Product Ruling

PR 2004/6

Income tax: Film Investment - 'Hating Alison Ashley'

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FOI status:

may be released

No guarantee of commercial success

The Australian Taxation Office (ATO) does not sanction or guarantee these products as investments. Further, we give no assurance that the products are commercially viable, that charges are reasonable, appropriate or represent industry norms, or that projected returns will be achieved or are reasonably based.

Potential investors must form their own view about the commercial and financial viability of the products. This will involve a consideration of important issues such as whether projected returns are realistic, the 'track record' of the management, the level of fees in comparison to similar products, how the investment fits an existing portfolio, etc. We recommend a financial (or other) adviser be consulted for such information.

This Product Ruling provides certainty for potential investors by confirming that the tax benefits set out below in the Ruling part of this document are available, provided that the arrangement is carried out in accordance with the information we have been given, and have described below in the Arrangement part of this document.

If the arrangements are not carried out as described below, investors lose the protection of this Product Ruling. Potential investors may wish to seek assurances from the promoter that the arrangements will be carried out as described in this Product Ruling.

Potential investors should be aware that the ATO will be undertaking review activities in future years to confirm the arrangements have been implemented as described below and to ensure that participants in the arrangements include in their income tax returns income derived in those future years.

Terms of use of this Product Ruling

This Product Ruling has been given on the basis that the person(s) who applied for the Ruling, and their associates, will abide by strict terms of use. Any failure to comply with the terms of use may lead to the withdrawal of this Ruling.

What this Product Ruling is about

1. This Ruling sets out the Commissioner's opinion on the way in which the 'tax laws' identified below apply to the defined class of persons who take part in the arrangement to which this Ruling relates. In this Ruling this arrangement is sometimes referred to as 'Hating Alison Ashley', 'the Film' or 'the Project'.

Tax law(s)

2. The tax laws dealt with in this Ruling are:

•

Division 5 of Part III of the Income Tax Assessment Act 1936 (ITAA 1936);

•

Division 10BA of Part III of (ITAA 1936);

•

Section 26AG of ITAA 1936;

•

Section 124ZAO of ITAA 1936;

•

Section 124ZAG of ITAA 1936;

•

Part IVA of ITAA 1936;

•

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997); and

•

Section 995-1 of ITAA 1997.

Unless otherwise stated, all legislative references that follow are in relation to the ITAA 1936.

Goods and services tax

3. In this Ruling, where applicable, all fees and expenditure referred to include Goods and Services Tax ('GST') set out in the A New Tax System (Goods and Services Tax) Act 1999 ('GST Act'). A person or entity who is registered for GST is entitled to claim input tax credits for the GST included in its expenditure provided that the acquisition is for a creditable purpose under Division 11 of the GST Act.

Business Tax Reform

4. The Government is currently evaluating further changes to the tax system in response to the Ralph Review of Business Taxation and continuing business tax reform is expected to be implemented over a number of years. Although this Ruling deals with the laws enacted at the time it was issued, future tax changes may affect the operation of those laws and, in particular, the tax deductions that are allowable. Where tax laws change, those changes will take precedence over the application of this Ruling and, to that extent, this Ruling will be superseded.

5. Taxpayers who are considering investing in the Project are advised to confirm with their taxation adviser that changes in the law have not affected this Product Ruling since it was issued.

Note to promoters and advisers

6. Product Rulings were introduced for the purpose of providing certainty about tax consequences for investors in projects such as this. In keeping with that intention, the Tax Office suggests that promoters and advisers ensure that potential investors are fully informed of any changes in tax laws that take place after the Ruling is issued. Such action should minimise suggestions that potential investors have been negligently or otherwise misled.

Class of persons

7. The class of persons to which this Ruling applies is those persons who enter into the arrangement described below on or after the date this Ruling is made. They will have a purpose of staying in the arrangement until it is completed, i.e. being a party to the relevant agreements until their terms expire, and deriving assessable income from this involvement as a result (as set out in the description of the arrangement). In this Ruling, each of these persons, will have accepted an offer made under subsections 708(1)-(11) of the Corporations Act 2001.

8. The class of persons to which this Ruling applies does not include persons who intend to terminate their involvement in the arrangement prior to its completion, or who otherwise do not intend to derive assessable income from it.

Qualifications

9. The Commissioner rules on the precise arrangement identified in the Ruling. If the arrangement described in the Ruling is materially different from the arrangement that is actually carried out, the Ruling has no binding effect on the Commissioner. The Ruling will be withdrawn or modified.

