Chapter 5
Incentives
INTRODUCTION
Incentives is one of the hottest new buzzwords in our industry, and you’ll hear it in questions like: “Which state or country is offering the best program right now?” “How much money can I save by shooting there?” “How much can I sell the tax credits for?” “How much will the bank loan me on the projected rebate or tax credit?” “How long will it take for me to get my money?”
Incentives have fostered an entire industry involving state and international governments, film commissions, CPAS, consultants, attorneys, bankers, payroll companies, studio and network executives and producers. Numerous positions have sprung up at studios, networks, law firms, payroll companies and consulting firms for incentive specialists. The best of these specialists possess the legal astuteness to analyze complex legislation; the training of a CPA to understand complicated tax issues; the shrewdness of a politician to deal with state officials and the knowledge of what’s important to studios, networks and producers. All of these skills are vital in assessing a wide range of incentive programs and in being able to advise others – providing them with the incredibly detailed information they need to decide where to shoot their projects.
There’s a great deal of consideration that goes into deciding where to shoot. Sometimes it’s a question of not wanting to venture far from home. Sometimes it’s about finding the right look, location or possibly, the ideal weather. Often it’s about the infrastructure. But very high on the list of determining factors are the various incentive programs being offered throughout the U.S. and internationally. Producers, studios and networks want to know where they’re going to save the most money and get the most out of their budgets. And with the variety of incentives currently being offered, they have a smorgasbord of choices.
THE EVOLUTION OF INCENTIVE PROGRAMS
There was a time when the United States (and in particular, the Los Angeles) film community fiercely lobbied to halt (or at least slow down) runaway production – the migration of shows (TV series, features and especially movies for TV, intended for initial release/exhibition or broadcast in the U.S.) that were being shot in other countries – primarily Canada and while producers eagerly took advantage of the favorable exchange rates, lower costs and lucrative tax incentives in other countries – sometimes reducing production costs by as much as 25 percent – the United States lost film jobs by the tens of thousands.
The tide finally started turning with the American Jobs Creation Act of 2004 and the 2004 enactment of Sections 181 and 199 of the Internal Revenue Code. The passing of Section 181 signaled the U.S. government’s response to runaway production by allowing an immediate 100 percent write-off for the cost of certain audiovisual works (which would include theatrical films, television, short films and documentaries).
The incentive allows individual investors or production entities (limited liability companies, corporations, trusts and partnerships) to claim up to $15 million ($20 million if shooting in a low-income area of the country) as a loss in the year (or years) the funds are being spent – no matter the amount of the budget or whether a distribution deal is in place. For a TV series, the incentive would apply to up to 44 episodes (with the production entity being able to claim a loss of up to $15 million per episode).
To qualify for Section 181-75% of the total compensation (excluding participations and residuals) must be for services performed and paid in the United States. The film or TV show cannot be sexually explicit. And the production cannot capitalize those same expenses that are being written off.
If an investor has no involvement in the film, then he is considered a passive investor and must have passive income to be able to benefit from the deduction. (Passive income is income received from such sources as residuals, rentals, royalties, dividends, interest and pensions.) And a passive investor can carry the loss for up to three years.
If an investor is involved in the production (as an executive producer, for example), then he or she is considered an active investor and can take the loss only in the year the funds are spent.
To obtain the tax loss, your accountant would be required to submit:
1. A modified K-1 (an IRS tax form requiring information relating to your investment, profits and losses)
2. A letter on production stationery attesting to what you invested and what was spent on the production – noting that your investment is a 100% loss
3. A copy of 181 guidelines
At this time, Section 181 is being renewed a year at a time. Once it’s no longer renewed, in order to be eligible for a project that’s going to be completed the following year, you must be in pre-production by the end of the current year to be grandfathered in. Once qualified, you’d have up to three years to complete your project. To be eligible, you must have:
1. A completed screenplay
2. A completed budget
3. All of your investment documents in place
4. Filmed at least one day of principal photography with at least one speaking role
Section 199 (also part of the American Jobs Creation Act of 2004) is a permanent law that doesn’t have to renewed yearly and states that of the taxable income returned to an investor – 6% can be subtracted before being taxed (so for example, if an investor were to make a $1,000 profit, only $940 would be subject to tax). In 2010 (and beyond), up to 9 percent can be subtracted.
