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Private motion picture investment and the income tax incentives in Canada Duffus, Andrew J. 1977

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PRIVATE MOTION PICTURE INVESTMENT AND THE INCOME TAX INCENTIVES IN CANADA by ANDREW J . DUFFUS B. Coirim., U n i v e r s i t y of B r i t i s h Columbia, 1972 A THESIS SUBMITTED IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE DEGREE OF MASTER OF BUSINESS ADMINISTRATION i n THE FACULTY OF GRADUATE STUDIES THE FACULTY OF COMMERCE & BUSINESS ADMINISTRATION We accept t h i s t h e s i s as conforming to the r e q u i r e d standard THE UNIVERSITY OF BRITISH COLUMBIA J u l y , 197/7 © A n d r e w J . Duff us, 1977 In presenting th i s thes i s in pa r t i a l fu l f i lment of the requirements for an advanced degree at the Univers i ty of B r i t i s h Columbia, I agree that the L ibrary shal l make it f ree ly ava i l ab le for reference and study. I further agree that permission for extensive copying of this thesis for scho lar ly purposes may be granted by the Head of my Department or by his representat ives. It is understood that copying or pub l i ca t ion of th is thes is for f inanc ia l gain sha l l not be allowed without my written permission. Department of (ttrtwwvL d u j l&is'MSS AJUdni zh-tJiOi*-The Univers i ty of B r i t i s h Columbia 2075 W e s b r o o k P l a c e V a n c o u v e r , C a n a d a V 6 T 1W5 Date ABSTRACT Private investment in motion pictures i s a popular form of tax she l ter in Canada, for high income earners. This thesis attempts to determine i f the tax shelter f a c i l i t a t e d by motion picture invest -ment adequately compensates the investor f o r the high r i s k of the investment. This i s an invest igat ion therefore, of the motion p i c -ture investment environment in Canada and an appraisal of the legal the f i nanc i a l impl icat ions of employing a motion p icture tax she l te r . A thorough unbiased examination of the consequences of pr ivate motion p icture investment i s needed because of the importance to the motion p icture industry of th i s source of f inancing. From the point of view of the investor i t i s important to determine i f motion p icture investment i s a v iable-tax she l ter . I f motion p icture investment i s a v iable she l te r , i t i s necessary to determine the minimum marginal tax bracket an investor must be in before considering such an invest -ment. It must be determined what form of f i nanc ia l arrangement the investment must take. An evaluation must be made to determine the type of motion pictures that are most l i k e l y to earn a p r o f i t . I t i s also necessary to determine the value of leveraging the i n i t i a l cap i ta l investment v i s -a - v i s the incremental future investor l i a b i l i t y incur -red by the pr ivate investor. Does the immediate tax shel ter benef it o f f se t the future l i a b i l i t y of the promissory notes? The method used to answer the questions posed i s to examine the current l i t e r a t u r e on motion p icture investments, examine the legal framework of the investments and examine the relevant income tax l e g i s l a t i o n . Actual motion p icture investments are reviewed and a quant i tat ive f i nanc i a l analysis i s undertaken to determine the net — i i -outcomes to i n v e s t o r s under various circumstances. National Revenue, Taxation i s the body of the fede r a l govern-ment which i n t e r p r e t s and administers the Income Tax Act and Regulations. The terminology of the Act i s not always p r e c i s e t h e r e f o r e the tax department must i n t e r p r e t the l e g i s l a t i o n i n accordance w i t h i t s man-date which i s to c o l l e c t as much income taxes as p o s s i b l e . I f a taxpayer disagrees w i t h National Revenue, Taxation's i n t e r p r e t a t i o n he has the r i g h t of appeal to the Canadian j u d i c i a l system. A t the present time the courts have upheld National Revenue, Taxation's p o s i t i o n t h a t a taxpayer i s not e n t i t l e d t o c l a i m a c a p i t a l c o s t allowance deduction f o r any amount th a t he has not p e r s o n a l l y committed to the motion p i c t u r e investment. This study evaluates through q u a n t i t a t i v e a n a l y t i c a l techniques the f i n a n c i a l outcomes to an i n v e s t o r who i n v e s t s i n a motion p i c t u r e w i t h and without the leveraged tax s h e l t e r f a c i l i t a t e d by the s i g n i n g of promissory notes. A motion p i c t u r e investment model i s designed which generates the net present value o f a motion p i c t u r e investment over a seven year time h o r i z o n . Two h y p o t h e t i c a l i n v e s t o r income l e v e l s are used t o evaluate investment i n educational video tape programs and t h e a t r i c a l f e a t u r e length motion p i c t u r e s . Assumptions are made about the d i s t r i b u t i o n r e c e i p t s of the two types of motion p i c t u r e s . The net present value of the investments are found. The outcomes are compared and contra s t e d and conclusions are drawn. The primary conclusions are th a t an i n v e s t o r must have a marginal income tax r a t e g r e a t e r than f i f t y percent o f h i s ta x a b l e earnings. The motion p i c t u r e investment must have a s t r u c t u r e which f a c i l i t a t e s leverage o f the i n v e s t o r ' s i n i t i a l c a p i t a l investment f o r income tax purposes. The f u t u r e l i a b i l i t y necessary f o r leverage must be at l e a s t p a r t i a l l y o f f s e t by a minimum d i s t r i b u t i o n revenue guarantee. The leverage w i l l reduce the i n v e s t o r ' s p o t e n t i a l l o s s through the r e d u c t i o n of income taxes. However, the i n v e s t o r w i l l not r e a l i z e a net gain unless the motion p i c t u r e earns revenue e x c l u s i v e of the minimum revenue guarantee. I f the motion p i c t u r e does not generate any net d i s t r i b u t i o n revenue f o r the i n v e s t o r he w i l l be l i a b l e i n the f u t u r e f o r the promissory notes t h a t f a c i l i t a t e d the t a x s h e l t e r T h e r e fore, motion p i c t u r e investment d e c i s i o n s must be based upon c a r e f u l and d e t a i l e d examination of the i n t e r n a t i o n a l commercial m e r i t s o f the motion p i c t u r e property. TABLE OF CONTENTS Page ABSTRACT i i TABLE OF CONTENTS v LIST OF TABLES x ACKNOWLEDGEMENTS xi Chapter I INTRODUCTION 1 1. LIMITATIONS 3 2. THE CANADIAN MOTION PICTURE INDUSTRY - A BRIEF DESCRIPTION 5 A. P r o d u c t i o n , D i s t r i b u t i o n and E x h i b i t i o n .. 5 B. The Canadian Motion P i c t u r e Industry 8 3. PROGRAMS TO ENCOURAGE MOTION PICTURE PRODUCTION IN CANADA 13 A. Canadian Film Development Corporation .... 15 B. Canada Council 20 C. Major E x h i b i t o r s ' Investment Program 21 D. Co-Production Agreements w i t h Foreign Countries 23 E. Income Tax Incentive Program 26 4. FORMAT OF STUDY 27 A. Method 27 5. SOURCES OF DATA AND INFORMATION 28 - v -- v i -Chapter Page I I INCOME TAX INCENTIVE PROGRAM . 33 1. MOTION PICTURE INVESTMENT FOR THE PRIVATE INVESTOR 33 A. Theory of Income Tax Inc e n t i v e 34 B. Basis of a Tax S h e l t e r 36 2. PRIVATE MOTION PICTURE INVESTMENT ARRANGEMENTS 40 A. L i m i t e d P a r t n e r s h i p s 40 B. J o i n t Venture 42 C. Investor-Owner of an Undivided I n t e r e s t 43 D. Sydicate-Guarantee 45 APPENDIX A TO CHAPTER I I HOW CAPITAL COST ALLOWANCE SHELTERS TAXABLE INCOME 52 I I I INCOME TAX ACT LEGISLATION AND REGULATIONS 53 1. INTRODUCTION 53 2. LEGISLATION AND REGULATIONS - 1960 54 3. LEGISLATION AND REGULATIONS - 1966 54 4. LEGISLATION AND REGULATIONS - 1972 55 5. LEGISLATION AND REGULATIONS - 1974 57 6. LEGISLATION AND REGULATIONS - 1976 59 IV NATIONAL REVENUE, TAXATION AND THE CANADIAN COURTS VIS-A-VIS PRIVATE MOTION PICTURE INVESTMENT . 68 1. NATIONAL REVENUE, TAXATION AND MOTION PICTURE INVESTMENT 68 A. I n t e r p r e t a t i o n B u l l e t i n s 68 B. Rul i n g D e c i s i o n on a Motion P i c t u r e Film Investment 82 2. THE TAX REVIEW BOARD, THE CANADIAN COURTS AND MOTION PICTURE INVESTMENT 84 - v i i -Chapter Page IV... A. Jacques Y. Paquin Appeal 85 B. Wayne F. C u r r i e Appeal 88 C. Lawrence H. Mandel Appeal 90 APPENDIX A TO CHAPTER IV INTERPRETATION BULLETIN IT-164 99 APPENDIX B TO CHAPTER IV RULING DECISION TR-38 103 APPENDIX C TO CHAPTER IV WAYNE F. CURRIE v. THE MINISTER OF NATIONAL REVENUE 106 V MOTION PICTURE INVESTMENT - A CASE STUDY 108 1. INTRODUCTION 108 2. FINANCIAL FEASIBILITY STUDY 109 3. PRODUCTION FINANCING 112 4. INVESTMENT DOCUMENTS 113 A. T r a n s f e r of T i t l e and Ownership 116 5. DISTRIBUTION 120 A. Accounting Requirements 120 B. D i s t r i b u t i o n Reports 124 APPENDIX A TO CHAPTER V LETTERS FROM DISTRIBUTORS 126 APPENDIX B TO CHAPTER V THE WORLD OF HEALTH - DISTRIBUTION REPORT 128 VI REASSESSMENT OF A CAPITAL COST ALLOWANCE DEDUCTION AND TAXPAYER APPEAL 133 1. INTRODUCTION ' 133 2. INCOME TAX REASSESSMENT AND APPEAL 135 - v i i i -Chapter Page VII QUANTITATIVE ANALYSIS OF MOTION PICTURE INVESTMENT 144 1. INTRODUCTION 144 2. MOTION PICTURE INVESTMENT MODEL LIMITATIONS .. 147 3. GENERAL ASSUMPTIONS 148 4. THE MOTION PICTURE INVESTMENT PACKAGES 151 A. Edu-Film VideoTape Program Leveraged 151 B. Edu-Film Video Tape Program Non-Leveraged . 151 C. Educational Video Tape Program Earning P a t t e r n 152 D. The S o m e r v i l l e House Corporation Feature Films Leveraged 153 E. The So m e r v i l l e House Corporation Feature Films Non-Leveraged 155 F. Feature F i l m Earning Pat t e r n 155 5. THE MOTION PICTURE INVESTMENT MODEL 157 A. Investor-Owner Income Tax C a l c u l a t i o n s ... 157 B. Cash Flow With Investment 161 C. Cash Flow No Investment 163 D. Annual Incremental Cash Flow From Investment 163 E. Annual Present Value 164 F. Net Present Value of the Motion p i c t u r e Investment 164 6. THE MOTION PICTURE INVESTMENT MODEL OUTCOMES . 164 A. Net Present Value Outcomes 167 7. COMPARISONS AND CONTRASTS 168 8. CONCLUSIONS 170 - i x -Chapter Page APPENDIX A TO CHAPTER VII RATIONALE FOR THE PURCHASE PRICE IN NON-LEVERAGED VIDEO TAPE PROGRAM INVESTMENT 175 APPENDIX B TO CHAPTER VII FEATURE FILMS INVESTMENT PACKAGE 180 APPENDIX C TO CHAPTER VII RATIONALE FOR THE PURCHASE PRICE IN NON-LEVERAGED FEATURE FILMS INVESTMENT 188 V I I I SUMMARY, RECOMMENDATIONS AND CONCLUSIONS 191 1. INTRODUCTION , 191 2. SUMMARY OF PREVIOUS CHAPTERS 191 3. PRIVATE MOTION PICTURE INVESTMENT - GENERAL CONCLUSIONS 197 4. RECOMMENDATIONS 203 A. Recommendations t o the Federal Government 204 B. Recommendations to the Motion P i c t u r e Industry 213 C. Recommendations t o P r i v a t e Investors 219 5. AREAS OF FURTHER STUDY 225 6. CONCLUSION . 228 BIBLIOGRAPHY 233 LIST OF TABLES Table Page I- I Motion P i c t u r e P r o d u c t i o n , D i s t r i b u t i o n and E x h i b i t i o n 7 I I - I Schematic of Cash Flow i n Sydicate-Guarantee Feature Film Financing Arrangement 48 V-I Edu-Film Video Tape Program Production and Purchase Cost 114 V-II Accounts and Ledgers Maintained f o r Each Video Tape Program . 121 V- I11 D i s t r i b u t i o n Revenue Flow Schematic „ 123 VI- I THE WORLD OF HEALTH S i x Year Revenue Forecast For a 15 Minute Program „ 137 V I I - I Video Tape D i s t r i b u t i o n Earning P a t t e r n 152 V I I - I I Feature Film D i s t r i b u t i o n Earning P a t t e r n 156 VI I-111 Motion P i c t u r e Investment Model Input And C a l c u l a t i o n s 158 VII-IV Motion P i c t u r e Investment Model 165 VII-V Net Present Value of Incremental Cash Flow From Motion P i c t u r e Investment a t a 10% Discount Factor .. 169 VII-VI Schematic of Cash Flow i n Syndicate-Guarantee Feature F i l m Financing Arrangement (Showing W r i t e r ' s Reimbursement Theory) 189 - x -ACKNOWLEDGEMENT The w r i t e r w i s h e s t o e x p r e s s h i s s i n c e r e a p p r e c i a t i o n o f t h e a s s i s t a n c e o f f e r e d b y ; Don F i e l d s , Ron F r a s e r , and J i m S t e p h e n s o n . Y o u r comments and e n c o u r a g e m e n t d u r i n g t h e w r i t i n g o f t h i s p a p e r were i n v a l u a b l e . A l i s o n A p p e l b e , y o u r p e r s e v e r a n c e w h i l e t y p i n g t h i s f i n a l d r a f t i s w o r t h y o f much p r a i s e . A s p e c i a l t h a n k y o u t o Peggy M a t h e s o n f o r y o u r e f f o r t s t o make i t c o m p r e h e n s i b l e . and t o W h e e l e r and D i e b e l , t h a n x . - xi -CHAPTER I INTRODUCTION Since 1970, motion p i c t u r e s have been a popular tax s h e l t e r investment i n Canada. This study i s an attempt t o analyze the income tax i n c e n t i v e s and to evaluate how they a f f e c t the p r i v a t e motion p i c t u r e i n v e s t o r . A thorough i n v e s t i g a t i o n of motion p i c t u r e investment tax s h e l t e r s i s warranted. Many a r t i c l e s have been pu b l i s h e d about the immediate a t t r a c t i o n of motion p i c t u r e investment - the glamour, the t ax s h e l t e r , the p o s s i b i l i t y of earning m i l l i o n s ! Yet no s e r i o u s attempt has been made t o evaluate Canadian motion p i c t u r e investment proposals over t h e i r e n t i r e time h o r i z o n . Such an attempt must employ modern f i n a n c i a l theory i n order to evaluate the f i n a l consequences . t o the i n v e s t o r . - 1 -- 2 -Few motion p i c t u r e s have earned a r e t u r n f o r the i n v e s t o r . Many of the c a p i t a l c ost allowance deductions which f a c i l i t a t e the income tax s h e l t e r aspect of the investment have been challenged by Na t i o n a l Revenue, Taxation. A number of those deductions challenged have e v e n t u a l l y been d i s a l l o w e d . The investment not only f a i l e d t o earn investment income, but i t a l s o f a i l e d to avoid or defer taxes payable on other sources o f taxpayer income. The study w i l l examine the motion p i c t u r e investment environment. The study w i l l use q u a n t i t a t i v e techniques and a motion p i c t u r e investment model t o analyze several investments under various i n v e s t o r circumstances. A premise of t h i s study i s t h a t motion p i c t u r e investments are a high r i s k venture. The study w i l l t h e r e f o r e attempt to determine whether or not t h a t r i s k can be reduced. A number of questions w i l l be posed. The answers t o these questions w i l l be used to draw con c l u s i o n s and suggest recommendations aimed a t improving motion p i c t u r e investment i n Canada. . The questions are: 1. What i s the value t o the i n v e s t o r o f the income t a x s h e l t e r f a c i l i t a t e d through the i n i t i a l c a p i t a l investment leverage? 2. What i s the optimum type of motion p i c t u r e investment and the optimum investment s t r u c t u r e ? This i s , what c h a r a c t e r i s t i c s are r e q u i r e d of both the i n v e s t o r and the investment? 3. How can the r i s k s inherent >n motion p i c t u r e investment be reduced through p o s i t i v e a c t i o n by the f e d e r a l government, the motion p i c t u r e i n d u s t r y and the i n v e s t o r ? - 3 -1. LIMITATIONS This study focuses on a narrow but extremely important aspect of the motion p i c t u r e i n d u s t r y . The focus i s on the f i n a n c i n g of motion p i c t u r e production i n Canada by p r i v a t e i n v e s t o r s . Many elements o f the i n d u s t r y are taken as given. The i n d u s t r y f u n c t i o n s of p r o d u c t i o n , d i s t r i b u t i o n and e x h i b i t i o n are examined only to the extent necessary to provide the reader w i t h a ba s i c understanding of the motion p i c t u r e i n d u s t r y . Perimeters to the study are f o r two reasons. The f i r s t reason i s the l i m i t a t i o n s of time and resources of the w r i t e r . The second reason i s t h a t aspects of the motion p i c t u r e i n d u s t r y not in c l u d e d i n t h i s study are a v a i l a b l e from other sources. For example, the many books on the i n d u s t r y and the numerous trade p u b l i c a t i o n s on p r o d u c t i o n , d i s t r i b u t i o n and e x h i b i t i o n . The study i s l i m i t e d to the period from 1960 to the l a t e s t f e d e r a l budget o f March 31, 1977. The major emphasis i s on the years from 1970 to 1977. Investment by chartered banks and fi n a n c e companies are not i n c l u d e d . Except f o r a few i s o l a t e d cases t r a d i t i o n a l lending i n s t i t u t i o n s have not been a c t i v e i n motion p i c t u r e f i n a n c e i n Canada. Motion p i c t u r e f i n a n c i n g through stocks or debentures issued by production companies i s not considered. Foreign investment i n Canada a l s o i s excluded. The motion p i c t u r e production of the National Film Board and the Canadian Broadcasting Corporation i s not i n c l u d e d because p r i v a t e - 4 -investment i s not in v o l v e d i n these government o r g a n i z a t i o n s . The a c t i v i t i e s of the p r i v a t e commercial broadcasting and c a b l e c a s t i n g t e l e v i s i o n networks are excluded. The q u a n t i t a t i v e a n a l y s i s o f p r i v a t e motion p i c t u r e investment (Chapter VII) i s l i m i t e d to several h y p o t h e t i c a l investment s i t u a t i o n s . These h y p o t h e t i c a l investments are t y p i c a l of the motion p i c t u r e i n v e s t -ments c u r r e n t l y o f f e r e d i n Canada. The hyp o t h e t i c a l investments do not represent every type of motion p i c t u r e investment package th a t could be o f f e r e d . The q u a n t i t a t i v e a n a l y s i s i s l i m i t e d to the computing c a p a b i l i t i e s a v a i l a b l e to the w r i t e r . A computer program could be devised to v a s t l y increase the scope and depth of the motion p i c t u r e investment model. No attempt i s made to prove c o r r e l a t i o n s between the number of d o l l a r amounts o f motion p i c t u r e production v i s - a - v i s the development of government production i n c e n t i v e s . The curr e n t methods used by S t a t i s t i c s Canada to gather and analyze production s t a t i s t i c s r e s u l t i n i n a c c u r a t e data. A l l producers i n Canada are asked to repo r t t h e i r annual production. Producers t r a d i t i o n a l l y sub-contract various phases of a motion p i c t u r e production to other producers. The S t a t i s t i c s Canada q u e s t i o n n a i r e and e v a l u a t i o n methods do not d i s t i n g u i s h t h a t f a c t , consequently the amount o f annual production i s ove r s t a t e d . Note. The Department of National Revenue, Taxation i s the branch of the Federal Government of Canada which administers the Income Tax Act and Regulations. "There i s no "income tax department as such".^ I t i s common to r e f e r to the Department of National Revenue, Taxation as "the income tax department", "the tax department" or simply "the department". The w r i t e r uses these expressions throughout t h i s paper. - 5 -The motion p i c t u r e i n d u s t r y produces, d i s t r i b u t e s and e x h i b i t s a r t i s t i c and dramatic photoplays on motion p i c t u r e f i l m and magnetic video r e c o r d i n g tape. In t h i s paper the expression "motion p i c t u r e " i n c l u d e s both f i l m and video tape. When i t i s necessary t o d i s t i n g u i s h between the two motion p i c t u r e formats the words " f i l m " or "video tape" are used. 2. THE CANADIAN MOTION PICTURE INDUSTRY - A BRIEF DESCRIPTION  A. P r o d u c t i o n , D i s t r i b u t i o n and E x h i b i t i o n P r o d u c t i o n , d i s t r i b u t i o n and e x h i b i t i o n , are the three major a c t i v i t i e s of the motion p i c t u r e i n d u s t r y . These a c t i v i t i e s are p a r a l l e l t o manufacturing, wholesaling and r e t a i l i n g i n many other i n d u s t r i e s which market a product to a l a r g e number o f consumers i n d i v e r s e geographical l o c a t i o n s . Production Production begins with the i n c e p t i o n of an idea which w i l l u l t i m a t e l y be made i n t o a motion p i c t u r e through a complex c r e a t i v e , t e c h n i c a l process. The f i r s t s tep i n v o l v e s o b t a i n i n g the r i g h t s t o a n o v e l , a research paper or a s c r i p t . The necessary pre-production steps are t h r e e f o l d : 1. securing the f i n a n c i n g ; 2. h i r i n g c r e a t i v e personnel and t e c h n i c i a n s ; 3. l e a s i n g f i l m i n g equipment, shooting l o c a t i o n s and/or s t u d i o s . The next stage i s the most e x c i t i n g and c r e a t i v e . I t i n v o l v e s the r e c o r d i n g of images and sounds. The v i s u a l ideas are dramatized or animated and the dialogue and sound e f f e c t s are simultaneously recorded. - 6 -« Post production consists of ed i t ing the o r i g i na l "elements" 1-(exposed f i l m and recorded sound tape) according to the intent ion of the s c r i p t . The f i n a l stage i s the legal process undertaken to protect the r ights of the f i n a l product (a motion p icture f i l m or a video tape) for i t s owners. The a r t i s t i c and dramatic contents of the "photoplay" must be copyrighted fo r protection against unauthorized dup l i ca t i on . D i s t r ibut ion D i s t r ibut ion i s the a c t i v i t y of marketing the motion p icture product. Feature length motion pictures are rented to exh ib i tors (owners of motion p icture theatres or d r i v e - i n s ) . Educational f i lms are so ld d i r e c t l y to audio-visual resource personnel of school boards, post-secondary i n s t i t u t i on s or hosp i ta l s . D i s t r ibutors ship copies of the motion p icture d i r e c t l y to t h e i r customers. D i s t r ibutors are responsible for the dup l i ca t i ng , cleaning and repai r ing of the copies. They coordinate advert is ing and promotional campaigns directed at educators and the movie going pub l i c . Exhib i t ion Exhib i t ion i s the promotion and screening of motion pictures to the publ ic and exhib i tors are the owners or operators of theatres and d r i ve - i n s . Through payment of a rental f e e l , the exh ib i to r obtains the r i ght to play the motion p i c t u r e ' f o r a s pec i f i c period of time. The rental fee i s subject to the expected "box o f f i c e " (gross t i c k e t sa les) of the pa r t i cu la r motion p icture as well as the s i ze and locat ion of the theatre. TABLE I-I Motion P i c t u r e P r o d u c t i o n , D i s t r i b u t i o n and E x h i b i t i o n Process FILM PR.OPUCT/ON  PROCESS H.m.B US. FIRMS WrtCH FIRMS ITALIAN MRWS SMMISH FIRMS CAMADlAM FIRMS £Pirm6 COLOUt MlAttCt J TECHNICIANS \ DIRECTOR HOHTUEATKICAL /6 MM ( 8 2 ) p/aecr CENTALS OA SALES (/trrwottxi e. I \ STATIONS I PH.IVATE GROUPS XctMiOttHiP I CJtlXTtOM Of FILM LAB ff/STJBBffTOR LOCAL fUWif.0 £, remix, psror * ! + 2 *3 * 7 \ ! 1 I 1 \ i i i \ I I I ! k i i i \ 1 1 1 r 4 r , THEATRES. CANADIAN MOTION PICTURE DIS/RI0UTION PROCESS OTHKA MM-TMMATKlCAL UMWUE ro TNBATKM Box OFFICE IHCOMB BOX OFFICE STtrtMEffT THEATRB OWN/FA'S KMVENUe Source: Canadian Motion P i c t u r e D i s t r i b u t o r s ' A s s o c i a t i o n , " P o s i t i o n Paper Concerning the Motion P i c t u r e D i s t r i b u t i o n Industry i n Canada". 1976. Figure 1. - 8 -B. The Canadian Motion P i c t u r e Industry In 1975, Canada's motion p i c t u r e market represented $211 m i l l i o n -3 over 7% of the t o t a l world wide gross motion p i c t u r e s a l e s . Eleven m i l l i o n d o l l a r s of Canada's t o t a l was spent on educational motion p i c t u r e s and $200 m i l l i o n on t h e a t r i c a l f e a t u r e f i l m s . ^ Today, Canada i s the second l a r g e s t market f o r motion p i c t u r e s i n the world. The United States occupies f i r s t p l a c e . The Canadian market i s very important to E n g l i s h and American p r o d u c t i o n , d i s t r i b u t i o n and e x h i b i t i o n companies because o f i t s s i z e and language. The appeal of Canada's s i z a b l e market and the h i s t o r i c a l ease with which f o r e i g n f i r m s have entered Canada has r e s u l t e d i n a Canadian i n d u s t r y dominated by f o r e i g n i n t e r e s t s . Foreign i n t e r e s t s are p a r t i c u l a r l y overwhelming i n the areas o f d i s -t r i b u t i o n and e x h i b i t i o n . The motion p i c t u r e product g e n e r a l l y i s not obtained from Canadian producers but i s imported from the United Kingdom and the United S t a t e s . Production i n Canada U n t i l 10 years ago there was almost no t h e a t r i c a l f i l m p roduction i n Canada. Even r e c e n t l y , s t a t i s t i c s i n d i c a t e d t h a t the number o f Canadian productions i s small r e l a t i v e to the s i z e o f the 5 t o t a l Canadian market f o r t h e a t r i c a l f i l m s . The production t h a t does take place i n Canada i s undertaken by two main groups: the major f o r e i g n producers and the independent Canadian producers. One of the main reasons f o r e i g n producers l i k e to work i n Canada i s because of t h i s country's r e l a t i v e l y unexposed geographical background. - 9 -Independent Canadian producers as a r u l e , work e i t h e r on s p e c u l a t i o n or under subcontract arrangement f o r a major f o r e i g n producer. Resident independent Canadian producers, w i t h few e x c e p t i o n s , do not enjoy a p a r t i c u l a r l y good r e p u t a t i o n i n the United States or abroad. Therefore subcontracting arrangements are uncommon. Production o f a high q u a l i t y t h e a t r i c a l product r e q u i r e s f i l m making e x p e r t i s e and adequate f i n a n c i n g . U n f o r t u n a t e l y the absence o f f i n a n c i n g and e x p e r t i s e have severely i n h i b i t e d the prod-u c t i o n c a p a b i l i t i e s of the independent motion p i c t u r e producers. Canadian s c r i p t w r i t e r s and d i r e c t o r s who do not have the necessary experience often choose themes t h a t do not s e l l . Themes which l a c k adventure, excitement and i n t e r n a t i o n a l t h r u s t have not enjoyed great p o p u l a r i t y w i t h the North American movie going p u b l i c . Paul Morton, P r e s i d e n t , Odeon-Morton Theatres L t d . d e s c r i b e d Canadian t h e a t r i c a l motion p i c t u r e s as "depressing downbeat l i t t l e p i c t u r e s t h a t nobody wants to see i n our country or anywhere else".*' The Canadian Motion P i c t u r e D i s t r i b u t o r s ' A s s o c i a t i o n s t a t e d that "the c u l t u r a l or educational aspects of the s t o r y w i l l not a t t r a c t viewers i f the product i s not p r i m a r i l y e n t e r t a i n i n g and o f good t e c h n i c a l q u a l i t y . " ^ Most independently produced Canadian t h e a t r i c a l motion p i c t u r e s l a c k the necessary craftsmanship and entertainment value. Canadian t h e a t r i c a l f i l m s t h e r e f o r e , are s u i t a b l e f o r n e i t h e r Canada's nor the world's commercial motion p i c t u r e market. Educational motion p i c t u r e producers have a marginal commercial e x i s t e n c e i n Canada because the North American market i s h i g h l y compet-a t i v e . I f the producers expect t h e i r motion p i c t u r e s t o be w i d e l y - 10 -d i s t r i b u t e d and earn a p r o f i t , t h e i r product must be compatible with educational curriculums throughout North America. The s l i g h t e s t f l u c t u a t i o n i n government spending on a u d i o - v i s u a l teaching a i d s can j e o p a r d i z e the p r o f i t a b i l i t y of an educational motion p i c t u r e . Sources o f f i n a n c e have been r e l u c t a n t to commit l a r g e amounts of money i n Canadian motion p i c t u r e p r o d u c t i o n , given the i n f a n c y o f the Canadian i n d u s t r y , the non-commercial a t t i t u d e of Canadian f i l m makers and the inherent investment r i s k . Consequently there i s a shortage of commercial Canadian made product. D i s t r i b u t i o n i n Canada Most t h e a t r i c a l d i s t r i b u t i o n i n Canada i s undertaken by f o r e i g n c o n t r o l l e d d i s t r i b u t o r s . The most important of these d i s t r i b u t o r s are the American s u b s i d i a r i e s of Walt Disney, Avco Embassy, 20th Century Fox, United A r t i s t s Corp., U n i v e r s a l F i l m s , Warner B r o t h e r s , Columbia P i c t u r e s , Paramount P i c t u r e s Corporation and Metro-Goldwyn-Mayer. In 1974 these companies, or t h e i r Canadian r e p r e s e n t a t i v e s earned most o f the $59,860,000 paid f o r the r e n t a l o f f e a t u r e l e n g t h motion o p i c t u r e s i n Canada. There are approximately 70 other f i l m d i s t r i b u t o r s i n Canada, none of which are very l a r g e and whose product i s of l i m i t e d commercial value. Several of these are a l s o owned or c o n t r o l l e d by f o r e i g n i n t e r e s t s . They are c a l l e d "independents" to d i s t i n g u i s h them from the "majors" (Walt Disney et a l ) . The educational d i s t r i b u t o r s are l a r g e l y owned by Canadians but s e v e r a l , such as McGraw-Hill, Ryerson L t d . , Encyclopedia B r i t a n n i c a Educational Films and B.F.A. Educational Media are owned by American - 11 -c o n t r o l l e d p u b l i s h i n g or media i n t e r e s t s . Canadian educational d i s t r i b u t o r s often form agreements with American d i s t r i b u t o r s to c a r r y t h e i r product l i n e s on an e x c l u s i v e b a s i s . The Draft Film P o l i c y commissioned by the Secretary of State s t a t e d t h a t about two-thirds o f the market f o r f i l m s and other educa-t i o n a l m a t e r i a l are occupied by imports mostly from the United S t a t e s . ^ Once a g a i n , through i n d i r e c t means, the American i n t e r e s t makes i t s e l f manifest i n the Canadian market. E x h i b i t i o n In Canada T h e a t r i c a l e x h i b i t i o n i s dominated by two companies: Famous Play-ers Theatres L i m i t e d and Odeon Theatres (Canada) L t d . who together own 60% of the 1,116 t h e a t r e s and 307 d r i v e - i n s i n CanadaJ° The remain-i n g 40% of Canadian e x h i b i t i o n o u t l e t s are owned and operated by the "independents". Some independents may operate as many as t e n the a t r e s or d r i v e - i n s . Famous Play e r s and Odeon, the two n a t i o n a l c h a i n s , because o f t h e i r high p r o f i l e s , are the t a r g e t of much c r i t i c i s m from Canadian f i l m makers, p a r t i c u l a r l y the Canadian Council o f F i l m Makers. The C.C.F.M., a h i g h l y vocal group, makes the accusation t h a t " s e c r e t " agreements e x i s t between c e r t a i n major d i s t r i b u t o r s and the two c h a i n s . T h i s accusation has f u r t h e r f u e l e d the arguments f o r f o r e i g n motion p i c t u r e quotas, a d d i t i o n a l box o f f i c e l e v i e s or p o s s i b l e n a t i o n a l i z a t i o n of the t h e a t r e chains. The major d i s t r i b u t o r s and e x h i b i t o r s are represented by the Canadian Motion P i c t u r e D i s t r i b u t o r s ' A s s o c i a t i o n . The C.M.P.D.A. - 12 -responds to the C.C.F.M.'s c r i t i c i s m by s t a t i n g t h a t the d i s t r i b u t o r s and e x h i b i t o r s need product as there i s a world wide shortage o f motion p i c t u r e s w i t h a high degree of p u b l i c appeal. They s t a t e i n t h e i r b r i e f e n t i t l e d " p o s i t i o n Paper Concerning the Motion P i c t u r e Industry i n Canada" t h a t "with regard to e x p l o i t a t i o n and d i s t r i b u t i o n " of Canadian product: contrary to some o p i n i o n , no p a r t i c u l a r problem i s envisaged provided the r i g h t product i s there. The o n l y yard s t i c k t hat governs the number of play dates and attendant box o f f i c e grosses i s p u b l i c support. F a i l i n g p u b l i c support, the t h e a t r e e x h i b i t o r , r e g a r d l e s s of h i s business r e l a t i o n s h i p s , w i l l r e f use to book a p i c t u r e . ^ The C.M.P.D.A. claims t h a t : , The shortage of s u c c e s s f u l Canadian f i l m s i s due to the absence of s i g n i f i c a n t economic o r g a n i z a t i o n w i t h the c a p a c i t y o f c o r r e c t l y packaging an a p p r o p r i a t e property t h a t has the r i g h t a r t i s t i c bias and a very s p e c i f i c i n t e r n a t i o n a l t h r u s t . ' 3 The arguments go back and f o r t h w i t h both s i d e s accusing the other of incompetence, dishonesty and ignorance. However, the f a c t remains t h a t o n l y ten Canadian f e a t u r e f i l m s have ever earned over $1 m i l l i o n i n box o f f i c e gross t i c k e t s a l e s i n Canada. ^ Of these t e n , o n l y three or f o u r have had any s i g n i f i c a n t p u b l i c appeal i n other E n g l i s h language markets i n the world. In c o n c l u s i o n , motion p i c t u r e production i n Canada o f both f e a t u r e s and educational f i l m s i s very unstable. The amount of Canadian production r i s e s and f a l l s w i t h the f l o w of government a i d i n the form of l o a n s , g r a n t s , and tax i n c e n t i v e s . The Canadian motion p i c t u r e i n d u s t r y i s dominated by f o r e i g n i n t e r e s t s which e f f e c t i v e l y c o n t r o l the product from production to e x h i b i t i o n . - 13 -3. PROGRAMS TO ENCOURAGE MOTION PICTURE PRODUCTION IN CANADA The f e d e r a l government f o r the past ten years has attempted to encourage the development of a v i a b l e Canadian f i l m i n d u s t r y . U n f o r t u n a t e l y the various i n c e n t i v e s to a t t a i n t h i s goal have not been very w e l l coordinated w i t h each other or with the tru e needs of the i n d u s t r y . The la c k of a c l e a r l y s t a t e d government f i l m p o l i c y f o r Canada and the u n c e r t a i n nature of the i n c e n t i v e programs, are s e r i o u s l y hampering long-term i n d u s t r y development. In c e n t i v e programs are devised, announced and implemented, but there i s evidence t h a t these are merely "stop-gap" measures responding to pressure from v a r i o u s s e c t o r s of the i n d u s t r y and the general p u b l i c . C l e a r l y what i s needed i s a coordinated study of the i n d u s t r y , i n c l u d i n g a s e r i o u s a p p r a i s a l of what Canada can o f f e r not only to the Canadian movie-going p u b l i c but a l s o , and most important, t o the world market. I t i s known that the government has commissioned s t u d i e s of the f i l m i n d u s t r y through the Secretary of State Department but as y e t no conclusions have been announced. For the past f o u r years the response from both the former and c u r r e n t S e c r e t a r i e s of State has been t h a t a concrete f i l m p o l i c y f o r Canada i s "under review". Meanwhile the various i n c e n t i v e programs limp along on a piece meal b a s i s w i t h one government department often s e r i o u s l y thwarting the e f f o r t s o f another government agency, e.g. Secretary of State's co-production agreements with f o r e i g n c o u n t r i e s versus the Department of Manpower and Immigration's p o l i c i e s regarding work permits and immigration v i s a s . Superimposed upon these f a c t o r s i s the competition - 14 -to the p r i v a t e independent f i l m / v i d e o tape production companies from the t o t a l l y government funded agencies: The Nati o n a l F i l m Board and Canadian Broadcasting Corporation. Why encourage development o f a v i a b l e Canadian f i l m i n d u s t r y ? F i r s t there are two economic reasons. 1. The monetary value of production and d i s t r i b u t i o n c o n t r i b u t e to the gross n a t i o n a l product. Production i s labour i n t e n s i v e and i s a stimulus to the n a t i o n a l employment l e v e l . For example, i n 1975, production was estimated a t $150 m i l l i o n . In the same year d i s t r i b u t i o n and e x h i b i t i o n i n the t h e a t r i c a l and n o n - t h e a t r i c a l market (educational and t e l e v i s i o n ) was $251 m i l l i o n . 1 5 2. The monetary value of e x p o r t a t i o n of Canadian motion p i c t u r e s c o n t r i b u t e t o the balance of payments. The export market f o r Canadian productions has great p o t e n t i a l c o n s i d e r i n g the s i z e of the E n g l i s h speaking motion p i c t u r e markets and t h e i r p r o x i m i t y to Canada. Second, there are the n a t i o n a l c u l t u r a l reasons f o r a v i a b l e Canadian f i l m i n d u s t r y : 1. Films act as a medium of c u l t u r a l exchange w i t h i n the various subcultures of our n a t i o n a l p r o f i l e . 2. I n t e r n a t i o n a l r e l e a s e of Canadian productions i n world t h e a t r i c a l and t e l e v i s i o n markets i s a n a t u r a l o u t l e t f o r expressing t h i s m u l t i - f a c e d Canadian c u l t u r e , l e a d i n g to a gre a t e r world r e c o g n i t i o n of Canada. The government programs to encourage and a i d motion p i c t u r e production i n Canada w i l l be reviewed under the Canadian F i l m Development - 10 -C o r p o r a t i o n , the Canada C o u n c i l , the Major E x h i b i t o r ' s investment Program the Co-Production Agreements w i t h Foreign Countries and the Income Tax Incentive Program. A. Canadian F i l m Development Corporation The Canadian Film Development Corporation (C.F.D.C.) was created by a f e d e r a l c a b i n e t d e c i s i o n i n August, 1964. The c a b i n e t approved i n p r i n c i p l e the establishment o f a loan fund t o a i d i n the development of a Canadian f e a t u r e f i l m i n d u s t r y . In the 1965 Speech from the Throne, the f e d e r a l government s t a t e d i t s i n t e n t i o n s to a i d the motion p i c t u r e i n d u s t r y . In October of t h a t same y e a r , the Secretary of State announced t h a t a Crown Corporation r e s p o n s i b l e f o r a d m i n i s t e r i n g a $10 m i l l i o n r e v o l v i n g fund would be e s t a b l i s h e d . The purpose of the crown c o r p o r a t i o n would be t o f i n a n c i a l l y a s s i s t Canadian motion p i c t u r e p r o d u c t i o n s . The C.F.D.C. would i n v e s t i n productions t h a t have a theme that f o s t e r s the develop-ment of a n a t i o n a l c u l t u r a l awareness of Canada and promotes the awareness a t home and abroad. The c o r p o r a t i o n would be a f i n a n c i n g i n s t i t u t i o n s i m i l a r to the Canadian I n d u s t r i a l Development Bank and the Nati o n a l F i l m Finance Corporation i n the United Kingdom. The c o r p o r a t i o n would have the power to a l l o t g r a n t s , and awards and to lend production funds t o Canadian producers. The proposed l e g i s l a t i o n would r e q u i r e the disbursement of a d m i n i s t r a t i v e c o s t s and other non-recoverable expenses from the $10 m i l l i o n fund. The c o r p o r a t i o n would be c r e d i t e d w i t h earnings on i t s loans and p r o f i t s from i t s investments i n f e a t u r e f i l m p roductions. - 16 -In June, 1966 l e g i s l a t i o n to e s t a b l i s h the c o r p o r a t i o n was introduced i n the House of Commons. The debate which f o l l o w e d i n d i c a t e d general support by Parliament f o r a f i l m development fund. The Members of Parliament were concerned t h a t the b i l l s a t i s f y the r e q u i r e -ments of t h e i r c o n s t i t u e n t s . They a l s o voiced t h e i r general concern over the problems of d i s t r i b u t i o n of Canadian motion p i c t u r e s . The l e g i s l a t i o n , B i l l C-204, was given t h i r d reading i n Parliament on February 3, 1967. The Senate subsequently passed the B i l l , without amendment, on March 3, 1967. (Canadian F i l m Development Act SC 1966-67 c.78 now RSC 1970 C C-8). In February, 1968, the chairman and the f i v e members were appointed and the Corporation came i n t o e x i s t e n c e as an agency of Her Majesty the Queen. On A p r i l 2, 1968, the members met f o r the f i r s t time. T h e i r adoption of the by-laws completed the formal establishment of the Canadian Film Development C o r p o r a t i o n . The o b j e c t s and powers of the c o r p o r a t i o n are contained i n Section 10 of the Canadian F i l m Development Corporation Act. They are as f o l l o w s : (1) The objects of the Corporation are to f o s t e r and promote the development of a f e a t u r e f i l m i n d u s t r y i n Canada, and without l i m i t i n g the g e n e r a l i t y of the f o r e g o i n g , the Corporation may, i n furtherance of i t s o b j e c t s , (a) i n v e s t i n i n d i v i d u a l Canadian f e a t u r e f i l m productions i n r e t u r n f o r a share i n the proceeds from any such pro d u c t i o n ; (b) make loans to producers of i n d i v i d u a l Canadian f e a t u r e f i l m productions and charge i n t e r e s t thereon; (c) make awards f o r outstanding accomplishments i n the production of Canadian f e a t u r e f i l m s ; (d) make grants to film-makers and f i l m t e c h n i c i a n s r e s i d e n t i n Canada t o a s s i s t them i n improving t h e i r c r a f t ; and (e) advise and a s s i s t the producer of Canadian f e a t u r e f i l m s i n the d i s t r i b u t i o n of such f i l m s and i n the a d m i n i s t r a t i v e f u n c t i o n s of f e a t u r e f i l m p r o d u c t i o n . - 17 -(2) For the purposes of th i s Act , a "Canadian feature f i l m " or "Canadian feature f i l m production" i s a feature f i l m or feature f i l m production in respect of v/hich the Corporation has determined (a) that the completed f i l m w i l l , in the judgement of the Corporation have a s i gn i f i c an t Canadian c rea t i ve , a r t i s t i c and technical content, and that arrangements have been made to ensure that the copyright in the completed f i l m w i l l be bene f i c i a l l y owned by an ind iv idual resident in Canada, by a corporation incorporated under the laws of Canada or a province or by any combination of such persons; or (b) That provis ion has been made fo r the production of the f i lm under a co-production agreement entered into between Canada and another country. (3) The Corporation shall..not be regarded as a partner in any f i l m production in which i t may invest and i t s l i a b i l i t y sha l l be l im i ted to the amount of i t s investment in the production. (4) The Corporation s h a l l , to the greatest possible extent consistent with the performance of i t s duties under t h i s Act , consult and co-operate with departments, branches and agencies of the Government of Canada and of the governments of the provinces having duties re lated t o , or having aims or objects re lated to those of the Corpor-a t ion . 18 Since i t s incept ion, the C.F.D.C. has been refinanced twice -once in 1972 for an addit ional $10 m i l l i o n and again in 1976 fo r $5 m i l l i o n . The C.F.D.C. has invested most of these funds in two motion p icture investment programs: the Feature Film Investment Program and the Special Investment Program. In the Feature Film Investment Program, the corporation could invest up to 50% of the production costs of the completed f i l m with a maximum in 1976 of $250,000. 1 9 When the C.F.D.C. invests in a f i l m i t w i l l pa r t i c ipate in 50% of the p r o f i t , in proportion to i t s share of the o r i g i na l f inancing. The other 50% of the p ro f i t s t r a d i t i o n a l l y goes to the producer to be shared with the w r i t e r , d i r e c t o r , actors and others involved in the production of the f i l m . When the - 18 -C.F.D.C. makes a l o a n , i t does not take a share i n the p r o f i t s but i t does request s e c u r i t y other than the f i l m 2 n i t s e l f . The r a t e of i n t e r e s t i s subject t o n e g o t i a t i o n . A f u r t h e r c o n d i t i o n f o r C.F.D.C. funding was th a t the producer secure guaranteed d i s t r i b u t i o n i n Canada. This was to be ensured by the requirement t h a t a d i s t r i b u t o r c o n t r i b u t e to the production c o s t s and/or a d v e r t i s i n g and promotion expenses. However, t h i s r u l e was not always enforced and the C.F.D.C. d i d p a r t i c i p a t e i n productions which d i d not have a d i s t r i b u t o r p r i o r to commencement of production. The S p e c i a l Investment Program was designed to permit young film-makers to develop and demonstrate t h e i r t a l e n t through production of a low budget f e a t u r e . The maximum budgets permitted i n t h i s program were between $100,000 and $135,000. The C.F.D.C. could provide up to 60% of the production budget c o s t s . The balance o f the budget was to be provided by p r i v a t e i n v e s t o r s or by v o l u n t a r y d e f e r a l o f the s a l a r i e s of those working on the f i l m . The C.F.D.C. was to r e c e i v e 25% of any revenue earned by the f i l m a f t e r the p r i v a t e s e c t o r o r d e f e r -a l s had been r e p a i d . Guaranteed d i s t r i b u t i o n was not necessary. I n i t i a l l y the Corporation's main concern was to get as many fe a t u r e s i n t o production as p o s s i b l e . However, i n the e a r l y 1970's the C.F.D.C. became i n c r e a s i n g l y concerned w i t h d i s t r i b u t i o n of the Canadian product. In 1971 a p o l i c y was adopted t h a t investment would be made only i n f i l m s t h a t had been accepted f o r d i s t r i b u t i o n by a d i s t r i b u t o r . This p o l i c y was somewhat hollow because u n c o n d i t i o n a l b i n d i n g acceptance of an uncompleted f i l m by a d i s t r i b u t o r i s imposs-i b l e to l e g a l l y enforce. The p o l i c y was l a t e r r e s c i n d e d and the C.F.D.C. continues to i n v e s t i n low budget f e a t u r e s without a p r i o r d i s t r i b u t i o n agreement. - 19 -In 1973 the C.F.D.C. extended i t s f i n a n c i a l a s s i s t a n c e so t h a t investment funds could be used f o r promotion during and f o l l o w i n g production. Thus b e t t e r marketing and wider d i s t r i b u t i o n o f Canadian f e a t u r e s was ensured. In 1975 the Corporation added to i t s s t a f f an experienced D i s t r i b u t i o n O f f i c e r to work w i t h Canadian d i s t r i b u t i o n companies to enable them to expand t h e i r a c t i v i t i e s both n a t i o n a l l y and abroad. In i t s 1975-76 f i s c a l year the C.F.D.C. put gr e a t e r emphasis than i t had p r e v i o u s l y on i t s s c r i p t w r i t i n g a s s i s t a n c e program. The C.F.D.C. recognized t h a t " i t i s v i r t u a l l y i m p o s s i b l e t o produce a 21 v i a b l e motion p i c t u r e without a c r e a t i v e , commercial s c r i p t . " To a s s i s t i n developing good Canadian s c r i p t w r i t e r s , the C o r p o r a t i o n , i n a d d i t i o n to supporting promising w r i t e r s , created the p o s i t i o n o f En g l i s h S c r i p t Consultant who was t o provide d e t a i l e d , c o n s t r u c t i v e feedback to s c r i p t w r i t e r s . The Corporation allowed t h a t one o f i t s most v i t a l o b j e c t i v e s would be "the combination o f c r e a t i v e freedom 22 wit h r e a l i s t i c commercial p o t e n t i a l " . Executive S e c r e t a r y Michael Spencer, declared t h a t the c o r p o r a t i o n had, i n the p a s t , i n v e s t e d i n the production of " f i l m s t h a t had no chance of ever g e t t i n g o f f the 23 ground" . I t has been proposed by Corporation management t h a t the C.F.D.C. d i s c o n t i n u e i t s p r a c t i c e of i n v e s t i n g i n low budget f e a t u r e s . None of these low budget f e a t u r e s have ever earned any r e t u r n s because very few have even been shown to a paying audience as t h e i r themes are not popular and the production value low. In 1976 the mandate of the C.F.D.C. was expanded to i n c l u d e r e s p o n s i b i l i t y f o r a d m i n i s t e r i n g and a s s i s t i n g i n n e g o t i a t i o n s o f - 20 -co-production agreements with f o r e i g n c o u n t r i e s . The c o r p o r a t i o n s c r u t i n i z e s a l l proposed co-productions to see i f they comply with the r e g u l a t i o n s regarding Canadian content and investment,and a r t i s t i c 24 and commercial p o t e n t i a l . " E l i g i b l e p r o j e c t s of high m e r i t " are recommended by the C.F.D.C. to the Secretary of S t a t e . The Secretary of S t a t e makes the f i n a l d e c i s i o n to a l l o w f i n a n c i a l a s s i s t a n c e to the co-productions. The C.F.D.C.'s expanded mandate a l s o i n c l u d e s c o - o r d i n a t i n g the a c t i v i t i e s of the various government agencies concerned with the f i l m i n d u s t r y i n Canada. Some government agencies are: The F i l m F e s t i v a l ' s Bureau - Secretary of State Department, Canada Council f o r A r t s , National F i l m Board, National Archives and the Department of External A f f a i r s . A f u r t h e r r e s p o n s i b i l i t y of the C.F.D.C. i s t o monitor the v o l u n t a r y quote agreements with the two n a t i o n a l t h e a t r e chains - Famous Play e r s L t d . and Odeon Theatres (Canada) L t d . These two predominant chains have v o l u n t a r i l y agreed with the Secretary of S t a t e to show Canadian-made fea t u r e s at each of t h e i r t h e a t r e s f o r a minimum of f o u r weeks each year. In 1977 the C.F.D.C. f u r t h e r increased i t s r e s p o n s i b i l i t i e s and broadened i t s mandate. The C.F.D.C. i s now i n v o l v e d i n almost every area of the Canadian motion p i c t u r e i n d u s t r y , i n c l u d i n g t e l e v i s i o n . B. Canada Council The Canada Council was e s t a b l i s h e d i n 1957 by the passing o f the Canada Council A c t . The C o u n c i l ' s mandate i s to " f o s t e r and promote the study and enjoyment o f , and the production of works i n the a r t s , 25 humanities and s o c i a l s c i e n c e s " . This mandate i s to be accomplished through the d i s t r i b u t i o n o f f e l l o w s h i p s and grants t o c r e a t i v e persons. - 21 -The Council has two programs which a f f e c t the f i l m i n d u s t r y : the F i l m Production Grant Program and the Video Production Grant Program. A p p l i c a n t s who have p r e v i o u s l y e s t a b l i s h e d a p r o f e s s i o n a l r e p u t a t i o n i n the v i s u a l a r t s can apply f o r grants of up to $25,000 f o r a f i l m ?fi production and of up to $10,000 f o r a video tape production. The i n t e n t i o n of these programs i s to support the film-maker who has demonstrated a degree of p r o f e s s i o n a l i s m but who needs f u r t h e r opport-u n i t y to demonstrate h i s c r e a t i v e and t e c h n i c a l a b i l i t y before embarking on a more s o p h i s t i c a t e d and c o s t l y commercial p r o j e c t . C. Major E x h i b i t o r s ' Investment Program A growing lobby made up mostly of n a t i o n a l i s t i c Canadian f i l m -makers has been pre s s u r i n g both the f e d e r a l and p r o v i n c i a l governments to f o r c e the two major t h e a t r i c a l e x h i b i t o r s to i n v e s t a g r e a t e r p o r t i o n of t h e i r box o f f i c e p r o f i t s d i r e c t l y i n f i l m p r o d u c t i o n . Famous Pl a y e r s L i m i t e d and Odeon Theatres (Canada) L t d . are f i n a n c i a l l y c o n t r o l l e d e i t h e r p a r t i a l l y or completely by f o r e i g n i n t e r e s t s . A l a r g e amount of t h e i r p r o f i t s flows out of Canada t o t h e i r parent companies. Various p a r t i e s i n c l u d i n g the Canadian Council of Film Makers, the Secretary of State Department and the C.F.D.C. have been seeking ways i n which t h i s flow of funds out of Canada could be reduced. Faced w i t h the t h r e a t of Canadian content quotas, a d d i t i o n a l box o f f i c e l e v i e s or o u t r i g h t n a t i o n a l i z a t i o n , the two major chains have consented to i n v e s t a p o r t i o n of t h e i r earnings i n Canadian f i l m p roduction. Famous Pl a y e r s invested some money i n motion p i c t u r e production i n the l a t e 1960s and e a r l y 1970s but i t was not u n t i l the p o s s i b i l i t y - 22 -of strong government a c t i o n became l i k e l y t h a t the two major chains agreed t o provide production f i n a n c i n g i n any s u b s t a n t i a l way. S e c r e t a r y of S t a t e , Mr. J . High Faulkner, announced on August 5, 1975 t h a t : the two l a r g e s t t h e a t r e chains i n Canada...have v o l u n t a r i l y agreed t o a quota of f o u r weeks per theatre per year and an investment program of a t l e a s t $1.7 m i l l i o n t o a i d the e x h i b i t i o n and production of Canadian f e a t u r e f i l m s . 2 7 The announcement noted t h a t Famous Players and Odeon would c o n t r i b u t e $1.2 m i l l i o n and $500,000 r e s p e c t i v e l y i n the f i r s t y e a r of the program. Attempts by the w r i t e r to a s c e r t a i n the requirements f o r investment by the two major chains were f r u s t r a t i n g . The two chains do i n v e s t but i t seems they do so r e l u c t a n t l y . They are r e t i c e n t about s p e c i f i c i n f o r m a t i o n regarding t h e i r program and do not encourage the submission o f production proposals. M.J. Lawrence P i l o n , Vice P r e s i d e n t and S e c r e t a r y of Famous Playe r s L i m i t e d s t a t e d i n a telephone conversation w i t h the w r i t e r t h a t Famous Pl a y e r s i n v e s t s up to $1 m i l l i o n per year i n c e r t i f i e d Canadian productions. Famous Play e r s w i l l c o n t r i b u t e up to $150,000 i n any one f e a t u r e f o r which they expect a share of the p r o f i t s ( p o i n t s ) i n accordance w i t h t h e i r percentage of the t o t a l budget investment on a p a r r i passu recoupment b a s i s . P r o j e c t s submitted to an e x e c u t i v e committee are evaluated w i t h regard t o : commerciality of the s c r i p t , the budget a l l o c a t i o n s , the proposed s t a r s and the r e p u t a t i o n and exper-ience of the p r i n c i p a l s and other i n v e s t o r s i n v o l v e d i n the production 28 company and the p r o j e c t . Mr. P i l o n would not say who was on the e x e c u t i v e committee and he refused to comment on the c r i t e r i a used t o determine acceptance of s c r i p t , budget, s t a r s , p r i n c i p l e s and i n v e s t o r s . - Li -D. Co-Production Agreements with Foreign Countries To develop a f i l m i n d u s t r y , Canadians must f i r s t l e a r n the necessary t e c h n i c a l and c r e a t i v e s k i l l s of the a r t . One way to do t h i s i s t o co-produce with film-makers from other c o u n t r i e s more experienced than o u r s e l v e s . To encourage Canadian film-makers to work w i t h f o r e i g n filmmakers the government, through the auspices of the Secretary of S t a t e Department, has negotiated three co-production t r e a t i e s s i n c e June, 1974. The advantage t o Canada, i s the o p p o r t u n i t y f o r Canadians to b e n e f i t from the experience and e x p e r t i s e of f o r e i g n craftsmen by working w i t h them i n Canada or abroad. Canadian p r o j e c t s produced under these t r e a t i e s w i l l be e l i g i b l e f o r any quotas or other market p r o t e c t i o n measures i n the p a r t i c i p a t i n g f o r e i g n country. The advant-ages f o r the f o r e i g n country are: 1. Access t o Canadian investment, i n c l u d i n g C.F.D.C. fu n d i n g ; 2. The o p p o r t u n i t y to t r a n s f e r f o r production purposes funds otherwise blocked by currency r e s t r i c t i o n s to Canada; 3. Access to Canada's under-exposed scenery f o r s t o r y back-grounds using experienced f o r e i g n crews and c a s t . The Department of Manpower and Immigration has been i n s t r u c t e d to r e l a x i t s work permit r e g u l a t i o n s i n order t o a l l o w f o r e i g n film-makers to work on Canadian co-productions; 4. Access to Canadian t e l e v i s i o n markets s i n c e motion p i c t u r e s produced under co-production agreements are deemed as '.'Canadian content" f o r broadcast purposes. The f i l m i t s e l f i s exempt from any import d u t i e s or quotas of e i t h e r o f the co-producing c o u n t r i e s and t h e r e f o r e can be f r e e l y e x p l o i t e d i n the two - 24 -c o u n t r i e s . The p r o f i t s earned i n each country, however, accrue s o l e l y to the r e s i d e n t co-producer of the country i n which they are earned. Each production company w i l l reserve i t s n a t i o n a l t e r r i t o r y f o r the e x p l o i t a t i o n of the f i l m and w i l l share the net p r o f i t s from the world i n pr o p o r t i o n to the amount of c a p i t a l advanced or c r e d i t made a v a i l a b l e t o the production. 