Investment in films and events: The new financing agreement of Article 39(7) of the Corporate income Tax act

To apply tax deductions in Spanish audiovisual productions and live events more effectively, Republican Party Esquerra Republicana submitted amendment 3090 to the draft bill of the 2021 General State Budget Act(LPGE), currently going through parliamentary process. This amendment introduces an innovative transfer scheme for tax credits governed by articles 36(1) and 36(3) of the Corporate Income Tax Act (CIT Act) by introducing alternative schemes already applicable in territories with a special tax status like Navarre (including audiovisual productions) and the provincial councils of Bizkaia and Gipuzkoa (regarding tax deductions for R&D&I) in the Spanish general tax regime.

In particular, the LPGE amends the CIT Act (adding a new paragraph 7 in article 39) to allow taxpayers contributing financially to Spanish films and TV series or producing and putting on live events to directly apply the tax deduction for Spanish audiovisual productions (article 36(1) of the CIT Act) and for music and theater events (article 36(3) of the CIT Act). Taxpayers acting as investors will not be required to establish an economic interest group (AIE) to structure the production, and entering into a financing agreement between them and the producer, subject to certain formal and substantive requirements, will suffice.

Under this new financing agreement, taxpayers contributing financially to the productions cannot acquire intellectual property rights or other kind of entitlements over them. The producer will hold these rights exclusively. This should facilitate and simplify the negotiation process, since there is no doubt that third-party investors (i.e., taxpayers) will be able to apply the relevant tax deduction but not acquire any rights to the audiovisual production or its results.

Another substantive requirement is that investors may contribute financially “at any stage of the production until they obtain the nationality certificate.” From the investor’s perspective, contributing financially to the production before obtaining that certificate entails a risk, since the certificate could be denied if the production does not fulfill the requirements of article 5 of Act 55/2007, of December 28, on the Film Industry. However, one may wonder whether the purpose of this substantive requirement is actually (i) that investors bear this risk; or (ii) to set a clear deadline for making any financial contributions to audiovisual productions. These consideratons could be relevant, e.g., when using an escrow account to make the financial contribution, where the contribution is made before obtaining the nationality certificate but the funds only become available to the producer afterwards. Therefore, there is some room for interpretation.

Subparagraph 3 of article 39(7) of the CIT Act sets out the mandatory minimum contents of the financing agreement: i) the identity of the taxpayers contributing financially to the production; ii) description of the production; iii) production budget, breaking down the expenses and, particularly, the expenses to be incurred in Spain; iv) financing scheme, breaking down the amounts contributed by the producer, by the taxpayer contributing financially, and any subsidies or economic aid; and v) any other aspects provided in the applicable regulations.[1]

Also, the maximum tax credit the investor can obtain is capped. Under subparagraph 4 of article 39(7) of the CIT Act, the maximum tax credit cannot exceed the financial contribution to the production multiplied by 1.20. Therefore, to maximize their tax credit, investors must contribute 83.33% of the deductible amount. However, this is a cap on the return, so that producers and investors are free to negotiate in the financing agreement the amounts to be invested and agree on returns below 1.20 times the amounts contributed by the investor. If the agreed deductible amount exceeds the cap, article 39(7) allows the producer to deduct any amount in excess.

Note that subparagraph 4 of article 39(7)[2] provides that the investors may apply the deduction, determining “[t]he deductible amount […] under the same conditions as if the deduction had been applied to the producer.” Therefore, if the producer fulfills the requirements to apply the deduction rates under articles 36(1) or 36(3) increased as provided for the Canary Islands Financial and Tax Regime (REF),[3] the producer could transfer that deductible amount to the investor, even if the investor is not a tax resident in the Canary Islands. This would create a significant difference with respect to the regime governing economic interest groups (agrupaciones de interés económico, AIEs), because the General Tax Directorate considers that, since AIEs apply deduction bases to their shareholders, investors that are shareholders in Canary Islands’ AIEs can only apply deductions if they are residents or have a permanent establishment in the Canary Islands. In practice, this has significantly hindered audiovisual productions in the Canary Islands.

Investors and producers must submit to the tax authorities (i) the financing agreement; (ii) the nationality and culture certificates (article 36(1)); and (iii) the certificates from the National Institute of Performing Acts and Music (article 36(3)). The producer and the investor must jointly sign this submission before the end of the relevant tax period, subject to the applicable regulations.[4] The provision suggests that it is the investor or taxpayer that must make this submission-i.e., “taxpayers seeking to apply the deduction provided in this article”-where “this article” means article 39(7) of the CIT Act.

The provision clarifies that the deduction for the taxpayer contributing financially to the production will be totally or partially incompatible with the deduction to which it would be entitled from the producer under paragraphs (1) and (3) of article 36 of the CIT Act. This makes sense because, otherwise, taxpayers would be receiving an incentive twice for the same investment.

According to the media, Spain notified this new tax deduction scheme to the European Commission (EC) subject to the State aid procedure provided in the TFEU. To date, the EC has found that all amendments to the Spanish tax deduction scheme for films and audiovisual productions are compatible with the internal market.[5]

The EC will issue a decision on whether the new measure fulfills the conditions of its 2013 Communication on State aid for films and other audiovisual works. Ultimately, the EC will assess if the adopted measure actually constitutes State aid, which requires, among other aspects, that the measure be selective. If so, the EC will assess whether the measure complies with the general principle of legality, ensuring that (i) it does not exceed maximum aid intensities; (ii) it is not granted for specific production activities or reserved for individual parts of the production value chain; and (iii) the remaining requirements of the 2013 EC Communication are fulfilled.

[1] As of the date of this document, there are no additional regulations governing any other aspects.

[2] “Taxpayers contributing financially to the production are entitled to the deduction provided in this article duly certifying it in their tax self-assessment. The deductible amount will be determined under the same conditions as if the deduction had been applied to the producer.”

[3] Article 94 of Act 20/1991, of June 7, amending tax aspects of the Canary Islands Financial and Tax Regime.

[4] As of the date of this document, there are no regulations governing this submission.

[5] For example, on December 22, 2020, the EC found that the amendments to articles 36(1) and 36(2) of the CIT Act through Royal Decree-Law 17/2020, of May 5, and Royal Decree-Law 34/2020, of November 17, (increasing the deduction percentages and the maximum intensities) were compatible with the TFEU.