Sale and Leaseback of British Films
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Sale and Leaseback of British Films The Materials These materials specifically cover the following areas: These materials have been provided by the • Qualification Checklist Media and Creative Industries Group of • Brief History of Sale and Leaseback Transactions Dorsey & Whitney and are intended for use • The Parties as general reference material on the topic of • The Basic Transaction British film sale and leaseback transactions. • The Documentation • The Purchase Price Dorsey & Whitney is an international law • Benefits firm with 21 offices across the United States, • End of the Lease Term Europe and Asia. As a team of seasoned • Definition of a “British Film” lawyers who are intimately familiar with the • Co-Production dynamics of the creative industries, Dorsey & • Recent Developments Whitney’s Media and Creative Industries Qualification Checklist Group provides tailor-made solutions The following is a qualification checklist, which designed to meet the needs of media and producers should consult when considering whether a entertainment clients operating at national particular film will qualify for a sale and leaseback and international levels. transaction. 1.1 Is the production company registered and The Group regularly calls upon the expertise centrally managed/controlled in the UK, or in of colleagues across many time zones, a state that is a member of the EEA1 or is a specialising in areas as diverse as intellectual signatory of the EC Association Agreement2 property, acquisitions and sales, licensing, (“Eligible State”)? financing and tax planning. This depth of 1.2 Is 70% of the production cost of the film being capability enables the Group to provide a spent on filmmaking activity in the UK? (If the seamless service to clients involved in the costs of one or two people are deducted from film, TV, video, DVD, music, fashion, the total labour costs - as detailed in 1.3 and 1.4 below - then the same costs must be deducted advertising, publishing, sport and leisure, from the total production cost before the 70% computer games and technology sectors. test is applied). 1.3 Can any key actor and/or production crewmember be considered Non-Qualifying Labour (i.e. not a citizen or ordinarily resident in an Eligible State or a Commonwealth www.dorseylaw.com 1 Creative Industries Group Country3 (hereinafter “Qualifying Labour”))? The Parties If so, then you may deduct the labour costs for A typical Sale and Leaseback transaction involves a one such non-qualifying person, then calculate Seller (usually a film production company) and a Buyer to ensure that 70% of the total labour cost is (usually a “film trading partnership”). being paid to Qualifying Labour. The Seller: must be registered and centrally managed 1.4. Alternatively, you may deduct the labour costs and controlled in the UK or another Eligible State. of two such non-qualifying individuals (one of whom must be an actor engaged in no other The Buyer: it’s important to note that film finance tax capacity), then calculate to ensure that 75% of relief (based on acquisition) is only available to entities the total labour cost is being paid to Qualifying or persons who acquire films in the course of their 4 Labour. business or trade. Thus, individuals who simply want to 1.5 Is no more than 10% of the playing time of the make a one-off investment in a film may not take film comprised of a sequence or sequences of advantage of this particular tax break. visual images from a previously certified film or In order to benefit, investors normally band together from a film by a different maker?5 into “film trading partnerships” (resident in the UK for 1.6 If one or more of the above requirements tax purposes) cannot be met, was the film made as an official that actively co-production pursuant to a co-production engage in the treaty?6 “Individuals who simply “business” of Brief History of Sale and Leaseback want to make a one-off acquiring and leasing films. Transactions investment in a film may not take advantage of this These partner- Thanks to industry lobbying efforts, British films have ships are usually benefited from various forms of tax relief for several particular tax break.” comprised of years. This tax relief functions to (1) provide tax high-net-worth incentives which benefit the makers of British films and individuals with (2) stimulate a large amount of outside investment in sufficient taxable income to absorb or take advantage of British films, thus providing British filmmakers with an the tax relief. excellent source of financial capital. The Basic Transaction While early forms of film-related tax relief came into The Buyer purchases the master negatives/tapes of a existence around 1979, in 1992 the Inland Revenue completed,9 qualifying