Product Ruling

PR 1999/51

Income tax: consequences for investors in the Second Drill Film Fund

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FOI status:

May be releasedFOI number: I 1019876

Preamble

What this Product Ruling is about

1. This Ruling sets out the Commissioner's opinion on the way in which the 'tax law(s)' 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 ' the Second Drill Film Fund', or just simply as 'the Fund', 'the Project', or 'the Product'.

Tax law(s)

2. The tax law(s) dealt with in this Ruling are:

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Division 10BA;

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section 26AG; and

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Part IVA of the Income Tax Assessment Act 1936 ('the ITAA 1936').

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

Class of persons

3. The class of persons to whom this Ruling applies is those 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 term expires) and deriving assessable income from this involvement as set out in the description of the arrangement.

4. The class of persons to whom 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

5. The Ruling provides this specified class of persons with a binding ruling as to the tax consequences of this Product. The Commissioner accepts no responsibility in relation to the commercial viability of this Product, and gives no assurance the prices charged for the Product are reasonable, appropriate, or represent industry norms. A financial (or other) adviser should be consulted for such information.

6. The Commissioner rules on the precise arrangement identified in the Ruling.

7. The class of persons defined in the Ruling may rely on its contents, provided the arrangement (described below at paragraphs 12 to 26 inclusive) is carried out in accordance with details described in the Ruling. If the arrangement described in the Ruling is materially different from the arrangement that is actually carried out:

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the Ruling has no binding effect on the Commissioner, as the arrangement entered into is not the arrangement ruled upon; and

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the Ruling will be withdrawn or modified.

8. 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 part may be reproduced by any process without prior written permission from the Commonwealth, available from AusInfo. Requests and inquiries concerning reproduction and rights should be addressed to the Manager, Legislative Services, AusInfo, GPO Box 1920, Canberra ACT 2601.

Date of effect

9. This Ruling applies prospectively from 9 June 1999, 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).

10. 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

11. This Product Ruling is withdrawn and ceases to have effect on 1 July 2001. The Ruling continues to apply, in respect of the tax law(s) 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 in the persons' involvement in the arrangement.

Arrangement

12. 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:

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Application for a Product Ruling lodged by Cinevest Limited ('Cinevest') dated 9 February 1999, together with the application's attachments listed below ('the application');

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Attachment 'A' - information requirements as referred to in Product Ruling PR 98/1, and the annexures accompanying Attachment 'A';

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Annexure A - a copy of the Trust Deed dated 19 May 1998 constituting the Osscca Film Group Trust Deed No 3 ('the Trust Deed');

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Annexure B - Production Agreement, incorporating the Distribution Agreement and the Disbursement Schedule, dated 28 April 1998, between Cinevest, John Gordon McCormack ('the Representative'), Second Drill Pty Ltd ('Drill') and Verdict Pictures Pty Ltd ('Verdict') ('the Production Agreement');

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Annexure C - copy of the Prospectus issued by Cinevest in relation to 'Second Drill' dated 15 June 1998 ('the Prospectus');

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Annexure D - Copy Certificate No P05230 issued under section 124ZAB for the proposed film 'Second Drill';

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Annexure E - a chart illustrating the structure of the Second Drill Film Fund;

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Annexure F - a chart titled 'Companies Chart';

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Attachment 'B' - draft of the proposed Product Ruling;

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letter to Cinevest from the Australian Taxation Office ('the ATO') dated 29 March 1999;

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letter to the ATO from Cinevest Limited dated 31 March 1999; and

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copy of an unexecuted schedule titled 'Supplementary Information for the Second Drill Prospectus' received by facsimile in the ATO on 19 April 1999 from the Managing Director of Cinevest ('Prospectus Insert').

13. For the purposes of describing the arrangement to which this Ruling applies, except for the agreements reflected by the documents listed at paragraph 12, there are no other agreements, whether formal or informal, and whether or not legally enforceable, to which the Investor, or an associate of an Investor, is or will be a party.