30 In February 1976 the Secretary of State appointed the C.F.D.C. 31 as a d m i n i s t r a t o r of a l l e x i s t i n g co-production agreements. The C.F.D.C. reviews any proposals and makes recommendations to the Secretary f o r f i n a l approval of those p r o j e c t s which the C.F.D.C. considers b e n e f i c i a l to Canada. Canada has co-production agreements with the United Kingdom, France and I t a l y . N e g o tiations are i n progress w i t h West Germany and I s r a e l . Canadian-French Co-Production Agreement The "Film R e l a t i o n s Agreement" between the governments of 32 Canada and France was signed on June 7, 1974. The Secretary o f S t a t e i n Canada and the D i r e c t e u r Generale de l a Centre Nationale de l a Cinematographie approve motion p i c t u r e s produced under the agreement. The two o f f i c i a l s must approve the c o n t r a c t u a l arrangements of each motion p i c t u r e production and market-sharing arrangments f o r f o r the completed product. The producers must be p r o f e s s i o n a l l y com-33 petent and adequately funded. The d i r e c t o r and p r i n c i p l e a c t i n g t a l e n t must be e i t h e r French or Canadian and the shooting must take 34 place i n e i t h e r France or Canada. Both a French and E n g l i s h sound 35 t r a c k v e r s i o n of the f i l m must be made. The pr o p o r t i o n of i n v e s t -ment and t e c h n i c a l and c r e a t i v e c o n t r i b u t i o n can range between 20% and 80%. U s u a l l y the investment and production s e r v i c e s c o n t r i b u t i o n s are o f the same r e s p e c t i v e p r o p o r t i o n . ^ - 25 -Canadian-Italian Co-Production Agreement The "Agreement Relating to the Co-Production of Fi lms" between the Government of Canada and the Republic of I ta ly was signed on July 4, 1974. The terms of the agreement are s im i l a r to the French co-production t reaty. The I t a l i an Ministry of Tourism and Entertainment i s the body which must approve projects involving the I t a l i an co-37 producers. Two versions of the motion p icture must be made, one 38 in I t a l i an and one in e i ther French or Engl ish. The contr ibut ions to f inancing by the two co-producers can vary between 30 and 70 percent. The creat ive and technical services are to ccnform to the respective 39 pa r t i c i pa t i on percentages. Canadian-United Kingdom Co-Production Agreement The Honourable Hugh Faulkner, Secretary of State, signed a three year co-production agreement with the United Kingdom on September 40 12, 1975. A f i l m qua l i f i e s for the benefits of th i s agreement i f i t has a co-producer (or co-production company) from each country that are corporately independent of one another. The budget must be over $350,000 orX.150,000 whichever i s the larger amount at the preva i l ing 41 rate of exchange. The majority of the persons working on the f i l m must be e i ther c i t i z en s or residents of the U.K. or Canada but leading 42 performers can be from a th i r d country. The rules regarding the r a t i o of cast , technical and c ra f t serv ices, d i s t r i bu t i on and sharing of net receipts are s im i l a r to those included i n the other two co-production t rea t i e s and the general conditions set out in the introduct ion of th i s sect ion. - 26 -E. Income Tax Incentive Program The income tax incentive program i s the use of the high depreciation rate for motion p icture and video tape programs v/hich i s allowed for income tax purposes. An investor-owner can u t i l i z e th i s depreciation rate - " cap i ta l cost allowance" - to reduce his gross income fo r tax purposes and thus reduce his taxes payable. A l l assets (property) have been assigned to certa in "c lasses " by way of ammendments to the Income Tax Act Regulations. Each class has been given a maximum rate at which the cap i ta l cost of an asset can be amortized. The rate i s ca l l ed the cap i ta l cost allowance (c.c.a An owner of property (taxpayer) can deduct up to the maximum c.c .a . from the undepreciated balance of the cost of that property. (For a detai led explanation of c . c .a . see Appendix A to Chapter I I ) . From time to time the various classes are amended by the government to include or delete certa in propert ies. These amendments may r e f l e c t new uses and hence economic l i f e expectancy of the property The amendments may also r e f l e c t government pol icy that i s designed to encourage or discourage ownership by Canadian taxpayers of that pa r t i cu la r property. Motion picture f i lms and video tapes are presently in c lass 10 (30%) and class 12 (100%) depending on t he i r content and ownership. The programs in c lass 10 are those which the government does not wish Canadians to invest in or own. The programs in c lass 12 are those in which the government desires to encourage pr ivate Canadian investment, hence the income tax based incent ive. It i s the value of the income tax incentive that w i l l be addressed in th i s thes i s . - 27 -•4. FORMAT OF STUDY  A. Method This i s a two pronged study of the cap i ta l cost allowance incentive program fo r motion p icture investment. F i r s t l y , the study examines the relevant income tax laws of Canada and t he i r i n te rp re t -at ion by the Department of National Revenue, Taxation and the Canadian j u d i c i a l system. Secondly, the study involves a quant i tat ive analysis of the f i nanc ia l impl icat ions to a taxpayer invest ing in Canadian motion p ictures. The intent ion of th i s study i s to invest igate motion p icture production in Canada and the consequences of invest ing in such produc-t ions from the point of view of the pr ivate investor. The method used to undertake th i s study i s as fo l lows: 1. The present motion p icture industry in Canada i s described. 2. The theory of cap i ta l cost allowance i s explained through the use of examples from motion p icture investment proposals. 3. The income tax l e g i s l a t i o n re l a t i ng to cap i ta l cost allowance and the motion p icture investment i s s c ru t i n i zed , described and commented upon. 4. Relevant court cases are examined. 5. An actual motion p icture investment package including an income tax reassessment and appeal experience of an investor -owner i s described. 6. A motion p icture investment model which incorporates both investor-taxpayer and investment cha rac te r i s t i c s i s designed. - 28 -7. The model i s u t i l i z e d to a r r i v e at various f i n a n c i a l out-comes depending upon such f a c t o r s as: - i n v e s t o r income; -motion p i c t u r e investment type; - e d u c a t i o n a l , - f e a t u r e , -investment format; -leveraged, -non-leveraged. 8. The f i n a n c i a l outcomes are compared and c o n t r a s t e d . Conclusions are draws.. 9. O v e r a l l conclusions are made based on the r e s u l t s of both the d e s c r i p t i v e and a n a l y t i c a l p a r t s of the study. 10. Recommendations are o f f e r e d to i n v e s t o r s , the motion p i c t u r e i n d u s t r y and the government. In summary, t h i s t h e s i s i s an e x t e n s i v e examination of the c u r r e n t s t a t e of the Canadian motion p i c t u r e i n d u s t r y and the r e l e v a n t income tax l e g i s l a t i o n , the embodiment of an o r i g i n a l experience of the w r i t e r i n t h a t i n d u s t r y , and the a p p l i c a t i o n of modern f i n a n c i a l p r i n c i p l e s to motion p i c t u r e investment. 5. SOURCES OF DATA AND INFORMATION The Canadian Income Tax Act and Regulations was a major source of i n f o r m a t i o n along w i t h i n t e r p r e t a t i o n s of the Act by the National Revenue, Taxation and the Canadian c o u r t s . Other sources of data and i n f o r m a t i o n i n c l u d e d the f o l l o w i n g : Motion p i c t u r e i n d u s t r y trade j o u r n a l s and magazines such as - 29 -V a r i e t y  Cinema Canada The Journal of the Producers G u i l d of America Canadian newspapers such as The F i n a n c i a l Post The Toronto Globe and Mail The Vancouver Sun Books w r i t t e n on the i n d u s t r y by lawyers, producers, d i r e c t o r s , and d i s t r i b u t o r s such as Motion P i c t u r e s and the A r t s i n Canada, Garth H. Drabinsky The F i l m I n d u s t r i e s , Michael F. Mayer Producing, Financing and D i s t r i b u t i n g F i l m , Paul A. Baumgarten and Donald C. Farber Motion P i c t u r e D i s t r i b u t i o n , Walter E. Hurst and W i l l i a m S. Hale Papers and speeches presented by lawyers and c h a r t e r e d accountants i n v o l v e d w i t h motion p i c t u r e f i n a n c i n g such as "Tax Advantages of F i l m Investments", Wayne G. Beach L'.L.B. "A Cineramic View of Motion P i c t u r e Investments", Richard M. Wise, C. "A Departmental P e r s p e c t i v e on Tax S h e l t e r s " , M.W. S t e e l e . Personal i n t e r v i e w s were conducted i n an attempt t o assess the v a l i d i t y o f what had been w r i t t e n by and about the motion p i c t u r e i n d u s t r y . The w r i t e r has been i n v o l v e d i n the p r o d u c t i o n , f i n a n c i n g and d i s t r i b u t i o n of educational/documentary motion p i c t u r e s f o r f i v e y e a r s . - 30 -FOOTNOTES CHAPTER I } n. a. 2 Thomas M. Ferguson, What To Do When The Taxman Comes (Vancouver: I n t e r n a t i o n a l Self-Counsel Press L t d . , 1976), p . x i . 3 S t a t i s t i c s i n the motion p i c t u r e i n d u s t r y are u n r e l i a b l e but common assumptions based on a number of sources lea d t o the market f i g u r e s quoted. These sources i n c l u d e V a r i e t y , The Journal  of the Producers G u i l d of America and The Dra f t F i l m P o l i c y presum-a b l y prepared by or f o r the Secretary of State and leaked t o the press i n the f a l l of 1976. 4 Dr a f t Film P o l i c y , leaked to the pr e s s , author unknown, Cinema Canada, November, 1976, p.22. 5 See various Canadian F i l m Development Co r p o r a t i o n Annual  Reports 1968 t o 1976. ^ Paul Morton, " R e f l e c t i o n s on Our Home Movies", Cinema Canada, A p r i l , 1976, p.37. ^ "A 'Major' Offense Against N a t i o n a l i s m " , Cinema Canada, February, 1977, p.20. 8 Canadian Motion P i c t u r e D i s t r i b u t o r s A s s o c i a t i o n Canadian  Fi l m D i g e s t , December, 1976, p.17. g "Draft F i l m P o l i c y " , o p . c i t . , p.25. ^ Dennis H. Diebel "The Role of the Federal Government i n the Commercial Feature Film Industry i n Canada: An I n t r o d u c t i o n " (unpublished Masters o f Business A d m i n i s t r a t i o n t h e s i s , U n i v e r s i t y of B r i t i s h Columbia, 1976), pp.26-27, ^ "A'Major' Offen s i v e Against N a t i o n a l i s m , " o p . c i t . , p.21. 1 2 I b i d . 1 3 I b i d . 1 4 "Canadian Films Grosses," V a r i e t y , November 24, 1976, p.32. 1 5 "Draft F i l m P o l i c y , " o p . c i t . , p.22. ^ R e l i a b l e motion p i c t u r e export f i g u r e s are u n a v a i l a b l e from S t a t i s t i c s Canada. The w r i t e r suspects these f i g u r e s are u n r e l i a b l e due to the design o f S t a t i s t i c s Canada's q u e s t i o n n a i r e and t h e i r survey methods. The w r i t e r ' s company has exported over $100,000 worth of - 31 -motion p i c t u r e product to the United States and Europe. The company has never been asked t o r e p o r t t h i s f a c t on the annual S t a t i s t i c s Canada Questionnaire f o r Motion P i c t u r e P r o d u c t i o n , Video Tape Pr o d u c t i o n , Laboratory Operations. ^ Secretary of State Press Release, October 17, 1965. 1 o Canadian F i l m Development Corporation A c t , Subsection 10, 14-15-16 E l i z a b e t h I I , Chapter 78, pp.863-864. 19 Dennis D i e b e l , o p . c i t . , p.53. 2 0 I b i d . 21 Canadian F i l m Development C o r p o r a t i o n , Annual Report 1975-76, I b i d . 23 Les Wedman, "The C.F.D.C. f i n a l l y promises t o smarten up", Vancouver Sun, J u l y , 1976, p.? 24 Canadian Film Development C o r p o r a t i o n , o p . c i t . , p.7. or The O r g a n i z a t i o n of the Government o f Canada (Information Canada, 1975, Catalogue No. 1 C 41-1/1975), p.750. The Canada Council A i d to A r t i s t s (The Canada C o u n c i l , J u l y , 1976), pp. 10-11. 27 Honourable J . Hugh Faulkner, Secretary of State News Release, August 5, 1975, p . l . 28 Statement by J . Lawrence P i l o n , Vice P r e s i d e n t arid S e c r e t a r y , Famous Players L i m i t e d . Speaking from Toronto, O n t a r i o , March 16, 1977. 29 Dennis D i e b e l , o p . c i t . , p.59. 30 Garth H. Drabinsky, Motion P i c t u r e s and the A r t s i n Canada, the Business and the Law, (Toronto: McGraw-Hill Ryerson L i m i t e d , 1976), p.134. 31 Canadian F i l m Development C o r p o r a t i o n , o p . c i t . , p.7. 3? Agreement between the Government of Canada and the Government  of France concerning Films and F i l m P r o d u c t i o n , i n t o e f f e c t June 7, 1974, A r t i c l e I ( i ) and A r t i c l e XI. 3 3 I b i d . , A r t i c l e I I ( i ) . 3 4 I b i d . , A r t i c l e I I ( i i ) and A r t i c l e I I ( i ) and ( i i ) . 3 5 I b i d . , A r t i c l e IX. 3 6 I b i d . , A r t i c l e I V ( i ) and ( i i ) . - 32 -37 Agreement between the Government of Canada and the Government  of the Republic of I t a l y R e l a t i n g to the Co-Production of F i l m s , signed J u l y 4, 1974, A r t i c l e I. 3 8 I b i d . , A r t i c l e V I I I . 0 3 I b i d . , A r t i c l e IV and A r t i c l e V. 40 Co-Production Agreement between the Governments o f the United  Kingdom of Great B r i t i a n and Norther I r e l a n d and the Government of  Canada, signed September 12, 1975. 41 Secretary o f S t a t e , News Release, September 12, 1975, p . l . 4 2 I b i d . CHAPTER II INCOME TAX INCENTIVE PROGRAM "L MOTION PICTURE INVESTMENT FOR THE PRIVATE INVESTOR The f e d e r a l government has s t a t e d that i t would l i k e a v i a b l e motion p i c t u r e i n d u s t r y to develop i n Canada. However f o r the i n d u s t r y to develop money must be invested i n the production of motion p i c t u r e s . Motion p i c t u r e s are a high r i s k investment. The odds of a motion p i c t u r e investment earning a reasonable rate of r e t u r n are very low. The attendant r i s k i s very high t h a t the production phase w i l l exceed the production budget or t h a t the production of the motion p i c t u r e w i l l not even be completed. The p r i v a t e investment community i s u n l i k e l y to cons i d e r such an investment unless there are a d d i t i o n a l i n c e n t i v e s other than the remote p o s s i b i l i t y of earning revenue from the motion p i c t u r e . The f e d e r a l government i s aware of the handicaps t o the i n v e s t o r due t o high r i s k of motion p i c t u r e investment i n Canada. Tax l e g i s l a t i o n has been enacted that i s designed to s t i m u l a t e the growth of the i n d u s t r y through investment by the p r i v a t e s e c t o r i n "government approved" motion p i c t u r e s . The tax i n c e n t i v e s o f f e r a safe income t a x d e f e r r a l i f c e r t a i n c r i t e r i a are met by both the investment i t s e l f , ( i . e . motion p i c t u r e f i l m o r video-tape program) and the t e c h n i c a l r u l e s upon which the investment i s founded. The income tax i n c e n t i v e s are created by r u l e s and r e g u l a t i o n s i n the Income-Tax Act th a t permit a generous c a p i t a l c ost allowance on motion p i c t u r e s . Taxpayers can use t h i s c.c.a. t o avoid or defer taxes on - 33 -income earned from other sources. A. Theory of Income Tax Incentive Martin O'Brien, a Canadian tax e x p e r t , once de s c r i b e d t a x a t i o n i n the f o l l o w i n g terms: Taxation i s e x p r o p r i a t i o n of property; wealth acquired by the sweat of one's brow i s taken away and used f o r the purposes of the S t a t e , some l a u d a t o r y , some laughable. (See the Auditor-General's Report of any Year). 1 Numerous taxpayers would r e a d i l y agree with O'Brien's d e f i n i t i o n even though i t might not be found i n c o n v e n t i o n a l , a c c r e d i t e d d i c t i o n a r i e s of the E n g l i s h language, or even i n accountants' handbooks. Taxpayers are r e l u c t a n t to be "expropriated" of t h e i r "hard earned" wealth. Since the advent of personal income t a x e s , taxpayers have been seeking s o p h i s t i c a t e d schemes to reduce the amount they must remit t o the govern-ment's tax c o l l e c t o r s . Commonly known as "tax s h e l t e r s " , such p r o p e r l y s t r u c t u r e d schemes to minimize tax have been approved by the courts over the years. As i s w e l l known a taxpayer's r i g h t s are somewhat s a f e -guarded by the c o u r t s , which are not l o a t h to d i s m i s s the Crown's c l a i m f o r tax where the claimed tax i s not s p e c i f -i c a l l y imposed by the l e g i s l a t i o n . 2 Lord Tom!in s a i d i n h i s d e c i s i o n i n the Duke of Westminster case: Every man i s e n t i t l e d i f he can so order h i s a f f a i r s so t h a t the tax a t t a c h i n g under the appropriate Acts i s l e s s than i t would otherwise be. I f he succeeds i n o r d e r i n g them so as to secure t h i s r e s u l t , however unappreciative the commissioners of I n t e r n a l Revenue or h i s f e l l o w taxpayers may be of h i s i n g e n u i t y , he cannot be compelled t o pay increased tax. 3 A tax s h e l t e r , one of the methods used to reduce income t a x e s , has been defined as: ...a t r a n s a c t i o n whereby tax otherwise e l i g i b l e i s deferred or avoided. This i s done by u t i l i z i n g a l o s s which does not r e q u i r e an outflow of d o l l a r s as a deduction a g a i n s t income. 4 - 35 -The use of tax s h e l t e r s : by taxpayers i s an attempt to defer the payment t o a l a t e r date of taxes p r e s e n t l y e x i g i b l e under the enabling l e g i s l a t i o n or to avoid them e n t i r e l y , thereby minimizing i n t e r f e r e n c e w i t h the i n d i v i d u a l ' s c i v i l r i g h t s . ^ Accountants and f i n a n c i a l advisors recommend t h a t both the taxpayer ( i n v e s t o r ) and the investment have c e r t a i n b a s i c c h a r a c t e r -i s t i c s i n order f o r a tax s h e l t e r t o be e f f e c t i v e . F i r s t , the account-ants and f i n a n c i a l advisors recommend t h a t the taxpayer: 1. Should be i n a p o s i t i o n to r e i n v e s t the cash savings from the c a p i t a l cost allowance i n a c t i v i t i e s t h a t w i l l earn a d d i t i o n a l income; 2. Should be w e l l advised not only as to the high r i s k of tax s h e l t e r investments but must have a long term plan to deal w i t h the u l t i m a t e termination of the s h e l t e r devise p r o v i s i o n s and the p o s s i b l e recapture of c a p i t a l cost allowance p r e v i o u s l y u t i l i z e d ; 3. Should be i n an o v e r a l l income and tax p o s i t i o n such t h a t he can f u l l y u t i l i z e the high deduction to o f f s e t the inherent high r i s k . ^ Second, the accountants and f i n a n c i a l a d v i s o r s recommend t h a t the investment have the f o l l o w i n g c h a r a c t e r i s t i c s : 1. Be a property that q u a l i f i e s f o r a high r a t e of c a p i t a l c o st allowance, p r e f e r a b l y higher than 30%; 2. Have a r a t e of r e t u r n which i s s u f f i c i e n t t o produce a "reasonable expectation of p r o f i t " ; 3. Be s t r u c t u r e d i n such a way t h a t the i n v e s t o r i s protected against f u r t h e r or unexpected l i a b i l i t i e s attached to the investment other than those t h a t he i s prepared to accept a t the outset. ^ - 36 -B. Basis of a Tax Shelter I f the reader requires a deta i led explanation of the mechanism of a cap i ta l cost allowance tax shelter he i s advised to turn to the explanation and example in Appendix A to Chapter II. The fol lowing are tax shelter examples of two motion picture investments in a feature length motion picture f i lm and an educational video tape production. The information in the examples i s taken from various prospectuses issued by the promoters of the motion picture invest -ments. The purpose of the examples is to f am i l i a r i z e the reader with the basics of motion picture tax shelter investment and to demonstrate the investment and investor cha rac te r i s t i c s . Example of a Non-Leveraged Motion Picture Investment The hypothetical investor in th i s example has a marginal tax rate of 66% (marginal tax rate i s the rate on v/hich the next do l l a r of income i s taxed). The investor has the funds read i l y ava i lable to invest in a motion p icture f i lm that w i l l be c e r t i f i e d by the Secretary of State as a "Canadian feature f i l m " . Ownership of the motion p icture f i l m w i l l e n t i t l e the taxpayer to a 100% rate of cap i ta l cost allowance that may be used for tax purposes to reduce other income. The motion picture f i l m w i l l be copyrighted in the names of the investors as proof of ownership of a property purchased to earn income. The investor and his f i nanc i a l advisors have analyzed the prospec-tus of the feature f i l m investment and,have agreed that the producer, d i r e c to r , and lead stars are of such ca l ib re that the f i lm i s expected to have a box o f f i ce draw that could y i e l d a "reasonable rate of p r o f i t " . The producers have secured a completion guarantee bond. The issuers of the bond w i l l pay any over-budget expenses of production. - 37 -Therefore the i n v e s t o r i s protected against a d d i t i o n a l l i a b i l i t i e s and can be assured that the p r o j e c t w i l l be completed. The producers have al s o negotiated an agreement f o r t h e a t r i c a l d i s t r i b u t i o n i n Canada and an option f o r American and world d i s t r i b u t i o n . The budget of the motion p i c t u r e f i l m i s $750,000.. Minimum investment u n i t s of $25,000 are being o f f e r e d . Each minimum investment u n i t e n t i t l e s the owner to 1/30th of the net p r o f i t s of the d i s t r i b u t i o n revenue of the motion p i c t u r e f i l m . The e x h i b i t i o n agreement f o r the motion p i c t u r e f i l m s p e c i f i e s t hat the e x h i b i t o r s ' share and t h e i r expenses w i l l be paid on a p r i o r i t y b a s i s . The balance of the d i s t r i b u t i o n revenue, a f t e r deduction of a d v e r t i s i n g , promotion and p r i n t c o s t s , w i l l be d i v i d e d pro r a t a and p a r i passu among each of the other e n t i t i e s l i s t e d below. I f $10,000,000 was the world wide box o f f i c e gross revenue of the fea t u r e f i l m , the gross w i l l be d i v i d e d among the investor-owner, p r o d u c t i o n , d i s t r i b u t i o n , and e x h i b i t i o n e n t i t i e s as f o l l o w s : Expected box o f f i c e gross (3 years) $10,000,000 Less: E x h i b i t o r s ' share 4,000,000 A d v e r t i s i n g , promotion and p r i n t s 500,000 Lead s t a r s ' share 500,000 D i s t r i b u t o r ' s share 3,000,000 Producer's share 750,000 I n i t i a l c a p i t a l investment 750,000 T o t a l : P r o f i t to investor-owners I 500,000 The f i l m w i l l earn no income during the f i r s t year o f the i n v e s t -ment because i t w i l l be i n production that year. Therefore, the in v e s t o r -owner of a 1/30 undivided i n t e r e s t w i l l then compute h i s taxable income ( l o s s ) from the investment as f o l l o w s : Income from d i s t r i b u t i o n $ n i l Less: C a p i t a l c ost allowance on investment @ 100% $25,000 Income ( l o s s ) f o r tax purposes T$25,000) - 38 -As the i n v e s t o r ' s marginal income tax rate i s 66% he w i l l have saved $16,500 i n taxes otherwise payable. This saving can be considered a $16,500 i n d i r e c t recovery on the investment and means that h i s a c t u a l incremental cash investment i s only $8,500 ( i e . $25,000 o r i g i n a l investment minus the $16,500 income tax sa v i n g ) . Revenue i n subsequent years w i l l be taxable a t h i s marginal r a t e . Example of a Leveraged Motion P i c t u r e Investment In t h i s example, the i n v e s t o r , a l s o a t the 66% marginal t a x r a t e , w i l l be i n v e s t i n g i n a Canadian video tape production that w i l l be marketed to education i n s t i t u t i o n s throughout North America. The i n i t i a l t a x saving a t t r a c t i o n w i l l be f u r t h e r enhanced by the use o f leverage i n the form of a fourteen year f u l l recourse promissory note bearing 6% i n t e r e s t c a l c u l a t e d on the outstanding balance at each year end. This promissory note w i l l be signed by the investor-owner and w i l l be payable t o the producer. The purchase c o n t r a c t s w i l l a l l o w f o r the promissory note to be paid out of earnings generated by the program, i f any. As t h i s i s a f u l l recourse promissory note i t must be paid o f f by the investor-owner at the end of the fourteen years r e g a r d l e s s of the fortune of the program. The f u l l purchase p r i c e of the video tape program i s $75,000. The i n v e s t o r ' s cash down payment i s $25,000 and the promissory note i s $50,000. The leveraged r a t i o of the cash investment i s three t o one. Educational Video Tape Program Cash down payment $25,000 Fourteen year promissory note 50,000 T o t a l : Purchase p r i c e ( C a p i t a l c ost) $75,000 A taxpayer whose marginal income tax rate i s 66% pays $49,500 taxes on $75,000 income taxed at th a t r a t e . ( i e . The $75,000 income - 39 -i s over and above income taxed at a lower marginal r a t e . ) Net Cash P o s i t i o n A f t e r Taxes - No Investment Income taxable at marginal r a t e $75,000 Taxes payable a t 66% 49,500 Equals: Net cash a f t e r taxes $25,500 I f the taxpayer i n v e s t s i n a motion p i c t u r e investment which i s e l i g i b l e f o r a 100% c a p i t a l c ost allowance deduction he can a v o i d income taxes on the c.c.a. deduction, ( i e . $75,000) Income taxabl e at marginal r a t e $75,000 Less: C a p i t a l c ost allowance deduction (100%) 75,000 Equals: Marginal t a x a b l e income n i l The taxpayer-investor-owner has improved h i s net cash flow by $24,500 because he has avoided paying $49,550 income taxes on the $75,000 earnings, yet h i s i n i t i a l cash investment has been only $25,000. Taxes payable i f no c a p i t a l cost allowance deduction a v a i l a b l e $49,500 Less: Cash down payment f o r video tape program 25,000 Equals: Net cash saving $24,500 The net cash saving of $24,500 through the tax recovery mechanism can then be r e i n v e s t e d at say, an average of 10% i n t e r e s t compounded over fourteen years. I f the video tape i s not a commercial s u c c e s s , and the promissory note i s not r e t i r e d from the video tape, earnings at the end of the fourteen y e a r s , the $24,500 cash s a v i n g , plus accumulated compound i n t e r e s t of $68,541, w i l l be s u f f i c i e n t to meet the note o b l i g a t i o n and i t s accumulated i n t e r e s t o f $42,000 and s t i l l r e t u r n a small p r o f i t of $1,041 to the investor-owner. Note t h a t t h i s example does not consider the time value of money (present v a l u e ) . I f a net present value was computed i t c o u l d be demonstrated t h a t the investment would not have earned a p r o f i t and the i n v e s t o r would have, i n f a c t , l o s t money. The concept of net present - 40 -value w i l l be f u l l y e xplained i n Chapter VII which explores the quant-i t a t i v e i m p l i c a t i o n s o f a motion p i c t u r e investment. The above two examples, although h i g h l y s i m p l i f i e d , demonstrate the b a s i s of the "tax s h e l t e r " aspect of motion p i c t u r e investment i n Canada. 2. PRIVATE MOTION PICTURE INVESTMENT ARRANGEMENTS There are several arrangements which p r i v a t e i n v e s t o r s have used f o r i n v e s t i n g i n motion p i c t u r e s i n Canada s i n c e 1970. The arrangements are: l i m i t e d p a r t n e r s h i p , j o i n t venture, undivided ownership, and a syndicate-guarantee. Each of these arrangements has advantages and disadvantages i n terms of l i a b i l i t y , p o s s i b l e reassessment by the tax department, f i n a n c i a l r i s k , p o t e n t i a l e a r n i n g s , complexity of the c o n t r a c t s , the number of i n v e s t o r s i n v o l v e d , and the p o s i t i o n of the producer. The objects of f i l m investment are to minimize exposure to both f i n a n c i a l l i a b i l i t y and tax reassessment w h i l e maximizing p r o f i t p o t e n t i a l and the b a s i s f o r c a p i t a l cost allowance (and hence income tax s a v i n g s ) . To devise such an i d e a l framework i s not an easy task. I f the i n v e s t o r ' s l i a b i l i t y i s l i m i t e d so i s h i s base f o r c.c.a. I f h i s l i a b i l i t y i s not l i m i t e d he may achieve a greater i n i t i a l tax d e f e r r a l but u s u a l l y h i s p r o f i t p o t e n t i a l i s reduced even i f the f i l m i s s u c c e s s f u l . The f o l l o w i n g i s an examination of the various schemes that have been developed. In each examination an attempt w i l l be made to define the s t r u c t u r e . The advantages and disadvantages from the i n v e s t o r ' s point of view w i l l be discussed. A. L i m i t e d P a r t n e r s h i p A l i m i t e d p a r t n e r s h i p i s defined i n Black's Law D i c t i o n a r y as: - 41 -A partnership consist ing of one or more general partners, j o i n t l y and several ly responsible as ordinary partners, and by whom the business i s conducted, and one or more special ( l imited) partners, contr ibuting in cash payment a s pec i f i c sum as cap i ta l to the common stock (or property), and who are not l i a b l e for the debts of the partnership beyond the funds so contributed. ° In Canada, such en t i t i e s are registered p r o v i n c i a l l y . Federal tax law does not deal s p e c i f i c a l l y with the legal e f fect s of business a c t i v i t i e s car r ied out by partnerships. Limited partnerships were the usual arrangement for organizing a group of indiv idual investors between 1970 and 1973 fo r the purpose of investing in motion p ictures . The advantage of the l imi ted partnership was that the ind iv idua l pr ivate investors ( l imited partners), had no f i nanc i a l l i a b i l i t y beyond the amount of money invested by each partner. Their l i a b i l i t y was l im i ted with respect to possible cause of action from a t h i r d party such as suing for damages for infringement of copyright, defamation of character, invasion of pr ivacy, breach of contract, etc. The general partner was l i a b l e for a l l such l i a b i l i t i e s . However, the general partner (usually newly incorporated for the s pec i f i c production) had minimal assets and simply declared bankruptcy in the event of an unsuccessful f i lm or a major s u i t . The major disadvantage of the l im i ted partnership structure stems d i r e c t l y from the l im i ted l i a b i l i t y aspect. The tax department w i l l not accept the claim for c .c.a. on an amount owed by the partnership but not d i r e c t l y owing by the indiv idual l im i ted partners. The tax department w i l l not allow non-recourse investment supplied by the C.F.D.C. or by a d i s t r i bu to r to be included in the cap i ta l cost. Nor w i l l the tax department allow non-recourse promissory notes to be included in cap i ta l cost. The p o s s i b i l i t y ex ists that the tax department could apply the short f i s c a l year ru le. The rule could be applied only i f the partnership n 42 -was deemed a "business". A p a r t n e r s h i p must have a year-end which may not n e c e s s a r i l y c o i n c i d e with the i n d i v i d u a l partners' year-end or the completion of the motion p i c t u r e production. I f the short f i s c a l year r u l e was a p p l i e d the c.c.a. would be pro-rated and r e s t r i c t e d to the number of days the pa r t n e r s h i p business had been a c t i v e . The a t t r a c t i v e -ness o f the pa r t n e r s h i p method i s diminished i f the c.c.a. i s r e s t r i c t e d i n the i n i t i a l year of the investment. The p a r t n e r s h i p must be l i a b l e f o r a d d i t i o n a l sums of money over and above t h a t which i s inv e s t e d by the partners to i n c o r p o r a t e the leveraged c a p i t a l cost f e a t u r e . The a d d i t i o n a l sums of money must be paid i f and when the motion p i c t u r e generates revenue from d i s t r i b u t i o n . A major p o r t i o n of the revenue must be d i r e c t e d toward r e t i r i n g the the par t n e r s h i p ' s l i a b i l i t y . However, si n c e c.c.a. on the leveraged amounts has already been claimed i n the i n i t i a l years of the investment, the l i m i t e d partners w i l l be r e q u i r e d to pay tax on revenue which i s not being r e c e i v e d by them but which i s being a p p l i e d to the p r e v i o u s l y i n c u r r e d l i a b i l i t i e s . This often means t h a t i f the i n v e s t o r s f i n d themselves with a commercially s u c c e s s f u l motion p i c t u r e they w i l l not r e c e i v e any cash income — y e t must pay taxes on monies being p a i d toward repayment o f the C.F.D.C. investment or to the vendor o f the f i l m f o r ret i r e m e n t of the promissory note. B. J o i n t Venture A j o i n t venture, l e g a l l y know as a j o i n t adventure, i s very s i m i l a r t o a l i m i t e d p a r t n e r s h i p but the j o i n t venture i s u s u a l l y not r e g i s t e r e d or given any corporate d e s i g n a t i o n . A j o i n t venture i s u s u a l l y s et up f o r the purpose of undertaking a s p e c i f i c business p r o j e c t or t r a n s a c t i o n , and i t i s terminated upon completion of th a t undertaking! - 43 -The p r o p o r t i o n i n which the r e s u l t a n t p r o f i t or l o s s w i l l be shared w i l l be mutually agreed between the partners of the venture according to the f i n a n c i a l r i s k run by them, or according to the value of the s e r v i c e s which w i l l be c o n t r i b u t e d by them.^ In the motion p i c t u r e business the i n d i v i d u a l p r i v a t e i n v e s t o r s supply the cash and the producer and h i s a s s o c i a t e s ( d i s t r i b u t o r , e t c . ) supply the s e r v i c e s . J o i n t ventures have been abandoned as a method of motion p i c t u r e f i n a n c i n g . The reason j o i n t ventures d i d not work i s because by d e f i n i t i o n of a j o i n t venture the i n v e s t o r s ' c o n t r i b u t i o n i s a f i n a n c i a l c o n t r i b u t i o n only. They are t h e r e f o r e , not true owners of the motion p i c t u r e , e n t i t l e d to c l a i m c.c.a. The tax a u t h o r i t i e s contended that the i n v e s t o r s i n a j o i n t venture are i n "business" and any income would be considered business income not investment income. Therefore c a p i t a l c ost would be pro-rated according to the short f i s c a l y ear r u l e . C. Investor-Owner of an Undivided I n t e r e s t The undivided i n t e r e s t investment s t r u c t u r e i s s i m i l a r to l i m i t e d p a r t n e r s h i p s and j o i n t ventures methods i n many re s p e c t s . There are t r a d e - o f f s between the undivided i n t e r e s t and the other two methods wi t h regard to tax advantages, i n v e s t o r l i a b i l i t y , and p o t e n t i a l minimum and maximum p r o f i t and l o s s . An undivided i n t e r e s t or undivided r i g h t , as i t i s sometimes c a l l e d , i s s i m i l a r i n law to co- or j o i n t tenancy. Black's Law D i c t i o n a r y d e f i n e s undivided r i g h t i n the f o l l o w i n g terms: An undivided r i g h t or t i t l e , or a t i t l e t o an undivided p o r t i o n of an e s t a t e , i s t h a t owned by one or more tenants i n common or j o i n t tenants before p a r t i t i o n . Held by the same t i t l e by two or more persons, whether t h e i r r i g h t s are equal as to value of q u a n t i t y or unequal. 10 I n t e r e s t i s defined as: - 44 -Any r i g h t i n the nature of property but l e s s than t i t l e ; a p a r t i a l or undivided r i g h t ; a t i t l e to a share. H The primary o b j e c t i v e of the undivided i n t e r e s t arrangement i s t o avoid the negative tax consequences of a p a r t n e r s h i p . A c c o r d i n g l y , many purchase and d i s t r i b u t i o n c o n t r a c t s s p e c i f i c a l l y i n c l u d e a d e n i a l of any i n t e n t to be considered a p a r t n e r s h i p (or j o i n t v enture). How-ever, f o r income tax purposes the Department o f National Revenue, Taxation has i n d i c a t e d t h a t i t does not n e c e s s a r i l y accept a d e n i a l phrase as meaningful, and i t may dec l a r e t h a t the r e l a t i o n s h i p i s a p a r t n e r s h i p f o r the purposes of c.c.a. The purchasers of an undivided i n t e r e s t i n t e n d t h a t they be considered co-owners of a property acquired f o r the purpose of g a i n i n g or producing income. The purchasers do not want t o be considered engaged i n a business because t h e i r c l a i m f o r c.c.a. expense would be subject to the short f i s c a l year r u l e . I f i n d i v i d u a l s owning an undivided i n t e r e s t i n a motion p i c t u r e are not considered to be i n a pa r t n e r s h i p or a j o i n t venture (and i t appears t h a t the tax department i s not prepared t o go out of i t s way to prove e i t h e r a pa r t n e r s h i p or a j o i n t venture e x i s t s ) , then the c l a i m f o r c a p i t a l cost allowance on the investor-owners' share o f the motion p i c t u r e i s stronger than i n the p a r t n e r s h i p or j o i n t venture arrangement. A s t r a i g h t - f o r w a r d b i l l of s a l e i s exchanged which, i n c l u d e d w i t h copy-r i g h t r e g i s t r a t i o n , i s accepted as adequate proof of ownership. I f i t i s intended that leverage be used, then the investor-owner signs a f u l l recourse promissory note f o r which he i s p e r s o n a l l y l i a b l e r e g a r d l e s s of the fortunes of the f i l m . A g a i n , h i s case f o r c.c.a. on t h i s amount i s strong. However, according to the terms o f the note he w i l l have to pay the holder of the note i t s face value a t some f u t u r e - 45 -predetermined date i f the d i s t r i b u t i o n r e c e i p t s have been i n s u f f i c i e n t . (Notes are u s u a l l y payable i n f i v e to fourteen years and bear i n t e r e s t from zero to ten percent). The promissory note l i a b i l i t y w i l l have t o be met with h i s personal resources and, (depending on the i n v e s t o r ' s tax p o s i t i o n and the degree of l e v e r a g e ) , can completely e l i m i n a t e any o v e r a l l cash saving through tax r e d u c t i o n . I f the f i l m i s s u c c e s s f u l , the investor-owner must pay taxes on h i s f u l l share of the net revenue, a p o r t i o n o f which w i l l be d i r e c t e d toward r e t i r i n g the promissory note. I f he has claimed h i s f u l l c.c.a. i n previous y e a r s , he w i l l probably have to f i n d an a d d i t i o n a l source of cash t o meet h i s tax o b l i g a t i o n . D. Syndicate-Guarantee The weaknesses of the three arrangements discussed above have induced the motion p i c t u r e i n d u s t r y to devise more s o p h i s t i c a t e d methods of f i n a n c i n g . The l a t e s t f i n a n c i n g arrangement i n v o l v e s formation of a syndicate of i n v e s t o r s who purchase undivided i n t e r e s t s i n a f i l m f o r a small cash down-payment and the s y n d i c a t e members agree t o pay a d d i t i o n a l amounts t o the vendor on d e f i n i t e dates f o r a number of y e a r s . The i n s t a l l m e n t payments are i n turn guaranteed t o the investor-owner by a t h i r d party (the d i s t r i b u t o r ) i n the form of minimum d i s t r i b u t i o n r e c e i p t s . This guarantee of the syndicate's l i a b i l i t y by the d i s t r i b u t o r i s o f t e n f u r t h e r assured by the purchase of a bank guarantee by the s y n d i c a t e . The syndicate-guarantee arrangement does not r e q u i r e investment p a r t i c i p a t i o n i n the a c t u a l production- by the C.F.D.C. d i s t r i b u t o r s or e x h i b i t o r s i n order to b u i l d i n the leverage f a c t o r and i n c r e a s e the investor-owner's c.c.a. The leverage i s created by the vendor (producer) s e l l i n g the motion p i c t u r e to the investor-ov/ner at a c o n s i d e r a b l e mark-up over a c t u a l production c o s t s . - 46 -A syndicate i s defined i n The D i c t i o n a r y of E n g l i s h Lav/ as: A body of persons t a k i n g p a r t j o i n t l y i n some venture or under-t a k i n g , a body of persons a s s o c i a t e d t e m p o r a r i l y f o r the purpose of buying a p r i v a t e business or other property and s e l l i n g i t at a p r o f i t , u s u a l l y to a l i m i t e d company. Sometimes a syndicate i s formed by persons who are i n d i v i d u a l l y possessed of property of the same d e s c r i p t i o n ( g e n e r a l l y shares or the l i k e ) , and wish to s ubject i t to a common management, with a view to i t s r e a l -i s a t i o n , a f t e r which each member takes the p r o f i t or l o s s a c c r u i n g i n respect of h i s p r o p o r t i o n . 12 The syndicate-guarantee arrangement appears a t t r a c t i v e to the i n v e s t o r at f i r s t glance. He i s a b l e to w r i t e o f f a very large amount of d e p r e c i a t i o n against other income i n the i n i t i a l y ear of the investment. The tax department i s u n l i k e l y to d i s a l l o w the i n v e s t o r ' s c.c.a. deduction f o r two reasons. F i r s t l y , the leveraged amount i s f u l l y repayable by the i n v e s t o r . His funds are "at r i s k " , even though the leveraged funds are guaranteed by the d i s t r i b u t o r and a bank guarantor. Secondly, the existence of a d i s t r i b u t i o n agreement with a d i s t r i b u t o r : appears t o favourably impress the tax department; such an agreement gives the department some assurance t h a t the f i l m w i l l be d i s t r i b u t e d . I 3 The p o s s i b i l i t y does e x i s t t h a t guaranteed d i s t r i b u t i o n r e c e i p t schemes could be l a b e l l e d a f i n a n c i n g arrangement r a t h e r than the out-r i g h t purchase of an a s s e t . The tax department might argue t h a t the i n v e s t o r s ' funds are not "at r i s k " s i n c e they are guaranteed by the d i s -t r i b u t o r . I f the motion p i c t u r e investment i s held t o be a f i n a n c i n g arrangement, c.c.a. w i l l not be allowed. Another p o t e n t i a l problem may e x i s t i f the d i s t r i b u t o r i s a r e s i d e n t of the United States or some other country which imposes w i t h -holding taxes on revenue earned by non-residents (e.g. Canadians). The guaranteed d i s t r i b u t i o n r e c e i p t s would be s u b j e c t to w i t h h o l d i n g taxes or the r e c e i p t s would be considered income earned by a non-resident. Thus the i n v e s t o r - 47 -would be r e q u i r e d to make up the d i f f e r e n c e between the net r e c e i p t s r e c e i v e d from the d i s t r i b u t o r and h i s l i a b i l i t y to the vendor of the motion p i c t u r e . Foreign w i t h h o l d i n g tax can be avoided or minimized by channeling the funds through a f o r e i g n country that has a favourable tax t r e a t y w i t h Canada, i e . a country t h a t imposes minimal or no w i t h h o l d i n g tax. Schemes i n v o l v i n g guaranteed r e n t a l s and an i n f l a t e d purchase p r i c e are at best only a d e f e r r a l of income taxes because the i n v e s t o r -owner i s subject to tax at h i s marginal r a t e on the flow of guaranteed funds from the d i s t r i b u t o r . The investor-owner must use h i s own funds to pay the d i f f e r e n c e between the amount he receives from the d i s t r i b -utor a f t e r income taxes and the amount th a t he must pay to the vendor of the motion p i c t u r e . Richard Wise made the f o l l o w i n g comment concerning the tax e f f e c t of the d i s t r i b u t o r ' s guarantee i n a syndicate-guarantee arrangement i n hi s a r t i c l e i n the Canadian Tax Journal.; There i s an absolute guarantee of income by the d i s t r i b u t o r which would be used t o discharge the i n v e s t o r s ' l i a b i l i t y but would c o n s t i t u t e taxable income to h i m . ^ Wise f u r t h e r commented on the e f f e c t s of the i n f l a t e d purchase i f the f i l m d i d earn bona f i d e d i s t r i b u t i o n revenue: A d m i t t e d l y , an i n f l a t e d s a l e s p r i c e w i l l reduce the i n v e s t o r ' s u l t i m a t e p r o f i t s should the f i l m prove to be a success; however, i t appears t h a t most i n v e s t o r s are more concerned with immediate tax b e n e f i t s or d e f e r r a l s r a t h e r than w i t h what i s o f t e n the dubious p o s s i b i l i t y of eventual p r o f i t s i n the future - most f i l m s being a bust. ^ The f u l l e f f e c t s of the tax l i a b i l i t y are o f t e n omitted i n the prospectus issued by the promoters of syndicate motion p i c t u r e investment. The q u a n t i t a t i v e a n a l y s i s of a syndicate-guarantee investment ir. Chapter VII w i l l consider the e f f e c t of the i n c u r r e d l i a b i l i t y by payment of the i n f l a t e d purchase p r i c e . - 48 -TABLE I I - I Schematic of Cash Flow i n Syndicate-Guarantee Feature Film Financing Arrangement World A s s o c i a t i o n Video Establishment (WAVE) guaranteed d i s t r i b u t i o n revenue of $5,514,000 Investor promissory note Swiss Bank ( i f d e f a u l t by WAVE) Owner l i a b i l i t y of $5,415,000 So m e r v i l l e House Corpo r a t i on/Producer (Vendor) The s o l i d l i n e s represent the flow of d i s t r i b u t i o n revenue from the d i s t r i b u t o r to investor-owner and i n turn to the producer. The Swiss bank on the r i g h t hand side would only pay the investor-owner i f WAVE d e f a u l t s . Source: S o m e r v i l l e House C o r p o r a t i o n , The ZerrO S y n d i c a t e , (October 3, 1975) - 49 -The Flow of Funds Schematic in Table II-I shows the flow of funds between the investor-owner, vendor and d i s t r i bu to r or bank guarantor. It appears that there must be some f a c i l i t y that permits the vendor (producer) to reimburse the d i s t r i bu to r i f the motion p icture i s unsuccess-f u l and the d i s t r i bu to r does not earn any revenue from bona f ide d i s t r i b -ution a c t i v i t i e s . However the wr i te r has not been able to prove that there is an arrangement fo r reimbursement between the d i s t r i bu to r and the producer. The promoters:of such investment arrangements are under-standably re luctant to confirm th i s theory. Summary. The four pr inc ipa l f inancing arrangements have been used by pr ivate investors in Canada during the l a s t seven years. The f i r s t two arrangements, the l imi ted partnership and the j o i n t venture are no longer used because the Department of National Revenue, Taxation and the Canadian j u d i c i a l system disallowed part or a l l of the investors ' cap i ta l cost allowance deductions. The circumstances for abanding these two f inancing arrangements w i l l ' b e explained in greater de t a i l in Chapter IV. The other two private investor motion picture f inancing arrange-ments, the undivided interest and the syndicate-guarantee, are s t i l l being used. The undivided in teres t arrangement i s usually used by a small number of investors who are f inancing e i ther a low budget feature f i l m or an educational f i lm or video tape program. This arrangement i s enhanced i f the i n i t i a l investor cash down payment i s leveraged fo r cap i t a l cost allowance purposes by the use of a promissory note. The syndicate-guarantee arrangement i s presently the most widely used method for f inancing feature f i lms in Canada. The feature f i lm investment i s often sold as a package consist ing of two or more feature f i lms . The production - 50 -budgets are u s u a l l y over $1,000,000 and the productions are often co-productions wit h n a t i o n a l s of another country. The i n v e s t o r ' s cash down payment i s leveraged because the purchase p r i c e i s i n f l a t e d over the production cost. The i n v e s t o r signs a promissory note or notes f o r the balance of the i n f l a t e d purchase p r i c e . The i n v e s t o r ' s l i a b i l i t y i s guaranteed by a d i s t r i b u t o r . The syndicate-guarantee f i n a n c i n g arrange-ment w i l l be f u l l y explored i n Chapter V I I . - 51 -FOOTNOTES CHAPTER II ^ Martin L. O'Brien, "An Overview of the Income Tax Law as i t a p p l i e s t o Tax S h e l t e r s " (Canadian Tax Foundation Twenty F i f t h Tax  Conference, 1973), p. 485. 2 I b i d . , p. 486. 3 Lord Tomlin, Commissioner of Inland Revenue v. Duke of Westminster (1936) Appeals Court 1, p. 19. 4 Canadian Current Tax, V o l . 14, November 23, 1973, Issue 47, (Butterworth & Co. (Canada) L t d . ) , p. 2. 5 O'Brien, op. c i t . 6 I b i d . , p. 491. 7 I b i d . , p. 492. 8 Henry Campbell B l a c k , Black's Law D i c t i o n a r y (West P u b l i s h i n g Co. 1968), p. 1277. 9 F r a n c i s W. P i x l e y ( e d . ) , The Accountants' D i c t i o n a r y , Vol.11 ( S i r Isaac Pitman & Sons, L t d . , 1926), p. 615. ^ B l a c k , op. c i t . , p. 1697. 1 1 I b i d . , p. 950. E a r l J o w i t t (ed.), The D i c t i o n a r y of E n g l i s h Law (Sweet & Maxwell L i m i t e d , 1959), p. 1717. 1 3 Wayne G. Beach, "Tax Advantages of Film Investments", CIT Tax Planning and Management 18 (Butterworth and Co. (Canada) L t d . , 1976), p.. 18-10". 1 4 R i c h a r d M. Wise, "A Cineramic View of Motion P i c t u r e F i l m Investment", Canadian Tax J o u r n a l , M a r c h - A p r i l , 1976, p. 162. 1 5 I b i d . APPENDIX A TO CHAPTER II HOW CAPITAL COST ALLOWANCE SHELTERS TAXABLE INCOME The f o l l o w i n g i s a basic explanation of c a p i t a l cost allowance. An asset or property has a cost to the taxpayer (owner). That i s , he must e i t h e r i n v e s t c a p i t a l upon purchase of the asset or promise to pay cash t o the vendor at some f u t u r e date. The aggregate of t h i s down payment and the f u t u r e payments i s the c a p i t a l cost to the taxpayer. The Income Tax Act and Regulations allow a taxpayer to expense, or deduct, a c e r t a i n p o r t i o n of t h i s cost from the taxpayer's income each year. Met Taxable income i s the balance of income remaining a f t e r a l l c a p i t a l cost deductions and other d e d u c t i b l e expenses. Each c l a s s of assets has a d i f f e r e n t r a t e at which t h i s deprec-i a t i o n expense may be deducted. The r a t e i s u s u a l l y , but not always, t i e d i n t o the h i s t o r i c u s e f u l economic l i f e of the a s s e t , thus assets which can be used f o r a long time have a low d e p r e c i a t i o n r a t e and assets, with a short economic l i f e s p a n have a high r a t e . For example i f the asset i s a b r i c k b u i l d i n g 5% of the undepreciated c a p i t a l cost may be deducted per year. I f the b u i l d i n g had a c o s t to the taxpayer (owner) of $100,000 he would be e n t i t l e d t o deduct $5,000 from h i s income and would pay no taxes on t h a t $5,000. The f o l l o w i n g year the undepreciated c a p i t a l c ost would be $95,000 and the taxpayer could deduct $4,750 from h i s income. I f , to c i t e an unusual case as an example, the b u i l d i n g had been e x p r e s s l y e r e c t e d by the taxpayer on the s i t e of the 1967 World E x h i b i t i o n (Expo) f o r a concession or other use, i t would be d e p r e c i a b l e at 100%. That i s , i f i t c o s t the taxpayer $100,000 he could deduct t h a t f u l l amount from h i s income i n that year and he would pay no taxes on that $100,000, i f he had that much income. The undepreciated c a p i t a l c o s t i n the f o l l o w i n g - 52 -- 52a -year would be zero, hence no deduction allowed i n the second year. A l l assets (property) have been assigned to c e r t a i n c l a s s e s by way of amendments to the Income Tax Act Regulations. Each c l a s s has been given a maximum c a p i t a l a m o r t i z a t i o n r a t e , meaning the taxpayer can deduct from the undepreciated c a p i t a l c ost balance up to that r a t e each year. CHAPTER I I I INCOME TAX ACT LEGISLATION AND REGULATIONS I. INTRODUCTION The primary s e c t i o n o f the Income Tax Act which f a c i l i t a t e s tax s h e l t e r s through the f i n a n c i n g by a tax payer of c e r t a i n i n v e s t -ments i s subsection 20(1). Subsection 20(1) provided t h a t a taxpayer may deduct from h i s income h i s c a p i t a l cost of property. The subsec-t i o n i s w r i t t e n as f o l l o w s : Notwithstanding paragraphs 18(1) ( a ) , (b) and ( h ) , i n computing a taxpayer's income f o r a t a x a t i o n year from a business o r proper t y , there may be deducated such o f the f o l l o w i n g amounts as are wholly a p p l i c a b l e to th a t source o r such p a r t of the f o l l o w i n g amounts as may be reasonably be regarded as a p p l i c -able t h e r e t o : (a) such p a r t of the c a p i t a l c ost to the taxpayer of p r o p e r t y , o r such amount i n respect of the c a p i t a l cost t o -| the taxpayer o f prope r t y , i f any, as i s allowed by r e g u l a t i o n . Subsection 13(21)(b) d e f i n e s d e p r e c i a b l e property as property on which the taxpayer can deduct the cost of the property as provided i n subsection 2 0 ( 1 ) ( a ) . Subsection 13(21)(b) s t a t e s : Depreciable property of a taxpayer as of any time i n a t a x a t i o n year means property i n respect of which the taxpayer has been allowed, or i s e n t i t l e d t o , a deduction under r e g -u l a t i o n s made under paragraph 20(1)(a) i n computing income f o r that or a previous t a x a t i o n year. 2 Subsection 18(1) s t a t e s t h a t the c a p i t a l c o s t deduction o f dep r e c i a b l e property must r e l a t e t o property t h a t i s owned f o r the purpose o f ga i n i n g or producing income. Subsection 18(1) i s w r i t t e n as f o l l o w s : - 53 -- 54 -In computing the income of a taxpayer from a business or property no deduction s h a l l be made i n respect of (a) an outl a y or expense except to the extent that i t was made o r in c u r r e d by the taxpayer f o r the purpose of g a i n i n g or producing income from the business or property; (b) an o u t l a y , l o s s or replacement of c a p i t a l , a payment on account of c a p i t a l on an allowance i n respect of d e p r e c i a t i o n , obsoles- ^ cence or d e p l e t i o n except as e x p r e s s l y permitted by t h i s p a r t . 2. LEGISLATION AND REGULATIONS - 1960 Part XI of the Regulations s t a t e s the maximum r a t e o f c a p i t a l c o s t allowance deductions f o r depreciable property t h a t may be taken each year by a taxpayer. The f i r s t p r o v i s i o n i n the Income Tax Act t h a t allowed a c a p i t a l cost deduction f o r motion p i c t u r e f i l m was Order i n Council P.C. 1960-225. Order i n Council P.C. 1960-225 was p u b l i s h e d on March 9, 1960 and was a p p l i c a b l e to 1959 and subsequent t a x a t i o n y e a r s . The Order added c l a s s 18 t o Part X I , Section 1100, Schedule B of the Income Tax Regulations , thus a l l o w i n g a 60% c a p i t a l c o s t allowance f o r "property t h a t i s a motion p i c t u r e f i l m . " 4 A motion p i c t u r e f i l m has been defined by Revenue Canada, Taxation as "a photographic f i l m on which a useable motion p i c t u r e has 5 been produced". The master f i l m " of a motion p i c t u r e f i l m i s d e f i n e d as: The o r i g i n a l production of a f i l m ( u s u a l l y i n the form of a photographic negative) from which are produced the copies t h a t w i l l be used f o r performance purposes, each of which i s r e f g r r e d to...as a "copy". 6 3. LEGISLATION AND REGULATIONS - 1966 On March 23, 1966, Order i n Council P.C. 1966-431 was pub l i s h e d which amended c l a s s 18 to add the words "other than a t e l e v i s i o n commercial message"^; and the phrase "a motion p i c t u r e f i l m t h a t i s a t e l e v i s i o n commercial message" was added to c l a s s 12 of Schedule B which allowed - 55 -the taxpayer t o deduct 100% of the undepreciated c a p i t a l c ost of the property of the c l a s s . T e l e v i s i o n commercial messages were thus made e l i g i b l e f o r 100% c a p i t a l cost allowance i n the year they were made. Video tapes were being used more f r e q u e n t l y f o r t e l e v i s i o n commercials and programs. A Revenue Canada, Taxation's I n t e r n a l Assessing Guide, dated June 16, 1969 made the f o l l o w i n g comments regarding the j u s t i f i c a t i o n f o r deducting the e n t i r e video-tape production expense i n the year i t was i n c u r r e d . Generally speaking, video tape i s l i t t l e used f o r long-term storage of the m a t e r i a l recorded on i t , as there w i l l be gradual d e t e r i o r a t i o n of the recorded images. A c c o r d i n g l y , there i s no c l a s s i n Schedule B t o the Regulations t h a t s p e c i f i c a l l y i n c l u d e s the c a p i t a l c ost of such m a t e r i a l . The kind of m a t e r i a l recorded on video tape f r e q u e n t l y i s of short-term use o n l y , because e i t h e r i t i s merely o f t o p i c a l i n t e r e s t and w i l l have value j u s t f o r a l i t t l e w h i l e o r , by the production arrangement with the Canadian Council o f Authors and A r t i s t s , i t i s intended to be shown only once (although p o s s i b l y by means of separate showings i n d i f f e r e n t time zones). The production and recording or purchase c o s t s o f m a t e r i a l of these kinds normally can be w r i t t e n o f f as expenses of the year. 9 The Assessing Guide s t a t e d 'there i s no c l a s s . . . t h a t s p e c i f i c a l l y i n c l u d e s the c a p i t a l c o s t " of video tape. The Assessing Guide i s i n c o r r e c t . Order i n Council P.C. 1961-24 S.0.R./61-22, pu b l i s h e d January 25, 1961 amended c l a s s 12 w i t h the a d d i t i o n of paragraph "(1) video t a p e . " ^ The amendment q u a l i f i e d video tape f o r 100% c a p i t a l c ost allowance. 