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HMRC internal manual

Video Games Development Company Manual

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HM Revenue & Customs
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Taxation: profit/loss calculation - matching income to expenditure

S1217BA, S1217BE Corporation Tax Act 2009 (CTA 2009)

Part 15B CTA 2009 sets out how the profits and losses of a video game trade of Video Games Development Companies (VGDCs) (VGDC10110) are calculated for tax purposes.

The method is modelled on the way in which profits are recognised in long-term contracts (see VGDC20220). This means recognising expected income in line with the state of completion of the video game as measured by the proportion of total costs to date that has been expended.

It operates by:

  • calculating what proportion of the video game’s estimated total costs have been incurred (and are reflected in work done) within each accounting period, and
  • allocating the video game’s estimated total income in similar proportions.

This method will adjust for both changes to the estimated total income from the video game, (for example, sale of further rights) and to changes in the estimated total cost (due, for example, to a change of plans during production).

In the calculation:

  • the estimated total cost of the video game will be the expected cost of making the video game plus any expected exploitation costs (VGDC20230), and
  • the estimated total income will be all the expected income from the video game (VGDC20210).

Estimated costs and income

A VGDC may need to estimate both total expected costs and total expected income to be able to operate the formula to determine taxable profits or losses.

Where actual income and costs are known, this estimate is not necessary. For example, if a video game has been sold and no rights to further income from that video game retained, then the income is the proceeds of the sale.

Estimated total costs

The estimated total cost will generally be the total estimated allowable costs shown by the most recent and reliable estimate in the video game development budget, plus a realistic estimated cost to the VGDC of exploiting any rights in the video game that it retains.

Budgets of this sort are generally maintained by VGDCs both as a management tool and because their existence is generally a condition imposed by the completion guarantor and the financiers or commissioning publisher.

Estimated total income

The estimated total income from the video game is the total income, received or expected, from the video game over its life.

The estimate of income should include income from all sources (VGDC20210) but it should only include income that the VGDC is in a position to realistically expect and quantify. This does not include hypothetical or potential income merely because a prediction of that income has been made such as by a sales agent. The realistic expectation of income is closer to that included in the statutory accounts.

So the estimated income should broadly include that income which the company would be confident enough to include in its Profit Loss account were the video game to be treated as being on revenue account.

Whether any particular contract or agreement gives the company rights such that income should be recognised under these rules will be a question of fact. See below for further detail of how estimates are to be made.

Estimating total income earned at the end of an accounting period

At the end of any accounting period the amount of income treated as earned is calculated as follows:

The income treated as earned = C x I / T
     

Where:

C = Total costs incurred to date on the video game and reflected in work done
     
I = Estimated total income of the video game
T = Total estimated costs of the video game

Calculation of profit or loss: first period of account after trading begins

In the first period of account following the commencement of trading (VGDC20100) there are no costs reflected in work done that are attributable to a preceding accounting period because any pre-trading expenditure is treated as work of the first accounting period (VGDC20120).

The expenditure to be taken into account as a debit in calculating the taxable profit is the expenditure of the first period that is reflected in the state of completion of the video game (VGDC20240). The income to be taken into account as a credit in calculating the taxable profits of the first accounting period is the income that is treated as earned at the end of the accounting period using the formula above.

For those video games which are completed within an accounting period, and then sold, this will be the normal method for calculating the profit or loss attributable to the video game.

Calculation of profit or loss: subsequent periods of account

In subsequent periods of account the profit for the period is calculated by comparing the further work done measured by the additional expenditure and the increase, or decrease, in the income treated as earned by the video game.

The expenditure to be taken into account as a debit in calculating the taxable profit is the expenditure to date, reflected in the state of completion of the video game, less the expenditure to date at the end of the previous accounting period. This gives the expenditure of the accounting period that is reflected in the state of completion of the video game.

The income to be taken into account as a credit in calculating the taxable profits is the income that is treated as earned at the end of the accounting period using the formula above less the income treated as earned at the end of the previous accounting period. This gives the increase or decrease in the income treated as earned in the accounting period.