As good as Section 181 sounds, and as much as it’s been a benefit to both producers and investors, its longterm future is in doubt, and it has its detractors. There are those who claim that for all the time and paperwork involved, it doesn’t generate enough money to be worth the effort. That may be true for large investors but less relevant to the smaller investors who have already benefited from this incentive. But we’ll see what happens. One thing’s is for sure, and that is in a poor economy, investors are less likely to be attracted to this tax deduction if for no other reason than that their passive income has most likely taken a big hit. It’s worth checking out though. So if Section 181 is still in effect when you start planning your next movie, consult with your attorney and tax advisor to understand the technicalities of the statute and to determine if these incentives would work for you and your film before you offer them as investment opportunities to potential investors.
Many other changes have occurred within the past few years, especially with the weakening U.S. dollar and the hassles of traveling and shipping in a post-9/11 world. As a result, many producers have made a 180-degree turn, making a beeline back to the United States to take advantage of the savings being offered by more than 40 different states flaunting lucrative incentive packages. In order to boost local film industries, create jobs, stimulate local economies and promote tourism, they appear to be tripping over each other to see which can offer the most desirable incentive package and attract the most film dollars – several having returned to their legislature two and three times in an effort to enhance what they can offer filmmakers.
So now the term runaway production has a whole new connotation. And instead of being synonymous with a U.S. show being shot in Canada, it now represents a show like Ugly Betty, a California-based TV series that in its 2008 season moved to New York to take advantage of that state and city’s generous 35% incentive program.
In addition to incentives for film and TV production, a number of jurisdictions also offer incentives for commercials, digital programming, post production, video game production and animation as well as for the development of or investment in infrastructure.
IN FLUX
As beneficial as this all sounds, these programs have their share of critics. An October 12, 2008, article in the New York Times written by Michael Cieply highlights those who view this scenario skeptically, believing that taxpayers shouldn’t be stuck subsidizing Hollywood bigwigs – especially in a sagging economy when so many other businesses are in need of the help. There are those who feel that with so much money involved, there’s too much temptation to inflate budgets for bigger payouts. But others worry that in a shaky economy, coffers set aside for rebates and tax credits will run dry before all the films shot in that state can collect their money. Some states, in fact, instead of increasing incentive packages, have tightened their guidelines, upped their criteria and set caps on rebates and tax credits at a lower level. It therefore seems inevitable that some state programs, without enough local support or the infrastructure to accommodate filming activities, will certainly fall by the wayside. But that’s not to say that these programs don’t make sense, because for numerous states they absolutely do. Several states have even had economic studies done to verify that they take in more than they give out, that the film industry is taking root, that jobs are being created and revenue is being generated. Incentives have revitalized many local economies, fostered continuing work for local crews and provided young people with careers about which they hadpreviously only dreamed.
I’m not sure what it’s going to be like by the time this new edition is printed, but today, as I sit in front of my computer, the competition is intense. And there’s no telling where it’ll end, as it changes on a day-to-day basis and includes not just the United States, but more countries than ever before as exchange rates fluctuate and new jurisdictions enter the race.
WHAT TO CONSIDER
Incentive packages come in many different sizes and flavors and may include cash rebates, tax credits or upfront/back-end production funding. Some offer exemptions and waivers on such things as hotel occupancy taxes (usually after 30 days), Use Tax, GST (Goods & Services Tax) and VAT (VALUE-ADDED Tax). Some incentives waive location fees for filming on state lands. Others sweeten the pot for “on-the-job training” (in order to obtain more experience for their growing workforce) or for shooting in certain core or depressed areas or at nonpeak times of the year (like winter in Alaska). And some states offer infrastructure credits for the creation of permanent facilities that will benefit their local film industry.
Each state and each country is different, and many of the programs are quite complex. If you’re working at a major studio or network, there is probably someone there whose responsibility it is to know and understand the intricacies of each incentive program. If you’re using a payroll company, they’ll most likely have an individual or department designated to interpret each program and the legislation it originated from.
Be aware that when structuring the financing for your picture, there are banks that will loan you a percentage of the money you’re projected to receive from an incentive program – whether from a rebate or the sale of transferable tax credits. For independents, however, the bank will provide loans on incentives only if your film is insured with a bond company.
When assessing your options, there’s a lot of fine print to consider, so check out the following appropriate contacts:
• Film commissions – most film commissions have their own websites, and their incentives are usually explained on the site. And talk to the film commissioner as well. Keep in mind, however, that most film commissioners are not in a position to provide the in-depth answers you need. But they are a great place to start.
• Original legislation – ask the Film Office or your local advisor for the statute, regulations, guidelines and/or rules.