4. LEGISLATION AND REGULATIONS - 1972 The "new" Income Tax Act which became law on January 1, 1972 did not d i r e c t l y change any o f the reguations f o r motion p i c t u r e f i l m or video tape. The Act d i d , however, make changes i n the c a p i t a l c ost - 56 -allowance deduction f o r r e n t a l r e a l - e s t a t e property. C a p i t a l cost deductions f o r r e n t a l p r o p e r t i e s (e.g. apartment b u i l d i n g s ) could no longer be deducted from a taxpayer's other sources of income. The c.c.a. deduction could only be taken against the r e n t a l income from the p r o p e r t y . 1 1 P r i o r to the passage of the new A c t , r e n t a l property has been the most common and conventional type of tax s h e l t e r f o r high income taxpayers. Thus tax reform increased the i n t e r e s t i n other tax s h e l t e r investments - motion p i c t u r e being one o f these. The new Act a l s o f e a t u r e d amendments to the computation of a partner's share of the income or l o s s from a p a r t n e r s h i p . Under the " o l d " A c t , the income of a p a r t n e r s h i p was a l l o c a t e d to the partners before any deduction f o r c a p i t a l c o s t allowance. A p a r t n e r s h i p was not a "taxpayer" as defined by the o l d A c t , t h e r e f o r e the p a r t n e r s h i p d i d not c l a i m c a p i t a l cost allowance. The partners i n d i v i d u a l l y claimed c a p i t a l cost allowances on t h e i r share of a s s e t s used by the p a r t n e r -s h i p . I f an i n d i v i d u a l partner wished, he could c l a i m as much or as l i t t l e c a p i t a l cost allowance as he r e q u i r e d and as was a v a i l a b l e t o him ( i . e . undepreciated) t o minimize h i s t a x a b l e income. A f t e r December 31, 1971the new Act required t h a t the p a r t n e r s h i p i t s e l f c l a i m c a p i t a l cost allowance (up to the maximum allowed on the d e p r e c i a b l e property owned by the p a r t n e r s h i p ) p r i o r t o a l l o c a t i o n of each 12 partner's share of the p r o f i t or l o s s . Few partners have i d e n t i c a l amounts of tax a b l e income. A partner w i t h a low amount of tax a b l e income i n a p a r t i c u l a r year may f i n d t h a t he has more deductions ( l o s s ) than t a x a b l e income. Because he ccwild no longer c a r r y t h a t l o s s to a subsequent year an a t t r a c t i v e income tax c o n s i d e r a t i o n was e l i m i n a t e d f o r many - 57 -motion p i c t u r e p a r t n e r s h i p s . A t h i r d f e a t u r e o f the new Income Tax Act was the p r o v i s i o n f o r 13 income averaging a n n u i t i e s . Designed to l e t an i n d i v i d u a l taxpayer spread unusually l a r g e r e c e i p t s of s p e c i f i e d types of income ( i n c l u d i n g s u b s t a n t i a l c a p i t a l gains or recaptured d e p r e c i a t i o n ) over c u r r e n t and f u t u r e y e a r s , an I.A.A. Contract provides d e f e r r a l of most of the tax on t h i s s p e c i a l income w h i l e r e s t r i c t i n g the use of the income to a f i x e d y i e l d . ' 4 Income averaging a n n u i t i e s are important to a motion p i c t u r e i n v e s t o r . I f he decides to s e l l h i s motion p i c t u r e investment the proceeds from the s a l e would become taxabl e income i f they exceeded c.c.a. p r e v i o u s l y claimed f o r income tax purposes. Under the new Act the i n v e s t o r could now i n v e s t the amount o f d e p r e c i a t i o n claimed but not s u f f e r e d i n an Income Averaging Annuity Contract to spread the recaptured d e p r e c i a t i o n over a number of f u t u r e income tax years. 5. LEGISLATION AND REGULATIONS - 1974 On J u l y 29, 1975, the f e d e r a l cabinet passed P.C. 1975-1822. Subsection 1104(2)(h) was thereby added t o the Income Tax Regulations e f f e c t i v e November 18, 1974 and created the p r o v i s i o n s f o r 100% c a p i t a l cost allowance o f a " c e r t i f i e d f e a t u r e f i l m " . The word "or" at the end of paragraph (1) was d e l e t e d and added a t the end of para-graph (m) and paragraph ( n ) : "a c e r t i f i e d f e a t u r e f i l m " was added t o 15 the d e s c r i p t i o n of c l a s s 12 i n Schedule B. The d e s c r i p t i o n of c l a s s was revoked and t h e r e a f t e r defined as': Property that i s a motion p i c t u r e f i l m other than (a) a t e l e v i s i o n commercial message and (b) a c e r t i f i e d f e a t u r e f i l m '° The c a b i n e t ' s i n i t i a t i v e was e x p r e s s l y designed t o " i n c r e a s e p r i v a t e s e c t o r support of the Canadian fea t u r e f i l m i n d u s t r y " . ^ ^ e - 58 -l e g i s l a t i o n was enacted as f o l l o w s i n Section 1104(2) of the Income  Tax A c t : (h) " c e r t i f i e d f e a t u r e f i l m " means a motion p i c t u r e f i l m c e r t i f i e d by the Secretary of State to be a f i l m of not l e s s than 75 minutes running time i n respect of which a l l photography or a r t work s p e c i f i c a l l y r e q u i r e d f o r the production thereof and a l l f i l m e d i t i n g thereof-was commenced a f t e r November 18, 1974, and c e r t i f i e d by him to be ( i ) a f i l m the production of which i s contemplated i n a co-production agreement entered i n t o between Canada and another country, or ( i i ) a f i l m i n respect of which (A) the person who performed the d u t i e s of producer was a Canadian, (B) no fewer than 2/3 i n number of a l l the persons of whom (I) was a person who performed the d u t i e s of d i r e c t o r , s c r e e n w r i t e r , music composer, a r t d i r e c t o r , p i c t u r e e d i t o r or d i r e c t o r of photography, or ( I I ) was the i n d i v i d u a l i n respect of whose s e r v i c e s as an a c t o r or a c t r e s s i n respect of the f i l m the highest remuneration or the second highest remuneration was p a i d or payable, were Canadians, (C) not l e s s than 75% of the aggregate of the remuneration paid or payable to persons f o r s e r v i c e s provided i n r e s p e c t of the f i l m (other than remuneration p a i d or payable t o or i n respect of the persons r e f e r r e d t o i n cl a u s e s (A) and (B) or remuneration paid or payable f o r p r o c e s s i n g and f i n a l preparation of the f i l m ) was paid or payable t o Canadians. (D) not l e s s than 75% of the aggregate of c o s t s i n c u r r e d f o r processing the f i n a l p r eparation o f the f i l m i n c l u d i n g l a b o r a t o r y work, sound r e c o r d i n g , sound e d i t i n g and p i c t u r e e d i t i n g (other than remuneration p a i d or payable to or i n respect of persons r e f e r r e d to i n clauses ( A ) , (B) and (C) was i n c u r r e d i n respect o f s e r v i c e s rendered i n Canada, and (E) the c o p y r i g h t p r o t e c t i n g i t s use i n Canada i s b e n e f i c i a l l y owned (I) by a person who i s e i t h e r a Canadian or a c o r p o r a t i o n i n c o r p o r a t e d under the laws of Canada or a p r o v i n c e , or ( I I ) j o i n t l y or otherwise by two or more persons d e s c r i b e d i n subclause ( I ) , other than a motion p i c t u r e f i l m i n respect o f which c e r t i f i c a t i o n under t h i s paragraph has been'revoked by the S e c r e t a r y of S t a t e as provided i n paragraph (10) ( b ) J 8 Subsection 1104 (10) of the Income Tax R e g u l a t i o n s , a l s o made law on J u l y 29, 1975, described a "Canadian" f o r the purposes of paragraph (2)(h) as : - 59 -(a) a "Canadian" i s an i n d i v i d u a l who was, a t a l l r e l e v a n t times, a Canadian c i t i z e n as defined i n the Canadian C i t i z e n s h i p Act or an immigrant whose landing has been authorized under the Immigration Act;19 Subsection 1104 (10) (b) provided a c e r t i f i c a t e r e v o c a t i o n c l a u s e : (b) a c e r t i f i c a t e issued under t h a t paragraph may be revoked by the Secretary of State ( i ) i f an i n c o r r e c t statement was made i n the f u r n i s h i n g of info r m a t i o n f o r the purpose of that paragraph, or ( i i ) i f , a t any time w i t h i n four years a f t e r the date t h a t the c e r t i f i c a t e becomes e f f e c t i v e , the co p y r i g h t r e f e r r e d t o i n clause ( 2 ) ( h ) ( i i ) ( E ) was not owned as r e q u i r e d by that c l a u s e , and a c e r t i f i c a t e that has been revoked s h a l l be n u l l and void from the time of i t s i s s u e , a 6. LEGISLATION AND REGULATIONS - 1976 In the May 25, 1976 Budget Speech, Finance M i n i s t e r , Donald S. Macdonald announced a s u r p r i s i n g number of c a p i t a l c o s t allowance amend-ments s i g n i f i c a n t l y a f f e c t i n g investments i n f i l m and video-tape production both i n d i r e c t l y and d i r e c t l y . I n d i r e c t l y , motion p i c t u r e investment was a f f e c t e d because the c a p i t a l c o s t allowance f o r a i r c r a f t , once a popular tax s h e l t e r investment, was reduced from 40% to 25%. The amendment removed a i r c r a f t from c l a s s 16 20 and placed them i n c l a s s 9. the government a l s o proposed t h a t c a p i t a l cost allowances, w i t h respect to leased p r o p e r t y , c o u l d not be used to create a l o s s to s h e l t e r non-leasing income. Finance M i n i s t e r Macdonald pronounced t h a t : The Government does not intend t h a t c a p i t a l c o s t allowances be a v a i l a b l e f o r unwarranted use by taxpayers as a means of s h e l t e r i n g income from i t s f a i r burden o f t a x a t i o n . With t h i s o b j e c t i v e i n mind, I am proposing t h a t a new l i m i t be i n t r o -duced t o prevent the c r e a t i o n of tax losses by c l a i m i n g c a p i t a l cost allowance on the l e a s i n g of moveable property. 21 The amendment r e s t r i c t i n g c.c.a. on leased movable property such as a i r c r a f t , reduced the i n t e r e s t i n t h a t type o f tax s h e l t e r and inc r e a s e d the i n t e r e s t i n other types of tax s h e l t e r s such as motion p i c t u r e s . - 60 -Macdonald f u r t h e r increased the i n t e r e s t i n motion p i c t u r e investment as a tax s h e l t e r when he r e i t e r a t e d t h a t i t i s "the government's 22 p o l i c y to encourage Canadian Productions". He went on t o say t h a t motion p i c t u r e "productions would be s p e c i f i c a l l y excluded from the so-23 c a l l e d ' a n t i - s h e l t e r i n g r u l e ' " a f f e c t i n g a i r c r a f t . The Department of Finance i s s u e d a press r e l e a s e on June 29, 1976 t h a t read: Finance M i n i s t e r Donald S. Macdonald confirmed t h a t the 100% w r i t e - o f f f o r c e r t i f i e d Canadian Film and video-tape productions w i l l not be a f f e c t e d by the c a p i t a l cost allowance l i m i t a t i o n f o r leased p r o p e r t i e s announced i n the budget of May 25, 1976.24 The new budget amendments d i r e c t l y encouraged p r i v a t e motion p i c t u r e f i n a n c i n g i n Canada because the amendments provided that the d i s t i n c t i o n between productions shot on o r d i n a r y f i l m and video tape would no longer e x i s t and the rate of 100% formerly a p p l i c a b l e to video tape would be revoked f o r non-Canadians productions and r e p l a c e d by the 30% r a t e . The government concluded t h a t the present 60% c a p i t a l c ost allowance r a t e f o r motion p i c t u r e f i l m s other than Canadian was too high and t h e i r c a p i t a l c ost allowance would be reduced t o 30% to more a c c u r a t e l y r e f l e c t the average, u s e f u l l i f e of such f i l m s . " The government proposal was enacted i n t o law by P.C. 1976-2763 SOR/76-748, e f f e c t i v e a f t e r May 25, 1975, by adding paragraph "(q) a 26 motion p i c t u r e f i l m or video tape acquired a f t e r May 25, 1976" to c l a s s 10 (30%) of Schedule B of the Income Tax Regulations. The reduced c.c.a. g r e a t l y decreased the a t t r a c t i v e n e s s of investment i n non-Canadian productions rega r d l e s s of t h e i r u l t i m a t e chances o f commercial d i s t r i b -u t i o n success v i s - a - v i s Canadian c e r t i f i e d f i l m s . A proposal by the f e d e r a l cabinet t o i n c r e a s e the c a p i t a l c o s t f o r s h o r t motion p i c t u r e f i l m s was made i n 1975 ( p r e v i o u s l y only f i l m s over 75 minutes q u a l i f i e d f o r the 100% c.c.a.). This proposal was greeted - 61 -e n t h u s i a s t i c a l l y by the Canadian motion p i c t u r e i n d u s t r y because i t meant that education f i l m s and documentaries would a l s o be given the p r e f e r e n t i a l w r i t e - o f f . The government's proposal was enacted by an amendment t o Se c t i o n 1104(2) and through Order i n Council P.C. 1976-2763 SOR/76-748, e f f e c t i v e a f t e r May 25, 1976. Section 1104(2)(h) was amended to i n c l u d e the phrase "and e i t h e r the f i l m was completed before May 26, 27 1976, or the photography or a r t work was commenced before May 26, 1976,". The amendment permitted the owners of p r e v i o u s l y produced motion p i c t u r e s and productions c u r r e n t l y i n progress to continue t o be e l i g i b l e t o c l a i m e i t h e r a 60% or 100% c.c.a. deduction. The amendment e l i m i n a t e d the use of the " c e r t i f i e d f e a t u r e f i l m " category f o r any f u t u r e Canadian motion p i c t u r e productions. C e r t i f i c a t i o n of a motion p i c t u r e by the S e c r e t a r y of State was now t o depend on the number of Canadians performing key f u n c t i o n s on the production and the percentage of t o t a l budget money p a i d to those Canadians. Subsection 1 1 0 4 ( 2 ) ( i ) and 1104(2)(j) were added t o s e c t i o n 1104. Subsection 1104(2)(i) defined a u n i t of production system t h a t would be used to determine i f a f e a t u r e length f i l m or video tape production could be c e r t i f i e d by the Secretary of State as a " c e r t i f i e d f eature prod-u c t i o n " and hence e l i g i b l e f o r a 100% c a p i t a l cost allowance. U n i t s o f production were a l l o t t e d according to the number o f Canadians who performed s e r v i c e s f o r the production and according t o the aggregate percentage o f the t o t a l production budget.spent on the motion p i c t u r e production i n Canada. Feature length f i l m or video tape co-productions between Canada and one of the c o u n t r i e s w i t h which Canada has a co-production t r e a t y , would continue t o be e l i g i b l e f o r c e r t i f i c a t i o n by the S e c r e t a r y of S t a t e and e l i g i b l e f o r 100% c.c.a. Subsection 1104(2)(i) reads as f o l l o w s : - 62 -( i ) " c e r t i f i e d f e a t u r e production" means a motion p i c t u r e f i l m or video tape c e r t i f i e d by the Secretary of State to be a f i l m or tape of not l e s s than 75 minutes running time i n r e s p e c t of which a l l photography, taping or a r t work s p e c i f i c a l l y r e q u i r e d f o r the production thereof and a l l f i l m or tape e d i t i n g t h e r e f o r Were commenced a f t e r . May 25, 1976, and c e r t i f i e d by him t o be ( i ) a f i l m or tape the production of which i s contemplated i n a co-production agreement entered i n t o between Canada and another country, or ( i i ) a f i l m or tape i n respect of which (A) the i n d i v i d u a l who performed the d u t i e s of producer was a Canadian, (B) the Secretary of State has a l l o t t e d not l e s s than an aggregate of 6 u n i t s of production f o r i n d i v i d u a l s who provided s e r v i c e s i n respect of the f i l m or tape, i n the f o l l o w i n g manner: (I) f o r the d i r e c t o r , two u n i t s of p r o d u c t i o n , ( I I ) f o r the s c r e e n w r i t e r , two u n i t s of p r o d u c t i o n , ( I I I ) f o r the a c t o r or a c t r e s s i n r e s p e c t of whose s e r v i c e s f o r the f i l m or tape the highest remuneration was paid or payable, one u n i t of p r o d u c t i o n , (IV) f o r the a c t o r or a c t r e s s i n respect of whose s e r v i c e s f o r the f i l m or tape the second highest remuneration, was p a i d or payable, one u n i t of production. (V) f o r the a r t d i r e c t o r , one u n i t o f p r o d u c t i o n , (VI) f o r the d i r e c t o r of photography, one u n i t p r o d u c t i o n , (VII) f o r the music composer, one u n i t of p r o d u c t i o n , and ( V I I I ) f o r the p i c t u r e e d i t o r , one u n i t of p r o d u c t i o n , s h a l l be a l l o t t e d , provided the i n d i v i d u a l i n respect of such all o t m e n t was a Canadian, (C) not l e s s than 75% of the aggregate of the remuneration paid or payable to persons f o r s e r v i c e s provided i n r e s p e c t of the f i l m or tape (other than remuneration paid or payable . t o , or i n respect o f , the i n d i v i d u a l s r e f e r r e d t o i n clauses (A) and (B) or remuneration paid or payable f o r processing and f i n a l p r e p a r a t i o n of the f i l m or tape) was paid or payable t o , or i n respect of s e r v i c e s provided by Canadians, and (D) not l e s s than 75% of the aggregate of a l l costs i n c u r r e d f o r processing and f i n a l p reparation of the f i l m or t a p e , i n c l u d i n g l a b o r a t o r y work, sound r e c o r d i n g , sound e d i t i n g and p i c t u r e e d i t i n g (other than remuneration paid or payable t o , or i n respect o f , the i n d i v i d u a l s r e f e r r e d t o i n clauses (A), (B) and (C)) was i n c u r r e d i n respect of s e r v i c e s provided i n Canada, other than a f i l m or tape i n respect of which c e r t i f i c a t i o n under t h i s paragraph has been revoked by the S e c r e t a r y of State as provided i n paragraph 10(b) ;28 Subsection 1104 ( 2 ) ( j ) d efined short motion p i c t u r e f i l m s and video tape productions that could be c e r t i f i e d by the S e c r e t a r y of S t a t e as " c e r t i f i e d short productions". Subsection 1104(2)(j) reads as f o l l o w s : - 63 -( j ) " c e r t i f i e d short production" means a motion p i c t u r e f i l m or video tape c e r t i f i e d by the Secretary of State to be a f i l m or tape of l e s s than 75 minutes running time i n r e s p e c t of which a l l photography, taping or a r t work s p e c i f i c a l l y r e q u i r e d f o r the production thereof and a l l f i l m or tape e d i t i n g t h e r e f o r were commenced a f t e r May 25, 1976, and c e r t i f i e d by him to be ( i ) a f i l m or tape that would be c e r t i f i a b l e under paragraph ( i ) i f t h a t paragraph were read without reference to the words "of not l e s s than 75 minutes running time", or ( i i ) a f i l m or tape i n respect of which (A) the i n d i v i d u a l who performed the d u t i e s of producer was a Canadian, and (B) not l e s s than 75% of the aggregate of a l l costs i n c u r r e d i n respect of producing the f i l m or tape, i n c l u d i n g remuneration and p r o c e s s i n g , was paid or payable t o , or i n respect of s e r v i c e s provided by, Canadians, other than a f i l m or tape i n respect of which c e r t i f i c a t i o n under t h i s paragraph has been revoked by the Secretary of State as provided i n paragraph ( 1 0 ) ( b ) ; and ^9 Section 1104(10) was a l s o amended by Order i n Council P.C. 1976-2763 SOR/76-748, e f f e c t i v e a f t e r May 25, 1976 s i n c e i t was con-sequental upon the amendments t o Section 1104(2). Sect i o n 1104(10) now reads as f o l l o w s : (10) For the purposes of paragraphs 2(h) to ( j ) , (a) "Canadian" means an i n d i v i d u a l who was, at a l l r e l e v a n t times, a Canadian c i t i z e n as defined i n the Canadian  C i t i z e n s h i p Act or an immigrant whose landing has been au t h o r i z e d under the Immigration A c t ; (b) a c e r t i f i c a t e issued under paragraph ( 2 ) ( h ) , ( i ) or ( j ) may be revoked by the Secretary of State i f an i n c o r r e c t statement was made i n the f u r n i s h i n g of i n f o r m a t i o n f o r the purpose of that paragraph and a c e r t i f i c a t e t h a t has been revoked s h a l l be n u l l and v o i d from the time of I t s i s s u e ; (c) "remuneration" does not i n c l u d e amounts determined by reference to the amount of income from a motion p i c t u r e f i l m video tape; and (d) " u n i t o f production" means a measure used by the Secretary of State i n determining the weight to be given f o r each i n d i v i d u a l Canadian r e f e r r e d to i n clause ( 2 ) ( i ) ( i i ) ( B ) who provides s e r v i c e s i n respect of a motion p i c t u r e f i l m or video tape.30 Class 12.•(-!) to (n) 100% of Schedule B was amended by Order i n Council P.C. 1976-2969 on December 2, 1976 to read: - 64 -(1) a video tape acquired before May 26, 1976 (m) a motion p i c t u r e f i l m or video tape t h a t i s a t e l e v i s i o n commercial message, (n) a c e r t i f i e d f eature f i l m , c e r t i f i e d f e a t u r e production or c e r t i f i e d short p r o d u c t i o n , or 31 S t r i p p e d of the l e g a l e s e , t h i s means t h a t any video-tape or motion p i c t u r e , r e g a r d l e s s of l e n g t h , but meeting the Canadian content and ownership requirements, i s e l i g i b l e f o r 100% c.c.a. A l l f o r e i g n productions (e.g. American), w i t h the exception of co-production t r e a t y p r o d u c t i o n s , w i l l only be e l i g i b l e f o r an annual c a p i t a l cost allowance of 30% on a d e c l i n i n g balance b a s i s . - 65 -FOOTNOTES CHAPTER I I I Canadian Income Tax Act. S.C. 1970-72 c.63, as amended w i t h Income Tax Reg u l a t i o n s , 47th e d i t i o n 1975-76, Consolidated t o February 15, 1976 (C.C.H., Canadian L i m i t e d , Don M i l l s , Ontario M3C 1S5, 1976), p.53. 2 Ibid.,pp.34-35. 3 I b i d . , pp.43-44. 4 Income Tax Act. R.S.C. c.148, Consolidated w i t h Amendments t o 1960, (Richard DeBoo L i m i t e d , Toronto, O n t a r i o , 1961), p. 515. 5 Revenue Canada, T a x a t i o n , Assessing Guide 16-6-69, p.4-128.. 6 I b i d . , p.4-126. 7 Canadian Income Tax A c t , Chap. 148, R.S.C. 1952 as amended to March 31, 1967, with Regulations Consolidated to March 31, 1967, 36th E d i t i o n 1966-67 (C.C.H. Canadian L i m i t e d , Don M i l l s , O n t a r i o , 1967), p. 11,374. 8 I b i d . , p. 11,373. 9 Assessing Guide, o p . c i t . , p. 4T128. ^ Income Tax Act. Annotated R.S.C. 1952, c. 148 Co n s o l i d a t e d w i t h Amendments t o 1961 (Richard DeBoo L i m i t e d , Toronto, O n t a r i o , 1962), p. 512. ^ (11) Notwithstanding subsection ( 1 ) , i n no case s h a l l the aggregate of deductions, each of which i s a deduction i n respect o f property of a p r e s c r i b e d c l a s s owned by a taxpayer t h a t i n c l u d e s r e n t a l property owned by him, otherwise allowed to the taxpayer by v i r t u e of subsection (1) i n computing h i s income f o r a t a x a t i o n y e a r , exceed the amount, i f any, by which, (a) the aggregate of amounts each of which i s ( i ) h i s income f o r the year from r e n t i n g or l e a s i n g a r e n t a l property owned by him, computed without regard to paragraph 20(1)(a) or the a c t , or ( i i ) the income of a p a r t n e r s h i p f o r the year from r e n t i n g or l e a s i n g a r e n t a l property of the p a r t n e r -s h i p , to the extent of the taxpayer's share of such income exceeds (b) the aggregate o f amounts each of which i s ( i ) h i s l o s s f o r the year from r e n t i n g or l e a s i n g a r e n t a l property owned by him, computed without r e g a r d t o paragraph 20(1)(a) of the A c t , o r ( i i ) the l o s s of a p a r t n e r s h i p f o r the year from r e n t i n g o r l e a s i n g a r e n t a l property of the p a r t n e r s h i p , to the extent of the taxpayer's share of such l o s s . - 66 -Regulation 1100(11) added by P.C. 1972-1612, J u l y 27, 1972, Canada Gazette, P a r t I I , August 9, 1972 e f f e c t i v e January 1, 1972, Canadian Income Tax-Act w i t h R e g u l a t i o n s , 47th E d i t i o n (C.C.H. Canadian L i m i t e d ) , pp. 37,174-37,175! 96.(1) Where a taxpayer i s a member of a p a r t n e r s h i p , h i s income, net c a p i t a l l o s s , n o n - c a p i t a l l o s s and r e s t r i c t e d farm l o s s , i f any, f o r a t a x a t i o n y e a r , as the case may be, s h a l l be computed as i f (a) the pa r t n e r s h i p were a separate person r e s i d e n t i n Canada Canadian Income Tax Act w i t h R e g u l a t i o n s , 47th E d i t i o n (C.C.H. Canadian L i m i t e d ) , p. 267. 1 3 I b i d . , S e c t i o n 61 to subsection 61 (4)(b) 1973-74 s.c.c. 14 s. 17(1), pp. 132. 14 B e a t r i c e R i d d e l l , "How To Treat Unaveraged Incomes", Finan- c i a l P o s t , February 14, 1976, p.35. 15 Canadian Income Tax A c t , o p . c i t . .Schedule B, p. 38,006. 1 6 I b i d . , p. 38,009. ^ Secretary of S t a t e , News Release, August 5, 1975. 1 o Canadian Income Tax A c t , op . c i t . , Regulation 1104(2)(h), pp. 37,195-37,196. 1 9 I b i d . , pp. 37,198-37,199. 1 9 a I b i d . 20 Order i n Council P.C. 1976-2969 dated December 2, 1976, e f f e c t i v e a f t e r May 25, 1976 t o provide f o r new c a p i t a l cost allowance on various c l a s s e s o f de p r e c i a b l e property. 21 The Honorable Donald S. Macdonald, Finance M i n i s t e r , May 25, 1976, Budget Speech (Richard DeBoo L i m i t e d , Toronto, O n t a r i o , S p e c i a l Release, May 25, 1976), p . l . 22 The Honorable Donald S. Macdonald, Finance M i n i s t e r , Department  of Finance, Press Release, June 29, 1976. 23 " I b i d . 2 4 I b i d . 25 Touche-Ross & Co. Chartered Accountants, Budget L e t t e r , May 25, 1976, p.5. Canadian Income Tax A c t , o p . c i t . , Consolidated t o December, 1976, p. 38,007. I b i d . p. 37,195. I b i d . pp. 37,195-37,197. I b i d . , p. 37,197. Ib i d . , p . 37,198. I b i d . , p. 38,008. CHAPTER IV NATIONAL REVENUE, TAXATION AND THE CANADIAN COURTS VIS-A-VIS PRIVATE MOTION PICTURE INVESTMENT 1. NATIONAL REVENUE, TAXATION AND MOTION PICTURE INVESTMENT A. I n t e r p r e t a t i o n B u l l e t i n s The widespread use of leveraged investments i n high r a t e c a p i t a l cost allowance p r o p e r t i e s prompted National Revenue, Taxation to p u b l i s h a number of i n t e r p r e t a t i o n b u l l e t i n s on c a p i t a l cost allowance. As t h e i r name i m p l i e s the purpose of these B u l l e t i n s i s t o g i v e , from time to time, the Department's i n t e r p r e t a t i o n o f s e c t i o n s o f the laws i t a d m i n i s t e r s : an e q u a l l y important purpose i s t o announce s i g n i f i c a n t changes i n departmental i n t e r p r e t a t i o n s and the e f f e c t i v e dates of any such changes. I n t e r p r e t a t i o n B u l l e t i n s are not law: that i s contained i n the Acts themselves and i n the Regulations made under them. Through the B u l l e t i n s the Department's assessors and a u d i t o r s are t o l d how t o i n t e r p r e t the law and the p u b l i c i s able to know what to e x p e c t J I f a taxpayer b e l i e v e s t h a t the tax department's i n t e r p r e t a t i o n o f the law i s i n c o r r e c t he has the a l t e r n a t i v e of c h a l l e n g i n g that i n t e r p r e t a t i o n i n f e d e r a l court. The courts have r u l e d i n favour of the taxpayer on occasion. Most t a x lawyers and accountants advise t h e i r c l i e n t s to f o l l o w the departmental i n t e r p r e t a t i o n s i n order t o avoid a reassessment from Revenue Canada. Therefore "the I n t e r p r e t a t i o n 3 B u l l e t i n s take on an aura of law". Since 1970 when the b u l l e t i n s were i n t r o d u c e d , there have been eleven i n t e r p r e t a t i o n s i s s u e d by the tax department t h a t can be a p p l i e d to motion p i c t u r e investments. The eleven i n t e r p r e t a t i o n b u l l e t i n s " 6 8 _ - 69 -p e r t a i n i n g t o : m o t i o n ' p i c t u r e investments w i l l be discussed under the f o l l o w i n g four headings: 1. c a p i t a l cost allowance; 2. government a s s i s t a n c e to i n d u s t r y ; 3. s a l e , lease-back agreements; 4. p a r t n e r s h i p s . National Revenue, Taxation prepares and publishes an i n t e r p r e t a t i o n b u l l e t i n when i t f e e l s t h a t there has been abuse of a tax "loop-hole" or when the department has re c e i v e d a number of e n q u i r i e s from taxpayers or requests f o r an advance r u l i n g on c e r t a i n income tax matters. C a p i t a l Cost Allowance The p r a c t i c e of le v e r a g i n g the investment i n high r a t e c a p i t a l cost allowance p r o p e r t i e s such as motion p i c t u r e s and a i r c r a f t had become widespread i n Canada. P r i v a t e s e c t o r investment accounted f o r as much as 20% of the t o t a l budgets of productions which the C.F.D.C. 4 invested i n between the years 1971 and 1973. P r i v a t e funding was a t t r a c t e d to motion p i c t u r e investment because a tax s h e l t e r could be s t r u c t u r e d when C.F.D.C. funding was a v a i l a b l e . The C.F.D.C. i s a Crown c o r p o r a t i o n which does not c l a i m c.c.a. P r i v a t e i n v e s t o r s had assumed they could i n c l u d e the C.F.D.C. funding i n t h e i r c a p i t a l c o st base. The f i r s t p u b l i c pronouncement th a t t h i s p r a c t i c e was not acceptable to the tax department was made by M.W. Steele i n a speech at the Canadian Tax Foundation Conference i n November, 1973. S t e e l e was S e c t i o n C h i e f i n the tax department's Rulings D i v i s i o n , L e g i s l a t i o n Branch, Ottawa. In h i s speech to the conference he s t a t e d t h a t the department was prepared to a l l o w as cost f o r the purposes of c a p i t a l - 70 -cost allowance i n motion p i c t u r e s : Only t h a t amount which has been put at r i s k by the p r i v a t e i n v e s t o r , e i t h e r through investment of cash or borrowed funds which he i s u n c o n d i t i o n a l l y o b l i g e d to repay, whatever the fortunes of the f i l m i n question might be Under e x i s t i n g law no degree of leverage can be recognized f o r purposes of computing c a p i t a l cost of assets which i s not represented by a binding commitment to repay borrowed c a p i t a l , notwithstanding the fortunes of the f i l m . . . 5 The essence of Steele's comments were contained i n IT-164 issued by National Revenue, Taxation on June 5, 1974. This b u l l e t i n o u t l i n e d the department's p o s i t i o n regarding c a p i t a l cost allowance on c e r t a i n leveraged investments, i n c l u d i n g motion p i c t u r e s . The b u l l e t i n , (which i s reporduced i n i t s e n t i r e t y i n Appendix A to Chapter IV) made the f o l l o w i n g p o i n t s : "Leveraged Investment" means an arrangement whereby a n — i n v e s t o r acquires a c a p i t a l property a t a s t a t e d purchase p r i c e s u b s t a n t i a l l y i n excess of the amount a c t u a l l y i n v e s t e d or put at r i s k by him. One of the main ob j e c t s o f the arrange-ment i s to secure the r i g h t to c a p i t a l c ost allowance on the t o t a l s t a t e d purchse p r i c e . G e nerally the i n v e s t o r intends t o use the a d d i t i o n a l c a p i t a l cost allowance to reduce other income. The leveraged investment i s g e n e r a l l y property which q u a l i f i e s f o r a high r a t e of c a p i t a l c ost a l l o w a n c e . . . f o r example, a motion p i c t u r e f i l m . . . When a f i l m i s acquired the purchase agreement g e n e r a l l y provides f o r an immediate cash o u t l a y s u b s t a n t i a l l y l e s s than the t o t a l s t a t e d purchase p r i c e w i t h the. balance to be r e p a i d only out of earnings from-the d i s t r i b u t i o n o f the f i l m . Gener-a l l y the only recourse by the vendor o f the f i l m f o r non-payment i s repossession of the f i l m a f t e r a s p e c i f i e d number of yea r s . The Department takes the p o s i t i o n t h a t the c a p i t a l cost of the f i l m to the i n v e s t o r f o r the purpose of paragraph 20(1)(a) i s only that cost which has been l a i d out or i n f a c t put at r i s k by the i n v e s t o r , e i t h e r through investment of cash or borrowed funds u n c o n d i t i o n a l l y repayable whatever the fortunes o f the f i l m i n question may be. Where, as a r e s u l t of earnings from the d i s t r i b u t i o n of the f i l m , a d d i t i o n a l amounts are paid by the i n v e s t o r toward i t s s t a t e d purchase p r i c e , such amounts c o n s t i t u t e a d d i t i o n a l c a p i t a l cost of that f i l m , except i n cases d e s c r i b e d i n the next paragraph. - 71 -In c e r t a i n cases the c a p i t a l c ost of a f i l m f o r the purpose of i t s i n c l u s i o n i n Class 18 of Schedule B of the Regulations i s NIL, s i n c e : (a) the f i l m i s not considered to have been acquired by the taxpayer f o r the purpose of gaining or producing income therefrom, or (b) the f i l m i s not i n f a c t a Class 18 p r o p e r t y ; f o r example, where the i n v e s t o r does not acquire a motion p i c t u r e f i l m but only the r i g h t s to i t s d i s t r i b u t i o n i n a s p e c i f i e d t e r r i t o r y . IT-164 a l s o d e a l t with the s u b j e c t of leveraged equipment l e a s e s . I t i s the department's contention that the purchase o f an asset by an i n v e s t o r and subsequent l e a s i n g of that property back to the o r i g i n a l vendor (user) i s a c t u a l l y a f i n a n c i n g arrangement rather than a purchase. No c.c.a. i s permitted. The b u l l e t i n reads i n p a r t : The i n v e s t o r arranges f o r the issuance of notes or c e r t i f i c a t e s by a t r u s t e e to other p a r t i e s supplying 80 percent o f the equip-ment c o s t . The other p a r t i e s agree to look only t o the equipment and the user f o r the s e c u r i t y of t h e i r funds. A c c o r d i n g l y , the i n v e s t o r has no l i a b i l i t y f o r the 80 per cent of the equipment c o s t . . . The i n v e s t o r pays h i s 20 percent t o the t r u s t e e and the t r u s t e e then pays the manufacturer i n f u l l f o r the equipment and receives t i t l e . The t r u s t e e then s e l l s the equipment t o the i n v e s t o r under a c o n d i t i o n a l s a l e agreement which permits t i t l e t o remain w i t h the t r u s t e e as s e c u r i t y f o r the notes or c e r t i f i c a t e s i s s u e d t o the other p a r t i e s . However, the terms of the c o n d i t i o n a l s a l e agreement s p e c i f y t h a t the i n v e s t o r i s r e q u i r e d to make payments to the t r u s t e e only to the extent of r e n t a l s t o be r e c e i v e d from the user. I t may be claimed t h a t under such an arrangement t h i s i n v e s t o r i s e n t i t l e d t o c a p i t a l cost allowances on the f u l l c o st o f the property by v i r t u e of being the s o l e owner of the equipment once the amounts owing to the other p a r t i e s have been discharged... However the Department's view i s t h a t , the c a p i t a l c o s t of the leased equipment to the i n v e s t o r cannot i n c l u d e any p a r t of the cost i n respect of which there i s no recourse a g a i n s t him i n the event of a d e f a u l t . In the above example the c a p i t a l c ost would not inc l u d e the 80 percent of t h a t cost f i n a n c e d through the other p a r t i e s . 7 The tax department could use t h i s i n t e r p r e t a t i o n t o attempt to d i s a l l o w c a p i t a l c ost allowance i n syndicate-guarantee motion p i c t u r e - 72 -investment arrangements. These s o p h i s t i c a t e d syndicate schemes o f f s e t f u t u r e i n v e s t o r payments w i t h guaranteed minimum d i s t r i b u t i o n r e c e i p t s . The department could argue that t h i s i s a f i n a n c i n g arrangement and t h a t c.c.a. i s not a v a i l a b l e t o the p r i v a t e i n v e s t o r . This p o t e n t i a l arguement by the tax department w i l l be examined i n g r e a t e r d e t a i l i n the d i s c u s s i o n of IT-17 and IT-233. The p u b l i c a t i o n o f IT-164 had a d i s a s t r o u s e f f e c t on the Canadian motion p i c t u r e i n d u s t r y . P r i v a t e i n v e s t o r s were no longer i n t e r e s t e d i n i n v e s t i n g i n motion p i c t u r e s i f the tax s h e l t e r f a c i l i t y was not a v a i l a b l e . P r i v a t e s e c t o r funding i n E n g l i s h language motion p i c t u r e productions that had C.F.D.C. investment dropped t o 12% or $410,000 i n the C.F.D.C.'s f i s c a l year of 1974-75. 8 I n t e r p r e t a t i o n B u l l e t i n IT-283 issued January 19, 1976 s e t s out g u i d e l i n e s p e r t a i n i n g to c.c.a. of f i l m s and video tapes. The b u l l e t i n o u t l i n e s departmental p o l i c y d i s t i n c t i o n s between cost and c a p i t a l c ost of video tapes and f i l m s . According t o the b u l l e t i n video tapes and f i l m s may be c a p i t a l i z e d under c l a s s 12 or c l a s s 18 i f the property was produced by the taxpayer himself or purchased f o r the purpose of earning income. The costs f o r the purposes of determination of c a p i t a l cost of a property under paragraph 2 0 ( l ) ( a ) w i l l o r d i n a r i l y i n c l u d e : The costs of s c r i p t s , musical arrangements, and m a t e r i a l s , the remuneration of w r i t e r s , d i r e c t o r s , performers, musicians, t e c h n i c i a n s and stagehands, and the r e n t a l or other costs of s t u d i o and p r o p e r t i e s and of photographic l i g h t i n g , sound r e c o r d -ing and other equipment-and overhead costs that can reasonably be a t t r i b u t e d to the property but nothing i n respect of p r o f i t which might have been earned had the asset been s o l d . 9 Government As s i s t a n c e to Industry The tax department issued four i n t e r p r e t a t i o n b u l l e t i n s t h a t o u t l i n e d the tax i m p l i c a t i o n s of government f i n a n c i a l a s s i s t a n c e t o i n d u s t r y . The b u l l e t i n s suggested two methods which were to be used to - 73 -t r e a t government a s s i s t a n c e . These methods depended upon the type of grant and the type of i n d u s t r y . E i t h e r the government grants were t o be used to reduce the taxpayer's expenses i n c l u d i n g the c a p i t a l cost base of c e r t a i n s p e c i f i e d types of property or the government grants were t o be added to the taxpayer's income. The f i r s t two b u l l e t i n s IT-49 and IT-53, were i s s u e d - i n l a t e 1971 and i n mid-1972 r e s p e c t i v e l y . The tax department advised t h a t f i n a n c i a l a s s i s t a n c e grants or subsides made by the government or i t s agencies to enable a taxpayer to acquire property that i s of a c a p i t a l n a t u r e ^ would reduce the c a p i t a l cost base of th a t property by the amount o f such government a s s i s t a n c e or investment. These two i n t e r p r e t a t i o n b u l l e t i n s d i d not mention the C.F.D.C. a s s i s t a n c e t o the motion p i c t u r e i n d u s t r y . However, i t was g e n e r a l l y acquiesced t h a t amounts of money granted o u t r i g h t , loaned, or in v e s t e d by the C.F.D.C. would have t o be excluded from the c a p i t a l cost base of a motion p i c t u r e . P r i o r to t h i s i n t e r p r e t a t i o n , the p r a c t i s e among motion p i c t u r e i n v e s t o r s was t o i n c l u d e the C.F.D.C. a s s i s t a n c e i n the c a p i t a l cost base. The i n v e s t o r s had been t r e a t i n g the C.F.D.C. investment as a l i a b i l i t y , but repayment was contingent upon the d i s t r i b u t i o n p r o f i t s of the motion p i c t u r e . In December 1975 and January, 1976 the tax department i s s u e d two a d d i t i o n a l b u l l e t i n s onthe sub j e c t of government a s s i s t a n c e . The former IT-273 was t o replace I T - 4 9 . ^ The other IT-276 s p e c i f i c a l l y advised the department's p o s i t i o n regarding C.F.D.C. funding: IT-276 reads, i n p a r t , t h a t : The basic purpose of the Canadian F i l m Development Corp-o r a t i o n i s to f o s t e r and promote the development of a f e a t u r e f i l m i n d u s t r y i n Canada. The co r p o r a t i o n supports the production of Canadian feature f i l m s by - 74 -(a) i n v e s t i n g i n i n d i v i d u a l Canadian f e a t u r e f i l m productions i n r e t u r n f o r a share i n any proceeds from them, and (b) making loans to producers of i n d i v i d u a l Canadian fe a t u r e f i l m productions. The Department considers t h a t amounts p a i d as described i n (a) above are income subj e c t t o tax i n the hands of the r e c i p i e n t when the amount i s rec e i v e d . Payments the r e c i p i e n t must pay to the C.F.D.C. out of the proceeds from the production of a f i l m are a d e d u c t i b l e expense a t that time.12 IT-276 says t h a t C.F.D.C. monies must be included i n the r e c i p i e n t ' s t a x a b l e income i n the year i n which the funds are r e c e i v e d . A Case Against National Revenue, Taxation's I n t e r p r e t a t i o n s IT-164 and IT-276 Several income tax ad v i s o r s b e l i e v e t h a t IT-164 and IT-276 13 are i n c o r r e c t and c o n t r a d i c t o r y . These advis o r s b e l i e v e t h a t N a t i o n a l Revenue, Taxation i s m i s i n t e r p r e t i n g the b a s i s of investment by the Canadian F i l m Development Corporation i n a motion p i c t u r e . IT-164, i s s u e d i n 1974, s t a t e s t h a t the tax department w i l l not accept the C.F.D.C. investment i n the c a p i t a l cost base of the motion p i c t u r e f o r purposes o f 14 a c a p i t a l c ost allowance deduction by p r i v a t e i n v e s t o r s . IT-276 issued i n 1976, s t a t e s t h a t an investment by the C.F.D.C. i s "income s u b j e c t t o 15 tax i n the hands of the r e c i p i e n t " . IT-276 i s not a replacement i n t e r p r e t a t i o n b u l l e t i n f o r IT-164. The p o s i t i o n of the i n v e s t o r i n a motion p i c t u r e investment which has C.F.D.C. funding i s c e r t a i n l y unclear and perhaps u n f a i r . The i n v e s t o r must exclude the C.F.D.C. f i n a n c i a l a s s i s t a n c e from the c a p i t a l cost base (IT-164) y e t the C.F.D.C. f i n a n c i a l a s s i s t a n c e must be reported by the r e c i p i e n t as income (IT-276). I f the producer o f the motion p i c t u r e i s the r e c i p i e n t , and the producer i s not the i n v e s t o r ( s ) , there i s no - 75 -confusion. The f i n a n c i a l a s s i s t a n c e from the C.F.D.C. i s income but the producer's production costs are expenses deductable from t h a t ( h i s ) income. I f the i n v e s t o r s are considered as producers then there i s a dilemma. Whether the producer and i n v e s t o r ( s ) are one and the same depends on the s t r u c t u r e of the motion p i c t u r e production investment. In some motion p i c t u r e production-purchase c o n t r a c t s the i n v e s t o r s are c o n t r a c t u a l l y considered the producers. Therefore, the i n v e s t o r s would be the r e c i p i e n t s of the C.F.D.C. f i n a n c i a l a s s i s t a n c e . The w r i t e r b e l i e v e s that the tax department d i d not foresee t h i s dilemma. The dilemma i s th a t funding received from the C.F.D.C. would be taxable i n the hands of the i n v e s t o r , and that the i n v e s t o r would not be e n t i t l e d t o cl a i m c.c.a. on the amount of investment the C.F.D.C. co n t r i b u t e s toward the production costs of the motion p i c t u r e , i f both . i n t e r p r e t a t i o n s are adhered t o by the i n v e s t o r . Income tax lawyers such as Beach and Sheppard poi n t t o the powers o f the C.F.D.C. as set out i n the Canadian Film Development Corporation Act. Paragraph 1 0 ( l ) ( a ) of the Act s t a t e s that the C.F.D.C. can " i n v e s t i n Canadian f e a t u r e f i l m productions i n r e t u r n f o r a share i n the proceeds from any such production". ^ This investment i s "made on the same b a s i s as the investments made by other non-equity i n v e s t o r s . . . terms s i m i l a r t o those which the p r i v a t e s e c t o r i n v e s t s " . ^ 7 Beach concludes t h a t amounts 18 i n v e s t e d by the C.F.D.C. are not taxable i n the hands of the r e c i p i e n t . The tax department bases i t s contention t h a t the C.F.D.C. investment i s taxable income t o the r e c i p i e n t on Subsection 13(7.1) of the Income Tax Act . Subsection 13(7.1) s t a t e s t h a t : ...where a taxpayer has r e c e i v e d a s s i s t a n c e from a government, m u n i c i p a l i t y or other p u b l i c a u t h o r i t y . . . a s a g r a n t , s u b s i d y , f o r g i v a b l e l o a n , deduction from t a x , investment a l l o w a n c e . . . ^ - 7 6 -then t h a t amount s h a l l be deducted from the c a p i t a l c o s t of the asse t . Beach,writing i n Butterworth's CIT Tax Planning and Management, rebuts the tax department's argument on the grounds t h a t funds provided under paragraph 1 0 ( l ) ( a ) of the C.F.D.C. Act are investments not l o a n s , 20 awards or grants. The C.F.D.C. does make lo a n s , awards and grants under other powers granted to i t i n Secti o n 10 of the C.F.D.C. Act but Beach i s concerned with the tax department's treatment of investments made by the C.F.D.C. Beach points out that the C.F.D.C. i s a Crown C o r p o r a t i o n , not a government or m u n i c i p a l i t y or p u b l i c a u t h o r i t y , and t h e r e f o r e 21 Subsection 13(7.1) of the Income Tax Act does not apply. That the C.F.D.C. does not f a l l i n t o the category of government, m u n i c i p a l i t y or other p u b l i c a u t h o r i t y was argued by John F. Sheppard a t the Canadian Tax Foundation Conference i n November, 1973. Sheppard, a lawyer w i t h the Toronto law f i r m of M i l l e r , Thomson, Sedgewick, Lewis and Healy, bases h i s argument on B r i t i s h and Canadian tax cases t h a t i n v o l v e d govern-22 ment a s s i s t a n c e t o i n d u s t r y . These cases considered the nature o f govern-ment bodies'and a u t h o r i t i e s ' (e.g. Ontario Hydro A u t h o r i t y ) f i n a n c i a l a s s i s t a n c e to i n d u s t r y . Sheppard concluded t h a t these cases defined p u b l i c a u t h o r i t y and t h a t : the C.F.D.C. i n l i g h t of i t s independence and the p r e v i o u s l y e s t a b l i s h e d commercial nature of i t s operations...was not a 'public a u t h o r i t y 1 w i t h i n the meaning o f paragraph 13(7.1) of the Income T a r Act. Sheppard presented an argument that the non-recourse investment and loans made by the C.F.D.C. are to be inc l u d e d i n the taxpayer's c o s t of the motion p i c t u r e f o r the purpose of c.c.a. d e s p i t e the tax depart-ment's i n t e r p r e t a t i o n of the Income Tax Act i n IT-164. Sheppard p o i n t s out tax court cases that support h i s argument, e.g. Birmingham Corporation - 77 -v_. B a r n e s . C H This case was concluded i n the taxpayer's favour before the House of Lords i n England i n 1935. Lord A t k i n s t a t e d i n the f i n a l d e c i s i o n that "the a c t u a l cost ( c a p i t a l cost of property to the taxpayer) has no r e l a t i o n to the source from which t h a t person rec e i v e d the money".' Sheppard pronounced t h a t : I t i s a f a c t t h a t a f i l m i s so d i f f e r e n t from our or d i n a r y t h i n k i n g o f what c o n s t i t u t e s an investment t h a t perhaps the M i n i s t e r has, i n r e a c t i n g to the tax b e n e f i t s , overlooked the p r i n c i p l e of law e s t a b l i s h e d i n the Birmingham case, and developed the approach t h a t "non-recourse" money cannot be subject t o c a p i t a l cost allowance. I t h i n k we a l l know of examples where "non-recourse" money has been accepted by the M i n i s t e r f o r c a p i t a l c o s t allowance purposes. For example, take the case where a c o r p o r a t i o n borrows money from a t r a d i t i o n a l lender to c o n s t r u c t an income-producing b u i l d i n g on lands which i t owns, and the terms of the mortgage s e c u r i t y provide t h a t the mortgagee w i l l look only to the property as s e c u r i t y f o r i t s loan and not to the c o r p o r a t i o n on the usual covenant to pay. Would anyone question the cor p o r a t i o n ' s r i g h t to c l a i m c a p i t a l cost allowance on the borrowed money?2o A case could be made then, that there i s a b a s i s f o r i n c l u d i n g the C.F.D.C. f i n a n c i n g i n the c a p i t a l cost of a motion p i c t u r e . The argument could be based on a s e c t i o n o f the tax department's own i n t e r -p r e t a t i o n b u l l e t i n IT-283 which s t a t e s t h a t : I f the producer...chooses to f o l l o w a c o n s i s t e n t p r a c t i c e o f i n c l u d i n g i n Class 12 or 18 such f i l m s . . . h e t h i n k s w i l l be of c o n t i n u i n g value to him...the c a p i t a l cost of (the) property under paragraph 20(1)(a) w i l l o r d i n a r i l y i n c l u d e costs of s c r i p t s ...the renumeration o f w r i t e r s . . . a n d the r e n t a l or other c o s t s of studio...27 A case could a l s o be made f o r excluding C.F.D.C. investment from the r e c i p i e n t ' s income. The taxpayer would have to be prepared t o j u s t i f y these a c t i o n s i n f e d e r a l court given the Department of Nati o n a l Revenue, Taxation's published p o s i t i o n s . The taxpayer could use the cases c i t e d from E n g l i s h and Canadian tax d e c i s i o n s ; the tax department would r e l y - 78 -h e a v i l y on the juri s p r u d e n c e e s t a b l i s h e d i n Lawrence H. Mandel v.  Her Majesty the Queen (MAHONEY'S ESTATE). 2 8 S a l e , Lease-Back Agreements The syndicate-guarantee motion p i c t u r e investment arrangement features the minimum guarantee of d i s t r i b u t i o n r e c e i p t s which o f f s e t a schedule of future i n v e s t o r payments ( i . e . promissory notes.) The syndicates-guarantee arrangements have been used to fi n a n c e motion p i c t u r e s i n Canada sin c e l a t e 1974. The i n v e s t o r s have been i n c l u d i n g i n the c a p i t a l cost the sum of t h e i r i n i t i a l down payment plus the f u t u r e payments f o r which they are l i a b l e . The tax department may consider t h i s t o be a f i n a n c i n g arrangement, thus no c.c.a. would be a v a i l a b l e to the i n v e s t o r . The department's p o s i t i o n would be based on i n t e r p r e t a -t i o n b u l l e t i n s IT-17 and IT-233 which consider c.c.a. i n s a l e , l e a s e -back t r a n s a c t i o n s . IT-17 was replaced and c a n c e l l e d by IT-233 issued on J u l y 14, 1975. IT-233 s t a t e s i n i t s opening preamble: I t i s necessary to determine, with regard to l e a s i n g agreements, whether payments i n respect of those agreements are i n substance payments o f rent or payments on account of the purchase p r i c e of property o r , i n the case of s a l e -lease-back agreements, repayments of a loan.29 The i n t e r p r e t a t i o n b u l l e t i n s t a t e d f u r t h e r : Where i t i s apparent t h a t the true i n t e n t of the p a r t i e s i s that the lessee borrow money on the s e c u r i t y o f p r o p e r t y , the agreement i s i n substance a loan arrangement. Such an i n t e n t i s s t r o n g l y i n d i c a t e d where the s a l e p r i c e o f the property i s s u b s t a n t i a l l y d i f f e r e n t from i t s f a i r market value.30 In a syndicate arrangement the producer s e l l s the motion p i c t u r e to the i n v e s t o r at a p r i c e s u b s t a n t i a l l y g r e a t e r than the a c t u a l cost to produce the motion p i c t u r e . Subsequently the producer u s u a l l y acts as the d i s t r i b u t o r when the motion p i c t u r e i s completed. The i n v e s t o r - 79 -and producer sig n a c o n d i t i o n a l s a l e s c o n t r a c t f o r purchase and production of the motion p i c t u r e . The i n v e s t o r and producer cum d i s t r i b u t o r s i g n a d i s t r i b u t i o n c o n t r a c t . Regardless of the form of the documentation, the tax department might argue t h a t the syndicate-guarantee motion p i c t u r e investment method i s a f i n a n c i n g arrangement and not a purchase. The investor-owner must act as a bona f i d e owner to counter the p o s s i b l e contention o f the tax department t h a t the syndicate-guarantee method i s analogous to a loan. The owner must e x e r c i s e a degree of c o n t r o l over the motion p i c t u r e . He must be e n t i t l e d t o more than j u s t the recoupment of h i s investment. In other words, he must be e n t i t l e d to a share of 31 the p r o f i t s p r o p o r t i o n a t e to h i s degree of ownership i n the motion p i c t u r e . To date, the tax department has not s a i d that the s y n d i c a t e -guarantee arrangement i s a f i n a n c i n g arrangement and not the purchase o f a motion p i c t u r e . I t i s c e r t a i n t h a t National Revenue, Taxation's l e g a l a d v i s o r s w i l l be c l o s e l y examining the syndicate-guarantee arrangement. The department w i l l undoubtedly make a s p e c i f i c i n t e r p r e t a t i o n statement soon. P a r t n e r s h i p s I n t e r p r e t a t i o n b u l l e t i n s IT-90 and IT-138 co n s i d e r p a r t n e r s h i p s and j o i n t ventures. Partnerships were used i n the e a r l y 1970's to i n v e s t i n motion p i c t u r e f i l m s . Today i t i s no longer d e s i r a b l e f o r i n v e s t o r s to form a p a r t n e r s h i p . Investors take steps to avoid t h e i r motion p i c t u r e investments being deemed par t n e r s h i p s by the tax department. One reason - 80 -par t n e r s h i p s and j o i n t ventures are no longer d e s i r a b l e i s that the short f i s c a l r u l e can be a p p l i e d by the tax department f o r the purpose of c a l c u l a t i n g the c.c.a. c l a i m . Contracts f o r recent motion p i c t u r e investment arrangements, such as the syndicate-guarantee arrangement, e x p r e s s l y deny e x i s t e n c e of a p a r t n e r s h i p or a j o i n t venture. IT-90, dated February 9, 1973, asks "What i s a p a r t n e r s h i p ? " and answers: A p a r t n e r s h i p i s the r e l a t i o n t h a t s u b s i s t s between persons c a r r y i n g on business i n common with a view to p r o f i t . However, co-ownership of one or more p r o p e r t i e s not a s s o c i a t e d with a business, (which under Common Law might be a j o i n t tenancy o r a tenancy i n common), does not of i t s e l f c r eate a p a r t n e r s h i p , and t h i s i s so regardless of an arrangement t o share p r o f i t s and l o s s e s . For guidance on whether a p a r t i c u l a r arrangement at a p a r t i c u l a r time c o n s t i t u t e s a p a r t n e r s h i p , reference should be made to the r e l e v a n t p r o v i n c i a l law on the s u b j e c t , and such law w i l l be viewed as persuasive by the Department of National Revenue.32 I t i s important that a syndicate i n v e s t i n g i n a motion p i c t u r e not be considered a p a r t n e r s h i p f o r income tax purposes. I f the syndicate was deemed a pa r t n e r s h i p the c a p i t a l cost allowance may be pro-rated over the p o r t i o n of the year the syndicate had been i n business. I f the syndicate^ (deemed p a r t n e r s h i p ) had not been i n business a f u l l year the short f i s c a l year r u l e would reduce the amount of l o s s t h a t the i n d i v i d u a l i n v e s t o r s could use to reduce t h e i r t a x a b l e income. IT-90 makes the f o l l o w i n g comment with regard to j o i n t ventures: A j o i n t venture agreement, whereby two or more persons agree th a t each provides h i s own property to perform a s p e c i f i c task and receives a s p e c i f i c d i v i s i o n of p r o f i t s from such a t a s k , may be considered a pa r t n e r s h i p as regards such p r o f i t s ; but as long as the property i s not held under j o i n t tenancy or tenancy i n common, i t i s not considered to be p a r t n e r s h i p property. Thus the c a p i t a l cost allowance p r o v i s i o n s r e l a t i n g to pa r t n e r -s h i p property do not apply.33 - 81 -The tax department could take the approach t h a t the producer-d i s t r i b u t o r i s c o n t r i b u t i n g p r o d u c t i o n - d i s t r i b u t i o n s e r v i c e s and the syndicate of i n v e s t o r s are c o n t r i b u t i n g f i n a n c i a l s e r v i c e s , t h e r e f o r e the arrangement i s a j o i n t venture. I f the arrangement between the producer cum d i s t r i b u t o r and the i n v e s t o r s i s a j o i n t venture, the sho r t f i s c a l year r u l e could be a p p l i e d because the income d e r i v e d , i f any, i s business income, not investment income. There i s a second reason t h a t deeming the arrangement a j o i n t venture would have u n d e s i r -able tax consequences to the motion p i c t u r e i n v e s t o r s . The reason i s tha t i f the tax department contended that; the debt held by the (producer) d i s t r i b u t o r i n substance c o n s t i t u t e s e q u i t y ; there (would be) no s h i f t o f the deprec-i a b l e base from the 'vendor' to the taxpayer. ^ The i n v e s t o r s could not deduct any c a p i t a l cost allowance from other income. IT-90 makes the f o l l o w i n g comment on the l i a b i l i t y arrangements between syndicate members: Where several persons form an a s s o c i a t i o n f o r the purpose of c a r r y i n g out p a r t i c u l a r business t r a n s a c t i o n s i n which they are mutually i n t e r e s t e d , the a s s o c i a t i o n has the char a c t -e r i s t i c of p a r t n e r s h i p . However, such persons may a s s o c i a t e without each accepting t o t a l l i a b i l i t y f o r the a s s o c i a t i o n ' s debts. In these circumstances, c o n t r a c t s may i n d i c a t e t h a t the a s s o c i a t e d persons w i l l be l i a b l e only f o r t h e i r r e s p e c t i v e agreed p o r t i o n s of the debts. The e x i s t e n c e o f such an arrange-ment i s viewed as an i n d i c a t i o n t h a t a p a r t n e r s h i p does not e x i s t . Syndicates often are i n t h i s c a t e g o r y . ^ A motion p i c t u r e investment syndicate could use the above quo t a t i o n from IT-90 to demonstrate that the a s s o c i a t i o n between the members (persons) c o n s t i t u t e a syndicate not a p a r t n e r s h i p . The syndicate members are only l i a b l e f o r t h e i r r e s p e c t i v e agreed p o r t i o n s of the debts. IT-138, published on December 18, 1973, was Na t i o n a l Revenue, Taxation's advice of computation of p a r t n e r s h i p income under the r u l e s of the new Income Tax Act. The tax department advised t h a t Subsection - 82 -9 6 ( 1 ) ( f ) and (g) of the Act provide that: In determining income or l o s s at the p a r t n e r s h i p l e v e l , c a p i t a l cost allowance on property owned by the p a r t n e r s h i p ...are claimed by the p a r t n e r s h i p and not the partners i n d i v i d u a l l y . 