Edited version of your written advice

Authorisation Number: 1051342426141

Date of advice: 1 March 2018

Ruling

Subject: Film investment

Question 1

If the film you invest in is successful and you receive income in excess of your investment, is the income you receive in excess of your investment assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Are you entitled to a deduction for your investment in a feature film under section 8-1 of the ITAA 1997?

Answer

No.

Question 3

If the film you invest in is not successful and you do not receive a return of all or part of your investment, is your loss an allowable deduction under section 8-1 of the ITAA 1997?

Answer

No.

Question 4

If you are entitled to a deduction for your investment or loss of investment in a feature film, when and how can you claim the deduction?

Answer

If you make a capital loss on the asset acquired with your investment, the loss will be included in your total capital losses for the year and can be offset against your total capital gains. Your capital loss happens at the time when a CGT event happens to your CGT asset.

This ruling applies for the following period(s)

1 July 20XX to 30 June 20XX

The scheme commences on

1 July 20XX

Relevant facts and circumstances

1. You are an Australian resident for taxation purposes.

2. You are a private investor and intend to invest in a slate of films.

3. You are not the producer of the films.

4. You are required to deposit the total investment into an Account, for disbursement by the account manager to the producer, of the applicable investment amount for each film, when the film concerned goes into production.

5. Several feature films will be produced over a period of years and that at the end of the period, or such later agreed time, any part of the total investment remaining in the Account that has not been committed to a film will be repaid to you. In addition, you are entitled to any net interest standing to the credit of the Account after final payment from the Account.

6. You transferred funds into the Account from 201Y to 201Y.

7. The earliest that your total investment in the Account was utilised for a film was 201Y for production of the first film.

8. In addition to your investment, you will also loan money to the producer of the film pursuant to a loan agreement.

9. In 201Y a sum of money has been deposited into the film producer’s account. This amount includes all of the equity (i.e. investment), part of your loan to the producer of the film and cash flow for the offset.

10. The Film Agreement is specific to each film.

11. The Film Agreement you enter in respect of each of the films you invest in will contain the same terms and conditions. The amount of your investment in respect of each individual film may vary.

12. In consideration for your investment the producer of the film assigns you the right to receive the revenue from the exploitation and marketing of the film.

13. The Film Agreement indicates the investor agrees they have made their own enquiries and formed an independent judgement as to the risks associated with the film and television industry and their investment under the agreement. And further, that the producer and production company do not warrant or represent the commercial success of the film.

14. The film’s producer owns the exclusive copyright for the film. You are not entitled to any share of the film’s copyright as a result of your investment in any of the films.

15. The producer’s rights, obligations and undertakings are detailed in the Film Agreement. The Film Agreement provides that the production company must produce and complete the film according to the budget and production schedule, and has exclusive control over all financial, creative and technical aspects of the film and its production.

16. Your investment gives you a right to income.

17. The Film Agreement states that the gross receipts from the film are to be dispersed in the order specified. Your investment entitles you to pro rata and pari passu: the return of your investment and a ‘premium’ equal to a percentage of your investment and a percentage share of profit.

18. Your investment in each of the other films will also entitle you to return of your investment, a premium and a share of profit.

19. Your intention in making the investment is to derive a profit and the transactions are commercial in nature.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 subsection 6-5(2)

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 subsection 8-1(1)

Income Tax Assessment Act 1997 subsection 8-1(2)

Income Tax Assessment Act 1997 section 15-15

Income Tax Assessment Act 1997 Parts 3-1 and 3-3

Income Tax Assessment Act 1997 subsection 102-10(2)

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 subsection 102-25(1)

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 subsection 104-10(3)

Income Tax Assessment Act 1997 subsection 104-25(1)

Income Tax Assessment Act 1997 subsection 104-25(2)

Income Tax Assessment Act 1997 subsection 110-25(2)

Income Tax Assessment Act 1997 subsection 110-55(2)

Reasons for decision

Question 1

Summary

The income you receive in excess of your investment will be assessable income under section 6-5 of the ITAA 1997.

Detailed reasoning

Subsection 6-5(2) of the ITAA 1997 states that the assessable income of an Australian resident taxpayer includes ‘ordinary income’ derived directly or indirectly from all sources whether in or out of Australia, during the income year.

