Was a company that digitally converted existing films for specialized theatrical display a producer whose box-office-share receipts followed California's film-in-release sales-factor rule?

Plain-English summary

California Chief Counsel Ruling 2013-01 held that a company digitally converting existing films for a specialized theatrical system was a motion-picture producer under title 18, regulation section 25137-8.2.

The company did more than provide a mechanical format change. It developed and created a new film product through digital encoding, customized algorithms, pixel creation, editing, sound and color work, and quality control.

Its share of theatrical-release receipts therefore followed the regulation's special sales-factor numerator rule for films in release to theaters.

Film-conversion business

The company contracted with studios to transform existing two-dimensional and three-dimensional films for exhibition in a specialized theater system.

In exchange, it received a redacted percentage of box-office receipts from theaters using that system.

The conversion process was described as analogous to conventional film production.

Production activities

The company:

• digitally encoded the original film;
• analyzed lighting, color, flaws, and trends;
• developed custom algorithms for each film;
• expanded and created color pixels through automated processes;
• employed editors, coordinators, accountants, sound technicians, and digital artists; and
• performed California quality control and necessary adjustments.

Most conversion work occurred outside California, but the producer-classification question turned on the nature of the activities rather than their location.

Finished-product distribution

The completed film could be placed on specialized negative stock and sent for creation of a digital cinema package or shipped directly to theaters.

The product was intended for theatrical exhibition in the company's display system.

Regulatory definition

Regulation section 25137-8.2(b)(5) defined a producer as a business entity that develops and creates motion-picture, television, or web-based content.

FTB found that the taxpayer performed activities traditionally associated with producing motion pictures and created a "new" film product for theatrical display.

Sales-factor holding

Because the company was a producer, its receipts from distributing the converted films were gross receipts from films in release to theaters.

Those receipts were assigned under regulation section 25137-8.2(c)(3)(A)(i)'s numerator rule.

What this means for you

Post-production and conversion companies

Substantial creative and technical transformation of existing content can qualify as producing new motion-picture content rather than merely processing someone else's property.

Entertainment companies

Revenue form mattered: the taxpayer earned a share of box-office receipts from theatrical exhibition of the converted product.

Media tax departments

Document creative steps, custom technology, production personnel, quality control, finished deliverables, distribution channels, and the relationship between compensation and theatrical release.

Common questions

Q: Did using an existing film prevent producer status?

A: No.

Q: What made the company a producer?

A: It developed and created a new theatrical film product through production-like creative and technical work.

Q: Did the company receive only a fixed service fee?

A: No. The ruling described compensation as a share of theatrical box-office receipts.

Q: Which special rule applied?

A: The film-in-release numerator rule in regulation section 25137-8.2(c)(3)(A)(i).

Citations and references

• Cal. Code Regs., tit. 18, § 25137-8.2(b)(5) and (c)(3)(A)(i)
• Cal. Rev. & Tax. Code § 21012(a)(1)

Source

• Landing page: California FTB Chief Counsel Rulings
• Official PDF: Chief Counsel Ruling 2013-01

Original ruling text

chair John Chiang | member Jerome E. Horton | member Ana J. Matosantos

Legal Division MS A260
PO Box 1720
Rancho Cordova, CA 95741-1720

tel: (916) 845-3306 fax: (916) 845-3648
ftb.ca.gov

06.14.13
CHIEF COUNSEL RULING 2013-01

Dear M. ***:

You requested a Chief Counsel with respect to the operation of California Code of Regulations, title 18, section 25137-8.2 pertaining to * Corporation and Affiliates.

FACTS

* is a motion picture entertainment company. One of its activities involves taking existing film properties and ** () the films. The *** process transforms two-dimensional and three-dimensional films so that they may be displayed in an
theater. In a typical *** arrangement, a film studio contracts with to produce the *** film, and in return is entitled to a share, ** to ** percent, of the *** film's box office receipts from display in all theaters using the *** display system.

The *** process is a multi-step process that is analogous to conventional film production.
* digitally encodes the 35mm version of a film for showing in theaters. The digitally encoded film is then analyzed for flaws and general trends such as lighting and color. Unique customized algorithms are developed for each film that expand and create color pixels in the conversion of the film for display in an ** theater. The pixels are applied via a computer-automated process. The majority of this work is performed outside of California. Quality control is conducted by a subsidiary located in California and necessary adjustments are made.

The *** process employs both manual and automated processes involving a number of individuals including editors, coordinators, accountants, sound technicians and digital artists.

Distribution is accomplished in several ways. The finished *** film on * negative film stock is shipped to another company, where it is compiled into an Digital Cinema package for exhibition in ** theaters, or it is drop-shipped to theaters for exhibition.

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ISSUE

For purposes of the *** process is * a "producer" such that the revenue derived from the *** process constitutes gross receipts from "films in release to theaters" so that such receipts will be assigned to the numerator of the sales factor pursuant to title 18, California Code of Regulations ("Regulation") section 25137-8.2(c)(3)(A)(i)?

HOLDING

For purposes of the *** process * is a "producer" such that the revenue derived from the *** process constitutes gross receipts from "films in release to theaters," so that such receipts should be assigned to the numerator of the sales factor pursuant to Regulation section 25137-8.2(c)(3)(A)(i).

DISCUSSION

Regulation section 25137-8.2(b)(5) defines a producer as "a business entity that develops and creates motion picture, television, or web-based content."

The activities that * engages in creating *** films out of existing 35mm film properties are all those of a nature traditionally performed by a producer of motion pictures. edits and enhances films for exhibition in movie theaters. converts existing films via a computer-automated process by expanding and creating color pixels so that the film may be displayed in an theater. It employs a number of individuals in capacities identical to those employed by producers of traditional motion picture films. Those capacities include those of, editors, digital artists, sound technicians, color technicians, production accountants, and coordinators. Products are reviewed to ensure quality control. develops and creates a "new" film product. *** is a producer within the meaning of regulation section 25137-8.2(b)(5).

Because * is a producer as defined in regulation section 25137-8.2(b)(5), the receipts it receives from the distribution of the films that it produces should be assigned pursuant to Regulation section 25137-8.2(c)(3)(A)(i).

Please be advised that the tax consequences expressed in this Chief Counsel Ruling are applicable only to the named taxpayer and are based upon and limited to the facts you have submitted. In the event of a change in relevant legislation, or judicial or administrative case law, a change in federal interpretation of federal law in cases where our opinion is based upon such an interpretation, or a change in the material facts or circumstances relating to your request upon which this opinion is based, this opinion may no longer be applicable. It is your responsibility to be aware of these changes, should they occur.

This letter is a legal ruling by the Franchise Tax Board's Chief Counsel within the meaning of paragraph (1) of subdivision (a) of section 21012 of the Revenue and Taxation Code.

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Please attach a copy of this letter and your request to the appropriate return(s) (if any) when filed or in response to any notices or inquiries which might be issued.

Very truly yours,

Benjamin F. Miller
Counsel, Multistate Tax Affairs