14. The arrangement is called 'the Second Drill Film Fund'.

The Trust Deed

15. The Trust Deed, among other things, recites and stipulates as follows:

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that Cinevest proposes, from time to time, to offer prescribed interests, by way of Prospectus, in relation to the production of a film in respect of which a fund will be established in accordance with this Deed;

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except for the Initial Fund that is established by this Deed and will be subject to this Deed, each Fund will be established by a Memorandum of Commencement and will be administered in accordance with the Trust Deed and the Memorandum of Commencement;

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that the Producer of each film will be required to enter into a Production Agreement with Cinevest and the Representative concerning the production and marketing of the Film;

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that Cinevest has offered to appoint the Representative in respect of the interests of the Investors in each Fund and the Representative has agreed to accept this appointment;

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that each Investor will contribute its subscription towards the making of the film in the Fund and participate in the benefits resulting from that investment;

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that this Deed is made with the intent that the terms and conditions of the Deed and benefits and obligations under it will enure to Cinevest, the Representative and, to the extent provided in and subject to the provisions of the Deed, to each Investor severally who is a party to a subscription agreement;

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that the Representative will represent the Investors, as their agent, where he enters into any agreement under which the copyright of a film of a fund is assigned to or vested in the Representative and an exclusive licence is granted by the Representative to the company of another person who agrees to produce the film according to the Production Agreement;

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that, except where he is acting as agent for the Investors, the Representative will act as Trustee of each Fund pursuant to the terms of the Trust Deed;

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that Cinevest intends, after 19 May 1998, to accept subscriptions for Prescribed Interests from Investors in multiples of $1,000 accompanied by Subscription Applications for Prescribed Interests in each Fund to be established from time to time under this Deed;

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that the beneficial interest in each fund will be divided into Prescribed Interests and Cinevest shall determine the number of units into which each fund will be divided;

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that, subject to certain qualifications, each Prescribed Interest will confer on the holder an equal interest in the Fund and the film in the Fund in which that Prescribed Interest is held;

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that every person wishing to apply for Prescribed Interests in a Fund must complete and lodge a completed Subscription Application together with the Applicant's Contribution (subject to certain qualifications);

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that Investors' subscriptions are handled by the Representative;

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that Cinevest has a discretion to accept or reject the whole or part of any Subscription Application;

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that, subject to:

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Cinevest's right of rejection of an application;

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conditions concerning the clearance of any cheque representing the Applicant Investor's contribution; and

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conditions relating to the payment of subscription amounts by instalments;

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acceptance will occur upon receipt by Cinevest of the Subscription Application and the deposit of the required amount of the Applicant Investor's Contribution;

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that, subject to certain conditions relating to the issue of Prescribed Interests to underwriters, unless otherwise permitted under the Corporations Law, neither the Representative or Cinevest will allot any Prescribed Interests after the expiry of a period of twelve months commencing on the date of issue of the Prospectus;

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that the Representative will open a 'Proceeds Account' where he will deposit the subscription amounts forwarded by Applicant Investors;

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that Cinevest will open a 'Non-Deductibles Account' within 5 days of the attainment of the Minimum Subscription;

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that Cinevest can declare the offer of Prescribed Interests in any Fund closed on any date upon being reasonably satisfied that the Minimum Subscription has been attained;

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that Cinevest has the responsibility of ensuring that the Producer opens a Production Account for each film of a Fund upon the Minimum Subscription being reached;

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that, on the attaining of the Minimum Subscription, Cinevest, at its sole discretion, can direct the Representative to transfer Subscription moneys received for the Fund to either the Production Account or the Non-Deductible Account,

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that Investors will not have to make further contributions to the Fund should it be later found that Fund liabilities exceed Fund assets;

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that Cinevest will ensure that a Production Agreement is entered into for each film of a Fund and that, furthermore, any such Production Agreement must contain certain specified generic provisions;

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that Cinevest will ensure that a Completion Guarantee Agreement satisfactory to itself and the Representative is entered into in respect of each film consistent with time frames outlined in either the Production Agreement or the Prospectus;

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that neither Cinevest nor the Representative are required to provide any amount to cover an overage on any film;

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that the costs of any overage on a film are to be recovered from the parties specified in the Production Agreement as having those responsibilities;

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should such overages not be recoverable from parties identified as responsible in the Production Agreement, then Cinevest will call a meeting of Investors to determine an appropriate course of action;

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that any underage in relation to a film will be dealt with in accordance with the provisions of the Prospectus and the Production Agreement;

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that provisions relating to the marketing of a film will be set out in the relevant Production Agreement;

