Tax Watch has taken a keen interest in the UK games industry recently, so it is no surprise to see another article in the last month that is critical of the games industry. It is disappointing that articles we have seen in the media effectively reiterate the Tax Watch reports without further looking into the benefits that video games tax relief (VGTR) has brought to the UK games industry.
The Cultural Test -- the source of much confusion
To qualify for the relief you must be a UK company and pass a points-based test administered by the BFI (British Film Instutute) and DCMS (Department for Culture, Media and Sport).
A lot of the articles that have criticised VGTR focus on the cultural test, which determines whether a game will be certified as a British video game. The assumption made by many is that if a game does not have British characters or a British setting then it is not culturally British -- the example that is often used is Grand Theft Auto V being set in Los Santos.
"The assumption is that if a game does not have British characters or a British setting then it is not culturally British"
I find it strange that this narrow definition of "culturally British" is assumed to be right. To my mind this ignores the notion that a culturally British game could be one that is made by a team of highly skilled, culturally British and European people working in companies in the UK. That is, diverse teams with exceptional talents and skillsets that would otherwise have to look outside of the UK for work.
By focusing on the most obvious aspects of the test (characters and setting), the Cultural Test is extremely easy to misrepresent -- and this has been the case in the articles circulating online to date. The Cultural Test itself examines different aspects of the game development, including the content of the game (setting / characters / story / language), British Heritage (a game set in Victorian London, for example), British Diversity (i.e., in-game characters that are BAME or LGBTQ+), as well as the development team that actually worked on the game (but only in respect of staff from the UK or EEA).
How can a game like GTA V pass the cultural test?
To pass the test you need to achieve 16 out of a possible 31 points, and the test itself is based on the test used for assessing the film and high-end television tax relief schemes. So, using GTA V as an example, a game set in a fictional American city will probably not score points for "Location," but it can still get the points in other sections of the test -- especially where it is being developed by a UK games studio.
Taking an educated guess I suspect that GTA V may have got points in the following areas of the test (I don't work for Rockstar or Take-Two, so this is just a guess):
- Development Team (up to eight points)
- Underlying Material (up to four points) -- i.e. The script or story. It doesn't have to be set in the UK, but has to be written/created by a UK or EEA citizen.
- Demonstrating British Creativity, Heritage and/or Diversity (up to 4 points) -- Given that the GTA franchise was created by DMA Design (now Rockstar North) back in 1997, it may get some points for Heritage, plus you can get a point for Diversity if the in-game characters or development team includes individuals from minority backgrounds (BAME, LGBTQ+).
- Showing that 50% of development/programming/design/music/audio takes place in the UK also counts (up to three points).
As you can see from these estimates, GTA V potentially gets up to 19 points and passes the threshold of 16 to qualify for the relief. The arguments made against Batman and GTA V being British only look at one small part of the test; that is, what you can see visually and the location that the game is set. However, as I've mentioned above, the test looks at this as well as who is actually involved in making the game and where the game itself is made, so it is far more nuanced than Tax Watch gives it credit for.
This information about what is required to pass the Cultural Test is also available on the BFI website, so anyone can deduce the elements required to pass the test -- and can see that it is more than just British characters and British location. However, most of the reports to date don't appear to have done so.
As I mentioned above, the Cultural Test itself is taken from the world of film and high-end television. That is why films such as Gravity and shows like Game of Thrones are also considered "British" -- the tests look at more than just the film/show/game itself, also considering who is making it. That is important.
"The simple fact is that there is more to being British than top hats, cups of tea and Big Ben"
The simple fact is that there is more to being British than top hats, cups of tea and Big Ben. Restricting VGTR to games that only meet a stereotypical viewpoint of "British-ness" represents a very narrow-minded interpretation as to what it means to be culturally British -- and completely ignores the effort that development staff put into these games, and the types of stories that can be told.
This narrow view as to what a "culturally British" game is should not be assumed to be right. You cannot ignore the contributions to GTA V and Batman that were made by teams of highly skilled, culturally British people.
How is VGTR calculated and what is the value?
The reporting in the press about the value of the relief could be clearer. The value of VGTR relief is calculated against a UK game developer's "core expenditure."
Core expenditure extends to any money spent on "designing, producing and testing" the game, but only core expenditure spent on game development activity in the UK and EEA is eligible for the relief (the EEA bit was required by the European Commission back when the relief was granted). This can cover a lot of development spend, but expressly excludes costs spent in pre-production (so coming up with the idea and developing a prototype of the game), and money spent on marketing is also excluded.
The relief itself works two-fold: if the game development company makes a profit then VGTR can reduce the company's taxable profits, meaning that it pays less tax and has more money to spend on staff or other development activity. Where the game developer is loss making, then it can surrender those losses to HMRC for a payable tax credit (essentially a cash payment from HMRC). The payable credit rate is a maximum of 25% of either: (i) a UK development company's actual core expenditure incurred in the UK and/or EEA; or (ii) 80% of a UK development company's total core expenditure, whichever is lower.