A substantial body of case law has evolved over time which sets out various factors that must be taken into account to determine whether an amount is ordinary income. Where an amount does not have the characteristics of ordinary income the amount may be regarded as capital in nature. Receipts of a capital nature do not constitute income according to ordinary concepts.

Jordan CJ considered the definition of 'income' in Scott v Commissioner of Taxation (NSW) (1935) SR (NSW) 215 at 219; 3 ATD 142 at 144-145 where his Honour said:

The word "income" is not a term of art, and what forms of receipts are comprehended within it, and what principles are to be applied to ascertain how much of those receipts ought to be treated as income, must be determined in accordance with the ordinary concepts and usages of mankind, except in so far as the statute states or indicates an intention that receipts which are not income in ordinary parlance are to be treated as income, or that special rules are to be applied for arriving at the taxable amount of such receipts.

In Eisner v Macomber 252 US 189 (1919) it was said:

The fundamental relation of "capital" to "income" has been much discussed by economists, the former being likened to the tree or the land, the latter to the fruit or the crop; the former depicted as a reservoir supplied from springs, the latter as the outlet stream, to be measured by its flow during a period of time. …Here we have the essential matter: not a gain accruing to capital, not a growth or increment of value in the investment; but a gain, a profit, something of exchangeable value proceeding from the property, severed from the capital however invested or employed, and coming in, being "derived" that is, received or drawn by the recipient (the taxpayer) for his separate use, benefit and disposal; …that is income derived from property. Nothing else answers the description.

In G.P. International Pipecoaters Proprietary Limited v The Commissioner of Taxation of the Commonwealth of Australia (1990) 90 ATC 4413 the High Court held that whether a receipt is income or capital depends on its objective character in the hands of the recipient. Brennan, Dawson, Toohey, Gaudron and McHugh JJ stated:

The character of expenditure is ordinarily determined by reference to the nature of the asset acquired or the liability discharged by the making of the expenditure, for the character of the advantage sought by the making of the expenditure is the chief, if not the critical, factor in determining the character of what is paid: Sun Newspapers Ltd. v. F.C. of T. (1938) 61 C.L.R. 337 at p. 363; Colonial Mutual Life Assurance Society Ltd. v. F.C. of T. (1953) 89 C.L.R. 428 at pp. 445-447, 454…[at 4419]

To determine whether a receipt is of an income or of a capital nature, various factors may be relevant. Sometimes, the character of receipts will be revealed most clearly by their periodicity, regularity or recurrence; sometimes, by the character of a right or thing disposed of in exchange for the receipt; sometimes, by the scope of the transaction, venture or business in or by reason of which money is received and by the recipient's purpose in engaging in the transaction, venture or business. The factors relevant to the ascertainment of the character of a receipt of money are not necessarily the same as the factors relevant to the ascertainment of the character of its payment. [at 4420]

The principle has also been established that profits arising from an isolated business or commercial transaction will be ordinary income if the taxpayer's purpose or intention to enter into the transaction is to make a profit, even though the transaction may not be part of the ordinary activities of the taxpayer's business (FC of T v. The Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; 18 ATR 693).

Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income (TR 92/3) provides guidance in determining whether profits from isolated transactions are ordinary income and therefore assessable under section 6-5 of the ITAA 1997. Paragraph 35 of TR 92/3 states that profits on isolated transactions may be ordinary income if:

● the intention or purpose of a taxpayer in entering into the transaction was to make a profit or gain; and

● the transaction was entered into, and the profit was made, in carrying out a business operation or commercial transaction.

In general terms, a transaction has the characteristics of a business operation or commercial transaction if it would constitute the carrying on of a business except there is no repetition or recurrence of the transaction or operations. Paragraph 13 of TR 92/3 lists some matters that may be relevant in considering and determining whether a transaction amounts to an isolated business operation or commercial transaction, including: the nature, scale and complexity of the transaction; the nature of the entity; the manner in which the operation or transaction was entered into or carried out; and the amount of money involved and the magnitude of the profit sought.

