Theresa Villiers (Shadow Chief Secretary To the Treasury, Treasury; Chipping Barnet, Conservative)

I beg to move amendment No. 40, in page 165 [Vol I], leave out lines 15 to 17.

Joe Benton (Bootle, Labour)

With this it will be convenient to discuss the following amendments: No. 42, in page 165, line 26 [Vol I], at end insert—

‘(1A) Where a company incurs expenditure on the development of a film that is abandoned before pre-production and subsequently begins to carry on a trade as a film production company in relation to another film, the expenditure may be treated as expenditure of the trade of the second film and as if incurred immediately after the company began to carry it on. Provided that the same expenditure is not to be given more than once.'.

No. 53, in page 166, line 19 [Vol I], leave out paragraphs 7, 8 and 9 and insert—

‘7 For the purposes of this Schedule profits and losses are calculated in accordance with generally-accepted United Kingdom accounting principles.'.

No. 55, in page 167, line 4 [Vol I], at end insert

‘; and accordingly—

(a) where, within six years of the end of the first period of account, it becomes clear that the original estimates  were incorrect, the film production company can elect in writing to amend the original tax computations to reflect the correct position;

(b) income taxed under the provisions of paragraph 7 of this Schedule shall not be taken into account for tax purposes in a subsequent period of account.'.

No. 41, in page 167 [Vol I], leave out lines 6 to 17.

Theresa Villiers (Shadow Chief Secretary To the Treasury, Treasury; Chipping Barnet, Conservative)

I would like to make a couple of preliminary points on schedule 4 and the new framework that it introduces. I welcome the fact that the Revenue said in the Budget that film tax returns would be channelled towards a limited number of tax offices, because this is clearly a specialist and technical area and it would be asking a lot of the average tax office to ask it to deal with that. The Government have made the right decision; if film companies get such specialist offices, that will lead to their tax returns being handled more efficiently.

I wish to raise another matter in this context that it is difficult to fit into a discussion of any particular part of the Bill. It would be useful if the Economic Secretary could say something about the transfer pricing issue that has arisen in relation to the film industry. As we have heard, in many cases films will be made by special purpose vehicles, and the practice in respect of SPVs will be to sell the film back to its parent company on completion. I am told that if the Revenue insists that the price that has to be paid for this to count as an arm’s-length sale transaction to the parent is any more than cost minus tax credit, that could pose problems in terms of film financing. Therefore, I shall be grateful for any guidance that the Economic Secretary can give on that.

Amendment No. 40 would delete paragraph 2 of schedule 4, which requires each film to be treated as a separate schedule D class 1 trade. We have examined the issues involved as they specifically apply to TV companies, but I would like to address them in the broader context of all companies that will be covered by the new regime, including those that can get the tax break. This is designed to deal with the significantly increased compliance burden of requiring each film to be treated as a separate trade. The procedure would not be hugely burdensome for the standard model, where a single film is made by a single company—a single SPV—and where compiling a single set of accounts for one film is the logical approach. However, the inclusion of pre-production in the definition in clause 32 means that there will be problems with that model.

Also, in many cases an SPV structure is not used, particularly where companies are in the film business for the long term. The Government have been encouraging companies that produce film after film. In their consultation document, they specifically talk about the desirability of a slate approach being taken by film companies and encouraging them to producea succession of films. In that case, there may be a considerable increase in the compliance burden. KPMG has helpfully circulated a briefing to all hon. Members, which states that some of its clients estimate that they might have to keep separate tax records for up to 600 films, whether or not they qualify for tax breaks.

The Chartered Institute of Taxation has stated that the new regime could give rise to considerable expenditure-tracking headaches. That arises because a  company producing a succession of films or a number at the same time, will inevitably incur expenditure that is difficult to allocate between the films. It would be complex to allocate that expenditure sensibly between the different projects. Furthermore, some expenses that are currently deductible will cease to be so for no obvious reason. The amendment would restore the existing position in which the overall results of the film production company are taken as the single trade for tax purposes, rather than require it to account separately for tax purposes for each film.

