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Media Companies Seek Retention of Benefits and Burdens Test

JAN. 15, 2016

Media Companies Seek Retention of Benefits and Burdens Test

DATED JAN. 15, 2016
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January 15, 2016

 

 

The Honorable Mark Mazur

 

Assistant Secretary (Tax Policy)

 

Department of the Treasury

 

 

The Honorable William J. Wilkins

 

Chief Counsel

 

Internal Revenue Service

 

 

CC:PA:LPD:PR (REG-136459-09)

 

Room 5203

 

Internal Revenue Service

 

POB 7604, Ben Franklin Station

 

Washington, DC 20044

 

Re: Proposed Amendments to Section 199 Domestic Production Activities Deduction Regulations

 

On behalf of Discovery Communications, Inc. (Discovery), Scripps Networks Interactive (Scripps) and AMC Networks, Inc. (AMC), we are pleased to submit comments regarding the Section 199 Domestic Production Activities Deduction proposed regulations (REG-136459-09). Our comments are focused on the proposed rule eliminating the benefits and burdens test under section 199. We are concerned that the proposed new rule will significantly undermine the intended incentives under section 199 to produce film and television content domestically. By contrast, we believe the current benefits and burdens test is consistent with the statute and has worked well to encourage domestic production as intended by Congress. We want to thank you in advance for your consideration of our views, and look forward to working with you further to address the administrative concerns that gave rise to this proposed regulation, while ensuring that the domestic production incentives underlying section 199 are maintained.

Our companies. Discovery, Scripps, and AMC are media companies that develop and provide cable programming.

Celebrating its 30th anniversary last year, Discovery is the world's largest pay-tv programmer with over 2.6 billion cumulative subscribers in 225 countries and territories around the world. Discovery is known for its operation of The Discovery Channel, TLC, Animal Planet, SCI, OWN, and a number of other network channels. In addition, Discovery offers standards-based digital content and a variety of other media services and educational products to schools.

Scripps began its lifestyle television network business more than 20 years ago and is one of the leading developers of engaging lifestyle content in the home, food and travel categories for television, the Internet and emerging platforms. The company's lifestyle media portfolio comprises popular television and Internet brands HGTV, DIY Network, Food Network, Cooking Channel, Travel Channel and Great American Country, which collectively engage more than 190 million U.S. consumers each month. It also has a growing international presence with programming in more than 150 countries. Scripps' on-air programming is complemented with online video, social media and companion websites reaching millions of customers around the world.

For more than 30 years, AMC Networks has been a pioneer in the cable television programming industry, having created and developed some of the industry's leading networks, with a focus on developing and airing original productions. AMC Networks owns and operates several popular and award-winning cable television brands: AMC, IFC, Sundance TV, WE tv and BBC America, as well as a film distribution business, IFC Films, all of which produce and deliver distinctive and culturally relevant content that engages audiences across multiple platforms. AMC Networks operates BBC America through a joint venture with BBC Worldwide. In addition, AMC Networks operates AMC Networks International, its global division.

Section 199. Congress enacted section 199 in the American Jobs Creation Act of 2004 as an incentive for companies to keep qualified manufacturing and production activities in the U.S. Also, "the deduction was designed to compensate for the repeal of the extraterritorial income (ETI) provision that had been found to be a prohibited export subsidy by the World Trade Organization (WTO)."1

Section 199 allows taxpayers to deduct a portion of their income from qualified production activities. For this purpose, Congress specifically provided that film production was a qualified production activity. Under section 199(c)(4)(A), the taxpayer's gross receipts from a "qualified film" are eligible for the deduction under section 199 provided the qualified film is produced by the taxpayer, and the receipts are derived from the "lease, rental, license, sale, exchange or other disposition" of the qualified film. To be a qualified film, at least 50% of film production compensation costs must be compensation for services performed by film production personnel in the United States.2

Under existing regulations, only the party that has the "benefits and burdens" of ownership of the produced property is treated as the producer for purposes of the section 199 deduction. Specifically, Treas. Reg. sec. 1.199-3(k)(8) provides "if one taxpayer performs a production activity . . . pursuant to a contract with another party, then only the taxpayer that has the benefits and burdens of ownership of the qualified film . . . is treated as engaging in the production activity." This is intended to ensure that only one taxpayer is eligible for the deduction with respect to a qualified film.

Work for hire arrangements. To produce their network content, Discovery, Scripps, and AMC (the "hiring company") all often hire independent third parties (an "independent producer") under relatively standard "work-for-hire" arrangements. Under these arrangements, the independent producer is paid a fee either as a percentage of the overall production budget or a per episode flat fee. The hiring company is responsible to cover production costs in accordance with production budgets approved by the hiring company (plus any mark-up charged by the independent producer), although, in certain cases, the independent producer is responsible for any cost overages and may retain any cost underages relating to the production budget. Moreover, under these agreements, the hiring company clearly owns and has the rights to exploit the content. As a result, the hiring company incurs the costs of production, and enjoys the success of -- or suffers any failure of -- the production. By contrast, the risk of loss is limited for the independent producer to (at most) any budget overages.

