What do Bob the Builder, Noddy and Thomas the Tank Engine have in common? You would be correct in saying they are highly successful children’s animation programmes, much loved by children – and their parents – all over the world. Moreover, they are quintessentially British programmes combining irreverent humour and pathos with a window into British culture and life for viewers.

Worryingly though, you would also be correct in saying that although British in flavour, they are high-profile examples of British animation projects that are developed, produced and shot in foreign jurisdictions. Attracted by favourable animation tax reliefs and subsidies, Thomas the Tank Engine is filmed in Canada, Bob the Builder in the USA and Noddy in Ireland.

They are not the only ones and there is a fear that the cream of the next generation of British animators will have no choice but to move abroad if they wish to pursue a career in the industry. When you add this flight of talent to the on- going struggle for animation production companies to obtain bank finance for new projects, it is easy to see why the UK children’s television industry has been facing an increasingly challenging environment.

It is for this reason that the government announced in its 2012 budget that it would introduce a new animation tax relief (“ATR”). With the aim of re-establishing and cementing the UK’s traditional status as one of the world’s leading producers of high quality, stimulating and exciting children’s entertainment, the ATR will be one of the most generous reliefs of its kind anywhere in the world. Judging from the praise from the UK animation industry’s most significant players, it is likely that the ATR will invigorate the industry, helping productions gain funding from UK broadcasters and private investors that was never previously available. It is also hoped that foreign animation production companies will be enticed to the UK although they will have to comply with the new British cultural test discussed below.

The provisions governing the ATR, introduced in the Finance Act 2013, are set out in the newly inserted part 15A of the Corporation Tax Act 2009. The ATR will be available in respect of qualifying programmes from the beginning of this current tax year.

The Reliefs

Based on a similar structure to the UK’s existing film production tax regime, the ATR allows animation production companies (“APCs”) to claim an enhancement of certain qualifying expenditure. This enhanced qualifying expenditure can be used either as an additional deduction set off against the APCs’ eligible profits chargeable to corporation tax, or alternatively surrendered in return for the APCs receiving a tax credit from HMRC of up to 25% of the APCs’ production expenditure, subject to a cap of 80% of such expenditure, effectively providing a 20% rebate.

The “qualifying expenditure” which is subject to the ATR is expenditure which only relates to the relevant animation programme and which includes expenditure on pre- production, principal photography and post-production.

How the Animation Tax Relief will work

It should be noted that ATR will be applicable to the profits/ losses of an individual animation programme rather than those of the APC as a whole. Each animated programme is treated as a separate trade for the purposes of calculating the ATR.
Where an APC and the animation programme it produces qualifies for the ATR, the APC will be eligible for an additional deduction based on the qualifying expenditure it incurs in respect of that particular programme. This additional deduction, together with any eligible tax deductible expenditure, is deducted from the income derived from the programme.
So, when calculating the profit/loss of the animation project, two deductions are made from a programme’s income: (1) total expenditure allowable for tax purposes; and (2), should the animation programme qualify for the ATR, the additional deduction.
The amount of this additional deduction is the lower of (1) UK qualifying expenditure; or (2) 80% of total qualifying expenditure. UK qualifying expenditure is qualifying expenditure incurred in the UK.
By way of example, say an APC produces, creates and develops a cartoon about a family of bears living in Manchester. This costs £3.5m but it receives £2.5m from a commissioning broadcaster. Of the £3.5m, £3m constitutes qualifying expenditure, £2.5m of which was UK qualifying expenditure.
80% of the qualifying expenditure is £2.4m. This figure is lower than the UK qualifying expenditure of £2.5m and would therefore be used as the additional deduction figure.

The surrenderable loss is the lesser of (1) the post ATR trading loss i.e. (£3.4m) in our example; or (2) the available qualifying expenditure i.e (£2.4m) in our example. Therefore in our example, the available qualifying expenditure is used as the surrenderable loss from which the tax credit is calculated.
The available tax credit would be calculated as follows: 25% of £2.4m = £600k. The animation production company is therefore entitled to a payment of £600k from HMRC taking its losses down from (£1m) to (£400k). It is highly likely that these losses will turn to profit when the distribution and merchandising rights to the animation programme are sold.

Conditions for Relief

For an APC to be eligible to claim ATR, a whole range of conditions needs to be satisfied. These relate not only to the APC itself but also to the particular animation programme. A non-exhaustive summary of some of the more significant conditions is set out below.
A programme will be a qualifying programme for the purposes of claiming ATR if:
• it is produced to be seen on television or the internet.
• it is a programme that is an animation. Animation is not
defined in the Bill and therefore has its natural meaning.
• it is a drama or documentary programme that contains an animation element which constitutes at least 51% of the total core expenditure on the whole programme.
• it is not animation content produced for the purposes of advertisements, current affairs shows, quiz or panel shows, training shows or competition shows.
• at least 25% of the core expenditure on the programme relates to services or goods, used or consumed in the UK.
• it passes a cultural test administered by the British Film Institute and is certified by the Secretary of State for Culture, Media and Sport as a “British Programme”. Further details on this test appear below.
An APC will be a qualifying production company in relation to a relevant animation programme for the purposes of obtaining ATR if:

• it is responsible for pre-production, principal photography and post-production and delivery of the animation programme and it is actively engaged in such activities (“Production Activities”).
• it directly negotiates, contracts and pays for rights, goods and services in relation to the animation programme (“Commercial Activities”).

The ATR will be available in respect of qualifying programmes from the beginning of the current tax year

• there is more than one company which carries out the Production Activities and the Commercial Activities, the qualifying production company will be the one which is the most directly engaged in such activities. There can only ever be one qualifying production company for a qualifying animation programme.

The Cultural Test

Similarly to the cultural test for the UK’s film production tax regime, the animation cultural test has been introduced as a pre-condition to obtaining ATR so that the ATR can comply with EU State Aid rules. State Aid approval of the ATR scheme was granted on 25 March 2013. Like the film production tax regime, the cultural test determines whether the animation programme is “culturally British”.

To assess whether an animation programme is “culturally British”, the test employs a points system. An animation programme will pass the cultural test if it is awarded 16 out of 31 points. There are four categories of points covering cultural content, cultural contribution, cultural hubs and cultural practitioners. What is “culturally British” encompasses in some of the categories listed below the even more nebulous concept of European Economic Area (“EEA”) culture and also programmes set in undetermined locations. As such, with
a creative approach, there is extensive scope for animation production houses to develop programmes which are likely to pass the test.

• Cultural content (16 points available)– measures the British/EEA subject matter of the animation programme – is the programme set in the UK/EEA or an undetermined location; are lead characters British/EEA citizens or from an undetermined location; based on British/EEA subject material; original dialogue in English or minority language;
• Cultural contribution (4 points available)– measures the animation programme’s contribution and representation to British cultural diversity, cultural heritage and creativity;
• Cultural Hubs (3 points available)– measures the use of the UK’s animation making facilities;
• Cultural practitioners (8 points available) – measures the use of EEA citizens or resident personnel in the creation and production of the animation programme.

The British Film Institute has already received numerous applications for the Cultural Test and granted interim assurance in respect of several animation programmes that formal approval will be given together with the requisite certificate as soon the ATR comes into full effect.

Adam Lawrence is a member of RW Blears LLP who since joining has worked on a variety of corporate, tax and regulatory matters including the launch of one of the UK’s first SEIS funds.