• The State’s Department of Revenue or Department of Economic Development/Commerce (which in most cases administers the program). Ask the Film Office or your local advisor for a contact.
• A tax attorney in the state you’re investigating, ideallyone who has already dealt with the incentive program.
• Other people who have shot there.
Do your homework and know what to expect. Ask the following questions:
• Would your production company need to be headquartered in a specific jurisdiction?
• Would the production company need to register to do business in a specific jurisdiction?
• Are there any local taxes that would affect the production, the cast or crew?
• Would there be costs for things such as filing fees and audits? Is there a gross receipts tax in that state?
• Which expenditures qualify for the rebate or tax credit? (Or, as they say, what’s considered “good spend”?) Consider costs such as rentals, purchases, shipping, box rentals, fringes and airfare.
• Do your purchases have to be made from vendors within the state/jurisdiction? Or, if not available locally, can local third parties/companies (pass-throughs) act as brokers and bill for mater ials or equipment being supplied by out-of-town vendors, as long as the materials and equipment are being used in that state?
• What are the rebates/tax credits for labor – local (resident) and nonresident labor? What about your talent who work through their loanout corporations – what are the guidelines for loanouts? Will their corporations be required to pay withholding taxes to that state? Do they need to register?
• Does the crew have to be paid by a local payroll company for their salaries to be eligible for the rebate or tax credit?
• What are the responsibilities of your payroll company?
• Does a certain percentage of filming have to be done in that jurisdiction?
• Does a certain amount of money have to be spent to qualify?
• How long was the incentive program voted in for, and when is it up for legislative review? Or using the proper terminology – when is its “sunset date,” after which the benefits are no longer available? Would your project qualify before the incentive expires?
• Will the production be subject to an audit at the end of principal photography? And if so, who would pay for that audit?
• Would you be required to hire a CPA from that state to conduct the audit?
• What are the caps imposed on how much you can claim on any one show, any one employee, in any one year?
• Is there a finite fund the state draws from when releasing rebates or tax credits, and is there a limitation on the available funds?
• If you’re being offered a transferable tax credit that you’ll be selling, what is the going rate for tax credits in that state? And are there known companies that would be willing to buy (or act as a broker for) your tax credits?
• Is it possible to monetize or drawdown on the rebate or tax credits prior to the completion of the film?
• With a transferable tax credit, once you receive a certificate for the credit, can you sell it immediately?
• Does the state work on a calendar year? (In other words, if you were to file at the end of one year, but your film ran into the following year, would you be eligible for the incentives in that subsequent year?)
• If you have to go back for reshoots after you’ve already filed, would you be eligible for the incentives upon your return?
• How long will it take to get your rebate or tax credit?
• Is there a requirement pertaining to the number of local crew members you must hire?
• Is there a cultural test to pass?
• Would you be required to provide this state/country with a screen credit or display their logo in your end crawl?
INFRASTRUCTURE
Does the state or country you’re interested in basing your show out of have a solid infrastructure? Do they have sound stages, enough office space, equipment houses, post facilities, a certified lab, qualified crews, an abundance of building materials? If you’re shooting on film, where would your raw stock come from, and how long would it take to obtain some from the time its ordered? Can you rent as many cars, trucks, trailers and vans locally as you’ll need? Are there luxury hotel accommodations available for your talent? What is the accessibility, features, availability and costs of their hotels/motels/condos/ apartments and restaurants? How much are you going to have to spend to ship in what isn’t already there?
Is this a right-to-work or union-based state? How many qualified crews do they have? (The correct expression is that a state or country is however many crews-deep.) Is the local crew truly local, or do they come from neighboring cities or states (in which case you would most likely have to provide them with accommodations and per diem)? Are there union guidelines dictating how many locals must be hired? Will the level of competence a local crew possesses meet the needs for your show?
Several of the states that offer incentive programs are also offering new and expanded educational opportunities for their budding filmmakers and local workforce, providing a myriad of film classes. And many of these courses are taught by highly skilled and experienced instructors from Los Angeles and New York. The more qualified the local crew, the fewer number of people the production has to bring with them, the more money they save. And the larger the local workforce, the more successful the incentive program is in providing jobs and raising state revenue.
The stronger the infrastructure, the more attractive the incentive package is going to look. Don’t evaluate the incentives without taking the infrastructure into consideration. For instance, take a state that offers a fabulous incentive program but has little infrastructure (or one that’s just getting established) with one that has a lessattractive incentive package but a solid infrastructure. Many times you’re better off with the latter.
