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On December 22, 2017, President Trump signed the "Tax Cuts and Jobs Act" (H.R. 1) (the Act) into law, capping off the first major overhaul of the federal income tax in more than 30 years. The Act reflects compromises by the House and Senate conferees in a host of areas, including a 21% corporate tax rate that will be effective in 2018 — up from 20% in the bills passed by the House and the Senate.

Several provisions — from the taxation of foreign earnings to the loss of certain deductions — will have important implications for the media and entertainment (M&E) industry. While effects will vary within the diverse M&E subsectors (including film and television, publishing, cable operators, advertising, music and sports), this Alert highlights some of the provisions with the broadest reach within the industry. Taxpayers should evaluate the legislation and model the effect of the provisions to enable timely planning.

Domestic taxation

Temporary 100% expensing of certain business assets

Bonus depreciation increases from 50% to 100% for "qualified property" placed in service after September 27, 2017 and before 2023. The Act follows the House bill in that the original use of the property need not commence with the taxpayer. The increased expensing phases down starting in 2023 by 20 percentage points for each of the five following years. A transition rule allows for an election to apply 50% expensing for the first tax year ending after September 27, 2017. For a comprehensive discussion of this provision, see Tax Alert 2017-2131.

Additionally, the term "qualified property" follows the Senate amendment that expands the definition of qualified property to include qualified film, television and live theatrical productions for which a deduction otherwise would have been allowable under Section 181. The incorporation of Section 181 property into the bonus depreciation rules of Section 168(k) has several important implications and planning opportunities.

For instance, there are several time periods to consider. Bonus deprecation will begin for Section 181 property placed in service after September 27, 2017. Thus, Section 181 costs incurred after December 31, 2016 and before September 27, 2017 must be capitalized and depreciated under Section 167. Bonus depreciation only applies if the property is placed in service after September 27, 2017. For this purpose, placed in service requires an actual exhibition of the property. Taxpayers should consider using the income forecast depreciation method for "stub" period properties because it is accelerated, and permits a write off in the year there is no future income.

Further, although there is not much time remaining in 2017 to take advantage of higher tax rates, taxpayers should consider speeding up any planned purchases of unreleased programming and placing any produced property into service before the end of the year by exhibiting it. Taxpayers should also reevaluate all of their scheduled foreign production and consider whether it should be moved to the United States to take advantage of bonus depreciation.

Additionally, Section 181 costs are now only recovered when the property is placed in service and not when incurred. Thus, taxpayers should capitalize development costs and recover them through bonus depreciation when the property is placed in service or, if no production occurs, under Revenue Procedure 2004-34.

Taxpayers, however, should be cautious in applying Section 168(k). Not all of its terms will apply to films and television programming because it is limited to qualified property as defined by Section 181. For example, the ability to expense used property will not apply to qualified Section 181 property because such property only includes films and television programming that have not been exhibited.

Repeal of Section 199 deduction

The Act follows the House bill in eliminating the domestic production deduction (Section 199), which allows, in some cases, a several-point tax rate reduction for many M&E companies, such as TV networks and film producers. The repeal provision is effective for tax years beginning after December 31, 2017.

As M&E companies are aware, Section 199 has been an ongoing focus of IRS examination activity, which has resulted in several cases pending in a variety of federal courts. Because the provision eliminates Section 199 for tax years beginning after December 31, 2017, it is unclear how the IRS will examine and litigate Section 199 claims for tax years beginning before 2018.

Limitation on deduction for interest

The Act limits the deduction for net interest expense of all businesses by amending Section 163(j). Unlike the House and Senate bills, however, the Act drops the additional interest expense limitation that would have been imposed through a worldwide debt cap under what would have been Section 163(n). The revised Section 163(j) limitation is on net interest expense that exceeds 30% of adjusted taxable income (ATI). For the first four years, ATI is computed without regard to depreciation, amortization, or depletion. Thereafter (beginning in 2022), ATI is decreased by those items, thus making the computation 30% of net interest expense exceeding taxable income before interest and tax. ATI is otherwise defined similar to current Section 163(j). Interest expense needs to be related to a "business," which means the interest is properly allocable to a trade or business. Certain activities are excluded from being a trade or business — e.g., performing services as an employee, a real property trade or business, and certain activities of regulated utilities. A small business exception is keyed to businesses satisfying a gross receipts test of $25 million. The provision is effective for tax years after 2017. For a comprehensive discussion of this provision, see Tax Alert 2017-2131.

