Connected Party Rules Across Creative Sector Tax Reliefs

Paying a company you own, or one under common control, is routine in creative production, whether that's a sister VFX studio, a venue management company or a related props business. For the Audio-Visual Expenditure Credit (AVEC), Video Games Expenditure Credit (VGEC), Theatre Tax Relief (TTR), Museums and Galleries Exhibition Tax Relief (MGETR) and Orchestra Tax Relief (OTR), those payments can reduce the expenditure you're able to claim.

The rule works in almost exactly the same way across all five reliefs. This post sets out what counts as a connected party, how the arm's length exception works, what you need to disclose, and the few points where HMRC's guidance differs between reliefs.

What counts as a connected party?

HMRC defines a connected party by reference to corporation tax law, and the same definition applies across all five reliefs. The HMRC guidance on the meaning of 'connected' turns on control and personal relationships, and it covers more than group companies.

An individual is connected with their relatives, their spouse or civil partner and with the relatives of their spouse or civil partner, and with their business partners and those partners' relatives. Settlements and trusts create connections too.

Two companies are connected if the same person controls both, or if control passes through people who are themselves connected.

A company is connected with a person who controls it and with that person's connected persons.

In practice, that means a supplier owned by a director, or by a director's family, can be a connected party even if it sits outside your group structure.

How do connected party transactions affect your claim?

If you pay a connected party for goods or services, HMRC excludes the connected party profit from your qualifying expenditure. Connected party profit is the amount by which your payment exceeds what the supplier actually spent to provide those goods or services. Only the profit element is excluded, not the whole payment.

The rule aims to reduce the risk of companies claiming large amounts charged by a connected party to inflate their relief, while the profits remain within the group.

Here is what it looks like in practice:

A production company pays a connected VFX studio £5 million for visual effects work. The studio's own costs of delivering that work were £2 million, so the connected party profit is £3 million. Unless the arm's length exception applies, that £3 million is excluded and only the £2 million counts towards the claim.

The calculation is the same in every sector.

How does the arm's length exception work?

The exclusion doesn't apply if the transaction meets the arm's length provision. HMRC sets the test like this: “the payment made as part of a transaction must be set as if the connected parties were unconnected.”

This essentially means asking what an independent supplier would have charged for the same goods or services. If your connected supplier charged that price, any profit built into it is acceptable.

You can support the price with comparable transactions between unconnected parties or with industry standard margins. A full transfer pricing analysis is useful evidence, but HMRC says it isn't a requirement, and small and medium-sized businesses stay outside the transfer pricing rules even when they apply the arm's length principle to a claim. HMRC also accepts that different transfer pricing methods can give different arm's length values; as long as the method you use is reasonable, the exception applies.

A theatre production company hires props from a connected company. The connected company charges the same rates it charges unconnected third parties, and the production company holds evidence of those rates. Any profit in the price is justified, so the expenditure isn't restricted.

Chains of connected parties

Passing work through an intermediary doesn't avoid the rule. When goods or services reach you through a chain of companies, HMRC looks through the chain to the original supplier's costs to work out the connected party profit, however many companies are in it.

A production company pays a connected company £100,000 for a sound crew. That company passes the work to its subsidiary for £80,000, and the subsidiary's actual cost of supplying the crew is £60,000. HMRC ignores the £80,000 step and compares the £100,000 payment with the £60,000 original cost, so the connected party profit is £40,000.

That's why the rule can't be managed by adding a layer between you and the company doing the work. It also means you need to know what the original supplier spent, not only what your direct supplier charged you.

What do you need to disclose to HMRC?

Every relief requires you to disclose connected party transactions when you claim. For all schemes, the disclosure sits in the Additional Information Form. You declare whether your claim includes connected party expenditure, how many connected parties you transacted with, and the combined value of those transactions.

You then upload a document listing each transaction with:

• the name of the connected party;
• the date of the transaction;
• the value of the transaction as claimed; and
• a description of the goods or services supplied.

In some cases, you may be able to bundle transactions, like multiple employees paid at the same rate.

What this means in practice

Connected party transactions are easiest to manage when you deal with them while the production is being budgeted, not when you prepare the claim. A workable routine looks like this:

1. Identify which suppliers are connected with your production company before you agree prices.
2. Compare each connected price with what an independent supplier would charge, and keep the evidence you used.
3. Where a connected supplier passes work through other companies, find out the original supplier's actual costs.
4. Record each connected party transaction as it happens, so your disclosure is complete when you claim.

Key takeaways

• Same rule across all five reliefs. AVEC, VGEC, TTR, MGETR and OTR all exclude connected party profit from your qualifying expenditure.
• Only the profit is excluded. The excluded amount is the difference between what you pay and what the original supplier spent.
• Pricing evidence decides the outcome. A price set as if the parties were unconnected (at arm's length) gives you an exception.
• Disclosure is required. Every connected party transaction needs to be declared and listed when you claim.

If you're using connected suppliers on a production and want to check how the rules apply to your claim, don't leave it to chance. Contact Myriad to talk it through.