A Novel Way for California to Match NYC Tax Gifts (Guest Column)

5:00 AM PST 05/14/2014 by Schuyler Moore
Illustration by: R. Kikuo Johnson

Loans, not giveaways, would provide needed cash for film and TV shoots, cut out wasteful middlemen and help the state compete with rivals willing to bankrupt themselves to lure productions, writes film finance attorney Schuyler Moore.

This story first appeared in the May 23 issue of The Hollywood Reporter magazine.

Alarm bells are ringing about California losing billions of dollars in film production each year. But the only proposed solution so far is a pending bill seeking to engage in an arms race with other states to give away the most tax credits before going bankrupt. The California Legislative Analyst's Office on May 1 poured cold water all over this approach, questioning its usefulness -- and for good reason. Freebie tax credits are just not viable for California because there is a substantial level of production in the state, and it is impossible to distinguish between productions that would shoot here in all events and those that decide on location based on tax credits. Thus, a generous credit ends up being wildly expensive without the ability to gauge its success.

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In addition, the tax credit process is wildly inefficient. For example, all state tax credits are funded at some time after production, so the credits are sold or financed for about 80 percent of the face amount of the credits, which means that a full 20 percent of the benefit of the credit is not being used to achieve the intended goal of local film production. Instead, it is going to brokers, lenders or other taxpayers that have nothing to do with film production.

There is a simple alternative that California could adopt that would put it ahead of all other states and actually would make California a profit to boot. Most film companies need cash for production, not a promise of funds at some later date, and they are willing to pay for it. Thus, California should implement a "last out" loan program, with the loan being secured by the film but subordinated to all other secured loans. Here are the advantages:

Film companies would get cash right up front during production, without having to bother with middlemen, brokers and financiers.

One hundred percent of the cash would go toward the intended subsidy of local production, rather than giving 20 percent of it to third parties.

California would be entitled to a financial return on its investment. To have the loan subordinated to other secured lenders is a risky position, but it is a whole lot better than just giving away the cash for free. And California can price for this risk by charging higher interest rates (perhaps in the 15 percent range) and getting a share of profits (perhaps 10 percent). Indeed, there are film funds that make a great return from providing just this form of capital in the form of equity or subordinated loans.

The loans would not show up as an expenditure or reduction of tax revenue on the state's books.

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If California provided just 20 percent of the budget of a film in this manner (which is less than the common practice of credits in the range of 30 percent), film companies (in particular, independent film companies) would line up to shoot here, since they would get 100 percent of the benefit and would get it in the form of cash. Most film companies are more than happy to provide an economic return to whomever supplies the last 20 percent of the budget up front during production, since that is the hardest capital to come by and is often the difference between a film and no film.

This approach would require California to undertake some discretion on film selection and to impose underwriting criteria, but the process could be relatively loose as long as the film meets the requirements now imposed to obtain tax credits, since California has nothing to lose compared with the current program and much to gain. It would not be that difficult to make sure that the film company is doing what it promised, and completion bond companies would no doubt be glad to make sure that they do for a relatively small fee.

This approach would permit California to compete with other states without significantly impacting its bottom line. The plan would revitalize film financing and provide a sustainable framework for subsidizing film production in the state.

Schuyler Moore is a film finance attorney at Stroock.

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