10. A Product Ruling may only be reproduced in its entirety. Extracts may not be reproduced. As each Product Ruling is copyright, apart from any use as permitted under the Copyright Act 1968, no Product Ruling may be reproduced by any process without prior written permission from the Commonwealth. Requests and inquiries concerning reproduction and rights should be addressed to:

Commonwealth Copyright Administration

Intellectual Property Branch

Department of Communications, Information Technology and the Arts

GPO Box 2154

Canberra ACT 2601

or by e-mail: commonwealth.copyright@dcita.gov.au.

Date of effect

11. This Ruling applies prospectively from 21 January 2004, the date this Ruling is made. However, the Ruling does not apply to taxpayers to the extent that it conflicts with the terms of settlement of a dispute agreed to before the date of issue of the Ruling (see paragraphs 21 and 22 of Taxation Ruling TR 92/20).

12. If a taxpayer has a more favourable private Ruling (which is legally binding), the taxpayer can rely on the private Ruling if the income year to which the private Ruling relates has ended, or has commenced but not yet ended. However, if the arrangement covered by the private Ruling has not begun to be carried out, and the income year to which it relates has not yet commenced, the Product Ruling applies to the taxpayer to the extent of the inconsistency only (see Taxation Determination TD 93/34).

Withdrawal

13. This Product Ruling is withdrawn on 30 June 2006 and ceases to have effect on and from that date. The Ruling continues to apply, in respect of the tax laws ruled upon, to all persons within the specified class who enter into the specified arrangement during the term of the Ruling. Thus, the Ruling continues to apply to those persons, even following its withdrawal, for arrangements entered into prior to withdrawal of the Ruling. This is subject to there being no change in the arrangement, or the persons' involvement in the arrangement.

Previous Ruling

14. This Ruling replaces Product Ruling PR 2002/70 which is withdrawn on and from the date this Ruling is made 21 January 2004. Product Ruling PR 2002/70 has no application to Investors as the production budget for the Film was not achieved by 30 June 2002.

Arrangement

15. The arrangement that is the subject of this Ruling is described below. This description is based on the following documents. These documents, or relevant parts of them, as the case may be, form part of and are to be read with this description. The relevant documents or parts of documents incorporated into this description of the arrangement are:

•

Application for a Product Ruling that became valid on 12 November 2003 as constituted by documents provided on: 2, 6, 23 and 25 May 2003, 4 September 2003, 7, 12, 24, 26 and 28 November 2003, 3 December 2003 and 5 January 2004; and additional correspondence dated: 28 April 2003, 23 May 2003, 4 September 2003, 6, 10, 12, 21, 24, 25 and 28 November 2003, 3 and 28 December 2003,

•

Correspondence from the ATO to the Applicant dated 14 and 28 May 2003, 4 June 2003, 18 September 2003, 14, 21, 24, 26 and 28 November 2003, 2 and 11 December 2003;

•

Provisional Certificate number P05361 under section 124ZAB dated 4 June 1998;

•

Production Budget and Budget Summary for the Film and its financial analysis, received by the ATO on 2 May 2003;

•

Shareholders and Producers Agreement between HAA Films Pty Ltd ('HAA Films'), Elizabeth Howatt, Tidepool Films Pty Ltd and John Brousek, received by the ATO on 5 January 2004;

•

Draft Standard Production and Investment Agreement together with Schedules to be entered into between HAA Films, Government and film industry investors and the Investors' Representative on behalf of the Investors, received by the ATO on 2 May 2003;

•

Draft Accession Deed between HAA Films, the Investor and the Investors' Representative received by the ATO on 5 January 2004;

•

Letter from HAA Films appointing A2Z Distribution Pty Ltd ('A2Z Distribution') as world wide distributor of the Film, dated 8 November 2003 and received by the ATO on 5 January 2004;

•

Letter of Intent from The Movie Network Channels Pty Ltd ('Movie Network') to invest and acquire Australian Pay TV rights, dated 14 May 2003 and received by the ATO on 12 November 2003;

•

Letter of Offer from Universal Pictures (Australasia) Pty Limited ('UPA') to acquire Australasian distribution rights (excluding Australian Pay TV), dated 30 October 2003 and received by the ATO on 12 November 2003;

•

Letter of Offer from Universal Pictures (UK) Limited ('UPUK') to acquire distribution rights for the UK and Ireland, dated 4 November 2003 and received by the ATO on 12 November 2003;

•

Sales Agency Short Form Agreement from Arclight Films International Pty Ltd ('Arclight') to acquire international sales agency rights for the world excluding Australasia, the UK and Ireland, dated 3 November 2003 and received by the ATO on 12 November 2003;

•

Draft Collection Account Management Agreement between Fintage Collection Account Management BV ('Fintage House'), Arclight, HAA Films, A2Z Distribution, Movie Network, Government and film industry investors and the Completion Guarantor, received by the ATO on 28 November 2003; and

•

Draft Information Memorandum, dated November 2003 and received by the ATO on 12 November 2003.