The provision reduces the advantage of financing merger and acquisition transactions with debt. To the extent the acquirer cannot deduct interest on acquisition debt, the economic cost of a debt-financed acquisition would be greater than under current law.

Taxpayers facing deferral or disallowance of interest deductions generally will have incentives to increase their net interest income, either by converting interest into another type of deductible expense or by converting another type of income into effectively tax-free interest income.

Amortization of research and experimentation expenditures

Section 174 will require taxpayers to treat research or experimental expenditures as chargeable to a capital account and amortized over five years (15 years in the case of foreign research). The Act also follows the Senate bill and modifies Section 174 to require that all software development costs be treated as research or experimental expenditures. In addition, any capitalized research and experimental expenditures relating to property that is disposed of, retired, or abandoned during the amortization period must continue to be amortized throughout the remainder of the period. Generally, purchased software may be amortized over just 36 months pursuant to Section 167(f)(1), so the Act puts taxpayers that develop their own software in a tax position that is less favorable than taxpayers who acquire it.

The concern within the M&E industry derives from the fact that all costs related to software development will constitute research and experimental expenditures. It is currently common practice for M&E companies to adopt a method of immediate expensing for software development costs under Revenue Procedure 2000-50. This eliminates the expensing method for such costs.

Special rules for tax year of income inclusion

This provision, which originated in the Senate bill, modifies the recognition of income rules by requiring a taxpayer to recognize income no later than the tax year in which the income is taken into account as income on an applicable financial statement or another financial statement under rules provided by the Secretary. However, in the case of a contract that contains multiple performance obligations, the provision allows the taxpayer to allocate the transaction price in accordance with the allocation made in the taxpayer's applicable financial statement.

Additionally, the provision codifies the deferral method of accounting for advance payments for goods and services contained in Revenue Procedure 2004-34. Under that method, taxpayers are permitted to defer the inclusion of income associated with certain advance payments to the end of the tax year following the tax year of receipt if the income is deferred for financial statement purposes. For a comprehensive discussion of this provision, see Tax Alert 2017-2131.

This provision generally results in an earlier accrual of income to the extent amounts are accrued earlier for financial statement purposes than currently required under Section 451. Taxpayers should consider this provision in conjunction with their ASC 606 adoption as the potential for an acceleration of taxable income exists. The exception for certain advance payments of income is an important one, preserving the current, widely applied favorable federal income tax treatment for such items. Advance payments governed by Revenue Procedure 2004-34 include amounts received for services, the sale of goods, the use of intellectual property (e.g., by license or lease), the occupancy or use of property if ancillary to the provision of services, the sale, lease or license of computer software, certain ancillary guarantee or warranty contracts, and eligible subscriptions and memberships.

International taxation

Transition tax on deferred foreign earnings

The Act requires a mandatory inclusion of the accumulated foreign earnings of a controlled foreign corporation (CFC) and other foreign corporations with a 10% domestic corporate shareholder (a 10/50 company), collectively referred to as specified foreign corporations, or SFCs. Whether a foreign corporation is a SFC is determined without the application of Section 958(b)(4) (preventing downward attribution from a foreign person to a US person), which is repealed for the foreign corporation's last year beginning before January 1, 2018. The mandatory inclusion is implemented by increasing the subpart F income of the SFC (treating a 10/50 company as a CFC solely for this purpose) in its last tax year beginning before January 1, 2018 (transition year), by the greater of its "accumulated post-1986 deferred foreign income" determined on November 2, 2017 or December 31, 2017. For a comprehensive discussion of this provision, see Tax Alert 2017-2166.

Media companies with E&P deficits in foreign ownership chains would continue to be able to offset those deficits against positive earnings for transition tax purposes. Unlike the Senate proposal, the Act allows net E&P deficits to be shared between affiliated group members. Additionally, dividends are allowed to be distributed between foreign CFCs, so long as the recipient includes the dividend income in its respective E&P for transition tax purposes.

Media companies should be working on determining their tax liability for transition tax purposes, including reviewing historic E&P and tax pools, determining cash and cash equivalent balances to be included as of the relevant dates, assessing their FTC utilization positions (including OFLs), and assessing the availability of attributes (e.g., existing or carryforward FTCs, NOLs or other credits) to offset their transition tax liabilities.