I come now to amendment No. 42. Will the Committee consider the treatment of expenditure on a film that does not go into production? That expenditure cannot qualify for the enhanced relief, because the film is not made. However, with the repeal of the existing rules on deduction under section 41 of the Finance (No. 2) Act 1992, that would leave companies without any statute to rely on to allow them to make a deduction along ordinary tax law principles. Can the Minister confirm that such expenses will be treated as an ordinary trading expense, so that even though they do not receive the enhanced deduction, they can be deducted in the normal way?

The Chartered Institute of Taxation considers that the Bill leaves those costs in limbo. Amendment No. 42 suggests another way to solve the matter. It would enable the expenditure on a film that has been abandoned to be carried over to the next film project carried out by a film production company. I emphasise that costs for films that do not get made should be considered a legitimate expense. Those films are encouraging creative talent in the film industry. It is inevitable that, if we are to have a flourishing industry that encourages innovation and the development of projects, a considerable number of those projects will never get off the ground. Film companies should not be deterred from embarking on the expenditure necessary to get films off the ground.

Paragraphs 6 to 9 of the schedule introduce the complicated and controversial new way of calculating profits and losses in the film industry, to which the Committee’s attention has already been drawn. Amendment No. 53 proposes to delete those paragraphs and substitute them with the provision:

“For the purposes of this Schedule profits and losses are calculated in accordance with generally-accepted United Kingdom accounting principles.”

Instead of the new regime applying, we will have accounting required according to generally accepted practices. The amendment disapplies the controversial new regime and leaves the film companies to account for their profits according to ordinary accounting principles. If the paragraphs are not deleted, the new tax framework could cause significant practical problems for some companies.

Paragraph 7 requires the entire estimated income from the film—regardless of how far in the future that income may arise—to be taxed in proportion to how the production costs are incurred. Once post-production is complete, a company will be taxed on all future estimated income, whether or not it has been earned by that stage. The requirement for estimated income could be very problematic, both for independent film makers and large production companies, mainly because it is almost impossible to  predict the success of a film. The proposed new rules will mean basically that companies will be paying tax, or receiving less by way of tax credit, on income that they never received. They could also mean that many companies will pay tax well ahead of receiving the relevant income. It may be that the experts who have written to Committee members are wrong in their interpretation of the provision, but I should like the Economic Secretary’s reassurance that the schedule will not have the effect that I have described, because it would be very damaging.

The impact is particularly harsh when a company not only produces a film but then exploits it through licensing. Examples of such licensing are in the DVD and TV markets, in soundtrack sales, in character merchandising, which is particularly relevant to children’s films, and in computer games, which are enormously important and provide a long-term income flow to film makers. Paragraph 6 of schedule 4 contains a wide definition of income for the purposes of the new regime, and takes account of income from all such licensing projects. That income can be unpredictable—I am sure that Members can think of many examples of films that were expected to generate substantial revenues but flopped at the box office and were never heard of again, whereas some films have limited initial success and are very small-scale, but begin to generate significant revenues some years down the line. That is particularly true of films that acquire cult status.

I quoted the accountancy firm of Malde and Co. in Tuesday’s sitting. They said that trying to calculate this income

“is like asking someone ‘how long is a piece of string’”.

I should be interested to hear from the Minister what type of supporting material would be needed to support an estimate of future income. Are film production companies required to rely on critics’ comments? Are sales agents’ predictions to be used? They could certainly produce some over-optimistic estimates.

Paragraph 8 refers to compiling estimates

“on a fair and reasonable basis, taking into consideration all relevant circumstances.”

That is an extremely broad approach, and it seems to leave the way open for serious disputes between film production companies and the Revenue as to what constitutes “fair and reasonable.” It could lead to uncertainty over the level of a tax break and the date when it might be paid.

To conclude, I quote the Chartered Institute of Taxation. Speaking of schedule 4, it said that it firmly believed

“that the new provisions will result in excessive taxation and move us further away from the tax follows accounts principle.”

I hope that the Government will either reconsider the structure, or at least reassure us that it will not work in the way that is anticipated by the experts who have sent representations to Committee members.

If, as I expect, the Government are reluctant to delete paragraphs 7 to 9, I hope that they will consider the alternative proposal suggested by my hon. Friend the Member for South-West Hertfordshire (Mr. Gauke) in the form of amendment No. 55. The amendment would insert, at the end of paragraph 8, a provision  allowing estimates to be revised subsequently if they prove incorrect. I hope that that modest change will be considered. If not, will the Economic Secretary indicate that the Government will find a way to ensure that estimates can be revised in those circumstances? If the Government are not prepared to accept amendment No. 55, I hope that a non-statutory procedure will be found, because it seems unfair to require companies to abide by estimates that subsequently prove to have been over-optimistic.