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that the disbursement of Proceeds in relation to a particular Fund will be made by the Representative or his delegate in accordance with the provisions of the relevant Production Agreement;

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that the payment entitlements of the Representative are as set out at clause 24;

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that the payment entitlements of Cinevest are as set out at clause 28;

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that there are no restrictions on the transfer of Prescribed Interests, provided they are transacted in the stipulated format;

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that, subject to any approval required by law and clause 43.2 of the Trust Deed, the Representative and Cinevest will by deed supplemental to this Deed effect any alteration, modification, addition or cancellation to this Deed (including clause 43) which:

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is in the opinion of the Representative necessary or expedient to comply with the provisions of any statute, regulation, by-law or ordinance or with the requirements of any statutory authority;

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is in the opinion of the Representative made to correct any manifest error or is of a formal, technical or administrative nature only;

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will in the opinion of the Representative enable the provisions of this Deed to be more conveniently, advantageously, profitably or economically administered or managed; or

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is approved by Special Resolution passed at a this Deed (clause 43.1).

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that, except in circumstances covered by clause 43.1, the powers of the Representative and Cinevest to modify the Deed are limited to situations where the conditions set out in clause 43.2 are complied with (clause 43.2 requires, among other things that Cinevest convene a meeting of Investors and that a vote be taken);

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that each Fund will terminate on the Termination Date specified in that Fund's Prospectus; and

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that the terms and conditions of this Deed are binding on the Representative, Cinevest and each Investor in the Fund and all persons claiming through them.

The Production Agreement

16. Pursuant to its obligations under the Trust Deed, Cinevest caused a Production Agreement dated 28 April 1998 to be entered into between itself, the Representative, Drill and Verdict. The said Production Agreement also incorporates a Distribution Agreement (Part B) and a Disbursement Schedule (Part C). Among other things, it recites and stipulates that:

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Cinevest hereby appoints Drill to produce, make or license to make, and market a Qualifying Australian Film called 'Second Drill' according to a format specified in the film schedule attached to the agreement;

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the Investors in the Second Drill Film Fund will become the first owners of a 50% undivided share in the Copyright of the produced film;

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Drill will acquire the other 50% of the Copyright and also acquire rights in partially or wholly developed Works, which have been granted a Provisional Certificate, to develop and produce the Film from the Works;

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upon completion of the film, Drill will deliver all Delivery Materials to Verdict for the purpose of marketing and distributing the completed Film world wide; and

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the Representative and Drill hereby grant the sole and exclusive licence to Verdict to distribute, exhibit and exploit the film Copyright and the Ancillary Rights of the Fund on the terms of this agreement.

Part A: production

17. This Part states, among other things, that:

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upon the Fund attaining Minimum Subscription and the proper execution of the relevant agreements being completed, the Representative shall transfer all subscription moneys to the film's Production Account;

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Drill agrees to make, or cause the making of, the film, and to faithfully and continuously produce a film until completion in accordance with this agreement and to the extent possible in accordance with the Production particulars and the Budget of the film;

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Drill shall not depart from such Production Particulars without the prior written consent of Cinevest;

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Drill shall have control of all artistic and associated technical aspects of the film, subject to certain specified conditions;

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Drill shall prepare a Budgeted Cost summary for the film (which includes both Deductible and Non-deductible Moneys) upon reaching the Minimum Subscription;

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that, before production, the Producer shall provide a detailed Budget (i.e., the Deductible Moneys referred to in the Budgeted Cost summary) and breakdown for the film;

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Drill shall use its best endeavours to produce the Film in accordance with the Budget (i.e., the Deductible Moneys referred to in the Budgeted Cost summary to be prepared by Drill);

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Drill and the Producer must not depart from the Budget in a material way, without the consent of Cinevest (clause 3.4);

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prior to Production, Drill may revise, reduce or increase the Budget with the prior written consent of Cinevest and Verdict (clause 3.5);

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Drill will select and secure, or cause the Producer to select and secure, the services of principal crew and of a suitable cast for the production of the film;

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Drill will complete the film by the completion date specified for the film, but in no event later than two Financial years after the end of the Financial Year in which the first Investor's contribution was accepted by Cinevest;

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Drill may subcontract all or any of its obligations under this agreement;

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Drill and the beneficial owners of the shares in Drill are all residents of Australia;

