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Tax reform impact on media and entertainment companies

Flashpoint 22: How media and entertainment companies can navigate the changes

Thanks to the bill formerly known as the 2017 Tax Cuts and Jobs Act, corporations are looking at a hefty tax rate cut, as the statutory rate decreases from 35 percent to 21 percent. That’s good news for media and entertainment (M&E) companies who operate as corporations as well as smaller businesses. Learn more about the strategic implications.

New tax laws, new opportunities

The new tax laws are good news for M&E companies who operate as corporations, since they have traditionally had high effective tax rates compared with other sectors. Smaller companies, such as production companies with a single owner, may also benefit as a result of new provisions that allow deductions for pass-through entities.

The new law allows companies that have deferred US taxation by reinvesting earnings overseas to bring back cash tax-free after paying a "transition tax." This increased cash flow will have a positive effect on mergers and acquisitions (M&A), debt repayment, and research and development (R&D) related to content, distribution technologies, and evolution of business models. Increased investments are also expected in new production facilities and new hires.

Deploying extra cash: A strategic decision

Many M&E companies may find themselves with extra cash as a result of the tax cut and the repatriation of earnings held overseas. As a result, an increase is expected in M&A activity as companies look to acquire other organizations with complementary businesses. However, many other possibilities exist: Companies may choose to pay down debt with the extra cash, reward employees with bonuses, or invest in new infrastructure, such as building a studio or an interactive venue.

In an industry that revolves around capturing viewers and generating exciting titles, new content reigns. Companies are expected to invest in content production and in exploring new technologies such as high definition, special effects, virtual reality, augmented reality, and artificial intelligence. The new law makes these investments especially attractive, since film, TV, and other content production costs can be expensed immediately.

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Technology investments could change distribution models

Other avenues for repatriated cash include R&D, especially development of new technologies for content distribution and investments in platforms. This may be especially important given that many established media companies are battling new market entrants that are finding ways to circumvent traditional content distribution. The historical model of producing a film, releasing it through various windows—from theaters to cable or on-demand—is often disrupted by streaming services. Many companies are looking for new and innovative ways to distribute their content, and to transform to platform models, so investment in technology is likely essential. The new law’s extension of the R&D tax credit can certainly encourage these forms of investment.

In addition to the R&D tax credit, the new law allows an immediate deduction for qualified R&D expenditures, although these expenditures will need to be capitalized and amortized beginning in 2023. With both the R&D tax credit and deductions for R&D expenditures, media companies can continue exploring not only new content development and distribution technologies, but ways of using blockchain and encryption technologies to safeguard their copyrights.

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States may entertain new incentives

Credits and incentives have always played a big part in determining where companies decide to produce content. With tax reform prompting more companies to bring production activities back to the United States, there is a good chance that states may ratchet up their efforts to attract these lucrative projects. For example, Georgia’s strategy of offering attractive film and other media tax credits turned it into a huge film production state, and other states may now decide to follow suit.

On the other hand, not all states will conform to the more favorable provisions of federal tax reform, so decisions to move to a particular state should be carefully considered.

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Is the party over? For some, it might be

It’s hardly a surprise that for M&E companies, parties and entertainment play an important role. Under the previous tax law, if a company threw a big party for business purposes, it was 50 percent deductible. The new law stipulates that entertainment expenses are no longer deductible, and this includes meals purchased during entertainment activities. Only meals with a substantial business purpose are 50 percent deductible.

The effect of the change goes beyond a dampening of the Hollywood party culture. Companies will need to enforce very accurate recordkeeping that describes a legitimate business purpose for a business meal. Furthermore, they may need to tweak their enterprise resource planning (ERP) systems to ensure employees use the correct expense codes, as well as institute appropriate training.

The restrictions on deductions for meals and entertainment may adversely impact some companies’ effective tax rates, because they will create a permanent difference from the financial accounting treatment.

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Keeping the crown jewels at home may beat housing them overseas

US media companies that house their intellectual property (IP) in the United States and license content to foreign companies will benefit from the new Foreign-Derived Intangible Income (FDII) deduction that encourages exports. Many US media and entertainment companies do distribute and license content offshore, so there could be some industry-wide benefits. There are some companies, however, that have moved their IP offshore, and they may be hit by new international tax provisions—both the Base Erosion Anti-Abuse Tax (BEAT) and the Global Intangible Low-Taxed Income (GILTI)—that were designed to penalize this type of planning.

Companies will likely be motivated to rethink their value chains and how they structure their licensing arrangements to determine whether their royalty streams can be structured to capture the benefits of the new tax law and avoid pitfalls.

Additional tax reform provisions

Foreign-Derived Intangible Income (FDII)

  • 37.5 percent deduction 2018–2025
  • 21.875 percent deduction starting in 2026

Global Intangible Low-Taxed Income (GILTI)

  • GILTI taxed immediately and subject to a 50 percent deduction through 2025, then 37.5 percent limited to taxable income

Base Erosion and Anti-Abuse Tax (BEAT)

  • 10 percent (5 percent in 2018) new "minimum tax" system

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Let's talk

Understanding the bill originally known as Tax Cuts and Jobs Act—and its impact on M&E companies—will take some time. The provisions are complex and its impacts are far-reaching. Deloitte’s tax professionals understand the ins-and-outs and how your business can maximize the benefits while minimizing any drawbacks. Let’s talk about what tax reform can mean to you.

In the meantime, be sure to check back for a monthly dose of the latest issues driving the future of technology, media, and telecommunications companies.

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