Amendment No. 41 would delete paragraph 9, and to that extent my comments on the deletion of paragraphs 7 to 9 embrace it. However, it was tabled individually for a specific reason—to highlight a further problem with paragraph 9, separate from the accounting difficulties. Paragraph 9 introduces a new concept of when film expenditure is incurred. Itsays that

“costs are incurred when they are represented in the state of completion of the work in progress.”

I am informed that that definition could produce difficulties in respect of film exploitation costs, which a company may incur at the same time as ongoing production. It seems to add an unnecessary layer of complexity for no apparent reason. Normally one would expect a cost to be incurred when there is an unconditional obligation to pay for it. Perhaps with interpretation we will find that the new rules operate similarly to the old ones, but if they differ from the current rules and ordinary accounting principles, that will add to the complexity of the tax regime faced by film companies. Can the Minister explain why it is proposed to depart from a well-understood definition of whether cost is incurred for tax purposes?

Rob Marris (Wolverhampton South West, Labour)

I should like clarification. Although I am not an accountant but a lawyer by background, the hon. Lady’s last remarks seemed to contradict her amendment No. 53, which calls for profit and lossesto be

“calculated in accordance with generally-accepted United Kingdom accounting principles.”

I thought that valuing and costing work in progress was a standard and generally accepted accounting principle. She seems to be saying that valuing work in progress, which is a standard accounting practice, could cause a problem, but surely that contradicts her amendment.

Theresa Villiers (Shadow Chief Secretary To the Treasury, Treasury; Chipping Barnet, Conservative)

My amendment would remove the new regime and leave in place the existing rules, which would operate in accordance with standard accounting practice. On that, I conclude my remarks and look forward to the Committee’s comments.

David Gauke (South West Hertfordshire, Conservative)

I ask for clarification, Mr. Benton. May I speak to amendment No. 55?

Joe Benton (Bootle, Labour)

Yes.

David Gauke (South West Hertfordshire, Conservative)

I shall add to the comments of my hon. Friend the Member for Chipping Barnet on paragraphs 7 to 9 to schedule 4. Paragraph 7 will require a film’s entire estimated income to be taxed in proportion to how production costs are incurred. Most of the experts who provided us with representations took that to mean that once post-production is complete, a company will be taxed on all future estimated income. I say “most of the experts”, but it is fair to say that KMPG presumed that the method of calculation would apply only where a film is in production. That was a presumption, however, and even KPMG acknowledged some ambiguity in the text. Clarification on the matter is important.

Amendment No. 55, which was tabled in my name, was drafted on the basis that the interpretation of most of the experts is correct. If so, as my hon. Friend said, there is no mechanism in the Bill for reducing the estimated income if projections prove optimistic. Given the nature of the film business, it is difficult to make accurate projections on such matters. We have a difficulty with the fact that a film might be taxed heavily but might not receive anything like the projected income a few years down the line.

The British Screen Advisory Council pointed out that that income is not discounted for time in any way. My amendment would merely provide a mechanism to deal with that problem. As my hon. Friend said, there might be a non-statutory way to do so, but I should be grateful for the Economic Secretary’s views on whether he acknowledges the problem and on how he would seek to address it if not by accepting amendmentsNos. 55 or 53.

The second point that my amendment raises was mentioned by KPMG, which stated that nothing in the Bill would allow film production companies preparing tax computations after the end of production to strip out the estimated income already taxed. That creates a danger of double taxation. Clearly that would be unfair, and my amendment seeks to address the problem. I should be grateful for the Economic Secretary’s views on whether that is an issue, how best to address it and whether amendment No. 55 would do so successfully.

Edward Balls (Economic Secretary, HM Treasury; Normanton, Labour)

We debated earlier the principles and purpose behind the new reliefs, and the schedule and the amendment address in detail how the reliefs will work in practice and how we can make a sensible and robust regime work properly. I can provide reassurance and clarification in a number of ways for the hon. Gentleman. As we discussed on clause 31 on Tuesday, however, the hon. Member for Chipping Barnet has proposed amendments that, in some cases, strain the boundaries and risk taking us back towards some of the problems even though she agrees with the new legislation’s fundamental purposes of tackling tax avoidance.

