FPC80030 - Avoidance and disclosure: avoidance - valuation of core expenditure

CTA2009/S1184(3)

The extent to which Film Tax Relief (FTR) is available is in part dependent on the amount of core expenditure on a film. The minimum amount of core expenditure that is UK expenditure must be 10%.

To prevent the size of the budget being artificially distorted, in determining the size of a film’s core expenditure,

  • where goods or services included within the film’s core expenditure are being supplied as a result of transactions entered into (directly or indirectly) between connected persons, and
  • the amount of core expenditure might have been expected to be lesser or greater if the transaction had been between independent parties, then
  • the amount of the expenditure should be established by reference to what the arm’s length value would have been had the parties been unconnected.

The rules for connected persons which should be applied for this purpose are those set out in CTA2010/S1122 and S1123.

Production fees and intra-group charges

Film production companies may be charged by fellow group companies or other connected parties at inflated rates for supply of workers and other production services. Because the group has only incurred the underlying costs in practice, when production companies include the inflated charges in their relief claims, they are in effect receiving relief for the profit element of the charge.

This is the case where the profit element of the amount receivable from a 3rd party financier is included within the intra-group charge, and where a group self-funds a project and makes intra-group charges at an anecdotal ‘industry rate’ which includes a profit margin.

Charges between connected parties including an inflated mark-up on underlying cost which exceeds the rate HMRC would expect to see between independent parties are not eligible for Film Tax Relief. FTR is designed to give relief for expenses that have genuinely been incurred by claimants.

HMRC accepts a reasonable mark-up on underlying costs to reflect the indirect cost of overheads such as office electricity and training costs. However, this mark-up should never exceed a genuine arm’s length rate.

HMRC does not set a specific ‘acceptable’ percentage mark-up, since the rate should be reflective of market rates which will naturally vary by industry and service provided.

To reach an arm’s length value, claimant companies should:

  • Conduct a robust transfer pricing analysis, applying the OECD Transfer Pricing Guidelines (FPC80060); or
  • Identify suitable third party comparables of production fees and other service fees charged in transactions between external, independent parties.

In both cases, HMRC expects the claimant company to be able to demonstrate that its method produces a just and reasonable mark-up rate, such as may be expected between unconnected parties in an arm’s length transaction.

If HMRC considers that a claim to FTR includes inflated intra-group or connected party charges, HMRC will consider all options available to challenge it. This includes, but is not limited to, transfer pricing challenges and use of the general anti-avoidance provision at s1205 CTA09 (FPC80050). HMRC considers that charges which are inflated at a rate that cannot be shown to be reflective of an arm’s length value by transfer pricing analysis or third party comparables would be disallowed by s1205.

To help with the processing of claims, HMRC encourages customers to make additional disclosures in their FTR claims where possible, detailing the mark-up rates used for connected party transactions and the underlying direct costs and overheads.