CREC036200 - Taxation: income: timing

Section 1179BB Corporation Tax Act (CTA) 2009 

Where the separate trade rules in Chapter 2 Part 14A CTA 2009 are applied to a production, income is recognised and expenditure is incurred in line with current accounting principles. This is the case even where the production expenditure would not usually be recognised on the profit and loss account because the company is creating a capital asset for exploitation (CREC037100). 

For more details on the matching of income to expenditure, see CREC038000. 

This treatment results in profits being recognised as production progresses and not just at completion. 

The amount of income to be recognised at the end of an accounting period is given by a formula (CREC038000). This measures the state of completion of the production by reference to the production expenditure incurred to date compared to the total production expenditure expected to be incurred overall. Future income should be discounted before being brought into this formula. 

When the production is complete, there will generally be no further expected expenditure on its development. If the rights in the production are sold outright, there will also be no further expenditure on its exploitation. All the known estimated income will have been recognised and any further income should be recognised as it is earned. 

If the production is retained and exploited there will be further expenditure on exploitation. 
 

Estimating income 

The treatment for calculating taxable profits of the production activities of a production company may involve estimating the total income and total costs of a film, TV programme or video game. The rules set out the basis on which such estimates are made. 

The aim of these rules is to ensure that the income that is recognised is in accordance with the substance of transactions in the same way that would be expected for statutory accounts. 

To be income, sums should be recognised using the same principles that are set out in FRS5 Application Note G and IAS18. These require that revenue should be recognised as the seller carries out its contractual obligations and so earns its rights to the revenue. This is on the basis that it is probable that the revenue will flow to the company and that the expected revenue can be measured reliably. 

For production companies, the estimate to be made is at the end of the accounting period using all the information available at that time, on a just and reasonable basis and taking into consideration all relevant circumstances. It follows, under the principles in FRS5 and IAS18, that speculative income, where potential buyers have not yet been identified, would not be brought into account. But where a seller has entered into a transaction with a buyer, revenue should be recognised in accordance with the substance of that transaction. 

If the revenue does not arise until the occurrence of a critical event, it is not recognised until that event occurs only if the occurrence is outside the control of the seller. The delivery of a completed production is regarded as an event that is within the seller’s control, and does not delay recognition of income. Similarly, the mere fact that the buyer has to accept the completed production does not delay recognition. 

Speculative productions 

While many productions are commissioned and will have a measure for estimated total income from the outset, some productions applying the Chapter 2 Part 14A CTA 2009 legislation may be highly speculative. There may be little, if any, income that can be brought into account in calculating profits for an accounting period. 

Nevertheless, it is likely that there will be a reliable estimate for the estimated total cost and so the costs to be debited in each accounting period will be the additional costs reflected in the work done, while the income may well be zero. 

Example 1 – sales forecasts 

At the start of development, income and expenditure for Video Game 1 is estimated as: 

Total cost of producing according to the budget and development schedule	£220k
Grants and equity investments	£50k
Existing pre-orders	£100k
Forecast of sales	£120k

 As development commences, the income to be brought into the computations under the Part 14A rules is the money which the development company expects to receive or already has; this is the grants and equity investments of £50k, plus the pre-orders of £100k. 

The forecast of £120k is the company’s judgement of how much income might be expected if the remaining rights are sold. It is speculative, with no buyer identified. The estimate, in this instance, is not considered to be sufficiently just and reasonable for the purposes of Part 14A CTA 2009 and is not included in the company’s estimated income. 

Example 2 – contracts under negotiation 

A TV production company is commissioned by a major broadcaster to make a programme for broadcast on a national channel. It is estimated that the programme will take three years to make and will have a total development budget of £1,500,000, which will be incurred on a straight-line basis over the three-year period (i.e., £500,000 a year). 

Under the terms of the commission contract, the production company will receive income of £2,100,000 in two equal tranches - the first after 18 months and the second on delivery of the programme. 

During the second year of development, the company enters into negotiations with a film company for the sale of the film rights in respect of one of the characters in the programme for £600,000. Although initial discussions were promising, negotiations fall through early in a third year of development and both parties decide not to proceed with the deal. 

The negotiations do not give the production company a realistic and quantifiable expectation of income and the income remains at £2,100,000. The income is spread over the three years of development in the form of £700,000 per year, following the straight-line expenditure of £500,000 per year. This gives taxable income of £200,000 per year. 

If the negotiations were brought to fruition in the third year, and the contract agreed as described, then the additional income of £600,000 would be recognised in Year 3. 

Example 3 – speculative production 

A film production company has purchased the rights for a book series and hopes to produce a film using them. The total cost of pre-production, shooting, editing, advertising and exploiting the film is reliably estimated as £10m. The company has established theatrical release deals for the film and intends to retain all the underlying rights itself. This includes selling digital copies of the film for home viewing, following the release in cinemas. From the company’s experience of producing similar home releases, it expects sales of not less than £60m. 

In the absence of contracts to sell the digital copies or the rights, the company has no reliably predictable income which it must estimate. 

Consequently, although expenditure on the digital copies needs to be fed into the calculation in Chapter 2 Part 14A CTA 2009 and will be deductible, there is no income to bring in until sales are made.