SPECIAL FEATURE: TAXATION OF THE ENTERTAINMENT INDUSTRY (SPECIAL REVIEW)

Many Nigerian entertainers are evading tax, not because some of them intentionally want to but because they don’t understand their taxable income. Likewise, the government of Nigeria, through all her tax agencies is losing billions of Naira every year from the entertainment sector because they are yet to discover a proper structure for taxation of the entertainment industry.

Understanding taxation of the entertainment industry helps in managing entertainment tax issues, know how the law characterizes ownership rights and interests, choose a business form that provides maximum tax advantage, determine the best time to report and recognize income, reduce the tax burden through deductions, depreciation, and the investment tax credit. It also helps in paying close attention to the special tax considerations that apply to talent.

A good understanding of Taxation of the Entertainment Industry will help entertainment practitioners spot unique issues before they become problems, interpret rules and regulations correctly, make business decisions that lower taxes, and ensure compliance with the law.

Show Business is one of the most of the most lucrative businesses in the world. This is true especially when it comes to tax planning for entertainers. Although taxpayers in the entertainment industry face tax planning issues similar to those of other high net worth individuals, the nature of the industry creates unique areas of exposure. From the various types of income, to the maximization of deductions and benefits, this article will highlight the need for tax planning that is as creative as the individuals being taxed.

The type of income entertainers receive depends on the activities or services performed and their rights as per contractual agreement. Entertainers involved in film and television production, including actors and other employees of studios and production companies, generally receive wages or salaries for their performance or compensation based on net profits or gross receipts of the production. Additionally, actors may receive residuals, payments for past performances and re-runs of television shows, movies, and commercials which are considered personal services income and are treated as wages.

Copyright owners, such as authors, recording artists, and songwriters, receive payments in the form of royalties or license fees. Royalties are periodic payments generated by the sale of copyrighted material. As intellectual property protected under copyright laws, the sale and license of copyrights could be subject to favorable capital gains treatment as opposed to being treated as ordinary income.

Celebrities also receive endorsement income for recommending products or making appearances, and participating in photograph sessions for their sponsors. Whether such income will be treated as royalty income (i.e., license of intangible property) or personal services income will depend on the actual purpose of compensation (usually defined in the contract). The income will be considered royalty income if the entertainer is paid for the right to use his name and likeness (e.g., his face on a shirt). However, if the entertainer is compensated for a performance, or an appearance in commercials or interviews, the income will be characterized as personal services income.

Entertainers are also compensated in forms other than cash. Fringe benefits and goods, such as wardrobes, housing, meals, travel and transportation, given to entertainers in lieu of, or in addition to, cash payments are considered compensation and should be included in their taxable income.

To understand fully the subject matter, it is helpful to become acquainted with the terminology that is unique to the entertainment industry. Certain key terms are defined below-

Talent: the actors, artistes, writers and directors are referred to as “talent”

Above –the-line and below- the – line costs: motion picture costs are often categorized as either ‘Above the line” costs or below the line costs. “Above the line” costs are payments to creative and executive personnel, such as talent. “Below the line” costs are all expenses that relate to the actual on-site shooting of the film and the post production costs (such as editing and soundtrack)

Deficit financing: in the television industry, it is common for a network to finance a substantial portion of the cost of a television show. The producer must provide the balance of financing through sales of foreign rights or loans. This process is often referred to as “deficit financing”

P and A: after a film is completed, it must be distributed. In the case of a so-called theatrical release (a release through motion picture theaters), substantial costs are incurred in making duplicate film prints and in advertising. These costs are often referred to as prints and advertising (P and A).

Participations- Talent will often receive participations entitling them to payments based on a percentage of the revenues from the film. Participations are usually tied to net revenue and are defined in such a way that they rarely earned. If the talent has a strong bargaining position, they may have a participation tied to gross revenues, which is certain to earn them at least some income.

Residuals- Residuals are essentially the same as participations, but then the term residuals is used when the payments are made to unions pursuant to guild agreement.

Negative pick –up: Negative pick –up is an agreement whereby a distributor agrees in advance to acquire worldwide rights in a film in perpetuity upon delivery by the producer. The distributor agrees to pay the producer a fixed amount upon delivery of the film and to make additional payments contingent on success of the film. The producer pledges the distribution agreement to a bank in exchange for a loan to use in the production of the film. As long as the film meets certain pre-approved criteria, the distributor must accept delivery, and the distributor’s payment is being used to pay down the bank loan.

PFD Agreement: in a “production, finance and distribution agreement” (a PFD agreement), a distributor acquires worldwide rights in perpetuity and owns all film rights during production, by directly funding all cost of production. The distributor has the right to make changes during production as long as the distributor pays for any additional cost. The producer is entitled to fixed producer’s fee plus contingent compensation based on the success of the film.

Many entertainers are paid under deferred compensation arrangements through which they avoid current taxation by deferring their income to future years. However, only deferred compensation plans that meet strict requirements should be respected.

Entertainers often “go where the money is,” that is, where their work takes them. As such, they can be subject to tax in many states, particularly because their whereabouts can easily be tracked due to their celebrity status. Entertainers are normally subject to tax in their resident state based on worldwide income. Entertainers may also be subject to tax in nonresident states to the extent that income was derived or “sourced” to that state. In order to determine the states in which their income is sourced, entertainers must determine “where performance occurs” and how many days they worked within that state over total days worked. A proper assessment of income sourcing and allocation is the key. There are many ways to minimize tax in the entertainment industry but proper tax planning is imperative.

To be continued……..

*Additional information by Schuyler Moore AND WTAS