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January 13, 2015
Sony E-Mails Show Plan to Exploit 'Loophole' in Expanded California Film Credits
by Brian Bardwell

Full Text Published by Tax Analysts®

[Editor's Note: This is the second in a series of articles providing the public with a behind-the-scenes look at how tax policy can drive decision-making for large, publicly traded corporations.]

Sony Pictures Entertainment is looking for ways to exploit a "programmatic loophole" that would allow the company to take advantage of California's recently expanded film tax credits, according to internal e-mails between company executives.

The state recently expanded a program that the industry long believed was too modest for the home of the American film industry, enacting a bill that will allow for $330 million annually in credits.

E-mails from Sony lobbyist Keith Weaver indicate that the company's tax planning may leave it with no state income tax to offset using the credits, which could mean that the company would be unable to take advantage of the new credits for studios, which generally cannot be transferred or sold.

"While others may be jubilant, this program is deeply flawed and doesn't allow us to use the program," Weaver wrote in an August 27 e-mail to top executives. "The program provides that the credits are offset against California income tax liability, and because we file taxes on a unitary basis with other Sony group companies and combined we're in an overall loss position, there is no way to monetize the credits."

Later in that e-mail chain, another executive asks whether Sony could secure an amendment that would let studios sell the credits back to the state; Weaver said that would probably not happen, as "the governor was unwilling to adopt those provisions."

But in a separate e-mail two days later, Weaver told the company's top lawyer that he was already examining a possible work-around.

"I'm not sharing this widely, but after some preliminary discussions with the tax group and outside counsel there may be a programmatic loophole that allows us (through production services agreements) to monetize these credits," he told SPE general counsel Leah Weil. "It seems viable -- even with Sony's loss issue. So we are working on a strategy to secure an administrative tax ruling to give us certainty on the approach, as well as researching risk factors."

The e-mails are part of a large cache of internal records released late last year by an entity calling itself Guardians of Peace and obtained by Tax Analysts. The FBI says it has linked Guardians of Peace to the North Korean government, which is lampooned in The Interview, a film that Sony released on Christmas.

Weaver promises Weil another update on the plans, but it does not appear to be contained in the files.

A Sony spokeswoman declined to comment on the company's strategy, but Schuyler Moore of Stroock & Stroock & Lavan LLP said he could imagine how the company might be trying to use production service companies, which are often contracted to handle various aspects of film production.

Moore is the author of Taxation of the Entertainment Industry, as well as an October article in Entertainment Law & Finance in which he described the recent changes to the California law.

"When you say a 'production service company,' that would sound to me like they are effectively trying to let someone else use the credit and then reduce the cost of the film that way," Moore said. "If you can't use the credit, you use a production service company that is owned by somebody else that can use the credit, and they effectively monetize the credit."

So because Sony has the rights to films that it pays production services companies to produce, Moore said, it also has leverage to require them to apply for the credits and then offset their bills to Sony by similar amounts.

"They are no doubt using a third-party production company in order to qualify as an 'independent' film, so the production company can sell the credit," Moore said.

That approach would take advantage of a clause that allows a one-time transfer of a credit of up to $2.5 million awarded for an independent film with a budget of at least $1 million produced by a company that is no more than 25 percent controlled by publicly traded companies, if the sale is reported to the Franchise Tax Board.

Moore also suggested that Sony might be exerting more effort than necessary by focusing only on state income taxes.

"You can offset the credit against state sales and use tax," Moore said, "so I would have thought that Sony would have enough sales tax or use tax to actually use the credit against those things."

Amy Lemisch, director of the California Film Commission, which administers the credits, said she could not answer questions about the legality or viability of Sony's strategy, but she said that she had not received a request for guidance from the studio and that the approach Moore described has not yet come up at her office.

Susan Maples of the Franchise Tax Board's taxpayer rights staff said the board has not received any requests for a ruling that would address how a movie studio's use of production service agreements could affect a project's eligibility for the use of film tax credits.

Assembly member Mike Gatto (D), who sponsored the bill expanding the film credits (AB 1839), did not answer questions about whether such an arrangement would be in line with the legislative intent or whether he would pursue legislation to clarify that such an approach was permitted or forbidden. Through a spokesman, he said only that "we were and remain unaware of any so-called 'loophole.'"

Despite Sony's characterization, Moore said he doesn't think the approach was much of a "loophole."

Sony may be comfortable selling control of production for millions of dollars, and the bill explicitly calls for the credit to be awarded to the company that controls production, he noted.

"That's done all the time," Moore said. "It's absolutely allowed."

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