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duction costs. However, the $10 cost for residuals is not to be eligible for the credit until the year in which these amounts are actually paid.

Of course, under the Act, where a film is purchased before it is placed in service in any medium, the credit base cannot exceed the purchase price of the film (if this is less than the credit base for the film as computed under the rules outlined above).

Under certain circumstances, it may be possible for the rights to the film to be leased under section 48 (d) before the film is placed in service. However, it is intended that the credit is to be available to the lessee only where the lessee acquires full rights to exploit the movie or film for its estimated useful life through a particular medium or in a particular geographic area; it is not to be available where the lessee is precluded (by law, regulation or governmental action) from acquiring all rights to exploit the film or tape commercially. Also, in the case of the transfer of a film to a lessee (under section 48 (d) of the Code), the lessee is generally to be treated as having acquired the film for an amount equal to the lessor's credit base with respect to that film (rather than its fair market value).

The rules outlined above concerning the credit base apply regardless of whether the taxpayer uses the general rule (two-thirds method) or the 90-percent method.

Who is entitled to the credit.-Under the Act, a taxpayer is to be entitled to the investment credit for a movie film if, and to the extent, that he has an "ownership interest" in the film at the time it is placed in service. For purposes of these rules, a taxpayer will be treated as having an ownership interest to the extent that his capital is at risk.

Thus, if the expenses of producing a movie are incurred by the producer, but are reimbursed by the distributor, either by means of a nonrecourse loan or otherwise, the distributor would be entitled to the credit, because the distributor's capital is at risk. Also, if the production costs are paid from the proceeds of a nonrecourse loan supplied by a bank but guaranteed by the distributor, then the distributor would be entitled to the credit because its capital was at risk in connection with the film. A similar result would follow if the producer was liable to the bank on the loan, but the distributor had contracted to pay at least the amount of the loan to the producer in connection. with the film.

The determination as to whose capital is at risk in connection with the film (and, therefore, as to who is entitled to the credit) is to be made as of the time the film is first placed in service (i.e., released). Thereafter, the film would be considered used property, which is not to be eligible for the credit under the Act.

Generally, where the distributor has borne the cost of producing a film, and first releases it through the medium of movie houses, it is the distributor who is entitled to the credit. In the case of a film or series which is made for television, the producer-distributor will also generally be entitled to the credit where the film is exhibited over the network pursuant to a licensing agreement. On the other hand, if the network purchased all rights to the film or series before it was placed in service, the network would be entitled to the credit.

It is possible that more than one taxpayer may be entitled to a share of the credit for the same film as, for example, where several investors

put up a portion of the capital needed to produce the film pursuant to a joint venture agreement. Generally, where more than one party bears the risk of loss with respect to a particular film, the Secretary of the Treasury or his delegate may establish procedures for determining who is entitled to the credit, or partial credit. (Of course, where there are several parties to a transaction involving a movie film, and one party is entitled to the investment credit with respect to that film under these rules, whereas the other party is not, the Congress anticipates that the availability of the investment credit may often be taken into account by the parties in determining their contract arrangements.)

It is also possible that more than one taxpayer may be entitled to the credit for a particular film where the film is placed in service in more than one medium or more than one geographic area. For example, suppose that a producer creates a U.S.-produced film having a credit base of $100. A distributor acquires exclusive perpetual distribution rights within the United States in exchange for a lump-sum payment of $50 and the film is subsequently placed in service. The distributor is entitled to a credit with respect to the film based on his cost of $50 in acquiring the U.S. rights. The producer, who retains the other rights to the film, would also be entitled to a part of the credit based on his capital at risk. The producer's credit base would be computed by subtracting the cost borne by the U.S. distributor ($50) from the credit base which the producer would otherwise be entitled to (i.e., the $100 cost of production). Thus, the producer's credit base would equal $50 in this case.