In addition, the hiring company maintains control and approval over all significant production decisions, such as production budgets, schedules, producers, directors, other talent, scripts and editing. Finally, the contracts provide that the hiring company retains all ownership rights in the programming and related elements, including copyrights, trademarks and other intellectual property. This includes the sole and exclusive rights to broadcast, transmit, license, or otherwise exploit the produced work, as well as any derivative works. Consequently, under these arrangements, we believe it is clear that the hiring company has the benefits and burdens of owning the contracted programming (and other content), and is the party entitled under existing regulations to the section 199 deduction for producing the content.

It is important to note that the economic decisions underlying these agreements (e.g., whether to produce, who to hire, where to produce, pricing, etc.) have all been based upon the clear understanding across our industry that the hiring party is entitled to the section 199 production incentive under both the statute and the current regulation. We have not witnessed any ambiguities with respect to these arrangements, and so we do not believe the standard needs to be changed with respect to these arrangements to ensure that only one party is entitled to section 199 benefits.

New proposed rule should not be finalized. The recently proposed regulations would eliminate the "benefits and burdens" test for determining the producer of the film eligible for section 199 benefits. In its place, the IRS proposes that only the party who performs the services under the production contract would be eligible for the section 199 deduction. We believe that replacing the benefits and burdens test with this new rule is inappropriate for several reasons.

Most importantly, we believe that the new proposed rule is contrary to the legislative intent to provide meaningful incentives for domestic film production. By providing section 199 benefits to the contract producer rather than the television network, the new rule runs counter to the statute and largely eviscerates any economic incentives to produce programming in the United States in several ways.

First, it is unclear whether the contract producer is eligible for any benefits under section 199. The statute requires that income be derived from the "lease, rental, license, sale, exchange, or other disposition" of the film. Given that the contract producer generally has no ownership or exploitation rights with respect to the produced film under a typical "work-for-hire" arrangement, it is not clear how the contract producer could ever "dispose" of a film in order to be eligible to take a section 199 deduction.3

Second, the network rather than the contract producer generally makes the decisions whether to "green light" a production and where to produce the show. The proposed regulation thus assigns the benefit away from the entity making entrepreneurial decisions regarding whether and where to produce to a party that has little or no control over these major production decisions, including whether the production remains in the U.S.

Third, the contract producer is generally paid a "fee" for production and has a lower profit margin than the network. As a result, the section 199 benefits for these television productions will be significantly reduced.

Consequently, we believe that the proposed rule at best seriously blunts the intended incentive effects under section 199 to produce films domestically, and at worst could lead to instances where no party is entitled to section 199 benefits.

The proposed rule would also significantly alter the underlying economics of thousands of existing production agreements. Many of these agreements are multi-year deals and were negotiated in reliance on the statute and the clear rule in the current regulations. Decisions on whether and where to produce a show, who to hire, and the pricing of the agreements all were premised on the ability of the hiring party to secure section 199 production incentives. Our experience has been that the availability of section 199 benefits (together with state and local incentives) to the hiring party provides a powerful incentive for domestic production that would be significantly reduced under the proposed regulations. We believe that the decision to change the economics of these agreements is misguided as it minimizes or negates a Congressionally-designed incentive to produce content domestically, and it is especially unfair with respect to existing arrangements negotiated and entered into based on settled law.

In addition to our concerns that the proposed rule runs counter to the statute and undermines any economic incentive intended by Congress, we also believe that the proposed regulation contradicts Congressional intent in other ways as well. As described above, because Congress was compelled to repeal the ETI regime to comply with the WTO's ruling, section 199 was enacted to reduce the harm to affected taxpayers and to continue to provide incentives for them to produce property, including films, domestically. Under the ETI regime, it was clear that the hiring studio or network was eligible for benefits, not the contract producers. Given that section 199 was a replacement for ETI, it seems illogical that Congress intended to switch the intended beneficiaries of the incentives without expressly saying so.

Also, since the adoption of the benefits and burdens rule in the regulations under section 199, Congress has amended section 199 in several ways with respect to films to address concerns raised by the industry. These changes were premised in part on (and are consistent with) a benefits and burdens approach (and are seemingly inconsistent with the proposed rule). For example, Congress provided that a qualified film includes the copyrights, trademarks and other intangibles with respect to a film.4 Given that the contracting party has no such rights under a typical "work-for-hire" arrangement and thus cannot earn DPGR with respect to such items, this legislative change would have been far less significant to the industry under the proposed rule. Similarly, Congress also provided that the methods and means of distribution do not impact eligibility under section 199.5 This change was made to clarify that income attributable to digital distribution of content by the networks is eligible for section 199 benefits. If the networks are not entitled to section 199 benefits on contract production (as under the proposed rule), this change again would have been far less significant to the industry. These changes were enacted at the behest of the industry under the existing regulations and were intended "to take into consideration how the film industry operates."6

Given these subsequent legislative fixes to section 199 were made after the final regulations adopted the benefits and burdens standard, it also seems that Congress tacitly approved use of the standard for purposes of section 199 under the legislative reenactment doctrine. In Boeing Co. v. United States, the Supreme Court held that "the fact that Congress did not legislatively override [the regulation] . . . serves as persuasive evidence that Congress regarded that regulation as a correct implementation of its intent."7 We believe this is clearly the case in a situation like this where the requested legislative fixes adopted by Congress were largely premised on the existence of the benefits and burdens standard.

