Law Office

Rationale
Proposed reliefs
General principles
Timeframe

Her Majesty's Treasury has issued a consultation paper(1) on the proposed tax reliefs for the video game, animation and high-end television(2) sectors announced in the 2012 Budget. It is hoped that the consultation process will ensure that the reliefs are as beneficial as possible for the games and television industries, and are properly tailored to those industries. The reliefs are intended to take effect from April 2013, subject to state aid approval. This update summarises the proposed reliefs.

Rationale

The underlying rationale for the reliefs is that despite the UK television and interactive entertainment industries having a strong history of producing high-quality and internationally acclaimed animation, high-end television and games, there is evidence that many productions are having to move overseas in order to be commercially viable, or in some cases are not being made at all. In the paper the government acknowledges that this could have a significant adverse effect, both culturally and economically, and is contrary to the government's plans to make the United Kingdom the technology centre of Europe.

The government plans to redress this in the proposed legislation, with the following stated aims:

• to promote the production of culturally relevant UK productions by providing direct tax relief to producers;
• to incentivise investment in productions which could not happen in the United Kingdom without tax relief; and
• to create a critical mass of infrastructure and skills to support UK productions.

In making its proposals for the reliefs, the government has drawn heavily on the structure of the existing film tax relief, which was introduced in the Finance Act 2006 and has widely been seen as a success in the UK film industry. The paper notes that between 2010 and 2011, the film tax relief provided more than £200 million of support to the film industry, across 190 films.

Proposed reliefs

Animation
Proposal
The paper proposes that a similar form of tax relief should apply to television animation to that currently in place for film, which in effect would provide producers with a payable tax credit.(3) The value of the proposed tax relief is to be determined by ministers, but the paper indicates that it should be similar in generosity to the level of the film tax relief. The value of the tax relief would depend on the programme's budget. For example, under the film tax relief rules, the current value of the film tax relief is:

• up to 20% of the UK qualifying expenditure(4) of a film with a core expenditure(5) of up to £20 million; and
• up to 16% of the UK qualifying expenditure of a film with a core expenditure of more than £20 million.

Under the proposals, 'core expenditure' would cover expenditure directly incurred in the production (including pre and post-production) of the programme, but would exclude ancillary expenditure such as the cost of seeking or servicing finance or the cost of advertising the programme.

Criteria for qualification
In order for a programme to qualify for the animation tax relief, the paper proposes that the following criteria be met:

• The programme must be an animated programme. The paper proposes defining 'animation' as "a sequence of images in two or three dimensions created by recording still images or objects one frame at a time with incremental changes in position, form and appearance between frames to create the impression of movement". The paper invites comment from the industry on the suitability of this definition.
• The programme should not fall foul of any of the proposed exclusions. These exclusions include animation produced for advertising, news, weather programmes or game shows, or animation which is pornographic in content. It is also proposed that the relief be limited to productions where expenditure on animation makes up 75% or more of the production costs of that programme (thus excluding many mixed-content programmes).
• The programme must be intended for broadcast. In particular, the government has identified the need to establish a rule to distinguish speculative expenditure that does not result in an end product from early-stage expenditure on a project with an identifiable end product. Accordingly, it suggests that early-stage costs might be eligible for relief only once a programme has been formally commissioned by a broadcaster, or that only costs incurred in producing a programme with the "potential to be broadcast as a finished product" would be eligible for relief.
• The programme must satisfy a cultural test. The government plans to consult separately on the design and administration of the cultural test. The test will be used to award points to the different elements that contribute to the overall cultural value of the production.
• The entity seeking relief must be an incorporated company and must be directly involved in the production of animated programmes. The paper proposes similar criteria for determining this as those applicable to the film tax relief – for example, the company must be responsible for actually producing the content and actively involved in the decision-making process relating to delivering the programme. The paper also acknowledges that there may be co-productions(6) which should qualify for relief; the government wishes to explore this issue during the consultation.
• At least 25% of the core expenditure must relate to goods or services used or consumed in the United Kingdom.

High-end television
Proposal
The paper proposes that a similar form of tax relief should apply to high-end television drama to that currently in place for film. The value of the relief would be the same as for animation.

Criteria for qualification
In order for a programme to qualify for the high-end television tax relief, the paper proposes that the following criteria be met:

• The programme in question must be a high-end television programme:
  • In order to be 'high end', the direct production costs of the programme (excluding ancillary expenditure, such as the cost of raising or servicing finance, the cost of advertising the programme and any grants or public subsidies) would need to be at least £1 million for each hour of running time (excluding commercial breaks) and the programme would need to have a running time of at least 30 minutes.
  • The proposed concept of 'television programme' would cover drama programmes, including comedy programmes, but would exclude advertising, discussion programmes, news or current affairs shows, quiz shows, panel shows and variety shows.
• The programme must be intended for broadcast. In particular, the government has identified the need to establish a rule to distinguish speculative expenditure that does not result in an end product from early-stage expenditure on a project with an identifiable end product. Accordingly, it suggests that early-stage costs might be eligible for relief only once a programme has been formally commissioned by a broadcaster, or that only costs incurred in producing a programme with the "potential to be broadcast as a finished product" would be eligible for relief.
• The programme must satisfy a cultural test. The government plans to consult separately on the design and administration of the cultural test. The test will be used to award points to the different elements that contribute to the overall cultural value of the production.
• The entity seeking relief must be an incorporated company and must be directly involved in the production of television programmes. The paper proposes similar criteria for determining this as those applicable to the film tax relief – for example, the company must be responsible for actually producing the content and actively involved in the decision-making process relating to delivering the programme. The paper also acknowledges that there may be co-productions(7) which should qualify for relief; the government wishes to explore this issue during the consultation.
• At least 25% of the core expenditure must relate to goods or services used or consumed in the United Kingdom.