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Drill will effect certain specified insurances prior to the commencement of principal photography;

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the Producer shall establish a Production Account for the Fund to be operated exclusively for the Deductible Moneys;

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the Production Account will be operated by a nominee of Drill;

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as soon as Production Assets are no longer necessary for the purposes of production, they shall be sold, if possible, and the proceeds of the sale will be applied in meeting the costs of the sale and then in meeting costs of production;

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Drill is not entitled to any further moneys from Investors, Cinevest or the Representative, in the event that there is an overage in respect of a film of the Fund;

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in the event that there is an overage for any film of the Fund, Drill can utilise any one or a combination of the following methods to raise moneys to complete the film:

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if applicable, cause the Completion Guarantor to fund any overage;

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if Drill does not have the resources available, it may take out a loan to pay for any overage, provided that such a loan does not encumber the Film or the Copyright in any way;

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Drill may use its contacts in the film industry to have facilities and services discounted;

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Drill may approach any exempt body as specified in section 66A of the Corporations Law for investment or a loan to pay for any overage; and

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Drill can utilise any revenue from Ancillary Rights;

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where there is an overage and Drill outlaid moneys to complete the film or has taken out loans for that purpose, Drill will be entitled to recoup those moneys plus any interest incurred or costs associated thereto, from the Proceeds Account of the Fund in accordance with the Disbursements Schedule;

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any underage in relation to any film of the Fund will be paid to Drill as an additional consideration for its obligations under this Production Agreement;

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Drill will comply with the terms of any Completion Guarantee Agreement which shall reflect film industry standards;

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prior to commencement of principal photography, Drill will procure a Completion Guarantee Agreement with a competent Australian based or represented Completion Guarantor company (which may be a related entity) with sufficient funds to meet their obligations under the agreement on contractual terms acceptable to the Representative and Cinevest;

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upon completion of the film, 50% of the film Copyright will be owned absolutely and beneficially by the Investors in the Fund until the Expiry of the Fund, with the remaining 50% being owned absolutely and beneficially by Drill;

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upon Expiry of the Fund, the complete ownership of the film Copyright shall automatically transfer to Drill, in so far as the Investors have not sold or otherwise disposed of the Copyright before the Expiry Date;

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Drill is acknowledged to be the sole owner of all Ancillary Rights to the film in the Fund; and

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Drill agrees to deliver to Verdict, such Delivery Materials as determined by Verdict, not later than the film completion date.

Part B: distribution

18. This Part provides, among other things, that:

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it automatically terminates:

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if the Fund fails to reach the Minimum Subscription;

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if the films do not reach completion; or

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if the films together with the Delivery Materials are not delivered to Verdict by the Delivery Date;

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upon completion and until Expiry of the Fund, the film Copyright will be owned to the extent of 50% by each of the Investors and Drill;

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upon Expiry of the Fund, the film Copyright will be owned entirely by Drill;

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Drill is the owner of the Ancillary Rights;

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the Representative and Drill hereby grant Verdict the sole and exclusive licence to distribute, exhibit and exploit the film Copyright and Ancillary Rights of the Fund worldwide for a period of one week less than the period of the film Copyright;

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Drill will consult with and receive approval of Verdict for any changes to script or work;

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among other things, Verdict agrees and warrants that:

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it will diligently market the film Copyrights and the Ancillary Rights;

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it will establish a Marketing Account for the payment of all marketing and other Non-Deductible items in relation to the film;

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it will provide moneys to the Marketing Account, as it deems necessary and prudent for the proper marketing of the Film and the associated rights; and

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it will collect or cause the collection of all proceeds, and after the withholding of all marketing expenses, moneys paid for marketing enhancements by Verdict to subdistributors and fees pursuant to clause 8 of this agreement together with interest, it will pay the balance into the Proceeds Account;

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Verdict shall establish a Marketing Account for the film upon the Minimum Subscription being attained (its directors or assignees will be the account signatory);

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Verdict may appoint sublicensees or agents in relation to any of its rights and benefits under this part of the agreement on terms it deems appropriate;

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the fees and commissions payable to Verdict and its appointed sublicensees or agents shall, in aggregate, not exceed 40% of the contracted amount of any Marketing Agreement;

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at any time after the Minimum Subscription has been attained, the Representative is to open a Proceeds Account into which proceeds shall be paid;

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the Representative or his assignees shall be the signatories of that account but no amount may be disbursed from that account without the prior approval of Verdict; and

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proceeds from the Proceeds Account shall be disbursed to Investors in the order and priority as set out in the Disbursements Schedule contained in Part C of this agreement.