British film (along with began to affirmatively grant producers and acquirers of worldwide distribution rights) from the Seller, and then British films tax relief equal to 33.3% of the film’s total immediately leases the negative/tape and all production costs. In 1997, this relief was extended to distribution rights back to the Seller (usually for a an amount equal to 100% of the production costs (for period of 10-15 years). films costing £15 million or less),7 during the year of expenditure.8 Initially slated to last until 1 July 2003, in Pursuant to the lease, the Lessee (Seller) is required to his budget speech of 2001, Gordon Brown announced make escalating annual rental payments to the Lessor that this relief would now continue for at least another (Buyer) over the term of the lease. These rental two years, until 1 July 2005. payments typically escalate at around a rate of 5% per annum. Historically, the definition of “British Film” for the purposes of tax relief has been liberally interpreted so as In almost all cases, the rental payments must be secured to include television programmes. However, Section by way of a bank guarantee or a standby letter of credit. 99 of the Finance Act 2002 restricts tax relief to The bank that provides such a guarantee or letter of expenditure on films “genuinely intended for theatrical credit will also normally require the Lessee to place a release.” The Government’s clear intention is to prevent significant proportion of the purchase price in escrow television programmes (soap operas in particular) from with a deposit bank. Over the period of the lease, this being able to claim relief. amount in escrow (plus any interest accumulated) will serve to meet the Lessee’s actual liability and the bank’s potential liability with respect to the rental payments. www.dorseylaw.com 2 Creative Industries Group In addition, in almost all cases the Buyer will have This analogy is not perfect, however, since a significant borrowed around 90% of the money used to purchase proportion of the purchase price is being held in the film. The Buyer will therefore assign to the lending escrow in order to secure the rental payments. Thus, bank the benefit of receiving all rental payments with the real net benefit of the transaction for the Seller will respect to the film, thus repaying the loan. For this be whatever is left over after depositing this amount in reason, the amount of each annual rental payment is escrow (usually between 10% - 15% of the total typically equal to the amount of each annual loan purchase price, subject to negotiation), minus costs.10 repayment. This leftover sum can be re-invested into the production company, used to pay off debts, buy The Documentation equipment, or for some other purpose. And remember, (1) The Sale and Purchase Agreement the Seller is still benefiting from the commercial (2) The Rights (Intellectual exploitation of the film (subject to Property) Agreement(s) whatever arrangements that exist with distributors, etc.) (3) The Lease Agreement (4) The Laboratory Agreement “It is in both the Seller’s 2. The Buyer: The Buyer benefits (5) The Bank Guarantee by being able to defer (not avoid) tax and the Buyer’s best liability, because it can deduct an (6) The Release of Charges (if interest to obtain the necessary) amount equal to the whole of the highest possible purchase purchase price from its taxable The Purchase Price price for the film.” income for the relevant accounting It is in both the Seller’s and the period. In some situations, the Buyer Buyer’s best interest to obtain the can also benefit from an immediate highest possible purchase price for injection of cash in the form of a tax the film (up to the £15 million cap). refund. However, the Inland Revenue will scrutinise the deal and will only grant relief if the purchase price is an For example, assume a film partnership had a trading accurate reflection of the film’s “value.” Since it is profit (for tax purposes) of £1 million and the partners difficult to gauge a film’s value prior to commercial paid income tax on that amount of say £400,000. If in release, the Inland Revenue’s March 1998 Statement of the next tax year, the partnership had no income and Practice states that an acceptable measure of a film’s incurred £1 million in acquiring the master version of value is its total production expenditure (excluding a film (which it then immediately leased back), the financing costs, advertising, and distribution expenses) partners could obtain relief for the £1 million loss and that Inland Revenue will not challenge such a which could include set-off against the previous year’s valuation where (1) the sale occurs prior to first release taxable income or capital gains and obtain a refund of or broadcast anywhere in the world, or (2) a pre-release any tax previously paid.