Amortisation of cost of production/cost of acquiring distribution rights of films - Assessments of film producers/distributors - General guidelines for allowance thereof - Income Tax - 154/1974

Circular No. 154 Dated 5/12/1974 Amortisation of cost of production/cost of acquiring distribution rights of films - Assessments of film producers/distributors - General guidelines for allowance thereof clarification 1 1. Attention is invited to Board's Circular No. 92, dated 18-9-1972 [ Clarification 2 ], modifying its earlier circulars issued on the above subject. 2. The Board has re-examined the question relating to the amortisation of the cost of production of feature films in the assessments of film producers and distributors. A study of the results of the business earnings of the feature films has revealed that it is not always possible to know the final receipts of any particular film in the first year. Therefore, it would be appropriate to make the assessments on a provisional basis in the first instance by allowing proportionate deduction in respect of cost of production and cost of acquiring distribution rights on an estimated basis. On determination of the final results on the expiry of the exploitation period, the income/loss can be adjusted under section 154 by revising the figure of allowance in respect of cost of production and acquisition of distribution rights in the proportion of the earnings spread over the period of exploitation. 3. By way of a general guideline, in the case of producers the entire cost of production can be allowed in the year of release if the picture was fully exploited in that year. For example, if all the territories have been sold by way of outright sale in the year of release the entire cost of production will be allowed in computing the income of the year of release to the producer. In the case of pictures sold on minimum guarantee (M.G.) basis, if the entire collections have come in the year of release, the full cost of production will similarly be allowed in the year of release, as it can be said that the picture was fully exploited in that year. In cases where all the territories have not been sold either on M.G. basis or on outright sale basis, the picture cannot be said to have been exploited fully in that year and, therefore, the entire cost cannot be allowed in the year of release. For this purpose, the most reliable factor to be taken into account for finding out whether the picture has been fully exploited or not is the actual collection from the film. As the figures of actual collection are not likely to be known in the first year of release, the assessments may be made on a provisional basis in the first year by adopting the actual receipts and allowing a part of cost of production also on an estimated basis taking into consideration future estimated receipts subject to final adjustment after the period of exploitation is over. 4. Three examples are given below by way of illustration of the above guidelines. In these examples, it has been presumed that the period of exploitation runs to 18 months. However, this period has to be determined by the Income-tax Officers with reference to facts of each individual case : EXAMPLE I Cost of production Rs. 50 lakhs Month of release September 1970 Accounting year of the assessee for 1971-72 assessment 31-3-1971 - Realisations up to 31-3-1971 (6 months) Rs. 45 lakhs - Realisations from 1-4-1971 to 31-3-1972 (12 months) Rs. 30 lakhs - Cost to be allowed for the 1971-72 assessment Rs. 50 lakhs × Rs. 45 lakhs Rs. 75 lakhs i.e., Rs. 30 lakhs - Cost to be allowed for the 1972-73 assessment Rs. 20 lakhs example ii Cost of production Rs. 50 lakhs Month of release September 1970 Accounting year of the assessee for 1971-72 assessment 31-3-1971 - Realisations up to 31-3-1971 Rs. 27 lakhs - Realisations from 1-4-1971 to 31-3-1972 Rs. 18 lakhs Total Rs. 45 lakhs Cost to be allowed for the 1971-72 assessment Rs. 50 lakhs × Rs. 27 lakhs Rs. 45 lakhs i.e., Rs. 30 lakhs Cost to be allowed for the 1972-73 assessment Rs. 20 lakhs example iii Cost of production Rs. 50 lakhs Month of release September 1970 Accounting year of the assessee for 1971-72 assessment 31-3-1971 Realisations up to 31-3-1971 Rs. 40 lakhs Realisations from 1-4-1971 to 31-3-1972 Nil In this case, the entire cost will be allowed in the 1971-72 assessment since the entire realisations during the 18-month period were effected before March 31, 1971 itself. 5. In the case of distributors, the entire cost of acquiring the distribution rights may be allowed on the basis of collections during the period of exploitation of the film. As the period of exploitation is likely to exceed one year, the assessment for the first year may be framed provisionally by allowing a part of the cost of distribution rights on an estimated basis against the actual receipts in the year under consideration. The final adjustment in the case of the producer will be made after the exploitation period under section 154. However, if a distributor produces evidence to the satisfaction of the Income-tax Officer that a particular picture has failed at the box office in the year of release itself and there is no possibility of further collection in the following years, the entire cost of acquisition of distribution rights may be allowed in the first year itself. 6. All pending assessments may be regulated in accordance with the guidelines spelt out in this circular. In case where the assessments were completed in accordance with the instructions contained in Board's Circular No. 92 and the appeals are pending either before the Appellate Assistant Commissioner or the Appellate Tribunal, the Department may agree to such assessment being set aside to be reframed on the basis of the guidelines laid down in this circular and the concerned assessees have agreed to the adoption of such a course of action. Circular : No. 154 [F. No. 201/5/71-IT(A-II)], dated 5-12-1974 . clarification 2 1. Attention is invited to Board's Circular No. 4 (XI-3)D, dated 9-4-1959, as modified by Circular No. 30, dated 4-10-1969 [Clarifications 3 and 4] on the above subject. 