16. In accordance with the above documents, an Investor who participates in the arrangement must have accepted an offer that was made under subsections 708(8)-(10) of the Corporations Act 2001. This Ruling does not apply unless the Investors are 'sophisticated investors'. The term 'sophisticated investor' is explained in paragraphs 44 to 47 below.

The Participants

17. A suitably qualified and experienced person will act as the Investors' Representative for the Division 10BA Investors.

18. Elizabeth Howatt-Jackman and John Brousek are the producers, directors and shareholders of HAA Films. HAA Films will act as the Production Company of the Film. The Film will be made exclusively in Australia. There will be no manager of the Film other than HAA Films. The Investors will appoint HAA Films as their agent to market the Film worldwide.

19. HAA Films will exclusively license A2Z Distribution to market and distribute the Film worldwide. A2Z Distribution has secured minimum guarantees for the distribution rights to the Film of approximately $1,047,000 (based on an A$1:US$0.72 exchange rate). A2Z Distribution will enter into the following sublicence agreements:

(i)

Movie Network for Australian Pay TV rights,

(ii)

UPA for all other Australasian distribution rights;

(iii)

UPUK for distribution rights in the UK and Ireland; and

(iv)

Arclight as international sales agent for the rest of the world. No distribution guarantee will be payable by Arclight.

20. Fintage House will act as the Collection Account Manager in relation to the Film.

21. Investors will contribute capital funds equal to the production budget of $6,760,909 and share in the Film Copyright as follows:

Unless otherwise stated, all references to Investor or Investors that follow are in relation to Division 10BA Investors. This Product Ruling has no application to Government and film industry investors, or any investment by HAA Films.

The Project

22. The Project involves the production of an Australian feature film to be titled 'Hating Alison Ashley'.

23. Provisional Certificate number P05351, dated 4 June 1998, has been issued by the Department of Communications, Information Technology and the Arts in respect of the Film to Elizabeth Howatt. This certificate is currently in force in relation to the Film and states that the proposed Film will, when completed, be a 'qualifying Australian film' for the purposes of Division 10BA.

24. The planned completion date is negotiable between the parties to the arrangement but will definitely be no later than 30 June 2006 in order to satisfy the two-year requirement in Division 10BA.

25. The production budget for the Film is $6,760,909 of which up to $2,047,222 is being sought from Investors. The balance of the production budget will be met by Government and film industry investors as outlined in paragraph 21 above.

26. Investors will make capital contributions towards the production of the Film under a contract to be executed no later than 30 June 2004. It is anticipated that each Investor will invest at least $100,000. No prospectus will be lodged and Investors will be Sophisticated Investors as set out in subsections 708(8)-(10) of the Corporations Act 2001.

Accession Deed

27. Once the amount sought has been attained each Investor will enter into an Accession Deed with HAA Films, as the Production Company, and the Investors' Representative. At clause 2(f) each Investor irrevocably and exclusively appoints the Investors' Representative to represent them in all dealings with HAA Films.

28. Clause 2(c) entitles Investors to share in the Copyright of the Film as follows:

(The Investor's Investment / The Total of all Investments) × 100%


The Investors will hold up to 30.28% of the Copyright in the Film (refer paragraph 21 above).

29. Under clause 2(d) each Investor grants an irrevocable exclusive licence of their interest in the Copyright to HAA Films and each Investor will be entitled to receive a share of the Gross Receipts received by HAA Films.

30. In accordance with clause 2(h) all rights held by investors in the Film, including Copyright and Gross Receipts, will revert to HAA Films on the Expiry Date. The Expiry Date will be on the 30th June in the year immediately following the date of seven years after completion of the Film (Item 9 of the Schedule). Non 10BA Investors will hold their Copyright interest in perpetuity.