Amendment No. 40 is at the heart of the new regime and the view that it is necessary for each film to be treated as a separate trade in order to deal with the problems of the past and to ensure that the tax avoidance industry cannot get its hands on these new reliefs. The proposal would not impose an unnecessary regulatory burden and does not run contrary to what has been explained to us as the normal industry  practice. Film makers are interested in keeping to budget and making a profit. It is normal practice for them to consider costs and income on a film-by-film basis. How else would they know whether a film was going to be profitable?

It is clear that each film is a project, and is handled and accounted for as such. The requirement to treat each film as a separate trade acknowledges that, but also recognises that the treatment in schedule 4—and, more particularly, in schedule 5—offers special and valuable opportunities. However, we need to draw a line round each film to ensure that the advantages of the reliefs apply to the making of British films and do not leak out more widely.

Like the hon. Lady, I have studied the submission from KPMG but, in our view and on the basis of our consultations, KPMG’s fears about compliance burdens are not broadly shared in the industry. What we are doing is in line with how the industry normally accounts for films already.

Amendment No. 42 addresses cases where development expenditure needs to be passed from an abortive film to an active film in order for it to be recognised for tax purposes. Our view is that amendment No. 42 is unnecessary. To return to some of the issues that I set out earlier, development expenditure goes on deciding whether to make a film, not on making it. If the idea for a film is abandoned, what has been abandoned is the idea, not the film. The idea becomes a film only when the film starts to be made, and the special tax treatment applies to the making of the film, as we discussed earlier.

If production has started, the value of the development is brought into the trade of producingthe film. The film production company buys the development work to make the film—it cannot be made without that work—or there is a transfer of costs within the company to recognise them. That is what paragraph 4 to the schedule is about. If the film is subsequently abandoned, those development costs are recognised.

Amendment No. 42 suggests that the expenditure on abandoned and fruitless ideas needs to be passed on to the film production trade, in order for it to be relieved, but that is not so. Just because a film production trade is ring-fenced does not preclude other expenditure in the company from being handled under normal rules for normal tax purposes. I can therefore give the hon. Lady the assurance that she asked for that those costs will still be treated for normal tax purposes; it is just that they will not be included in the calculation of the enhanced relief.

Amendment No. 53 is more radical and containsat its heart the proposition that tax must follow accountancy. As I said in my introductory remarks, the accounting treatment of film is not without doubt and, where doubt exists, there is the opportunity to rearrange things for tax advantage. The purpose of the Bill is to ensure that such activity does not cause tax avoidance or the leakage of reliefs away from the making of British films. Amendment No. 53 proposes that profits and losses should be

“calculated in accordance with generally-accepted United Kingdom accounting principles.”

However, the problem, as we have discovered in recent years, is that there is no generally accepted treatment.

In the end, treatment falls back on industry practice for reporting profits to company owners. The danger is that the proposal smacks of letting the company’s own accountants decide what the taxable profits should be; but until the introduction of new international accounting standards, that is not where we want to be. The method set out in the Bill is in accordance with where international accounting standards are going, best practice in the industry, and where accountants’ standards are moving to—so much so that some companies will need to make few, if any, computational adjustments to their accounts. Amendment No. 53 would take us backwards and away from international best practice.

John Hemming (Birmingham, Yardley, Liberal Democrat)

The key question about amendment No. 53 is: when does the cash come in as income? One can make an estimate at the start, but it is a finger in the air. That is why amendment No. 55 is a good amendment if amendment No. 7 fails. However, I still have a problem understanding why anyone would want to go through this regime if they are in the business of producing film, because most of the income comes in at the tail; it does not come at the start. Where is the cash coming from to pay all these taxes?

Edward Balls (Economic Secretary, HM Treasury; Normanton, Labour)

In our earlier debates, it was explained why we are bringing in a tax treatment to qualify for an enhanced relief. People would want to go through these procedures to get the 20 per cent. tax credit for a smaller film and 16 per cent. for a larger film. That is why companies will go through the regime: to get the advanced tax support.