3 6 This b u l l e t i n r e i n f o r c e d the changes between the o l d Income  Tax Act and the new Act which became law on January 1, 1972. The e f f e c t of the amendment i n the method of computing p a r t n e r s h i p income or l o s s e s has been discussed e a r l i e r i n Chapter I I I and has i m p l i c a t i o n s i n the tax appeals considered i n the next s e c t i o n of t h i s chapter. B. R u l i n g D e c i s i o n on a Motion P i c t u r e F i l m Investment On October 18, 1976 Revenue Canada, Taxation published the f i r s t formal advance r u l i n g d e c i s i o n on investment i n a motion p i c t u r e ,., 37 f i lm. The i m p l i c a t i o n s of advance r u l i n g d e c i s i o n s are considered i n National Revenue, Taxation's Information C i r c u l a r No. 74-8 which s t a t e s : A published r u l i n g w i l l i n d i c a t e the p o s i t i o n of the Department -of National Revenue at the time the actual r u l i n g was given. However, i t i s not intended that published r u l i n g s w i l l subsequently be r e v i s e d to r e f l e c t l a t e r changes i n Departmental i n t e r p r e t a t i o n s . Any such change i n i n t e r p r e t a t i o n w i l l be announced i n an a p p r o p r i -ate I n t e r p r e t a t i o n B u l l e t i n . Consequently, a published r u l i n g must not be r e l i e d upon as being a b i n d i n g r u l i n g even i n circum-stances where a p a r t i c u l a r s i t u a t i o n seems to be the same as t h a t i n respect of which the actual r u l i n g was given.38 The circumstances of the proposed motion p i c t u r e investment were presented i n TR-38. The i n v e s t o r was to purchase an undivided i n t e r e s t i n a motion p i c t u r e f o r $80,000. The i n v e s t o r was to make a downpayment of $20,000 cash and s i g n an u n c o n d i t i o n a l promissory note f o r $60,000, the balance of the f u l l p r i c e . The leverage f a c t o r of the cash investment would be four to one. - 83 -The tax department's advance r u l i n g was a disappointment t o the motion p i c t u r e investment community. The department r u l e d t h a t the i n v e s t o r would be a c q u i r i n g an undivided ownership i n the motion p i c t u r e but they d i d not r u l e what rate of c a p i t a l cost he would be e n t i t l e d t o . Nor d i d the department r u l e what amount would c o n s t i t u t e h i s c a p i t a l c ost base, $20,000; $60,000; or $80,000. The r u l i n g fahich i s reproduced i n Appendix B to Chapter IV) d i d not o f f e r f u r t h e r i n s i g h t i n t o the a t t i t u d e of National Revenue, Taxation concerning motion p i c t u r e i n v e s t -ment i n Canada. Summary. The Department o f Finance w r i t e s the Income Tax Act and  Regulations and Revenue Canada, Taxation administers the tax laws as contained i n the Act. .Revenue Canada, Taxation must apply t h e i r i n t e r -p r e t a t i o n s of the law as the Act i s not always c l e a r even to those who a d minister i t . The tax department attempts to set out t h e i r i n t e r p r e t a -t i o n i n i n t e r p r e t a t i o n b u l l e t i n s , information c i r c u l a r s and tax r u l i n g d e c i s i o n s . These p u b l i c a t i o n s by the tax department are s t u d i e d c l o s e l y by those f i n a n c i a l a d v i s o r s , lawyers and accountants i n v o l v e d w i t h a d v i s i n g Canadians i n tax matters. Although the tax department's p u b l i c a t i o n s are not law they are g e n e r a l l y accepted as such. Therefore the p r e v a i l i n g p r a c t i c e by Canadian taxpayers i s to adhere to these i n t e r p r e t a t i o n s of the Income Tax Act by s t r u c t u r i n g any tax s h e l t e r schemes according to the tax department's i n t e r p r e t a t i o n s . The i n t e r -p r e t a t i o n s discussed have had a pronounced e f f e c t on investment i n motion p i c t u r e s i n Canada, some f i n a n c i n g arrangements have been abandoned and others have been developed i n order to work w i t h i n Revenue Canada, Taxation's i n t e r p r e t a t i o n s of the Income Tax Act. - 84 -2. THE TAX REVIEW BOARD, THE CANADIAN COURTS AND MOTION PICTURE INVESTMENT The Federal Parliament has passed i n c r e a s i n g l y generous tax i n c e n t i v e l e g i s l a t i o n to encourage investment i n Canadian motion p i c t u r e production. One may speculate t h a t Parliament's i n c e n t i v e s are a d i r e c t counter-measure t o the attempts by Revenue Canada, Taxation and the courts to reduce the amount of tax d o l l a r s i nvested i n motion p i c t u r e s h e l t e r investments. The c o n t r a r i e t y w i t h i n the f e d e r a l government i s not s u r p r i s i n g . Parliament i s committed to the goal of the develop-ment of a s e l f - s u p p o r t i n g Canadian motion p i c t u r e i n d u s t r y . Revenue Canada, Taxation i s committed to i t s mandate to maximize income t a x revenue w i t h i n the terms of the Income Tax Act and the process a f f o r d e d by the c o u r t s . In 1970, Donald J . Johnston, a partner i n the Montreal law f i r m o f Johnston, Heenan & B l a i k i e , recognized t h a t motion p i c t u r e s would be a good investment f o r tax w r i t e - o f f s . This r e s u l t e d i n a p r o l i f e r a t i o n of "tax s h e l t e r " motion p i c t u r e production i n Canada from 1970 to 1973. Many of these investments were high leverage (up to ten to one) which were made s o l e l y f o r the purpose of r e d u c i n g , i f not a l t o g e t h e r e l i m i n a t i n g income tax. There was l i t t l e emphasis placed on expectations of commercial success. Many investments i n the e a r l y 1970's were s t r u c t u r e d so t h a t the: tax saving would be g r e a t e s t i f the f i l m s earned no income and none of the investment recovered, i n f a c t , t h ere would be l i t t l e tax advantage to the i n d i v i d u a l i n v e s t o r s i f the f i l m proved to be very s u c c e s s f u l . 3 9 Most e a r l i e r tax s h e l t e r arrangements centered around the formation of a l i m i t e d p a r t n e r s h i p i n which the l i a b i l i t y of the - 85 -i n d i v i d u a l partners would be l i m i t e d to the extent of each partner's c a p i t a l c o n t r i b u t i o n . The a v a i l a b l e c a p i t a l cost allowance would f l o w through t® the i n d i v i d u a l p a r t n e r s . In 1972, the Department of National Revenue, Taxation began que s t i o n i n g the v a l i d i t y of c e r t a i n c a p i t a l cost claims made i n previous y e a r s . A number of reassessment n o t i c e s were i s s u e d . The Tax Depart-ment took the p o s i t i o n t h a t the i n v e s t o r ' s c a p i t a l cost was the a c t u a l cash the i n v e s t o r had p e r s o n a l l y i n v e s t e d or was u n c o n d i t i o n a l l y committed to pay to the vendor (producer) of the motion p i c t u r e . The c a p i t a l cost allowance deduction f o r the i n v e s t o r was based on the amount of i n v e s t o r ' s money which was "at r i s k " . The tax a u t h o r i t i e s contested the p r a c t i c e of p r i v a t e i n v e s t o r s c l a i m i n g c a p i t a l cost allowance on Canadian F i l m Development C o r p o r a t i o n funds i n v e s t e d or loaned, or on non-recourse promissory notes which would be payable only i f the f i l m was s u c c e s s f u l . Many reassessed i n v e s t o r s accepted the department's arguments and paid back-taxes owing, plus i n t e r e s t . Several i n v e s t o r s decided to f i l e n o t i c e s of o b j e c t i o n t o the reassessments and a few of these cases have gone before the Tax Review Board and the Federal C o u r t - T r i a l D i v i s i o n . A. Jacques Y. Paquin Appeal The f i r s t reassessment appeal was the case of Jacques Y. Paquin 40 v. The M i n i s t e r of National Revenue. The appeal was heard by the Tax Review Board on June 3, 1974. Paquin and f i f t y - f o u r others were l i m i t e d partners i n a l i m i t e d p a r t n e r s h i p set up i n 1971 to acquire motion p i c t u r e f i l m r i g h t s a t p r i c e s f a r i n excess of t h e i r production c o s t . The l i m i t e d p a r t n e r s r e g i s t e r e d the l i m i t e d p a r t n e r s h i p under the name Cheverny. They - 86 -invested $605,000 with the p a r t n e r s h i p to purchase what they claimed to be $3,821,000 worth of motion p i c t u r e s . The partners submitted t h a t t h e i r personal c a p i t a l cost was the t o t a l purchase p r i c e and a c c o r d i n g l y claimed a c.c.a. °f 60% of that amount i n the i n i t i a l year of the investment. The l i m i t e d p a r t n e r s h i p , Cheverny, purchased r i g h t s to c e r t a i n f i l m s w i t h down payments i n the amount mentioned, but the purchase co n t r a c t s s t a t e d that the balance of the purchase p r i c e was to be p a i d at the purchaser's d i s c r e t i o n and those outstanding amounts bore no i n t e r e s t . Cheverny i t s e l f had no o b l i g a t i o n to pay the balance and the i n d i v i d u a l l i m i t e d partners were p e r s o n a l l y protected from the l i a b i l i t y by the l e g a l nature of the l i m i t e d p a r t n e r s h i p . The only recourse o f f e r e d the vendor i n d e f a u l t of payment by Cheverny was t h a t the purchaser would r e s t o r e the f i l m r i g h t s to the s e l l e r . I f t h i s occurred Cheverny would be absolved of a l l o b l i g a t i o n s as per the terms of the c o n t r a c t between the p a r t i e s . Tax Review Board A s s i s t a n t Chairman, Lucien C a r d i n , Q.C. objected to the arrangement. He commented: In my view, the Board i s here confronted w i t h a w e l l -organized scheme which enabled the p a r t i c i p a n t s to make u n j u s t i f i e d claims to tax deductions on income from other sources by means of an abuse of the c a p i t a l c ost d e p r e c i a t i o n system.4' The Tax Review Board took the p o s i t i o n t h a t the l i m i t e d p a r t n e r s h i p d i d not have a c a p i t a l cost allowance l o s s based on the f u l l (and i n f l a t e d ) purchase p r i c e f o r 1971, the year i n q u e s t i o n , because the p a r t n e r s h i p had no l e g a l o b l i g a t i o n to pay the balance of the purchase p r i c e . Chairman Cardin d i d a l l o w that the p a r t n e r s h i p would have been - 87 -e n t i t l e d t o deduct a c a p i t a l cost allowance on the ba s i s of the a c t u a l cash o u t l a y under Sect i o n l l ( l ) ( a ) of the Act. However, the partner-s h i p had not claimed any c.c.a. because i t was intended t h a t the c.c.a. be made a v a i l a b l e to each of the l i m i t e d partners p e r s o n a l l y . Cardin r u l e d t h a t the i n d i v i d u a l partners had no c l a i m to c.c.a. whatsoever. His argument was th a t "the r e s u l t of the p a r t n e r s h i p ' s operations must, however, be determined before p r o f i t s can be d i s t r i b -42 uted or the loss e s claimed'.' He f u r t h e r s t a t e d t h a t the r e s u l t i n g l o s s to the pa r t n e r s h i p when pro-rated among the partners would not be "a deduction...for c a p i t a l cost allowance under Sect i o n 1 1 ( 1 ) ( a ) , but a deduction f o r a business l o s s pursuant to Secti o n 27(1)(e) of 43 the Act." Because Cheverny had not claimed c.c.a. t h a t y e a r , i t had not i n c u r r e d a l o s s on i t s o p e r a t i o n s . Therefore, even the business deduction was u n a v a i l a b l e to the l i m i t e d partners p e r s o n a l l y . Lucien Cardin's r u l i n g was unusual because the appeal was f o r Pacquin's 1971 income tax r e t u r n . Under the o l d A c t , c.c.a. was not claimed a t the pa r t n e r s h i p l e v e l but by i n d i v i d u a l p a r t n e r s . Cardin seems to have been i n f l u e n c e d by the new Act which r e q u i r e d the partne r -s h i p to deduct the c.c.a. expense before d i s t r i b u t i n g the p r o f i t o r 44 lo s s to the p a r t n e r s . The Paquin appeal was unsuccessful due t o t e c h n i c a l d e f i c i e n c i e s i n the operation of the l i m i t e d p a r t n e r s h i p ' s accounting p r a c t i c e s and the m i s - i n t e r p r e t a t i o n of the Income,Tax Act by the pa r t n e r s h i p ' s accountants. The pa r t n e r s h i p d i d not r e f i l e i t s claims nor appeal the r u l i n g and the case i s now considered by many as precedence. The reassessment had s u f f i c i e n t e f f e c t on f u t u r e motion p i c t u r e tax s h e l t e r p r o j e c t s t o cause the promoters t o abandon the l i m i t e d p a r t n e r s h i p concept - 88 -of f i n a n c i n g i n 1973. B. Wayne F. C u r r i e Appeal The second motion p i c t u r e c a p i t a l c ost allowance reassessment appeal case to be heard by the Tax Review Board was Wayne F. C u r r i e v. 45 The M i n i s t e r of National Revenue. In 1972, the investor,Wayne C u r r i e , purchased a video tape program f o r a t o t a l purchase p r i c e o f $10,000. He paid a down-payment of $2,500 and agreed to pay the balance on or before November-30, 1979. C u r r i e d signed a seven year n o n - i n t e r e s t bearing promissory note. The a p p e l l a n t then claimed a c a p i t a l c o s t allowance deduction on h i s 1972 income tax re t u r n of $10,000. The video tape, being of c l a s s 12, Schedule B, was an asset d e p r e c i a b l e at a r a t e of 100%. In a d d i t i o n to the purchase agreement there e x i s t e d a separate d i s t r i b u t i o n agreement which C u r r i e signed with the vendors and intended d i s t r i b u t o r s of the video tape. The d i s t r i b u t i o n agreement provided t h a t one-half of. any net. revenue due to £urrie be a p p l i e d to the promissory note retirement. The M i n i s t e r of National Revenue took a d i f f e r e n t stance on t h i s motion p i c t u r e investment than he took i n the Cheverny i n v e s t -ment. The m i n i s t e r contended t h a t the t r a n s a c t i o n was not a "bona f i d e " purchase of an asset acquired f o r the purpose of g a i n i n g o r producing income, but was entered i n t o s o l e l y f o r the purpose of reducing income taxes. The appeal was dismissed on the grounds t h a t t h i s t r a n s a c t i o n was a sham, p r o h i b i t e d under Section 245 of the Income Tax Act. S e c t i o n 245(1), which i s couched i n very broad all-encompassing terms, reads as f o l l o w s : In computing income f o r the purposes of t h i s A c t , no deduction may be made i n respect of a disbursement o r expense made or i n c u r r e d i n respect of a t r a n s a c t i o n or o p e r a t i o n t h a t , i f a l l o w e d , would unduly or a r t i f i c i a l l y reduce the income.46 - 89 -The w r i t e r and o t h e r s , i n c l u d i n g Wayne Beach , are of the opi n i o n t h a t the C u r r i e appeal was r u l e d u n f a i r l y . I t i s tru e t h a t t h i s video tape investment f a i l e d to earn any income between 1972 when i t was purchased and February 19, 1975 when the case was heard by the Tax Review Board. The f a c t t h a t the video tape investment had not earned any income does not mean t h a t the prospects to earn income d i d not appear promising to both the vendors and the purchaser given the o r i g i n a l circumstances surrounding the i n i t a l t r a n s a c t i o n . No one, even those i n the motion p i c t u r e i n d u s t r y can p r e d i c t w i t h c e r t a i n t y whether a motion p i c t u r e w i l l earn income or not. D i r e c t o r s , producers, d i s t r i b u t o r s and e x h i b i t o r s can be quoted as s t a t i n g u n c o n d i t i o n a l l y t h a t a c e r t a i n motion p i c t u r e w i l l be a commercial f a i l u r e , y e t the movie-going p u b l i c has queued f o r blocks to gain admission to the th e a t r e to see the f i l m . Of course, the opposite has occurred even more f r e q u e n t l y . Roland S t . Onge, Q.C. of the Tax Review Board, dwelled on the f a c t t h a t the video tape program had' not earned any income and i t appears that t h i s was a major i n f l u e n c e i n h i s f i n a l d e c i s i o n . I f the lack of revenue was an i n f l u e n c e then he based h i s d e c i s i o n not on the o r i g i n a l circumstances of the investment but on the l a c k of p o s i t i v e r e s u l t s from the investment three years l a t e r . This d e c i s i o n i s u n f a i r . C u r r i e i s appealing the d e c i s i o n to the Federal Court-T r i a l D i v i s i o n . When the case comes to t r i a l , C u r r i e has a chance of having h i s appeal upheld, given the previous u n w i l l i n g n e s s of the c o u r t s 48 to apply the r a t h e r harsh and s t r i n g e n t S e c t i o n 245. I t would appear l i k e l y t hat t h i s p r o v i s i o n w i l l be a p p l i e d only i n the most b l a t a n t cases; f o r example, h i g h l y leveraged, - 90 -non-recourse s i t u a t i o n s where i t i s obvious t h a t the f i l m had no chance of success and no serious attempts were made to d i s t r i b u t e the f i l m or t r a n s a c t i o n s i n which the purchase p r i c e of the f i l m was c l e a r l y i n f l a t e d . 4 9 C u r r i e signed a f u l l recourse promissory note f o r $7,500 payable i n 1979. Mo one could say at the i n c e p t i o n of the t r a n s a c t i o n whether the video tape was l i k e l y to earn income or not. The producers d i d make ser i o u s attempts t o d i s t r i b u t e the program. (The Dominion Tax Case r e p o r t o f the appeal i s reproduced i n Appendix C to Chapter IV.) C. Lawrence H. Mandel Appeal The t h i r d case i n Canada i n v o l v i n g motion p i c t u r e investment i s the Lawrence H. Mandel ( P l a i n t i f f ) v. Her Majesty the Queen (Defendant) which was concluded i n Federal C o u r t - T r a i l D i v i s i o n , August 9, 1976. This i s the f i r s t motion p i c t u r e tax case to reach Federal Courts, o r i g i n -a t i n g from an appeal by the p l a i n t i f f of a reassessment o f h i s 1971 income tax r e t u r n . The p l a i n t i f f had become a l i m i t e d partner i n a l i m i t e d p a r t n e r s h i p . The p a r t n e r s h i p , which was r e g i s t e r e d i n l a t e 1971, was to acquire a feature length motion p i c t u r e f i l m e n t i t l e d MAHONEY'S ESTATE. The l i m i t e d p a r t n e r s , through the p a r t n e r s h i p , invested $150,000. Other i n v e s t o r s were the Canadian Film Development C o r p o r a t i o n , the Bank of Montreal, and the various producers and c r e a t i v e persons i n v o l v e d i n the production. In a d d i t i o n to the cash i n v e s t e d , the producers, d i r e c t o r , w r i t e r , l e a d i n g actors and others agreed to defer p o r t i o n s o f t h e i r fees. These fees would be paid'"contingent" upon the f i l m earn-ing money from d i s t r i b u t i o n (The word "contingent" plays a major r o l e i n the f i n a l d e c i s i o n of the Mandel t r i a l ) . By December 31, 1971, the income tax year i n q u e s t i o n , the a u d i t o r s f o r the production s t a t e d that the cost of the f i l m thus f a r - 91 -had been "$577,892, although the payment of some p o r t i o n s o f t h i s 51 amount was def e r r e d " . The term "deferred" meant th a t the payments would be met by the various p r o d u c t i o n , d i s t r i b u t i o n and investment e n t i t i e s i n v o l v e d (and by t h i s time there were many!) i f and when c e r t a i n events took p l a c e , i n c l u d i n g but not l i m i t e d to the re l e a s e of the f i l m and subsequent e a r n i n g s , i f any. Due to the l i m i t e d p a r t n e r s h i p arrangement, none of the l i m i t e d partners were p e r s o n a l l y l i a b l e beyond t h e i r i n i t i a l $150,000 commitment unless the f i l m generated revenue. I f the f i l m d i d generate revenue, the l i a b i l i t i e s were t o be met from that revenue, not by the l i m i t e d p a r t n e r s . The production became more and more complicated as time went on. Several times the f i l m was ref i n a n c e d during the f i v e years o f production. Some e n t i t i e s i n c l u d i n g the C.F.D.C. withdrew from the p r o j e c t . A prolonged and i r r e c o n c i l a b l e d i s p u t e between the c r e a t i v e personnel occurred. I t was 1976 when the p r o j e c t was f i n a l l y f i n i s h e d . At t h a t time the case was being heard i n f e d e r a l t r i a l c o u r t . Witnesses t e s t i f i e d at great length as to the a r t i s t i c and commercial merits o f the f i l m . The p l a i n t i f f found many "expert" witnesses who s a i d that MAHONEY'S ESTATE was a c r e a t i v e masterpiece. The defendents presented j u s t as many "experts" who s a i d the f i l m was t o t a l l y " l a c k i n g i n commer-52 c i a l or a r t i s t i c value." The tax department accepted i n the c o u r t case t h a t the treatment of the c a p i t a l cost allowance and expenses was c o r r e c t , t e c h n i c a l l y . The l o s s of $577,982 i n c u r r e d by the p a r t n e r s h i p i n the year 1971 was a t t r i b u t e d to the p a r t n e r s h i p f i r s t . Each i n d i v i d u a l p a r t n e r then - 92 -c o r r e c t l y claimed h i s share of the lo s s from the p a r t n e r s h i p . At f i r s t blush the case appears r a t h e r lengthy and complicated clue to the number of e n t i t i e s i n v o l v e d and the problems associated w i t h production and f i n a n c i n g during the e x c e p t i o n a l l y long time i t took to complete the f i l m . The M i n i s t e r o f National Revenue presented a barage of reasons why the c.c.a. deduction should be d i s a l l o w e d and the i n d i v -i d u a l l i m i t e d partners reassessed. However, as J u s t i c e Walsh a s t u t e l y pointed out i n h i s di s p o s a l of the p r e l i m i n a r y i s s u e s , (decided i n favour of the p l a i n t i f f ) , the case r e s t s on the meaning of the phrase "contingent l i a b i l i t y " and how i t should be i n t e r p r e t e d by the l e g a l and accounting p r o f e s s i o n and, i n t u r n , i n the Income Tax Act. The d i s p o s a l of the p r e l i m i n a r y issues by Walsh, J . i s import-ant because he r u l e d i n favour of the p l a i n t i f f on the p r e l i m i n a r y i s s u e s . Walsh, J.'s f i n d i n g s appear to be opposite to those Roland St. Onge used to dismiss the Wayne C u r r i e appeal. The observations of Walsh, J . could be used as precedence by several motion p i c t u r e investment cases y e t to come to t r i a l , i n c l u d i n g the C u r r i e appeal to the Federal C o u r t - T r i a l D i v i s i o n . In the Statement'of Defense to the taxpayer's Notice of O b j e c t i o n , the M i n i s t e r of National Revenue presented several reasons why the c.c.a. deduction from the taxpayer's income should not be allowed. The reasons f o r c h a l l e n g i n g the c.c.a. deduction f a l l under three head-ings as f o l l o w s : 1. P a r t n e r s h i p and ownership a. The l i m i t e d p a r t n e r s h i p was not i n business i n 1971 and i t had not acquired the f i l m i n 1971. I f the p a r t -nership was not i n business i t could not own an a s s e t , t h e r e f o r e no c.c.a. would be permitted. - 93 -b. I f the p a r t n e r s h i p was i n business i n 1971 the p a r t n e r s h i p had acquired only the r i g h t s to d i s t r i b u t e the f i l m , not ownership of the property ( f i l m ) . D i s t r i b u t i o n r i g h t s are not a property and are not e l i g -i b l e f o r c.c.a. 2. Business operating l e s s than 12 months a. The p a r t n e r s h i p v/as a business. The c.c.a. deduction f o r a business i s l i m i t e d to the p o r t i o n of the t a x a t i o n year i t has been i n operation under the terms of Regula-t i o n 1100(3) and 1104 of the Income Tax Act, ( i . e . the short f i s c a l year r u l e . ) 3. A c q u i s i t i o n of the property not made to earn income a. The i n t e r e s t i n the f i l m d i d not gain or produce income. The p a r t n e r s h i p d i d not acquire the f i l m f o r any bona f i d e business purpose. Therefore, the a c q u i s i t i o n was a sham with no l e g i t i m a t e business purpose other than to minimize tax. I f the i n t e r e s t i n the motion p i c t u r e f i l m v/as not acquired to earn or produce income i t can not be included i n c l a s s 18 of the r e g u l a t i o n s because the c.c.a. v/ould unduly or a r t i f i c a l l y reduce income.53 Walsh, J . reviewed the M i n i s t e r ' s defense arguments. He r e a l i z e d t h a t the taxpayers would be i n a more favourable n e t - a f t e r -tax p o s i t i o n i f the motion p i c t u r e investment f a i l e d to earn any revenue at a l l and the f u l l leveraged purchase p r i c e was upheld as the basis f o r c a p i t a l cost. Walsh, J . commented: This does not, however, j u s t i f y a c o n c l u s i o n that t h i s was i n any way improper nor t h a t t h e i r motivation has the conse-quence of d e p r i v i n g them of whatever tax advantages r e s u l t e d from the purchase, since i t i s a fundamental p r i n c i p l e i n t a x a t i o n law that a businessman may so arrange h i s a f f a i r s i n the frame of the r e l e v a n t t a x i n g s t a t u t e and r e g u l a t i o n s as to minimize h i s tax l i a b i l i t y . ^ Walsh, J . r u l e d on each of the M i n i s t e r ' s p r e l i m i n a r y contentions as f o l l o w s : 1. P a r t n e r s h i p and ownership a. The p a r t n e r s h i p was duly r e g i s t e r e d and i n business i n 1971. The p a r t n e r s h i p ' s operating c h a r t e r set out that the p a r t n e r s h i p was to purchase ownership i n motion - 94 -p i c t u r e f i l m s . The purchase c o n t r a c t s f o r MAHONEY'S ESTATE c l e a r l y s t a t e d that the p a r t n e r s h i p was the "owner" of a property which was acquired to be d i s t r i b u t e d and e x p l o i t e d throughout the world. 2. Business operating l e s s than 12 months a. The f a c t s were that the p l a i n t i f f s were p r i n c i p a l l y lawyers, and were not i n the f i l m business. Therefore any income derived from the property ( f i l m ) would be investment income not income from a business. The short f i s c a l year r u l e would not apply. 3. A c q u i s i t i o n not made to earn income a. Although the l i m i t e d partners recognized t h a t f i l m investment i s a r i s k y investment, the circumstances at the time of purchasing the property d i d not i n d i c a t e t h a t the f i l m d i d not have p o t e n t i a l to earn income. The p o t e n t i a l to earn income from the property was among the reasons the C.F.D.C. and the Bank o f Montreal i n v e s t e d i n the f i l m . When the p l a i n t i f f s bought the f i l m i n 1971 there was no evidence t h a t the p l a i n t i f f s a n t i c i -pated the f i l m would not be a commercial success. Evidence was presented i n the 1976 court t r i a l t h a t arrangements had been made to e x h i b i t the f i l m i n several Canadian c i t i e s l a t e r that year. The p o s s i b i l i t y e x i s t e d t h a t the f i l m might earn income even at t h i s l a t e date.55 Walsh, J . r u l e d t h a t the t r a n s a c t i o n was not a sham as the M i n i s t e r of National Revenue contended. The f i l m , MAHONEY'S ESTATE was a property owned by an a c t i v e p a r t n e r s h i p f o r the purpose of gaining or producing income. The p a r t n e r s h i p was e n t i t l e d to c l a i m a c a p i t a l cost allowance deduction. Walsh, J . then addressed the important q u e s t i o n , what amount of the purchase p r i c e of the f i l m was e l i g i b l e f o r a c a p i t a l cost allowance deduction by the l i m i t e d p a r t n e r s h i p ? The i n d i v i d u a l partners had invested $150,000 and the p a r t n e r s h i p had a l i m i t e d l i a b i l i t y f o r $427,892 "contingent" upon the revenue earned by the f i l m i n d i s t r i b u t i o n . - 95 -Once ag a i n , witnesses v/ere summoned. These w i t n e s s e s , tax accountants from reputable Canadian acounting f i r m s , o f f e r e d t h e i r o p i n i o n s as to whether or not a contingent l i a b i l i t y should be i n c l u d e d i n the c a p i t a l cost base. The accountants r e f e r r e d to accounting textbooks, terminology p u b l i c a t i o n s and previous tax cases to support t h e i r o p i n i o n s . In the f i n a l d e c i s i o n Walsh, J . recognized that the taxpayers d i d not, i n 1971, have an unconditional l i a b i l i t y f o r the e n t i r e amount of $577,892 i n c l u d i n g the leveraged amount of $427,892. He r u l e d t h a t c.c.a. could only be claimed on the a c t u a l investment by the l i m i t e d partners of $150,000. He concluded t h a t : When and i f the f i l m generates p r o f i t s and a d d i t i o n a l pay-ments are made on account of the l i a b i l i t y , as now appears p o s s i b l e i n view of the d i s t r i b u t i o n of the f i l m v/hich i s now commencing, the p a r t n e r s h i p can at that time set up these f u r t h e r payments as part of the c a p i t a l cost and P l a i n t i f f can b e n e f i t by c l a i m i n g c a p i t a l c ost allowance a g a i n s t same i n the year^Qr years i n which such a d d i t i o n a l c a p i t a l c ost i s c reated. ° Summary. The three reassessment cases to be appealed to the Tax Review Board and the Federal C o u r t - T r i a l D i v i s i o n have been r u l e d i n favour of the Department of National Revenue, Taxation. The tax department's i n t e r p r e t a t i o n of the Income Tax Act i s being r e i n f o r c e d . In the Wayne C u r r i e case, which i s to be appealed, the c a p i t a l cost deduction v/as denied on the f u l l purchase p r i c e of the video tape program, i n c l u d i n g both the leveraged amount and C u r r i e ' s cash i n v e s t -ment. In a l l cases the c a p i t a l c o s t allowance deduction has been denied on any amount f o r which the i n v e s t o r s were not p e r s o n a l l y l i a b l e , r e g a r d l e s s of the fortunes of the motion p i c t u r e i n d i s t r i b u t i o n . - 96 -FOOTNOTES CHAPTER IV 1 Department of National Revenue, Information C i r c u l a r , No. 70-1, August 25, 1970, pp.1-2. Arthur Drache, " I n t e r e s t Free Loans Gone at Revenue's Whim," F i n a n c i a l Post, May 7, 1977, p . l . 3 I b i d . 4 Canadian Film Development C o r p o r a t i o n , Annual Reports, f o r years 1971 to 1973. 5 M.W. S t e e l s , "A Departmental Pe r s p e c t i v e on Tax S h e l t e r s " , 1973  Conference Report (Canadian Tax Foundation, 1974), p. 526. ^ Department of National Revenue, Ta x a t i o n , I n t e r p r e t a t i o n  B u l l e t i n , IT-164 (June 5, 1974), pp.1-3. 7 I b i d . , p.4. Canadian Film Development, Annual Report 1974-75, June 30, 1975, p. 4. Q Department of National Revenue, Ta x a t i o n , I n t e r p r e t a t i o n B u l l e t i n , IT-283 (January 19, 1976), pp.1-2 ^ Department of National Revenue, T a x a t i o n , I n t e r p r e t a t i o n  B u l l e t i n , IT-49 (December 29, 1971), p . l . 1 1 Department of National Revenue, T a x a t i o n , I n t e r p r e t a t i o n  B u l l e t i n , IT-273 (December 22,1975). 12 Department of National Revenue, T a x a t i o n , I n t e r p r e t a t i o n  B u l l e t i n , IT-276 (January 5, 1976), p.6. 1 3 John E. Sheppard, "An Overview of the Income Tax Law as I t Relates to Investing In Motion P i c t u r e F i l m s , " 1973 Conference Report (Canadian Tax Foundation, 1974), pp.497-515; and Wayne G. Beach, "Tax Advantages of F i l m Investment," CIT Tax Planning and Management 18 (Butterworth & Co. (Canada) L t d . , 1976), pp. 18-1 - 18-15. 14 Department of National Revenue, T a x a t i o n , I n t e r p r e t a t i o n  B u l l e t i n IT-164, o p . c i t . , paragraph 9, p.3. i s B u l l e t i n IT-276, o p . c i t . paragraph 30a, p.7. ^ Canadian Film Development Corporation A c t , Subsection 10(1) ( a ) , 14-15-16 E l i z a b e t h I I , Chapter 78, p.863. 1 7 Wayne G. Beach, "Tax Advantages of Film Investment", CIT Tax Planning and Management 18 (Butterworth & Co. (Canada) L t d . , 1976), p. 1.3-8. J Department of National Revenue, T a x a t i o n , I n t e r p r e t a t i o n - 97 -1 8 I b i d . , pp. 18-7 - 18-8. 19 Canadian Income Tax Act with R e g u l a t i o n s , 47th E d i t i o n C.C.H. Canadian L i m i t e d ) , p.29. 20 Wayne Beach, op.cit.,p.18-7. 21 T L • J I b i d . 2? Birmingham Corporation v. Barnes, (1934) 1 K.B. 484 (C.A.); (1935) A.C. 292 (H. of L.) and Ottawa V a l l e y Power Co. v M.N.R., 69 DTC 5166. 23 John E. Sheppard, "An Overview of the Income Tax Law as I t Relates to Investing i n Motion P i c t u r e F i l m s , " 1973 Conference Report (Canadian Tax Foundation, 1974), p.512. OA Birmingham Corporation v. Barnes (H.M. Inspector of Taxes) (1935), 1 K.B. 484 (C.A.); (1935) A.C. 292 (H. of L . ) . 25 I b i d . 26 John Sheppard, o p . c i t . , p. 507. 27 Department of National Revenue, T a x a t i o n , I n t e r p r e t a t i o n  B u l l e t i n , IT-283, o p , c i t . , p.2. po Lawrence H. Mandel ( P l a i n t i f f ) v. Her Majesty The Queen  (Uefendent), Federal C o u r t - T r a i l D i v i s i o n , August 9, 1976, Dominion  Tax Cases (CCH Canadian L i m i t e d , September 9, 1976), pp.6316-6331. 29 Department of National Revenue, Taxation I n t e r p r e t a t i o n  B u l l e t i n , IT-233 ( J u l y 14, 1975), p . l . 3 0 Ibid.,p.3. 31 Richard M. Wise, "A Cineramic View of Motion P i c t u r e Film Investments", Canadian Tax J o u r n a l , March/April 1976, (Canadian Tax Foundation, 1976), pp.162-163. 32 Department of n a t i o n a l Revenue, T a x a t i o n , I n t e r p r e t a t i o n  B u l l e t i n , IT-90 (February 9, 1973), p . l . 33 J J I b i d . 3 4 Richard Wise, o p . c i t . , p.164. 35 Department of National Revenue, T a x a t i o n , I n t e r p r e t a t i o n  B u l l e t i n , IT-90, o p . c i t . , pp.1-2. Department of National Revenue, T a x a t i o n , I n t e r p r e t a t i o n  B u l l e t i n IT-138 (December 18, 1973), p . l . - 98 -37 Revenue CanadajTaxation , Ruling D e c i s i o n , TR-38, October 18, 1976, pp.1-3. 38 Department of National Revenue, Taxation Information  C i r c u l a r No. 74-8, [larch 4, 1974, p . l . 3 9 Walsh, J . , Handel v. H.M-, o p . c i t . , p. 6322. 40 Jacques Y. Paquin v. M i n i s t e r of National Revenue, Tax Review Board, June 3, 1974, Dominion Tax Cases (C.C.H. Canadian L i m i t e d , June 1974), pp.1142-1145. 4 1 I b i d . , p.1143. 4 2 I b i d . , p. 1145. 43 ^ I b i d . 4 4 Martin L. O'Brien, C.I.T. Canadian Current Tax, June 28, 1974, Issue 26 (Butterworth & Co. (Canada) L t d . , 1974) p.2. 45 Wayne F. C u r r i e ( A p p e l l a n t ) v. The M i n i s t e r of National  Revenue (Respondent), Tax Review Board, February 19, 1975, Dominion Tax Cases, (C.C.H. Canadian L i m i t e d , A p r i l 11, 1975), pp.57-59. 46 Canadian Income Tax Act with R e g u l a t i o n s , 47th E d i t i o n , 1975-76 (C.C.H. Canadian L i m i t e d , 1976) p.604. 47 Wayne Beach, o p . c i t . , pp. 18-6 - 18-8. 48 For a d e t a i l e d d i s c u s s i o n of the meaning and a p p l i c a t i o n of s e c t i o n 245 see DesRosiers v. The Queen, 75 Dominion Tax Cases 5298. 49 Wayne Beach, o p . c i t . , p. 18-8. 50 Mandel v. H.M.. o p . c i t . , pp. 6316-6331. 51 I b i d . , Delorthe, Hoskins and S e l l s , Chartered Accountants, p.6319. 52 I b i d . , Don Owen,; p.6321 t)0 Mandel v. H.M. , o p . c i t . , p.6317. 0 4 I b i d . , Walsh, J. p.6322. , 55 0 3 I b i d . 5 6 I b i d . , p.6331. DEPARTMENT OF NATIONAL REVENUE. TAXATION MIN1STERE DU REVENU NATIONAL. IMPOT S E R I A L N O : R E F E R E N C E : INCOME T A X A C T Capital Cost Allowance on Certain Leveraged Investments IT-164 June 5,1974 D A T E : Paragraph 20(l)(a) O B J E T : LOI DE L'IMPOT SUR LE R E V E N U Deduction pour amortissement a l'egard de cer-tains placements speculatifs IT-164 NO D E S E R I E : " " D A T E : 5 jllin 1974 R E N V O I : Alinea20(l)a) 1. This bulletin presents the Department's views in the determination of the capital cost of certain "leveraged investments" for the purpose of calculating capital cost allowance under paragraph 20(1 )(a) of the Act. 2. In this bulletin "leveraged investment" means an arrangement whereby a person (or persons) (hereinafter called "the investor") acquires an equity interest in capital property ("the investment") at a stated purchase price substantially in excess of the amount actually invested or put at risk by him. One of the main objects of the arrangement is for the investor to secure the right to capital cost allowance on the total stated purchase price. Generally the investor intends to use the addi-tional capital cost allowance to reduce other income. 3. The leveraged investment is generally property which qualifies for a high rate of capital cost allowance as provided by the Income Tax Regulations, for ex-ample, an aircraft (40 per cent), a motion picture film other than a television commercial (60 per cent), videotape or a motion picture film that is a television commercial message (100 per cent), and certain manu-facturing and processing equipment (50 per cent). A leveraged investment may also form part of a leasing arrangement where the user of equipment is tax-exempt (for example, a municipality) or non-taxable, or where the capital cost allowance claim by the investor can be greater than that by the user on the same equipment; for example, railway rolling stock that is part of a railway system is Class 4 (6 per cent) but to the investor is Class 8 (20 per cent). 4. The general nature and form of such investments are described below under the headings "Motion Picture Films" and "Leveraged Equipment Leases". Motion Picture Films 5. A leveraged investment in a motion picture film may generally be categorized according to whether the investment is made: (a) prior to the completion of production, or 1. Le present bulletin expose les vues du Ministere a l'egard de la determination du coiit en capital de certains "placements speculatifs" aux fins du calcul de la deduction pour amortisse-ment en vertu de l'alinea 20( 1 )a) de la Loi. 2. Dans le present bulletin, l'exprcssion "placement specula-tif" signifie un arrangement en vertu duquel une personne (ou plusieurs personnes) (appelee(s) ci-apres l'"investisseur") acquiert une participation a des biens d'investissement ("le placement") a un prix d'achat indique excedant de beaucoup le montant effectivement investi ou mis en jeu par l'investis-seur. L'un des buts principaux de Farrangement est d'assurer a l'investisseur le droit a la deduction pour amortissement sur le prix d'achat global indique. L'investisseur desire generalement utiliser la deduction pour amortissement supplementaire afin de reduire d'autres revenus. 3. Le placement speculatif est ordinairement un bien don-nant droit a un taux eleve de deduction pour amortissement tel que prevu par les Reglements de l'impot sur le revenu, par exemple, un aeronef (40 pour cent), un film cinematogra-phique autre qu'une annonce publicitaire televisee (60 pour cent), une bande magnetoscopique ou un film cinematogra-phique qui est un message publicitaire televisfe (100 pour cent) et certain materiel de fabrication et de transformation (50 pour cent). Un placement speculatif peut aussi faire partie d'un arrangement de location a bail en vertu duquel l'usager du materiel est exempte d'impot (par exemple, une municipalite) ou non imposable, ou en vertu duquel la deduction pour amortissement reclamee par l'investisseur peut etre plus elevee que celle reclamee par l'usager a l'egard du meme materiel; ainsi, le materiel roulant qui fait partie d'un reseau ferroviaire est classe dans la categorie 4 (6 pour cent) mais, en ce qui concerne l'investisseur, il entre dans la categoric 8 (20 pour cent). 4. Les rubriques "Films cinematographiques" et "Locations a bail speculatives de materiel" traitent ci-dessous de la nature et de la forme generates de ces placements. Films cinematographiques 5. Un placement speculatif dans un film cinematographique peut generalement etre classe selon que le placement est fait a) avant la fin de la production, ou PUBLISHED UNDER T H E AUTHORITY OF T H E DEPUTY P U B L I E A V E C L ' A U T O R I S A T I O N D U S O U S - M 1 N I S T R E MINISTER OF NATIONAL R E V E N U E FOR TAXATION D U R E V E N U N A T I O N A L P O U R L ' I M P O T - 99 -- 100 -IT-164 (b) after the completion of production and perhaps after varying degrees of distribution. 6. The following example illustrates the general fea-tures of a leveraged investment made prior to the completion of the film: (a) The film has a budgeted cost of $500,000. (b) Financing of the film is as follows: (i) $180,000 obtained through loans and ad-vances by other parties involved in producing, exhibiting and distributing the film; (ii) an investment of $200,000 by the Canadian Film Development Corporation (CFDC) pursuant to paragraph 10(l)(a) of the CFDC Act (the CFDC is a Crown corporation established to invest in Canadian feature films to assist the Canadian film industry); (iii) a cash investment of $120,000 by the investor. (c) All monies advanced will only be recouped from earnings from the distribution of the film. In addition, all parties share, in a specified manner, in the earnings in excess of those used to repay the advances. (d) For his investment the investor purports to obtain title to the film upon its completion. None of the other parties have any effective recourse against the investor for monies advanced since their rights to repayment are limited to their participa-tion in the earnings of the film. (e) The film i? property of the investor described in Class 18 of Schedule B of the Income Tax Regula-tions and as such is subject to a capital cost allowance rate of 60 per cent. 7. The investor described above is often a limited partnership with a group of individual investors as limited partners and a newly incorporated company as a general partner with the limited partners as shareholders of the corporation. Each of the limited partners con-tributes a share of the investment (in the above example, $120,000) and the limited partnership obtains title to the film. 8. Where a film is acquired after production is com-pleted, the purchase agreement generally provides for an immediate cash outlay (say $120,000) substantially less than the total stated purchase price (say $500,000) with the balance to be repaid only out of earnings from the distribution of the film. Generally the only recourse by the vendor of-the film for non-payment is repossession of the film after a specified number of years. Where a limited partnership is the investment vehicle, recourse other than repossession may be indicated by the agreement but generally the only effective action against non-payment is still the repossession of the film. b) apres la fin de la production, et peut-etre apres diverses etapes de la distribution. 6. L'exemple suivant illustre les modalites generates d'un placement speculatif fait avant la fin de la production d'un film: a) Le cout prevu du film s'eleve a $500,000. b) Le film est finance de la facon suivante: (i) $180,000 sont obtenus au moyen d'emprunts et d'avances par d'autres parties se livrant a la produc-tion, a la presentation et a la distribution du film; (ii) La Societe de developpement de l'industrie cin6-matographique canadienne (SDICC) investit $200,000 conformement a 1'aline a 10(l)a) de la Loi sur la SDICC (La SDICC est une societe de la Couronne etablie pour investir dans des longs metrages canadiens afin d'aider l'industrie cinematographique canadienne); (iii) L'investisseur fait un placement en especes de $120,000. c) Toutes les sommes avancees ne seront recouvrees que des recettes decoulant de la distribution du film. En outre, toutes les parties se partagent, d'une facon precise, les gains excedant ceux qui servent a rembourser les avances. d) En contrepartie de son placement, Finvestisseur vise a obtenir le titre de propriete du film une fois qu'il sera termine. Aucune des autres parties n'a de recours efficace contre l'investisseur a l'egard des sommes avancees, puisque leurs droits au remboursement se trouvent limites a leur participation aux gains decoulant du film. e) Le film constitue le bien de l'investisseur, comme le mentionne la Categorie 18 de l'Annexe B des Reglements de l'impot sur le revenu, et il fait, a ce titre, l'objet d'un taux de deduction pour amortissement de 60 pour cent. 7. L'investisseur mentionne ci-dessus est souvent une societd a responsabilite limitee composee d'un groupe d'investisseurs particuliers agissant a titre de commanditaires et d'une compagnie nouvellement constituee qui est l'associee en nom collectif, les commanditaires etant les actionnaires de la corporation. Chaque commanditaire contribue une partie du placement (dans l'exemple ci-dessus, $120,000) et la societe en nom collectif obtient le droit de propriete du film. 8. Lorsqu'un film est acquis apres la fin de la production, le contrat d'achat prevoit generalement des debours immediats en especes (par exemple $120,000) considerablement infe-rieurs au prix d'achat total indique (par exemple $500,000) et le solde doit etre rembourse seulement sur les gains decoulant de la distribution du film. Generalement, le seul recours qu'a le vendeur du film en cas de non-paiement est de reprendre possession du film apres un nombre determine d'annees. Lorsque les placements se font par l'entremise d'une societ6 en nom collectif, le contrat peut stipuler un autre moyen que la repossession, mais, en regie generate, la seule mesure efficace en cas de non-paiement reste encore la reprise de possession du fiim. - 101 -IT-164 9. Under the types of financial arrangements outlined above the Department takes the position that the capital cost of the film to the investor for the purpose of paragraph 20(l)(a) is only that cost which has been laid out or in fact put at risk by the investor, either through investment of cash or borrowed funds unconditionally repayable whatever the fortunes of the film in question may be. Subject to the remarks in paragraph 11, in either case noted above that capital cost is $ 120,000. 10. Where, as a result of earnings from the distribution of the film, additional amounts are paid by the investor toward its stated purchase price, such amounts consti-tute additional capital cost of that film, except in cases described in paragraph 11. 11. In certain cases the capital cost of a film for the purpose of its inclusion in Class 18 of Schedule B of the Regulations is NIL, since: (a) the film is not considered to have been acquired by the taxpayer for the purpose of gaining or producing income therefrom, or (b) the film is not in fact a Class 18 property; for example, where the investor does not acquire a motion picture film but only the rights to its distribution in a specified territory. Leveraged Equipment Leases 12. It is necessary to determine whether payments made in respect of leasing agreements where there is an option to acquire the leased property are in substance payment of rent or payment on account of the purchase price of property or, in the case of sale-leaseback agreements, repayment of a loan. This determination must be made on the basis of general law and the provisions of the agreement itself. Departmental policy in this area is expressed in the Interpretation Bulletin entitled "Lease-Option and Similar Agreements, Sale and Leaseback Agreements". The following comments assume that the lease referred to is in substance a lease. 13. A typical leveraged equipment-leasing arrangement is as follows: (a) A taxpayer (called "the user") arranges with a manufacturer for certain equipment. (b) The user (or in some cases the manufacturer) invites various financial institutions to submit tenders for the financing of the equipment. (c) A financial institution may submit a tender which calls for one of its clients ("the investor") to put up approximately 20 per cent of the asset cost with the remaining 80 per cent to be supplied by other parties (e.g., insurance companies, banks and pension funds) whose participation is also arranged for by the financial institution. The financial institu-tion may itself take the position of the investor. (d) The tender showing the lowest financing cost to the user generally is awarded the financing contract. 9. Dans le cadre des genres d'arrangements financiers men-tionnes ci-dessus, le Ministere considere que le cout en capital du film pour l'investisseur aux fins de l'alinea 20(1 )a) est seulement le cout qui a ete etabli ou mis en jeu par l'investisseur, soit au moyen de placement de sommes en especes ou de fonds empruntes inconditionnellement rembour-sables, quoi qu'il advienne du film concerne. Sous reserve des cas mentionnes au paragraphe 11, ce cout en capital est de $120,000 dans chacun des cas mentionnes ci-dessus. 10. Lorsqu'en raison des gains decoulant de la distribution du film, l'investisseur verse des sommes additionnelles en vue de payer le prix d'achat indique, ces sommes constituent le cout en capital supplemental de ce film, sauf dans les cas mentionnes dans le paragraphe 11 ci-dessous. 11. Dans certains cas, le cout en capital du film aux fins de son incorporation dans la Categorie 18 de PAnnexe B des Reglements est NEANT pour les raisons suivantes: a) le film n'est pas considere avoir ete acquis par le contribuable dans le but d'en tirer un revenu ou de lui en faire produire un; ou b) le film n'est pas reellement un bien de la Categorie 18; par exemple, lorsque l'investisseur n'acquiert pas un film cinematographique mais seulement les droits a sa distri-bution dans un territoire indique. Locations a bail speculatives de materiel 12. II faut determiner si les versements effectu6s dans le cadre de conventions de bail offrant la possibility d'acquerir les biens loues sont en substance des paiements de loyers ou bien des versements a valoir sur le prix d'achat des biens ou, dans le cas de conventions de vente et de relocation, des remboursements d'emprunts. La question se tranchera a la lumiere des dispositions generates de la loi et des stipulations de la convention. La politique du Ministere a cet egard est definie dans le Bulletin d'interpretation intitule "Conventions de bail avec option et conventions semblables, conventions de vente et de relocation." Dans les notes qui suivent, il est presume que le bail mentionne est en substance un bail. 13. Voici un example typique de location a bail speculative de materiel: a) Un contribuable (appele "l'usager") s'entend avec un fabricant au sujet d'un materiel. b) L'usager (ou dans certains cas le fabricant) invite . diverses institutions financieres a faire des soumissions pour le financement du materiel. c) Une institution financiere peut faire une soumission prevoyant qu'un de ses clients ("l'investisseur") fournira environ 20 pour cent du cout du bien, les 80 pour cent restants etant apportes par d'autres parties (par exemple, des compagnies d'assurance, des banques et des caisses de pensions) dont l'institution financiere arrange aussi la participation. L'institution financiere peut assumer elle-meme le role de l'investisseur. d) La soumission prevoyant le cout de financement le plus faible pour l'usager decroche ordinairement le contrat de financement. - 102 -IT-164 (e) The investor arranges with a trustee (usually a trust company) for the issuance of notes or certifi-cates by the trustee to the other parties supplying 80 per cent of the equipment cost. The other parties purchasing these notes or certificates agree to look only to the equipment and the user for the security of the funds they invest. Accordingly, the investor has no liability for the 80 per cent of the equipment cost financed by the issue of the notes or certifi-cates. The investor pays his 20 per cent to the trustee and the trustee then pays the manufacturer in full for the equipment and receives title. (f) The trustee then sells the equipment to the inves-tor under a conditional sale agreement which permits title to remain with the trustee as security for the notes or certificates issued to the other parties. However, the terms of the conditional sale agree-ment specify that the investor is required to make payments to the trustee only to the extent of rentals to be received from the user under a lease arrangement between the user and the investor. (g) The lease between the investor and the user calls for a lease term approximately the same as the equipment's useful life. The lease rentals, which are calculated to yield sufficient rental revenue to pay only principal and interest on the notes or certifi-cates plus a fair market yield on the 20 per cent invested by the investor, are assigned to the trustee as payments due under the conditional sale agree-ment. The proceeds are used by the trustee to pay the principal and interest on the notes or certificates issued by the trustee with the balance payable to the investor. e) L'investisseur s'arrange avec un fiduciaire (ordinaire-ment une compagnie de fiducie) pour que ce dernier emette des billets ou des certificats aux autres parties qui fournissent 80 pour cent du cout du materiel. Les autres parties qui achetent ces billets ou ces certificats convien-nent de s'en tenir uniquement au materiel et a l'usager pour ce qui est de la garantie des fonds qu'elles ont investis. En consequence, l'investisseur n'est pas responsa-ble a l'egard des 80 pour cent du cout du materiel finances par remission des billets et des certificats. L'investisseur verse ses 20 pour cent au fiduciaire et le fiduciaire paie alors tout le materiel au fabricant et recoit le titre de propriete. f) Le fiduciaire vend alors le materiel a l'investisseur en vertu d'un contrat de vente conditionnelle, ce qui permet au fiduciaire de conserver le titre comme garantie en contre-partie des billets et des certificats emis aux autres parties. Cependant, les termes du contrat de vente conditionnelle precisent que rinvestisseur n'est tenu de verser des paiements au fiduciaire que jusqu'a concurrence des loyers a recevoir de l'usager en vertu d'une convention de bail entre l'usager et l'investisseur. g) Le bail entre l'investisseur et l'usager doit avoir une duree a peu pres equivalente a celle pendant laquelle le materiel sera utile. Les loyers du bail, calcules pour produire un revenu Iocatif suffisant pour payer seulement le principal et les interets sur les billets-ou les certificats, plus un rendement a la juste valeur marchande sur les 20 pour cent places par l'investisseur, sont confies au fiduciaire a titre de paiements dus en vertu du contrat de vente conditionnelle. Le fiduciaire utilise le produit pour payer le principal et les interets sur les billets et les certificats qu'il a emis, le solde etant a payer a l'investis-seur. 14. All the written agreements evidencing the above-listed sequence of events generally are dated the same day and the purchase, sale and lease are integral parts of the whole financing arrangement. Accordingly, any review of the arrangement cannot be based on the terms of any single document. 