The UK’s long-awaited Video Games Tax Relief received European Commission state aid approval on 27 March 2014, meaning that the full introduction of a tax relief which was announced in the 2012 Budget is within sight (likely to be later this month). Neil McKnight, a Senior Associate in the Tax and Incentives Group at Taylor Wessing, provides an overview of the tax relief.
The UK’s video games tax relief provides welcome support to UK video game developers, giving qualifying video game development companies the opportunity to either reduce their UK corporation tax bill or, perhaps more importantly, receive a cash tax credit from the Government. Originally targeted for introduction on 1 April 2013, delays to the relief – caused by delays in European state aid approval in part due to fears that the relief may promote a subsidy race between Member States - have been much publicised, causing many to question whether the relief would ever be introduced.
However, and with a few last minute tweaks (most notably the extension of the tax relief to expenditure incurred in other European Economic Area countries), the tax relief will soon be introduced, and will be available to UK companies incurring expenditure on the development of “culturally British” games which are intended for commercial release. The tax relief will be backdated to development expenditure incurred by such companies on or after 1 April 2014 – disappointingly not 1 April 2013 as was originally intended.
What kind of game will qualify?
One of the most important questions is what is a video game? It is clear that the Government has recognised that the video games market is constantly changing and evolving, so it has decided not to try and define the term restrictively. Instead, ‘video game’ has been given its natural meaning which means that the tax relief should keep up with new game formats as they come to market.
However, certain types of game cannot qualify for tax relief. Games which are produced for advertising or marketing purposes (for example, apps tied to new product launches), real money (gambling) games or apps, and those which contain pornographic or “offensive” material are specifically excluded and, as the tax relief is intended to support developers bringing new games to market, it will not be available if the game was not, from the outset, developed with the intention that it be exploited commercially and supplied to the general public.
“Culturally British” test
The “culturally British” test is perhaps the most complicated aspect of the tax relief, as the “Britishness” (or, following the recent changes, the “Europeanness”) of games is to be determined by reference to a points test (the game must score 16 points out of a possible 31) administered by the British Film Institute (“BFI”) based on the well-established test used for the UK’s successful Film Tax Relief.
Although the test is yet to be finalised, the draft regulations which set out details of the test have been available for some time and the BFI has recently released guidance on how the test will work in practice.
The majority of these points will be awarded if the game is set in the EEA (including the UK), if it depicts characters who are EEA nationals, or if it is produced in English. Points are also awarded if the game is developed by EEA nationals in the EEA. The Department for Culture, Media and Sport is responsible for certifying that the game scores enough points and it will not be possible to claim the tax relief without obtaining a certificate to this effect.
The BFI has produced a summary of how the points will be allocated under the cultural test, which may be found on their website: http://www.bfi.org.uk/film-industry/british-certification-tax-relief/cultural-test-video-games/ summary-points-cultural-test-video-games.
How will the tax relief work?
As a starting point the tax relief is only available to companies who pay UK corporation tax (which means that the company must either be managed and controlled in the UK, or it must have a branch or permanent establishment in the UK). To qualify, at least 25% of the “core” expenditure on the game – that is expenditure on the designing, production, and testing of the game – must be incurred in the UK or in another EEA country. Additionally, the development company must be established before any development activity begins (it is not, for example, possible to transfer a development project into a new UK company in order to claim the tax relief).
The tax relief is given as an additional UK corporation tax deduction in respect of the direct costs incurred by the developer in the design, production and testing of the new game. Although the additional deduction could amount to a further 100% of the expenditure actually incurred in the UK or another EEA state (so for every £1 of UK or EEA expenditure incurred, up to £2 of tax relief may be available), in practice this additional deduction will be subject to an overall cap of 80% of the total expenditure incurred by the developer on the video game.
The tax relief should be available for primary expenditure on video game development such as salaries of coders, designers, software engineers, business overheads relating directly to development activity and the costs of creating a soundtrack for the game. Tax relief may also be claimed on sub-contracted development activities, although this is subject to a £1million expenditure cap.
The tax relief will not, however, extend to expenditure incurred on devising the initial concept of the game, nor to debugging, updating and other costs once the game has been released (including ongoing maintenance costs such as, for example, server maintenance costs for cloud-based games).
For video game developers wishing to claim tax relief the normal rules which determine how, and when, revenues are recognised and how profits are calculated are modified slightly. Broadly, this means that income should be recognised as expenditure is incurred even if the revenue has not actually been received. This means that developers will be required to estimate the revenues to be generated by the game and, at the end of each accounting period, treat a proportion of that estimated revenue as earned in that period. That proportion is calculated by reference to the proportion of the development costs incurred in the accounting period and which are represented in the work that has already been done on the game. This does not, however, mean that developers are required to recognise speculative revenues - so, for example, if at any early stage of development the developer contracts to licence the game it would be required to recognise the revenues under that licence but it would not be required to recognise sales forecasts.
In later periods credit is given for revenue already treated as earned to ensure that the same revenue is not taxed more than once. The estimate should be revised at the end of each accounting period to take into account any revenue actually earned in that period.
Procedure for claiming the tax relief
Claims for tax relief should be made in the company’s “CT600” corporation tax return, in respect of qualifying expenditure incurred after 1 April 2014.
Before claiming the tax relief the developer must have received certification from the BFI that the game meets the cultural test – which will be given either on an interim basis if the video game is still in production, or on a final basis if the game has been completed. Although the BFI is unable to issue certificates until the final legislation is enacted it is accepting draft applications and will provide written comfort that certification will be given (assuming the relevant conditions are met).
Summary of the tax relief
- Tax relief will be available to video games development companies and will be given by increasing the available tax deduction for expenditure directly incurred in the design, production and testing of the new game.
- Total tax relief will be up to 180% of the expenditure incurred.
- Loss-making video game development companies will be able to surrender losses to HMRC in exchange for a cash tax credit equal to 25% of the surrendered loss.
- Expenditure incurred in other EEA jurisdictions, as well as UK expenditure, will be eligible for tax relief, although sub-contracted expenditure will be capped at £1million.
- To qualify for tax relief, video games must pass a “culturally British” test.