2. The Board has reconsidered the question relating to the amortisation of the cost of production of a feature film. The effective life of a feature film depends on many factors, the most important among them being the market value of the stars acting in the films, which in turn is reflected in the cost of production. On the basis of cost of production, the feature films can be categorised into three classes : Class Cost of production including cost of positives and advertisement expenses incurred by the producer A Rs. 35 lakhs and above. B Between Rs. 10 to 35 lakhs. C Below Rs. 10 lakhs. 3. Normally feature films are disposed of by a producer either under the minimum guarantee formula or by way of outright sale. Under the minimum guarantee system a minimum amount is guaranteed to be paid to the producer by the distributor. In addition, a right to participate in the overflow is also retained by the producer. Overflow represents the amount which is arrived at after the distributor has recouped the minimum guaranteed amount and his commission. In the case of outright sale, the producer transfers all his rights of exploitation of the feature film to the distributor for a lump sum consideration. 4. An actual case study of the films in A class was undertaken. Feature films produced with the cost of production of Rs. 35 lakhs and above were found to have a run of more than 2 years. The Board has, therefore, decided to revive the amortisation formula for such films under which the value of the film will be depreciated by 60 per cent in the first year, 25 per cent in the second year and 15 per cent in the third year on time basis as elucidated in Board's Circular dated 9-4-1959 referred to in para 1. The percentages are not to be deviated from and are to be followed in allowing cost of amortisation of A class feature films. 5. The effective life of feature films in B and C categories was found to be normally of one year. It has, therefore, been decided by the Board that the entire cost of production may be allowed in the very first year of production if the film was released in the first half of the accounting year. In case the film was released in the later half of the accounting year, the value of the film should be taken at 50 per cent of the cost of production at the end of that accounting year and the balance 50 per cent should be adjusted in the second year. 6. The Board has also decided that the cost of acquiring distribution rights should be treated in the hands of the distributor in the same way as the cost of production is treated in the hands of the film producer, the rates of the allowance and the manner being as indicated in paras 4 and 5 above. 7. If the producer sells the film outright for all the territories, the entire cost of production should be allowed as a deduction in the year of the sale irrespective of the category to which the film belongs. If the distributor after having acquired the film by way of outright purchase sells the film outright to another person in the first or subseq-uent years, he would be assessable on the profits made on that transaction by allowing the deduction for the price which he had paid to acquire the exploitation rights. 8. In cases where the producer or the distributor disposes of the exploitation rights of an A class film on mixed basis, i.e., some territories on minimum guarantee and others on outright sale, the deduction for the cost of production should be effected in the same proportion as the amount of outright sale bears to total receipts. The remaining balance of the cost of production should be amortised on lines indicated in para 4 above. If, for example, the cost of production of an A class film is Rs. 40 lakhs and the exploitation lights for three territories are disposed of for Rs. 20 lakhs on minimum guarantee basis, and the remaining territories for Rs. 25 lakhs by way of outright sale, the cost of production should be amortised on the following basis : Cost of production Rs. 40 lakhs Minimum guaranteed amount Rs. 20 lakhs Outright sale Rs. 25 lakhs Rs. 45 lakhs 25 : 45 = X : 40 = Rs. 22, 22,222 Therefore, the outright deduction from the cost of Rs. 40 lakhs would be Rs. 22,22,222. The balance amount i.e., Rs. 40 lakhs less Rs. 22,22,222, should be amortised on time basis as indicated in para 4. 9. Board's circulars referred to in para 1 above stand modified to the extent indicated above. Circular : No. 92 [F. No. 201/5/71-IT (A-II)], dated 18-9-1972 . clarification 3 1. Attention is invited to Board's Circular No. 4 (XI-3) D, dated 9-4-1959 [Clarification 4] on the above subject. 2. The film producers have represented to the Board that a cinema film no longer has an effective life of about 3 years as was presumed by the Income-tax Department when devising the formula for the amortisation of the cost of the films spelt cut in the circular mentioned above. 3. The matter has been carefully considered by the Board. In view of the changed situation regarding the minimum guarantee system operating in the film industry at present, it is perhaps inappropriate to resort to the inflexible rule in every case of amortisation of the cost of the film over a period of 3 years. The Board also agree that the effective and earning life of the large majority of the present-day cinema films seldom exceeds one year. 4. It has, accordingly, been decided that if the producer of a film does not wish to write off the cost of the film in his books in the manner indicated in Board's circular mentioned above, then he may be permitted to write off the entire cost in the year in which the picture is released. On his doing so, the entire cost of the film will be allowed as an admissible deduction in the year in which the picture is released and the cost of the film is written off in the books. 