Schedule 4
Finance (No. 2) Bill
9:45 am
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?