Aims of film and television tax reliefs – Andrew Parkes

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Andrew Parkes, National Tax Director at Andersen discusses the aims of film and television tax reliefs, and in particular the UK media’s recent furore in relation to Netflix.

Andrew’s article was published in Taxation, 5 November 2019, and in their October/November 2019 issue and can be found here.

The black mirror

Like Pavlov’s dogs, the mainstream media have once again seen that a large US company, in this case Netflix, is not paying huge amounts of corporation tax in the UK, indeed has the temerity to obtain a refund, and has inferred they are avoiding tax.

That the company is, in fact, taking advantage of not one, but two tax breaks in the UK appears to have slipped past their “outrage-o-meters”.

Show me the money

Let’s start with the question of the refund. Netflix has, “shock, horror”, claimed a refund in respect of losses it made on making films and television programmes in the UK. In 2012, the Government announced that it was looking into introducing tax reliefs for high-end television programmes to go along with its successful film tax relief. This was to “support technical innovation and ensure that the companies working in these highly creative industries continue to contribute to UK economic growth and to British culture”.

Now, depending on whether you consider programmes such as The Crown or Free Rein (ask your daughter) and films such as those from the, admittedly non-Netflix, Marvel Cinematic Universe contribute to British Culture, they do certainly add to the economy. Netflix’s plans have led to £232mn being spent on Shepperton Studios with 25,000 people being employed making the films and shows.

Tax cost and yield

The British film Institute (BFI) reported that in 2016, the film and TV tax reliefs cost £632mn but brought in tax of £2bn and supported over 137,000 jobs. It should be clear to all, including the media, that firms such as Netflix are not parasites, and do pay their way adding significantly to the economy.

And how does the refund arise? The tax relief allows Netflix to claim an extra 100% of its qualifying expenditure, effectively doubling its production “costs” and if this leads to a loss, then a repayment can be claimed. Given how generous this relief is, is it any wonder that repayments are due?

I await with bated breath, the sequel to this story, when the £400m that Netflix has reportedly spent on UK programming over the past 9 months leads to probably a much bigger pay-out next year!

Into the upside down

The other charge against Netflix is that it has not paid enough UK corporation tax based upon its guesstimated UK turnover. This wilfully ignores the fact that, despite the large investment in UK programming, the vast majority of Netflix’s expenditure on programming is outside the UK. When they spend hundreds of millions of dollars for Friends or Seinfeld, you don’t have to be an American teenager in the 1980’s to work out that a large proportion of the UK subscription is going to flow to the US.

Also, the company is not the same as some of the other internet companies in the media’s spotlight as Netflix does not have vast warehouses and fleets of vans in the UK, nor does it have a platform where the more UK users there are the more profits can be generated from the network effect. Instead, you have a more traditional business model, albeit, one based on the internet. You pay your subscription to Netflix and they allow you to watch their programmes. They do this by having over 200 servers in the UK, and here is where the second tax break kicks in. Countries have many double taxation agreements, with the UK having one of the largest networks in the world. Under these agreements, one country, the source state (here the UK) is only able to tax the business income of the trader in the residence state (here Netflix in the Netherlands) if the trader has a taxable presence in the source state, known as a permanent establishment.

The majority of the world’s double taxation agreements are based upon the OECD’s model agreement. This includes the UK’s and, indeed, HMRC helped draft the model. Alongside the model treaty, the OECD also produces commentaries to help interpret the model. HMRC treats these commentaries very seriously and treats them as near gospel. The commentary for business profits has a section on e-commerce (paragraphs 122 to 131 of the commentary to Article 5) and this confirms that servers can be a permanent establishment creating a taxable presence in a country. I assume it is this provision that has led to Italy taxing Netflix on its profits there.

However, despite Netflix having over 10 times the servers in the UK that it has in Italy (according to a 2016 study by Queen Mary University of London), and a much bigger presence here, the UK has no intention of taxing Netflix upon this income, or at least not via the usual route of taxation. HMRC announced on 11 April 2000 that it would not treat a server as a permanent establishment and despite the noises from the Government about taxing the internet giants, it reaffirmed this position when the latest OECD commentaries were published on 21 November 2017.

HMG is clearly happy that a Dutch company uses servers in the UK to generate income it will not tax. Anyone upset about Netflix’s lack of corporation tax payments (assuming that they are not covered by the film and tv tax reliefs) would be better served by shouting at the Government as it is their policy that means no tax is due.

This being said, it seems the UK Government doesn’t know what it wants (how odd). As well as the breaks mentioned above, we have the Diverted Profits Tax, the UK’s attempt to tax e-commerce and circumvent those pesky OECD treaties. It does this by arguing (some may say pretending) that the DPT is not like corporation tax and so not covered by the treaties (walking, looking and quacking all spring to mind here). If it is used against Netflix, I think they can feel aggrieved as they are following Government policy in placing their servers in the UK, when the UK knew this would lead to no tax being paid. Time will tell if the disputes noted in their US filings come to anything.

That’s all folks

Once again the media have proved the adage, a little bit of knowledge is a dangerous thing. Netflix is taking advantage of two UK tax reliefs, bringing in much needed foreign investment and supporting thousands of jobs, but they are obviously “do-badders” as they do not meet an arbitrary (some would say imaginary) target for “fair taxation”.

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