15. It may be claimed by the investor that under a typical arrangement as described above he is entitled to capital cost allowances on the full cost of the property by virtue of being the sole owner of the equipment once the amounts owing to the other parties have been discharged and the initial term of the lease has ended. However the Department's view is that, for the purpose of paragraph 20(1 )(a), the capital cost of the leased equipment to the investor cannot include any part of the cost in respect of which there is no recourse against him in the event of a default. In the above example the capital cost would not include the 80 per cent of that cost financed through the other parties. 14. Tous les accords ecrits ponctuant les differentes phases exposees ci-dessus sont generalement dates le meme jour; l'achat, la vente et le bail font integralement partie de l'arrangement de financement. C'est pourquoi, aucune revision de l'arrangement ne peut se faire sur la base d'un seul document. 15. II se peut que l'investisseur reclame, en vertu d'une arrangement typique comme celui expose ci-dessus, le droit a la deduction pour amortissement sur le cout total des biens, en se prevalant du fait qu'il est le proprietaire unique du materiel apres l'acquittement des montants dus aux autres parties et l'expiration de la duree initiate du bail. Le Ministere considere, cependant, qu'aux fins de l'alinea 20(1 )a), le cout en capital du materiel loue pour l'investisseur ne peut inclure aucune fraction du cout a l'egard de laquelle il n'existe aucune possibilite de recours contre lui en cas de manquement a ses obligations. Dans l'exemple ci-dessus, le cout en capital n'inclura pas les 80 pour cent du cout finances par l'intermd-diaire des autres parties. £3fc » ''-ft '.'•J*. t APPENDIX B TO CHAPTER IV INCOME TAX N O T R - 3 8 p'uBLiSHEDiOctober 18, 1976 S U B J E C T Investment in a motion picture film i i EN MATIERE D'IMPOT SUR LE REVENU N oTR-38 P U B L I C A T I O N ^ 18 octobre 1976 OBjETJnvestissement dans un film cinematographique R E F E R E N C E : Paragraph 20(1 )(a) R E N V O I : Alinea 20(1 )a) This is in reply to your request for an advance income tax ruling on behalf of M r . Z Proposed transaction Our understanding of the relevant facts is as follows: 1. M r . Z proposed to purchase not less that 20% of all right, title and interest in and to the copyright protecting its use in Canada and 10% of all right, title and interest in and to the master negative of a film provisionally entitled the " F i l m " to be produced in 1975 by B . C . Inc. or a wholly owned subsidiary of that company. The company producing the Film and selling an interest therein to Mr. Z is hereinafter called the " V e n d o r " . 2. M r . Z will make a written offer to purchase from the Vendor an undivided 10% interest in the Fi lm as stated in paragraph 1 above. 3. The purchase price for the 10% interest will be used by the Vendor to finance to the extent of 10% the production of the Film, which will have an estimated cost of $800,000. 4. T h e purchase price of the said 10% interest will be approximately $80,000 to be paid by means of a cash down-payment of not less than $20,000 and the balance of price by the delivery of a promissory note in an amount not exceeding $60,000 payable on December 31, 1979. The promissory note will bear interest at the rate of 8% per annum on the amount thereof from time to time outstanding from the date of its acceptance by the Vendor to the date of payment in full . The balance of the purchase price may be prepaid, in whole or in part, without penalty. The promissory note will be fully negotiable and the obligation of Mr. Z to pay the balance outstanding thereon will be unconditional and personal. PUBLISHED UNDER T H E AUTHORITY OF T H E DEPUTY MINISTER OF NATIONAL R E V E N U E FOR TAXATION La presente fait suite a votre demande de decision anticipee en matiere d'impot sur le revenu a l'egard de M . Z Transaction projetee V o i c i notre interpretation des faits pertinents: 1. M . Z se propose d'acheter, a l'egard d'un film, provisoi-rement intitule le " f i l m " et devant etre produit en 1975 par B . C . Inc. ou une filiate a cent pour cent de cette corporation, non moins de 20% de tout droit, titre et participation relies aux droits d'auteur qui protegent l'utilisation de ce film au Canada, et de 10% de tout droit, titre et participation relies a la copie originate du film. L a compagnie qui doit produire le film et vendre a M . Z une participation dans celui-ci sera designee ci-apres comme le "vendeur" . 2. M . Z adressera au vendeur une offre d'achat ecrite en vue d'acquerir une participation indivise de 10% dans le fi lm, tel qu'enonce au numero 1 ci-dessus. 3. Le prix d'achat de ladite participation de 10% sera utilise par le vendeur pour financer jusqu'a 10% la production du film, dont le cout prevu est de $800,000. 4. Le prix d'achat de ladite participation de 10% sera d'environ $80,000. II devra etre paye a raison d'un acompte d'au moins $20,000 et, pour le reste, d'un billet a ordre de $60,000 au plus, payable le 31 decembre 1979; ce billet produira un interet annuel de 8%, lequel sera exigible de temps a autre depuis la date ou le vendeur aura accepte ces conditions jusqu'a la date oil le montant en question aura ete entierement regie. Le reste du prix d'achat peut etre paye d'avance, en totalite ou en partie; aucune penalite ne sera alors imposee. Le billet a ordre sera entierement ndgociable, et l'obligation qu'aura M . Z d'en payer le solde sera incondi-tionnelle et personnelle. PUBLIE A V E C L' AUTORISATI ON_ DU SOUS-MINISTRE DU REVENU NATIONAL POUR L'IMPOT 103 -- 104 -2 T R - 3 8 5. The written offer to purchase (referred to hereafter as the "Agreement") will contain inter aha the following terms and conditions: (a) The master negative of the Film will remain in possession of the Vendor as security for the balance of the price and other obligations set forth in the Agreement but it shall be made available to autho-rized distributors at all reasonable times for the purpose of making prints. (b) Should Mr. Z default on any obligations set forth in the Agreement and should such default continue | for a period of 15 days after the Vendor gives him written notice by registered mail thereof, then the Vendor shall have the right to set aside the Agree-ment by a further notice to Mr. Z by registered mail and to obtain immediate repossession of all his right, title and interest in and to the Film. The Vendor shall also have the right to retain all payments then made pursuant to the provisions of the Agreement as liquidated damages, without prejudice to whatever rigits he may have against Mr. Z under the Agree-ment and/or under the promissory note referred to in paragraph (4) of this letter, provided, however, that nothing contained in this clause shall limit or in any way restrict Mr. Z's right to set up such defences (including compensation) as may be available to him. Te rmination of the Agreement as aforesaid shall not caiTy with it the termination of any distribution agieement but the Vendor shall be automatically subrogated in Mr. Z's rights (if any) thereunder and ths: same will remain in full force and effect. (c) Mr. Z shall be entitled to receive not less than 7% of net film rentals received from the date of the Vendor's acceptance of the offer, until such time as he shall have received the sum of $80,009; thereafter he shall receive not less than 3l/i % of net film rentals from the Film; for the purposes of this clause, "net film rentals" means the net amount returned to the Vendor or to a disbursing agent acting on behalf of all investors by distributors of the Film. (d) Until such time as the balance of price shall have been paid in full by Mr. Z , he assigns and transfers to the Vendor all his right, title and interest in and to all amounts to which he is entitled pursuant to para-graph (c) above. In the event the balance of price has not been paid in full through the foregoing assign-ment, or otherwise prepaid by Mr. Z, then the amount remaining unpaid thereof shall be paid in full on December 31, 1979. (e) A clause whereby the Vendor represents and warrants that the Film does or will qualify under the provisions of paragraph 1104(2)(h) of the "Income Tax Regulations" as a "certified feature film". 6. The funds paid by Mr. Z as aforesaid will not be expended in the production of the Film until at least $600,000 has been received by or unconditionally committed to the Vendor for such production costs. 5. L'offre d'achat dcrite (designee ci-apres comme la "con-vention") comprendra notamment les conditions suivantes: a) La copie originale du film restera en la possession du vendeur en guise de garantie pour la fraction exigible du prix d'achat et des autres obligations precisees par la convention, mais elle sera mise a la disposition des distributeurs autorises en tout temps raisonnable pour permettre a ceux-ci d'en faire des contre-types. b) Si M. Z manque a 1'une quelconque des obligations enoncdes dans la convention et si cet etat de choses persiste 15 jours apres que le vendeur a envoye a M. Z un avis par la poste recommandee, le vendeur aura le droit d'annuler la convention, en envoyant a M. Z un nouvel avis a cet effet par la poste recommandee, et de reprendre immediatement possession de tout droit, titre et participation relies au film. Le vendeur aura egalement le droit de conserver a titre de dommages-interets toutes les sommes versees aux termes de la convention et ce, sans qu'atteinte ne soit portee aux droits qu'il pourrait avoir vis-a-vis M. Z en vertu de la convention et (ou) du billet a ordre dont il est question au numero 4 des presentes, a condition toutefois que rien dans cette disposition ne limite ou ne restreigne d'une facon quelconque le droit de M. Z de recourir aux moyens de defense (y comprise des dedommagements) auxquels il a acces. L'annulation de la convention comme il est dit ci-dessus n'entrainera pas la resiliation de toute convention de distribution qui aurait pu etre conclue mais, plutot, les droits deM. Z,s'il en est, seront immediatement transferes au vendeur aux termes de cette convention, laquelle restera pleinement en vigueur. c) M. Z aura droit a non moins de 7% des redevances nettes recues pour la location du film depuis la date a laquelle le vendeur aura accepts l'offre d'achat jusqu'a la date a laquelle celui-ci aura recu la somme de $80,000, apres quoi M. Z ne recevra pas moins de 3i/2% des redevances nettes percues pour la location du film; aux fins de cette disposition, "redevances nettes pour la location du film" designe la somme nette qui est remise par les distributeurs du film au vendeur ou a un agent payeur agissant pour le compte de tous les investisseurs. d) Tant que M. Z n'aura pas entierement regie ce qu'il doit, il attribue et transfere au vendeur tous ses droits, titres et participations relies aux montants qui lui revien-nent d'apres le numero 5 c) ci-dessus. Si le prix n'est pas paye entierement par le biais de cette cession et s'il n'est pas non plus paye d'avance d'une facon quelconque par M. Z, le solde exigible doit etre regie en entier le 31 decembre 1979. e) Une dispoistion etablissant que le vendeur declare et certifie que le film constitue ou constituera un "long metrage portant visa" en vertu de l'alinea 1104(2)h) des Reglements de l'impot sur le revenu. 6. Les sommes payees par M. Z comme il est dit plus haut ne seront pas affectees a la production du film tant qu'au moins $600,000 n'auront pas ete verses ou promis inconditionnelle-ment au vendeur en vue de couvrir ces frais de production. - 10b -T R - 3 8 7. The Film will be distributed in Canada by AMN Films Ltd., a Canadian corporation, under a standard distribution agreement between that company and the Vendor. 8. B.C. Inc. is a Canadian corporation incorporated under the laws of Quebec, whose principal object is to produce motion pictures, television series and other theatrical and non-theatrical productions. The company is a subsidiary of RST Ltd., a public Canadian company listed on the Montreal Stock Exchange. RST Ltd., through its various subsidiaries, has previously been involved in a number of feature motion films and has been carrying on business in the industry for many years. 9. We understand that Mr. Z will include in his income amounts that represent the share of net film rentals to which he is entitled. For greater certainty, these amounts are those to which reference is made in sub-paragraph 5(c) of this letter. Ruling given Provided that our understanding of the facts as summarized hereinabove is correct and all the relevant aspects of the transaction are carried out in the manner described by you, we donfirm that Mr. Z will, upon execution and acceptance of the offer to purchase and completion of the Film, acquire in a motion picture film an undivided interest the cost of which will, on the basis of a cash payment of $20,000-and a promissory note of $60,000 under the terms and conditions outlined above, be $80,000. We are not in a position to confirm whether the Film will be an asset described in Class 12 or Class 18 as set out in Schedule B of the Income Tax Regulations. This is a question of fact that will depend upon whether or not the Film will be a "certified feature film" under the provisions of subparagraph 1104(2)(h) of the Regulations. The date of completion of the Film is also a question of fact upon which we are not able to express an opinion. This ruling is given subject to the general limitations and qualifications set forth in Information Circular 70—6 dated September 14, 1970, issued by the Department of National Revenue, Taxation, and is binding provided the Agreement is entered into by Income Tax Rulings are published for the general information of taxpayers but are considered to be binding on the Department only in respect of the taxpayer to whom the ruling was given. 3 7. Le film sera distribue au Canada par AMN Films Lt6e, une corporation canadienne, aux termes d'une convention ordi-naire de distribution conclue entre cette corporation et le vendeur. 8. B.C. Inc. est une corporation canadienne qui a ete constitute conformement aux lois du Quebec et dont l'objectif principal est de produire des films cinematographiques, des emissions televisees en s6rie et d'autres representations thea-trales ou non theatrales. Cette corporation est une filiale de RST Lt6e, une corporation publique canadienne inscrite a.la bourse de Montreal. Par l'interrnediaire de ses diverses filiales, RST Ltee s'est deja engaged a l'egard d'un certain nombre de longs metrages cinematographiques et elle fait affaire dans ce domaine depuis de nombreuses annees. 9. Nous croyons savoir que M. Z inclura dans son revenu des montants reprcsentant la part qui lui revient des redevances nettes pour la location du film. Nous precisions qu'il s'agit des montants mentionnes au numero 5c) des presentes. Decision rendue Si notre interpretation des faits exposes ci-dessus est exacle et que tous les elements de la transaction soient executes de la facon decrite, nous confirmons que suite a l'acceptation de l'offre d'achat, de l'achat et de la realisation du film, M. Z acquerra dans un film cinematographique une participation indivise dont le cout sera de $80,000, dont $20,000 exigibles sous forme d'acompte et $60,000 sous forme de billet a ordre, conformement aux conditions enoncees ci-dessus. Nous ne pouvons confirmer si le film sera un bien de la categorie 12 ou 18 selon l'annexe B des Reglements de l'impot sur le revenu. II s'agit ici d'une question de fait qui sera tranchee selon que le film constituera ou non un "Ion mttrage portant visa" en vertu du sous-alinea 1104(2)h) des Reglements. Quant a la date a laquelle le film sera acheve, cela est egalement un point de fait sur lequel nous ne sommes pas en mesure de nous prononcer. Cette decision est rendue sous reserve des restrictions et conditions generates enoncees dans la Circulaire d'information 70-6 du 14 septembre 1970 publiee par le ministere du Revenu national, Impot, et elle s'applique pourvu que la convention soit conclue au plus tard le Les decisions en matiere d'impot sur le revenu sont publiees pour I'in format ion des contribuables, mats elles n'obligent le Ministere qu'd l'egard du contribuable vise par la decision rendue. APPENDIX C TO CHAPTER IV WAYNE F. CURRIE v. THE MINISTER OF NATIONAL REVENUE Board Decisions—Cited 75 D T C Currie v. M.N.R. Wayne F. Currie (Appellant) v. The Minister ol National Revenue (Respondent). Tax Review Board, February 19, 1975. (Received from the Board, April 2. 1975.) Deductions—Sham purchase of asset !o claim depreciation—Artificial reduction of income—Income Tax Act, S.C. 1970-71-72, c. 63, s. 245. The appellant taxpayer was a financial adviser and consultant living in Toronto. On November 30, 1972 he purported to buy from a company incorporated in England, a video-tape of n motion picture entitled "An Introduclion lo Dissection", which was only one of a series of six photoplays entitled "Biology", produced by the English company. Of tho total purchase price of S10,000 the taxpayer paid only $2,500. The balance v/as lo be paid by applying half the amount due to the taxpayer under the terms of a distribution agreement signed on the same day by which the taxpayer purported to give to the English company the exclusive right to distribute throughout the world all prints, adaptations and derivations of the videotape. Any remaining balance was to bs paid by November 30, 1979. The tax-payer never took possession of the tape. This asset, being of Class 12, Schedule B, was depreciable at a rate of 100%. The taxpayer, therefore, claimed a deduction of $10,000 for the 1972 taxation year. The Minister disallowed the deduction on the basis that the videotape was not acquired as an investment for the purpose of gaining or producing income and that the transaction was a sham prohibited by section 245 of the Act. The taxpayer appealed, arguing that he was the owner of the tape in 1972 and that it was an arm's length transaction carried out in a business manner. He admitted that although the tax implications played a certain role in the transaction, he also intended So earn income therefrom. The promissory note which he had signed in the amount of $7,500 showed his commitment to pay the balance of the purchase price. Held: The appeal was dismissed. The taxpayer v/as not entitled to the deduction. The transaction was not a bona fide purchase for the purpose of claiming a deduction with respect io capita! cost allowance. In 1972 the taxpayer was not in any business connected with videotapes, nor did he have possession of the tape. The promissory note had no date of payment, only the year 1979. A taxpayer could so arrange his affairs in order to pay less tax as long as it was legal and not too artificially done. However, the possibility of earning income out of this transaction was so remote that no serious businessman would havo contemplated it unless it was to use it as a lax shelter to unduly or artificially reduce his income. D . C . Nathanson for the appellant; N . Helficld for the respondent. Before: Roland St-OnKc, Q.C. R O L A N D S T - O N O I - . Q . C , : This : s an appeal the appellant prepared his income tax return from a reassessment dated June 26, 1973, for the 1972 taxation year, he claimed wherein a tax was levied in respect oi the therein a deduction of $10,000. 1972 taxation year. The balance of the purchase price was to On November .10, 1972, the appellant, a he paid as follows: financial adviser and consultant in Toronto, si Kncd as purchaser a document with Sea- t l l c balance remaining of $7,500 of the bourne Lnlcrpiiscs Limited, " a company purchase price by application thereto oi incorporated under the laws of Kiifs 'land. one-half ('A) of the moneys which the . in order to acquire one videotape recorded ' Appellant was entitled to receive «-.u motion picture photoplay entitled " A u account of net revenues from the d.s-Introducliou to Dissection", which video- tnbution of the videotape pursuant to tape was one of a series of s ix videotape a distribution agreement (described recorded motion picture photoplays entitled below) and by the payment in any " I U O I O K V " , produced lw Seahourne. The e v c n t °" t l l c 3 0 l h o i November, total purchase'price was ' $10,000 but the 1979. of the portion, if any. of tiie pur-appellant paid only $2,500 in 1972 and the c l , a s e P"cc t l l c " remaining unpaid, balance was to be paid later. R y a K r c e i H c n t l n a d c i h c s a m c b c . w , . , . . , This asset, bcinx of Class 12, Schedule P.. the same parties, the appellant as owner was depreciable at a rate of 100%. So,.when granted to Scabourne the exclusive rij;iit Dominion Tax Cases - 106 -- IU/ -to dis t r ibute to exhibi tors for e x h i b i t i o n t h r o u g h o u t the w o r l d prints a n d all adapta-tions and der ivat ions thereof of the v i d e o -tape o n , inlrr alia, the fol lowing t e r m s : (a) T h e term o( the exc lus ive right to dis -tr ibute the videotape to be fifteen (15) years f r o m the 30th day of N o v e m b e r , l'>/2, with an a u t o m a t i c renewal of the said term for a fur ther p e r i o d of fifteen (15) years in the absence of ci ther p a r t y to the d i s t r i b u t i o n a g r e e m e n t d e l i v e r i n g notice l o the other of its intent ion to terminate the a r r a n g e m e n t ; (b) S c a b o u r n e as D i s t r i b u t o r to devote its \ best efforts to the p r o p e r m a r k e t i n g ! a n d d i s t r i b u t i o n of the v ideotape so as to m a x i m i z e gross r e t u r n s ; (c) S c a b o u r n e as D i s t r i b u t o r to o b t a i n a certificate or certificates of c u l t u r a l or educat ional va lue f r o m a p p r o p r i a t e authori t ies in E n g l a n d r e g a r d i n g the ' v i d e o t a p e ; ' (d ) S c a b o u r n e as D i s t r i b u t o r to insure the videotape adequate ly a n d to note the interest of the A p p e l l a n t o n a n y i n s u r -ance p o l i c y in that r e g a r d ; (e) S c a b o u r n e as D i s t r i b u t o r to be enti t led to be r e i m b u r s e d for d is t r ibut ion expenses i n c u r r e d b y it out of g r o s s receipts d e r i v e d f r o m the d i s t r i b u t i o n of the v i d e o t a p e ; (f) U n t i l $10,000 has been paid to the a p p e l -lant a n d S c a b o u r n e u n d e r the dis t r i -but ion agreement , ihc appel lant to payj i n SeabiMirue 10% of net reveuuesj ( c r o s s receipts m i n u s certain d i s l r i b u - j t ion eosis) d e r i v e d f r o m d i s t r i b u t i o n of the v i d e o t a p e ; (g) T h e appellant i r r e v o c a b l y directed Sea- , b o u r n e to pay on its behalf one-ha l f C/i) of the m o n e y s required to be paid In the appellant under the dist ri l iul inn . i i ' . i ' i ' i i i . i i l tn Sea ! rue unti l the Mini ol 'j'7..'i(l0 b a » been paid to S e a b o n r u e • ni account iif the purchase price of the Vinci ita lie; (II) A f i r e <)(>(( l i .n been 11 i II11' i 11111 r • I lo ibe • i>•]<('<!;1111 anil S e a b o n r u e under the • '!•<Ii~iI*i11i>m agreement , Hie dil i l i i b u l i o u f'-e payable In Sea In n u n e |o lie 50% of Ibe net i r v r i l l i f l i|r i iv i ! i | f r o m d i s t r i -but ion of the v i i le . i lape. T h e M i n i s t e r d i s a l l o w e d the d e d u c t i o n ! o n tiie basis that ibe videotape, wan not: a c q u i r e d as au i n v e s t m e n t for the p u r p o s e of g a i n i n g or p r o d u c i n g i n c o m e a n d that the. t ransact ion was a s h a m p r o h i b i t e d u n d e r sect ion 245 of the Income Tax Act. T h e appellant testified that before a c q u i r i n g ! the videotape he had m a d e some research o n S c a b o u r n e E n t e r p r i s e s L i m i t e d to dis-c o v e r that M r . J o h n S c a b o u r n e was an honest , reputable i n d i v i d u a l and that his c o m p a n y was in g o o d financial s t a n d i n g . Lie also stated that he was not in the business of b u y i n g , s e l l i n g °>" d i s t r i b u t i n g videotapes or i n any all ied b u s i n e s s ; that he never entered into possess ion o: the said v i d e o -tape; that in b u y i n g the tape the i n c o m e tax i m p l i c a t i o n played a certain role and that his in tent ion in b u y i n g the said tape was also to earn i n c o m e t h e r e f r o m . H e filed a P r o m i s s o r y N o t e ( E x h i b i t A - 4 ) in tlic a m o u n t of $7,500 to s h o w his c o m m i t m e n t to p a y the b a l a n c e of the p u r c h a s e p r i c e . T h i s exhibi t m e n t i o n s no date b u t o n l y the year 1979 for the p a y m e n t of the said s u m o r such earlier date for the p a y m e n t of t w o -thirds thereof to be paid to the p u r c h a s e r p u r s u a n t to the A g r e e m e n t b e t w e e n the v e n d o r a n d the p u r c h a s e r dated N o v e m b e r 30, 1972, a l r e a d y m e n t i o n e d . H e also filed a d o c u m e n t to s h o w that he was the o w n e r of the tape in 1972 a n d that the said tape was i n s u r e d f o r a s u b -stantial s u m of m o n e y . C o u n s e l for the a p p e l l a n t a r g u e d that the I appel lant ' s p u r p o s e in b u y i n g the tape w a s : to earn i n c o m e a n d that the said p u r c h a s e was not a s h a m because the a g r e e m e n t is still in f o r c e ; that there was n o a t tempt w h a t s o e v e r to d isguise the nature of the contrac t or to deceive tiie M i n i s t e r of N a t i o n a l R e v e n u e ; that the appel lant had . executed a P r o m i s s o r y N o t e for the balance ; of the p u r c h a s e p r i c e ; that it was an a r m ' s \ l ength tran.'tactiou carr ied out in a business \ m a i m e r a m i thai In l')72 the appel lant was I Ibe o w n e r of the tape n o t w i t h s t a n d i n g the ' fact that hi! h a d left the possess ion of it to , the seller. In short , lie s la ted that the H o a r d •iliotild look at the contrac t , the : appellant 's course of c o n d u c t and his in tent ion . C o u n s e l for the respondent a r g u e d that the Iraiii . 'U ' lioii under d i s c u s s i o n was not n . / "mil full' purchase and referred Ihc Hoard a m o n g other cases lo an A m e r i c a n d e c i s i o n in Marvin M, and Lorraine A/<iy v. Coinmis- i xhncr, T . C . M e m o . 1972-70 . . . D e c . 31, ' 3 ( )9 (M) . In that case a t a x p a y e r entered Into an nrrnnKement In which he pur- ' purled to purchase 13 television film episodes (or t mi alleged price nt $3(55.000. His out-of-pocket I costs were $35,000 and it was never intended ! that lie pay any more, notwithstanding that he j was theoretically obligated to pay the entire purchase price, l i e nttcmpted to take deprecia-tion deductions nggregallni ; $305,000 over n two-year period. Held. In the circumstances o t : this case, this wns not n bona fide purchase, and taxpayer was not entitled to the claimed deductions. , I n 1972 the appel lant was not in p o s - : session of the v ideotape a n d was not in t h e ! business of b u y i n g , s e l l i n g or d i s t r i b u t i n g videotapes o r in a n y business c o n n e c t e d t h e r e w i t h . M o r e o v e r , the poss ibi l i ty of e a r n i n g i n c o m e out of this t ransact ion was so remote that no serious business m a n w o u l d have entered into such a t ransact ion unless it was to use it as a tax shelter l o u n d u l y or ar t i f i c ia l ly reduce his i n c o m e . A t a x p a y e r is a l l o w e d to a r r a n g e his affairs to pay less taxes as l o n g as it is ! c ; ; a l a n d not too ar t i f i c ia l ly d o n e . In the c i r c u m s t a n c e s of this appeal the t ransact ion u n d e r d i s c u s s i o n is not a binia fide purchase for the purpose of c l a i m i n g a . d e d u c t i o n w i t h respect to capital cost a l l o w -ance. C o n s e q u e n t l y the a p p e a l is d i s m i s s e d . © 1975, C C I I C a n a d i a n L i m i t e d CHAPTER V MOTION PICTURE INVESTMENT - A CASE STUDY 1. INTRODUCTION Chapter V examines in deta i l an actual motion picture invest -ment in education health video tape and f i lm programs. These programs were produced by Edu-Film Productions L t d . J a Canadian producer-d i s t r i bu to r of education audio-visual programs spec i a l i z i ng in health top ics . The programs were marketed under the c o l l e c t i v e t i t l e of THE WORLD OF HEALTH. The theme and format of Edu-Film's product w i l l be explained as well as the marketing background. The f i nanc ia l and contractual arrangements between the product ion-d i s t r ibut ion company and the private investors w i l l be explained. Edu-Film Productions Ltd. was chosen as a case study for f i v e reasons: 1. The wr i te r i s employed by the company. The information concerning the company operations was accessible a l be i t in t h i s paper some deta i l s are changed to comply with a request for anonymity from the pr inc ipa l s of Edu-Film Productions Ltd. 2. The characte r i s t i c s of the' investment and the investors were suitable to explain and demonstrate some of the points a r i s ing from the analysis of the tax court cases and the Department of National Revenue, Taxation 's in terpretat ion of the Income Tax Act and Regulations. 3. The company had experience in complete product development - 108 -- 109 -from conception through f inanc ing, production and marketing. 4. One of the company's investors experienced an income tax reassessment which the investor appealed. This was brought to a successful conclusion in favour of the investor although the f i l e at the tax department i s s t i l l considered open. This chapter and the succeeding chapter on the reassessment experience, w i l l demonstrate the many arguments which National Revenue, Taxation 's auditors can use to attack a tax she l ter investment, even i f the tax department aud i to r ' s accept the commercial r e a l i t y of the investment. 5. A f i n a l reason for including a case study was to impart upon the reader a further background in the mechanics of leveraged motion picture investment. This background w i l l be important in understanding the motion picture investment model and the quant itat ive analysis of motion picture investment undertaken in Chapter VII. 2. FINANCIAL FEASIBILITY STUDY In 1973 Edu-Film Productions Ltd. recognized that there was a need for short educational f i lms on popular health topics such as s t re s s , physical f i t ne s s , weight control and n u t r i t i o n . There v/as a lack of such up-to-date audio-visual material and the topics were becoming of increasing concern to the medical profession and general publ ic a l i k e . The concept of audio-visual health programs i s explained in Edu-Fi lm's brochure introduction quoted below: THE WORLD OF HEALTH In recent years man's awareness and comprehension of his world has expanded in two major d i r ec t i on s : outwards, to grasp.the - n o -concept of "Spaceship E a r t h " , and inwards, to focus on h i s own body - h i s personal "capsule" - equipped w i t h i n f i n i t e l y complex l i f e support systems, i n which he t r a v e l s through time and space. Man's pre-occupation with h i s body and i t s f u n c t i o n s i s not new; but h i s f u l l e r understanding had been blocked f o r c e n t u r i e s by a mystique that grew up around the knowledge and p r a c t i c e of medicine. Only r e c e n t l y have sweeping changes i n a t t i t u d e and i n the techniques of communication s t a r t e d to unlock the door to these s e c r e t s of l i f e . As a r e s u l t , p u b l i c demand f o r medical knowledge has become almost i n s a t i a b l e . This trend - and i t s p o t e n t i a l as a market-ing v e h i c l e - i s evident i n a l l the communications media. C u r i o s i t y alone does not generate t h i s quest f o r knowledge. Man's concern f o r health of h i s t o t a l biosphere d u p l i c a t e s h i s concern f o r a h e a l t h i e r l i f e s t y l e . "THE WORLD OF HEALTH" i s a s e r i e s of 10-12 minute f i l m e d programs de a l i n g with the most common and most i n t r i g u i n g aspects of p h y s i c a l and mental h e a l t h . Each program seeks to accomplish three o b j e c t i ves: 1. To e n t e r t a i n by presenting f a c t u a l m a t e r i a l i n a v i s u a l -l y f a s c i n a t i n g way: through the use of animation; by t a k i n g the viewer on an actual voyage o f e x p l o r a t i o n through the body and i t s organs; by e n t e r i n g i n t o microscopic worlds t h a t reveal the awesome beauty and complexity of the body we i n h a b i t and the micro-organisms t h a t , i n t u r n , i n h a b i t our body. 2. To inform by i n c o r p o r a t i n g the l a t e s t medical research a v a i l a b l e - approved by top experts i n each f i e l d - and by presenting t h i s m a t e r i a l i n a manner than can be understood e a s i l y by a l a y audience. 3. To promote a h e a l t h i e r l i f e s t y l e . This i s the missing i n g r e d i e n t i n many m e d i c a l l y - o r i e n t a t e d p r e s e n t a t i o n s , what-ever the medium. These programs w i l l present not only i n f o r m a t i o n but p r a c t i c a l advice on how to apply t h a t information to achieve a h e a l t h i e r l i f e s t y l e . This i s an important new dimension i n medical communications. I t r e f l e c t s the growing i n t e r e s t i n the r o l e each i n d i v i d u a l can play i n preventive medicine - an i n t e r e s t expressed at a l l l e v e l s of the medical w o r l d , from governments to p r i v a t e p r a c t i t i o n e r s . ^ Edu-Film undertook a four month f e a s i b i l i t y study which i d e n t i f i e d the need, the p o t e n t i a l markets and the production resources which were - I l l -a v a i l a b l e to f i l l that need. The study i n d i c a t e d t h a t programs c o s t i n g an average of $25,000 to produce could more than recoup t h e i r c o s t s i n three major markets over a period of about three to f i v e years. The three markets i n North America were: 1. E d u c a t i o n a l : s c h o o l s , c o l l e g e s , u n i v e r s i t i e s ; 2. Medical: p h y s i c i a n s ' o f f i c e s , health c l i n i c s and h o s p i t a l s ; 3. T e l e v i s i o n : education and commercial. In Appendix A to Chapter V are two l e t t e r s from i n t e r n a t i o n a l educational/medical f i l m d i s t r i b u t o r s . The l e t t e r s i n d i c a t e the d i s t r i b u t o r s ' response to Edu-Film's f i r s t program, BIRTH CONTROL: FIVE EFFECTIVE METHODS. The l e t t e r s i n c l u d e an estimate of sal e s f o r the program. Edu-Film based i t s f i n a n c i a l f e a s i b i l i t y study, i n p a r t , on these s a l e s estimates made by the d i s t r i b u t o r s . The f o l l o w i n g i s another excerpt from Edu-Film's promotional l i t e r a t u r e . The excerpt e x p l a i n s the three markets and review Edu-Film's progress i n pene t r a t i n g these markets through s u b - d i s t r i b u t o r s and sa l e s agents. EDUCATIONAL MARKET The f i r s t of these markets has been long e s t a b l i s h e d . I t inc l u d e s s c h o o l s , u n i v e r s i t i e s , c o l l e g e s , t r a i n i n g h o s p i t a l s , community o r g a n i z a t i o n s e t c . The requirements f o r s u c c e s s f u l educational programs are w e l l d efined and Edu-Film's programs are designed to f i l f i l l these requirements to ensure t h e i r widespread use. The s e l e c t i o n of t o p i c s has been based on feedback from both end-users and d i s t r i b u t o r s i n the United States and Canada. I t i s expected that t h i s market w i l l be a major source of revenue as /the response from these education d i s t r i b u t o r s has been most encouraging. MEDICAL MARKET The second market i s p h y s i c i a n s ' and surgeons' o f f i c e s and health c l i n i c s throughout North America. The l a r g e s t d i s t r i b u t o r i n t h i s market i s Medical D i s t r i b u t o r s , Inc., a Los Angeles - 112 -company incorporated s i x years ago. P r e s e n t l y they have over 5,000 doctors s u b s c r i b i n g to t h e i r programs. The recent expansion of t h e i r s a l e s f o r c e and the endorsement of p a t i e n t education programs by the American and Canadian Medical Assoc-i a t i o n s has r e s u l t e d i n a s u b s t a n t i a l increase i n the number of users. The p o t e n t i a l i s s t a g g e r i n g , as the number of medical doctors i n North America exceeds 300,000. U l t i m a t e l y a l a r g e percentage of t h i s number w i l l be s e r v i c e d by a p r i v a t e c a b l e -v i s i o n network to i n d i v i d u a l medical p r a c t i t i o n e r s ' o f f i c e s . TELEVISION MARKET Edu-Film's t h i r d area of d i s t r i b u t i o n i s the entertainment t e l e v i s i o n market. CXYZ t e l e v i s i o n , a c t i n g as our t e l e v i s i o n s a l e s agents have made consi d e r a b l e progress i n t h i s market. CXYZ produced a video-tape p r e s e n t a t i o n w i t h The Common Cold f i l m demonstrating how i t could be expanded i n t o an e n t e r t a i n i n g y e t i n f o r m a t i v e half-hour program with each l o c a l s t a t i o n pro-v i d i n g the 15 minute wrap-around. This demonstration program was d i s p l a y e d by Four S t a r Entertainment C o r p o r a t i o n , one of the foremost independent t e l e v i s i o n program d i s t r i b u t o r s , at the National A s s o c i a t i o n of T e l e v i s i o n Program Executives Convention i n Los Angeles during February, 1974. The r e c e p t i o n was e n t h u s i a s t i c and the h e a l t h programs s e r i e s w i l l be syndicated i n 1975.3 3. PRODUCTION FINANCING Edu-Film proposed to r a i s e i t s production f i n a n c i n g from the p r i v a t e investment community. An i n v e s t o r would be o f f e r e d undivided ownership i n an a u d i o - v i s u a l educational h e a l t h program. The program would have a c a p i t a l cost to the i n v e s t o r of $50,000. The i n v e s t o r -owner would pay i n cash $25,000 and s i g n a seven y e a r , f u l l r e c o u r s e , 5% i n t e r e s t bearing promissory note f o r $25,000. The program's c a p i t a l c o s t would be e l i g i b l e f o r c a p i t a l cost allowance because i t would be a property purchased to gain pr produce income. Edu-Film was producing i t s education h e a l t h programs on both motion p i c t u r e f i l m and video tape depending upon the t e c h n i c a l i t i e s of p r o d u c t i o n . 4 I f the program was a f i l m , the c a p i t a l cost to the i n v e s t o r of $50,000 would be e l i g i b l e f o r 60% c.c.a. on a d i m i n i s h i n g balance b a s i s according to the income tax r e g u l a t i o n s i n e f f e c t at the time - 113 -(1974). I f the program was to be produced as a video tape i t s c a p i t a l cost of $50,000 would be e l i g i b l e f o r a 100% c.c.a. The inducement to i n v e s t was enhanced by the use of 2:1 leverage f a c i l i t a t e d through the promissory note. The low leverage r a t i o was regarded as very conservative v i s - a - v i s other f i l m i n v e s t -ment packages being o f f e r e d but was l e s s l i k e l y to be questioned by the tax department. The low leverage o f f e r e d an immediate tax advantage but d i d not expose the i n v e s t o r to an excess l i a b i l i t y f o r which he may have been c a l l e d upon to s e t t l e i n the f u t u r e i f the program f a i l e d to earn s u f f i c i e n t income to s a t i s f y the note. Edu-Film emphasized the commerciality. of the programs and t h e i r p o t e n t i a l to earn income -not the tax s h e l t e r aspect - although a l l requirements to make the investment a tax s h e l t e r were s a t i s f i e d . Mo investment was accepted by Edu-film unless the i n v e s t o r had consulted h i s lawyer and/or account-ant and/or f i n a n c i a l a d v i s o r s and the investment met w i t h t h e i r a p p r o v a l . Ownership i n educational f i l m or video tape programs i n v o l v e s complex l e g a l and accounting p r i n c i p l e s , t h e r e f o r e any person contemplating such an investment i s urged t o seek competent l e g a l and f i n a n c i a l advice.5 Table VI-I o u t l i n e s the Edu-Film video tape program production budget components. The t a b l e a l s o shows the s t r u c t u r e of the i n v e s t o r purchase payments. 4. INVESTMENT DOCUMENTS There v/ere three separate documents exchanged between the i n v e s t o r and producer. The f i r s t was a production-purchase c o n t r a c t which f a c i l -i t a t e d the purchase of the investment and advancement of funds by the i n v e s t o r as the production work progressed. The producer i n e f f e c t was c o n t r a c t i n g to produce a f i l m or video tape f o r the investor-owner. - 114 -TABLE V-I Edu-Film Video Tape Program Production and Purchase Costs Production Costs: P r o c u r a t i o n : 10% $2,500 'Research and s c r i p t i n g ; 15% 3,750 Preproduction and P r o d u c t i o n : ^ animation, e t c ; 30% 7,500 P r i n c i p a l photography and sound t r a c t 25% 6,250 E d i t i n g , l a b o r a t o r y , e t c . 10% 2,500 Overhead: 10% 2,500 T o t a l : Production c o s t s : 100% $25,000 Purciiase Cost: Cash Down payments: P r o c u r a t i o n ; $8,333 P r i n c i p a l photography; 8,333 Answer p r i n t ; 8,334 S u b - t o t a l : cash down: $25,000 Seven year promissory note: $25,000 T o t a l : Purchase p r i c e : $50,000 Source: Edu-Film Productions L t d . , Investment Prospectus, The World  of Health (1974), p.5. - 115 -This c o n t r a c t emphasized that the work had to f o l l o w a pre-arranged schedule and to meet acceptable standards of motion p i c t u r e production. The c o n t r a c t vested complete ownership of the program to the i n v e s t o r -owner i n a l l r i g h t s and t i t l e to the program i n c l u d i n g c o p y r i g h t and d i s t r i b u t i o n r i g h t s . Two p e r t i n e n t clauses from the Production-Purchase Contract were: The vendor d e s i r e s to s e l l and the purchaser d e s i r e s to purchase the program on the execution date and upon the terms and c o n d i t i o n s h e r e i n a f t e r contained. The term "Program" as used herein s h a l l be deemed to i n c l u d e a l l w r i t t e n m a t e r i a l produced i n the research stage, a l l s c r i p t s , a l l m a t e r i a l r e l a t e d to p r e p r o d u c t i o n , production and p o s t - p r o d u c t i o n , the o r i g i n a l video-tapes and f i l m g n e g a t i v e s , together with a l l c o p y r i g h t s attached t h e r e t o . Upon completion of the p r o j e c t and f i n a l acceptance by the investor-owner, the seven y e a r , f u l l r ecourse, 5% i n t e r e s t bearing promissory note was signed. The note was f o r $25,000, the balance of the f u l l $50,000 purchase p r i c e . The promissory note read as f o l l o w s : FOR VALUE RECEIVED, ( h e r e i n a f t e r c a l l e d the "Purchaser") hereby acknowledges himself indebted and promises to pay Edu-Film Productions L t d . ( h e r e i n a f t e r c a l l e d the "Vendor") on , 19 , upon p r e s e n t a t i o n and surrender of t h i s Promissory Mote the sum of TWENTY-FIVE THOUSAND DOLLARS ($25,000.00) i n lawful money of Canada together w i t h i n t e r e s t at the r a t e of f i v e percent (5%) per annum c a l c u l a t e d on the balance o f the p r i n c i p a l sum outstand-ing on the 31st day of December i n each year and payable at the p r i n c i p a l o f f i c e of the Vendor i n , or at such other place as the Vendor designates i n w r i t i n g provided that the Purchaser may make any payments on the p r i n c i p a l of t h i s Mote at any time without n o t i c e or bonus. DATED the day of 197 . 7 The t h i r d document was a c o n t r a c t which appointed Edu-Film Productions Ltd. as the d i s t r i b u t o r s of the program f o r a period of f i f t e e n years. The terms of the c o n t r a c t gave Edu-Film f u l l c o n t r o l - 116 -over d i s t r i b u t i o n subject to r a t i f i c a t i o n of any s u b - d i s t r i b u t i o n c o n t r a c t s by the program investor-owner, l i m i t a t i o n s on expenses and a best e f f o r t s c l a u s e . The f i r s t clause i n the D i s t r i b u t i o n Contract read: The Owner hereby grants to the D i s t r i b u t o r subject to the terms and c o n d i t i o n s herein set f o r t h and f o r the term herein provided, and the D i s t r i b u t o r hereby a c c e p t s , the s o l e and e x c l u s i v e r i g h t and l i c e n c e to s e l l , r e n t , l i c e n c e , l e a s e , d i s t r i b u t e and otherwise e x p l o i t to e x h i b i t o r s f o r e x h i b i t i o n throughout t h e world ( h e r e i n a f t e r c a l l e d the " T e r r i t o r y " ) p r i n t s , video-tape c o p i e s , video d i s k conies or any other adaptation or d e r i v a t i o n s thereof ( h e r e i n a f t e r c o l l e c t i v e l y c a l l e d "copies") of the video-tape program e n t i t l e d . . . .8 A. Transfer of T i t l e and Ownership Steps were taken to avoid the p i t f a l l s t hat may have exposed the investment and i t s c a p i t a l cost allowance deduction to attack from National Revenue, Taxation. Tax a d v i s o r s often ask the question^ when does a motion p i c t u r e a c t u a l l y become an asset e l i g i b l e f o r c.c.a.? When deprec-i a t i o n s t a r t s f o r tax purposes i s a h i g h l y t e c h n i c a l q u e s t i o n . Since production of even a short documentary heal t h program can take as long as a year to complete, i t was important, to the investor-owner's tax p o s i t i o n , that the asset be e l i g i b l e f o r c.c.a. i n the f i r s t year of the investment. I f the program i s not considered a completed asset e l i g i b l e f o r the f u l l c.c.a. i n the f i r s t y e a r , the c.c.a. may have to be pro-r a t e d and l i m i t e d to the number of days the asset had been i n pr o d u c t i o n . Another p o s s i b i l i t y i s t h a t only the cash committed by the i n v e s t o r -owner at year end may be considered e l i g i b l e f o r c.c.a. A t h i r d p o s s i b -i l i t y i s t h a t no c.c.a. be deducted from the investor-owner's t a x a b l e income u n t i l the program i s a c t u a l l y completed and has been d e l i v e r e d to the investor-owner. This d e l i v e r y may not take place u n t i l a f t e r - 117 -year-end i f the p r o j e c t was s t a r t e d l a t e i n the year. The high r i s k of motion p i c t u r e investment and the f i c k l e nature of i n v e s t o r s (taxpayers) has caused many i n v e s t o r s to delay committing themselves u n t i l very l a t e i n t h e i r tax year ( o f t e n mid-December). The taxpayers suddenly r e a l i z e they are going to be l i a b l e f o r a l a r g e amount of income tax unless they do some very f a s t tax planning. The year-end rush i n t o investments of t h i s k ind o f t e n precludes a c a r e f u l examination o f the business sense and economics of the va r i o u s p r o j e c t s due to the "pressure cooker" atmosphere t o f i n d a t a x s h e l t e r . 9 This p r a c t i c e of year-end investment has been questioned i n a l l appeal cases before the tax review board and the c o u r t s , but has not y e t been d i r e c t l y a ttacked. The t a x department's lawyers f e l t they could d i s a l l o w the c.c.a. c l a i m on a l t e r n a t i v e grounds. The completion date of the program had t o occur p r i o r to the taxpayer's year-end (December 31st) to q u a l i f y the investment f o r maximum c.c.a. Edu-Film took steps to ensure t h a t there be no question about the completion date. The steps Edu-Fiim took were: 1. No programs would be o f f e r e d f o r s a l e a f t e r September 1s t . 2. Production schedules were arranged which ensured t h a t at l e a s t " p r i n c i p a l photography" was f i n i s h e d before December 31st. The tax department i n d i c a t e d that i f p r i n c i p a l photography was completed i t was prepared to accept a motion p i c t u r e as e l i g i b l e f o r c.c.a. even though i t may not be i n marketable form. This was a reasonable p o s i t i o n on t h e i r part because the bulk of production costs are expended upon completion o f p r i n c i p a l photography. The committment of funds must a l s o be u n e q u i v o c a l l y e s t a b l i s h e d p r i o r to year-end i n order that the investor-owner be e n t i t l e d to c l a i m - 118 -c.c.a. The f i n a l production payment was not due from the i n v e s t o r -owner u n t i l he had viewed and approved the completed program i n marketable form. I f the program was not going to be i n marketable form u n t i l a f t e r December 31st, Edu-Film arranged f o r an escrow holder to hold the balance of the production monies i n t r u s t . The promissory note was a l s o signed p r i o r to year-end and held i n escrow. The f o l l o w i n g are r e l e v a n t clauses from the Escrow Agreement between the vendor and the purchaser. Clause 1 of that agreement reads: The expression "the date of completion" and "the time of d e l i v e r y " wherever they appear i n the Purchase Agreement s h a l l mean and be deemed to mean the date of completion of p r i n c i p a l photography of the program ( h e r e i n a f t e r c a l l e d the "Completion Date"). 1 0 Clause 6 reads: The Purchaser s h a l l d e l i v e r to the Escrow Holder on the Completion Date the s a i d c e r t i f i e d cheque i n favour of the Vendor i n the amount of Eight Thousand Three Hundred and T h i r t y - F o u r ($8,334.00) D o l l a r s and the s a i d Promissory Note i n favour of the Vendor i n the amount o f Twenty-Five Thousand ($25,000.00) D o l l a r s and the Escrow Holder s h a l l hold the same i n escrow and u n d e l i v e r d and s h a l l d e l i v e r same upon the f o l l o w i n g c o n d i t i o n s : H The performance r e q u i r e d by these clauses was considered s u f f i c i e n t to e s t a b l i s h that the i n v e s t o r ' s funds were committed or "at r i s k " . The ac t u a l moment of t r a n s f e r of ownership of the program was very important and measures were taken to ensure t h a t there could be no doubt as to when t h i s t r a n s f e r had occurred. The p r o d u c t i o n -purchase c o n t r a c t s were worded so that the ownership was considered t r a n s f e r r e d upon execution of the documents. The v a r i o u s production payments were considered c o n d i t i o n a l i n s t a l l m e n t s " - 119 -The Purchaser hereby purchases and the Vendor hereby s e l l s , assigns and t r a n s f e r s to the Purchaser a l l r i g h t s , t i t l e and i n t e r e s t i n and to the Program and a l l such copy-r i g h t s i n v o l v e d t h e r e i n as and from the date of execution thereof.12 The productions were insured f o r t h e i r f u l l value a t the ou t s e t and the proceeds were payable to the investor-owners not the producer. During the production the investor-owners r e c e i v e d up-to-date r e p o r t s on the production of t h e i r program i n c l u d i n g a cost accounting of funds spent. The investor-owners backed up t h e i r c l a i m f o r c.c.a. by submission of the budget r e p o r t s with t h e i r income tax r e t u r n s . I t was important t h a t the investor-owner be considered i n co n t r o l and a c t i n g l i k e an owner and not merely a f i n a n c i e r . The advancement of funds upon approval by the investor-owner of the va r i o u s production stages was emphasized. The production-purchase c o n t r a c t contained the f o l l o w i n g p r o v i s i o n : PROVIDED HOWEVER the sums provided i n subparagraph (b) and (c) s h a l l o n l y be payable to the Vendor i f the Purchaser i s s a t i s f i e d t h a t sums expended to the date of such payments by the Vendor have been expended i n an appropriate manner towards the completion of the Program and the Purchaser i s s a t i s f i e d w i t h the q u a l i t y of the m a t e r i a l produced to the date of each such payment.13 The d i s t r i b u t i o n c o n t r a c t f u r t h e r emphasized the investor-owner's c o n t r o l . Although the d i s t r i b u t i o n c o n t r a c t was w i t h the producer, the owner had the r i g h t to terminate the agreement i f s p e c i f i c c o n d i t i o n s were not f u l f i l l e d . P h y s i c a l d e l i v e r y of the motipn p i c t u r e asset to the i n v e s t o r -owner was a point r a i s e d i n some of the previous tax reassessment cases. Therefore once Edu-Film had completed the motion p i c t u r e program i t was p h y s i c a l l y d e l i v e r e d to the investor-owner and the d e l i v e r y of the program was duly n o t a r i z e d i n order to f u r t h e r - 120 -emphasize the t r a n s f e r of ownership. Upon completion of the program i t was o f f i c i a l l y r e g i s t e r e d i n the investor-owner's name with the Copyright O f f i c e o f the fe d e r a l Department of Consumer A f f a i r s under the Copyright Act of Canada. E s t a b l i s h i n g copyright of the program i n the investor-owner's name pr o t e c t s the program from being u n l a w f u l l y d u p l i c a t e d and d i s t r i b u t e d , and "may be the margin of d i f f e r e n c e i n proving t i t l e t o a motion p i c t u r e " . ^ 4 A l l copies of the program ( f i l m or video tape p r i n t s ) remained i n the owner-investor's name to f u r t h e r emphasize bona f i d e ownership of the motion p i c t u r e investment. The d i s t r i b u t i o n c o n t r a c t s t a t e d t h a t : T i t l e to Copies and parts t h e r e o f ordered by the D i s t r i b u t o r and any other a c c e s s o r i e s and m a t e r i a l s d e l i v e r e d to the D i s t r i b u t o r hereunder s h a l l be and remain i n the Owner's name at a l l times, s u b j e c t to the r i g h t of the D i s t r i b u t o r to use such Copies and other m a t e r i a l s i n accordance with and subj e c t to the terms of t h i s Contract. 5. DISTRIBUTION A. Accounting Requirements When the programs were completed and the d i s t r i b u t i o n c o n t r a c t executed, i n d i v i d u a l accounting records and bank accounts were set up f o r each investor-owner and h i s program. The d i s t r i b u t o r was merely a c t i n g i n the c a p a c i t y of an agent. Gross s a l e s , expenses and net revenue were entered i n the appr o p r i a t e subledgers f o r each program i n the investor-owner's name as per the d i s t r i b u t i o n agreement: The D i s t r i b u t o r agrees that i t w i l l keep and maintain i n the name of the owner f u l l and accurate books of accounts and records with reference to the Program and Copies l i c e n c e d hereunder, which books of account and records s h a l l show - 121 -r e a d i l y the Gross Receipts of the s a i d Copies together with a l l deductions a p p l i c a b l e thereto...16 The necessary accounts and ledgers are l i s t e d i n Table V - I I . TABLE V-II Accounts and Ledgers Maintained f o r Each Video Tape Program 1. Bank Account 2. Gross Sales Subledger 3. D i r e c t D i s t r i b u t i o n Expenses Subledger 4. I n d i r e c t D i s t r i b u t i o n Expenses Subledger 5. Net Sales Subledger 5. 5% D i s t r i b u t i o n Fee Subledger 7. Owner's Revenue Subledger 8. Promissory Note Subledger Source: Edu-Film Productions L t d . , accounting records. Gross sales of copies of the education video tapes were subje c t to a d i s t r i b u t i o n fee by Edu-Film 1s d i s t r i b u t o r s . The d i s t r i b u t i o n fee ranged between 10% and 75% depending on the market the program copy was s o l d i n . Edu-Film deducted c e r t a i n expenses to which i t was e n t i t l e d from the amount re c e i v e d from the d i s t r i b u t o r s . The balance, the net revenue, was then c r e d i t e d to the investor-owner's t r u s t account. From t h i s sum was paid the f o l l o w i n g : - 122 -1. 5% d i s t r i b u t i o n agents fee to Edu-Film; 2. 40% promissory note payments; 3. 