Part C: Disbursement Schedule

19. The Disbursements Schedule determines the order and priority of payments from the Proceeds Account and states, among other things, that:

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the priority and order of payment from the Proceeds Account may only be amended by resolution of Investors; and

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payments are to be made according to the following order and priority:

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for the repayment of any moneys raised incurred by Drill, the Completion Guarantor and Verdict to complete, finalise or enhance the film, together with any interest and any associated expenses paid or payable thereon;

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in repayment to Drill for any deferments and overages paid for by it from its own resources or from loans obtained by Drill, together with interest and costs of the loans (Drill is also entitled to interest if the payment out of the Proceeds Account is to repay Drill for moneys advanced by it for overages);

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in the repayment of any ongoing costs of the Fund pursuant to the provisions of the Trust Deed, and in the setting aside of moneys to meet Production Account reserve requirements; and

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in repayment of Investors' contributions to the Fund;

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in pari-passu payment to:

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Investors - 36.0% of Proceeds;

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Drill - 30.0% of Proceeds;

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Verdict - 30.0% of Proceeds;

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the Representative - 1.0% of Proceeds; and

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Cinevest - 3.0% of Proceeds.

The Prospectus

20. The Prospectus is dated 15 June 1998 and expires on 14 June 1999. Cinevest has applied to the Australian Securities and Investment Commission for an extension of the Prospectus period.

21. Investors participating in the Second Drill Film Fund will fill in an application form attached to the back of the Prospectus titled 'An Application for Units in the Second Drill Film Fund'. Unless Cinevest rejects the application, by signing the application, the Investor, among other things, irrevocably:

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acknowledges and accepts the appointment of the Representative as the Representative under the Trust Deed;

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adopts and ratifies the Representative's actions in entering into, on behalf of investors, certain material contracts identified in the Prospectus, and authorises and directs the Representative to enter into, on behalf of the Investor, those agreements not as yet entered into;

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appoints the Representative as the Investor's agent, in particular, to accept an assignment of future Copyright in each film on the Investor's behalf for the relevant period ending 30 June 2005 and to license such rights exclusively to Verdict indefinitely;

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agrees to be bound by the terms of the Trust Deed and all the Material Contracts specified in the Prospectus entered into, or to be entered into, by the Representative as Trustee of the fund or as Agent of the Investor (as the case may be);

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acknowledges that the Representative acts as Trustee of the Fund, holding all property of the Fund for the benefit of the Investors and other beneficiaries, and as agent of the Investors (as the case may be);

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acknowledges that the entitlement of the Investor to receive proceeds is governed by the provisions of the Material Contracts; and

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acknowledges that the Representative shall only be entitled to enforce any agreement entered into by the Representative in a manner provided for in the Deed and the Materials Contracts.

22. The Prospectus states, among other things, that:

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the budgeted cost of the film is $3,500,000;

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the minimum investment by an Investor is $1,000, comprising 1 unit, and thereafter in multiples of $1,000;

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the Minimum Subscription for the Fund is $1,000,000;

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each Investor will acquire an undivided legal and beneficial interest as a tenant in common in 50% of the Copyright of the film, and each Investor will be a first holder of said Copyright;

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Verdict shall be granted the right to market and distribute the film worldwide;

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Cinevest will be the Manager of the Fund, being a fund management company specialising in the film and television industry, incorporated in 1982;

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maximum brokerage of 10% is payable by Cinevest to licensed dealers or holders of proper authorities under the Corporations Law, but Cinevest retains the right to determine how much is actually paid to those parties;

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the Representative shall be John Gordon McCormack;

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the issue of Interests under the Prospectus will not be underwritten;

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the Production Company is Drill, a company that, at the date of the Prospectus, has not traded;

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Drill has entered into a Production Agreement with Cinevest and the Representative pursuant to which it has agreed to produce and market the film;

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at the date of the Prospectus, no Completion Guarantee Agreements had been entered into by any of the parties; and

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that the Fund shall terminate on the date being the later of:

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3 months after the last day of the financial year in which Proceeds received by the Representative for disbursement first do not in total exceed $100,000; or

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7 years after the end of the financial year in which the first subscription was received by Cinevest or the Representative.