In addition to undermining the intended economic incentives for domestic production which will likely lead to a significant loss of U.S. film production jobs, we believe the proposed rule will have other unintended adverse effects as well. To the extent feasible, networks and studios will move their production work in-house to retain section 199 eligibility, thereby harming independent film producers. To survive, independent film producers may move their companies overseas to allow their films to take advantage of generous foreign film subsidies. Also, smaller networks [like ours] may be disadvantaged relative to others with greater capacity to move productions in-house (in order to retain section 199 benefits). Those with capacity to do so will receive greater benefits under section 199 for their films, than those who don't.

While we share the concern underlying the proposed new rule that tax regulations should be relatively easy to administer, we do not believe the current benefits and burdens standard is unclear or difficult to administer, particularly with respect to the typical "work-for-hire" arrangements in our industry. For example, we believe it is clear that the hiring company under these contracts would have the 'benefits and burdens' of ownership under the nine-factor test articulated by the Tax Court recently in ADVO Inc. v. Commissioner.8 However, to minimize tax administrability concerns, we believe the approach adopted by LB&I in its recent directive9 could be an effective solution that would minimize disputes, ensure that only one contracting party claims the deduction, and help to optimize the intended incentives for domestic film production under section 199.10

For all of these reasons, we respectfully request that the proposed rule not be finalized and the benefits and burdens test be retained. We believe that this test under the current regulations has worked well for our industry and provides effective incentives for domestic production under section 199 as intended by Congress.

We very much appreciate the opportunity to submit these comments on behalf of our respective companies. These issues are critically important to our companies and our business models We are grateful for your consideration of our concerns, and please do not hesitate to contact any of us if you have any questions or comments.

Very truly yours,

 

 

Todd Davis

 

Discovery Communications, Inc.

 

 

John Viterisi

 

Scripps Networks Interactive

 

 

Sal Focella

 

AMC Networks, Inc.

 

cc:

Emily McMahon, Deputy Assistant Secretary

Thomas West, Tax Legislative Counsel

Kenneth Beck, Office of Tax Legislative Counsel

Erik Corwin, Deputy Chief Counsel (Technical)

Curt Wilson, Associate Chief Counsel, Pass-throughs and Special Industries, Internal Revenue Service

Paul Handleman, Branch Chief, Office of the Associate Chief Counsel (Pass-throughs and Special Industries)

James Holmes, Office of the Associate Chief Counsel (Pass-throughs and Special Industries)

 

FOOTNOTES

 

 

1 Shurlock, "The Section 199 Production Activities Deduction: Background and Analysis," Congressional Research Service, February 27, 2012, p. 1.

2 I.R.C. § 199(c)(6).

3 In fact, Congress had to provide a special rule for certain government contracts because the producer of the property would not have otherwise been able to meet the "disposition" requirement because it does not have ownership of the property. See I.R.C. § 199(c)(4)(C),

4 I.R.C. § 199(c)(6).

5 See id.

6 Joint Comm. on Tax'n, "General Explanation of Tax Legislation Enacted in the 110th Congress," JCS-1-09 (2009), p. 447.

7 123 S. Ct. 1099, 1111-12 (2003).

8 See 141 T.C. No. 9 (2013). The nine factors used by the ADVO court are; (i) whether legal title passes; (ii) the intention of the parties; (iii) whether an equity interest was acquired; (iv) whether the contract creates a present obligation on the seller to execute and deliver a deed and a present obligation on the purchaser to make payments; (v) whether the right of possession is vested in the purchaser and which party has control of the property or process; (vi) which party pays the property taxes; (vii) which party bears the risk of loss or damage to the property; (viii) which party receives the profits from the operation and sale of the property; and (ix) whether the hiring party actively and extensively participated in the management and operations of the activity. Under our work-for-hire arrangements, the hiring party has legal title, maintains the equity interest, bears the risk of loss, receives the profits and actively participates in the management of the production, and the parties intend that the hiring party has all rights of ownership and exploitation. The other factors are not applicable to our arrangements. Consequently, it is clear that the hiring party has the benefits and burdens of ownership under the ADVO test.

9 See Directive LB&I-04-0713-006 (July, 2013), instructing examiners not to challenge a taxpayer's claim that it has the benefits and burdens if (i) a statement is provided explaining why the taxpayer qualifies and (ii) a certification is provided executed by each party to the contract designating which party will claim the section 199 deduction. See also Directive LB&I-04-1013-008 (October, 2013), which revised certain procedural aspects of the prior directive. Such an approach should apply only to production contracts entered into after the effective date of the new regulation.

10 The ADVO court expressed some support for the directive saying it can help "to resolve in advance cases like this one." 141 T.C No. 9, p. 37.

 

END OF FOOTNOTES
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