Films Placed in Service in the Past

For the past (ie., for taxable years beginning before January 1, 1975), in general, taxpayers will come under one of two rules, either the "90-percent method," as described above, with certain modifications to deal with the foreign-use problem, or a "40-percent method," under which a taxpayer would be entitled to receive 40 percent of a full credit for all of his films, regardless of the useful life or predominant foreign use of any particular film. However, taxpayers may elect to come under the general rule for the future (the two-thirds method, as described above) for all section 50 property placed in service after the restoration of the investment credit under the Revenue Act of 1971.

Finally, certain taxpayers, who have already filed suit for a determination as to their entitlement to the investment credit for past years, may elect the application of the rules of prior law, rather than the provisions of this Act, in determining their entitlement to the credit for all past periods.

General rule for past.-Under the Act, as a general rule, the investment credit for films placed in service in taxable years beginning before January 1, 1975, is to be computed on a film-by-film basis. In determining the useful life of the film, taxpayers would use the 90-percent method as described above. However, an additional rule is necessary for the past to determine whether or not there was predominant foreign use of the film.

Under the Act, a film is to be treated as having a predominant foreign use in the first taxable year in which 50 percent or more of

the gross revenues received or accrued from the film were received or accrued from showing the film outside the United States. This is a year-by-year test (not a cumulative test). For example, assume a film was released on February 1, 1972, and revenues of $100 were received that year from showing the film in the United States (with no foreign revenues), while in 1973 there were $75 of income from U.S. showings, and $25 of income from foreign exhibitions, and in 1974 there were $40 of U.S. revenues, and $60 of revenue from foreign exhibitions. In this case, there would be a predominant foreign use of the film in 1974, and as a result the film would cease to qualify as section 38 property in that year. This would mean that the taxpayer would not be entitled to an investment credit with respect to the film because the disqualifying event would have occurred less than 3 years after the property had been placed in service."

Films of a transitory or topical nature would not be eligible for an investment credit."

The 40-percent method.-Under the Act, the taxpayer can elect to receive 40 percent of a full credit for all of his films placed in service in taxable years beginning before January 1, 1975.8 If the taxpayer makes this election, he is to receive the 40-percent credit, regardless of the actual useful life or predominant foreign use of any particular film. This 40-percent method is offered as a way of avoiding costly litigation with respect to past years. It is believed that this method achieves, for the average member of the film industry, about the same size credit which he would receive for all his films, on the average, were he actually to litigate.

A taxpayer is not to receive a credit for any films of a transistory or topical nature (because almost all of these films have a useful life of less than three years). Also, a taxpayer using the 40-percent method for the past is not entitled to credits for any films which were produced and shown exclusively abroad.

The election to use the 40-percent method is to be made by the taxpayer within six months after the date of enactment (October 4, 1976) in a manner to be prescribed in regulations. Any such election, once made, is to apply to all the taxpayer's films placed in service in the past (except those, if any, covered under the general rule for the future), and can be revoked only with the consent of the Internal Revenue Service.

To prevent a situation where two different taxpayers may attempt to claim the credit for the same film, the Act provides that any taxpayer making the 40-percent election must consent to join in a judicial proceeding to determine which of the competing claimants was entitled to the credit, or whether each of the parties was entitled to part of the

For this limited purpose, gross foreign revenues from showing films in future years must also be taken into account. In other words, if a taxpayer uses the 90-percent method for 1974, and 50 percent or more of the revenues from showing the film in 1975 are from foreign exhibitions, this would constitute a predominant foreign use of the film placed in service in 1974, and the taxpayer would not be entitled to an investment credit with respect to that film.

The Congress intends that no inference should be drawn from this report or this legislation as to what constitutes useful life, predominant foreign use, the basis on which the credit is to be computed, or any other aspect of the application of the investment credit under prior law.

