Schuyler Moore , Contributor
California has just extended the film production tax credit from 2020 through 2025 and made the fund larger. California is attempting to play catch-up with other states that offer tax subsidies for local production, and while California’s provisions are not as generous as other state tax credits, the new legislation provides substantial benefits for film and television production in California. Unless otherwise defined in the text of this article, all capitalized terms have the meanings set forth in the glossary at the end of this article. This article updates the continuing rules and adds the new rules to provide a comprehensive overview.
Qualified Motion Picture. The credit only applies to “Qualified Motion Pictures,” which are audio-visual works that are produced for distribution to the general public in any media and that are one of the following:
A Feature with a minimum Budget of $1 million;
A movie of the week or mini-series with a minimum Budget of $1,000,000;
An Independent Film with a minimum Budget of $1 million;
A pilot or new TV Series with episodes longer than 40 minutes (excluding commercials) and a minimum per episode Budget of $1 million; or
A “Relocating TV Series” (regardless of length of each episode) with a minimum per episode Budget of $1 million that films its prior season (a minimum of six episodes) outside of California and for which the Production Company certifies to the Commission that availability of the credit is the primary reason for relocating to California.
In addition, to be a “Qualified Motion Picture,” all of the following conditions must be met:
Either (a) 75% of the principal photography days (i.e., not “pick-up” or second unit shooting) must occur wholly within California or (b) 75% of the Budget must be incurred for (i) the payment of services performed within California and (ii) the purchase or rental of property used within California. For a TV Series, this test is applied to the aggregate production days for all episodes in the season.
Completion must occur within thirty months of the date on which the Commission approves the initial application.
The film cannot be a commercial, music video, home video, school project, news program, talk show, game show, sporting event, award show, telethon, reality television program, clip-based program, documentary, variety program, soap opera, strip show (i.e., multiple segments shot in one day), or pornography.
Qualified Expenditures. The credit is only permitted for “Qualified Expenditures,” which are defined as expenses incurred in connection with production of a Qualified Motion Picture only for (i) the purchase or lease in California of tangible personal property used within California and (ii) all compensation (including related fringe benefits) paid during the Production Period for services rendered in California, excluding:
Payments to the Production Company or its affiliates;
Expenses relating to the acquisition, development, financing, overhead, marketing, promotion, or distribution of the Qualified Motion Picture;
Federal payroll taxes;
Expenses for music directors, composers, and supervisors; and
Expenses relating to writers, directors, producers, and performers (including actors, dancers, signers, and stunt persons, but excluding extras)
Amount of Credit. In general, the credit is 20% of Qualified Expenditures, except that the credit is 25% of Qualified Expenditures for:
Independent Films (subject to a cap on Qualified Expenditures of $10 million);
The first season for a Relocating TV Series;
Costs incurred during the Production Period prior to completion of principal photography outside the Los Angeles 30-mile Zone;
Visual effects (but not for fully animated films) as long as the lesser of (a) $10 million or (b) 75% of all visual effects is incurred in California; and
Music scoring and track recording.
In addition, even films qualifying for the initial 25% credit can increase the credit by an additional (a) 5% for production outside the Los Angeles 30-mile zone (b) 10% of wages paid to Californian’s living outside the Los Angeles 30-mile Zone.
Who Gets the Credit? The credit is given to the entity that pays the Qualified Expenditures, produces the Qualified Motion Picture, and “controls” the Qualified Motion Picture during the Production Period (referred to as the “Production Company” in this article), even if it does not own the copyright to the Qualifying Motion Picture.
Credit Against What? The credit is an offset against any California income or sales and use tax owed by the Production Company. If the Production Company is a pass-through entity, such as a partnership, an LLC, or an S corporation, the credit against income taxes passes through to the owners.
Limitation on Amount of Total Credits. The Commission is directed to allocate up to $330 million for each fiscal year from 2020-2025. If any portion of credits is not used in any given fiscal year, the unused portion carries forward to subsequent years. In general, (a) Independent films with qualified expenditures of ten million dollars or less shall be allocated only 4.8% of the credit fund, (b) Independent films with qualified expenditures in excess of ten million dollars shall be allocated only 3.2% of the credit fund, (c) 35% of credits are reserved for Features, (d) 17% of credits are reserved for relocating TV Series, and (e) 40% of credits are reserved for other qualifying television programming (i.e., TV Series, mini-series, etc.). The Commission is directed to approve credits for each year in the order of the Jobs Ratio (discussed below) of the projects, and the ordering of priority will be applied within each category mentioned above. The Commission is directed to establish two or more allocation periods per fiscal year after that, so Production Companies will just need to make sure that their applications are submitted by the last date for each allocation period established by the Commission, since the new ordering of priority is based on the Jobs Ratio
The Jobs Ratio. The “Jobs Ratio” is the ratio of Qualified Expenditures for compensation divided by the total amount of the credit (excluding the 5% portion of the credit allowed for expenses incurred outside the Los Angeles 30-mile Zone). The Jobs Ratio leads to some perverse results:
It will be higher for films that don’t qualify for the higher 25% credit within a particular category. For example, a Feature that has visual effects that qualify for the 25% credit will have a lower Jobs Ratio than one that doesn’t, even if all the visual effects costs are compensation, and is thus less likely to get any credit at all.
It will be lower for films that spend more on props, such as period pieces or special effects films, even if all the props are used in California.