31. Item 6 of the Schedule, and Schedule 5 of the Production and Investment Agreement, sets out the order in which HAA Films will disburse the Gross Receipts it receives from A2Z Distribution, as follows:

1st

To the Division 10BA Investors as priority recoupment an amount equal to 50% of their Investment payable from the proceeds of the pre-sales received by A2Z Distribution as outlined in Item 7 of the Schedule (refer to paragraph 32 below);

2nd

Marketing and distribution expenses as follows:

(a)

Distribution Expenses of up to $200,000 and sales commission of 15% on international sales, will be deducted from the Fintage House HAA Collections Account and paid to Arclight;

(b)

The Collections Agent Fee of 1.5% of international sales will be deducted from the Fintage House HAA Collections Account and paid to Fintage House;

(c)

Sales Commission of up to 1.5% of worldwide sales will be deducted from the A2Z Distribution's HAA Collections Account and paid to A2Z Distribution (including the retroactive payment of commission due on pre-sales);

(d)

A fee of up to 0.5% of gross proceeds received by HAA Films is payable to the Investors' Representative (including the retroactive payment of the fee due on pre-sales).

3rd

Payment to the Division 10BA Investors of the unrecouped portion of their Investment pro rata and pari passu with the Government and film industry investors, proceeds of all other sales until each has received 100% of the amount they have invested in the Film.

4th

To the Production Company for the amount of Overages paid or borrowed for Overages including any interest on loans.

5th

To the Completion Guarantor to repay any moneys provided by the Completion Guarantor in relation to the Film.

6th

(a)

To the Government and film industry investors and the Division 10BA Investors 50%, and to each Investor pari passu and pro rata that their Investment bears to the total of all Investments;

(b)

To the Production Company 50%; NB: Any share of proceeds which the Production Company agrees to give to any other party will be paid from the Production Company's share of Proceeds.

32. Item 7 of the Schedule sets out the pre-sale minimum guarantees payable to A2Z Distribution. Item 8 of the same Schedule provides the approximate payment dates of these pre-sales. These details are summarised in the tables below.

Production and Investment Agreement (PIA)

33. The PIA is between HAA Films, as the Production Company, Government and film industry investors, and the Investors' Representative on behalf of the Investors. Each Investor is required to contribute their investment into the Trust Account, established by the Investors' Representative, by no later than 30 June 2004 (clause 10.1).

34. Under Part B of Schedule 3 HAA Films is entitled to draw down funds from the Trust Account into the Production Account. If the Production Account is not interest bearing, clause 11.1 requires an Investment Account to be established. In accordance with clause 11.6 any interest that accrues from these deposits will be applied in accordance with Schedule 2 Part E of the PIA.

35. In accordance with clause 3 HAA Films will assign each Investor an interest in the Copyright, and future Copyright, of the Film. The Investors will hold the Copyright as tenants in common in the proportion that their contribution bears to 100% of the total budget.

36. HAA Films is to meet any Overages from its own resources and may use money provided by the Completion Guarantor or third party lenders (clause 12.1). Any funds remaining in the Production Account at the completion of the Film will be applied in accordance with Schedule 2 Part F as a refund to Government and film industry investors in proportion to their Investments. The pro-rata portion that would otherwise be refunded to the Investors will be applied towards the enhancement of music and special effects (clause 12.2).

37. Within 14 days after the Completion Date of the Film, HAA Films is to establish the HAA Collections Account (clause 11.1 (b)).

38. At clause 1 Gross Receipts means all money resulting from marketing of the Film actually received by HAA Films. Sales Commissions and Marketing expenses pursuant to Schedule 6 will have been deducted prior to receipt by A2Z Distribution.

Distribution

39. Under clause 14.1 of the PIA, each Investor grants HAA Films an exclusive licence to market the Film throughout the world for their interest in the Underlying Rights and the Copyright.

40. HAA Films, acting as agent for the Investors, will enter into a Distribution Agreement with A2Z Distribution for worldwide distribution of the Film. A2Z Distribution, acting in its own capacity as head distributor for the Film, will enter into sub-distribution agreements with UPA for Australasian distribution for twenty five (25) years and with Arclight for international sales for fifteen (15) years from the delivery of the Film. Except for the pre-sales negotiated by HAA Films for Australian Pay TV and UK distribution, UPA and Arclight will be entitled to commissions plus expenses from all receipts from any media included in the Agreements.

Collection Account Management Agreement

41. The agreement is between Fintage House as Collection Account Manager, Arclight as Sales Agent, HAA Films as Producer, A2Z Distribution as Distributor, Movie Network, Government and film industry investors and the Completion Guarantor. The agreement will be for the same term as the Arclight Sales Agency Agreement and the territory covered by the agreement will be the world excluding Australasia and the United Kingdom.

42. Fintage House will establish a Collection Account in the Netherlands into which Arclight and any sub-distributors are to transfer Gross Receipts from the distribution, exhibition or other exploitation of the Film. The Investors are not entitled to any distributions from the Fintage House Collection Account.