In your case, it is considered your investment satisfies the requirements specified in TR 92/3 and is an isolated transaction from which your profit will be assessable as ordinary income.

Your investment is facilitated by the Film Agreement entered in respect of each of the feature films. You have agreed to invest in the slate of films to be produced over a number of years or such further time as agreed to, indicating that at least initially it is envisaged that the films will commence production within a few years. Slate development for the films commenced in 201Y.

Your total investment is held in the Account until it is dispersed to the producer of each film when the film concerned goes into production. A Film Agreement will be entered in respect of each film and the Film Agreement together with a tax invoice will be provided to the Manager of the Account in order that the funding for the film is then dispersed to the producer of the film. You commenced making your investment into the Account in 201Y. Your funds in the Account were first utilised in 201Y for the production of the first film.

The Film Agreement clearly specifies that as an investor you are entitled to receive revenue from the exploitation and marketing of the film as specified. You are not entitled to copyright in the films. Your entitlements include the return of your investment and, in excess of your investment, a premium amount and a share of ‘profit’.

The circumstances of your investment clearly characterise it as a transaction that is a commercial transaction. Your investment is not part of the normal course of your business. This is the case even though your total investment occurs through several transactions at different times. The circumstances also indicate you made the investment for the purpose of making a profit. Therefore your investment is an isolated commercial transaction undertaken for the purpose of profit.

Any amount you receive comprising the recoupment of your investment is not ordinary income and is not assessable income pursuant to section 6-5 of the ITAA 1997.

You are entitled to a profit component on your investment. The income you receive in excess of your investment is ordinary income and is assessable under section 6-5 of the ITAA 1997.

Statutory income

In addition to assessable income including amounts that are ordinary income, the ITAA 1997 includes in your assessable income amounts that are not ordinary income.

Section 15-15 of the ITAA 1997 operates to include in a taxpayer's income any profit arising from the carrying on or carrying out of a profit-making undertaking or plan. It does not apply to profit that is assessable as ordinary income under section 6-5 of the ITAA 1997.

Should the Commissioner have erred in characterising your profit on your investment as ordinary income, the revenue you receive in excess of your investment would be included in your assessable income pursuant to section 15-15 of the ITAA 1997. This is because you have entered into the investment with the intention of making a profit.

Question 2

Summary

You are not entitled to a deduction under section 8-1 of the ITAA 1997 for the amount of your investment. Your investment will be taken into account to determine whether you make a capital loss or a capital gain on your investment.

Detailed reasoning

Subsection 8-1(1) of the ITAA 1997 allows a deduction for all losses and outgoings to the extent they are incurred in gaining or producing assessable income. However, subsection 8-1(2) of the ITAA 1997 limits subsection 8-1(1) of the ITAA 1997 and, as is relevant, states:

8-1(2)

However, you cannot deduct a loss or outgoing under this section to the extent that:

(a) it is a loss or outgoing of capital, or of a capital nature; …

As stated in Question 1, a substantial body of case law has evolved over time which sets out various factors that must be taken into account to determine whether an amount has the characteristics of ordinary income or is to be regarded as capital in nature.

In Colonial Mutual Life Assurance Society Ltd v FC of T (1953) 10 ATD 274; (1953) 89 CLR 428, Fullagar J stated (at ATD 283; CLR 454) the questions that commonly arise to determine whether expenditure is capital are:

(1) What is the money really paid for? and (2) Is what it is really paid for, in truth and in substance, a capital asset?

Taxation Ruling TR 2011/6 Income tax: business related capital expenditure – section 40-880 of the Income Tax Assessment Act 1997 core issues (TR 2011/6) provides further summary of relevant case law and provides guidance in characterising expenditure as capital or capital in nature. Whilst TR 2011/6 concerns expenditure in the context of a business, the explanation of what constitutes capital expenditure also applies in a non-business context. TR 2011/6 states:

64. The expression 'capital expenditure' is not a defined term. Whether expenditure is capital in nature is determined on the facts of each particular case having regard to the principles established by the case law.

65. Merely because expenditure fails the positive limbs of section 8-1 will not necessarily mean that it will be capital expenditure.