The Commission is authorized to increase the Jobs Ratio by 25% for any application based on other factors having a California economic impact, so the Commission could, in theory, eliminate the perversities the Jobs Ratio introduces.
Once a TV Series has been approved for a credit, subsequent seasons will continue to be entitled to the credit regardless of the Jobs Ratio.
If, at the end of production, the actual Jobs Ratio is lower than the projected Jobs Ratio set forth in the application without reasonable cause, then if the shortfall is more than 10%, the credit is proportionately reduced, and if the shortfall is more than 20%, the Production Company may not apply for further credits for a year
Diversity. The legislation would require feature film and television projects that apply for the credits, which are assigned based on jobs created, to report diversity statistics to the state and designate people to handle misconduct claims. The revised tax credit program would also require applicants to submit their policy prohibiting harassment and retaliation. In addition, major studios would have to report whether they have diversity programs. Applicants who receive the tax credit would help fund a program to train people from underrepresented communities to do “below the line” jobs on film sets. The Production Company must participate in a “Career Readiness Program” that has been implemented by the Commission. “The Commission shall identify training and public service opportunities that may include, but not be limited to, hiring interns, public service announcements, and community outreach.”
Initial Application. To apply for the credit, the Production Company must submit an initial application to the Commission containing detailed information set forth in the statute at least thirty days prior to commencement of principal photography. The required information includes (a) financials on the Production Company, (b) the names of all partners or members if the Production Company is a partnership or LLC, (c) the estimated amount of compensation included in Qualified Expenditures, and (d) a statement that the credit is a significant factor in the applicant’s choice of producing the film in California. Principal photography must commence during a window commencing after the Commission approves the initial application and ending no later than 180 days after that date, unless delayed due to a force majeure event. This means that the Production Company must hold up principal photography until the application is approved.
Final Certification. Upon Completion, the Production Company then submits a request for final certification to the Commission setting forth additional detailed information set forth in the statute. Critically, one of the additional items of information requested is the copyright registration number, but it can take up to sixteen months after a copyright registration application is filed with the Copyright Office before a work is registered and the registration number is obtained. Fortunately, the Commission interprets this requirement to refer to copyright registration of the screenplay or the Qualified Motion Picture, which helps significantly. The Production Company must also submit a statement of Qualified Expenditures signed by a certified public accountant chosen by the Production Company who is licensed in California and has attended the Commission’s orientation seminar before the final credit is approved. The credit is limited to the amount certified by the Commission.
Application to TV Series. The initial and final application process, and the determination of Completion, for a TV Series is done by aggregating all episodes in the season of the TV Series.
Year of Use of Credit. The credit is available in the tax year during which the Commission issues the final certificate authorizing the credit, even if the Qualified Expenditures are incurred in prior tax years (but after the initial application is approved). If the credit cannot be used in full in the relevant tax year, any excess is carried forward for five subsequent years.
Financing the Credit
Nonrefundable. The credit is not refundable, so if the Production Company and its 100% corporate affiliates does not have any California income, sales, or use tax liability, it will not benefit itself from the credit. Therefore, the Production Company will not be able to raise financing for production by borrowing against the credit, except for Independent Films, as discussed below. Unless the Production Company is confident that it can use the credit against its own (or its 100% corporate affiliates) income, sales, or use tax liability, or unless the Production Company can sell the credit for an Independent Film, as discussed below, it is important for the Production Company to be structured as a pass-through entity so its owners can use the credit against their own income taxes (although not against their own sales and use tax).
Sale of Credit. The Production Company (and not its owners if it is a pass-through entity) for an Independent Film only may make one sale of the credit against income taxes (and not sales or use tax) to an unrelated party if, prior to the sale, the Production Company reports certain relevant information set forth in the statute to the Franchise Tax Board. However, the credit may not be sold more than once, so brokers acting as financiers must be careful to structure the transaction as a “loan,” not a “purchase” and “resale,” of the credit.
Effective Date. The revised credit statute applies beginning in June, 2020.
“Budget” means an estimate of all expenses incurred with respect to a Qualified Motion Picture during the Production Period. The statute states that the Budget must be the same as the budget used for all other purposes (the drafter must not know that films often have multiple budgets depending on who is asking!). The Budget includes the total budget for a Qualified Motion Picture, including any portion funded by third parties. The Budget excludes financing costs, but it is not clear if it includes the standard 10% contingency. The Budget is relevant only for purposes of determining if an audio-visual work meets the minimums required to be a Qualified Motion Picture, and it is not relevant for calculating the amount of the credit.
“Commission” means the California Film Commission.
“Completion” means completion of the composite answer print for films, the digital air master for television programs, the digital air master of the last episode of a season for a TV Series, or the digital cinema package, if applicable.
“Feature” means a film intended for commercial distribution to a motion picture theater, directly to the home video market, or via the Internet.
“Independent Film” means a Feature with a minimum Budget of $1 million, and the Production Company for such film is not publicly traded and is not more than 25% owned, directly or indirectly, by publicly traded companies.
“Los Angeles 30-mile Zone” means the circular area within a thirty-mile radius from the intersection of Beverly Boulevard and La Cienega in Los Angeles.
“Production Company” has the meaning set forth in Paragraph 4.
“Production Period” means a period commencing upon preparation for physical production after there is a binding agreement for funding or greenlighting and which continues until Completion.
“TV Series” means a television series with episodes longer than 40 minutes (excluding commercials).