Utilising Tax Credits in the Entertainment Industry
By Marc Jacobson & David Jacob
Posted: 18th December 2013 09:34One of the biggest concerns of every film and TV producer is how to take advantage of tax credits and rebates. These incentives can heavily influence where a producer chooses to spend its budget during all three phases of the production (preproduction, production and post-production). The purpose of the tax incentives is to attract productions into the state that will create jobs and increase local spending, thus stimulating the local economy. In New York State alone, the 30% tax credit helped support the creation of 28,900 jobs while the State collected a total of $748 million in tax revenues in 2011. For New York, which allocates $420 million annually to the tax incentive program, this means that for every $1.00 of credit distributed, the State received $2.23 in taxes.(1)
There are a number of different variables producers need to consider when deciding which state’s incentive program offers the best advantages for their production. For starters, a producer will need to know what types of productions are eligible for the tax incentive. Generally speaking, most traditional productions (movies and television series) will qualify, assuming each production meets any minimum-spending requirement (for example, North Carolina requires a minimum local spend of $250,000 and whereas Michigan requires only $100,000(2)). However, non-traditional programming qualifications can vary state to state. New York State is one of the few that offers tax incentives for expenses relating to commercials and post-production activities, but New York does exclude documentaries, reality TV shows, game shows and most other non-traditional programming.
The percentage of tax credits also varies from state to state. New York first passed a 10% tax credit in 2004 when a total of only 18 productions were located in the State and participated in the program. New York then increased this rate to a much more production-friendly rate of 30% in 2008. Since that time the number of productions has steadily increased every year—reaching 135 productions in 2011.(3) Programs in other states can range anywhere from 5% to 42%, with a number of factors contributing to how those credits are applied.
Another extremely important variable is determining what types of expenditures will count towards the tax incentive. In some states, like New York, the expenditures are limited to only those “below the line” expenses for qualifying productions. “Above the line” refers to the main actors, producers, writers and directors, whereas “below the line” refers to nearly everyone else on the payroll (assistants, crew members, stylists, editors, engineers, etc). These distinctions could cause a producer to film in one state, but handle all the post-production in a different state.
Producers also must consider whether the tax incentive is offered as either a credit or a rebate. The main difference between the two is that tax credits are claimed only after filing a tax return in the state providing the incentive, whereas rebates do not require the producers to actually file a return. Producers typically prefer states that offer rebates or refundable tax credits. Due to the economics of the transaction, producers are able to realise a greater value from a lender who offers a loan directly against any such rebate or refundable tax credit. If the program only offers a transferable tax certificate, the certificate will first have to be sold (at a discount) and then the producer will find a lender to grant a loan against the sale price of the certificate (rather than the actual face value of the certificate). Some states, such as California, only offer non-transferable credits, which limits a producer’s ability to take advantage of the credit early in the production process.
The most crucial part of making a film is finding the money to actually fund the production. Therefore, borrowing against these tax credits early in the production, usually for somewhere between 80 to 90 cents on the dollar, allows the producer to get their hands on money that can immediately be used to fund the production. From a producer’s perspective, the ability to get value from the credit early in the production process is nearly as important as the overall value of the credit.
For any company that will have substantial tax liability it can be very lucrative to be aware of the availability of tax credit programs in the states where taxes are owed. Only few states place restrictions on the types of taxes the credit can be applied against. For example, in Nevada, the tax credits can only be used for gaming, payroll and insurance premium taxes.(4) But for a large company that may owe significant payroll taxes, they may be able to purchase a tax credit granted to a local film production valued at $100,000 for a price somewhere between $80,000 to $90,000 dollars. This transaction will effectively save the company $10,000 in taxes with relatively low risk.
These programs are routinely updated and modified in each state. States are essentially competing against each other to attract the business of major productions. The state of California has been under pressure to expand its $100 million incentive program to bring more productions back to Hollywood.(5) It’s limited program, which is only available for independent film productions under $75 million, caused the state’s share of all network one-hour TV series to drop from 89 percent in 2005 to just 37 percent in 2012. The California Film Commission noted that most of these productions have been lured to New York because of their $420 million incentive program.(6)
Not all states are in agreement about the value of these tax credit programs. North Carolina, a state that had been an attractive destination in recent years (The Hunger Games, Homeland, Iron Man 3), recently approved a budget that calls for the current incentives to expire at the end of 2014.(7) Although North Carolina enjoyed $278 million and 14,100 temporary jobs in exchange for its $69 million investment in 2012, lawmakers still argued that the tax breaks could be better used elsewhere.
Tax incentive programs are available outside the US as well. The UK recently announced an expansion to their tax credit incentives, which originally launched in 2007, and immediately began attracting high-profile Hollywood movies (Thor: The Dark World, Captain America and Gravity).(8) Canada has long been an attractive destination with its nationally available 16% refundable tax credit to go along with the many additional provincial incentives offered across the country. “Runaway productions” (the industry term for productions that occur outside Hollywood) are sure to continue as long as each state and country competes with each other to offer the most attractive package of tax incentives. Although the tax credits are meant to benefit the actual producers, there are plenty of other parties that can benefit from these transactions.
The opportunities for investors are to act as the lender against a tax credit/rebate, where the payment risk is on the solvency of the government, but the availability of payment is dependent on execution of the paperwork by which the credit/rebate is issued. In addition, an investor who invests in a film with equity, will have some comfort that at least some portion of the cost of production will be reimbursed from the tax credit.