5. Board's Circular No. 4 (XI-3) D, dated 9-4-1959 is modified to the extent indicated above. Circular : No. 30 [F. No. 9/80/69-IT(A-II)], dated 4-10-1969 . clarification 4 1. Attention is invited to Board's Circular No. 1-D, dated 4-1-1951 [Clarification 5] on the above subject. 2. For paragraph 2 of the above circular, the following shall be substituted : "While it will not be right and may lead to tax evasion if the percentages mentioned in the 'standard' formula are applied irrespective of the point of time a film is purchased or released for exhibition in a particular year, the Board feel that insistence on allowance of these percentages strictly on time-basis alone may not be fair in several cases and that, therefore, it would be desirable to also take into account the figures of collections in a particular period for determining the percentage of amortisation for that period. The Board, therefore, direct that amortisation in cases of films which conform to the norm of the three year life should be worked out in the manner indicated in the following example : The accounting year of a film producer is the year ended December 31, 1954 and a film produced during that year was released for public exhibition on October 1, 1954. The collections were as under : 1954 : From l-10-1954 to 31-12-1954 Rs. 9,50,000 Total for twelve months: 1955 : From 1-1-1955 to 30-9-1955 Rs.16,00,000 Rs. 25,50,000 From l-10-1955 to 31-12-1955 Rs. 1,90,000 Total for twelve months: 1956 : From 1-1-1956 to 30-9-1956 Rs. 4,75,000 Rs. 6,65,000 From l-10-1956 to 31-12-1956 Rs. 1,50,000 Total for twelve months: 1957 : From 1-1-1957 to 30-9-1957 Rs. 2,50,000 Rs. 4,00,000 The allowance for amortisation should be as follows : Accounting year Assessment year Rate of amortisation 1954 1955-56 60 × 9,50,000/25,50,000 = 22.3% approximately 1955 1956-57 60 × 16,00,000/25,50,000 + 37.7% approximately plus 25 × 1,90,00,000/6,65,000 + 7% approximately 1956 1957-58 25 × 4,75,000/6,65,000 + 18% approximately plus 15 × 1,50,000/4,00,000 + 5.6% approximately 1957 1958-59 15 × 2,50,000/4,00,000 + 9.4% approximately" Circular : No. 4(XI-3) D [F. No. 45A/200/54-IT], dated 9-4-1959 . clarification 5 1. Attention is invited to Board's demi-official letter R. Dis. No. 178-IT/37, dated 13-5-1937 [Clarification 6]. On representations made by the film industry, the Board wish to make it clear that the general or "standard" formula regarding amortisation of the cost of production of a film, at 60 per cent in the first year, 25 per cent in the second year and 15 per cent in the third year should not be treated as inflexible and that it may be varied in favour of the assessee if he is able to prove by adducing appropriate evidence that the earning capacity of the film was extinguished much earlier than over the period presumed in the above formula. If, for example, an assessee is able to prove that the film had no real life beyond the first year and there were no receipts in respect thereof in the next year, the entire cost of the film should be allowed in the first year. [ 2. It should, however, be carefully noted that the percentages mentioned in the standard formula are percentages to be allowed strictly on time-basis, for any other method may open the way for tax evasion. A person may purchase a film towards the end of the year and claim to be allowed 60 per cent of the amounts in that very year. With a view to safeguarding against such possibilities the rates of 60 per cent, 25 per cent and 15 per cent should be treated as rates per annum. If, for example, the accounting year of a film producer is the year ended December 31, 1947 and film produced during that year came to be exhibited on October 1, 1947, the allowance for amortisation should be as follows: Accounting year Assessment year Rate of amortisation 1947 1948-49 15% (¼ of 60%) 1948 1949-50 45% (¾ of 60%); 6¼% (¼ of 25%) 1949 1950-51 18¾% (¾ of 25%); 3¼% (¼% of 15%) 1950 1951-52 11¼% (¾ of 15%)]. 3. The Board have also decided that the cost of acquiring distribution rights should be treated in the hands of the distributor in the same way as the cost of production is treated in the hands of the film producer, the rates of allowance and the manner of their application being as indicated in paragraph 2 above. Circular : No. 1-D [C. No. 9(48)-IT/48], dated 4-1-1951 . clarification 6 After consulting the Commissioners, I have come to the conclusion that films in the hands of their producers and of their purchaser should be treated as stock-in-trade. In arriving at the closing stock valuation the assessee's figure should be accepted if it appears reasonable. In this connection, it should be borne in mind that since our rates are on a sliding scale and losses are not allowed to be carried forward, an assessee may be tempted to manipulate this figure. As a general rule the greatest deterioration in the value of a film takes place in the first year. Vachha suggests that a film may be valued at 40 per cent of its cost after one year, 15 per cent after two years and thereafter at nothing. Bown suggests a figure of about 30 per cent of cost after one year, 10 per cent after two years and 5 per cent after three years. The Income-tax Officer will have to decide for himself what figures to adopt in each case since the "life" of a film is subject to great variations. Where films are hired for a lump sum for a period of years, the same basis should be adopted. Where they are hired for annual payments, the hire paid will be treated as expenditure of the year in which it is paid. Letter : No. RD No. 178-IT/37, dated 13-5-1937 .