Product Ruling

PR 2004/46

Income tax: Three Dollars Film Project

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FOI status:

may be released

No guarantee of commercial success

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

Potential participants must form their own view about the commercial and financial viability of the product. 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 and how the product fits an existing portfolio. We recommend a financial (or other) adviser be consulted for such information.

This Product Ruling provides certainty for potential participants by confirming that the tax benefits set out 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 arrangement is not carried out as described, participants lose the protection of this Product Ruling. Potential participants may wish to seek assurances from the promoter that the arrangement will be carried out as described in this Product Ruling.

Potential participants should be aware that the ATO will be undertaking review activities to confirm the arrangement has been implemented as described below and to ensure that the participants in the arrangement 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 'Three Dollars', 'the Film' or 'the Project'. Persons who enter into the arrangement are referred to as Private Investor(s).

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 the ITAA 1936;

•

Section 26AG of the ITAA 1936;

•

Section 124ZAO of the ITAA 1936;

•

Section 124ZAG of the ITAA 1936;

•

Part IVA of the ITAA 1936;

•

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997);

•

Section 8-1 of the ITAA 1997; and

•

Section 995-1 of the 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 be a 'wholesale client' within the meaning of Section 761G of Corporations Act 2001 (Corporations Act).

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 part 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 28 April 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.

Arrangement

14. 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 24 November 2003 as constituted by documents provided on 11 and 24 November 2003;

•

Correspondence, phone calls and e-mails between the ATO and the Applicant dated 11, 13, 21 and 24 November 2003; 1, 5,16 and 23 December 2003; 12 and 14 January 2004;

•

Provisional Certificate number P06486 under section 124ZAB dated 27 May 2003;

•

Draft Production and Investment Agreement ('PIA') together with Schedules to be entered into between ArenaFilm Pty Limited ('Arena'), Government and film industry investors and Corrs Chambers Westgarth ('Corrs') on behalf of the Private Investors received by the ATO on 21 November 2003;

•

Production Budget, Budget Summary and drawdown schedule for the Film received by the ATO on 23 November 2003 ;

•

Draft Collection Account Management Agreement between Fintage Collection Account Management BV ('Fintage), Becker Films International Pty Ltd ('Becker'), Arena, Maze Film Sales Pty Ltd ('Maze') and Government and film industry investors, received by the ATO on 11 November 2003 and amended version received 8 December 2003;

•

Draft Information Memorandum (IM), dated October 2003 and received by the ATO on 11 November 2003;

•

Draft Completion Guarantee Agreement received by the ATO on 11 November 2003;

•

Draft Global Distribution Agreement between Maze and Arena received by the ATO on 11 November 2003;

•

Draft Australasian Distribution Contract ('Footprint Agreement') between Maze and Footprint Films Pty Ltd ('Footprint') received by the ATO on 11 November 2003;

•

Draft International Distribution Agreement ('Becker Agreement') between Maze and Becker received by the ATO on 11 November 2003;

•

Draft Licence Agreement for Italy between Maze, Arena and Fandango Srl ('Fandango') received by the ATO on 11 November 2003;

•

Draft Licence Agreement ('Pay TV Agreement') between Footprint and Premium Movie Partnership ('PMP') received by the ATO on 11 November 2003 ; and

•

Draft Maze Investor Agreement between Maze and Corrs on behalf of the Private Investors received by the ATO on 17 December 2003.

15. In accordance with the above documents, a Private Investor who participates in the arrangement must be a wholesale client as defined in section 761G of the Corporations Act, as explained in paragraphs 56 to 60 below. This Ruling does not apply unless an Investor is a wholesale client.

The Participants

16. Arena will act as the production company for the film. The film will be made exclusively in Australia. There will be no manager for the film other than Arena.

17. The investors, including government and film industry investors and Private Investors, will grant an exclusive licence to Arena to use their interest in the copyright to market the film throughout the world. In return investors will be entitled to receive a share of the gross receipts.

18. Corrs have agreed to act as the Private Investors' representative in respect of the project.

19. Arena will licence Maze to act as a distributor of the film worldwide until 2029.

20. Arena and Maze will enter into a licence agreement with Fandango to act as distributor of the film in Italy.

21. Maze will enter sublicence agreements with the following:

•

Footprint to act as distributor of the film in Australasia; and

•

Becker to act as distributor of the film in the rest of the world

22. Arena, Maze and Footprint have common directors and shareholders.

23. Investors will contribute capital funds equal to the production budget for the film of $6 million and share in the Film Copyright as follows:

Unless otherwise stated, all references to Private Investor or Investors that follow are in relation to Division 10BA Investors. This Product Ruling only applies to the $1,650,000 contributed by Division 10BA Investors.