Anti-base erosion rules — Global Intangible Low-Taxed Income (GILTI)

The Act follows the Senate bill and imposes a tax on a US shareholder's aggregate net CFC income that is treated as global intangible low-taxed income (GILTI). GILTI is gross income in excess of extraordinary returns from tangible depreciable assets excluding effectively connected income (ECI), subpart F income, high-taxed income, dividends from related parties, and foreign oil and gas extraction income. The extraordinary return base is equal to 10% of the CFCs' aggregate adjusted basis in depreciable tangible property. Only 80% of the foreign taxes paid on the income is allowed as a foreign tax credit. All CFCs are aggregated for purposes of the computation. For tax years beginning after December 31, 2017 and before January 1, 2026, the highest effective tax rate on GILTI is 10.5%. For tax years beginning after December 31, 2025 the effective tax rate on GILTI is 13.125%. For a comprehensive discussion of this provision, see Tax Alert 2017-2166.

Media businesses should think through the GILTI implications of their international legal structures and operating models going forward. Due to the availability of the deduction for foreign derived intangible income (FDII), media companies may be eligible for a 13.1% rate on future foreign intangible income regardless of IP ownership in the United States or offshore.

Companies in the media sector should then focus on managing the effective rate on future FDII and GILTI income, as well as the local country tax rate on international operations. IP investment and centralization strategies should be based on commercial, legal, human resource and other business considerations, as well as the availability of tax attributes in the United States and locally to support future US or foreign hub models. Media companies considering inbounding IP to the United States will also need to be mindful of the potential tax costs of bringing such IP to the United States.

Anti-base erosion rules — Base Erosion Anti-Abuse Tax (BEAT)

The Act introduces a base erosion minimum tax (generally referred to as a BEAT). In general, the BEAT applies to an applicable taxpayer (i.e., corporations, other than RICs, REITs, or S-corporations) that is subject to US net income tax with average annual gross receipts of at least $500 million for the three-year period ending with the preceding tax year, and that has made certain related party deductible payments, determined by reference to a base erosion percentage of at least 3% (2% in the case of banks and certain security dealers) of the corporation's total deductions for the year.

A corporation subject to the tax generally determines the amount of tax owed under the provision (if any) by adding back to its adjusted taxable income for the year all deductible payments made to a foreign affiliate (base erosion payments) for the year (the modified taxable income). Base erosion payments do not include cost of goods sold, certain amounts paid with respect to services, and certain qualified derivative payments. The excess of 10% (5% in the case of one tax year for base erosion payments paid or accrued in tax years beginning after December 31, 2017) of the corporation's modified taxable income over its regular tax liability for the year (net of an adjusted amount of tax credits allowed) is the base erosion minimum tax amount that is owed. For tax years beginning after December 31, 2025, the rate is increased from 10% to 12.5%. For a comprehensive discussion of this provision, see Tax Alert 2017-2166. Accordingly, while there are some clarifications that present good news to M&E entities, such as the cost of goods sold provisions, the lower threshold may mean that more M&E companies will be subject to BEAT.

Companies in the media industry will need to closely examine their supply chain models regardless of whether they have US or offshore hub structures in the future for potential BEAT exposures. Planning opportunities around re-designing supply chain flows and contracting models are available but companies will need to evaluate the business purpose to justify potential future restructuring.

Foreign branches and hybrid proposals — Limitation on cross-crediting and possible hybrid treatment

The Act establishes a separate foreign tax credit basket for branches. This will minimize a corporation's ability to cross-credit between branches and CFCs.

This could have a real impact on M&E businesses with a combination of foreign branch and CFC structures, and could incentivize such companies to review the US tax positions of their branch structures and consider tax-efficient options for their branch operations if the restriction is enacted.

In addition, the Act follows the Senate bill and denies a deduction for any amount paid to a hybrid company or pursuant to a hybrid transaction if the recipient country treats the payment differently than the United States. However, Treasury has been provided broad discretion to include branches or branch payments as either hybrid entities or hybrid payments, respectively. For a comprehensive discussion of this provision, see Tax Alert 2017-2166.

Accordingly, inbound and outbound M&E companies should consider the potential applicability of these hybrid rules on their financing and/or IP structures and evaluate alternative options from a planning perspective if required.

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