Cross-Border Film Financing
Non-U.S. investors have increasingly provided financing to U.S. film productions in various forms. This article discusses equity financing by non-U.S. investors in U.S. film production. Generally, a co-production arrangement is entered into among investors from multiple territories where each investor contributes either funding or production services in exchange for their profit share. The arrangement could be structured as a partnership or corporation for U.S. income tax purposes.
Partnership Structure
Under a partnership structure, profits and losses of the co-production partnership entity are passed through to its partners. The partnership structure provides parties with flexibility to allocate profits and losses based a distribution waterfall that reflects their economic deal. If applicable, a deduction under IRC §199A for domestic qualified business income passed through from the co-production partnership may be available to an individual with income under a certain threshold. However, if it is determined that the partnership generates income effectively connected with a U.S. trade or business (“ECI”), non-U.S. investors would be required to obtain a U.S taxpayer identification number and file a U.S. income tax return to report their distributive shares of the ECI. Also, quarterly federal withholding tax would be required by the partnership on the ECI allocated to non-U.S. investors, and state withholding tax may apply.
Corporate Structure
The co-production entity could be set up as a corporation. Alternatively, non-U.S. investors could set up a corporate entity and invest in the co-production partnership entity through the corporate entity (commonly called a blocker structure). Under a corporate structure, tax would be imposed at the corporate level and annual reporting may not be required at the non-U.S. investor’s level. If any film rights are held by the U.S. co-production entity and would be licensed to a person outside of the U.S., Foreign-Derived Intangible Income (“FDII”) deduction may be available to the U.S. corporation or U.S. corporation owner if the income qualifies. However, any net operating losses generated or passed through to a corporation would be trapped at the corporate level. Also, there is a potential for double taxation since the investors may be subject to tax on any dividends received. Tax on dividends paid to non-U.S. investors depends on whether an income tax treaty between the U.S. and the applicable foreign jurisdiction applies.
Certain states in the U.S. offer production tax incentives that could be considered for film financing. If productions occur outside of the U.S., other U.S tax provisions such as Global Intangible Low-Tax Income applicable to controlled foreign corporations and Base Erosion Anti-Abuse Tax would need to be considered for U.S. investors.
There are pros and cons under each structure. While the partnership structure provides one level of tax and flexibility in profit allocation, the corporate structure may protect non-U.S. investors from filing in the U.S., and certain tax provisions such as FDII deduction are only available to corporations. Investors should analyze the potential ramifications and exit strategies in setting up the initial structure.