24. Part of the funds provided by the government investor will be used to finance the non deductible items in the production budget. The balance of the funds will be used to meet the film production budget. No funds from the Private Investors will be used to pay non deductible costs.

The Project

25. The Project involves the production of a 100 minute Australian feature film to be titled 'Three Dollars'.

26. Provisional Certificate number P06486, dated 27 May 2003, has been issued by the Department of Communications, Information Technology and the Arts in respect of the Film to Arena. 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.

27. It is anticipated that the Film will be completed prior to 30 June 2006 in order to satisfy the two year requirement in Division 10BA.

28. The investment will be made up of two distinct parts. The first being an investment in the production of the film. The second is the acquisition of the right to a share of the net commission earned by Maze via the Maze Investor Agreement.

29. The production budget for the Film is $6,000,000 of which up to $1,650,000 is being sought from Private Investors. The balance of the production budget will be met by government and film industry investors as outlined in paragraph 23.

30. The Private Investors will make capital contributions towards the production of the Film under a contract to be executed no later than 30 June 2004. No prospectus will be lodged with ASIC and Private Investors will be 'wholesale clients' within the meaning of section 761G of the Corporations Act.

31. Funds from the Private Investors will be contributed as 'Preferred Gap Equity'. Preferred Gap Equity means money contributed by the Private Investors to meet expenditure relevant to the Film which is eligible for deduction under Division 10BA and which has a preferential recoupment position as defined in the PIA.

32. In addition to contributing to the cost of production of the film Private Investors will purchase the right to share in the net commissions earned by Maze via the Maze Investor Agreement ('the Investment'). The cost of the Investment will be 0.91% of the Private Investors' total investment.

Application

33. A Private Investor applies to invest in the project via the application form contained in the IM. Once the application is accepted a Private Investor is required to forward application money to Corrs who will hold the money in trust until it is required to be released under the drawdown schedule.

34. Upon signing the application the Private Investor agrees to grant Corrs a power of attorney to enter into the necessary agreements on their behalf.

Production and Investment Agreement (PIA)

35. The PIA is between Arena, as producer, government and film industry investors and the Private Investors.

36. Clause 11.1 requires Arena to establish a Production Account and the Australasian Collection Account on execution of the PIA. Where the production account is not an interest bearing account Arena must also establish an interest bearing investment account. Arena is to ensure that the Collection Account relating to the Becker Agreement is also contemporaneously established on execution of the PIA.

37. At the time of the first drawdown of an Investor's funds Arena assigns to the Investor an interest in the copyright and future copyright of the film (Clause 3).

38. Investors hold the film copyright in perpetuity and as tenants in common in proportions specified in Schedule 2 Part B of the PIA.

39. Clause 12 requires Arena to meet any overage in respect of the film. 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 the government and film industry investors.

40. Schedule 3 of the IM and Schedule 5 of the PIA specify how receipts are to be disbursed. For Private Investors the funds will be distributed as follows:

•

100% of Gross Receipts from Australia and New Zealand until $300,000 had been recouped;

•

50% of Gross Receipts from North America and Germany & 80% of Gross Receipts from the Rest of the World (excluding Australasia and Italy) until $1,350,000 has been recouped; and

•

After government and film industry investors have recouped their investments, then pari passu 13.75% of net profits.

Distribution

41. Under Clause 14.1 Investors grant to Arena the exclusive licence of the copyright, underlying rights and marketing materials for marketing the film throughout the world.

42. Arena, acting as agent for the Investors, will enter into a distribution agreement with Maze for worldwide distribution of the film until 2029.

43. Maze, as head distributor, and Arena, as producer, will enter into a sub distribution agreement with Fandango to act as distributor of the film in Italy for 20 years from the date of delivery of the film.

44. Maze, in it's capacity as head distributor, will also enter into the following sub distribution agreements:

•

with Footprint to act as distributor of the film in Australasia for 15 years from the date of delivery of the film; and

•

with Becker to act as distributor of the film in the rest of the world (excluding Italy) for 7 years from date of delivery of the film.