Prospectus Insert

23. Although unsigned by any authorised officer of Cinevest, this Prospectus Insert was transmitted by facsimile to the ATO on 19 April 1999 by the Managing Director of Cinevest on the basis that the statements it contained represented the latest changes to the Second Drill Film Fund, and that, before the issue of any Prescribed Interests in the Fund, all prospective Investors would be required to forward to the Representative a written consent to the effect that they accept the said changes.

24. Among other things, the Prospectus Insert states that:

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the Completion Date for the film of the Fund listed in the Prospectus will now be 30 June 2001; and

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the Expiry Date of the Fund will now be 30 June 2006.

Provisional Certificate

25. A Provisional Certificate has been issued under section 124ZAB in respect of the film of the Fund as follows:

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Certificate No P05230 for the proposed feature film, 'Second Drill'.

Statements made in the Application, in documents lodged subsequent to the Application and in discussions with the Applicant

26. Cinevest, the Product Ruling applicant, makes the following statements and commitments in support of its application for a Product Ruling:

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that this Project contains no financing arrangement under which prospective investors will gain access to funds to enable them to make their investment in the Project;

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that Investors must make their own financing arrangements to fund their investment in the Project;

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that there are no pre-sale arrangements in place, as at the date of the Application;

•

to the extent that Drill is entitled to retain any underage under clause 9 of Part A of the Production Agreement in relation to the film of the Fund, that the term 'underage' is defined to mean an amount equal to the difference between the aggregate of the Division 10BA Deductible Moneys budgeted for in relation to the film and the actual cost of producing the film for delivery to Verdict, the Principal Distributor;

•

to the extent that Drill is entitled to retain any underage in relation to the film of the Fund, that Cinevest agrees that Drill will retain an amount limited to 5% of the aggregate of the Division 10BA Deductible Moneys budgeted for in relation to that film ('the 5% amount');

•

that Cinevest undertakes that any amount of underage in excess of the abovementioned '5% amount' will be returned to Investors;

•

that no amount will be classified as an underage until such time as the film has been completed and delivered to Verdict, the Principal Distributor;

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that Drill will maintain separate details of all underages and their ultimate application; and

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that the 'in pari-passu' payment to Drill of '30.0% of Proceeds' mentioned at clause 5(b) of Part C (Disbursements Schedule) of the Production Agreement is to be further split up as follows:

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Drill - '15.0% of Proceeds'; and

•

the cast and crew selected by Drill or the Producer pursuant to clause 3.6 of the Production Agreement - '15.0% of Proceeds'.

Ruling

27. Subject to the assumptions listed below at paragraph 28 of this Ruling:

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for the year ended 30 June 1999, a deduction is available to Investors in the Fund under Division 10BA for capital moneys expended in the year ended 30 June 1999 by way of contribution to the cost of producing the film, 'Second Drill', mentioned in the Prospectus;

•

distribution advances, pre-sale amounts, or any other amounts payable to the Investors in the Fund for the exploitation of their interest in the film Copyright and any rights they hold that are attached thereto will be assessable to the Investors as film income under section 26AG upon receipt; and

•

the relevant provisions in Part IVA will not be applied to cancel a tax benefit obtained under a tax law dealt with in this Ruling.

28. The Ruling at paragraph 27 is made on the basis of the following assumptions:

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that moneys contributed by the Investors in the Fund towards the cost of production of the film of the Fund will be directly expended in the production of the film (paragraph 124ZAFA(1)(a) read in conjunction with subsection 124ZAA(6));

•

that, at the time the moneys are expended by Investors in the Fund by way of contribution to the cost of producing the film of the Fund ('the relevant time'), all Investors are Australian residents (subparagraph 124ZAFA(1)(b)(i));

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that, at the relevant time, a provisional certificate (section 124ZAB) or a final certificate (section 124ZAC) is in force in relation to the film of the Fund;

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that there is evidence to show that the Investor, at the relevant time, expects to become one of the first owners of the Copyright in the film of the Fund when that Copyright comes into force (subparagraph 124ZAFA(1)(c)(i));