5% i n t e r e s t due on promissory note, i f any; 4. Balance to the investor-owner The revenue flow schematic and subledgers are shown i n Table V — I I I . Subledgers were set up to record the various amounts paid and the amounts owing on each investor-owner's promissory note. The m u l t i p l i c i t y o f subledgers f o r each f i l m , owner-investor and f u n c t i o n was considered necessary to strengthen the owner's c l a i m t h a t he was, i n f a c t , an "owner with respect to h i s e n t i r e i n t e r e s t i n both c a p i t a l and p r o f i t s " . ^ The separation of accounting was a l s o necessary to demonstrate t h a t the i n d i v i d u a l investor-owners were not merely partaking i n a p a r t n e r s h i p or j o i n t venture e i t h e r among themselves or w i t h the producer cum d i s t r i b u t o r . In a d d i t i o n , there was the f o l l o w i n g denial of p a r t n e r s h i p and j o i n t venture i n the d i s t r i b u t i o n c o n t r a c t : Nothing herein contained s h a l l be construed as i n any way c o n s t i t u t i n g t h i s a p a r t n e r s h i p between, or a j o i n t venture by, the p a r t i e s hereto or be construed to evidence the i n t e n t i o n of the p a r t i e s to c o n s t i t u t e such a r e l a t i o n s h i p . N either of the p a r t i e s s h a l l hold i t s e l f out c o n t r a r y to the terms of t h i s paragraph by a d v e r t i s i n g or otherwise, nor become l i a b l e or bound by a r e p r e s e n t a t i o n , act or omission whatsoever of the other party contrary to the p r o v i s i o n s of t h i s paragraph.^" A d e n i a l of p a r t n e r s h i p or j o i n t venture i n c o n t r a c t s between two p a r t i e s does not mean th a t the tax department or the c o u r t s w i l l agree t h a t a p a r t n e r s h i p or j o i n t venture does not i n f a c t e x i s t . The behaviour of the investor-owners and d i s t r i b u t o r e s t a b l i s h e s whether a p a r t n e r s h i p or j o i n t venture e x i s t s f o r tax purposes. - 123 -TABLE V-III D i s t r ibut ion Revenue Flow Schematic Gross Sales of Program Edu-Fi1m Program Account "7* Net Revenue To Dist r ibutors Educational: U.S.A. Canada Medical: Televi s i on: Fees & Expenses 75% 62% 70% 10%-50% Gross Sales - General Ledger Program Gross Sales - Subledger Direct & Indirect Expenses - Subledgers Investor-owner's Trust Account and Subledger D i s t r ibut ion Agent's Fee - Subledger Owner's Revenue CHEQUE TO OWNER Investor-Owner Taxable Income -Subledger Promissory Note Payable - General Ledger Sources: Edu-Film Productions L t d . , accounting records and Edu-Film Productions Ltd. Investment Prospectus, The World of Health (1974), p.6. - 124 -B. D i s t r ibut ion Reports The investor-owners were en t i t l ed to and received a complete report of the d i s t r i bu t i on of t h e i r audio-visual educational health program every three months. The d i s t r i bu t i on report included a l l the information as per the subledgers as well as important information concerning the sales campaign in each of the three major markets. Spec i f i c information on major sa les , new advert is ing brochures, program reviews and f i l m f e s t i v a l s was reported. The purpose of issuing a deta i led report was twofold: to keep the investor-owner f u l l y informed and to ca re fu l l y document the d i s t r i bu t i on e f fo r t s to demonstrate a bona f ide investment in a property made to gain or produce income. Summary. This chapter has reviewed a motion p icture investment in audio-visual educational health programs. The producer-d istr ibutor recognized that there was a need for such programs in North America. Given intensive d i s t r i bu t i on an investment made in well researched and well produced education health f i lms or video tapes could be a p ro f i t ab le venture. The investor-owner's cash investment was leveraged by the use of a promissory note payable out of program earnings or by the investor -owner in seven years, which ever occurred f i r s t . The chapter also reviews the contractual steps which were taken to ensure that the investor-owner was protected from poor performance by the producer-distr ibutor and that the investor-owner could claim the maximum c.c .a . on his property for income tax purposes. The production-purchase and d i s t r i bu t i on contracts were quoted to demonstrate how the investment was structured. The contents of the quarter ly d i s t r i bu t i on reports from the d i s t r i bu to r to.the investor-owner were out l ined. Part of a d i s t r i bu t i on report by Edu-Film to i t s investor-owner group i s i n -cluded in Appendix B to Chapter V. - 125 -FOOTNOTES CHAPTER V ^ Edu-Film Productions Ltd. i s not the registered name of the product ion-d i s t r ibut ion company that produced THE WORLD OF HEALTH eduction ser ies. The pr inc ipa l s of the actual company requested that the registered name of the company not be used in th i s thes i s . 2 Edu-Film Productions L t d . , Investment Prospectus, The World of  Health (1974), p.2. 3 I b id . , pp.3-4. 4 For example, animated audio-visual programs had to be produced on f i l m ; l i v e action programs could be shot on f i l m or video tape depending on the previous experience of the d i rector and produc-t ion crew. 5 Edu-Film Productions L t d . , Investment Prospectus, The World  of Health, o p . c i t . , p . l . Edu-Film Productions L t d . , Production-Purchase Contract (1974), p . l . ^ Edu-Film Productions L t d . , Promissory Note (1974). Edu-Film Productions L t d . , D i s t r ibut ion Contract (1974), p.2. 9 " C e r t i f i e d Feature Films Rev i s i ted " , Tax Bracket, January, 1977 (Thorne Riddel 1 & Co., Chartered Accountants, 1977), p.2. ^ Edu-Film Productions L t d . , Escrow Agreement (1974). p.2. ^ I b id . , p.3. 12 Production-Purchase Contract, o p . c i t . , p . l . 1 3 I b i d . , p.4. 14 Garth H. Drabinsky, Motion Pictures and the Arts in Canada, The Business and the Law (Toronto: McGraw-Hill Rverson L imited, 1976), p.42. 15 D i s t r ibut ion Contract, o p . c i t . , p.4. ^ I b id . , p.6. ^ Richard M. Wise, "A Cineramic View of Motion Picture Film Investment", Canadian Tax Journal , March, A p r i l , 1976 (Canadian Tax Foundation, 1976), p.163. 18 » D i s t r ibut ion Contract, o p . c i t . , p.9. APPENDIX B TO CHAPTER V P R O D U C T I O N S LTD. THE WORLD OF HEALTH D I S T R I B U T I O N R E P O R T 4th Quarter - 197 The f i n a l quarter of 197 f i n i s h e d strongly f o r Edu-Film despite the soft educational f i l m market i n North America. Gross rec e i p t s for THE WORLD OF HEALTH se r i e s during the 3 month period from October 1st to December 31st, 197 were h a l f those x^hich were earned i n the en t i r e preceding 12 months. While t o t a l sales did not reach this years expectations we are s u f f i c i e n t l y encouraged by t h i s f i n a l quarter to look toward 197 with optimism. Previews & F e s t i v a l s In the f a l l , several widely read educational magazines and journals reviewed THE WORLD OF HEALTH s e r i e s . The reviews appeared i n the following magazines and w i l l be a further stimulus to sa l e s . - Canadian Asso c i a t i o n for Health, P h y s i c a l Education and Recreation News - Lander's Film Reviews (U.S. publication) - Journal of N u t r i t i o n Education (U.S. pu b l i c a t i o n ) - Educational Film Library A s s o c i a t i o n Inc. (U.S. publication) * Gross receipts O c t . l - Dec. 31st 197 : $ Gross re c e i p t s Oct.1,197 - Sept.30, 197 : $ - 128 -- 129 -The Canadian D i e t e t i c A s s o c i a t i o n Journal reviewed the four n u t r i t i o n programs and found them " t i m e l y . . . e n t e r t a i n i n g . . . c r e d i b l e . . . and informative". The N u t r i t i o n Education Committee concluded i t s review by s t a t i n g that these programs "mark a valuable c o n t r i b u t i o n to Canadian N u t r i t i o n Education Resources". STRESS - THE WORLD OF HANS SELYE was entered by the Secretary of State Film F e s t i v a l s Bureau i n the 197 Melbourne Film F e s t i v a l held i n A u s t r a l i a . The f i l m was well received and an a r t i c l e about i t s f e s t i v a l appearance was published i n prominent A u s t r a l i a n newspapers. PHYSICAL FITNESS - THE NEW PERSPECTIVE has been chosen by the Canadian Red Cross Society for entry i n the VII I n t e r n a t i o n a l F e s t i v a l of Red Cross and Health Films to be held i n Varna, Bulgaria, June 197 . The program SNACKING - GARBAGE IN YOUR GUT? won a "Golden Babe" (statuette) award at the Chicago Educational F i l m F e s t i v a l . An a r t i c l e about the f e s t i v a l and our c r e a t i v e success i s being prepared by the A s s o c i a t i o n for Educational Communications and Technology Journal. (A.E.C.T.) B r i t i s h Columbia D i s t r i b u t i o n Again, Edu-Film's d i r e c t d i s t r i b u t i o n e f f o r t s generated the most revenue. The B.C. market accounted for over % of the gross revenue earned i n the f i n a l quarter of 197 . This r e s u l t was due to the c l o s i n g of a major video tape sale to the B r i t i s h Columbia Department of Education. Edu-Film entered i n t o a 5 year V.T.R.' arrangement with the P r o v i n c i a l Education Media Centre for a t o t a l sum of $ . This arrangement e n t i t l e s P.E.M.C. to dub V.T.R. copies of a l l programs which w i l l be widely c i r c u l a t e d throughout B.C. schools, community colleges and u n i v e r s i t i e s . - 130 -The sale's l e v e l the se r i e s i s cur r e n t l y enjoying i n our province i s the i n d i c a t i o n of the trend that w i l l develop when the national d i s t r i b u t o r s have completed i n i t i a l a d v e r t i s i n g exposure throughout t h e i r larger markets. Canadian Educational D i s t r i b u t i o n Canadian Educational Pictures Ltd. i s undertaking an extensive mail out of the i r promotional l i t e r a t u r e . They now have four separate sets of information describing the s e r i e s . - THE WORLD OF HEALTH (4 page brochure devoted e x c l u s i v e l y to the series) - HEALTH AND CAREER DEVELOPMENT (Breakout from master catalogue for schools) - HEALTH EDUCATION AND CARE (Breakout from master catalogue for p r o v i n c i a l health departments) - CANADIAN EDUCATIONAL PICTURES LTD. 16mm FILM CATALOGUE Beginning i n September t h i s promotional l i t e r a t u r e was included i n several mass mailings to schools, public health units and h o s p i t a l s throughout Canada. American Educational D i s t r i b u t i o n American Educational D i s t r i b u t o r s , Inc. reported t o t a l sales of the se r i e s has now reached $ ' Last month, American Educational completed preparation of study guides to be included with each program. These guides o f f e r suggestions to the teachers as to how they can make optimum use of the programs as an audio-visual teaching aid. The guides include a d e t a i l e d d e s c r i p t i o n - 131 -of each program's contents and a ser i e s of questions to be considered by the student audience. American Educational i s rele a s i n g i t s new catalogue which devotes two f u l l pages to THE WORLD OF HEALTH. The programs are f u r t h highlighted by a d e s c r i p t i o n of the s e r i e s i n a p r i o r i t y p o s i t i o n on the i n s i d e front cover of the new American Educational catalogue. North American Medical D i s t r i b u t i o n Medical D i s t r i b u t o r s Incorporated recently published a brochure that describes THE WORLD OF HEALTH programs. Thi s brochure has been mailed to Medical D i s t r i b u t o r ' s 1 5 , 0 0 0 subscribers as w e l l . as the many p o t e n t i a l c l i e n t s among North America's 3 5 0 , 0 0 0 physicians and surgeons. The f i r s t Edu-Film d i s t r i b u t e d by Medical D i s t r i b u t o r s , BIRTH CONTROL - FIVE EFFECTIVE METHODS, has sold p r i n t s i n t h i s market since i t s release 2 years ago. The gross r e c e i p t s to the U.S. d i s t r i -butor amounted to $ and have been s u f f i c i e n t to return approx-imately $ to the owner/investor and i n a d d i t i o n reduce h i s promissory note by $ Foreign D i s t r i b u t i o n Several of the programs were screened at the I n t e r n a t i o n a l Week f o r Education and Teaching F i l m s - i n Antwerp, Belgium and at the Melbourne, A u s t r a l i a Film F e s t i v a l l a s t summer. To p u b l i c i z e t h i s event Edu-Film contacted over 50 fore i g n d i s t r i b u t o r s i n advance. Enquiries have been received from several European d i s t r i b u t o r s and - 132 -from one d i s t r i b u t o r i n Japan. I t i s expected that d i s t r i b u t i o n arrangements w x l l be completed i n a number of fore i g n markets early t h i s year. STRESS - THE WORLD OF HANS SELYE has now been released i n Sweden. The Swedish d i s t r i b u t o r has placed an order for 10 p r i n t s to use i n th e i r marketing campaign. A p o s i t i v e review of the f i l m appeared i n Dageous Nyheter, the largest Swedish newspaper, c o i n c i d i n g with the release of the Swedish Version. In Summary Sales of THE WORLD OF HEALTH s e r i e s are continuing to b u i l d ; gross revenues were 41% higher t h i s quarter over the previous quarter, while d i s t r i b u t i o n expenses were 50% lower. I t i s expected that t h i s trend w i l l continue and that 197 sales forecasts w i l l be met, as the ser i e s i s being e n t h u s i a s t i c a l l y received by those concerned with p u b l i c health education i n North America. CHAPTER VI REASSESSMENT OF A CAPITAL COST ALLOWANCE DEDUCTION AND TAXPAYER APPEAL I. INTRODUCTION National Revenue, Taxation has reviewed most motion p i c t u r e investments made i n Canada si n c e 1970. A review i s i n i t i a t e d by the assessing d i v i s i o n of the tax department. I f the assessi n g d i v i s i o n can f i n d reason f o r denying a l l or part of the c.c.a. deduction, the department n o t i f i e s the taxpayer. The n o t i f i c a t i o n to the taxpayer i s e i t h e r a Notice of Assessment or a Notice of Reassessment. I f the assessing d i v i s i o n i s reviewing the taxpayer's income tax r e t u r n a t the time of f i l i n g , the d i v i s i o n sends the taxpayer a Notice of Assessment. I f the assessing d i v i s i o n ' s review occurs a f t e r the o r i g i n a l f i l i n g , the d i v i s i o n i s s u e s a Notice of Reassessment. E i t h e r n o t i c e s t a t e s the changes that are being made to the taxpayer's income tax re t u r n and the reasons f o r the changes. The taxpayer has n i n e t y days to respond!to the tax department's changes. I f the taxpayer queries the reassessment, and the matter can not be s e t t l e d by the a s s e s s i n g d i v i s i o n , the taxpayer's f i l e i s forwarded to the a u d i t d i v i s i o n of the tax department. Few motion p i c t u r e c a p i t a l c ost claims are s e t t l e d by the assessing d i v i s i o n . The a u d i t d i v i s i o n begins a d e t a i l e d i n v e s t i g a t i o n o f the motion p i c t u r e investment with a f i e l d a u d i t of the producer/vendor - 133 -J - 134 -company. The a u d i t o r s analyze the c o n t r a c t u a l arrangements between the production company and the investor-owner of the motion p i c t u r e . Upon completion of the i n v e s t i g a t i o n the a u d i t s u p e r v i s o r decides whether or not the reassessment i s v a l i d . I f the a u d i t o r decides the reassessment i s v a l i d the taxpayer can appeal the n o t i c e . The taxpayer begins a formal appeal of the reassessment by f i l i n g a Notice of O b j e c t i o n , form T400A. normally, s t r a i g h t forward tax disputes can o f t e n be s e t t l e d by a c l a r i f i c a t i o n of the f a c t s between the taxpayer and the assessor or an appeals o f f i c e r a t the d i s t r i c t o f f i c e l e v e l . However, disputes i n v o l v i n g c a p i t a l cost i n motion p i c t u r e investments are u s u a l l y f o r -warded to the r e g i o n a l appeals o f f i c e . The r e g i o n a l appeals o f f i c e s t a f f i s more experienced and maintain c l o s e r contact w i t h the appeals branch head o f f i c e i n Ottawa. National Revenue, Taxation recognizes that there i s very l i t t l e precedence i n motion p i c t u r e investment i n Canada. The tax department i s attempting to e s t a b l i s h j u r i s p r u d e n c e i n motion p i c t u r e c a p i t a l cost deductions. In the i n t e r e s t s of main-t a i n i n g u n i f o r m i t y i n a p p l i c a t i o n and i n t e r p r e t a t i o n of the Income  Tax A c t , the r e g i o n a l appeals o f f i c e r e g u l a r l y seeks guidence from the head o f f i c e i n motion p i c t u r e c a p i t a l cost appeals. n a t i o n a l Revenue, Taxation's o f f i c i a l a t t i t u d e : i s n e u t r a l w i t h respect to the use of f i l m s as subjects f o r tax s h e l t e r s . The department does o b j e c t , however, t o the s e t t i n g aside or m i s r e p r e s e n t a t i o n of p r o v i s i o n s of the Income Tax Act and i t s Regulations i n order to o b t a i n u n j u s t i f i e d advantages."^ Therefore very few motion p i c t u r e investments escape c l o s e s c r u t i n y by the tax department. - 135 -2. INCOME TAX REASSESSMENT AND APPEAL One of Edu-Film Production Ltd.'s investor-owners was s i n g l e d out. His refund c l a i m based on the c a p i t a l cost allowance deduction f o r h i s video tape investment i n an education health program was challenged. A Notice o f Reassessment was issued. The taxpayer contacted the d i s t r i c t o f f i c e and asked f o r an e x p l a n a t i o n . The tax department took several stances as to why the c.c.a. was denied during the twelve months i t took to review the case. Each stance was pro-g r e s s i v e l y more s p e c i f i c than the previous stance. The investor-owner and h i s f i n a n c i a l a d v i s o r s found i t necessary to prepare a r e b u t t a l f o r each of the tax department's arguments as to why the c.c.a. deduc-t i o n should be d i s a l l o w e d . Edu-Film cooperated and a s s i s t e d i n the preparation of each r e b u t t a l . The tax department's a u d i t o r asked the f o l l o w i n g q u estion. Was the video tape program purchased to gain or produce taxa b l e income or was i t bought s o l e l y to reduce the taxpayer's income taxes? I f the video tape was bought only to reduce income taxes otherwise payable, the c.c.a. c l a i m would be denied. The denial would be based on subsection 245(1) of the Income Tax Act. Subsection 245(1) p r o h i b i t s any t r a n s a c t i o n which unduly or a r t i f i c i a l l y reduces a taxpayer's 2 income. The investor-owner answered the a u d i t o r ' s question by presenting the f i n a n c i a l f e a s i b i l i t y study of the educational h e a l t h program investment. This study had been prepared by Edu-Film and presented to a l l p r o s p e c t i v e i n v e s t o r s . The study i n c l u d e d minimum and maximum earning p r o j e c t i o n s of an educational h e a l t h program. The p r o j e c t i o n s - 136 -were based on the educational audio-visual market conditions of 1973 and sales estimates from various education f i lm d i s t r i bu to r s throughout ilorth America. Table VI-I i s from the f i nanc ia l f e a s i b i l i t y study. The table projects expected revenue from a typ ica l educational health program for a s ix year period. The tax department studied the information submitted and concluded that while the transaction did minimize the investor-owner's taxes, the purchase appeared to have been made for legit imate business reasons and contained elements of "commercial r e a l i t y " . The tax- department conceded that the video tape investment could make economic sense i f the product ( f i lm or video tape program) met acceptable market standards. In other words, the tax department auditors were questioning the qua l i t y and marketabi l i ty of the product produced by Edu-Film. The auditors had good reasons for asking questions about product qua l i t y and marketab i l i ty . F i r s t l y , an eastern Canadian company had produced some video tape programs which v/ere considered by audio-visual media experts to lack marketab i l i ty . In 1973-75 that pa r t i cu l a r company produced over one hundred programs which had r e l a t i v e l y low budgets of $7,000 to $10,000 per program. The eastern Canadian company sold these programs to investors on the very high leveraged basis of $60,000-$75,000. The of fer ing of these video tape programs to investors emphasized the immediate tax shelter aspects of the investment. The sales potential of the video tape programs was secondary. The tax auditors wanted proof that Edu-Film's programs were marketable and that the investment was not so le ly to shelter income from taxes. - 137 -TABLE VI-I THE WORLD OF HEALTH  Si x Year Revenue Forecast f o r a 15 Minute Program GROSS SALES OF PROGRAM: Educ a t i o n a l : Canada (100 x $180) $ 18,000 U.S.A. (500 x $190) 95,000 Foreign 16,000 Medi c a l : (1000 x $300) 300,000 T e l e v i s i o n : 4,000 TOTAL GROSS SALES: ~ $433,000 Less D i s t r i b u t o r s ' Fees & Expenses: E d u c a t i o n a l : Canada 62% 11,160 U.S.A. 75% 71,250 Foreign 75% 12,000 Medical: 70% 210,000 T e l e v i s i o n : 10%-70% (Average 30%) 1,200 D i s t r i b u t i o n Agent's expenses 6,000  Total fees & Expenses $311,610 TOTAL NET REVENUE OF PROGRAM $121,390 Less: D i s t r i b u t i o n Agent's F e e * 31,089 I n t e r e s t on Promissory Mote 4,000 Program Purchase P r i c e 50,000 Subtotal $ 85,089 SIX YEAR NET INCOME TO INVESTOR $ 36,301 AVERAGE YEARLY MET INCOME TO INVESTOR BEFORE INCOME TAXES $ 6,050 • D i s t r i b u t i o n Agent's Fee Breakdown: 5% up to Net Revenue of $65,789 = $ 3,289 5% t h e r e a f t e r = $ 27,800 Total Fee ' $ 31,089 Source: Edu-Film Productions L t d . , Investment Prospectus, The World  of Health (1974), p.7. - 138 -Secondly, the tax department a u d i t o r s questioned Edu-Film 1s production c a p a b i l i t i e s because the company had only been i n the motion p i c t u r e business a very s h o r t time and the p r i n c i p a l s of the company had l i t t l e or no f i l m production experience. P r i n c i p a l s of Edu-Film met with o f f i c i a l s o f Na t i o n a l Revenue, Taxation. The purpose of the meetings was to demonstrate the q u a l i t y and m a r k e t a b i l i t y o f the product produced by Edu-Film. Edu-Film p r i n c i p a l s e x p l a i n e d t h a t Edu-Film's p o l i c y was to engage the s e r v i c e s of several of Canada's top motion p i c t u r e d i r e c t o r s . T h i s p o l i c y i s not a guarantee of a r t i s t i c and commercial success but i t does i n c r e a s e the chances of producing a program which meets market requirements. •Edu-Film h i r e d such d i r e c t o r s as Jack McGaw and Donald B r i t t a i n . flcGaw i s wel l known f o r h i s i n v e s t i g a t i v e j o u r n a l i s m on the Canadian T e l e v i s i o n Network's W-5 INQUIRY program. He i s a l s o the winner of numerous awards f o r h i s d i r e c t i n g , i n c l u d i n g the 1973 Roland Mitchner Award f o r Journalism. B r i t t a i n was the d i r e c t o r of such f i l m s as BETHUNE, CANADA AT WAR and MEMORANDUM. B r i t t a i n ' s l a t e s t f i l m VOLCANO: AN INQUIRY INTO THE LIFE AND DEATH OF MALCOLM LOMRY was nominated f o r an Academy Award i n e a r l y 1977. The c r e d e n t i a l s of both d i r e c t o r s f a v o u r a b l y impressed the tax department a u d i t o r s . They were more impressed, however, by the e x h i b i t of s i z a b l e purchase orders from several p r o v i n c i a l h e a l t h departments and Health and Welfare, Canada. The f i n a n c i a l f e a s i b i l i t y study of the video tape investment, which was, by d e f i n i t i o n , t h e o r e t i c a l , had been r e i n f o r c e d by proof t h a t the product was of marketable q u a l i t y . The tax department v/as unsuccessful i n denying the c.c.a. deduction on the ba s i s of "commercial r e a l i t y " of the investment. - 139 -The tax department lawyers then attacked the legal t e chn i c a l i t i e s of the video tape investment cap i ta l cost allowance. Success in the technical aspects of the investment would not have el iminated the cap i ta l cost deduction altogether but would have forced the investor-owner to spread the deduction over several years. The tax shelter advantage to the investor-owner may have been reduced in the i n i t i a l year of the investment and he would have to pay in teres t on any back • taxes owed. The f i r s t question the tax department lawyers asked was, when was the 'pr inc ipal photography" of the video tape completed? To ansv/er the question, copies of invoices for laboratory serv ices, .edit ing rooms and sound transfers were submitted. These invoices were evidence that the investor-owner's funds had been expended in the year for which the c .c .a . deduction was claimed. As further evidence that p r i nc ip le photography had been completed, a notorized l e t -ter from the d i rector was presented. The l e t t e r , which was on the d i r e c t o r ' s letterhead and bore his company's corporate s ea l , stated that pr inc ipa l photography and other phases of production had been completed pr io r to December 31st. The tax department accepted th i s evidence without further question. The tax department lawyers investigated the transfer of owner-ship between Edu-Film and the investor-owner. The purchase contracts between Edu-Film and i t s investor were, examined by National Revenue, Taxation lawyers in Ottawa. The Ottawa lawyers decided that the investor -owner had acquired the video tape program in the f i r s t year of the investment even though the programs were not completely f in i shed un t i l - 140 -the fol lowing year. Physical del ivery to the investor-owner and copyright reg i s t ra t ion of the video tape program in the owner's name did not take place un t i l the second year. The tax department accepted that the inves tor ' s cash payments had e i ther been expended on the production or, as were the promissory notes, held in escrow by an independent th i rd party pending completion of the programs. Therefore the inves tor ' s funds were "at r i s k " and the c .c .a . deduction require-ments s a t i s f i e d . A subsequent technical argument arose over whether the asset belonged to class 12, or whether i t belonged to class 18 as set out in Schedule B of the Income Tax Regulations. The investor-owners who had purchased the video tapes deducted a c .c.a. of 100% as per class 12. It must be noted that the technical d i s t i nc t i ons between motion picture f i lm and video tape are read i l y apparent but modern production f a c i l i t i e s permit t ransferr ing between the two formats. The Depart-ment of National Revenue and the Department of Finance belatedly acknowledged the ease of transfer between f i l m and video tape. Accordingly, the federal budget of flay, 1976 eliminated the d i s t i n c t i on between f i l m and video tape for c .c .a . purposes. The Edu-Film investment was made in 1974, pr io r to the 1976 amendment. The tax department o f f i c i a l s were try ing to prove that the educational health program was in fact a f i lm production, not a video tape production. If the tax department could prove that the program was a f i l m , the c .c .a . deduction would be reduced from 100% to 60% in the f i r s t year of the investment. The investor-owner 's deduction would have been reduced by $20,000. - 141 -Edu-Film used both f i l m and video tape production techniques on a l l i t s productions depending on v/hich technique was i n the best i n t e r e s t s of expedient production and program q u a l i t y . The f i n a l e d i t e d v e r s i o n of the product v/as f i n i s h e d on video tape and a video tape copy d e l i v e r e d to the investor-owner. The tax deparment's i n i t i a l approach was to send l e t t e r s t o all Edu-Film's investor-owners s t a t i n g t h a t National Revenue, Canada considered t h e i r programs to be motion p i c t u r e f i l m s which are i n c l a s s 18 (60% c.c.a. i n 1974). The tax department s t a t e d i n the l e t t e r s t h a t i t was amending the investor-owner's tax return f o r the f i r s t year of the investment and that the investor-owner was to submit the d i f f e r -ence i n back taxes plus i n t e r e s t . Edu-Film, through an i n v e s t o r -owner, asked the tax department f o r a l i s t of t e c h n i c a l c r i t e r i a of a video tape production. The tax department d e c l i n e d to supply a l i s t of c r i t e r i a . The investor-owner r e i t e r a t e d t h a t the "master copy" of the educational h e a l t h program was a two inch quad master video tape and t h a t the investor-owner had taken d e l i v e r y o f a video tape copy of the master. Therefore the 100% c.c.a. deduction v/as c o r r e c t . Given the recent amendment to the Income Tax Act and the d i f f i c u l t i e s i n d i s t i n -g u i s h i n g between motion p i c t u r e f i l m and video tape production techniques, the tax department decided to l e t the matter r e s t . The tax department has i n d i c a t e d t h a t i t w i l l monitor the marketing of the educational health programs and the subsequent r e t i r e -ment of the promissory notes held by Edu-Film. The w r i t e r i s of the o p i n i o n that i f the programs have f a i l e d to recoup the m a j o r i t y of t h e i r production c o s t s , a d d i t i o n a l reassessments may be issued before the - 142 -four year l im i t a t i on period has elapsed. Reassessment appeal pro-ceedings can take several years to complete. Before the appeal has been s e t t l ed , the tax department would be able to observe whether or not Edu-Film demands the balance of any outstanding promissory notes in 1981. If Edu-Film does co l l e c t or the notes have been r e t i r ed previous ly, the tax department w i l l have the sa t i s f ac t i on of c o l l e c t -ing taxes on Edu-Film 1s net income at the preva i l ing corporate ra te . If Edu-Film f a i l s to c o l l e c t the promissory notes the tax department may apply Section 80 of the Income Tax Act to the investor-owners. Section 80 states that a taxpayer who rea l i zes any net gain on settlement of a debt must include th i s amount in computing his income. •The investor-owner would then have to pay addit ional income taxes at his preva i l ing personal tax rate on the amount of debt forgiven. - 143 -FOOTNOTES CHAPTER VI Rulings D i v i s i o n of Revenue Canada, T a x a t i o n , l e t t e r , c i t e d by Wayne Beach, "Tax Advantages of Film Investments", CIT Tax Planning  and Management 18, March 1 , 1976 (Butterworths, 1976), p. 18-13. 2 Canadian Income Tax Act with R e g u l a t i o n s , 47th E d i t i o n , 1975-76 (C.C.H. Canadian L i m i t e d , 1976), p.604. 3 I b i d . , p.184. CHAPTER VII QUANTITATIVE ANALYSIS OF MOTION PICTURE INVESTMENT 1. INTRODUCTION This chapter i s a q u a n t i t a t i v e a n a l y s i s to determine the i n v e s t -or's a f t e r - t a x p o s i t i o n i n two motion p i c t u r e investments. The two motion p i c t u r e investments are an educational health video tape program and a fe a t u r e length t h e a t r i c a l motion p i c t u r e f i l m . A seven year model i s developed t h a t i n c o r p o r a t e s c h a r a c t e r i s t i c s of the two tynes of motion p i c t u r e s both leveraged and non-leveraged and the c h a r a c t e r i s t i c s of h y p o t h e t i c a l i n v e s t o r s at two a r b i t r a r y annual income l e v e l s ($30,000 and $100,000). The educational h e a l t h video tape program i s based on the Edu-F i l m Productions L t d . investment package which was described i n Chapter V. The fe a t u r e f i l m investment package i s based on an investment o f f e r i n g by the S o m e r v i l l e House Corporation. (Some of the d e t a i l s , of the two investment packages however, have been a l t e r e d and some assumptions made f o r the purpose o f t h i s a n a l y s i s . ) S o m e r v i l l e ' s p r o j e c t c o n s i s t s of two feature length motion p i c t u r e f i l m s and i s t y p i c a l of the s t r u c t u r e of syndicated f i l m investment packages o f f e r e d i n Canada. The i n v e s t o r makes a down payment and a s e r i e s of s i x annual payments to S o m e r v i l l e , the vendor of the two motion p i c t u r e f i l m s . The s e r i e s of f u t u r e payments i s guaranteed to be paid to the i n v e s t o r by a t h i r d p a r t y , the f o r e i g n d i s -t r i b u t o r of the f i l m s . The arrangement i s c a l l e d a syndicate-guarantee - 1 4 4 -- 145 -motion picture investment. A motion picture investment model v/i l l be developed that i n c o r — porates the f i nanc ia l arrangements of the educational health video tape program and the feature f i lm syndicate-guarantee investments. Sixteen a f te r - tax outcomes w i l l be generated through the model by appl icat ion of a present value factor to the annual incremental cash flow from the motion picture investments. Pess imist ic and opt imi s t i c d i s t r i bu t i on revenue forecasts w i l l be made. Met present value (N.P.V.) f i nanc ia l outcomes w i l l be calculated for the two motion picture investment pack-ages when no income i s generated by the motion picture (pess imist ic fo re -cast) and when "moderate" income i s generated (opt imist ic forecast ) . I f no income i s generated in the leveraged investments the investor-owner i s ca l l ed upon to pay the promissory notes to the vendor (or produc-er) of the motion p icture. The investor-owner's a f ter - tax f i nanc i a l pos i t ion w i l l be computed for both leveraged and non-leveraged motion picture investments. (The leveraged investments permit the investor-owner to claim a cap i ta l cost allowance deduction which i s based on the sum of the i n i t i a l cash down payment and the future payments to the vendor of the motion p icture. The investor-owner 's cap i ta l cost deduction in the f i r s t year of the invest -ment can exceed his i n i t i a l cash out lay, thereby reducing his taxes pay-able and increasing his cash flow in that year.) To determine the value of leverage to the investor-owner a number of assumptions w i l l be made and the leveraging aspect of the motion picture investment el iminated from the model. Then the investor-owner's a f te r - tax f i nanc i a l pos i t ion in the non-leveraged investment w i l l be computed. The non-leveraged f i nanc ia l outcomes w i l l be compared to the a f te r - tax f i nanc ia l outcomes in the leveraged motion picture investment. The value of the tax shel ter 146 aspect of motion p i c t u r e investment to the h y p o t h e t i c a l investor-owners can then be evaluated. The f o u r v a r i a b l e s i n the motion p i c t u r e investment model are: 1. The motion p i c t u r e investment type, e i t h e r : a. educational h e a l t h video tape program b. feature length t h e a t r i c a l f i l m s . 2. The motion p i c t u r e ' s d i s t r i b u t i o n e a r n i n g s , e i t h e r : a. no d i s t r i b u t i o n revenue ( p e s s i m i s t i c f o r e c a s t ) b. moderate d i s t r i b u t i o n revenue ( o p t i m i s t i c f o r e c a s t ) . 3. The motion p i c t u r e investment's f i n a n c i a l s t r u c t u r e , e i t h e r : a. leveraged b. non-leveraged. 4. The motion p i c t u r e investor-owner's annual b a s i c income, e i t h e r : a. $30,000 b. $100,000. These v a r i a b l e s are combined to obtain s i x t e e n a f t e r - t a x f i n a n c i a l out-comes f o r the motion p i c t u r e investor-owner. The s i x t e e n combinations of v a r i a b l e s are as f o l l o w s : Eriu-Films Video Tape-Program Investment  $30,000 income l e v e l 1. Leveraged 2. Leveraged 3. Non-leveraged 4. Non-leveraged $100,000 income l e v e l 5. Leveraged 6. Leveraged 7. Non-leveraged 8. Non-leveraged no motion p i c t u r e revenue moderated motion p i c t u r e revenue no motion p i c t u r e revenue moderate motion p i c t u r e revenue no motion p i c t u r e revenue moderate motion p i c t u r e revenue no motion p i c t u r e revenue moderate motion p i c t u r e revenue So m e r v i l l e House Corporation Feature Films Investment  $30,000 income l e v e l 9. Leveraged - no motion p i c t u r e revenue - 147 -10. Leveraged - moderate motion p i c t u r e revenue 11. Non-leveraged - no motion p i c t u r e revenue 12. Non-leveraged - moderate motion p i c t u r e revenue $100,000 income l e v e l 13. Leveraged - no motion p i c t u r e revenue 14. Leveraged - moderate motion p i c t u r e revenue 15. Non-leveraged - no motion p i c t u r e revenue 16. Non-leveraged - moderate motion p i c t u r e revenue 2. MOTION PICTURE INVESTMENT MODEL LIMITATIONS Model l i m i t a t i o n s are determined not only by the f i n i t e number of v a r i a b l e s which can be included i n the model's design but a l s o by the s p e c i f i c computing c a p a b i l i t i e s of the ( p a r t i c u l a r ) user of the model. The model developed i n t h i s study considers only two motion p i c t u r e i n v e s t -ments, the educational video tape program o f f e r e d by Edu-Film Production and the feature f i l m s o f f e r e d by S o m e r v i l l e House. I t can not t h e r e f o r e be used without m o d i f i c a t i o n f o r a q u a n t i t a t i v e a n a l y s i s of a l l motion p i c t u r e investment packages. The model i s used to c a l c u l a t e the outcome f o r i n v e s t o r s a t o n l y two l e v e l s of annual income. The model does not take i n t o account the general averaging p r o v i s i o n a v a i l a b l e to Canadian taxpayers. (General averaging bases the taxes payable on the taxpayer's annual income on an average of the past f i v e years. General averaging i s a p p l i e d to a t a x -payer's income which has increased over the previous year's income.) The model considers the motion p i c t u r e revenue when i t i s n i l and when i t i s a moderate amount. The model does not consider the proba-b i l i t y f a c t o r of these revenue l e v e l s being reached. Nor does the model consider the e f f e c t of f o r e i g n w i t h h o l d i n g taxes on the motion p i c t u r e - 148 -investment revenue earned outside of Canada. The d i f f e r e n t outcomes of the video tape program and the f e a t u r e f i l m s w i l l be compared and contrasted. However, comparisons are not t r u l y v a l i d . The c h a r a c t e r i s t i c s of the two investments are not e x a c t l y the same and the model i s not s o p h i s t i c a t e d enough t o account f o r the d i f f e r -ences between them. An educational video tape program and a f e a t u r e f i l m have very d i f f e r e n t r i s k s and p o t e n t i a l earning f a c t o r s . A w e l l produced and e f f e c t i v e l y d i s t r i b u t e d video tape program u s u a l l y generates revenue but a w e l l produced and e f f e c t i v e l y d i s t r i b u t e d f e a t u r e f i l m can f a i l to earn any money i f the movie going p u b l i c i s unreceptive. An educational video tape has an upper l i m i t of approximately 3,000 p r i n t s a l e s (assuming a s e l l i n g p r i c e of $250 per p r i n t , 3,000 p r i n t s would gross $750,000) but a f e a t u r e f i l m can gross over $200 m i l l i o n (eg JAWS). The down payments f o r each investment are s i m i l a r but the f u t u r e l i a b i l i t i e s are d i f f e r e n t i n the leveraged s i t u a t i o n s . In the video tape program, the investor-owner's future l i a b i l i t y i s $25,000 plus i n t e r e s t . In the fea t u r e f i l m the investor-owner's f u t u r e l i a b i l i t y i s $82,045 which i s guaranteed by the f o r e i g n d i s t r i b u t o r . In the leveraged investments the i n i t i a l income tax s h e l t e r i n the f e a t u r e f i l m s investment i s l a r g e r than i n the video tape program investment. In the q u a n t i t a t i v e a n a l y s i s of the non-leveraged investments the h y p o t h e t i c a l investor-owner's cash investment i s $25,000 f o r a 1/66th share i n the f e a t u r e f i l m s and $35,000 f o r a video tape program. (See Appendices A and C to Chapter VII.) 3. GENERAL ASSUMPTIONS A number of general assumptions are made f o r the motion p i c t u r e investment model input. The investor-owner's annual p r o f e s s i o n a l , business - 149 -or salary income i s assumed to be constant over the seven year model horizon. There i s no provis ion for cost of l i v i n g increases or the p o s s i b i l i t y of income decrease because of retirement, loss of job , e tc . The assumption i s made that the Canadian income tax rates remain constant over the seven years. The rates are the preva i l ing 1976 income tax rates without the 10% federal surtax on taxes payable over $8,000 in 1976. The model assumes that no other tax shelter investments are made during the seven years. R e a l i s t i c a l l y , an investor could she l ter h i s basic annual income and any motion picture revenue in other tax she l ter investments, e.g.gas and o i l exploration investments. The assumption is made that the investor-owner 's annual income and any revenue generated from the motion p icture investment i s spread evenly throughout any given year of the model. The present value discount factor i s 10% because the wr i ter believes that the investment r i s k d ictates that an investor should require an a f ter - tax return of 10% on a motion picture investment. The rat iona le of the der ivat ion of the 10% a f ter - tax return i s based on the required pre-tax return. The required pre-tax return i s derived from the to ta l of the annual i n f l a t i o n rate plus the real return on a r i s k free invest -ment plus the required r i sk premium for the investment. Annual i n f l a t i o n rate 6% Plus: Real return on r i s k free investment 3% Required r i sk premium return 10% Tota l : Required pre-tax return of,motion picture investment 19% The 19% pre-tax return i s r e a l i s t i c i f the return of a l te rna t i ve invest -ments i s considered and an allowance i s made for the higher r i s k s of motion p icture investments. An opportunity cost approach i s taken to further r a t i ona l i ze the required pre-tax return of 19%. - 150 -Y i e l d on a r i s k f r e e long term investment (e.g. Canadian Government savings bond) 9.0% P l u s : Apparent r i s k premium required on high q u a l i t y , marketable Canadian u t i l i t y •, stocks 4.3% Risk premium f o r incremental r i s k of motion p i c t u r e investments ( s u b j e c t i v e ) 5.7% T o t a l : Required pre-tax r e t u r n of motion p i c t u r e investment. 19.0% The pre-tax investment r e t u r n of the motion p i c t u r e investment i s s ubject to income taxes at the i n v e s t o r ' s personal tax r a t e . The income taxes are subtracted from the pre-tax investment r e t u r n t o determine the r e q u i r e d a f t e r - t a x r e t u r n . Assuming the i n v e s t o r pays income tax of 47.4% of h i s investment earnings the r e q u i r e d a f t e r - t a x •must be 10% . Required pre-tax r e t u r n of motion p i c t u r e investment 19% Less: Iihcome taxes payable (19% x 47.4% = 9%) 9% Equals: Required a f t e r - t a x r eturn of motion p i c t u r e investment 10% I f an e q u i v a l e n t investment return were earned, f o r example, from a " r i s k y " common stoc k , the tax r a t e would be the same as i f the earning were from the motion p i c t u r e investment. The c u r r e n t tax r a t e can be a p p l i e d to the pre-tax opportunity cost to determine the a f t e r - t a x o pportunity cost. The a f t e r - t a x o p p o r t u n i t y cost t h e r e f o r e , i s assumed to be 10%. This 10% discount f a c t o r i s a p p l i e d to the annual incremental cash flows i n order t o c a l c u l a t e the net present value outcomes i n the motion p i c t u r e investment model. - 151 -4. THE MOTION PICTURE INVESTMENT PACKAGES 2 A. Edu-Film Video Tape Program Leveraged Video Tape Program Cost Production cost $25,000 Producer's p r o f i t $25,000 T o t a l : Program purchase p r i c e $50,000 Payment Plan Cash down payment $25,000 Seven year 6% i n t e r e s t promissory note $25,000 . T o t a l : Payments $50,000 The 6% simple i n t e r e s t i s c a l c u l a t e d on the outstanding promissory note balance on December 31st of each year-end. Revenue Sharing Arrangement Gross revenues ( a f t e r d i s t r i b u t i o n expenses) 100% Less: D i s t r i b u t i o n agent's fee 5% Equals: Net revenue 95% Less : Promissory note payment 2/5ths o f 95% Equals: Cash to i n v e s t o r 3/5ths of 95% When the promissory note i s f u l l y r e t i r e d the d i s t r i b u t i o n agent's fee i s increased to 50% of the gross revenues and the investor-owner i s paid the remaining 50% of the gross. The note i s f u l l y r e t i r e d when t o t a l net revenue has reached $65,789. B. Edu-Film Video Tape Program Non-leveraged Video Tape Program Cost Production cost ' $25,000 Producer's p r o f i t 10,000 T o t a l : Program purchase p r i c e $35,000 For the r a t i o n a l e of the $35,000 program purchase p r i c e see Appendix A to Chapter V I I . - 152 -Payment Plan T o t a l : Cash payment $35,000 Revenue Sharing Arrangement Gross Revenues ( a f t e r d i s t r i b u t i o n expenses) 100% Less: D i s t r i b u t i o n agent's fee 50% Equals: Cash to i n v e s t o r 50% C. Educational Video Tape Program Earning Pattern The assumption i s made that i f the video tape program generates revenue, the revenue i s earned between the second to seventh year of the investment. The percentages of gross revenue, a f t e r d i s t r i b u t i o n expenses, are shown i n Table VII-1. TABLE VI I - I Video Tape D i s t r i b u t i o n Earning P a t t e r n Annual Percentages of Total D i s t r i b u t i o n Revenue of Video Tape Program 40% -35% -30% -25% -20% -15% -10% -5% -0% -1 2 3 4 5 6 7 years Source: General assumptions by the educational f i l m i n d u s t r y i n North America. For the video tape program earning a moderate income a f t e r d i s t r i b u t i o n expenses, the amount i s assumed to be $100,000 per program. - 153 -In the leveraged investment, the investor-owner's share of the $100,000 moderate income i s $79,606 a f t e r the d i s t r i b u t i o n agent's fee i s deducted. The promissory note payments and i n t e r e s t are deducted from the $79,606. In the non-leveraged investment s i t u a t i o n , the d i s t r i b u t i o n agent's fee i s a constant 50%. Therefore, the investor-owner's share i s $50,000 a f t e r deduction of the d i s t r i b u t i o n agent's fee. D. The S o m e r v i l l e House Corporation Feature Films Leveraged The S o m e r v i l l e investment package c o n s i s t s of two motion p i c t u r e s , Z0RR0 and THE STORY OF 0. These two f i l m s are o f f e r e d to i n v e s t o r s at 3 a t o t a l c a p i t a l cost of $7,000,000 i n the leveraged investment s i t u a t i o n . The S o m e r v i l l e prospectus f o r the ZorrO Syndicate i s reproduced i n i t s e n t i r e t y i n Appendix B to Chapter V I I . This investment package was o f f e r e d p r i o r to the amendment i n the c a p i t a l cost allowance p r o v i s i o n which was increased to 100%. Consequently the c a p i t a l c o s t allowance at the time of o f f e r i n g was 60% per year. For the purposes of t h i s i n v e s t -ment a n a l y s i s i t i s assumed that the two motion p i c t u r e f i l m s would q u a l i f y f o r the 100% c a p i t a l cost allowance, that i s , Canadian c e r t i f i e d f e a t u r e f i l m s o r Canadian co-productions. Feature Films Cost Production c o s t : expended X $1,585,000 deferred J " * \ . ? ? P o r t i o n guaranteed by d i s t r i b u t o r \ . 5,415,000 T o t a l : Purchase p r i c e of f i l m s $7,000,000 Cost of bank guarantee 65,000 T o t a l : C a p i t a l cost $7,065,000 For the purpose of the q u a n t i t a t i v e investment a n a l y s i s i t i s assumed th a t an i n v e s t o r wants to i n v e s t $25,000 cash i n the leveraged motion p i c t u r e f i l m s investment. A 1/66th share of the motion p i c t u r e investment can be purchased f o r an i n i t i a l o u t l a y of $25,000. Payment Plan ( f o r 1/66th share of motion p i c t u r e f i l m s ) Cash down payment $24,015 Cost of bank guarantee 985 T o t a l : Cash payments 1st year 25,000 Promissory Notes 82,045 T o t a l : Payments $107,045 The i n v e s t o r signs f i v e f u l l recourse n o n - i n t e r e s t - b e a r i n g promissory notes. A promissory note f o r $15,152 i s payable each year i n years two to f i v e of the investment. A f i n a l note of $21,439 i s due and payable i n the s i x t h year. In the syndicate f i n a n c i n g arrangement, the i n v e s t o r buys an undivided i n t e r e s t i n the two motion p i c t u r e s . The investor-owner i s re s p o n s i b l e f o r marketing the f i l m but i n p r a c t i c e , the investor-owner turns t h i s f u n c t i o n over to the producer cum d i s t r i b u t o r . The producer-d i s t r i b u t o r i n turn puts the f i l m s i n the hands of p r o f e s s i o n a l i n t e r -n a t i o n a l t h e a t r i c a l motion p i c t u r e d i s t r i b u t o r s . Revenue Sharing Arrangement The ZorrO Syndicate w i l l r e c e i v e 30% of the gross d i s t r i b u t i o n r e c e i p t s from the d i s t r i b u t i o n of ZORRO and 10% of the gross d i s t r i b u t i o n r e c e i p t s from the d i s t r i b u t i o n of THE STORY OF 0 i n the United States and Canada. The North American d i s t r i b u t o r i s A l l i e d A r t i s t s of Los Angeles. The two f i l m s w i l l be d i s t r i b u t e d i n the f o r e i g n markets by World A s s o c i a t i o n Video Establishment (WAVE). The ZorrO Syndicate i s guaranteed to re c e i v e $5,415,000 i n d i s t r i b u t i o n r e c e i p t s from WAVE. These guaranteed r e c e i p t s are to be paid by WAVE to the investor-owners on or before the promissory notes are to be paid by the investor-owners to the vendor o f the f i l m s . The syndicate w i l l not r e c e i v e any a d d i t i o n a l d i s t r i b u t i o n r e c e i p t s from d i s t r i b u t i o n o f the f i l m s i n the f o r e i g n markets. I t i s assumed that the syndicate's expenses are deducted from the revenues received from the North American markets. - 155 -E. The Somerville House Corporation Feature Films Non-Leveraged The S o m e r v i l l e feature f i l m s investment package wi11 be analysed without the tax s h e l t e r leverage f a c i l i t a t e d by the promissory notes. I t i s assumed that the 1/66th share of the motion p i c t u r e f i l m s w i l l be purchased f o r $25,000. The assumption i s made that, the syndicate w i l l only receive d i s t r i b u t i o n r e c e i p t s from the North American motion p i c t u r e markets. The vendor (or producer) of the f i l m s w i l l r e c e i v e any d i s t r i b -u t i o n revenue earned i n the f o r e i g n motion p i c t u r e markets. These assumptions are based on the theory concerning the flow of funds between the producer and the d i s t r i b u t o r advanced by the w r i t e r i n the Chapter IV d i s c u s s i o n of the syndicate-guarantee f i n a n c i n g arrangements. A more d e t a i l e d d i s c u s s i o n of the r a t i o n a l e behind the $25,000 purchase p r i c e f o r a 1/66th share of the f e a t u r e f i l m s investment package i s given i n Appendix C to Chapter V I I . F. Feature Film Earning Pattern The promoters of the ZorrO Syndicate have proj e c t e d minimum earnings of the two f i l m s i n the North American markets at $2,350,000. The f o r e i g n d i s t r i b u t o r , WAVE, has guaranteed $5,415,000 d i s t r i b u t i o n revenue. Motion p i c t u r e producers (promoters) overestimate the p o t e n t i a l of t h e i r p r o j e c t s . A.H. Howe, Vice President of the Bank of America i n Los Angeles s t a t e d : I can only repeat that over the years I have t a l k e d to hundreds of producers, each with the world's best p i c t u r e , a p r o j e c t where i t was impossible to miss, where a h i t was a b s o l u t e l y certain...The d i f f i c u l t y i s , proved over and over again, that these c e r t a i n h i t s , when made, are u s u a l l y l o s t i n the s h u f f l e and more often than not, f a i l to r e t u r n t h e i r c o s t s . - 156 -For the purposes of the a n a l y s i s of both the leveraged and non-leveraged feature f i l m s investments, the North American earnings p r o j e c t e d by Somerville are reduced by approximately 50% to a r r i v e a t the "moderate" revenue f i g u r e . The f o r e i g n r e c e i p t s are taken as given because those r e c e i p t s are guaranteed by WAVE i n the leveraged f e a t u r e f i l m s investment. ( I f WAVE f a i l s to honour i t s commitment, the Swiss bank w i l l pay the investor-owners the guaranteed amount.) In the non-leveraged f e a t u r e f i l m s investment, the earnings i n the f o r e i g n market, i f there are any earnings, w i l l be considered the vendor's (producer's) p r o f i t . The assumption i s made that i f the feature f i l m s generate revenue i n the North American markets, the revenue i s earned betv/een the t h i r d and f i f t h years of the investment. The annual percentage of t o t a l revenue o c c u r r i n g to the ZorrO Syndicate i s shown below i n Table VI I-11. TABLE VI I-11 Feature Film D i s t r i b u t i o n Earning P a t t e r n Annual percentages of Total D i s t r i b u t i o n Revenue of Feature Films i n North American Markets 50% -45% -40% -35% -30% -25% -20% -15% -10% -5% -0 -1 2 3 4 5 6 7 years Source: General assumptions by the t h e a t r i c a l f i l m i n d u s t r y . The moderate earnings of the two featu r e f i l m s w i l l be assumed to be $1,135,030 a f t e r syndicate expenses. The share a t t r i b u t a b l e to - 157 -each 1/66th of the motion p i c t u r e w i l l be $17,955 i n leveraged f e a t u r e f i l m s investment. In a d d i t i o n , guaranteed d i s t r i b u t i o n r e c e i p t s from WAVE of $82,046 w i l l be earned by each 1/66th share. In the non-lever-aged investment s i t u a t i o n , the investor-owner w i l l only r e c e i v e $17,955 from Tlorth American d i s t r i b u t i o n f o r each 1 /66th share owned. The syndicate w i l l not receive any guaranteed d i s t r i b u t i o n revenue from WAVE nor any earnings from the f o r e i g n markets i n the non-leveraged f e a t u r e f i l m s investments. 