The digitization of the media and entertainment industry has transformed most aspects of its global supply chain, from the creation and acquisition of content to processing, editing, and global distribution. In addition to dramatically eroding the constraints of distance, time, and transaction costs, the digitized supply chain provides the opportunity for enhanced tax efficiencies. However, such tax efficiencies are not derived automatically. Proactive planning is required.
PLANNING FOR GLOBAL TAX EFFICIENCIES
Typically, individuals or business entities that create content maintain physical and tax residence in a single country. In many cases, this country of residence is not conducive to maximizing global tax efficiencies related to the content produced.
Let’s take the example of a U.S. media and entertainment business (corporation or passthrough) that produces content for international distribution. Let’s assume that it creates some content in the U.S. and other content is created via contract by individuals or entities in countries outside the U.S.
SCENARIO I – TAXATION WHERE CONTENT IS U.S. OWNED
• U.S. Source Income
Income generated by the U.S. corporation from the exploitation of content in the U.S. market is taxed at the corporate rate of 21%. Upon distribution, shareholders are taxed again at the rate of 23.8%. If the content is exploited via a U.S. pass-through entity (e.g., U.S. LLC or partnership), individual owners are taxed on such income at their normal graduated rates (max of 37%).
• Foreign Source Income
Income generated by a U.S. company from exploiting content outside the U.S. is referred to as “Foreign Derived Intangible Income” (“FDII”) and currently benefits from a U.S. preferential export rate of 13.125%. Once distributed to individual shareholders, such income is taxed again at 23.8%.
In comparison, content exploited outside the U.S. via a U.S. passthrough entity results in individual owners being taxed at their normal graduated rates (max of 37%). While these U.S. rates may appear favorable for select businesses and individuals compared to their available options for having the content owned outside the U.S., in most cases careful planning for foreign ownership of content results in maximum global tax efficiency. Should Congress pass the proposed tax measures described below, the advantages of foreign ownership will be even more pronounced.
• Proposed Increase in U.S. Tax Rates
The latest Congressional proposals call for increasing U.S. corporate tax rates from 21%
to 26.5% and the U.S. capital gains rate from 20 percent to 25%. In addition, Congress has set forth proposals that would increase the preferential FDII export rate from 13.125% to 20.7%. Finally, Congress is proposing to increase the tax on corporate dividends from 23.8% to 28.8%.
SCENARIO II – TAXATION WHERE CONTENT IS FOREIGN-OWNED
As an alternative to U.S. content ownership, let’s assume the U.S. media or entertainment business (again a corporation or passthrough) sets up a foreign corporate subsidiary (“FORCO”) in a low tax jurisdiction to contract with the U.S. and foreign content creators. The U.S. company can still be in charge of identifying content creators, marketing, and U.S. distribution, but the use of a foreign company ensures that content is funded and owned outside the U.S. and that the premium licensing and sales revenue is generated and primarily taxed outside the U.S. The relevant tax considerations of utilizing such a foreign arrangement are as follows:
• FORCO Local Country Taxation
As long as FORCO funds and directly engage foreign content producers, it should be considered the content owner with all the rights to exploitation. Assuming FORCO is in a low tax jurisdiction with a good tax treaty network, it should be able to generate global leasing and sales income in a very tax-efficient manner with minimal withholding tax. Moreover, FORCO should be able to benefit from a tax rate between 0 and 15% in its country of origin.
• FORCO U.S. Taxation
Due to changes in U.S. tax law after the Tax Cuts and Jobs Act of 2017 (TCJA), the operating income earned by FORCO will be included in the taxable income of U.S. shareholder(s) as a “deemed” (i.e., fictional) dividend, whether or not FORCO actually makes a cash distribution. However, the U.S. tax on this deemed dividend will be as low as 0% where the corporate tax paid in the foreign country is at least 13.2%. Alternatively, the U.S. tax will be a max of 10.5% if FORCO is exempt from corporate tax in its country of residence.
With appropriate planning, foreign earnings can be distributed to a US corporate shareholder without incurring any additional tax. In addition, since tax at the ultimate individual shareholder level can be deferred until shareholders actually receive a dividend, the strategy of creating and exploiting content from outside the U.S. offers the opportunity to realize enhanced tax efficiency.
The digitized supply chain of the media and entertainment industry offers substantial opportunities for tax-efficient tax planning. In addition to reducing the global effective tax rate, a well-planned international tax structure should permit ultimate shareholders to defer U.S. tax, thereby permitting more of the business’s after-tax income to be reinvested into the supply chain and into the creation of new content.
Fernando R. Lopez JD, MBA is principal and leader of international tax for Prager Metis.
Contact him directly via firstname.lastname@example.org or visit pragermetis.com.
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