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The Producer Offset: why there’s a watching brief on films and reinvestments

Ten years after its introduction the Producer Offset (PO) is proving invaluable to producers not accessing any other government funding. But there are concerns.

First: a recap on the PO and how it works. In very broad terms, the PO is worth up to 40% of the cost of production to feature producers and is claimed upon completion – up to rather than 40% because it’s only payable on qualifying Australian production expenditure (QAPE) and some expenditure can’t be counted. So a film costing say $1.5 million could get up to $600,000; a film costing $15 million up to $6 million.

The value of the Producer Offset also represents the Australian producer’s equity in the film, giving them a position in the recoupment waterfall and an ongoing stake in the success of the film. See the Skin in the Game: The Producer Offset 10 Years On report for further context and information about the mechanics of the Producer Offset here.

Eligible feature films have to be Australian, at least 60 minutes in length (45 minutes in the case of IMAX) and be produced for exhibition to the public in cinemas. Part of Screen Australia’s role as administrator is to make decisions about eligibility and in that process it does not make judgments about a film’s content.

Second: here’s an interesting statistic. In each of the last three years 25-30% of all Australian feature films – excluding documentary – have received the Producer Offset (PO) without any other funding from federal and state agencies or film festivals. Put another way, at least a quarter of the slate is getting government funding through the tax-based incentive only. (More about the data comes later.)

Third: there is a particular concern. Arguably the statistics indicate that this is a feature film production pathway that’s now embedded in the film financing landscape. But producers taking this path need to beware. Why? Because alarm bells are ringing at the growth in films that set out on this trajectory having unreasonably high fees, a big proportion of which are being reinvested with the expectation that all will be regarded as QAPE. (This will be spelled out later.)

FOR THE PURPOSES OF THE PO, WHAT IS A FEATURE FILM?

There are many complexities to administering the PO but one matter that consistently keeps Michele McDonald, Senior Manager of the Producer Offset and Co production Unit (POCU), awake at night is the threshold question of what constitutes a feature film.

A lot hinges on this question for producers because feature films, including animated and documentary features, are the only format eligible to receive 40% of QAPE via the PO – other eligible productions, television drama for example, get half that.

One of the reasons for this is that when the Offset was introduced back in 2007, the 40% rebate afforded to feature films was to acknowledge the higher cost of making theatrical feature films – e.g. shooting on film, higher cast fees – as opposed to television programs. While McDonald acknowledges that this is no longer necessarily the case, producers should understand that POCU is still operating under the same tax legislation and Screen Australia can’t change this; only the Government can change what gets 40% and what gets 20% PO through legislative amendment.

The current tax legislation only makes brief reference to this: a film, it states, has to have been “produced for exhibition to the public in cinemas”. The interpretation fell to Screen Australia and decisions are solely based on section 2.5.4 of the agency’s PO Guidelines.

To further emphasise this, a feature length straight-to-SVOD film (say, a film for Netflix) gets the 20% PO.

Ten factors are considered. Three of them relate to the attachment of an Australian theatrical distributor and the nature of that distributor’s financial commitments and plans. If a well-known theatrical distributor is attached, has paid a meaningful minimum guarantee and plans a 100-screen cinema release there’s little question that what’s being made is a feature. The issue is tricky if the applicant is adopting a cinema-on-demand model or planning to self-distribute the film, which might involve dealing directly with exhibitors. A four-wall arrangement where the producer pays a flat fee to book out a cinema screen is not considered a bona fide release. Questions can also arise around small boutique distributors with little track record of getting films into cinemas.

Other factors in a film’s favour when feature film certification is being sought include elements typical of a feature film such as: the presence of arm’s length film investors, a theatrical sales agent or international theatrical sales being in place; cast being engaged on industry-standard feature contracts; and plenty of experience on the creative team in getting projects into cinemas.

McDonald says a common criticism from some filmmakers is that they are being forced to sign bad deals with unenthusiastic distributors, but she counters this by saying that people other than the filmmaker’s friends, family and associates have to express interest in a project’s theatrical suitability and viability via a commercial deal in order to have the 40% approved.