5. THE MOTION PICTURE INVESTMENT MODEL The model enables the i n t e r a c t i o n between the f i n a n c i a l c h a r a c t e r -i s t i c s of the i n v e s t o r and the motion p i c t u r e investment t o be analyzed. The planning horizon f o r the investment d e c i s i o n i s seven years. Seven years i s considered the economic l i f e o f the f e a t u r e f i l m s and video tape program motion p i c t u r e investments. The ZorrO Syndicate promissory notes payments are spread over s i x years and the Edu-Film promissory note i s due i n the seventh year. The i n v e s t o r commits h i s funds f o r t h i s seven 5 year period and i s now hostage to the f u t u r e consequences. Each year i n the model i s represented by the v e r t i c a l columns of numbers Tabled 1 t o 7. The h o r i z o n t a l l i n e s of input and c a l c u l a t i o n s are shown i n Table VII-I I A. Investor-Owner Income Tax C a l c u l a t i o n s The f i r s t step i n u t i l i z i n g the model i s t o c a l c u l a t e the investor-owner's annual income taxes. This i s done by deducting the c a p i t a l cost allowance (and cost of the bank guarantee and i n t e r e s t , i f any) from the income earned by the investor-owner from a l l sources i n c l u d i n g any motion p i c t u r e investment revenue. The investor-owner's income from b u s i n e s s , p r o f e s s i o n a l or s a l a r y sources f o r the purpose of t h i s model i s a net amount before - 158 -TABLE VII-I11 Hotion P i c t u r e Investment Model Input and C a l c u l a t i o n s INVESTOR-OWNER INCOME TAX CALCULATIONS:(Step One) Income: Business, P r o f e s s i o n a l or S a l a r y : Motion P i c t u r e Investment Revenue: Gross Income: Less: Cost o f Guarantee: I n t e r e s t Payments: C a p i t a l Cost Allowance: Taxable Investor-Owner Income: Income Taxes Payable: CASH FLOW WITH INVESTMENT: (Step Two) Gross Income: Less: , Investment Down Payment: I n t e r e s t Payments : Cost of Guarantee : Promissory Note Payments: Income Taxes Payable: Net Cash: CASH FLOW NO INVESTMENT: (Step Three) Income: Business, P r o f e s s i o n a l o r S a l a r y : Less: Income Taxes Payable: Net Cash: ANNUAL INCREMENTAL CASH FLOW: (Step Four)  ANNUAL PRESENT VALUE @ 10%: (Step F i v e ) MET PRESENT VALUE OF MOTION PICTURE INVESTMENT: (Step S i x ) - 159 -income taxes, but i s a f ter pension contr ibut ions, medical, c h i l d , marriage and any other personal deductions have been taken. It i s assumed that the deductions e i ther remain constant for the seven year model or any increases or decreases are o f f set by pa ra l l e l income changes. The motion picture revenue, i f any, i s the amount paid to the investor-owner. D i s t r i bu to r ' s or syndicator ' s fees and expenses are not included in the gross amount. The motion p icture revenue each year i s calculated according to the revenue pattern assumed as cha rac te r i s t i c of the type of motion picture under considerat ion. The guaranteed d i s t r i bu t i on revenue i s included in the leveraged feature motion p icture analys is only. Gross income i s the tota l income earned by the investor-owner., from a l l other sources a f te r personal deductions, plus the motion p i c -ture investment revenue. The cost of the guarantee i s the investor ' s share of the guarantee purchased from a bank in the feature f i lms leveraged investment. The bank guarantor w i l l pay to the investor the yearly amount which the investor-owner must pay the vendor of the feature f i l m motion pictures should the d i s t r i bu to r default in his payments to the investor-owner. The guarantee i s purchased in the f i r s t year of the investment and i s an expense for tax purposes deductable against gross income in the f i r s t year. The in teres t payments are the amount the investor-owner of the Edu-Film video tape program must pay to the holder of the promissory note. The in teres t rate is 6% calculated on 'the outstanding balance of the note on December 31st of each year. The in teres t i s not compounded. The cap i ta l cost allowance i s the amount the investor-owner deducts for tax purposes from his gross income each year. The ava i l ab le cap i t a l cost deduction i s deducted during the seven year period of the investment - 160 -so t h a t the investor-owner optimizes h i s cash flow p o s i t i o n v i s a v i s the 10% r e t u r n expected i n the net present value c a l c u l a t i o n . In almost a l l of the motion p i c t u r e investments analyzed the optimal cash flow t o the investor-owner i s a r r i v e d at by u t i l i z i n g , a v a i l a b l e c.c.a. to brin g the investor-owner down one complete marginal tax bracket f o r as many years as there i s a c a p i t a l deduction a v a i l a b l e . That i s , i f the investor-owner i s earning $30,000 annually before income taxes he i s i n the 44.10% marginal tax bracket. (Taxes payable at a r a t e o f 44.10% on any income earned i n excess of $23,606 u n t i l an annual income l e v e l of $31,368 i s reached.) The c a p i t a l cost deduction i s then used to b r i n g the investor-owner down t o the top of the next bracket which, i n t h i s example, begins a t $18,298 annual income. Income exceeding $18,298 but l e s s than $23,606 i s taxable at a r a t e of 43.58%. I f the motion p i c t u r e investment increased the investor-owner's taxable income he may, depending upon the amount of motion p i c t u r e revenue, move i n t o a higher tax bracket t h a t year. I f the investor-owner moves up i n t o a higher bracket because of motion p i c t u r e revenue any c.c.a. would be a p p l i e d to brin g him down to the top of the next bracket. The c.c.a. i s spread from one to s i x years depending on the investor-owner's t o t a l t a x a b l e income and the c a p i t a l c o s t of the motion p i c t u r e . Taxable income i s the investor-owner's gross income minus the cap-i t a l cost allowance deduction taken f o r the year and i n t e r e s t , i f any, (and the cost of the bank guarantee i n the f i r s t year of the feat u r e f i l m s investment). In the l a t t e r years o f the investment model when no c.c.a. i s a v a i l a b l e , the taxabl e income i s the same amount as the gross income. Income taxes payable are based on the fe d e r a l income tax r a t e and the B r i t i s h Columbia p r o v i n c i a l tax rate i n e f f e c t f o r 1976. The t a x computations do not consider the 10% f e d e r a l surtax imposed on f e d e r a l tax - ibi -payable over $8,000 i n e f f e c t f o r 1976. The tax c a l c u l a t i o n s are computed according to the "Federal and P r o v i n c i a l Income Tax Rates For I n d i v i d u a l s - 1976" ta b l e s p u blished by C.C.H. Canadian L i m i t e d . 7 B. Cash Flow With Investment The second step to u t i l i z e the model i s to c a l c u l a t e the net cash flow to the investor-owner a f t e r h i s actu a l cash investment expenses and taxes payable are deducted from h i s t o t a l income from a l l sources. Gross income i s the investor-owner's income from a l l sources i n c l u d i n g motion p i c t u r e revenue, i f any. This i s the same t o t a l f o r each year which i s a r r i v e d at i n the model's f i r s t s t e p , the income t a x c a l c u l a t i o n s . The investment down payment i s the down payment by the investor-owner to the vendor of the motion p i c t u r e i n the f i r s t year of the investment. The amount of the down payment i s chosen to impart a degree o f c o m p a t i b i l i t y between the d i f f e r e n t types of motion p i c t u r e investment under a n a l y s i s . The video tape program investment down payment i s $25,000 i n the leveraged investment s i t u a t i o n . The balance of the f u l l purchase p r i c e of $50,000 i s the f u l l recourse seven year 6% i n t e r e s t bearing promissory note payable by the purchaser ( i n v e s t o r -owner). In the non-leveraged video tape program investment a n a l y s i s , the payment i n the f i r s t year i s $35,000. This payment i s the f u l l c o st o f the investment. In the non-leveraged s i t u a t i o n the payment t o the vendor of an a d d i t i o n a l $10,000 i n the f i r s t year represents the discounted value to the vendor (producer) of the seven year promissory note. (See Appendix A to Chapter VII f o r a f u l l e x p l a n a tion of the assumptions used to a r r i v e a t an amount of $10,000.) In the f e a t u r e f i l m s motion p i c t u r e investment, the investment payment i n year 1 i n the leveraged s i t u a t i o n i s $24,015. The payment of - 162 -$24,015 plus the cash payment of $985 f o r the bank guarantee t o t a l $25,000. The $25,000 buys the i n v e s t o r T/66th of the feature f i l m s motion p i c t u r e investment package. The investor-owner i s e n t i t l e d t o l / 6 6 t h of a l l net r e c e i p t s from the d i s t r i b u t i o n of the f e a t u r e f i l m s . The cost of 1/66th of the f e a t u r e f i l m s investment package i n the non-leveraged s i t u a t i o n i s assumed to be $25,000. (The r a t i o n a l e behind t h i s p r i c e i s explained i n Appendix C to Chapter VII.) The i n t e r e s t payments are the annual i n t e r e s t charges on the outstanding balance of the seven year promissory note i n the leveraged video tape program investment. The cost of the guarantee i s the investor-owner's p o r t i o n ( l / 6 6 t h ) of the bank guarantee purchased by the f e a t u r e f i l m s motion p i c t u r e .investment syndicate i n the leveraged f e a t u r e f i l m s investment. No guarantee purchase i s necessary i n the non-leveraged f e a t u r e f i l m s i n v e s t -ment. The promissory note payments are the investor-owner's payments to the vendor of the motion p i c t u r e . These payments are only a p p l i c a b l e i n the leveraged investments. The feature f i l m s ' promissory notes are r e t i r e d at a constant amount of $15,152 per year f o r years 2 to 5. In the s i x t h y e a r , a f i n a l payment of $21,439 i s made. The guaranteed d i s t r i b u t i o n r e c e i p t s are paid to the investor-owner i n an i d e n t i c a l p a t t e r n i f the bona f i d e d i s t r i b u t i o n r e c e i p t s are i n s u f f i c i e n t . In the video tape program investment the promissory notes are r e t i r e d according to the amount o f revenue earned by the, video tape program. Forty percent of the motion p i c t u r e revenue earned each year by the investor-owner i s a p p l i e d a gainst the promissory note u n t i l the note i s f u l l y r e t i r e d . I f the video tape program f a i l s to earn any revenue f o r the investor-owner during the seven year p e r i o d , the investor-owner pays the promissory note i n f u l l at the end of the seventh year. - 163 -The income taxes payable are the f i n a l f i g u r e a r r i v e d at i n the tax c a l c u l a t i o n s f o r each year i n step one. Net cash i s the amount of money remaining each year from the investor-owner's annual gross income a f t e r the annual cash expenses of the investment and income taxes have been deducted. C. Cash Flow No Investment The t h i r d step i n the model i s to a r r i v e at an annual net cash flow f o r a h y p o t h e t i c a l taxpayer who has the same business, p r o f e s s i o n a l or s a l a r y income as the taxpayer i n v e s t i n g i n a motion p i c t u r e . The annual net cash amounts of the two taxpayers w i l l be compared a f t e r c a l c u l a t i n g the net a f t e r - t a x amounts. The taxpayer's income from business, p r o f e s s i o n a l or s a l a r y sources i s assumed to be i d e n t i c a l to that of the taxpayer i n v e s t i n g i n the motion p i c t u r e , that i s , a l l personal deductions have p r e v i o u s l y been taken. The taxpayer's income i s assumed to remain constant f o r the seven year time span of the motion p i c t u r e investment model. The income taxes payable are based on the f e d e r a l and B r i t i s h Columbia p r o v i n c i a l income tax rates p r e v a i l i n g i n 1976. Net cash i s the amount of disposable cash income that the tax-payer has a f t e r payment of h i s income taxes. D. Annual Incremental Cash Flow From Investment The annual incremental cash flow i s the cash d i f f e r e n c e between the two taxpayers, the taxpayer who i n v e s t s i n the motion p i c t u r e i n v e s t -ment and the taxpayer who does not i n v e s t . The non-investing taxpayer's net cash flow i s subtracted from the i n v e s t i n g taxpayer's cash flow each year. I f the taxpayer who i n v e s t s has l e s s net cash than the taxpayer who does not i n v e s t , the amount i s set between parenthesis f o r t h a t p a r t i c u l a r year. - 164 -E. Annual Present Value The discounted present value i s c a l c u l a t e d a nnually f o r the d i f f e r e n c e i n cash flow between the motion p i c t u r e i n v e s t o r and the taxpayer, who has the same b a s i c income but does not p a r t i c i p a t e i n the motion p i c t u r e investment. The annual incremental cash flow i s discounted by a present value f a c t o r o f 10%. Present value i s defined as the value today ( i e . time equals 0) of a cash payment rece i v e d sometime i n the fu t u r e a f t e r a p p l y i n g a given discount f a c t o r . F. Net Present Value of the Motion P i c t u r e Investment The net present value i s the t o t a l seven year incremental cash flow from the motion p i c t u r e investment discounted at 10%. The net present value amount i s the f i n a l f i n a n c i a l outcome of the motion p i c t u r e investment model. I f p a r t i c i p a t i o n i n the motion p i c t u r e investment reduces the investor-owner's discounted cash flow ( i e . creates a f i n a n c i a l l o s s ) the net present value amount i s set i n paren t h e s i s . 6. THE MOTION PICTURE INVESTMENT MODEL OUTCOMES The net present value outcomes f o r each h y p o t h e t i c a l i n v e s t o r -owner and motion p i c t u r e investment (leveraged and non-leveraged) are c a l c u l a t e d . The a v a i l a b l e c.c.a. i s u t i l i z e d to reduce the i n v e s t o r -owner's income taxes payable so that the best p o s s i b l e net present value i s found f o r each model outcome given the computing c a p a b i l i t i e s and time resources o f the w r i t e r . See Table VIJ.-IV f o r an example of the actu a l c a l c u l a t i o n s of one net present value outcome of an i n v e s t o r with a $30,000 ba s i c income purchasing a leveraged educational video tape program which earns moderate d i s t r i b u t i o n revenue. TABLE VII-IV MOTION PICTURE INVESTMENT MODEL Educational Video Tape Program Leveraged Investment Investor's Basic Income: $30,000 D i s t r i b u t i o n Revenue: "Moderate" INVESTOR-OWNER INCOME TAX CALCULATIONS: (Step One) Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Totals Income: Business, Professional or Salary: Motion Picture Investment Revenue: $30,000 0 $30,000 4,750 $30,000 14,250 $30,000 28,500 $30,000 22,106 $30,000 7,500 $30,000 2,500 $210,000 79,606 $289,606 Gross Income: Less: Cost of Guarantee: Interest Payments: Capital Cost Allowance: Taxable Investor-Owner Income: Income Taxes Payable: $30,000 $34,750 $44,250 $58,500 $52,106 $37,500' $32 ,500 n.a. 0 11,702 18,298 $ 5,46.8 n.a. 1,155 9,989 23,606 $ 7,781 n.a. 870 19,774 23,606 $ 7,781 n.a. 300 8,535 49,665 $20,835 n.a. 0 52,106 $22,156 n.a. 0 37,500 $14,548 n.a. 0 32,500 $11,564 n.a. 2,325 50,000 237,281 $ 90,533 CASH FLOW WITH INVESTMENT: (Step Two) Gross Income: Less: Investment Down Payment: Interest Payments : Cost of Guarantee : Promissory Note Payments: Income Taxes Payable: Net Cash: $30,000 25,000 0 n.a. 0 5.468 ($468) $34,750 n.a. 1,155 n.a. 1,900 7.781 $23,914 $44,250 n.a. 870 n.a. 5,700 7,781 $29,899 $58,500 n.a. 300 n.a. 11,400 20.835 $25,965 $52,106 n.a. 0 n.a. • 6,000 22.156 $23,950 $37,500 n.a. 0 n.a. 0 14.548 $22,952 $32,500 n.a. 0 n.a. 0 11.986 $20,535 $289,606 25,000 2,325 n.a. 25,000 90,533 $146,747 CASH FLOW NO INVESTMENT: (Step Three) Income: Business, Professional or Salary $30,000 $30,000 $30,000 $30,000 $30,000 $30,000 $30,000 $210,000 Less: Income Taxes Payable: Net Cash: 10,747 $19,253 10.747 $19,253 10.747 $19,253 10.747 $19,253 10,747 $19,253 10.747 $19,253 10,747 $19,253 75,229 $134,771 ANNUAL INCREMENTAL CASH FLOW: (Step Four) ($19,721) $ 4.661 $10,646 $ 6,712 $ 4,697 $ 3,699 $ 1,283 $ 11,977 ANNUAL PRESENT VALUE (•> 10%: (Step Five) ($17,928) $ 3,852 $ 7.998 $ 4,584 $ 2,916 $ 2,088 $ 658 $ 4,168 NET PRESENT VALUE OF MOTION PICTURE INVESTMENT: (Step Six) $ 4,168 5» 00 Key: n.a. = not applicable - 166 -The determination of the best p o s s i b l e net present value f i g u r e ( l e a s t discounted l o s s or g r e a t e s t discounted p r o f i t ) f o r each investor-investment s i t u a t i o n can inv o l v e c a l c u l a t i o n of many d i f f e r e n t outcomes. These d i f f e r e n t outcomes are dependent pn the amount of c a p i t a l c o s t allowance deduction which i s used i n each year of the investment. For example, i n the investment s i t u a t i o n i n which the i n v e s t o r earns $30,000 an n u a l l y and has the opportunity t o buy a. $35,000 non-leveraged educational h e a l t h video tape program, f o u r p o s s i b l e out-comes are c a l c u l a t e d . The f o u r outcomes are dependent on how much of the $35,000 c a p i t a l c ost i s deducted each year. In t h i s example i t i s assumed no d i s t r i b u t i o n revenue i s earned. Four p o s s i b l e uses of the c.c.a. deductions are as f o l l o w s : 1. Take maximum c.c.a. i n year 1 to reduce the investor-owner's taxab l e income to n i l . ($30,000 c.c.a.) Take the balance o f the c.c.a. ($5,000) i n year 2. The N.P.V. of the i n v e s t o r ' s incremental cash flow i s then a l o s s of $20,131. 2. Spread c.c.a. over s i x years to reduce the investor-owner's taxable income to the top of hi s present bracket ( i e . $23,606). Therefore, he pays a maximum of 41.30% on income exceeding $18,298 i n s t e a d of 44.10% on income over $23,606. The N.P.V. of i n v e s t o r ' s incremental cash flow i s a l o s s o f $19,781. 3. Spread c.c.a. over two years to b r i n g the investor-owner down t o the 43.58% marginal tax bracket ( i e . annual income $18,298). Use the balance of the a v a i l a b l e c.c.a. i n year 3. The N.P.V. of the i n v e s t o r ' s incremental cash flow i s a l o s s of $18,724. 4. Random use of the c.c.a., eg. cla i m $20,000 i n year 1 and $15,000 i n year 2. The N.P.V. of incremental cash flow from the investment i s a l o s s o f $18,896. - 16/ -The net present value i s a negative i n a l l these s i t u a t i o n s , but the optimum p o s i t i o n of the combinations c a l c u l a t e d i s to use the c.c.a. to place the investor-owner at the beginning of the next lowest marginal tax bracket assuming h i s b a s i c $30,000 annual income, i e . as i n 2 above. A. Met Present Value Outcomes The s i x t e e n net present value outcomes f o r each motion p i c t u r e investment model's seven year incremental cash flow are as f o l l o w s : Edu-Films Production's Video Tape Program Investment  $30,000 income l e v e l No motion p i c t u r e revenue ($21,000) C Leveraged , Moderate motion p i c t u r e revenue $ 4,168 f 3. No motion p i c t u r e revenue. ($18,724) Non-leveraged' •i: Moderate motion p i c t u r e revenue ($ 2,164) $100,000 income l e v e l 5. No motion p i c t u r e revenue ($10,567) Leveraged { Non-1 everaaed«f 6. Moderate motion p i c t u r e revenue $ 6,281 •7. No motion p i c t u r e revenue ($12,650) .8. Moderate motion p i c t u r e revenue ($ 288) So m e r v i l l e House Corporation's Feature Films Investment  $30,000 income l e v e l 9. No motion p i c t u r e revenue ($12,921) Leveraged 10. Moderate motion p i c t u r e revenue ($ 5,518) '11. No motion p i c t u r e revenue ($13,008) Non-leveraged' r 0 2 . Moderate motion p i c t u r e revenue ($ 6,678) $100,000 income l e v e l No motion p i c t u r e revenue ($ 2,090) r i 3 . 1.14. Leveraged t Moderate motion o i c t u r e revenue $ 2,683 - 168 -(15. No motion p i c t u r e revenue ($ 8,739) Non-1everagedj M6. Moderate motion p i c t u r e revenue ($ 3,965) 7. COMPARISONS AND CONTRASTS Comparisons and c o n t r a s t s can be made between the s i x t e e n f i n a n c i a l outcomes. (The net present value of the motion p i c t u r e i n v e s t -ments' cash flows using a 10% discount f a c t o r . ) These comparisons and c o n t r a s t s are used to support the w r i t e r ' s conclusions and recommendations with regards to motion p i c t u r e investment. The reader should r e f e r to Table VII-V while c o n s i d e r i n g the f o l l o w i n g comparis onsand c o n t r a s t s between the f i n a l f i n a n c i a l outcomes of the motion p i c t u r e investment. 1. None of the non-leveraged motion p i c t u r e investments has a p o s i t i v e net present value a t a 10% discount r a t e . 2. In a l l the motion p i c t u r e investments except one, the l o s s was g r e a t e r i n the non-leveraged investment than the s i m i l a r leveraged motion p i c t u r e investment. (The exception was the video tape investment made by the $30,000 income l e v e l i n v e s t o r -owner when no d i s t r i b u t i o n revenue was earned.) 3. In a l l cases the investor-owner i n the leveraged investment was b e t t e r o f f than i f he i n v e s t e d i n the non-leveraged investment when the motion p i c t u r e earned moderate d i s t r i b u t i o n revenue. 4. The investment had a p o s i t i v e net present value only i f the motion p i c t u r e earned a moderate amount of d i s t r i b u t i o n revenue. However, even i f moderate revenue was earned, the outcome was negative f o r the $30,000 investor-owner i n v e s t i n g i n the f e a t u r e fi1ms. 5. The negative net present value of the incremental cash f l o w was s u b s t a n t i a l f o r the $30,000 investor-owner i f the investment TABLE VII-V Net Present Value of Incremental Cash Flow From Motion P i c t u r e Investment at a 10% Discount Factor VIDEO TAPE PROGRAM FEATURE FILMS LEVERAGED NON-LEVERAGED LEVERAGED NON-LEVERAGED MOTION PICTURE ($13,008) ($21 ,001) ($18,724) REVENUE: NIL ($12,921) Investor-owner 1s Investor-owner' Basic Income Basic Income $30,000 $30,000 MOTION PICTURE ($6,678) $4,168 ($2,164) REVENUE:" MODERATE" ($5,518) LEVERAGED NON-LEVERAGED LEVERAGED NON-LEVERAGED MOTION PICTURE ($8,739) ($10,567) ($12,650) REVENUE: NIL ($2,090) i Investor-owner' Investor-owner 1s Basic Income Basic Income 1 $30,000 $100,000 MOTION PICTURE $2,683' ($3,965) $6,281 ($288) REVENUE:1 MODERATE" - 170 -f a i l e d t o generate any revenue i n d i s t r i b u t i o n . 6. The $30,000 investor-owner had a l o s s i n a l l the s i t u a t i o n s t e s t e d except i n the leveraged video tape program which generated a moderate amount o f d i s t r i b u t i o n revenue. 7. The p o t e n t i a l l o s s to the $30,000 investor-owner i s approxim-a t e l y twice the p o t e n t i a l l o s s to the $100,000 investor-owner i n the leveraged video tape program. The f i n a n c i a l outcome f o r the $30,000 investor-owner i s the highest p o t e n t i a l l o s s of any o f the motion p i c t u r e investment model outcomes. His p o t e n t i a l g a i n , i f the leveraged video tape program generates a moderate amount of revenue, i s approximately one-half o f the p o t e n t i a l amount which the $100,000 investor-owner would earn. 8. The video tape program investment o f f e r s a g r e a t e r p o s i t i v e net present value t o e i t h e r the $30,000 or the $100,000 investor-owner than i n the feature f i l m s investment i f moderate revenue i s generated. A l b e i t i n a l l cases the p o t e n t i a l l o s s i s gr e a t e r than the p o t e n t i a l l o s s i n the feat u r e f i l m s investment which has guaranteed d i s t r i b u t i o n 9 revenue to o f f s e t the f u t u r e l i a b i l i t i e s . However, the video tape program has a d e f i n i t e upper l i m i t t o i t s earning p o t e n t i a l whereas t h e . f e a t u r e f i l m s could be "blo c k b u s t e r s " . I f even one o f the fea t u r e f i l m s i s a blockbuster the earnings c o u l d be very high. The p o t e n t i a l box o f f i c e gross o f an ex c e p t i o n a l f e a t u r e length motion p i c t u r e can be i n the $100 m i l l i o n s . 8. CONCLUSIONS Given the c h a r a c t e r i s t i c s of the investor-owner and motion p i c t u r e investments, s p e c i f i c and general conclusions can be drawn about motion p i c t u r e investment by studying the motion p i c t u r e investment model outcomes. - 171 -1. The a t t r a c t i v e n e s s o f a motion p i c t u r e investment i s s e v e r e l y diminished i f the investment i s not leveraged i n order to enhance the tax s h e l t e r aspect of the investment. I t appears that an i n v e s t -or would be unwise to consider investment i n a motion p i c t u r e unless there i s at l e a s t a two to one leverage of the i n i t i a l i n v e s t -ment. There must be a minimum d i s t r i b u t i o n revenue guarantee to o f f s e t promissory note l i a b i l i t y , p a r t i c u l a r l y i f the leverage r a t i o i s high. 2. There i s no net tax advantage to an i n v e s t o r i f the motion p i c t u r e f a i l s to generate any d i s t r i b u t i o n revenue. Contrary to what motion p i c t u r e investment promoters m a i n t a i n , the t a x s h e l t e r aspect alone i s not enough to make motion p i c t u r e i n v e s t -ments a t t r a c t i v e . Therefore, a taxpayer should not i n v e s t unless the motion p i c t u r e has a r e a l i s t i c p o t e n t i a l to earn d i s t r i b u t i o n revenue. 3. The i n v e s t o r ' s marginal tax r a t e has a d e f i n i t e e f f e c t on the outcomes of motion p i c t u r e investments. The higher the taxpayer's marginal tax rate the lower the p o t e n t i a l l o s s on the investment and the g r e a t e r the p o t e n t i a l g a i n . 4. Given the high p o t e n t i a l downside and low p o t e n t i a l earnings i t appears that a taxpayer w i t h a base income of $30,000 or l e s s would be unwise to consider i n v e s t i n g i n any kind of motion p i c t u r e investment. 5. The leveraged video tape program investment returns a g r e a t e r amount than the leveraged f e a t u r e f i l m investment given the circumstances o u t l i n e d i n t h i s a n a l y s i s . However, the p r o b a b i l i t i e s of success or f a i l u r e of e i t h e r type of motion p i c t u r e investment would have to be c a r e f u l l y considered. - 172 -This q u a n t i t a t i v e a n a l y s i s through the use of a motion p i c t u r e investment model has determined the f i n a l investment outcomes to an investor-owner given c e r t a i n f i n a n c i a l c h a r a c t e r i s t i c s and circumstances. The net present value of the incremental cash flow allowed comparisons and c o n t r a s t s between the investor-owner's a f t e r - t a x p o s i t i o n based on two income l e v e l s , two types of motion p i c t u r e investments and two d i s t r i b -u t i o n revenue p a t t e r n s . Comparisons and c o n t r a s t s were made between leveraged and non-leveraged motion p i c t u r e investments. From these comparisons and c o n t r a s t s c o n c l u s i o n s were drawn concerning the income tax i n c e n t i v e s of motion p i c t u r e investment. I t must be remembered that no mechanical r u l e s can be s u b s t i t u t e d f o r sound business judgement. The r e l a t i v e r i s k and f i n a n c i a l c h a r a c t e r -i s t i c s of each motion p i c t u r e investment package must be considered. In the f i n a l a n a l y s i s , the p o t e n t i a l i n v e s t o r must weigh the motion p i c t u r e investment from two a n g l e s , the i n v e s t o r ' s personal tax p o s i t i o n and the s p e c i f i c merits of each motion p i c t u r e investment package. - 173 -FOOTNOTES CHAPTER VII W.B. Wheeler, Investment Analyst, Pemberton Secur i t ies L t d . , Vancouver, personal interview, Ap r i l 24, 1977. Wheeler offered the fol lowing example to j u s t i f y his statement that a marketable Canadian u t i l i t y stock v/ould in his opinion require an incremental apparent r i s k premium of 4.3% over a r i s k free Canadian government savings bond: Calgary Power common stock i s allowed by government regulation to earn a 15% return on common equity. The y i e l d i s 5.8%. The reinvestment rate i s 50% so the internal growth rate i s 7.5% (15% x .5 = 7.5%). Therefore the investor ' s apparent to ta l return equals 13.3% (5.8% + 7.5% = 13.3%). To ca lcu late the incremental premium for a u t i l i t y investment t h e r y i e l d on a r i s k free investment (e.g.Canadian government savings bond = 9%) is subtracted from the apparent t o ta l of the u t i l i t y invest -ment. The incremental r i s k premium i s 4.3% (13.3% - 9% = 4.3%). 2 The, educational video tape investment i s based on Edu-Film Productions L t d . , Investment Prospectus, The World of Health (1974), various pages. 3 The feature f i lms syndicate investment is based on an invest -ment offered in The Somerville House Corporation, The ZerrO Syndicate (October 3, 1975), various pages. 4 A.H. Howe, "A Banker Looks at the Picture Business - 1971," The Journal of the Producers Guild of America, Volume 13, Number 2, (1971), page 4. . 1 J . Fred Weston and Eugene F. Brigham, Manageri al Fi nance (2nd Ed i t i on , New York: Holt, Rinehart and Winston, Inc., 1966), p.139. The optimum minimum income tax payable pos it ion in r e a l i t y i s not possible by simply deciding to u t i l i z e the capita l co.st allowance deductions to reduce the taxpayer 's taxable income to the next lower income tax bracket. There are too many uncertainties in a taxpayer 's seven year planning horizon. The optimum minimum income tax posit ion would only be possible i f " ret roact ive or hindsight" tax planning was permitted on a regular basis by National Revenue, Taxation through r e f i l i n g previous years ' income tax returns. In r e a l i t y most tax planners advise deducting the maximum c .c .a . ava i lab le in the i n i t i a l year or years to reduce taxable income by as much as poss ib le. Any incremental cash flow generated in a tax she l ter can then be reinvested in other investments. 7 F inancial Compound Interest and Annuity Tables, F i f t h Edit ion (Boston;: Boston Financial Publishing Company"). o A multitude of f i nanc ia l outcomes are possible for each set of investor-motion picture investment circumstances. A computer program would be necessary to determine the absolute optimum use of the c .c .a . for each investor-investment combination. - 174 -I f guaranteed d i s t r i b u t i o n revenue was b u i l t i n t o the educational video tape program investments the outcomes to the i n v e s t o r would be q u i t e d i f f e r e n t . Hence the conclusions and recommendations to the i n v e s t o r would a l s o be d i f f e r e n t from the ones o f f e r e d i n t h i s chapter. However, educational producers have not o f f e r e d guaranteed d i s t r i b u t i o n revenue i n packages a v a i l a b l e to Canadian i n v e s t o r s . APPENDIX A TO CHAPTER VII RATIONALE FOR PURCHASE PRICE IN NON-LEVERAGED VIDEO TAPE PROGRAM INVESTMENT The p r i c i n g d e c i s i o n f o r the non-leveraged video tape program investment i s both o b j e c t i v e and s u b j e c t i v e . The p r i c e a t which the producer s e l l s a non-leveraged motion p i c t u r e investment should r e l a t e o b j e c t i v e l y to the net present value of the cash flow to the producer when he s e l l s a leveraged motion p i c t u r e investment. A comparison i s made of the net present value of the cash flow t o the producer when the video tape program earns no d i s t r i b u t i o n revenue and when i t earns moderate d i s t r i b u t i o n revenue. The net cash flow to the producer i n the f o u r p o s s i b l e combination of v a r i a b l e s i s discounted by a present value f a c t o r of 10%. The v a r i a b l e s of d i s t r i b u t i o n revenue and leverage are combined as f o l l o w s : 1. No d i s t r i b u t i o n revenue - leveraged 2. No d i s t r i b u t i o n revenue - non-leveraged 3. Moderate d i s t r i b u t i o n revenue - leveraged 4. Moderate d i s t r i b u t i o n revenue - non-leveraged The p r i c i n g d e c i s i o n i s al s o based s u b j e c t i v e l y on the c o l l e c t -i b i l i t y of the seven year promissory note by the producer. Discounted Cash Flow to the Producer Assuming No D i s t r i b u t i o n Revenue In the leveraged investment the investor-owner would be l i a b l e to the producer f o r $32,500 i f no revenue was earned by the video tape program during the seven years. Promissory note 1 $25,000 I n t e r e s t f o r 5 years @ $1500/yr. 7,500 Tot a l paid by i n v e s t o r t o producer assuming no d i s t r i b u t i o n revenue earned-leveraged investment $32,500 - 175 -- 176 -The net present value of the cash flow of $32,500 over seven years i s $17,730 when the discount r a t e f o r the time value of money i s 10%. The t o t a l discounted cash flow to the producer i s $42,730. Investor down payment (production cost) $25,000 N.P.V. of promissory note and i n t e r e s t 17,730 T o t a l : discounted value to producer assuming no d i s t r i b u t i o n revenue earned-leveraged investment $42,730 I f the producer o f f e r s the non-leveraged investment f o r $35,000 and no d i s t r i b u t i o n revenue i s earned, the producer g i v e s up a p o t e n t i a l d i s counted cash flow of $7,730. Leveraged investment discounted cash flow to the producer $42,730 Minus: non-leveraged investment cash flow to the producer 35,000 D i f f e r e n c e : assuming no d i s t r i b u t i o n revenue earned $ 7,730 Discounted Cash Flow to the Producer Assuming Moderate  D i s t r i b u t i o n Revenue The net present value e f f e c t on the producer's share of moderate d i s t r i b u t i o n revenue must be considered f o r the leveraged and non-leveraged investment s i t u a t i o n s . The annual d i s t r i b u t i o n revenue f l o w f o r an education video tape program i s shown i n Table V I I - 1 . I f the video tape program investment i s leveraged, the producer cum d i s t r i b u t o r i s e n t i t l e d to a 5% d i s t r i b u t i o n fee u n t i l the promissory note i s r e t i r e d and a 50% d i s t r i b u t o r ' s fee t h e r e a f t e r . Moderate revenue i n the amount of $100,000 would earn the p r o d u c e r - d i s t r i b u t o r $47,719, i n c l u d i n g the $25,000 promissory note, the i n t e r e s t on the note and the d i s t r i b u t i o n f e e . (See Table VII-IV) The net present value of $47,719 spread over the seven year horizon at a 10% discount r a t e i s $31,391. The t o t a l discounted cash flow to the producer i s $56,391 i n the leveraged video tape program investment. - 177 -Production costs $25,000 N.P.V. of promissory note, i n t e r e s t and d i s t r i b u t i o n fee earnings 31,391 T o t a l : discounted cash flow to the producer assuming moderate d i s t r i b u t i o n revenue earned - leveraged investment $56,391 I f the educational video tape program i s s o l d as a non-leveraged investment, the producer cum d i s t r i b u t o r would r e c e i v e 50% o f the d i s t r i b u t i o n revenue as a d i s t r i b u t i o n agent's fee. I f moderate revenue of $100,000 i s earned by the non-leveraged video tape program the producer's share i s $50,000. Assuming the d i s t r i b u t i o n revenue p a t t e r n of Table V I I - I , the net present value of $50,000 i s $32,777. The t o t a l discounted cash flow to the producer i s $67,777 i f the video tape program investment i s s o l d by the producer to the i n v e s t o r f o r $35,000. Production costs $25,000 Production p r o f i t 10,000 SubTotal: Non-leveraged purchase p r i c e $35,000 N.P.V. of producer's share of d i s t r i b u t i o n revenue 32,777 T o t a l : discounted cash flow to producer assuming moderate d i s t r i b u t i o n revenue earned - non-leveraged investment $67,777 The producer earns a d d i t i o n a l revenue with a net present value of $11,386 i f he s e l l s the video tape program investment a t $35,000 and the program earns d i s t r i b u t i o n revenue of $100,000. Non-leveraged investment discounted cash flow t o producer $67,777 Minus: leveraged investment discounted cash flow t o producer 56,391 D i f f e r e n c e : assuming moderate d i s t r i b u t i o n revenue earned $11,386 Comparison of Net Present Value of Cash Flows t o Producer The four net present value cash flows to the producer are as f o l l o w s : - 1/8 -Leveraged Non-leveraged Investment Investment D i s t r i b u t i o n Revenue: N i l $42,730 $35,000 D i s t r i b u t i o n Revenue: $100,000 $56,391 $67,777 There i s a reasonable t r a d e - o f f between the leveraged and non-leveraged net present value cash flows to the producer (vendor) of an educational video tape program. I f the producer s e l l s a video tape program investment which i s leveraged, h i s minimum cash flow ($42,730) i s higher than i f he s o l d the program as a non-leveraged investment. However, i f the video tape program earns moderate d i s t r i b u t i o n revenue he w i l l r e c e i v e l e s s of that revenue ($56,391). I f the producer s e l l s a video tape program investment which i s not leveraged h i s minimum cash flow ($35,000) i s lower but his share ($67,777) of the moderate d i s t r i b u t i o n revenue w i l l be g r e a t e r . The t r a d e - o f f i s that the producer gives up some of h i s i n i t i a l cash flow but i s e n t i t l e d to a greater share of the f u t u r e p r o f i t s , i f any. S u b j e c t i v e Discount Factor There i s a s u b j e c t i v e f a c t o r i n s e l e c t i n g the s e l l i n g p r i c e of the non-leveraged video tape program investment. The o b j e c t i v e net present value d i f f e r e n c e between the leveraged and non-leveraged investment -assuming no d i s t r i b u t i o n revenue - i s $7,730. That i s , the producer i s g i v i n g up earnings with a net present value of $7,730 i f he s e l l s the non-leveraged investment f o r $35,000. However, the p r i c e of $35,000 can be j u s t i f i e d s u b j e c t i v e l y , because the producer may not be able to c o l l e c t the promissory note and i n t e r e s t from the i n v e s t o r a t the end of the seven years. This absence of c o l l e c t i b i l i t y may be due to several reasons. 1. The producer i s no longer i n business. 2. E i t h e r the producer or investor-owner are deceased. - 179 -3. The investor-owner i s bankrupt or disappears. 4. The investor-owner refuses to pay the promissory note because the investment f a i l e d to meet revenue e x p e c t a t i o n s . The producer would be forced to sue the investor-owner i n co u r t . The s u i t may be expensive and may be l o s t by the producer. Therefore, i t i s reasonable t h a t the producer f u r t h e r discount the seven year promissory note o b j e c t i v e net present value f o r s u b j e c t i v e f a c t o r s such as c o l l e c t i b i l i t y . FOOTNOTES APPENDIX A TO CHAPTER VII There i s no i n t e r e s t due f o r the f i r s t year of the investment because the note i s signed on the l a s t day of the year. There i s no i n t e r e s t due f o r the seventh year because the note i s r e t i r e d on or before December 31. APPENDIX B TO CHAPTER VII FEATURE FILMS INVESTMENT PACKAGE The Somen/ille House Corporation October 6, 1975 ' ' , . ,1- Avenue, Vancouver, B.C. re: f a l l , 1975 f i l m package, Zorro a n d Tha Story of 0 • Dear M r . . — . j Further to your request, I am pleased to enclose herewith a brochure d e s c r i b i n g two f i l m s which we have acquired the r i g h t to purchase and which, we b e l i e v e , have great p o t e n t i a l f o r commercial success. Zorro, a commercial production of an o l d f a v o r i t e , w i l l r e t urn to the owners 30% of gross d i s t r i b u t o r ' s r e n t a l s i n excess of $500,000 (U.S. and Canada only - the r e s t of the world i s subject to a d i s t r i b u t i o n agreement p r o v i d i n g guaranteed r e n t a l s ) . The Story of 0, a h i g h l y commercial f i l m based upon an extremely popular French n o v e l and presently the subject of much p u b l i c i t y , w i l l r e t u r n to the owners 10% of gross d i s t r i b u t o r ' s r e n t a l s from the f i r s t d o l l a r on the same b a s i s as f o r Zorro (see above). The Somerville Fiouse Corporation i s forming a syndicate to purchase the f i l m s and a mid-November c l o s i n g i s a n t i c i p a t e d , c o - i n c i d i n g with the North American r e l e a s e of the f i l m s . Minimum co n t r i b u t i o n s to the zorrO syndicate have been set at $25,000, although, as always, c o n s i d e r a t i o n w i l l be shown to smaller i n v e s t o r s . • Syndicate and C o n t r i b u t i o n Agreements are presently being prepared, and w i l l be forwarded to you upon request. As i s our p o l i c y , we w i l l accept syndicate members' c o n t r i b u t i o n s on a " f i r s t -come, f i r s t - s e r v e d " b a s i s . Please do not h e s i t a t e to contact me should you wish any f u r t h e r information or explanation with regard to t h i s venture. . Yours s i n c e r e l y , - :/by enclosure -180 -181 The Someri/ille House Corporation the zorrO syndicate OCTOBER 3, 1975 CONTENTS PAGE Proposed Transactions 2 Synopsis - Zorro 4 Synopsis - The Story of 0 "5 D i s t r i b u t i o n 6 Revenue Considerations 7 COPY FOR: - 182 -the zorrO syndicate PROPOSED TRANSACTIONS The Somerville House Corporation w i l l form and manage a s y n d i c a t e , to be c a l l e d "the zorrO syndicate", f o r the purpose of purchasing the motion p i c t u r e f i l m s known as Zorro and The Story of 0.. Members of the Syndicate w i l l i n i t i a l l y i n vest the sum of $1,650,000 U.S. ($1,585,000 U.S. for the down payment i n respect of the purchase - see below; $65,000 U.S. to purchase a bank guarantee i n r e s p e c t of- the r e c e i p t of c e r t a i n of the f i l m r e n t a l s - see page 6) and w i l l share i n the p r o f i t s and losses of the syndicate pro rata to t h e i r r e s p e c t i v e investments. The syndicate, f o r and on behalf of i t s members, w i l l purchase a l l r i g h t , t i t l e and i n t e r e s t i n and to the motion p i c t u r e f i l m s , Zorro and The Story of 0, from . - „,~j.-_'~, a Swiss cor p o r a t i o n , and w i l l own the c o p y r i g h t and o r i g i n a l negative thereof. At the time of a c q u i s i t i o n of the f i l m s , the i n v e s t o r s w i l l acquire undivided i n t e r e s t s i n the ownership of the f i l m s . I t i s not intended or d e s i r e d that a partnership be formed among the syndicate members. In f a c t , the express i n t e n t i o n i s that there be no partnership. The purchase p r i c e to be paid f o r the f i l m s w i l l be $7,000,000 U.S., of which $1,585,000 U.S. w i l l be paid on c l o s i n g and the balance of $5,415,000 U.S. w i l l be paid i n the following i n s t a l l m e n t s on the dates i n d i c a t e d : $1,000,000 U.S. on A p r i l 1, 1976 $1,000,000 U.S. on A p r i l 1, 1977 $1,000,000 U.S. on A p r i l 1, 1978 $1,000,000 U.S. on A p r i l 1, 1979 $1,415,000 U.S. on A p r i l 1, 1980 Each i n v e s t o r s h a l l have the o b l i g a t i o n to pay h i s or her p r o p o r t i o n a t e share of the balance of purchase p r i c e . Such o b l i g a t i o n s h a l l be with f u l l recourse and must be paid when due. The f i l m s are to be d i s t r i b u t e d i n the U.S. and Canada by A l l i e d A r t i s t s P i c t u r e Corporation and i n the r e s t of the world by World A s s o c i a t i o n Video Establishment (Wave). The agreement with A l l i e d A r t i s t s p rovides f o r . contingent r e n t a l s , based on A l l i e d A r t i s t s ' r e c e i p t s , and the agreement with Wave provides f o r guaranteed r e n t a l s . The syndicate w i l l purchase a bank guarantee to ensure the r e c e i p t of the guaranteed r e n t a l s from Wave. Page 6 hereof contains f u r t h e r d e t a i l s i n respect of the d i s t r i b u t i o n agreements. The Story of 0 has been released i n France and has r e c e i v e d immense p u b l i c i t y . ("Half of P a r i s seems to be queuing up to see i t - and the other h a l f i s t a l k i n g about i t " - Time, September 22, 1975) North American release of both f i l m s has been moved up from January to November i n order to c a p i t a l i z e on the p u b l i c i t y being g i v e n to The Story of 0y which w i l l include a feature i n the November i s s u e of Playboy. the zorrO syndicate PROPOSED TRANSACTIONS CONTINUED 8. A l l transactions of the syndicate w i l l be made i n U.S. funds and, ac c o r d i n g l y , members w i l l purchase t h e i r i n t e r e s t i n the f i l m s i n U.S. d o l l a r s and w i l l r eceive d i s t r i b u t i o n s of syndicate funds i n the same currency. 9. A l l i e d A r t i s t s , Wave, . - ....... ..*_, the investors and the bank which w i l l provide the guarantee of Wave's o b l i g a t i o n s under i t s d i s t r i b u t i o n agreement are not r e l a t e d to each other by family, ownership, c o n t r o l or other than by v i r t u e of the tra n s a c t i o n s r e f e r r e d to above. 1 0 . The Somerville House Corporation w i l l not receive any fees from the syndicate for the o r g a n i z a t i o n or management; thereof, but w i l l be e n t i t l e d to recover its expenses incurred i n managing the operations of the syndicate. The Vendor is l i a b l e f o r costs of o r g a n i z i n g the syndicate and consummating the purchase of the f i l m s . The Sommerville House Corporation w i l l , however, r e c e i v e remuneration from the Vendor and from A l l i e d A r t i s t s , as fo l l o w s : a. from the Vendor, as a fee f o r organizing the venture, the sum of approximately $ 1 4 0 , 0 0 0 ; and / b. from A l l i e d A r t i s t s , 2 w % of gross r e c e i p t s i n excess of $ 5 0 0 , 0 0 0 from the U.S. and Canadian d i s t r i b u t i o n of Zorro and 2s% of gross r e c e i p t s i n excess of $ 2 , 5 0 0 , 0 0 0 from the U.S. and Canadian d i s t r i b u t i o n of The Story of 0. 1 1 . Persons wishing to purchase an i n t e r e s t i n the fil m s should: a. s i g n two (2) copies of a c o n t r i b u t i o n agreement; b. s i g n two ( 2 ) copies of a syndicate agreement; c. forward both copies of the c o n t r i b u t i o n and syndicate agreements, together with a cheque i n U.S. FUNDS f o r the amount of t h e i r investment and payable to * . r ..-..is., '• i n t r u s t " , to The Somerville House Corporation. One fu l l y - e x e c u t e d copy of the c o n t r i b u t i o n agreement and the syndicate agreement w i l l be returned to you f o r your f i l e s . 3. - 184 -the z o r r O s y n d i c a t e SYNOPSIS - ZQRRO Z o r r o (Don D i e go de V e g a ) , t he b l a c k g a r b e d R o b i n Hood o f S p a n i s h C a l i f o r n i a o r i g i n a t e d as the h e r o o f a 1919 s t r i p c a r t o o n by J o h n s t o n M c C u l l e y and was s u b s e q u e n t l y f e a t u r e d i n a number o f f i l m s - The Mark of Zorro, Don Q, Son of Zorro, The Bold Caballero, The Sign of Zorro and Zorro and the Three Musketeers, as w e l l as s e r i a l i z a t i o n s . I n t h i s 1975 f i l m v e r s i o n , Z o r r o , t he d e v i l - m a y - c a r e r i g h t e r o f w rong s , assumes t h e r e s p o n s i b i l i t i e s o f G o v e r n o r o f New A r a g o n upon the d e a t h o f h i s good f r i e n d M i g u e l . I n t h i s new p o s i t i o n , Z o r r o a d o p t s t h e p e r s o n a l i t y o f t he p a l a c e p l a y b o y to c a m o u f l a g e h i s t r u e i d e n t i t y as t h e r e s t o r e r o f j u s t i c e t o t h e t e r r i t o r y . A F r a n c o - I t a l i a n c o - p r o d u c t i o n by M o n d i a l T E . F I and L e s P r o d u c t i o n s A r t i s t e s A s s o c i e s , p r o d u c e d by L u c i a n o M a r t i n o and d i r e c t e d by D u c c i o T e s s a n i . A l a i n D e l o n . . . F r e n c h l e a d i n g man who became an i n t e r s n a t i o n a l s t a r t h r o u g h s u c h f i l m s a s The Leopard, The Yellow Rolls Royce, Once a Thief, Is Paris Burning and Texas Across the River. S t a n l e y B a k e r . . . t ough l o o k i n g Welshman who has p l a y e d i m p o r t a n t r o l e s i n The Crv.el Sea, Alexander the Great, Richard I I I , The Angry H i l l s , The Guns of Navarone and Sands of the Kalahari. And c o - s t a r r i n g t h e b e a u t i f u l I t a l i a n a c t r e s s , O t t a v i a P i c c o l o . $ 4 , 5 0 0 , 0 0 0 - 185 -the zorrO syndicate STOOPSIS - THE STORY OF 0 STORY LINE: Based on the most widely read contemporary French novel by Pauline Reage. PRODUCTION: A Franco-German co-production between S.H. Prodis-Yar Films - A.D. Creation and Terra Filmkunst GmbH. DIRECTOR: Just J a e c k i n whose l a s t year's success, Emmanuelle, became the top grossing f i l m i n French h i s t o r y . STAR: Corinne C l e r y PURCHASE PRICE: $2,500,000 - 186 -the. zorrO syndicate DISTRIBUTION AGREEMENTS A l l i e d A r t i s t s P i c t u r e Corporation w i l l d i s t r i b u t e the f i l m s i n the United States and Canada, the zorrO syndicate i s to receive percentages of such d i s t r u b u t o r ' s gross r e c e i p t s , as follows: a. i n respect of Zorro, 30% of gross r e c e i p t s i n excess of $500,000; and b. i n respect of The Story of 0, 10% of gross r e c e i p t s from the f i r s t d o l l a r . (Gross r e c e i p t s are, g e n e r a l l y , a l l monies received by the d i s t r i b u t o r from the e x p l o i t a t i o n of the f i l m s i n a l l media, before the deduction of any fees, expenses or other amounts due to or paid by the d i s t r i b u t o r . ) World A s s o c i a t i o n Video Establishment (Wave), a Swiss Corporation, w i l l d i s t r i b u t e the f i l m s i n the re s t of the world. the zorrO syndicate i s to receive from such d i s t r i b u t o r guaranteed f i l m r e n t a l s of $5,415,000, payable on or before the vari o u s dates on which syndicate members w i l l be required to make payments on account of the balance of purchase p r i c e of the f i l m s . the zorrO syndicate w i l l , r e c e i v e no other f i l m r e n t a l s from Wave. .-In order to insure the r e c e i p t of such guaranteed r e n t a l s , the syndicate w i l l purchase, at a cost of approximately $65,000, a guarantee from a major Swiss banking o r g a n i z a t i o n that i f Wave f a i l s to pay i t s r e n t a l s when due, the bank w i l l make payment i n i t s stead. - 187 -the zorrO syndicate REVENUE CONSIDERATIONS Zorro and. The Story of 0 are of s u f f i c i e n t q u a l i t y and should have s u f f i c i e n t box o f f i c e a t t r a c t i o n to make them a f i n a n c i a l success and to produce a s u b s t a n t i a l r eturn on the investment t h e r e i n . Based on fi l m s of s i m i l a r natures, what we b e l i e v e to be a conservative cash flow p r o j e c t i o n i s as f o l l o w s : RECEIPTS FROM ALLIED ARTISTS - U.S. AND CANADA:-. Zorro, gross r e c e i p t s estimated at $ 5 , 0 0 0 , 0 0 0 of which the syndicate w i l l r e c e i v e 30% of $ 4 , 5 0 0 , 0 0 0 1 ,350 ,000 The Story of 0 , gross r e c e i p t s estimated at $ 1 0 , 0 0 0 , 0 0 0 of which the syndicate w i l l r e c e i v e 10% 1 , 0 0 0 , 0 0 0 RECEIPTS FROM WAVE - REST OF THE WORLD: Guaranteed r e n t a l s 5 , 4 1 5 , 0 0 0 TOTAL ESTIMATED RENTALS 7 , 7 6 5 , 0 0 0 Costs Cost of f i l m s 7 , 0 0 0 , 0 0 0 Cost of bank guarantee 6 5 , 0 0 0 7 , 0 6 5 , 0 0 0 ESTIMATED MINIMUM CASH SURPLUS (before income taxes and expenses of operation) $ 7 0 0 , 0 0 0 Syndicate members w i l l appreciate that the ownership of motion p i c t u r e f i l m s i s a high r i s k investment and no guarantee or r e p r e s e n t a t i o n i s made h e r e i n . APPENDIX C TO CHAPTER VII RATIONALE FOR PURCHASE PRICE IN NON-LEVERAGED FEATURE FILMS INVESTMENT A 1/66th share of the two feature f i l m s o f f e r e d by the S o m e r v i l l e House Corporation i s assumed to cost the i n v e s t o r $25,000 i f the i n v e s t -ment i s not leveraged. The assumption i s made that i n the non-leveraged investment, the syndicate w i l l r e c e i v e only the d i s t r i b u t i o n revenue earned i n the North American t h e a t r i c a l f i l m markets. The vendor (producer) of the two fe a t u r e f i l m s w i l l r e c e i v e any revenue earned by the f i l m s i n the f o r e i g n t h e a t r i c a l motion p i c t u r e markets. These assumptions are based on the w r i t e r ' s theory that there must be some arrangement between the vendor of the f i l m s and the f o r e i g n d i s t r i b u t o r to reimburse the d i s t r i b u t o r should the d i s t r i b u t o r have t o pay the investor-owner's promissory note l i a b i l i t y . Table V11-VI i s a schematic of the cash flow of the syndicate-guarantee f i n a n c i n g arrangement. The dotted l i n e s represent the suspected flow of funds between the vendor and the f o r e i g n d i s t r i b u t o r - g u a r a n t o r or bank guarantor. I f t h i s theory i s c o r r e c t the net e f f e c t of the flow of money between d i s t r i b u t o r - i n v e s t o r -v e n d o r - d i s t r i b u t o r i s zero. (This flow of money could be e f f e c t e d by wi t h h o l d i n g income taxes, however.) Therefore, i f the vendor reimburses the d i s t r i b u t o r , i f the f i l m i s a f i n a n c i a l f a i l u r e i n the f o r e i g n markets, the vendor i s p r i m a r i l y concerned with the amount of money i n i t i a l l y i n vested by the i n v e s t o r s ($1,585,000). I f some money i s earned by the f i l m s i n the f o r e i g n markets, th a t amount would be p r o f i t to the vendor because the vendor would not have to reimburse to the d i s t r i b u t o r t h a t amount recei v e d from the syndicate o f i n v e s t o r s . For example, suppose the f i l m s earned $415,000 i n the f o r e i g n - 188 -- 189 -TABLE VII-VI Schematic of Cash Flow i n Syndicate-Guarantee Feature Film Financing Arrangement (Showing Writer's Reimbursement Theory) World A s s o c i a t e d Video Establishment (WAVE) guaranteed d i s t r i b u t i o n revenue of $5,514,000 Swiss Bank ( i f d e f a u l t by WAVE) ' . i N I Investor-Owner 1 promissory note l i a b i l i t y of $5,415,000 So m e r v i l l e House Corporation/Producer (Vendor) The s o l i d l i n e s represent the flow of d i s t r i b u t i o n revenue from the d i s t r i b u t o r to Investor-Owner and i n turn to the Producer. The Swiss Bank on the r i g h t hand s i d e would only pay the investor-owner i f WAVE d e f a u l t s . The broken l i n e s represent the suspected cash reim-bursement of any funds paid by the d i s t r i b u t o r , WAVE or the bank should the f e a t u r e f i l m s f a i l to earn at l e a s t enough f o r the i n v e s t o r s to pay the promissory notes of $5,415,000 to the producer. Source: S o m e r v i l l e House C o r p o r a t i o n , The ZerrO Syndicate, (October 3, 1975) - 190 -markets i n bona f i d e d i s t r i b u t i o n . The d i s t r i b u t o r , WAVE, would be out-of-pocket $5,000,000 when WAVE was c a l l e d upon to pay the i n v e s t o r s the guaranteed d i s t r i b u t i o n r e c e i p t s of $5,415,000. The i n v e s t o r s would i n t u r n , use the $5,415,000 to pay the promissory notes held by the vendor. And, i f the w r i t e r ' s theory i s c o r r e c t , the vendor would reimburse the d i s t r i b u t o r the $5,000,000 the f o r e i g n d i s t r i b u t o r was out-of-pocket to meet the guaranteed d i s t r i b u t i o n revenue o b l i g a t i o n . The vendor would have a p r o f i t of $415,000 before income taxes. I t appears t h a t the s e r i e s of promissory notes and the guaranteed d i s t r i b u t i o n revenues t o o f f - s e t the promissory notes, i s a charade designed soley to o f f e r t o i n v e s t o r s a tax s h e l t e r , or at l e a s t a de f e r -ment of taxes payable by the i n v e s t o r s . CHAPTER VII I SUMMARY, RECOMMENDATIONS AND CONCLUSIONS 1. INTRODUCTION The purpose of t h i s chapter i s 1. To summarize the most important p o i n t s o f each chapter w h i l e p l a c i n g p a r t i c u l a r emphasis on the motion p i c t u r e i n d u s t r y environment i n Canada and on the consequences t o the p r i v a t e i n v e s t o r i n v o l v e d i n tha t environment. 2. To o f f e r recommendations as to how the f e d e r a l government and the motion p i c t u r e i n d u s t r y together can a t t r a c t the necessary investment c a p i t a l f o r the development of a s t a b l e motion p i c t u r e i n d u s t r y i n Canada. 3. To repeat the s t e r n premonition t h a t motion p i c t u r e i n v e s t -ments are l i k e l y to be a f i n a n c i a l l o s s . 4. To o f f e r recommendations as to how those i n v e s t o r s s t i l l i n t e r e s t e d i n investment, may increase t h e i r chances of earning a r e t u r n on t h e i r e q u i t y . 5. To o f f e r suggestions f o r fu t h e r study of the motion p i c t u r e i n d u s t r y . 