45. Footprint will enter into a licence agreement for Pay TV rights in Australia with PMP.

Fandango Agreement

46. $250,000 will be received by Arena, as the film's producer, from the Fandango agreement. The money is a pre completion licence fee and will be contributed by Arena to production costs of the film. No other money will be received in relation to the Fandango agreement.

47. Private Investors will have no right, title or interest in the $250,000 received by Arena. This amount will not form part of the returns to Private Investors.

Collection Account for Australasia

48. Net Revenue from the Footprint Agreement derived from marketing and distributing the film under the agreement or any sublicence agreement, such as the Pay TV Agreement, are to be deposited in the Australasian Collection Account to be established by Arena in accordance with the PIA. Footprint is entitled to deduct commissions as described in clauses 10, 11, 12 and 13 and expenses as described in clause 8 of the Footprint Agreement.

49. Funds in the Australasian Collection Account are to be distributed in accordance with schedule 5 of the PIA.

Collection Account Management Agreement (CAMA)

50. The agreement is between Fintage, as Collection Account Manager ('CAM'), Arena, Maze, the government and film industry investors and the Completion Guarantor. The CAMA applies to the territory covered by the universe excluding the Footprint Territory and the Fandango Territory.

51. Fintage will establish a Collection Account in the Netherlands into which gross receipts from distribution agreements covered by the agreement are to be deposited. The Investor are not entitled to any distributions from the CAMA.

52. Amounts received under the CAMA are distributed in accordance with Exhibit A attached to the agreement.

Maze Investor Agreement

53. The Private Investors will agree to provide the Investment (see paragraph 32) to assist Maze in the distribution of the Film. In return the Private Investors will be paid a share of the Commission earned by Maze from distribution of the film. The amount of the Investment will be to 0.91% of their total investment and is not more than $15,000 in total between all Private Investors.

54. Under the agreement the Private Investor(s) will be entitled to a 'Receipt Amount' which will be made up of a share of the Maze Commission and amounts received by Maze under the CAMA. The 'Receipt Amount' is calculated in accordance with clause 4.1:

The Receipt Amount that will be paid to the Investor will be calculated in accordance with the following formula:

(a)

In relation to Commissions:

Australasia:

Receipt Amount = (Investment / 15,000) × 30% of the Commission


World excluding Australasia, , North America and Italy:

Until A$4million in Gross Receipts is recouped:

Receipt Amount = (Investment / 15,000) × 37.5% of the Commission


After A$4million in Gross Receipts is recouped:

Receipt Amount = (Investment / 15,000) × 25% of the Commission


North America:

Receipt Amount = (Investment / 15,000) × 50% of the Commission


Plus;

(b)

the Investor's proportion of the Gross Receipts received by Maze, in the amounts and proportions set out in Schedule 5 of the PIA (see paragraph 40).

Finance

55. This ruling does not apply if a finance arrangement entered into by a Private Investor to fund the Private 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 the Private Investor(s) 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.

Corporations Act 2001

56. For this Ruling to apply, an offer for an interest in the Film must have been made to, and accepted by an Investor, who qualifies as a wholesale client as defined in Section 761G of the Corporations Act. Offers to wholesale clients do not require a prospectus or product disclosure statement.

57. A person will be a wholesale client where the persons satisfies one of the following tests contained in the Corporations Act:

•

the 'product value test' (paragraph 761G(7)(a));

•

the 'individual wealth test' (paragraph 761G(7)(c)); or

•

the 'professional investor test' (paragraph 761G(7)(d)).

58. A participant in a managed investment scheme, referred to below as 'the person' or 'the person to whom the offer is made', will satisfy the 'product value test' 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; or

•

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.

59. A participant in a managed investment scheme, referred to below as 'the person' or 'the person to whom the offer is made', will satisfy the 'individual wealth test' where, 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:

•

has net assets of at least $2.5 million; or

•

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

60. A participant in a managed investment scheme, referred to below as 'the person' or 'the person to whom the offer is made', will satisfy the 'professional investor test' where:

•

the person is a financial services licensee; or

•

the person controls at least $10 million for the purposes of investment in securities.

Ruling

Division 10BA

61. A deduction is available to a Private Investor in the Film under Division 10BA for the amount contributed to the cost of producing the Film (See example at paragraph 94).

62. A deduction is not available until the production budget of $6,000,000 has been achieved and the PIA has been executed on or before 30 June 2004.

Assessable Income

63. 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 Australasian Collection Account and under the PIA. 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.