The challenge of determining whether something is a feature film is made even more difficult because POCU is usually considering the matter well before the film goes into production.

Mad Max: Fury Road

SECURING A PROVISIONAL CERTIFICATE PROVIDES CERTAINTY

Producers generally borrow money prior to production secured against what they will get back from the PO once a film is completed. A project has to obtain a final certificate to claim the PO and applications for final certificates can only be made once a film is completed. It therefore can have very serious implications to get the PO at 20% when 40% was expected.

Getting a provisional certificate first is not obligatory but can remove uncertainty: McDonald says no project with provisional approval as a feature has ever been refused a final certificate as a feature where nothing about the film changed. This is true even when the planned theatrical release did not go ahead: maybe the film didn’t turn out as well as hoped, the distributor realised they had five horror films including that one to usher into cinemas, or something else happened that was beyond the control of the producer. That said, the creative team might be more carefully scrutinized when they apply for certification with a new project.

“The bar on assessing distribution at provisional certification stage is high because the PO is taxpayers’ money … "

“The bar on assessing distribution at provisional certification stage is high because the PO is taxpayers’ money and once we make a decision on this we specifically state that we will not revisit it unless the key elements change. We also err on the side of caution for the sake of producers. Not all projects will be approved as features at the provisional stage but the producers can still apply at the final certificate stage for the 40% and, if they can demonstrate there was a genuine theatrical release, be successful.”

Provisional certification is often necessary anyway because traditional film lenders won’t lend against a 40% rebate unless it has been approved by Screen Australia. They often seek assurance directly from POCU staff on the mechanics of the offset and whether the PO can be abolished at a whim – it can’t because the legislation would have to be repealed by Parliament. This provides certainty and comfort to lenders.

It was once necessary to acquire a provisional certificate before applying for direct funding from Screen Australia. The number of provisional certificates that never went on to apply for final certificates has fallen since this was changed in April 2017. The assessment fees also discourage applications for projects not definitely going into production. Fees range from $127 (for a project budgeted at less than $1 million) to $4,441 (more than $30 million).

REINVESTMENTS ARE CAUSING A CONCERN

As stated at the outset, increased levels of reinvestments in feature films are causing concern in POCU. Let’s spell out the concern. A director or producer with limited or no feature filmmaking experience is paid a fee of about $400,000. In anyone’s book, this is way over the market rate. Of this amount, $300,000 is reinvested into the production budget as an equity stake with potential returns. This means the director or producer is an “interested party”, that is, someone who has a financial interest in the film beyond their fee. Under the relevant section of the tax legislation that addresses related party transactions, this obliges POCU to assess the expenditure and confirm it is charged at a market rate.

The fee paid to a director or producer falls under QAPE but if it is determined that the fee is indeed above an arm’s length market rate not all of it will be regarded as QAPE. Back to the example: 40% of $400,000 adds a not insignificant $160,000 in government funding compared to the $40,000 that would apply if the director’s or producer’s fee was $100,000.

The legislation also restricts to 20% of total film expenditure what can be claimed as QAPE on above the line (ATL) fees. However, if the budget has been inflated because of the high level of fees due to reinvestments the 20% cap becomes less of a guide when assessing arm’s length. Above the line refers to those key creators with the biggest influence on the film such as writer, director, producer and cast.

Reinvestments seem to be frequently appearing at the low end of the budget scale. The PO was not set up to support very low-budget films. Attempts by filmmakers to use reinvestments to get their films above the $500,000 QAPE threshold will be closely examined in terms of whether the related party transactions are market rate.

DECISIONS ARE MADE IN CONJUNCTION WITH THE INDUSTRY

POCU has no jurisdiction over what producers pay cast and crew. Producers can pay above market rates if they want to.  But POCU does have jurisdiction over how much QAPE can be attributed to that payment when the amounts are to interested parties, which determines how much can be claimed from the Australian Tax Office (ATO) under the PO. And that’s the issue here. (Screen Australia’s direct investment arm, however, may take a view on appropriate fees on films it has invested in.)

Decisions on market rates are made in partnership with industry, says McDonald, and about 20 very experienced line producers, production accountants and others have been trained on the intricacies of the PO and are called upon for advice. There’s also 10 years’ worth of data to refer to.