Finance

43. This ruling does not apply if a finance arrangement entered into by an Investor to fund the Investor's investment in the arrangement includes or has any of the following features:

•

there are split loan features of the type referred to in Taxation Ruling TR 98/22;

•

entities associated with the Project are involved, or become involved, in the provision of finance to Investors for the Project;

•

there are indemnity arrangements, or other collateral agreements, in relation to the loan, designed to limit a borrower's risk;

•

the funding arrangements transform the Project into a 'scheme' to which Part IVA may apply;

•

repayments of principal and payments of interest are linked to derivation of income from the Project;

•

the funds borrowed, or any part of them, will not be available for the conduct of the Project, but will be transferred (by any means, and whether directly or indirectly) back to the lender, or any associate of the lender;

•

lenders do not have the capacity under the loan agreement, or a genuine intention, to take legal action against defaulting borrowers; or

•

the terms or conditions are not arm's length.

Section 708 of the Corporations Act 2001

44. For this Ruling to apply, an offer for an interest in the Project must have been made to, and accepted by, an Investor under one of the exclusions in subsections 708(8)-(10) of the Corporations Act 2001. These provisions set out situations where a prospectus or similar disclosure document is not required.

45. An Investor who is a 'sophisticated investor' may accept an offer for interests in the Project under subsections 708(8) and (9). Under subsection 708(8), an Investor in a managed investment scheme, referred to below as 'the person' or 'the person to whom the offer is made', will be a 'sophisticated investor' where:

•

the minimum amount payable for the interests in the Project on acceptance of the offer by the person to whom the offer is made is at least $500,000;

•

the amount payable for the interests in the Project on acceptance by the person to whom the offer is made and the amounts previously paid by the person for interests in the Project of the same class that are held by the person add up to at least $500,000; or

•

it appears from a certificate given by a qualified accountant no more than 6 months before the offer is made that the person to whom the offer is made:

(i)

has net assets of at least $2.5 million; or

(ii)

has a gross income for each of the last 2 financial years of at least $250,000 a year.

46. An Investor may also participate in the Project where the offer is made by a licensed dealer under subsection 708(10). Under this provision the dealer must be satisfied that the person to whom the offer is made has previous experience in investing which allows them to assess the merits of the offer, the value of the interests in the Project, the risks involved in accepting the offer, their own information needs and the adequacy of the information provided.

47. The licensed dealer must provide a written statement of reasons for being so satisfied. Where an Investor is accepted into the Project under this provision he or she must sign an acknowledgment that they did not receive a prospectus in relation to the offer.

Ruling

48. A deduction is available to an Investor in the Film under Division 10BA for the amount contributed to the cost of producing the Film.

49. A deduction is not available until the production budget of $6,760,909 has been achieved and the Investor has entered into the Accession Deed.

50. The Investors who acquire Copyright will comprise a tax law partnership for the purposes of Division 5 of Part III (see definition of 'partnership' in section 995-1 of the ITAA 1997) as they will be in receipt of income jointly from the commercial exploitation of their Copyright interest. The licence fees received by a Partnership in respect of the Film, less any GST on those licence fees, are assessable income of the Partnership under section 26AG in the income year in which they are received from the HAA Films Collection Account. However, pursuant to subsection 26AG(9), any income received by a Partnership from the use of, or the right to use, the Copyright is taken to have been derived by the partners. No such income is taken into account for the purposes of calculating the net income or loss of the Partnership of any year of income and, if this is the only income derived by the Partnership, it will not be necessary to lodge partnership income tax returns. Any income derived will be taken to be the income of each Investor in proportion to their share in the Partnership.

51. Interest in respect of funds borrowed and any other revenue outgoings relating to the investment incurred by the Investors to make their contributions may be deductible to the Investors in accordance with section 8-1 of the ITAA 1997, but only to the extent of film income which is derived, subsection 124ZAO(2). Any excess interest and revenue outgoings may be carried forward indefinitely and offset against future film income, subsection 124ZAO(3).

52. The deductibility or otherwise of interest arising from loan agreements entered into with financiers is outside the scope of this Ruling.

53. Upon completion of the Film, after the audit has been carried out by an independent auditor, Division 10BA deductions will be withdrawn from Investors in respect of the moneys spent on non-tax deductible items, section 124ZAG.