Some of the U.S. states (other than California) that currently offer solid infrastructures include New Mexico, Louisiana, North Carolina, Pennsylvania and Massachusetts.
I can’t stress enough how important it is to talk to people who have shot in the locations you’re considering. Many film commission websites include a list of projects that have shot there (and if not, just ask), and you can look up the studio, producers and UPM on IMDb.com to know who to call. Find out what their experience was like with the local crew. Were there individuals who stood out as excellent or others who should be avoided at all costs? Did they have enough experience, were they professional, did they come through for them? How long did it take to get their rebate or tax credit? Did they have any trouble getting the things they needed for their shoot? How was their experience getting permits and working with local authorities. Was it a film-friendly location?
TYPES OF INCENTIVES
The following is based on information taken from Entertainment Partners’ booklet The Essential Guide to U.S. & International Production Incentives, and I think you’ll find it helpful. For more information and the specifics on individual incentive programs, check out www.production incentives.com.
Rebate
A cash rebate is the amount of money paid to a qualified production company based on the qualified expenditures made or the jobs created in the state. These funds don’t require a tax return to be filed and are not handled by the local tax authorities. They’re administered by the local Film Office, Departments of Trade and Industry, Commerce or Economic Development. The rebate funds are set aside by the government agency administering the incentive, and once the production has completed filming in that state and all necessary documentation has been filed (usually in the form of an audit) detailing what is eligible for rebate, it generally takes 30 to 60 days (depending on the state) in which to receive the rebate.
Tax Credits
Tax credits can be refundable or nonrefundable, transferable or non-transferable, and they’re administered by the local taxing authority, most often the Department of Revenue. When entering into an incentive program that offers tax credits, I suggest that you request a letter from the state’s Department of Revenue guaranteeing that the funds will be available (in the form of the tax credits) once the production has ended and the production’s income tax return has been filed.
Refundable Tax Credits
Although administered differently, a refundable tax credit functions in the same way as a production rebate, but can be claimed only by filing a tax return. The production company must file a tax return regardless of whether it has any income or owes any tax in the jurisdiction. If the production company does owe tax, a refund will be granted for the excess of the credit over the amount of tax owed. In some cases, banks or other lenders can monetize refundable tax credits so the production company can receive the money earlier. Generally speaking, a cost is associated with an advance of the funds.
Transferable Tax Credits
Transferable tax credits are nonrefundable, so if a production company’s tax liability isn’t great enough or the production chooses not to wait until after an audit to capture their credit, they’re allowed to sell (“transfer”) the tax credits directly to local taxpayers – often to corporations that would buy them to offset their own tax liabilities. In addition, the production company will need to discount the credit from its face value to entice local taxpayers to purchase them. Rates often range from 85-90¢ on the dollar (sometimes lower), and the transfer can be handled directly by the production company or indirectly through the use of a broker (who would generally charge a commission).
Jurisdictions vary in how they regulate these transfers. Some jurisdictions permit a single credit to be divided amongst multiple transferees. Others permit multiple transfers, allowing transferees to sell all or a part of the credit they purchased to another taxpayer.
Nonrefundable, Nontransferable Tax Credits
Entertainment Partners defines a nonrefundable, nontransferable tax credit as a tax credit that “can generally be carried forward and used to reduce taxes in subsequent years if the production company has no current tax liability. Each jurisdiction sets forth the period of time within which the tax credit can be carried forward.”
Up-Front or Back-End Funding
These are funds provided by local investors or taxpayers in exchange for advantageous local tax treatment and are granted to eligible productions.
CONCLUSION
Incentive programs are not only complicated, but also constantly changing, so do your due diligence, seek the advice of someone who thoroughly understands these programs and know what you’re getting into.
I’d like to extend many thanks to Joe Chianese, Entertainment Partner’s Vice President of Marketing, Business Development and Production Planning, and MaryAnn Hughes, Disney’s Vice President of Production Planning for their help with this chapter. Joe and MaryAnn are two of the top incentive gurus in this industry, and I, along with countless others, rely heavily on their continued guidance and advice. Entertainment Partners provides both a guide (The Essential Guide to U.S. & International Production Incentives) and website that are part of their ongoing commitment to providing the production community with the tools and knowledge needed to maximize the value of their production dollars. For more information, go to www.productionincentives.com. Thanks also to Hal “Corky” Kessler of Levin Ginsburg in Chicago, entertainment attorney and committed advocate for Section 181.