“Producers sometimes ask us to tell them what the market rate is for a particular budget line item however, as the Film Authority (for the PO), it’s not our role to set rates,” McDonald says. “It is the producer’s responsibility to benchmark, negotiate and demonstrate to us that what they’re paying is appropriate for the film in question.

“We are committing taxpayers’ money on behalf of the government and we take that responsibility seriously. Even though it is an uncapped incentive we have to maintain the integrity of the intent of the legislation and report to Treasury every quarter on what has been paid out.”

“ … we have to maintain the integrity of the intent of the legislation ... "

More and more below the line crew appear to be getting higher than normal fees too and reinvesting a portion: sometimes the weekly rate will be high; sometimes it will be the going rate but the crew member is working on the film for an unusually long time making the total fee outside the market range: “An editor just out of film school working from home on Final Cut Pro might be getting an acceptable weekly rate but it’s being claimed for a full year, and they’re reinvesting a big portion,” she says. “We’re also seeing increases in post costs by post houses investing in features and office expenses and overheads being reinvested.”

“In any of these cases we have to ask ‘what’s reasonable?’ and ‘would it be different if it were a third party not an interested party transaction?’ Traditionally reinvestments were used to fill small gaps in finance plans – that last 5%. Not anymore. Sometimes it appears to be in order to reach $500,000 QAPE, which a film must have to claim the PO, sometimes to maximize QAPE and therefore the size of the claim.”

McDonald confirms that, if, during the final certificate assessment, a fee or service is considered to be above the market rate, QAPE will be reduced to what is considered commercially reasonable for the film. “We will always have discussions with the applicant and give them an opportunity to substantiate the claim, however at the end of the day if the QAPE claim is considered to be unreasonably high it will be reduced accordingly”. Producers need to be wary of entering PO loans based on QAPE figures boosted by significant reinvestments.  They may find that the final offset cannot clear the loan.

McDonald also advises all creatives and crew to get independent tax advice because of the potential implications: “People have to declare the full amount as taxable income in their tax returns and may have a big tax debt as a result. This is irrespective of if they ever see the cash from their equity investment. They have to understand what they’re signing. The ATO is aware of the reinvestment structure and may check, on a case by case basis, what is being declared in individual and company tax returns.”

A PO committee meets fortnightly. Besides being alert to fees/reinvestment and distribution arrangements, projects with numerous non-Australian elements and those likely to make significantly high claims are also examined carefully. The members are all from within Screen Australia: the Chief Executive (Graeme Mason); Chief Operating Officer (Michael Brealey); Head of Content (Sally Caplan); Head of Business Affairs and Offset (Tim Phillips); and POCU Senior Manager (Michele McDonald).

The Great Gatsby

CRUNCHING THE NUMBERS

As mentioned, in each of the last three years 25-30% of the Australian feature film slate had received the Producer Offset (PO) without any other funding from federal and state agencies or film festivals.

The table below that bears this out is taken from the extensive data gathered annually for Screen Australia’s annual drama reports (See here for the 2016/17 edition) so documentary features are not included. Also not included are some very low budget films. See note (2). The second table is also taken from this data.

Films are attributed to the financial year in which they began principal photography and the full budget is allocated to that year. In other words, if filming began on a $10 million film on 25 June 2015 the film is counted as a 2014/15 title and the budget is counted in that year.

AUSTRALIAN FEATURE FILMS ACCESSING THE PRODUCER OFFSET (PO)

2014/15-2016/17

14/15 15/16 16/17 Three-year average Three-year total
Accessed the PO and other government money 26 22 25 24 73
Accessed the PO but no other government money 10
(25.6%)
8
(25%)
12
(29.3%)
10 30
Did not access the PO (1) 3 2 4 3 9
TOTAL 39 32 41 37 112
  1. These films did not spend enough to access the PO – QAPE must be $500,000 in order for a claim to be made.
  2. These totals represent all the Australian feature films (drama) made except those budgeted under $500,000 that did not get a cinema release or a festival screening.