66. The classic test for determining whether expenditure is of a capital or revenue nature is explained in the following passage from the judgment of Dixon J in Sun Newspapers Ltd. and Associated Newspapers Ltd. v. Federal Commissioner of Taxation (1938) 61 CLR 337; (1938) 5 ATD 23; (1938)1 AITR 403 (Sun Newspapers):

There are, I think, three matters to be considered, (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and (c) the means adopted to obtain it; that is, by providing a periodical reward or outlay...

67. The character of the advantage sought provides important direction. It provides the best guidance as to the nature of the expenditure as it says the most about the essential character of the expenditure itself. This was emphasised in the decision of the High Court in G.P. International Pipecoaters v. Federal Commissioner of Taxation (1990) 170 CLR 124; 90 ATC 4413; (1990) 21 ATR 1.

68. If expenditure produces some asset or advantage of a lasting character for the benefit of the business it will be considered to be capital expenditure. As stated in Sun Newspapers at 355 per Latham J, an enduring benefit does not require that the taxpayer obtain an actual asset, it may be a benefit which endures, in the way that fixed capital endures. Menzies J in John Fairfax & Sons Pty Ltd v. Federal Commissioner of Taxation (1959) 101 CLR 30; (1959) 11 ATD 510; (1959) 7 AITR 346 concluded that a capital expense can also result in the reduction of capital. In Foley Brothers Pty Ltd v. FC of T (1965) 13 ATD 562; (1965) 9 AITR 635, outgoings incurred for the purpose of altering the organisation or structure of the profit-yielding subject (including its demise) were considered to be of a capital nature.

In addition, in relation to ‘rights’, Taxation Determination TD 1999/82 Income tax: capital gains: can you acquire a contractual or other legal or equitable right even though there may be no tax consequences for the entity creating the right? makes it clear that expenditure for the acquisition of a contractual right is of a capital nature, stating:

1. Yes. CGT event D1 (about creating contractual or other rights) in section 104-35 of the Income Tax Assessment Act 1997 happens if one entity creates a contractual right or other legal or equitable right in another entity. The event still occurs even if there is no capital gain or loss for the entity creating the right (paragraph 102-23(a)).

2. Although there may be no tax consequences for the entity creating the right, you acquire the right 'when the contract is entered into or the right created' and you do so under the general acquisition rules in subsection 109-5(2).

In your case, the Film Agreement provides that in return for your investment you are assigned ‘the right to receive the revenue from the exploitation and Marketing of the Film in the proportion and manner set out...’ You therefore acquire contractual rights under the agreement; the right to income from the exploitation and marketing of the film.

Your investment expenditure is capital in nature because you acquire an asset. A contractual right is a ‘CGT asset’ as defined in section 108-5 of the ITAA 1997 which states that a CGT asset is any kind of property, or a legal or equitable right that is not property. It also includes part of, or an interest in, property or a legal or equitable right that is not property. Examples of assets are specified in Note 1 of section 108-5 and include ‘a right to enforce a contractual obligation’.

Your investment is each of the films is proposed to occur over a period of time. You acquire a separate CGT asset, in respect of each Film Agreement you enter into. That is, in return for your investment in each film, the Agreement for that film provides you with a CGT asset which is the acquisition of contractual rights under that particular Film Agreement for the right to income of that particular film.

You incur an outgoing, your investment, in order to produce assessable income as required by subsection 8-1(1) of the ITAA 1997. However, you are not entitled to a deduction under section 8-1 of the ITAA 1997 for your investment because funds used to purchase CGT assets are capital in nature and are therefore excluded from being deductible under section 8-1 by subsection 8-1(2) of the ITAA 1997.

Question 3

Summary

You are not entitled to a deduction under section 8-1 of the ITAA 1997 for your loss if you do not receive a return of all or part of your investment.

The investment amount is included in the cost base or reduced cost base of your CGT asset because it is money you pay to acquire the contractual rights. When you dispose of your asset or when the asset comes to an end, the amount of the capital loss is the amount by which the reduced cost base exceeds the capital proceeds. Your capital loss can then be used to reduce any capital gains you make.

Detailed reasoning

As explained in Question 2, you are not entitled to a deduction under section 8-1 of the ITAA 1997 because your investment is capital in nature and is specifically prevented from deduction under section 8-1 of the ITAA 1997.