54. Part IVA will not apply to deny deductibility or to accelerate assessability of the above amounts.

Assumptions

55. This Ruling is made subject to the following assumptions:

(a)

The Investor was a resident of Australia for tax purposes at the time the money was expended (subparagraph 124ZAFA(1)(b)(i));

(b)

The investment moneys will be paid to the Production Company by way of contribution to the cost of producing the Film under a contract entered into on or before the end of the financial year in which the capital moneys are to be expended, being 30 June 2004. The production contract will specify that the investment moneys contributed represent the estimated cost of production of the Film (paragraph 124ZAFA(1)(a) and subparagraph 124ZAFA(1)(d)(iv));

(c)

At the relevant time, a provisional certificate (section 124ZAB) or a final certificate (section 124ZAC) is in force in relation to the Film;

(d)

Each Investor, at the relevant time, expects to become one of the first owners of the Copyright in the Film when the Copyright comes into force (subparagraph 124ZAFA(1)(c)(i));

(e)

Each Investor, at the relevant time, intends to use the interest in the Copyright for the purpose of producing assessable income from the exhibition of the Film as mentioned in subparagraph 124ZAFA(1)(c)(ii);

(f)

There will be in force a declaration lodged in respect of the Film in accordance with subsection 124ZADA(1) by a person accepted by the Commissioner under subsection 124ZADA(2) as an appropriate person to make such a declaration (subparagraph 124ZAFA(1)(d)(iii));

(g)

Before the expiration of six months after the time when the Film is completed, an application will be made for a final certificate in accordance with section 124ZAC, otherwise the provisional certificate shall be deemed never to have been in force (subsection 124ZAB(10));

(h)

All requirements of the Department of Communications, Information Technology and the Arts will be met and final certificates will be issued;

(i)

The Film will be completed and the Investors' interest in the Copyright in the Film will be used for income producing purposes within two years after the close of the financial year in which the contributions are made (subsection 124ZAFA(2));

(j)

By reason of the said capital moneys being expended, the Investor will become one of the first owners of the Copyright in the Film before 1 July 2006;

(k)

In producing the Film:

•

where an amount is expended by a person ('the Film producer') for the supply of goods or the provision of services; and

•

the Commissioner is satisfied that the Film producer and the person supplying the goods or providing the services are not dealing with each other at arm's length in relation to the transaction;

that the amount of moneys expended on the supply of those goods or the provision of those services will not exceed the amount of moneys that would have been expended by the Film producer if the Film producer and the person supplying the goods or providing the services had dealt with each other at arm's length (section 124ZAJ);

(l)

At the time the Investor expends the capital moneys by way of contribution to the cost of producing the Film, the Investor is at risk, according to the definition of 'risk' in subsection 124ZAM(2), with respect to an amount equal to or greater than the amount of those capital moneys expended (subsection 124ZAM(1));

(m)

No pre-sale arrangements, distribution rights agreements, distribution guarantee agreements, or other like agreements, have been, or will be, entered into in circumstances where such agreements would put funds into the hands of the Investors, by loan or otherwise, to enable them to expend capital moneys by way of contribution to the cost of producing the Film;

(n)

In the event of any underage, the Producer will expend the portion that would otherwise be rebateable to the Investors on the enhancement of the Film in a manner that will preserve the status of the Film as a 'qualifying Australian Film';

(o)

The dominant purpose of the Investors is to make a commercial return from their investment in the Film and the arrangements will be executed in the manner described in this Ruling; and

(p)

Expenditure associated with the Project which is not deductible under Division 10BA will not be met by the Division 10BA investors.

Explanation

Division 10BA

The 'directly expended' requirement

56. Subsection 124ZAA(6) requires that capital money contributed to the production of a film must be expended directly in producing the film in order for a deduction under Division 10BA to be available.

57. Paragraph 8 of Taxation Ruling IT 2111 discusses this requirement. It states: 'Direct expenses on a film production which qualify for a deduction under Section 124ZAFA can generally be described as those relating to the production process as distinct from those associated with financing or marketing of the Film. Such expenses would typically include amounts paid for the acquisition of story rights and the surveying of locations, payments to the producers, directors and cast, and the costs of insurance of production associated risks, drawing up performers' contracts and the building of sets and scenery' (emphasis added).

58. Our view is that the 'directly expended' requirement is not met at the point in time when the Investors make payments to HAA Films in respect of the budget for the Film. Rather, the extent of the application of the money by HAA Films to elements of production will ultimately determine the portion of the Investors' contribution that meets this requirement. Generally, this will not be known until after the completion of the Film.

59. The Investors will pay the application money to HAA Films for application towards the production costs. In doing this, HAA Films is to ensure that funds contributed by Investors are only expended on items within the Film production budget, with non-deductible expenditure to be met by funds contributed by non 10BA investors.