Video games
Proposal
The paper proposes that a similar form of tax relief should apply to video games as that currently in place for film. The value of the relief would be the same as for animation.

Two alternative models – namely, a model structured on the existing UK research and development tax credit, and the video games tax credit model currently available in France – were also considered. However, the government was of the view that the model proposed above, which is similar to that in place for film, is likely to benefit a wider range of companies within the United Kingdom.

The government has also stated in the paper that it is committed to designing a tax relief that works across all video games business models, including the traditional 'product-based' model (eg, console games sold on a physical media) and the more recent 'service-based' model (eg, casual games played via social networks or on mobile phones).

Criteria for qualification
In order for a video game to qualify for the video games tax relief, the paper proposes that the following criteria be met:

• It must meet the definition of a 'video game':
  • The paper acknowledges that the government will need to establish a definition of 'video games' which is workable in legislation, compliant with state aid guidelines and recognised by the video games industry itself.
  • Although the paper indicates that the government will continue to seek views as to the most appropriate definition, it currently proposes to adopt a similar definition to that currently used in France.(8)
  • The government does not intend to offer relief to video games whose primary purpose is gambling or advertising products, or video games which include pornographic or other material which would be refused an age-rating certificate under the UK video game classification regime.
• The entity seeking relief must be an incorporated company and must be directly involved in the production of the relevant video game. The paper proposes similar criteria for determining this as those applicable to the film tax relief – for example, the company must be responsible for actually producing the content and actively involved in the decision-making process relating to delivering the video game.
• The video game must be intended for commercial release. In particular, the government has identified the need to establish a rule to distinguish speculative expenditure that does not result in an end product from early-stage expenditure on a project with an identifiable end product. Accordingly, it suggests that early-stage costs might be eligible for relief only once a video game has been "formally commissioned by a publisher", or that only costs incurred in producing a video game with the "potential to be approved for commercial release" would be eligible for relief.
• The video game must satisfy a cultural test. It is expected that in order to qualify for the video games tax relief, a video game will have to qualify as a UK video game through a cultural test. However, the government plans to consult separately on the design and administration of the cultural test. The test will be used to award points to the different elements that contribute to the overall cultural value of the production.
• At least 25% of core expenditure must relate to goods or services used or consumed in the United Kingdom. Under the proposals, 'core expenditure' would cover expenditure directly incurred in the production (including pre and post-production) of the video game, but would exclude ancillary expenditure such as the cost of seeking or servicing finance or the cost of advertising the video game. In particular, "genuine further development" which takes place after the game has been released to the public (eg, expansion packs and add-ons) may benefit from tax relief but, as a general rule, the paper indicates that any costs associated with "code debugging and maintenance" after the video game has reached a certain stage (most likely open beta) will not qualify.
• The development costs of the video game may need to satisfy a specific financial threshold. The government is considering whether there is a case for a threshold to entry for tax relief on development costs for video games. The French video games tax credit has a threshold to entry of €150,000 of development costs and the paper indicates that, in initial research, industry representatives suggested a threshold of £50,000 may be appropriate for the proposed video games tax relief in the United Kingdom.

General principles

The paper sets out the following general principles regarding the reliefs.

Making claims
Under the proposals, claims for tax relief would be made in a similar way to the film tax relief – that is, by way of submission of a tax return for the relevant accounting period (a film need not be complete for a claim to be made). The producer would need to obtain confirmation (probably from the Department for Culture, Media and Sport) that the programme or game will pass the cultural test before a claim is made. The remainder of the process would be largely self-assessed, although the paper anticipates that in some cases, companies may wish to seek advance clearance where there is tax uncertainty.

Other tax reliefs
Producers would be unable to claim for one of the proposed tax reliefs and also benefit from any other tax relief (eg, film tax relief or research and development tax credits). If a programme or game qualifies for more than one relief, it will be up to the producer to decide which is more beneficial.

Separate trade
As with film tax relief, the paper suggests that for the purposes of the tax relief, each programme or game will be treated as a separate trade, with separate profits and losses from other projects.

Timeframe

The government is inviting responses to the paper until September 10 2012. It will confirm the design of the reliefs and publish draft legislation in Autumn 2012.(9)

For further information on this topic please contact Alan Moss, Sarah Pons or Michael Lister at Harbottle & Lewis LLP by telephone (+44 20 7667 5000), fax (+44 20 7667 5100) or email (alan.moss@harbottle.com, sarah.pons@harbottle.com or michael.lister@harbottle.com).

Endnotes

(1) The paper was published in June 2012 and is available at www.hmtreasury.gov.uk/d/consult_creative_sector_tax_reliefs_180612.pdf. Responses can be submitted until September 10 2012 (including by email to creativesectortaxreliefsconsultation@hmtreasury.gsi.gov.uk).

(2) For the purpose of the consultation, the term 'high-end television' broadly means high-quality television drama costing £1 million or more for each hour of running time.

(3) Annex A of the paper contains a detailed description of how the film tax relief works.

(4) 'UK expenditure' means core expenditure on goods or services that are used or consumed in the United Kingdom.

(5) 'Core expenditure' means production expenditure on pre-production, principal photography and post-production of the film.

(6) For this purpose, 'co-production' means where two different companies produce animated content, rather than where they co-finance the content.

(7) Ibid.

(8) In France, a 'video game' is defined as:

"Leisure software made available to the public on a physical medium or online and incorporating elements of artistic and technological creation; the latter cover not only PC and console video games but also mobile games, on-line games for one or more players, educational or edutainment software and, provided that they incorporate sufficient interactivity and creativity, cultural CD-ROMs."

(9) Annex D of the paper sets out the planned timetable for implementation of the reliefs.