64. Under the Maze Investor Agreement a Private Investor, in return for the payment of the Investment, is entitled to share in the commission earned by Maze as head distributor. Amounts received under the agreement that relate to the Investment will be the income of each Private Investor and not income of the partnership. These amounts will be assessable under section 6-5 of the ITAA 1997.

65. The pre-paid licence fee of $250,000 received from the Fandango Agreement is not assessable income to Private Investors.

Section 8-1

66. Interest in respect of funds borrowed and any other revenue outgoings relating to the investment incurred by the Private Investors to make their contributions may be deductible to the Private 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) of the ITAA 1936). Any excess interest and revenue outgoings may be carried forward indefinitely and offset against future film income (subsection 124ZAO(3) of the ITAA 1936).

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

68. Upon completion of the Film, after the audit has been carried out by an independent auditor, Division 10BA deductions will be withdrawn from the Private Investor(s) in respect of the moneys spent on non-tax deductible items (section 124ZAG of the ITAA 1936).

Maze Investor Agreement

69. The amount paid by a Private Investor for the Investment, i.e. the right to share in the commissions earned by Maze as head distributor, is equal to 0.91% of total funds invested. The cost of the Investment is a capital expense and is not deductible under section 8-1 of the ITAA 1997. Nor is it an expense to which Division 10BA applies (see example at paragraph 94).

Part IVA

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

Assumptions

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

(a)

The Private 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 Arena (the Production Company) by way of contribution to the cost of producing the Film under the PIA. 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 Arena ('the Film producer') for the supply of goods or the provision of services; and

•

the Commissioner is satisfied that Arena 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 Arena if the Arena 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)

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

(o)

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

Explanation

Division 10BA

The 'directly expended' requirement

72. 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.

73. 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).

74. Our view is that the 'directly expended' requirement is not met at the point in time when the Private Investors make payments to the Arena in respect of the budget for the Film. Rather, the extent of the application of the money by Arena 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.

75. The Private Investors will pay the application money to Arena for application towards the production costs. In doing this, Arena is to ensure that funds contributed by Private 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.

76. 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.

77. 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

78. 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).

79. 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.'

80. 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.

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

Non-arm's length transactions

82. 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.

83. 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.

84. 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

85. 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)). Any excess interest may be carried forward to succeeding years of income for offset against future film income (subsection 124ZAO(3)).

Assessable Income

Australasian Collection Account and PIA

86. The Investors in Three Dollars 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 Australasian Collection Account and under the PIA. 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.

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

Maze Investor Agreement

88. Under the Maze Investor Agreement a Private Investor, in return for the payment of an Investment, is entitled to share in the commission earned by Maze as head distributor. Amounts received under the agreement that relate to the Investment will be the income of each Private Investor and not income of the partnership. These amounts will be assessable under section 6-5 of the ITAA 1997.

89. The cost of acquiring the right to share in the commissions earned by Maze as a distributor of the film represents the acquisition of a right to a future stream of income. Accordingly, no deduction can be claimed in respect of the Investment as the cost of acquisition is a capital expense under subsection 8-1(2) of the ITAA 1997.

Part IVA

90. 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.

91. 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

92. 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.

93. 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 under which the Commissioner can remit, in appropriate circumstances, the whole or part of the charge.

Example

94. Bob satisfies the wholesale client test in section 761G of the Corporations Act and decides to invest $100,000 in the Three Dollars Film Project. Bob's investment is allocated between the Maze Investment amount and the cost of producing the film as follows:

95. Based on the assumptions contained in paragraph 71 the following applies in relation to Bob's investment:

•

The $910 Maze Investment is a capital expense and non deductible; and

•

The $99,090 allocated to the actual cost of producing the film will be deductible in full under Division 10BA as the non deductible film expenses will be paid out of the investment from non Division 10BA investors (per paragraph 75).

Detailed contents list

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

Commissioner of Taxation
28 April 2004

Not previously released in draft form.

References

ATO references:
NO 2003/14281

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(2)
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
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 6-5
ITAA 1997 8-1
ITAA 1997 8-1(2)
ITAA 1997 17-5
ITAA 1997 995-1
Corporations Act 2001 761G
Corporations Act 2001 761G(7)(a)
Corporations Act 2001 761G(7)(c)
Corporations Act 2001 761G(7)(d)
TAA 1953 Pt IVAAA
TAA 1953 8AAG
A New Tax System (GST) Act 1999
ANTS (GST)A 1999 11
Copyright Act 1968