60. In determining the amount that is 'directly expended' on the production of the Film, we will also consider the ultimate application of any funds obtained by HAA Films as 'underage'. In this regard, HAA Films has agreed that any underage that would have otherwise been refunded to Investors will be applied towards the enhancement of music and special effects, in a manner that will preserve the status of the Film as a Qualifying Australian Film.

61. Quantification of the amount of money directly expended on the production of a film, and consequently the deduction available under Division 10BA, can only be determined after a film has been produced. To do this, a full audit of the application of the film production funds would normally be required. The practice of conducting an audit of the contribution account that is held by a Production Company (known as an audit of the 'film fund') is considered inadequate in this regard.

62. Accordingly, while a deduction should be available in respect of the contributions made by Australian Investors, the deduction will be withdrawn with retrospective effect if the amounts contributed are not directly expended on the Film.

The 'at risk' rule

63. Section 124ZAM reduces claims for Division 10BA deductions where the Commissioner is satisfied that a taxpayer was not at risk in respect of any part of the expenditure of capital moneys the taxpayer made by way of contribution to the cost of producing a film. Subsection 124ZAM(2) specifies the amount of risk is the amount of loss that, in the Commissioner's opinion, would be suffered by reason of the taxpayer's said capital expenditure where no income is derived from the taxpayer's interest in the Copyright of the Film, other than excepted income as defined in subsection 124ZAM(3).

64. Paragraph 13 of Taxation Ruling IT 2111 discusses the 'at risk' rule and states the rule:

'... does not operate to affect the deductions available to Investors where pre-sale arrangements or the sale of distribution rights are effected prior to completion of the Film unless the arrangements put funds into the hands of Investors - by loan or otherwise - to enable them to make their contributions to the costs of film production. Similar considerations apply in respect of a distribution guarantee arrangement under which an amount may be paid to Investors by a producer or another person in exchange for distribution rights, if a specified return is not achieved within a particular period (e.g. a specified percentage of the Film budget within 2 years). Payments under an arrangement of that kind would also not offend the 'at risk' rule.'

65. The 'at risk' rule applies to an investor's risk of loss before and after completion and distribution of the Film. Any arrangement which limits an investor's risk of loss can breach the 'at risk' rule. Certain types of common industry arrangements affecting risk during production of the Film are accepted as not offending the 'at risk' rule. This acceptance does not extend to arrangements which put funds into the hands of Investors to enable them to make their contributions to the costs of film production. This cannot be taken to mean that post-completion arrangements are also acceptable if they do not put funds into the hands of Investors to enable them to make their contributions. The position in paragraph 13 of IT 2111 is limited to the situations expressly mentioned.

66. The arrangement ruled on does not contain any features which attract the operation of section 124ZAM.

Non-arm's length transactions

67. Where, in producing a film, an amount is expended by a person ('the film producer') for the supply of goods or the provision of services, subsection 124ZAJ(1) allows the Commissioner to reduce deductions under Division 10BA for such amounts where he is satisfied that:

•

the film producer and the person supplying the goods or providing the services were not dealing with each other at arm's length in relation to the transaction; and

•

the amount of moneys expended on the supply of those goods or the provision of those services exceeds the amount of moneys that would have been expended by the film producer if the film producer and the person supplying those goods or providing those services had dealt with each other at arm's length.

68. The Commissioner will not be in a position to determine whether his discretion in subsection 124ZAJ(1) ought to be exercised until such time as the Film has been produced. Furthermore, to make such a determination, a full audit of the Film's application and production funds would normally be required.

69. Accordingly, while a deduction should be available in respect of capital moneys expended by Investors by way of contribution to the cost of producing the Film before the end of the financial year ending 30 June 2004, the deduction will be reduced with retrospective effect if the Commissioner determines that a producer of the Film dealt with a supplier of goods or a provider of services, in the course of producing the Film, in circumstances where the parties were not dealing at arm's length and the producer paid more for the goods or the services than the producer would have paid had the transaction been at arm's length.

Interest on borrowed funds

70. Interest incurred in respect of funds borrowed by the Investors, if any, to make their contributions will only be deductible in any year to the extent of film income derived in that year (subsection 124ZAO(2) of the ITAA 1936). Any excess interest may be carried forward to succeeding years of income for offset against future film income (subsection 124ZAO(3)).

Assessable Income

71. The Investors in Hating Alison Ashley will be considered to be a partnership for income tax purposes as they are in receipt of ordinary income or statutory income jointly (see the definition of 'partnership' in section 995-1 of the ITAA 1997). The licence fees received by a Partnership of Investors in a Film, less any GST payable on those licence fees, will be assessable income of the Investors under section 26AG in the income year in which they are received from the HAA Films Collection Account. Although there exists a tax law partnership, subsection 26AG(9) provides that income of a partnership assessable under section 26AG is taken to be income derived by the partners/Investors. The amounts received as income are payments for the right to use the rights attaching to a 'qualifying Australian film' possessed by the Investors in respect of a particular period.

