This will upset some people, but John just isn’t a financial expert. His stabs at trying to understand the new UK tax relief rules for games development have been enthusiastic, but inexpert. Which is why we’ve turned to Chris England – developer of Xenonauts, and qualified accountant. As an independent developer, and a financial expert, the subject affects and interests him directly. So he’s taken a deeper look to see how it really applies to the UK’s indie developers, and why it fails to take into account the newer methods for funding development.

Back in March, the UK government made all of us happy by announcing that 2013 would herald the arrival of a new tax relief for the video games industry. They confirmed this in the Autumn Statement last week – but what does the draft legislation actually mean for British indie companies? Well, it’s (qualified) good news! The tax relief being proposed is pretty generous. Here’s a simple breakdown of how it will work.

Unsurprisingly it is calculated based on the development costs incurred in making a game, but specifically it refers to the “core expenditure”.

What counts as core expenditure? Most things, really. It’s a general term that encompasses the cost of designing, producing and testing the game. The most notable exclusion is marketing, but also specifically discounted are the costs in producing the initial concept for the game and debugging or “maintenance” work on a completed game.

If more than 25% of this core expenditure is spent in the UK, congratulations – you meet the financial criteria for the tax relief!

If so, this core expenditure is placed in a separate pot, with a different pot for each game in production. Also added to the pot is any income received from that game (pre-order sales or Kickstarter revenue, for example). This gives a core profit / loss for each game, which can be used in two ways.

The first is a 100% tax relief on the lower of either:

1) 80% of the core expenditure

2) 100% of the core expenditure spent in the UK

The second is a 25% tax credit, which can only be taken if the calculation of the core income / loss for a game has come out as a loss. If there is a loss, that amount can be surrendered to receive a 25% tax credit on the amount of the loss.

Here’s an example to show how it works in practice:

A UK indie begins work on a game 2013. Inevitably, it will be called NOUNFACE. NOUNFACE takes two years to produce, costing £20,000 in total. In 2015, NOUNFACE is released on Steam and the company receives £50,000 in sales.

Without Tax Relief

• There is a net profit on NOUNFACE of £30,000. (£50,000 – £20,000 = £30,000)

• In 2015, the company pays £6,000 of tax at the 20% small company tax rate ( £30,000 * 20% = £6,000)

• This leaves the company with £24,000 total profit, received in 2015.

Tax Relief

• There is £50,000 of income for NOUNFACE and £20,000 of core expenses.

• £16,000 extra tax relief arises (£20,000 x 80% = £16,000)

• This gives a net profit of £14,000 (£50,000 – (£20,000 + £16,000) = £14,000)

• The company pays £2,800 tax (£14,000 * 20% = £2,800)

• This leaves the company with £27,200 total profit, received in 2015.

Tax Credit

• NOUNFACE spends two years in development, each costing £10,000. Therefore there is a £10,000 loss in both 2013 and 2014.

• The company can surrender this loss in return for a 25% tax credit, worth £2,500 per year (£10,000 * 25% = £2,500)

• On release, the net profit is £30,000 and the company pays £6,000 tax as normal.

• The company therefore receives £2,500 in 2013, £2,500 in 2014 and £24,000 in 2015. This is a total post tax profit of £29,000.

Both the tax relief and the tax credit are useful, but the 25% tax credit is the better option. A developer receives more money in total and also receives a portion of it earlier than they would if they just used the tax relief (allowing it to be spent on development).

Simple, eh? But the maths hides a few important issues, the largest of which is the infamous cultural test. In short, you’re not entitled to any tax relief if your game is deemed insufficiently “British”.

This is down to European Union law. Nations can’t offer direct financial aid to companies as it would give them an unfair advantage over others in the common market, but for some reason it is allowable to offer them based on promoting culture. Hence the cultural test.

This presents an additional obstacle, but it isn’t an impassable one – particularly for gamers, who are more used than most to operating within arbitrary sets of rules. The full test can be found here, but there are a few key points:

• You need 16 points to pass the test.

• You get 4 points if more than 75% of the game is set in the EEA (pretty much all of Europe), or 3 points if more than 66% of the game is set in the EEA or an “undetermined location”

• You get 4 points if more than 66% of the lead characters are from the EEA, or an “undetermined location” .

• You get 4 points if more than 75% of the game is in English.

• You get a point (max 2) if more than 50% of any of the following are done in the UK: concepting, storyboarding, programming or visual design.

• You get 1 point if more than 50% of the audio is done in the UK.

• You can get up 8 points if any of the following roles are from EEA (1 point each): project leader, scriptwriter, composer, lead artist, lead programmer, lead designer, any head of department, bonus point if more than 50% of the team are from Europe.

• Almost all of the above are on a sliding scale, so you’ll get points for partially ticking the boxes.

It is thus very easy to pass the test. An indie team based in Britain consisting of an artist and a programmer would get 14 of the 16 points just for their nationalities, making their game in English and splitting the project leader, lead designer, lead artist and lead programmer roles between them.

That said, this tax relief and the cultural test are still in draft form and are yet to be approved by the EU. They may therefore be changed before April 2013 – but if not, these are my concerns at present:

1) The structure rewards traditional development models. To take advantage of the 25% tax credit, you want to make as large a loss as possible each year until release. An indie who alphafunds their game or does a Kickstarter will gain an income for that, so will have to take the less generous tax relief on the equivalent amount of core expenditure. Annoying.

2) The small print of the legislation states a “A video game is completed when it is first in a form in which it can reasonably be regarded as ready for copies of it to be made and made available to the general public.”

Again, for a traditional development model that works fine – but many indies rely on alpha-funding to support themselves. The wording potentially implies that releasing an alpha version of a game to pre-orderers will mark the game as completed, which may mean that further development on the completed game would just count as “maintenance” and not generate tax relief. Potentially massive issue!

3) The small print makes it explicit that UK expenditure consists of products or services that are used within the UK by the game developer, but that this is assessed purely on the recipient rather than the provider and the nationality of the provider has no bearing on this. It is possible that this means using overseas contractors (even those outside the EEA) actually counts as UK expenditure. Got an American freelancer? That’s UK expenditure! Maybe.

I’m seeking some clarification from the relevant government bodies on the last two points, as well as enquiring about a more specific definition of “undetermined location” for the cultural test (i.e. does a fictional location count as an undetermined location, or must a name actually not be specified for it to count?) and will let you know once I hear back.

Overall, though, my provisional opinion is that the tax reliefs on offer are pretty damn good. Every penny counts when you’re an indie, so having 25% more of them will certainly help out!