As a result of making your investment you acquire a CGT asset (i.e. contractual rights under each Film Agreement), therefore any gain or loss you make in respect of your CGT asset will be accounted for pursuant to the CGT provisions in Parts 3-1 and 3-3 of the ITAA 1997.

To calculate whether you have made a capital gain or capital loss you take the difference between your capital proceeds and the cost base or reduced cost base of your CGT asset. The cost base or reduced cost base of a CGT asset includes the money you paid (or are required to pay) and the market value of any other property you gave (or are required to give) in respect of acquiring the asset (subsections 110-25(2) and 110-55(2) of the ITAA 1997).

Your contractual rights under each Film Agreement is the relevant CGT asset. Your investment in each film will therefore be included in the cost base or reduced cost base of that particular CGT asset and will be taken into account to determine if you make a capital gain or a capital loss at the time when a CGT event happens to your asset.

The Film Agreement provides for the return of your investment ‘pro rata and pari passu until each Approved Investor has recouped a sum equal to their respective investments…’ Your recoupment of your investment may therefore comprise several ‘returns’. Each return of your investment will constitute CGT event C2 (as discussed below) happening to the relevant ‘part’ of your asset. If a CGT event happens only to part of your CGT asset, you generally apportion the asset's cost base and reduced cost base to work out the capital gain or capital loss from the CGT event.

If the film you invest in is not successful and you receive no capital proceeds for the disposal of your asset or the ending of your asset, then your capital loss will equal your reduced cost base.

If you make a capital loss on your investment, that loss will be included in your total capital losses for the year (which includes any net capital losses from previous years). If your total capital losses exceed your total capital gains you will have a net capital loss.

Question 4

Summary

If you make a capital loss on the CGT asset acquired with your investment, your loss happens at the time when a CGT event happens to your asset. Your loss will be included in your total capital losses for the year and can be offset against your total capital gains.

Detailed reasoning

As explained in Questions 2 and 3 you cannot claim a deduction for your investment under section 8-1 of the ITAA 1997.

Your investment and the asset you acquire by making your investment is subject to the CGT provisions in the ITAA 1997.

Section 102-20 of the ITAA 1997 states you only make a capital gain or capital loss if a CGT event happens to a CGT asset that you own. CGT events are the different types of transactions that may result in a capital gain or capital loss. The gain or loss is made at the time of the CGT event.

Subsection 102-25(1) of the ITAA 1997 explains that in those circumstances where more than one event may be applicable, the one you use is the one that is the most specific to your situation. In your case, the possible CGT events that may be relevant are:

● CGT event A1 – when you dispose of your contractual rights (section 104-10 of the ITAA 1997)

● The time of event is when you enter into the contract for the disposal, or if there is no contract when the change of ownership occurs (subsection 104-10(3) of the ITAA 1997)

● CGT event C2 – when your contractual rights end by the asset being redeemed, cancelled, released, discharged or satisfied (subsection 104-25(1) of the ITAA 1997).

● The time of event is when you entered into the contract that results in the asset ending, or if there is no contract – when the asset ends (subsection 104-25(2) of the ITAA 1997).

If you make a capital loss when a CGT event happens to your CGT asset you can apply that loss against your capital gains. To the extent that your total capital losses cannot be offset against your total capital gains in an income year, your capital losses can be carried forward and offset against any capital gains realised in subsequent years. There is no time limit on how long you can carry forward a net capital loss.

You cannot deduct a net capital loss from your assessable income (subsection 102-10(2) of the ITAA 1997).

The ATO website (www.ato.gov.au) provides information about how to include net capital gains in your tax return and whether you need to report your capital losses.

The Trust tax return requires you to indicate whether you had a CGT event during the year (item 21 in the Trust tax return 2017) and to include the amount of your net capital gain (if you have one). You may also be required to complete a Capital gains tax (CGT) schedule and attach it to your tax return.

Whilst you cannot deduct a net capital loss from your assessable income and therefore do not include the loss as a deduction in your tax return you may be required to provide details of your losses with your tax return by completing and attaching a Losses Schedule to your tax return.