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that there is evidence to show that the Investor, at the relevant time, intends to use his/her interest in the said Copyright for the purpose of producing assessable income from the exhibition of the film of the Fund to the public in cinemas or by way of television broadcasting (subparagraph 124ZAFA(1)(c)(ii));

•

that there will be in force a declaration lodged in respect of the film of the Fund 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));

•

that, before the end of the financial year ending 30 June 1999, there will be a production contract entered into, under which an amount of capital moneys specified in the production contract as the estimated cost of producing the film of the Fund will be expended in producing, or by way of contribution to the cost of producing, that film (sub-subparagraph 124ZAFA(1)(d)(iv)(A));

•

that an application for a final certificate in respect of the film of the Fund is made in accordance with section 124ZAC before the expiration of 6 months after the time when the film is completed (subsection 124ZAB(10));

•

that, before 1 July 2001:

•

the Investor will have used his/her interest in the Copyright of the film of the Fund for the purpose of producing assessable income from the exhibition of the film to the public in cinemas, or by way of television broadcasting, or from the granting of rights to exhibit the film to the public in cinemas or by way of television broadcasting; or

•

the Investor will have derived assessable income under an agreement entered into before the Copyright in the film came into existence under which the Investor agreed, upon the Copyright coming into existence, to grant rights to another person to exhibit the film to the public in cinemas or by way of television broadcasting;

•

that, by reason of the said capital moneys being expended, the Investor will become one of the first owners of the Copyright in the film of the Fund before 1 July 2001;

•

in producing a film of the Fund:

•

where a person ('the film producer') expends an amount 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);

•

that, at the time the Investor expends the capital moneys by way of contribution to the cost of producing the film of the Fund, he/she 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));

•

that there is not, and will not be, a 'Minimum Commitment' (where the expression 'Minimum Commitment' is defined to mean a commitment to repay Investors the amount of their subscription(s) to the Fund, in whole or in part, from funds derived from sources other than from the amounts banked into the Fund's Proceeds Account obtained from the exploitation of the film Copyright) in place in respect of the film;

•

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

•

that Investor subscriptions made pursuant to the Prospectus of the Fund reach the Minimum Subscription (as that expression is defined in the Project documentation listed at paragraph 12) level of $1,000,000 set out in the Prospectus; and

•

that the dominant purpose of Investors in investing in the Fund is to derive assessable income from the exploitation of the Copyright of the film of the Fund and that the arrangements constituting the Fund will be implemented in the manner described under the Arrangement part of this Product Ruling.

Explanations

The 'directly expended' requirement

29. Subsection 124ZAA(6) requires that capital moneys 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 in respect of them.

30. Paragraph 8 of Taxation Ruling IT 2111 discusses this requirement. It states:

'Direct expenses of a film production which qualify for deduction under section 124ZAFA can generally be described as those relating to the production process as distinct from those associated with the 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 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).

31. Our view is that the 'directly expended' requirement is not met at the time when the Investors, through the Representative, make payments to Cinevest and Drill in respect of the budget for the film of the Fund. Rather, the extent of the application of these moneys by Cinevest and Drill to elements of production will ultimately determine the portion of the Investors' contributions that meets this requirement. Generally, this will not be known until after the completion of the film of the Fund.

32. In determining the amount that is 'directly expended' on production of the film of the Fund, we will also consider the ultimate application of any funds obtained by Drill as 'underages'. In this regard, under the arrangement, Drill will be entitled to retain the '5% amount' (as defined in paragraph 26). Where entitled to be retained, this '5% amount' is an additional consideration for Drill's performance of its obligations under the Production Agreement. Amounts of underage in excess of this '5% amount' will be returned to Investors.

33. Quantification of the amount of moneys directly expended on the production of the film of the Fund, and consequently the deduction available under Division 10BA, can only be determined after the film has been produced. To do this, a full audit of the application of the film's production funds would normally be required. The practice of conducting an audit of the contributions account that is held by the Representative is considered as inadequate in this regard.

34. Accordingly, while a deduction should be available in respect of capital moneys expended by Investors before the end of the financial year ending 30 June 1999, by way of contribution to the cost of producing the film of the Fund, the deduction will be withdrawn, with retrospective effect, if the amounts contributed are not directly expended on the film.

