SECURING A PROVISIONAL CERTIFICATE PROVIDES CERTAINTY
Producers generally borrow money prior to production secured against what they will get back from the PO once a film is completed. A project has to obtain a final certificate to claim the PO and applications for final certificates can only be made once a film is completed. It therefore can have very serious implications to get the PO at 20% when 40% was expected.
Getting a provisional certificate first is not obligatory but can remove uncertainty: McDonald says no project with provisional approval as a feature has ever been refused a final certificate as a feature where nothing about the film changed. This is true even when the planned theatrical release did not go ahead: maybe the film didn’t turn out as well as hoped, the distributor realised they had five horror films including that one to usher into cinemas, or something else happened that was beyond the control of the producer. That said, the creative team might be more carefully scrutinized when they apply for certification with a new project.
“The bar on assessing distribution at provisional certification stage is high because the PO is taxpayers’ money … "
“The bar on assessing distribution at provisional certification stage is high because the PO is taxpayers’ money and once we make a decision on this we specifically state that we will not revisit it unless the key elements change. We also err on the side of caution for the sake of producers. Not all projects will be approved as features at the provisional stage but the producers can still apply at the final certificate stage for the 40% and, if they can demonstrate there was a genuine theatrical release, be successful.”
Provisional certification is often necessary anyway because traditional film lenders won’t lend against a 40% rebate unless it has been approved by Screen Australia. They often seek assurance directly from POCU staff on the mechanics of the offset and whether the PO can be abolished at a whim – it can’t because the legislation would have to be repealed by Parliament. This provides certainty and comfort to lenders.
It was once necessary to acquire a provisional certificate before applying for direct funding from Screen Australia. The number of provisional certificates that never went on to apply for final certificates has fallen since this was changed in April 2017. The assessment fees also discourage applications for projects not definitely going into production. Fees range from $127 (for a project budgeted at less than $1 million) to $4,441 (more than $30 million).
REINVESTMENTS ARE CAUSING A CONCERN
As stated at the outset, increased levels of reinvestments in feature films are causing concern in POCU. Let’s spell out the concern. A director or producer with limited or no feature filmmaking experience is paid a fee of about $400,000. In anyone’s book, this is way over the market rate. Of this amount, $300,000 is reinvested into the production budget as an equity stake with potential returns. This means the director or producer is an “interested party”, that is, someone who has a financial interest in the film beyond their fee. Under the relevant section of the tax legislation that addresses related party transactions, this obliges POCU to assess the expenditure and confirm it is charged at a market rate.
The fee paid to a director or producer falls under QAPE but if it is determined that the fee is indeed above an arm’s length market rate not all of it will be regarded as QAPE. Back to the example: 40% of $400,000 adds a not insignificant $160,000 in government funding compared to the $40,000 that would apply if the director’s or producer’s fee was $100,000.
The legislation also restricts to 20% of total film expenditure what can be claimed as QAPE on above the line (ATL) fees. However, if the budget has been inflated because of the high level of fees due to reinvestments the 20% cap becomes less of a guide when assessing arm’s length. Above the line refers to those key creators with the biggest influence on the film such as writer, director, producer and cast.
Reinvestments seem to be frequently appearing at the low end of the budget scale. The PO was not set up to support very low-budget films. Attempts by filmmakers to use reinvestments to get their films above the $500,000 QAPE threshold will be closely examined in terms of whether the related party transactions are market rate.
DECISIONS ARE MADE IN CONJUNCTION WITH THE INDUSTRY
POCU has no jurisdiction over what producers pay cast and crew. Producers can pay above market rates if they want to. But POCU does have jurisdiction over how much QAPE can be attributed to that payment when the amounts are to interested parties, which determines how much can be claimed from the Australian Tax Office (ATO) under the PO. And that’s the issue here. (Screen Australia’s direct investment arm, however, may take a view on appropriate fees on films it has invested in.)
Decisions on market rates are made in partnership with industry, says McDonald, and about 20 very experienced line producers, production accountants and others have been trained on the intricacies of the PO and are called upon for advice. There’s also 10 years’ worth of data to refer to.
“Producers sometimes ask us to tell them what the market rate is for a particular budget line item however, as the Film Authority (for the PO), it’s not our role to set rates,” McDonald says. “It is the producer’s responsibility to benchmark, negotiate and demonstrate to us that what they’re paying is appropriate for the film in question.
“We are committing taxpayers’ money on behalf of the government and we take that responsibility seriously. Even though it is an uncapped incentive we have to maintain the integrity of the intent of the legislation and report to Treasury every quarter on what has been paid out.”
“ … we have to maintain the integrity of the intent of the legislation ... "
More and more below the line crew appear to be getting higher than normal fees too and reinvesting a portion: sometimes the weekly rate will be high; sometimes it will be the going rate but the crew member is working on the film for an unusually long time making the total fee outside the market range: “An editor just out of film school working from home on Final Cut Pro might be getting an acceptable weekly rate but it’s being claimed for a full year, and they’re reinvesting a big portion,” she says. “We’re also seeing increases in post costs by post houses investing in features and office expenses and overheads being reinvested.”
“In any of these cases we have to ask ‘what’s reasonable?’ and ‘would it be different if it were a third party not an interested party transaction?’ Traditionally reinvestments were used to fill small gaps in finance plans – that last 5%. Not anymore. Sometimes it appears to be in order to reach $500,000 QAPE, which a film must have to claim the PO, sometimes to maximize QAPE and therefore the size of the claim.”
McDonald confirms that, if, during the final certificate assessment, a fee or service is considered to be above the market rate, QAPE will be reduced to what is considered commercially reasonable for the film. “We will always have discussions with the applicant and give them an opportunity to substantiate the claim, however at the end of the day if the QAPE claim is considered to be unreasonably high it will be reduced accordingly”. Producers need to be wary of entering PO loans based on QAPE figures boosted by significant reinvestments. They may find that the final offset cannot clear the loan.
McDonald also advises all creatives and crew to get independent tax advice because of the potential implications: “People have to declare the full amount as taxable income in their tax returns and may have a big tax debt as a result. This is irrespective of if they ever see the cash from their equity investment. They have to understand what they’re signing. The ATO is aware of the reinvestment structure and may check, on a case by case basis, what is being declared in individual and company tax returns.”
A PO committee meets fortnightly. Besides being alert to fees/reinvestment and distribution arrangements, projects with numerous non-Australian elements and those likely to make significantly high claims are also examined carefully. The members are all from within Screen Australia: the Chief Executive (Graeme Mason); Chief Operating Officer (Michael Brealey); Head of Content (Sally Caplan); Head of Business Affairs and Offset (Tim Phillips); and POCU Senior Manager (Michele McDonald).