72. Section 17-5 of the ITAA 1997 excludes from assessable income an amount relating to GST payable on a taxable supply.

Part IVA

73. For Part IVA to apply, there must be a 'scheme' (section 177A), a 'tax benefit' (section 177C), and a dominant purpose of entering into the scheme to obtain a tax benefit (section 177D). The arrangement subject to this Ruling will be a 'scheme'. The Investor will obtain, for example, a 'tax benefit' from entering into the scheme, in the form of a deduction allowable under the provisions in Division 10BA that would not have been obtained but for the scheme. However, it is not possible to conclude, from the arrangement outlined in this Ruling, that the scheme will be entered into or carried out with the dominant purpose of obtaining this tax benefit.

74. An Investor to whom this Ruling applies intends to stay in the scheme for its full term and derive assessable income from the exploitation of the Copyrights of the Film. Further, there are no features of the Project, as described in the said arrangement, that suggest that the Project is so 'tax driven' and 'so designed to produce a tax deduction of a certain magnitude', that the operation of Part IVA is attracted.

Payment of interest by an Investor where an assessment is amended

75. Section 204 provides that where an amendment of an assessment increasing the liability of a taxpayer to tax is made, the taxpayer is liable to pay a general interest charge to the Commissioner on the amount by which the tax payable by the taxpayer under the amended assessment exceeds the tax payable by the taxpayer under the assessment that was amended.

76. Investors who expend capital moneys by way of contribution to the cost of producing a film should be aware of this provision because, should the circumstances surrounding the production of a 'qualifying Australian film' require the Commissioner to go back and reduce the deductions claimed by Investors in that film, section 204 will have application. There is a discretion in section 8AAG of the Taxation Administration Act 1953 (TAA 1953) under which the Commissioner can remit, in appropriate circumstances, the whole or part of the charge.

Detailed contents list

77. Below is a detailed contents list for this Product Ruling:

Commissioner of Taxation
21 January 2004

This Ruling has been previously released as PR 2002/70.

References

ATO references:
NO 2003/004383

Related Rulings/Determinations:

PR 1999/95
TR 92/1
TR 92/20
TR 97/16
TR 98/22
TD 93/34
IT 2111

Subject References:
Australian films
film income
film industry
interest expenses
Product Rulings
Public Rulings
tax avoidance
tax administration

Legislative References:
ITAA 1936 26AG
ITAA 1936 26AG(9)
ITAA 1936 Div 5 of Part III
ITAA 1936 Div 10BA
ITAA 1936 124ZAA(6)
ITAA 1936 124ZAB
ITAA 1936 124ZAB(10)
ITAA 1936 124ZAC
ITAA 1936 124ZADA(1)
ITAA 1936 124ZADA(2)
ITAA 1936 124ZAFA
ITAA 1936 124ZAFA(1)(a)
ITAA 1936 124ZAFA(1)(b)(i)
ITAA 1936 124ZAFA(1)(c)(i)
ITAA 1936 124ZAFA(1)(c)(ii)
ITAA 1936 124ZAFA(1)(d)(iii)
ITAA 1936 124ZAFA(1)(d)(iv)
ITAA 1936 124ZAFA(2)
ITAA 1936 124ZAG
ITAA 1936 124ZAJ
ITAA 1936 124ZAJ(1)
ITAA 1936 124ZAM
ITAA 1936 124ZAM(1)
ITAA 1936 124ZAM(2)
ITAA 1936 124ZAM(3)
ITAA 1936 124ZAO(2)
ITAA 1936 124ZAO(3)
ITAA 1936 Part IVA
ITAA 1936 177A
ITAA 1936 177C
ITAA 1936 177D
ITAA 1936 204
ITAA 1997 8-1
ITAA 1997 995-1
Corporations Act 2001 708(1)
Corporations Act 2001 708(2)
Corporations Act 2001 708(3)
Corporations Act 2001 708(4)
Corporations Act 2001 708(5)
Corporations Act 2001 708(6)
Corporations Act 2001 708(7)
Corporations Act 2001 708(8)
Corporations Act 2001 708(9)
Corporations Act 2001 708(10)
Corporations Act 2001 708(11)
TAA 1953 Pt IVAAA
TAA 1953 8AAG
A New Tax System (GST) Act 1999
ANTS (GST)A 1999 11
Copyright Act 1968