The 'at risk' rule

35. 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 he/she made by way of contribution to the cost of producing a film. Subsection 124ZAM(2) specifies that 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 to be derived from the taxpayer's interest in the copyright of the film, other than excepted income as defined in subsection 124ZAM(3).

36. Paragraph 13 of IT 2111 discusses the 'at risk' rule and states that 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.'

37. As there are, and will be, no pre-sale arrangements, distribution rights agreements, distribution guarantee agreements or other like agreements in existence, with provisions that allow funds to be put into the hands of Investors, by loan or otherwise, to enable them to expend capital moneys by way of contribution to the cost of producing the film, there is, and will be, no mechanism in place under which the risk attaching to the contribution of capital moneys by Investors towards the cost of producing the film, is reduced. Accordingly, on these facts, we consider that subsection 124ZAM(3) does not apply.

Non-arm's length transactions

38. 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.

39. 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 of the Fund has been produced. Furthermore, to make such a determination, a full audit of the application of the film's production funds would normally be required.

40. Accordingly, while a deduction should be available in respect of capital moneys expended before the end of the financial year ending 30 June 1999 by Investors, by way of contribution to the cost of producing the film of the Fund, the deduction will be reduced, with retrospective effect, if the Commissioner subsequently determines that the producer dealt with a supplier of goods or a provider of services, in the course of producing that 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 he/she would have paid had the dealing been at arm's length.

Payment of interest by an Investor where an assessment is amended

41. Section 170AA provides that, where an amendment of an assessment increasing the liability of a taxpayer to tax is made, the taxpayer is liable to pay interest 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.

42. 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 respect of that expenditure, section 170AA will have an application. There is, of course, a discretion in subsection 170AA(11) under which the Commissioner can remit, in appropriate circumstances, the whole or part of the interest payable under section 170AA.

Part IVA

43. 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 Second Drill Film Fund, as outlined at paragraphs 12 to 26 inclusive, will be a 'scheme'. It commenced in the period leading up to the execution of the Production Agreement. 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, for the amounts referred to in paragraph 27, that would not have been obtained but for the scheme. However, it is not possible to conclude, from the arrangement outlined at paragraphs 12 to 26 inclusive, that the scheme will be entered into or carried out with the dominant purpose of obtaining this tax benefit.

44. An Investor to whom this Ruling applies enters this scheme with the predominant purpose of deriving assessable income from the exploitation of the Copyright of the film of the Fund and will stay in the scheme for its full term. Further, there are no features of the scheme, as described in the arrangement part of this Ruling, that might 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.

Detailed contents list

45. Below is a detailed contents list for this Ruling:

Commissioner of Taxation
9 June 1999

No draft issued

References

ATO references:
NO 99/1557-5

Related Rulings/Determinations:

IT 2111
IT 2476
IT 2629
PR 98/1
PR 98/2
TR 92/20
TR 97/11
TR 97/16
TD 93/34

Subject References:
Australian films
fee expenses
film income
film industry
product rulings
public rulings
taxation administration
tax avoidance
tax benefits under tax avoidance schemes
tax shelters

Legislative References:
ITAA1936 26AG
ITAA1936 Div 10BA
ITAA1936 124ZAA
ITAA1936 124ZAA(6)
ITAA1936 124ZAB
ITAA1936 124ZAB(10)
ITAA1936 124ZAC
ITAA1936 124ZADA(1)
ITAA1936 124ZADA(2)
ITAA1936 124ZAFA
ITAA1936 124ZAFA(1)(a)
ITAA1936 124ZAFA(1)(b)(i)
ITAA1936 124ZAFA(1)(c)(i)
ITAA1936 124ZAFA(1)(c)(ii)
ITAA1936 124ZAFA(1)(d)(iii)
ITAA1936 124ZAFA(1)(d)(iv)(A)
ITAA1936 124ZAFA(2)
ITAA1936 124ZAG
ITAA1936 124ZAJ
ITAA1936 124ZAJ(1)
ITAA1936 124ZAM
ITAA1936 124ZAM(1)
ITAA1936 124ZAM(2)
ITAA1936 124ZAM(3)
ITAA1936 170AA
ITAA1936 170AA(11)
ITAA1936 Pt IVA
ITAA1936 177A
ITAA1936 177C
ITAA1936 177D