The tax credit element of the relief (described above) is actually brilliant, especially for smaller development teams or indies. We often see indies use the tax credit relating to a game they have just shipped to help start development on their next game.
Intention of the relief
The MCV article reports that VGTR "was designed to help smaller producers of culturally British games." To some extent this is true and, as mentioned above, VGTR has proved so far to be extremely valuable to the survival and success of indie game developers in the UK.
However, the real driving force behind the relief being introduced was to allow the UK games industry to compete with similar reliefs that were available in countries like Canada and France. The real purpose here was to encourage inward investment into the UK from overseas -- which the UK was losing to these countries -- as well as the creation of more games sector jobs in the UK. The knock on is that smaller developers also benefit from the relief, which is extremely beneficial and lots of great indie developers credit VGTR with helping keep the lights on when budgets are tight.
"Lots of great indie developers credit VGTR with helping keep the lights on when budgets are tight"
VGTR is only available to UK developers so it is a bit misleading to say that VGTR is "corporate welfare for multinational companies." The fact is that UK games companies (whether they are subsidiaries of multinational companies or not) are validly claiming tax relief on money they have actually spent on making games in the UK/EEA.
VGTR works by offering a return against money actually spent in the UK or EEA, so if you need to spend £4 on developing your game to get £1 back in VGTR (where the company does not make a profit). By way of example, a company claiming £500,000 in VGTR may have spent around £2 million in the UK/EEA -- that makes the scheme a great success. The articles that are critical of the scheme also ignore the other contributions that companies like Rocksteady and Rockstar North make, such as all of the jobs created, national insurance and pension contributions, the income tax that their staff will pay on their salaries, and so on.
Why using details of game sales is misleading
There is a big deal made about Batman: Arkham Knight selling five million copies, and then being critical of Rocksteady for declaring a loss in its accounts. The articles by Tax Watch and MCV make the assumption that Rocksteady was to be remunerated by its parent company, Warner Media, based on the performance or sales of the game.
However, this assumes a lot about the terms of the development agreement and terms between Rocksteady and Warner Media. Not all such agreements will allow for a revenue share based on game sales. Typically, development arrangements are "work-for-hire" with no back end revenue share.
As the details of the development agreement between Warner Media and Rocksteady are not public information, it is misleading to say that the game has sold "X" and yet the developer has only recorded "X" from this game on its balance sheet. Despite Warner Media owning Rocksteady, it is not obliged to provide its subsidiary with a share of game sales.
Confusing the issues
"Without VGTR, Rocksteady likely would have to outsource development activity to a cheaper territory"
At the foundation of each article that is critical of VGTR, there are two prominent issues that appear to be mixed together: (i) large multinational companies structuring their operations in such a way to pass less tax (as we have seen with Google, Facebook, Starbucks and Amazon); and (ii) the assumptions and criticisms that games such as GTA V and Arkham Knight cannot be British games because they are not set in the UK or have any British characters.
On the first point, we would need to see more evidence or information to say whether the allegations of profit shifting or tax avoidance are true of Take2/Rockstar, Warner/Rocksteady, or Sega/Creative Assembly. However, what we can say is that the contributions that these companies bring to the UK games industry and economy extend beyond paying corporation tax and should not be ignored for a catchy headline.
If Rocksteady, for example, is posting a tax loss after they have paid PAYE, National Insurance and pension contributions, then the net benefit to the UK economy is still positive even after Rocksteady receive VGTR. The alternative is that, without VGTR, Rocksteady would possibly not have the resources to pay its UK staff (or cover its existing tax liabilities), and likely would have to outsource development activity to a cheaper territory. In that instance, the UK economy and the UK games industry both lose.
On the second point, in terms of what makes a British Game and the cultural test, I disagree that these games should not qualify because there is nothing "British" about them. That is simply not true, and the test itself measures "culturally British" against more than setting your game in the UK.
The importance of VGTR
The UK is extremely good at making games, and boasts a wide range of incredibly talented game development and publishing companies -- from indies to AAA. These companies (and the individuals working for them) are making ground-breaking games, and pushing the boundaries of creativity. This aspect of being "culturally British" should not be ignored, and the Cultural Test in its current form rightly takes the efforts of the individuals working on the games into account.
Making video games is extremely expensive. If we want to continue to encourage growth and innovation in a sector that employs thousands of people in the UK across many disciplines -- from programming to art to animation to production to music -- then VGTR is an essential part of making that happen.
Tim is a games, IP and finance lawyer in Sheridans' renowned Interactive Media team. He is widely regarded as the “go to” legal and commercial advisor for independent game developers, having been recognised by GamesIndustry.biz as one of the “rising stars in the games industry,” and listed in The Legal 500 as a Next Generation Lawyer for his advice to games companies. Tim is also a huge advocate for indie games and helps run Bonus Stage, an indie games showcase that takes place each year as part of London Games Festival. You can find him on Twitter at @tagdavies.