2. SUMMARY OF PREVIOUS CHAPTERS Chapter I. The marketing a c t i v i t i e s i n the motion p i c t u r e i n d u s t r y i n Canada are f o r e i g n dominated. The d i s t r i b u t i o n companies - 191 -- 192 -are subs id iar ies of several large internat ional American-based companies. Theatr ical exh ib i t ion i s dominated by two nat ional theatre chains which control over 60% of the theatre screens in Canada. The two chains are owned by foreign interest s . The product marketed by the d i s t r i bu to r s and exh ib i tor s i s predominantly foreign produced. Late ly , Canada has been producing an average of about 30 feature f i lms each year - an amount which i s equivalent to 10% of the annual American production. Commercial Canadian product with mass audience appeal is in short supply. Educational motion p icture production and d i s t r i b u t i on i s American dominated. The product i s fo r the most par t , American and the d i s t r i bu t i on companies are e i ther American subs id iar ies or American influenced through exclusive product exchange agreements. A federal government goal i s the development of a motion p icture industry in Canada. The f i r s t method the government devised to achieve th i s goal was the founding of the Canadian Film Development Corporation. The C.F.D.C. i s a crown corporation which has a mandate to invest i n , or loan money to Canadian motion picture production. The C.F.D.C. has expended over $25 m i l l i o n in i t s attempt to nuture a Canadian f i l m industry. The d i rect f i nanc ia l returns on th i s investment have been disappointing. The benefits to the motion p icture industry and to the Canadian economy as a whole are cont rove r s i a l . The second concession the federal government offered the motion picture industry was the income tax shelter incent ive designed to encourage d i rect pr ivate investment in Canadian motion p ictures . To date the provis ion for deducting the cap i ta l cost of motion pictures - 193 -from other sources of income has not worked f o r the mutual b e n e f i t of t i i e i n d u s t r y or the i n v e s t o r s . Both a v a r i c i o u s t a x p a y - i n v e s t o r s and rapacious promoter-producers have devised schemes which r e s u l t e d i n very few products that were commercially v i a b l e . The r e s u l t of these schemes v/as to increase the work load of the already over-burdened National Revenue, Taxation employees, who had to p a i n s t a k i n g l y prove that the motion p i c t u r e investments were made f o r no other purpose than to reduce the i n v e s t o r s ' income tax l i a b i l i t i e s . The long term r e s u l t was l o s s of the investment, hence i n v e s t o r d i s s a t i s f a c t i o n thus supporting the d i s r e p u t a b l e motion p i c t u r e investment image. A t h i r d program to encourage the development of a motion p i c t u r e i n d u s t r y i n Canada i s the co-production t r e a t i e s w i t h f o r e i g n c o u n t r i e s . These t r e a t i e s o f f e r Canadians the opportunity to become in v o l v e d i n i n t e r n a t i o n a l productions which draw on a much gr e a t e r corps of t e c h n i c a l and c r e a t i v e t a l e n t . P r operly a d m i n i s t e r e d , the co-production program may be the key to reaching the goal of a Canadian motion p i c t u r e i n d u s t r y which produces a product which can compete i n the world market. Chapter II explores the basics of motion p i c t u r e investment through the tax s h e l t e r approach. The c h a r a c t e r i s t i c s of the i n v e s t o r and the investment are examined. The advantages and disadvantages of the v a r i o us f i n a n c i n g arrangements are evaluated. The major po i n t of the chapter i s t h a t the f i n a n c i n g arrangement must be s a t i s f a c t o r y t o the i n v e s t o r and at the same time adhere to the requirements of the Canadian Income Tax Act and Regulations. - 194 -Chapter III describes the relevant sections of the Income  Tax Act and Regulations as they pertain to motion picture investment and cap i ta l cost allowance. The Income Tax Act and Regulations are wr itten by the Department of Finance under the auspices of Federal Parliament. The purpose of income tax i s to provide a means of revenue for the state. The revenue i s used to supply the services and f a c i l i t i e s expected by Canadian c i t i z en s . The Act attempts to tax the p ro f i t s of Canadians so that the government can d i r e c t l y provide certa in services and f a c i l i t i e s . The Act also attempts to encourage taxpayers to invest the i r income (before taxes) in a prescribed manner which w i l l i n d i r e c t l y provide certa in services and f a c i l i t i e s to Canadians. The government does not wish to exc lus ive ly provide educa-t iona l and entertainment motion p ictures. The government would prefer that taxpayers provide motion pictures for themselves, therefore cap i t a l cost incentive for investment in Canadian made or co-produced motion pictures has been devised. The current Income Tax Regulations state that to be e l i g i b l e for the 100% cap i ta l cost allowance, the motion picture investment must be in a " c e r t i f i e d feature production" or a " c e r t i f i e d short production". Those productions are e ither Canadian productions which meet the Canadian production content c r i t e r i a or co-productions with nationals of a country with which Canada has a co-production t reaty. The Secret-ary of State must approve and c e r t i f y the motion p ic ture. Chapter IV. The government's intent ion i s to encourage the use of the cap i ta l cost allowance system to aid in the development of the Canadian motion picture industry. National Revenue, Taxation 's mandate i s to c o l l e c t as much revenue from the Canadian taxpayer as possible by - 195 -applying the terms of the Income Tax Act and Regulations. The Act and  Regulations i s not always wr itten in precise terminology, therefore the tax department has adopted the pol icy of publishing interpretat ions -t he i r interpretat ions - as to the impl icat ions of the wording of the Act. The tax department contends that a taxpayer can only claim a cap i ta l cost allowance deduction for an asset i f both the taxpayer and the asset uncondit ional ly meet certa in requirements. The requirements are: 1. Ownership - which means that the owner behave in the manner of a true owner, exercis ing control over the asset; 2. Commitment - which means that the asset must have been purchased with the taxpayer 's funds or with funds for which the taxpayer i s uncondit ional ly l i a b l e ; 3. Purpose - which means that the asset must have been purchased for the purpose of gaining or producing income. In Chapter IV National Revenue, Taxation 's in terpretat ion of the three requirements for a cap i ta l cost allowance deduction in a motion p icture investment are reviewed. If a taxpayer does not agree with National Revenue, Taxation 's in terpretat ion of the provisions of the Act and Regulations the taxpayer can submit his income tax return based on his own i n te rp re ta t i on . Such action by the taxpayer w i l l almost ce r ta i n l y be contested by the tax department's assessors. The taxpayer can appeal to the Tax Review Board for a ru l ing and in turn to the Federal Court -Tr ia l D iv i s ion . The taxpayer can present his case s tat ing the grounds he used to ca lcu la te his income tax and why he believes he is e n t i t l ed to a cap i ta l cost allowance deduction. The Minister of National Revenue w i l l present arguments which contend that the taxpayer 's income tax ca lcu lat ions are not in accordance with the wording of the Act. - 196 -Chapter IV includes the c o n s i d e r a t i o n of three tax cases: two appeals to the Tax Review Board and one appeal to the Federal Court-T r i a l D i v i s i o n . A l l cases were r u l e d i n favour of the Queen or her r e p r e s e n t a t i v e , the M i n i s t e r of National Revenue. The p r i n c i p a l p o i n t i n a l l cases was t h a t the taxpayer i s not e n t i t l e d to deduct from h i s income.,capital cost allowance which in c l u d e s i n the c a p i t a l c ost base, amounts which were not p e r s o n a l l y committed by him or f o r which he was not p e r s o n a l l y l i a b l e . N ational Revenue, Taxation's i n t e r p r e t a t i o n has been upheld. C a p i t a l cost allowance i n motion p i c t u r e investment can only be deducted i f the taxpayer has p e r s o n a l l y and u n c o n d i t i o n a l l y committed and expended the c a p i t a l . Chapter V i s a d e t a i l e d case study of a motion p i c t u r e i n v e s t -ment i n an educational video tape program. The purpose of the case study was to demonstrate how the mechanics of a motion p i c t u r e i n v e s t -ment f u n c t i o n w i t h i n the perimeters of the Income Tax Act and R e g u l a t i o n s . The emphasis was that the investment be one of commercial r e a l i t y , and t h a t the l e g a l language of the c o n t r a c t u a l arrangements between the i n v e s t o r , the vendor-producer and the d i s t r i b u t o r be c a r e f u l l y designed to avoid the adverse e f f e c t s of d e n i a l by the tax department of the c a p i t a l c ost allowance deduction. The chapter examines such f a c t o r s as commitment of investment funds, completion dates, c o p y r i g h t , ownership, and the f l o w of d i s t r i b -u t i o n revenue. A l l these f a c t o r s are important to the. tax s h e l t e r f e a t u r e of the investment. Chapter VI e x p l a i n s National Revenue, Taxation's procedures f o r r e a s s e s s i n g and a u d i t i n g a taxpayer. The chapter reviews the - 197 -reassessment of the motion p i c t u r e investment o u t l i n e d i n the case study i n the previous chapter. The arguments f o r reassessment by the tax department and the taxpayer's r e b u t t a l of the arguments are presented. The chapter demonstrates why the t e c h n i c a l and l e g a l s t r u c t u r e of a motion p i c t u r e investment must be so thoroughly con-s i d e r e d f o r every p o s s i b l y contingency. Chapter V I I . In Chapter VII a motion p i c t u r e investment model was developed. The purpose of the model was to undertake a q u a n t i -t a t i v e a n a l y s i s of the f i n a n c i a l outcomes to h y p o t h e t i c a l taxpayers i n v e s t i n g i n an education video tape program and t h e a t r i c a l f e a t u r e f i l m s . The a n a l y s i s s t u d i e d the f i n a n c i a l e f f e c t s o f leveraged and non-leveraged investments. The conclusions of t h i s a n a l y s i s w i l l be considered i n the next s e c t i o n of t h i s chapter. 3. PRIVATE MOTION PICTURE INVESTMENT - GENERAL CONCLUSIONS P r i v a t e motion p i c t u r e investment i s a com p l i c a t e d , high r i s k venture. P r i v a t e f i n a n c i n g must be arranged i n a s o p h i s t i c a t e d manner i n order to s a t i s f y the requirements of the i n v e s t o r , the investment, the motion p i c t u r e producer-vendor and the income tax laws of Canada. There i s an obvious r i s k t h a t the motion p i c t u r e w i l l be an a r t i s t i c and commercial f a i l u r e . There i s a l s o a r i s k t h a t the motion p i c t u r e w i l l f a i l to q u a l i f y f o r a c a p i t a l cost allowance deduction from the i n v e s t o r ' s other sources of income. A taxpayer contemplating investment i n a motion p i c t u r e should be prepared to at l e a s t s a t i s f y questions v/hich tax department o f f i c i a l s w i l l ask concerning the s t r u c t u r e of the investment. A taxpayer may have to submit to a tax department a u d i t . The taxpayer should be prepared - 198 -f o r the a u d i t and he sould i n c l u d e a f i n a n c i a l contingency f o r add-i t i o n a l l e g a l and accounting fees i n h i s c o n s i d e r a t i o n of the i n v e s t -ment. The a u d i t can be very time consuming: ...since the (tax department) a u d i t o r has p l e n t y of time to do the j o b , he/she looks over a l l the returns i n the f i l e . . . and asks any questions which come to mind based on the ' i n f o r m a t i o n . . . f i l e d . He/she might as w e l l f i l l the page , as long as he/she i s w r i t i n g to you (the taxpayer) anyway. A taxpayer should not consider motion p i c t u r e investment i f he can not stand the r i g o r s (mental, p h y s i c a l , f i n a n c i a l , emotional and/or s p i r i t u a l ) of a National Revenue, Taxation a u d i t . The f i n a l outcomes of the q u a n t i t a t i v e analyses of the motion p i c t u r e investments i n d i c a t e that the investment must be s t r u c t u r e d so t h a t the i n i t i a l c a p i t a l investment i s leveraged and t h a t the c a p i t a l c ost allowance c l a i m i n the f i r s t year i s equal to or g r e a t e r than the i n i t i a l c a p i t a l investment. The l i a b i l i t y i n c u r r e d by the l e v e r -age i s o f f s e t by the minimum d i s t r i b u t i o n revenue guarantee. There-f o r e the l o s s to the i n v e s t o r i s minimized i f the motion p i c t u r e i s a commercial f a i l u r e . A taxpayer i s advised t h a t he should only consider motion p i c t u r e investment i f h i s b a s i c income exceeds $30,000 a n n u a l l y , that i s , h i s marginal income tax r a t e i s 50% or more. Many motion p i c t u r e investment-promoters and even some tax a d v i s o r s f a i l to consider the long term i m p l i c a t i o n s of the tax s h e l t e r f e a t u r e of motion p i c t u r e investment. The f u l l long range e f f e c t must be evaluated. Many i n v e s t o r s see the,immediate tax deduction but f a i l t o f u l l y consider the f u t u r e l i a b i l i t i e s attached to the promissory notes. Investors often f a i l to consider the f u t u r e tax consequences i n syndicate-guarantee arrangements. The guaranteed revenue c r e d i t e d - 199 -to the investor-owner by the d i s t r i b u t o r i s paid to the producer-vendor, y e t the investor-owner must pay taxes on the revenue flow. Investors e n t i c e d by the excitement of motion p i c t u r e glamour and/or the i n i t i a l tax d e f e r r a l make naive statements. For example: Who cares (what the prospects of the f i l m a r e ) , I only know tha t f o r every d o l l a r I put up I r e c e i v e a t w o - d o l l a r tax refund.2 This l i n e of reasoning i s dangerous. I f the motion p i c t u r e does not earn any d i s t r i b u t i o n revenue the net present value of the incremental cash flow i s negative. The i n v e s t o r w i l l lose money i n the long term. A taxpayer must not consider investment unless the p r o j e c t has e l e -ments of commercial r e a l i t y . U n r e a l i s t i c p r o j e c t s w i l l f a i l to gener-ate a r e t u r n on equity and the c.c.a. c l a i m may be d i s a l l o w e d on the grounds that the investment i s a sham made s o l e l y f o r the purpose of reducing tax. A taxpayer must consider only p r o j e c t s which have a r e a l i s t i c chance of e x p l o i t a t i o n i n the i n t e r n a t i o n a l market. A motion p i c t u r e w i l l have a r e a l i s t i c chance of commercial e x p l o i t a t i o n i f i t w i l l appeal to American audiences. Therefore, an i n v e s t o r should consider only those motion p i c t u r e p r o j e c t s which are based on a s c r i p t which has a t t r a c t e d the s e r i o u s i n t e r e s t of a l a r g e United States based i n t e r n a t i o n a l d i s t r i b u t o r . I d e a l l y , the p r o j e c t would have p a r t i a l f i n a n c i a l backing from an American d i s t r i b u t o r . The w r i t e r b e l i e v e s educational f i l m s and video tapes are not as good a n investment as a w e l l packaged t h e a t r i c a l f e a t u r e f i l m s . This b e l i e f i s based on the motion p i c t u r e investment model outcomes and the d e f i n i t e r e s t r i c t i o n to educational a u d i o - v i s u a l program earnings. The p o t e n t i a l earnings of an educational motion p i c t u r e are not enough - 200 -to outwoigh the p o t e n t i a l l o s s e s . A higher leverage r a t i o than was used i n the model (2:1) could be incorporated i n t o an educational motion p i c t u r e investment. This leverage would reduce the i n v e s t o r ' s downside. The higher promissory note l i a b i l i t y however, would make • i t impossible f o r the i n v e s t o r to earn any revenue because of the gross s a l e s c e i l i n g of educational motion p i c t u r e s . I f education producers o f f e r e d a minimum d i s t r i b u t i o n revenue guarantee to o f f s e t the promissory note l i a b i l i t y the f i n a n c i a l outcomes of an unsuccessful educational motion p i c t u r e would be improved. Education producers have not o f f e r e d t h i s f i n a n c i n g arrangement i n Canada. The w r i t e r recommends that i n v e s t o r s consider only feature f i l m s . Feature f i l m investments can be more h i g h l y leveraged than educational motion p i c t u r e investments because feature f i l m s have a higher revenue c e i l i n g than educational motion p i c t u r e s . The leverage l i a b i l i t y i s o f f s e t by guaranteed d i s t r i b u t i o n revenue. Tiie high leverage reduces the f i n a n c i a l exposure f o r the high income taxpayer because the avoidance or d e f e r r a l of income tax i s e q u i v a l e n t to a government investment or i n t e r e s t f r e e loan. The p o t e n t i a l i n v e s t o r must r e a l i z e that very few feature length motion p i c t u r e s earn money f o r the i n v e s t o r . Motion p i c t u r e i n d u s t r y spokesmen are fond of quoting t h a t there i s "one chance i n seven of earning some money on an investment and one chance i n ten 3 of backing a box o f f i c e smash." The w r i t e r disputes these f i g u r e s . The motion p i c t u r e i n d u s t r y i s notorious f o r t o u t i n g s t a t i s t i c s which are , at the very l e a s t , out of context and, at worst, dishonest. Howard T. Lewis, w r i t i n g i n The 'lotion P i c t u r e Industry, s t a t e s : - 201 -The i n d u s t r y has made no r e a l attempt to give the p u b l i c any thorough-going, unbiased d i s c u s s i o n of i t s organiza-t i o n , operation or p r o f i t s and that such inform a t i o n as has been given has been f r a n k l y biased and intended p r i m a r i l y to promote f r i e n d l y p u b l i c r e l a t i o n s . . . The motion p i c t u r e i n d u s t r y spokesmen who quote f i g u r e s o f one i n seven and one i n ten are t a l k i n g about fea t u r e f i l m s which are a c t u a l l y completed and released i n the North American markets. The quoted f i g u r e s do not in c l u d e the many p i c t u r e s which are s t a r t e d but never completed or those t h a t are completed but never r e l e a s e d , notion p i c t u r e s which are not completed w i l l not be e l i g i b l e f o r a c a p i t a l cost allowance deduction because the tax department does not allow d e p r e c i a t i o n on an asset which does not e x i s t . C a p i t a l c o s t allowance w i l l l i k e l y be denied on unreleased t h e a t r i c a l f e a t u r e s . I f no s e r i o u s d i s t r i b u t i o n attempts are made then the tax department could contend t h a t the asset was not purchased to gain or oroduce income. The Canadian Film Development Corporation has in v e s t e d $25 m i l l i o n i n feat u r e f i l m s . None of those f i l m s have been "block b u s t e r s " and only three or four have earned any revenue f o r the C.F.D.C. (approximately $4 m i l l i o n i n t o t a l ) . These f a c t s confirm the w r i t e r ' s o p i n i o n that the commonly quoted i n d u s t r y s t a t i s t i c s are f a l s e -p a r t i c u l a r l y i n Canada. The corporate s t r a t e g y of the la r g e American motion p i c t u r e p r o d u c t i o n - d i s t r i b u t i o n companies f u r t h e r confirms the high r i s k of motion p i c t u r e investment. These companies, which are i n the best p o s i t i o n to evaluate the p r o b a b i l i t y of commercial success and r e t u r n on investment are c u r r e n t l y i n v e s t i n g i n few motion p i c t u r e s d e s p i t e a good cash flow from some except i o n a l " h i t s " . The companies are i n v e s t i n g i n other businesses "quite f a r removed from (motion p i c t u r e - 202 -pr o d u c t i o n ) . . . - i n areas that promise more s t a b l e and p r e d i c t a b l e ,,5 earnings. A Canadian taxpayer contemplating motion p i c t u r e investment must be f u l l y prepared and able to lo s e h i s investment. On the other hand, changes i n the movie-going p u b l i c ' s h a b i t s could make the investment pay o f f handsomely. S t a t i s t i c s i n d i c a t e that fev/er people are attending fewer motion p i c t u r e s but when a motion p i c t u r e w i t h mass appeal i s r e l e a s e d a greater number of people w i l l a ttend t h a t p a r t i c u l a r movie. The reason people are attending fewer f i l m s than they once d i d i s that admission p r i c e s have s t e a d i l y i n c r e a s e d . The cost of a t h e a t r e t i c k e t i s as high as $5.00. A person spending .that amount of money makes a p o s i t i v e d e c i s i o n to attend much l e s s r e a d i l y than he d i d when the admission p r i c e v/as $1.00 or l e s s . George Destounis, p r e s i d e n t of Famous Pla y e r s L t d . , s t a t e d : ...audiences have every r i g h t to be s e l e c t i v e . They're buying. They're no longer k i l l i n g time at 95 cents but g choosing what they want to see at $3.25, $3.50 or $3.75. Motion p i c t u r e s must a l s o compete with t e l e v i s i o n as a form o f enter-tainment. I f , however, a t h e a t r i c a l motion p i c t u r e i s p o p u l a r , the revenues generated by t h a t movie are g r e a t e r than ever before : From the f i r s t days of filmmaking u n t i l 1970, o n l y a dozen or so movies ever grossed as much as $25 m i l l i o n . No fewer than 25 f i l m s s i n c e 1970 have done t h a t w e l l , and that does not count f o r e i g n d i s t r i b u t i o n which can sometimes double the take.'' Emanual Gerard, executive o f f i c e r o f Warner Communications, Inc. s t a t e d i n Business Week "the upside payoff has shot up f a s t e r than g (production) c o s t s , and when you score, you score b i g . " - 203 -There are no proven formulas f o r a successful f e a t u r e length motion p i c t u r e e i t h e r i n theme, c r e a t i v e content or budget s i z e . There are elements which a p o t e n t i a l i n v e s t o r should i n s i s t on i n any motion p i c t u r e investment under c o n s i d e r a t i o n . The most important o f these elements i s tha t the motion p i c t u r e have i n t e r n a t i o n a l market appeal. The i n t e r n a t i o n a l appeal f a c t o r can be best assured by i n v e s t i n g i n a Canadian co-production. The co-production must be produced or d i r e c t e d by a filmmaker o f i n t e r n a t i o n a l renown. Other elements which should be i n a t h e a t r i c a l motion p i c t u r e investment w i l l be o u t l i n e d i n t h i s chapter i n the s e c t i o n e n t i t l e d "Recommendations to P r i v a t e I n v e s t o r s " . A p o t e n t i a l i n v e s t o r must seek competent tax advice before i n v e s t i n g i n a motion p i c t u r e . The i n v e s t o r and his a d v i s o r s must prepare f o r the e v e n t u a l i t y of e i t h e r a motion p i c t u r e " h i t " and the subsequent r e t u r n on the investment, or of a motion p i c t u r e "bust". The tax planning should i n c l u d e contingencies f o r e i t h e r e v e n t u a l i t y . Plans must be made which e i t h e r reduce the f u t u r e tax l i a b i l i t i e s through other tax d e f e r r a l investments or reduce the promissory note l i a b i l i t i e s with income from low r i s k investments. Good tax planning takes time and c a r e f u l c o n s i d e r a t i o n . Therefore a taxpayer i s advised to i n v e s t i g a t e motion p i c t u r e i n v e s t -ments e a r l y i n h i s tax year. He should avoid any l a s t minute d e c i s i o n s . Decisions which are made i n haste canaot i n c l u d e and c a r e f u l l y consider a l l the f a c t o r s i n v o l v e d i n motion p i c t u r e investment. 4. RECOMMENDATIONS - 204 -A. Recommendations to the Federal Government The f e d e r a l government has a goal to encourage the development of a s e l f - s u p p o r t i n g motion p i c t u r e i n d u s t r y . Various p o l i c i e s and i n c e n t i v e s have been i n s t i t u t e d during the past ten years i n an attempt to achieve the government's goal. The p o l i c i e s and i n c e n t i v e programs have not been coordinated and are often i n i t i a t e d on an i n d i v i d u a l b a s i s i n order to appease the most vocal pressure group of the moment. This patch work f i l m p o l i c y has r e s u l t e d i n a s i t u a t i o n which has c e r t a i n government departments and agencies working at cross purposes to one another. The s i t u a t i o n reduces the p o s i t i v e e f f e c t on the motion p i c t u r e i n d u s t r y . The f i r s t step toward e s t a b l i s h i n g a Canadian f i l m p o l i c y and v i a b l e motion p i c t u r e i n d u s t r y should be a comprehensive examination of the p o t e n t i a l b e n e f i t s f o r Canada of a motion p i c t u r e i n d u s t r y . The government must determine what the b e n e f i t s are and then evaluate Canada's production and d i s t r i b u t i o n c a p a b i l i t i e s to d e r i v e these b e n e f i t s . The e v a l u a t i o n of Canadian c a p a b i l i t i e s must be based on a r e a l i s t i c a p p r a i s a l of what can be accomplished immediately and i n the f u t u r e . Canada must decide what i s i t s present s t r e n g t h i n motion p i c t u r e production and d i s t r i b u t i o n and what s k i l l s Canadians can develop from the present base. Canadian Market and Product , Canada's population and hence market i s not l a r g e enough to support the expense of motion p i c t u r e production. Canadians must produce products which are commercially acceptable i n Canada and i n the i n t e r -- 205 -na t i o n a l markets, p a r t i c u l a r l y the world's E n g l i s h and French speaking markets. I t must be accepted t h a t u n t i l Canada's t e c h n i c a l and c r e a t i v e production s k i l l s are developed Canada i s best to supply the current needs of the i n t e r n a t i o n a l motion p i c t u r e markets. Canadian filmmakers must develop a r e p u t a t i o n f o r e x c e l l e n t t e c h n i c a l production before they attempt to make statements r e f l e c t i n g Canada's c u l t u r e i n t h e i r motion p i c t u r e s . Sweden, a country with a population of l e s s than 50% of Canada's p o p u l a t i o n , has a t h r i v i n g motion p i c t u r e i n d u s t r y . T h e i r f i l m t e c h n i c i a n s are among the best i n the world. When a country has a r e p u t a t i o n f o r t e c h n i c a l e x c e l l e n c e i t can develop an i n t e r e s t .in the country's c u l t u r e among i t s world wide audience. The Canadian f e d e r a l government must r e s i s t the temptation to use the motion p i c t u r e i n d u s t r y as a p o l i t i c a l t o o l . The govern-ment's motion p i c t u r e p o l i c y must consider the economic b e n e f i t s of a s e l f - s u p p o r t i n g motion p i c t u r e i n d u s t r y . The government must put aside the c u l t u r a l and p o l i t i c a l b e n e f i t s u n t i l the i n d u s t r y can stand on i t s own f e e t . Production of motion p i c t u r e s i n v o l v e s m i l l i o n s o f d o l l a r s . The Canadian Motion P i c t u r e D i s t r i b u t o r s ' A s s o c i a t i o n considered the economic versus the n a t i o n a l i s t i c c u l t u r a l arguments i n t h e i r " P o s i t i o n Paper Concerning the Motion P i c t u r e D i s t r i b u t i o n Industry i n Canada." The paper s t a t e d as a premise that motion p i c t u r e s have a c u l t u r a l and educational impact on s o c i e t y . The A s s o c i a t i o n recognized t h a t the Canadian motion p i c t u r e market can not economically support purely s o c i e t a l o b j e c t i v e s and be s e l f - s u s t a i n i n g . "A movie w i l l ha.ve l i m i t e d - 206 -c u l t u r a l or educational impact i f the movie going p u b l i c i s u n w i l l i n g to attend."^ The primary t h r u s t of the government's motion p i c t u r e p o l i c y must be to develop an i n d u s t r y which w i l l provide the type of product demanded by the market place. What i s needed now i s a c l e a r d e c l a r a t i o n of the government's determination to b u i l d a motion p i c t u r e i n d u s t r y - not j u s t a Canad-ian motion p i c t u r e i n d u s t r y but a motion p i c t u r e i n d u s t r y i n Canada capable of competing i n the world markets. A government study or perhaps a r o y a l commission should look i n t o the a c t i v i t i e s of the various government bodies concerned with motion p i c t u r e s . A p o l i c y must evolve which coordinates the a c t i v i t i e s of the p u b l i c and p r i v a t e p r o d u c t i o n / d i s t r i b u t i o n o r g a n i z a t i o n s . A cost b e n e f i t analy-s i s of the C.F.D.C. and the National Film Board must be undertaken. Canadian Film Development Corporation The government must decide i f the C.F.D.C.'s present mandate i s c o r r e c t . The w r i t e r b e l i e v e s that the C.F.D.C should be more concerned with earning a r e t u r n on i t s f i n a n c i a l p a r t i c i p a t i o n i n motion p i c t u r e s . Les Wedman, the Vancouver Sun movie c r i t i c has s t a t e d t h a t : g e t t i n g government money (from the C.F.D.C. and Canada C o u n c i l ) has become a n a t i o n a l pastime and everybody i s p l a y i n g w i t h film-making J I The w r i t e r agrees. Some " f i l m producers" have developed a g r e a t e r s k i l l f o r o b t a i n i n g government f i n a n c i n g than they have f o r making motion p i c t u r e s . The i r r e s p o n s i b l e a t t i t u d e of these producers does not develop the Canadian i n d u s t r y , i t simply c o n t r i b u t e s to the boom or bust c y c l e s . When government money i s p l e n t i f u l many u n s k i l l e d or untalented persons become i n v o l v e d i n f i l m productions. L a t e r , when government a s s i s t a n c e i s reduced, these non-professional persons swell the ranks - 207 -of the unemployed, thereby adding to the taxpayer's burden by c o l l e c t i n g unemployment insurance b e n e f i t s . These people l i s t t h e i r occupation as "filmmakers" and can l e g i t i m a t e l y refuse to take other forms of employ-ment. They can continue to c o l l e c t unemployment insurance cheques u n t i l the advent of the next government handout through the C.F.D.C. The o r i g i n a l i n t e n t i o n of the government i n 1965-66 was to e s t a b l i s h a loan fund to f o s t e r and promote the development of a f e a t u r e motion p i c t u r e i n d u s t r y i n Canada. I t was expected a t t h a t time t h a t the i n j e c t i o n of some $10 m i l l i o n would be s u f f i c i e n t to a s s i s t the i n d u s t r y and make i t s e l f supporting. But the i n d u s t r y has not become s e l f - s u p p o r t i n g . The i n c o r p o r a t i o n of the C.F.D.C. created y e t another •government bureaucracy. The C.F.D.C. i n league w i t h the motion p i c t u r e i n d u s t r y lobby i n Canada, seems to have s u f f i c i e n t weight t o not only o b t a i n some $15 m i l l i o n more i n operating and investment funding from the Federal Treasury Board but to increase i t s mandate as w e l l . The C.F.D.C. o f f i c e r s argue t h a t : I t has become i n c r e a s i n g l y c l e a r that government a s s i s t a n c e i s fundamental to the s u c c e s s f u l c o n t i n u a t i o n o f a Canadian f i l m i n d u s t r y i n v o l v e d i n fe a t u r e f i l m production and t h a t the Canadian Film Development C o r p o r a t i o n , f a r from being an agency which could launch the i n d u s t r y and leave i t to go on i t s own, must have a co n t i n u i n g r o l e " . ^ The C.F.D.C. can, of course, p u b l i s h s t a t i s t i c s i n i t s annual r e p o r t s and make presentations to the government which i n d i c a t e the value of the C.F.D.C. c o n t r i b u t i o n t o the i n d u s t r y . I t i s common knowledge that s t a t i s t i c s can be made man i p u l a t i v e . S t a t i s t i c s Canada's production q u e s t i o n n a i r e i s badly designed. The q u e s t i o n n a i r e leads t o ove r s t a t e d production s t a t i s t i c s as i t does not d i s t i n g u i s h between sub-contracted production work among d i f f e r e n t producers. Therefore, - 208 -the basis of the s t a t i s t i c s which are used by C.F.D.C. are unre l iab le ; . It may be conceded that the C.F.D.C. had to learn by experience 8 during these past nine years. The to ta l return of $4 m i l l i o n on the $25 m i l l i o n investment of the Canadian taxpayer 's money i s very poor. The wr i ter believes that encouraging tax shelter investment by wealthy taxpayers who can perhaps af ford to take a r i s k i s a superior method to that which forces a l l taxpayers to contribute to an industry which i s faced with intense world-wide competition in a dec l in ing market. Foreign Co-Production Wedman of the Vancouver Sun suggested: do away with the ent i re C.F.D.C. as i t current ly ex i s t s and put film-making under the control of one man who knows how to spend money wisely and how to make money.13 The wr i ter believes that the C.F.D.C. should have a d i f f e r en t mandate -not to invest in motion pictures d i r e c t l y but to encourage and f a c i l i t a t e production by coordinating a l l agencies involved. The C.F.D.C. should ac t i ve l y develop more internat ional motion picture co-production t rea t i e s . The C.F.D.C. should o f fe r non-monetary government aid to foreign producers. Part of th i s a id for example, could be in the form of a s s i s t ing the foreign producer in obtaining permits and l icences necessary to shoot in certa in publ ic or r e s t r i c t ed locat ions . The C.F.D.C. could act as a l iason with other government bureaucracies. Foreign productions in Canada would help to reduce the present c y c l i c a l pattern of motion picture production. Foreign producers must be made aware that they are expected to contr ibute to the Canadian industry i f they wish to take advantage of - 209 -Canada's o f f e r of a s s i s t a n c e and encouragement. The f o r e i g n filmmakers must agree to partake i n a p p r e n t i c e s h i p t r a i n i n g programs f o r Canadian filmmakers. The e d i t o r s of Cinema Canada, Connie and J e a n - P i e r r e Tadros, have e d i t o r i a l i z e d : C e r t a i n l y the more f i l m s (co-productions) v/hich are made in Canada, the b e t t e r things w i l l be f o r the t e c h n i c i a n s who work and l e a r n , and the stronger the i n d u s t r y w i l l become.^ The Department of Manpower and Immigration must be d i r e c t e d to make s p e c i a l work permit concessions to f o r e i g n filmmakers working on Canadian co-productions. Most important, streamlined processes must be developed which w i l l permit a f o r e i g n producer t o get h i s f i l m crews i n t o Canada i n an e x p e d i t i o u s manner, with minimal red tape. A s p e c i a l program to encourage f o r e i g n e r s to work i n Canada should have sunset p r o v i s i o n s . A time horizon should be determined i n advance which would g r a d u a l l y c l o s e the door to f o r e i g n e r s . I t would be undesirable to allow f o r e i g n e r s to become entrenched i n the Canadian motion p i c t u r e i n d u s t r y r e s u l t i n g u l t i m a t e l y i n a competitive s i t u a t i o n f o r Canadian filmmakers. Income Tax Incentives The w r i t e r b e l i e v e s t h a t the income tax c a p i t a l cost allowance l e g i s l a t i o n should be improved so that there i s a g r e a t e r i n c e n t i v e f o r high income taxpayers to finance motion p i c t u r e s . The i n c e n t i v e should not be so generous t h a t the t a x p a y e r - i n v e s t o r s u n f a i r l y take advantage o f the s i t u a t i o n but that they end up i n the same net p o s i t i o n as i f they had o r i g i n a l l y paid t h e i r taxes. In order t o avoid a s i t u a t i o n i n which every wealthy Canadian i n v e s t s i n motion p i c t u r e s and there i s a p r o l i f -e r a t i o n of u n r e a l i s t i c motion p i c t u r e p r o j e c t s , the onus w i l l be on the - 210 -i n v e s t o r s and producers to prove t h a t the unsuccessful motion p i c t u r e s are honest commercial f a i l u r e s i f c.c.a. i s to be allowed. That i s the p i c t u r e was a f a i l u r e because the p u b l i c was unreceptive to the c r e a t i v e elements, not because the t e c h n i c a l elements were poor or the p i c t u r e was not a g g r e s s i v e l y marketed. I f the motion p i c t u r e i s a success the i n v e s t o r s should be e n t i t l e d to a f a i r r e t u r n on t h e i r e q u i t y . Paul Morton, president of Odeon-Morton Theatres L t d . says t h a t : i f there i s to be a f i l m i n d u s t r y i n Canada, i t w i l l have to be done with the co-operation of a l l segments of the p r i v a t e s e c t o r together with government.15 Morton b e l i e v e s t h a t "the g r e a t e s t problem i s how to f i n a n c e a Canadian •J r motion p i c t u r e " . He suggests: take the government out of d i r e c t f i n a n c i n g of commercial p i c t u r e s , l e t them provide tax i n c e n t i v e s to p r i v a t e c a p i t a l by extending c a p i t a l cost allowances past the 100% mark. There i s no magic i n that f i g u r e and there i s nothing to preclude c a p i t a l cost allowance from being at 115% or 125% f o r a few years as an experiment. This would not c o s t the government any more than they are c u r r e n t l y spending with the C.F.D.C, but i t would s t i m u l a t e p r i v a t e c a p i t a l , and the a b i l i t y and c r e a t i v e n e s s of the people whomanage i t , and b r i n g them i n t o the f i e l d of f i l m production.! I A coordinated government p o l i c y encouraging p r i v a t e investment would help develop the motion p i c t u r e i n d u s t r y . P r i v a t e i n v e s t o r s would become s o p h i s t i c a t e d i n assessing motion p i c t u r e investment proposals. The i n v e s t o r s would know what elements t o look f o r . I t has been the w r i t e r ' s experience t h a t the p r i v a t e i n v e s t o r a t t r a c t s the s e r i o u s motion p i c t u r e producer who has r e a l i s t i c p r o j e c t s i n mind. The p r i v a t e i n v e s t o r i s a businessman more concerned w i t h making a r e t u r n on h i s investment than the C.F.D.C. i s i n t e r e s t e d i n making a r e t u r n cr> t h e i r s . Producers should r e a l i z e that a p r i v a t e i n v e s t o r w i l l not i n v e s t s o l e l y to avoid income taxes. There i s no net saving f o r the - 211 -i n v e s t o r i f he does. The government has t r i e d i n the past to a i d the motion p i c t u r e i n d u s t r y d i r e c t l y through the C.F.D.C. I t i s time to l e t the i n d u s t r y b u i l d i t s e l f through i n d i r e c t i n c e n t i v e s . This suggested approach may e l i m i n a t e the incompetent filmmakers and the non-commercial p r o j e c t s . I f the government f o l l o w s the recommendation to ammend the r u l e s f o r motion p i c t u r e investment and c a p i t a l cost allowance, the r u l e s must be c l e a r l y s p e l l e d out f o r both the i n v e s t o r and f o r National Revenue, Taxation. The ammendrnents to the Income Tax Act  and Regulations must be w r i t t e n i n c l e a r , concise terminology. Nothing w i l l be accomplished i f the f e d e r a l government adopts c e r t a i n income tax i n c e n t i v e p o l i c i e s and the tax department a u d i t o r s d i s a l l o w the i n c e n t i v e s . Educational f i l m s and video tapes provide an e x c e l l e n t medium f o r young filmmakers to gain experience i n motion p i c t u r e production. Many educational motion p i c t u r e s are simply short f e a t u r e s - the t e c h n i c a l and c r e a t i v e processes are s i m i l a r and the p r o j e c t must work w i t h i n the economic perimeters of budget and market p o t e n t i a l . The w r i t e r b e l i e v e s t h a t i f the government i s s e r i o u s about a motion p i c t u r e i n d u s t r y i n Canada then the government should encourage the production of short f i l m s by the p r i v a t e s e c t o r . (The National Film Board i s w e l l known f o r i t s short motion p i c t u r e s but t h a t i s the p u b l i c s e c t o r ) ^ The market p o t e n t i a l of an educational motion p i c t u r e has a d e f i n i t e upper l i m i t , a l b e i t , the costs and the r i s k of complete commer-c i a l f a i l u r e are lower. The government should consider s p e c i a l tax i n c e n t i v e s to encourage p r i v a t e investment i n educational motion p i c t u r e s . - 212 -The educational video tape investment model s i m u l a t i o n s and the conclusions i n Chapter VII demonstrated t h a t educational programs were not as a t t r a c t i v e an investment as fe a t u r e s because o f the educational market's revenue c e i l i n g . Perhaps a s t r u c t u r e o f tax i n c e n t i v e s could be devised, s i m i l a r to the dividend tax c r e d i t scheme which was r e c e n t l y increased i n the March, 1977 budget. The scheme could be designed to reduce the taxes which i n v e s t o r s pay on income from an educational motion p i c t u r e investment thereby i n c r e a s i n g the a f t e r - t a x - y i e l d as compensation f o r the r e s t r i c t e d e d ucational audio-v i s u a l market. S p e c i a l tax i n c e n t i v e s would s t i m u l a t e the p r i v a t e i n v e s t o r and the production of educational motion p i c t u r e s . T h e a t r i c a l Quotas The w r i t e r does not agree with the recommendation made to the government by the Canadian Council of F i l m Makers and o t h e r s , t h a t a t h e a t r i c a l screen time quota f o r Canadian motion p i c t u r e s should be imposed. I t i s not p o s s i b l e to l e g i s l a t e audiences to see motion p i c t u r e s made i n Canada or anywhere e l s e : The main thrust...was that i f quotas v/ere enacted i n Canada, we would have a v i a b l e Motion P i c t u r e Industry and the p u b l i c would a u t o m a t i c a l l y go to see every Canadian F i l m . Of course t h i s i s r i d i c u l o u s , you cannot l e g i s l a t e people to pay $3.50 to see something they have no d e s i r e to see.18 Audiences w i l l not attend the theatres unless the motion p i c t u r e i s appeal!ing to them. However, even i f Canadian motion p i c t u r e s were supported by theat r e quotas and Canadian content t e l e v i s i o n r u l e s , the motion p i c t u r e s w i l l s t i l l not earn a p r o f i t i n the Canadian market alone. The market i s simply not big enough. In 1974, the average f i l m r e n t a l - 213 -fees earned by motion p i c t u r e s d i s t r i b u t e d i n Canada v/as $70,000 per 19 p i c t u r e . The maximum amount expected "even w i t h the best bookings 70 and a sound e x p l o i t a t i o n i s $400,000". Given t h a t f i l m r e n t a l s are the so l e means by which i n v e s t o r s recoup production c o s t s , the Canadian market i s o b v i o u s l y not making s i g n i f i c a n t p r o f i t s f o r producers from any country.21 Quotas on Canadian t e l e v i s i o n would have the same adverse e f f e c t . Viewers simply change channels i f they are not i n t e r e s t e d i n viewing a p a r t i c u l a r motion p i c t u r e . Motion p i c t u r e s which cannot compete i n the i n t e r n a t i o n a l markets should not be produced. The United States has produced more t h e a t r i c a l length motion p i c t u r e s than any other country i n the world. American motion p i c t u r e s have been t h r u s t upon most western markets. Canada's market has not been an exception. Nor i s i t a dumping ground f o r American products. Other c o u n t r i e s w i t h even s m a l l e r domestic markets than Canada (e.g. Sweden), have developed t h r i v i n g motion p i c t u r e i n d u s t r i e s . These c o u n t r i e s ' i n d u s t r i e s produce products f o r both n a t i o n a l and i n t e r n a t i o n a l consumption, i n c l u d i n g the American market. The Canadian motion p i c t u r e i n d u s t r y must s t r i v e f o r the same market g o a l . B. Recommendations to the Motion P i c t u r e Industry Canadian filmmakers must ignore the prevalent rumours t h a t taxpayers i n v e s t i n motion p i c t u r e production s o l e l y f o r the tax w r i t e -o f f s . The tax s h e l t e r i s not s u f f i c i e n t to a t t r a c t s e r i o u s i n v e s t o r s . Canadian f i l m makers must r e a l i z e t h a t t h e i r p r o j e c t s must be designed to earn a p r o f i t f o r the i n v e s t o r . - 214 -Promotion i n an I n t e r n a t i o n a l Industry Members of the motion p i c t u r e i n d u s t r y must recognize t h a t motion p i c t u r e s are an i n t e r n a t i o n a l i n d u s t r y . I f Canada i s i s o l a t e d through the imposing of screen time quotas, import r e s t r i c t i o n s and other government i n t e r f e r e n c e w i t h the f r e e market, r e t a l i a t i o n by other c o u n t r i e s i s l i k e l y , notably by the United S t a t e s . Budge Crawley, one of Canada's most p r o l i f i c and s u c c e s s f u l producers commented i n Quest magazine: you can't make money without world-wide d i s t r i b u t i o n and t h a t means you have to crack the American market. I f the Americans don't buy your f i l m , nobody w i l l . 2 2 The message i s c l e a r that Canadian motion p i c t u r e s must be d i s t r i b u t e d i n t e r n a t i o n a l l y . I n t e r n a t i o n a l d i s t r i b u t i o n means not o n l y a p i c t u r e w i t h i n t e r n a t i o n a l appeal but proper i n t e r n a t i o n a l d i s t r i b u t i o n and promotion. Motion p i c t u r e producers i n Canada have not been spending enough money on promotion of t h e i r product b e f o r e , during and a f t e r production. The w r i t e r recommends that Canadian producers i n v e s t a greater p r o p o r t i o n of the production cost of the p r o j e c t s i n promotion. D i s t r i b u t o r s , e x h i b i t o r s and audiences must be aware of your f i l m -they must a n t i c i p a t e i t s r e l e a s e . This i s a key t o commercial success. Fran c i s Mankiewicz, one of Quebec's d i r e c t o r s says: promotion i s c r u c i a l . You can have the most b e a u t i f u l f i l m i n the world but i f people don't know about i t they won't go to see i t . Canadian d i s t r i b u t o r Len Herberman, of Ambassador F i l m D i s t r i b u t o r s says: I wish they (Canadian producers)'d get d i s t r i b u t o r s i n v o l v e d r i g h t at the beginning of a f i l m , when i t ' s s t i l l at the s c r i p t and screen treatment stage, i n s t e a d o f b r i n g i n g them i n when the p i c t u r e i s already f i n i s h e d . 2 4 Herberman points out that a d i s t r i b u t o r needs time to prepare an e f f e c t i v e s a l e s campaign. A motion p i c t u r e should not " s i t on the s h e l f " when i t i s completed. The p i c t u r e must be d i s t r i b u t e d as soon - Zlb -as i t i s f i n i s h e d to take advantage of the p u b l i c i t y momentum developed during production. I t i s imperative that the producers of educational motion p i c t u r e s seek d i s t r i b u t o r guidance p r i o r to commencing an educational production. D i s t r i b u t o r s r e c e i v e feedback from t h e i r s a l e s f o r c e as to the education-a l market needs. The d i s t r i b u t o r can provide an educational producer with i n f o r m a t i o n about the market requirements f o r c u r r e n t s u b j e c t s , content, s t y l e and optimal length. An educational d i s t r i b u t o r i's i n an e x c e l l e n t p o s i t i o n to a s s i s t i n s a l e s f o r e c a s t i n g f o r a s p e c i f i c educational motion p i c t u r e t o p i c . Educational motion p i c t u r e producers must face the r e a l i t y o f . t h e i r market. The recent r e d u c t i o n i n c e r t a i n government spending, p a r t i c u l a r l y at the municipal l e v e l , has reduced the p o t e n t i a l s a l e s f o r educational a u d i o - v i s u a l programs. School boards have been f o r c e d to reduce a l l but e s s e n t i a l s e r v i c e s . Money th a t used to be spent on the purchase and r e n t a l o f a u d i o - v i s u a l m a t e r i a l s i s being d i v e r t e d to other uses - e.g. teachers' e s c a l a t i n g s a l a r i e s . The educational producer must r e a l i s t i c a l l y consider h i s production c o s t s v i s - a - v i s the p o t e n t i a l gross s a l e s . A p o r t i o n of the f i n a n c i n g f o r educational and entertainment motion p i c t u r e s should be sought by the producer from the d i s t r i b u t i o n branch of the i n d u s t r y ; Money investment (by a d i s t r i b u t o r ) i s i n h e r e n t l y the best m o t i v a t i o n f o r e f f e c t i v e d i s t r i b u t i o n of product towards recouping such investment and t u r n i n g a p r o f i t . 2 5 A d i s t r i b u t o r i s u n l i k e l y to i n v e s t i n a motion p i c t u r e which, i n h i s view, i s non-commerical. - Zib -Unions The members of the motion p i c t u r e i n d u s t r y must review the f i l m union r e g u l a t i o n s and practices i n the i n d u s t r y . The unions must r e l a x t h e i r r u l e s i n order to permit f o r e i g n filmmakers to work t e m p o r a r i l y i n Canada. The f o r e i g n e r s w i l l give Canadian motion p i c t u r e s the necessary i n t e r n a t i o n a l appeal and they w i l l teach Canadian filmmakers. P r e s e n t l y the Canadian unions have a p p l i e d pressure to the Department of Manpower and Immigration which has e f f e c t i v e l y prevented many proposed co-productions i n Canada. The motion p i c t u r e co-productions (often i n v o l v i n g Canadian investment) are being shot i n the co-producing country where the government bur-eaucracies are more cooperative. The net r e s u l t has been t h a t i n s t e a d of l e a r n i n g from the f o r e i g n e r s working i n Canada, Canadian filmmakers have not worked at a l l . The motion p i c t u r e unions are going to have to examine the current "feather-bedding" p r a c t i c e s . The number of t e c h n i c i a n s a producer i s f o r c e d to h i r e and the high wage s c a l e s are i n c r e a s i n g the already enormous co s t s of motion p i c t u r e p roduction. Canada has an i n t e r n a t i o n a l r e p u t a t i o n among many i n d u s t r i e s , f o r high wages and low p r o d u c t i v i t y . Canadian filmmakers must not a l l o w a r e p u t a t i o n of non-productiveness to become synonymous w i t h the f l e d g l i n g Canadian motion p i c t u r e i n d u s t r y . Production costs must be kept low so t h a t the p r i v a t e i n v e s t o r s who finance these.costs can expect a favourable e q u i t y r e t u r n r a t i o . - 217 -D i s t r i b u t o r s D i s t r i b u t o r s of educational and t h e a t r i c a l motion p i c t u r e products both i n Canada and the United States must examine t h e i r oper-a t i n g overhead s t r u c t u r e . P r e s e n t l y the percentage of the gross s e l l i n g p r i c e or box o f f i c e r e c e i p t s which i s returned to the producer i s f a r too low v i s - a - v i s the producer's (or h i s i n v e s t o r ' s ) c a p i t a l investment and r i s k : The terms of d i s t r i b u t i o n are going to have to be enhanced to motivate those who wish to make f i l m s to do so and to r i s k t h e i r own c a p i t a l , or to obtain r i s k c a p i t a l from ( p r i v a t e i n v e s t o r s ) . 2 6 Many motion p i c t u r e d i s t r i b u t o r s t r e a t independent producers very u n f a i r l y . This treatment i s s u r p r i s i n g because the d i s t r i b u t o r s must r e l y on the producers f o r product supply. The d i s t r i b u t o r s take advantage of the producer's r e l a t i v e l y weak f i n a n c i a l p o s i t i o n . Some d i s t r i b u t o r s are slow to remit to the producer h i s share of the gross r e c e i p t s . These d i s t r i b u t o r s often use questionable accounting methods, i n f l a t e expense accounts or worse simply f a i l to remit the producer's share at a l l . Many independent producers are f o r c e d to sue a d i s t r i b u t o r i n court i n order to o b t a i n money which i s r i g h t f u l l y t h e i r s . Producers The producers i n turn must r e a l i z e that t h e i r r e p u t a t i o n and f u t u r e funding depends on t h e i r treatment of t h e i r sources o f p r i v a t e f i n a n c i n g . Producers must prepare the r o y a l t y r e p o r t s to t h e i r i n v e s t o r s . Most important, they must remit the i n v e s t o r ' s share of the motion p i c t u r e r e c e i p t s on time and i n f u l l . - 218 -The poor r e p u t a t i o n of some Canadian producers' treatment o f t h e i r f i n a n c i a l backers must be r e c t i f i e d i f p r i v a t e motion p i c t u r e investment i s to in c r e a s e . Herberman, of Ambassador Films commented on t h i s problem i n Cinema Canada: Another of Herberman's pet peeves i n v o l v e s producers who, i n s p i t e of e v e r y t h i n g , do manage to make money on t h e i r p i c t u r e s , but who then proceed to r i p o f f t h e i r i n v e s t o r s . "The i n v e s t o r s , " he says, " i n some cases never get a dime „7 back on the p i c t u r e , even when the p i c t u r e has earned money" Dishonesty has no place i n the motion p i c t u r e i n d u s t r y i n Canada, nor in any other i n d u s t r y . Dishonesty i s only one of the problems which make i t d i f f i c u l t f o r i n v e s t o r s to earn a r e t u r n . Lack of i n v e s t o r knowledge o f the i n d u s t r y i s a l s o a problem, p a r t i c u l a r l y l a c k of knowledge concerning the method by which motion p i c t u r e revenues are shared. Producers must examine t h e i r present revenue sharing arrangements. The w r i t e r recommends th a t the producers adopt revenue sharing arrangements which are more generous to the i n v e s t o r s . I f the i n v e s t o r s never recoup t h e i r o r i g i n a l investment nor r e c e i v e t h e i r f a i r share of the d i s t r i b u t i o n p r o f i t s they are u n l i k e l y to i n v e s t a second time. Producers would be wise to consider a revenue sh a r i n g formula which permits most of the d i s t r i b u t i o n revenue to be paid d i r e c t l y t o the i n v e s t o r u n t i l the i n v e s t o r has recouped h i s investment. A f t e r the i n i t i a l investment has been re p a i d the producer can then r e c e i v e a g r e a t e r share of the p r o f i t s . I f i n v e s t o r s i n s i s t e d on the revenue formula suggested, many marginal p r o j e c t s would be e l i m i n a t e d before they were begun. The producers would consider the economics o f production and d i s t r i b u t i o n more c a r e f u l l y i f they r e a l i z e d t h a t they would be paid only a f t e r the i n v e s t o r had recouped h i s investment. - 219 -When Canadian f i l m makers have developed the necessary t e c h n i c a l and c r e a t i v e s k i l l s to be commercially s u c c e s s f u l i n the i n t e r n a t i o n a l markets, they can then a l l o w themselves the luxury o f c u l t u r a l n a r c i s s i s m . Canadian f i l m makers must prove t h e i r commercial a b i l i t y "to b u i l d an e x p o r t - o r i e n t e d i n d u s t r y that could e v e n t u a l l y serve t o r e i n f o r c e 28 Canadian i d e n t i t y and c u l t u r e " . Honest and generous treatment of i n v e s t o r s by the motion p i c t u r e i n d u s t r y w i l l b u i l d a sound business repore which w i l l g r e a t l y a i d the development of the motion p i c t u r e i n d u s t r y i n Canada. C. Recommendations to P r i v a t e Investors The f i r s t f a c t o r t h a t an i n v e s t o r should r e a l i z e i s t h a t other than the Income Tax Act and Regulations motion p i c t u r e i n v e s t -ment i s unregulated. There are no government or i n d u s t r y bodies screening or approving motion p i c t u r e investment packages o f f e r e d to the p u b l i c . There i s , f o r example, no motion p i c t u r e e q u i v a l e n t of a s e c u r i t i e s and exchange commission. I t i s not necessary f o r a producer to i s s u e a prospectus. Anyone who wants t o c a l l h i m s e l f a producer can do so: The entertainment world has more than i t s share of sharks j u s t w a i t i n g f o r the unwary i n v e s t o r . The r u l e of thumb in movie i n v e s t i n g i s : watch out. A l o t of t h i s b o i l s down to d e a l i n g with r e l i a b l e people warns Sobol (Daniel Sobol, former chairman of Mew York's Chelsea Nat i o n a l Bank). And (New York lawyer) Lee S t e i n e r cautions t h a t anybody can be a movie producer these days - he can be good a t i t or a complete novice.29 The p r i v a t e i n v e s t o r must demand s o l i d evidence t h a t the motion p i c t u r e has commercial p o t e n t i a l . The i n v e s t o r should i n s i s t t h a t the producer supply an uncol1aborated gross s a l e s f o r e c a s t from - 220 -a reputable d i s t r i b u t o r . The i n v e s t o r should s e r i o u s l y consider only investments i n v/hich a d i s t r i b u t o r , independent of the producer, i s prepared to make e i t h e r a f i n a n c i a l commitment or at the very l e a s t guarantee d i s t r i b u t i o n o f the completed f i l m . The w r i t e r b e l i e v e s t h a t the best way to ensure d i s t r i b u t i o n of Canadian fe a t u r e s would be to arrange a pre-production commitment o f f i n a n c i n g from d i s t r i b u t o r s and/or e x h i b i t o r s . A commitment on the part of the d i s t r i b u t o r s or e x h i b i t o r s would o f f e r some guarantee t h a t an e f f o r t would be made to market the f i l m i f only to recoup t h e i r share of the investment. As a c o n d i t i o n of investment the i n v e s t -or should r e q u i r e t h a t the producer r a i s e some f i n a n c i n g from the motion p i c t u r e i n d u s t r y i t s e l f , i . e . d i s t r i b u t o r s and/or e x h i b i t o r s . The d i s t r i b u t o r s and e x h i b i t o r s know through t h e i r marketing experience what types of motion p i c t u r e s and what themes are l i k e l y to appeal to t h e i r audiences. The d i s t r i b u t o r s ' and e x h i b i t o r s ' o pinion of a s c r i p t would be worthwhile e v a l u a t i o n s of the motion p i c t u r e ' s chances of commercial success. T h e i r e v a l u a t i o n , w h i l e not i n f a l l i b l e , would counter-balance the e v a l u a t i o n of the producer and o t h e r s , e.g. the C.F.D.C. bureaucrats. The C.F.D.C. o f f i c e r s and Canadian independent producers are f r e q u e n t l y accused by f i l m c r i t i c s and the North American motion p i c t u r e i n d u s t r y of making inaccurate judgements of the economic r e a l i t i e s of production and marketing. The i n v e s t o r should ob t a i n independent sales f o r e c a s t s from other d i s t r i b u t o r s . This would determine whether or not the s a l e s f o r e c a s t prepared by the producer-promoter and the producer's d i s t r i b -utor i s r e a l i s t i c . - 221 -The i n v e s t o r , w i t h the help of h i s accountant and lawyer, must i n v e s t i g a t e a l l aspects of the motion p i