AVERAGE BUDGETS OF AUSTRALIAN FEATURE FILMS ACCESSING THE PO

2014/15-2016/17

14/15 15/16 16/17
Accessed the PO and other government money (1) $4.5m $8.6m $10.9m
Accessed the PO but no other government money $1.5m $2.4m $5.7m (2)
  1. “Other government money” might include direct funding from state and federal screen agencies and film festivals, whether that be development, production or post money. Some of these films go into production with the creative team thinking they may only have taxpayer funding available to them via the PO but subsequently they find additional government support: one to four films per year receive post-production/completion money from Screen Australia, for example. 
  2. A small number of titles with substantial budgets pushed up the average.

The two tables below come from a different source: POCU itself. All applicants for certification for the PO must tick a box within the online application form to indicate format. The following two tables captures three years’ worth of applications, resolved in that time frame, that had ticks in the feature film, animated feature or documentary feature boxes.

Final certificates cannot be sought until a film is completed so the 145 films included in the first table represent finished films. It is believed that they also represent every application for feature film status that was submitted. (That said, if a project was issued a certificate in a format that differs from what was originally on their application form the database would have been amended to reflect the certificate issued not what was applied for. Without a manual check of all applications, it cannot be categorically stated that there were no applications that failed to be certified for either the 20% or 40% PO. This clarification applies to both final and provisional applications.)

FINAL CERTIFICATES ISSUED FOR FEATURE FILMS

2015/16-2017/18

ALREADY HAD A PROVISIONAL CERTIFICATE AT 40% (1) HAD A PRO-VISIONAL BUT NOT AT 40% (2) DID NOT HAVE A PROVISIONAL (3) TOTAL
15/16 16/17 17/18 15/16 16/17 17/18 15/16 16/17 17/18
Feature films 24 32 26 4 5 5 4 5 5 110
Feature animation 1 1 0 0 0 0 0 0 0 2
Feature documentary 7 7 12 2 2 0 0 2 2 34
TOTAL 32 40 38 6 7 5 4 7 7 146
  1. None of these 110 projects that already had a provisional certificate as a feature film were refused a final certificate.
  2. These 18 projects had provisional certificates but not at 40%. The applicants either did not have theatrical distribution approved against the criteria in the PO guidelines or did not request a ruling on distribution – they may have applied for provisional certification because they may have had concerns about passing the significant Australian content (SAC) test or they did not have a distributor attached and intended to pass the theatrical hurdle only at final certificate stage. The schedule to the provisional certificate would have noted that theatrical distribution had not been approved. The filmmakers would have proceeded on the basis that they were only sure they would get the PO at 20%.
  3. The applicants behind these 18 films did not have a provisional certificate and had not applied for one. (One did but withdrew the application prior to consideration for reasons unrelated to the PO.)

PROVISIONAL CERTIFICATES ISSUED FOR FEATURE FILMS

2015/16-2017/18

The 202 feature film provisional certificates included in this second table were provided before a film went into production. (Bear in mind that some of the projects referred to here would also be in the table above).

Approved at 40% (1) Approved at 20% (2) Distribution not considered (3) TOTAL
15/16 16/17 17/18 15/16 16/17 17/18 15/16 16/17 17/18
Feature films 34 25 44 5 3 4 8 14 7 144
Feature animation 0 0 5 0 0 0 1 1 0 7
Feature documentary 7 12 18 0 2 4 2 2 4 51
TOTAL 41 37 67 5 5 8 11 17 11 202
  1. These 145 applicants over the three-year period could safely assume they would qualify for the 40% PO when they came to apply for a final certificate providing they made the film in the way they had outlined in their provisional application.
  2. These 18 applicants received provisional certificates but the schedule to the certificate noted that theatrical distribution had not been approved. The filmmakers would have proceeded on the basis that they were only sure they would get the PO at 20%. It is possible, however, that they might get final certification at 40%.
  3. These 39 applicants did not ask for a judgment on whether the film was being produced for exhibition to the public in commercial cinemas. It is possible that they might get final certification at 40%.

Thanks to Information and Research Analyst, Strategic Policy and Industry Insights Natasha Aslanian and Coordinator, Producer Offset & Co-production Kym Stewart for the number crunching.