We are applying this model because of the way in which the industry works. I do not know whether the hon. Gentleman had the chance to read the KPMG briefing to which the hon. Member for Chipping Barnet referred earlier, but it contains a worked example on a different point about whether estimates could be revised. In the example, the film does not get made in the end, but costs are applied through the life of the making of the film, and there are two tranches of income, one of which comes in the first 18 months and one of which is to come on completion. Because the film is not made, a concern about estimates is claimed. In the example, the income to the film production company comes well in advance of the completion of the film precisely so that the costs of making the film can be covered. We are putting in place a tax treatment that allows income and costs to be spread over the lifetime of the film. With the old system, that occurred only on completion.

John Hemming (Birmingham, Yardley, Liberal Democrat)

On that point, I understand that the system is designed to replace a regime that effectively allows the capital that is placed on risk and invested in intellectual property to be treated as a revenue spend right at the start and then for the income to be brought in against that—meaning not only income in terms of investment, but income from which one gets the cash right at the start. There is some merit to that. However, I just do not understand where the cash comes from. Who pays whom for what?

Edward Balls (Economic Secretary, HM Treasury; Normanton, Labour)

Without wanting to delay the Committee unnecessarily on this point, I reiterate my earlier  comments that this is how film making works. Cost is spread through the lifetime of the making of the film, and income is generally spread through the lifetime of the film to cover those costs. According to our consultation with the industry, that model works for film making in order to qualify for the reliefs. The old model to which the hon. Gentleman referred was both out of date with best practice and subject to substantial abuse. We are trying to implement a model that will avoid some of the problems that we discussed earlier.

Theresa Villiers (Shadow Chief Secretary To the Treasury, Treasury; Chipping Barnet, Conservative)

What abuse are the Government afraid of? If the system gives rise to abuse, the Opposition will, of course, support the Government’s approach, but we have not heard a convincing explanation about the abuse they are trying to prevent, or how the new structure requiring payment of tax in advance of income is needed to solve a real problem.

Edward Balls (Economic Secretary, HM Treasury; Normanton, Labour)

We are in danger of repeating our debate on clause 31. We are trying to move from a regime that was out of line with the accounting practices of film production companies. It too often allowed tax relief to leak out of the making of films; instead, it could be shared by financial vehicles and financiers. We are putting in place a new model, which we debated at length under clauses 31 and 32, to ensure that the tax relief goes to the maker of the film—the film production company. It does so throughout the making of the film.

If, under schedule 4, we were to debate how we operate those rules, it would be a sensible debate. However, as I said at the beginning, although the hon. Lady proclaims to support the new model, she is swayed by those who have proposed amendments and who want to take us back to the old world. We have to make a choice. We can operate the old regime, but she seems to want it for only part of the time—for TV companies and for DVD films. We want to operate the new regime all the time because we want to avoid the old problems; we do not want to be taken back to them. I urge her to reflect again on the good speech that she made at the beginning of the debates on this chapter, and I ask her to help us to implement the measure rather than always harking back to past problems.

I turn to amendment No. 55. The hon. Member for South-West Hertfordshire, in what I think is a probing amendment, is trying to help us clarify how estimates should be used in the calculation of taxable income or allowable losses. The amendment would ensure that estimates can be revisited, and that something included as an estimate in one year would not be included in another year if the income projection proved to be accurate and hence taxed twice. I assure the hon. Gentleman that the way in which schedule 4 treats estimates and revisions will meet his concerns.

Paragraph 8 to schedule 4 makes it clear that estimates are to be made using a proper view of the situation at the accounting date. It is possible that estimates made in relation to that date may not be correct when taking all the information available into  account. In such cases, returns can be amended. No special legislation is needed to enable companies to do so, nor is it necessary to set a time limit on when that can be done. In our view, the mechanisms to allow companies to do what the hon. Gentleman asks are already available in the schedule.

We also do not need legislation to reflect changing estimates that arise from new facts or new situations, including new estimates of income or costs. For example, if I have a contract this year to exploit my company’s film that, in the substance of the transaction, will yield me £1 million over five years, I shall make an estimate, which is akin to fair value in accountancy terms—I use that term with some trepidation, as I am neither an accountant nor a lawyer. However, things may change, and the new estimate, based on all the relevant circumstances, including the new ones, may be that I will receive only £900,000.

