If you have ever considered investing in film projects in North Carolina and you’ve been sitting on the fence, you may want to jump down and get into the game. Recently, the General Assembly and the federal government enacted laws intended to promote film investment, and these laws make investing in films in the state more attractive than ever. These incentives, together with North Carolina’s existing Qualified Business Venture Tax Credit, the talented pool of filmmakers here, the broadening relationships between filmmakers and distributors in Hollywood and the box office and critical success of independent films during the past 10 years make this a compelling time to consider film investment in the state.
Film Industry Job Incentives Act
Last year, Gov. Mike Easley signed into law a film-incentive package that makes a refundable tax credit available to film and television production companies that produce their projects in North Carolina. Under the law, qualifying production companies will receive an income-tax credit (or refund) equal to 15% of qualifying production expenses.
To qualify for the tax credit, a production company must spend at least $250,000 in “qualifying production expenses.” These expenses include any goods and services leased or purchased in North Carolina in connection with the production. Qualifying production expenses also include compensation paid in connection with the production that is subject to state withholding taxes. Wages paid to “highly compensated individuals,” for example, an actor who gets in excess of $1 million, do not apply as qualifying expenses.
The 15% credit is a direct credit against taxes, not a deduction, and any amount of credit that is in excess of tax liability will be refunded directly to the production company. The law does not allow a limited-liability company (the most common form of entity for a film production) to distribute the credit directly to its owners. Instead, because LLCs generally do not have tax liability at the entity level, it would receive the credit in the form of a refund. The refund may then be used to pay other production expenses or post-production costs (such as acquiring music rights for the soundtrack) or the refund could be distributed to investors. Importantly, this credit is not limited to North Carolina production companies or investors.
The American Jobs Creation Act of 2004
On Oct. 22, 2004, the American Jobs Creation Act of 2004, which amends the Internal Revenue Code of 1986, was signed into law. The act creates three incentives expressly applicable to motion pictures. One, Section 181 of the code, is especially significant to independent film producers, who make low- and medium-budget films, and investors in such films. The law allows producers of qualifying films to elect out of the uniform capitalization rules mandating that film costs be deducted gradually over a film’s useful life or be matched to a film’s projected income. Costs of qualifying films may now be deducted in full in the year in which they are incurred. The purpose of the law is to stimulate investment in domestic film production and make it more competitive with foreign productions.
he Section 181 deduction election is only available to “qualified film or television productions,” defined generally as any production having an aggregate budget of $15 million or less, in which 75% of the total compensation of the production is for services performed in the U.S. by actors, directors, producers and other production personnel. Qualifying films will generally be “independently produced” American films.
The incentive for investors is that those seeking to offset passive income from other sources will ben-efit from the accelerated availability of passive losses from these qualifying films. The new tax deductions remain subject to the rules governing the deductibil- ity of passive losses and the recognition of passive income. Accordingly, although the new rules enable qualified production companies to accelerate the tax deductions from the production, the deductions will pass through to the investors as passive losses. They will not be deductible by the investors against their other outside active income (salaries and other earnings) until certain events occur, such as disposition of an investor’s entire interest in the production company or a dissolution of the production company. In the meantime, the passive losses may be utilized to offset passive income from the production company and other sources and can be carried forward until used. This incentive may be particularly attractive to real-estate developers and others who have significant passive income.
Qualified Business Venture Tax Credit
For years, North Carolina has fostered investment in small business through its Qualified Business Venture tax-credit program. This program, while applicable to many types of businesses, is often used by filmmakers who expect to raise money from investors in the state. Investors who purchase equity securities of a QBV are generally allowed a tax credit against state income taxes equal to 25% of the amount invested (up to a maximum credit of $50,000). For example, an investor who invests $100,000 in an independent film qualified as a QBV is entitled to a credit of $25,000 against state income taxes. The credit may be lost if (a) the company generates revenues in any year in excess of $5 million, (b) the investor participates in the operations of the business within three years of the investment, (c) the investor, within one year after the investment, transfers his securities (except upon his death or certain other events) or (d) the company redeems the securities within five years after the investment.
These incentives may be combined and may significantly reduce the risk of investing in independent films. Also, because of the tax benefits that may be derived from these incentives, investors may enjoy positive economic benefits before the film generates any revenue. While these incentives are a positive step for the North Carolina film industry, potential film investors should never lose sight of the factors that make up a good film investment — that is, don’t invest just for the incentives. Invest in good projects. Some things film investors should look for include a great script, a good structure for payment of proceeds from the exploitation of the picture, a reasonable budget, the availability of known actors and actresses, a qualified and experienced production team, the availability of distribution in theaters, home video and/or television, and qualified advisers (lawyers, accountants, etc.).