The formula in paragraph 7 to the schedule says that such a decrease will be recognised in the second year. That is not new; it is the normal sort of accountancy valuation and re-estimate required properly to reflect the substance of the arrangement, which adjusts year on year to track the proper view of income. We do not need specific provisions to allow that sort of change to be made to estimates; it can be done within the ambit of the schedule. I hope that I have reassured the hon. Gentleman.

David Gauke (South West Hertfordshire, Conservative)

I am grateful to the Economic Secretary for clarifying the matter. Is KPMG wrong in its assumption that the method of calculation described in the schedule applies only if a film is in production?

Edward Balls (Economic Secretary, HM Treasury; Normanton, Labour)

I referred earlier to the KPMG letter and to the hon. Gentleman’s description of the example in appendix 1 of its notes and its concern that there would be a restriction on the ability to re-estimate. In our view, it is not right to be concerned about that. The schedule works through an examination of the difference between this year’s estimated income and last year’s, and that is in line with standard accountancy treatment. We do not need to set a limit at which there can be re-estimation. If the world changes, estimates will be able to be changed and recalculated for tax purposes even after the completion phase. I can give the hon. Gentleman the assurance that he seeks.

David Gauke (South West Hertfordshire, Conservative)

I apologise if I am being a little slow. Does that mean that the mechanism contained in the schedule applies not only when a film is in production but subsequently?

Edward Balls (Economic Secretary, HM Treasury; Normanton, Labour)

I think that I am right to say that the hon. Gentleman is asking us to give extra clarification to something that is normally and readily understood. That is the intention behind the amendment. In normal accountancy practice, if estimates change, they are reflected in the following year’s treatment. That applies at any point in time—forwards or backwards. We do not need a special clarification or amendment. The hon. Gentleman is right that if the situation arises and the world changes, re-estimation will be allowed at any stage, including after the completion of a film. Does that give him the clarification that he asks for?

David Gauke (South West Hertfordshire, Conservative)

I think it does. The statement from KPMG suggests that it presumes that the method of calculation described in the schedule applies only when a film is in production, as the Economic Secretary has fully explained. I question that statement; I do not think that that is right. However, I am grateful for the clarification.

Edward Balls (Economic Secretary, HM Treasury; Normanton, Labour)

I am also grateful for this opportunity. The hon. Gentleman thinks that I have clarified the matter and I think that I have. I see nodding, which suggests that I have. As soon as KPMG concludes that I have, we will all be happy.

Rob Marris (Wolverhampton South West, Labour)

May I ask my hon. Friend and his officials to re-examine, although not today, paragraph 7(2)(b)? I understand what he is trying to do, but I am not sure that paragraphs 7(2)(b) and 7(3) achieve what he wants.

Edward Balls (Economic Secretary, HM Treasury; Normanton, Labour)

I am disappointed that we did not have a discussion on the explanatory notes on the matter, which will explain it further. I am always grateful to my hon. Friend for his advice, and I will have no problem examining whether we have got the paragraphs absolutely right. I believe that we have, and any ambiguities could be clarified in guidance later. When I read the paragraphs, I understood them. Given that I started from a low base of understanding, I hope that that is of some reassurance.

Amendment No. 41 would remove the rules on when costs should be recognised for tax purposes. A central objective in introducing the new tax relief for British  films is to design out opportunities for abuse and the tax avoidance problems that we have had in the past. Chapter 3 contains a number of provisions that have been designed specifically to prevent the new relief from being abused in the same way as previous reliefs, and paragraph 9 to schedule 4 is an example of that intention. In the past, there have been instances in which the actual level of production expenditure was artificially inflated by the inclusion of deferments, fees that are not paid until a film starts to make a profit. They are fairly common in the industry. Paragraph 9(2) states that any payments in advance should be ignored until the work is done, and that

“deferred payments are recognised to the extent that the work is represented in the stage of completion.”

Paragraph 9(3) states that only money subject to an unconditional obligation to pay can be treated as having been incurred, and paragraph 9(4) sets out that if an obligation is linked to income being earned, the costs can be included only when an appropriate amount of income has been brought into account. I hope that that clarifies why our approach is the right one to take. We do not want to go backwards by accepting amendment No. 41.

I must give one more reassurance to the hon. Member for Chipping Barnet—on the issue of transfer pricing. In that area, there is nothing particular or novel about the film industry—