8 As described below, the taxpayer can also use this method for films placed in service on or before August 15, 1971, but elect to use the general rule for the future for all of his section 50 films.

credit. The rules with respect to entitlement to the credit (i.e., the capital at risk rules, etc.) are the same for the past as for the future. Credit base. In general, under the Act, the rules as to the size of the credit base for the past (including those with respect to participations) are similar to the rules which are to apply for the future. However, for the past there has not been a U.S. production test in connection with movie films, and the Congress does not believe it would be appropriate to impose such a test retroactively. (The Act does impose a U.S. production test for the future, in order to encourage the U.S. production of movie films.) Thus, for the past, taxpayers may include in the credit base all the direct and indirect expenses of production, as described above, regardless of whether the film would have satisfied the 80-percent United States direct production expenses test and regardless of whether some of the expenses (actors' pay, costumes, etc.) included in the credit base were paid for services performed abroad, or for equipment and supplies which were used abroad.

The rules described above with respect to the credit base would apply both to taxpayers using the 90-percent method for the past, and to taxpayers using the 40-percent method.

Application of the general rule for the future to certain past years.In connection with the Revenue Act of 1971 Congress made clear that it intended the investment credit to be available for movie films (whereas this question has not been completely resolved prior to that time) even though, as described above, certain subsidiary issues were not settled in that Act. For this reason, the Act provides that those taxpayers who wish to do so are to be allowed to use the general rule for the future with respect to all of their section 50 property (generally property placed in service after August 15, 1971). Thus, the Act provides that taxpayers may elect to use the general rule for the future. for all of their section 50 movie films. (Taxpayers making this election could still use either the 90-percent method or the 40-percent method for all films placed in service in the past which do not qualify as section 50 property.)

Taxpayers who make this election are to be covered under the general rule for the future for all purposes, including, for example, the rules with respect to the size of the credit base, which include an 80 percent U.S. production test and exclude expenses of foreign production from the credit base.

The election to use the general rule for the future for section 50 films would have to be made within one year after the date of enactment of this Act, in a manner to be prescribed in regulations. The election would have to apply to all of the taxpayer's section 50 films, and the election, once made, could not be revoked without the consent of the Internal Revenue Service. Other rules with respect to use of this method for the past may also be prescribed by regulations.

The Congress is concerned, however, that this procedure should not unnecessarily delay the allowance of the credit in cases where it is reasonably clear that there is only one plausible person who has a right to claim the credit. The Congress intends that the Service will develop such reporting and other procedures as it deems necessary to determine whether there is a likelihood that several persons may claim a credit with respect to the same film, and that where there is no such likelihood, allowance of the credit will not be unduly delayed.

Taxpayers who have already litigated

Some taxpayers have already litigated the issues outlined above for certain prior years. The Congress believes that these taxpayers should be entitled to the fruits of their litigation because of the substantial effort and expense which they have incurred in connection with their suits. Accordingly, the Act provides that any taxpayer who has filed a petition before any court before January 1, 1976, with respect to his entitlement to the investment credit for any prior year, may elect (within 90 days after the date of enactment) to have his right to the investment credit for all taxable years beginning prior to January 1, 1975, determined under prior law, as interpreted by the courts, rather than under one of the methods prsecribed in this Act. (As an alternative, taxpayers who have filed suit prior to January 1, 1976, may elect to have their credit determined under prior law for years prior to 1971, and elect the general rule for the future for all their section 50 property.) But, of course, issues which have not already been resolved by court proceedings (such as predominant foreign use, the size of the credit base, etc.) must be settled by further litigation, and it is intended that no inference be drawn from the provisions of this Act as to how such issues should be resolved under prior law.

Generally, under this procedure, a taxpayer wishing to make an election under these provisions may do so by mailing a letter to this effect to the Commissioner of Internal Revenue within the 90-day period. Any such election is to be irrevocable.

Taxpayers relying on litigation to determine their credits for past. years still must use either the general rule for the future or the 90percent method for all taxable years beginning after December 31, 1974.

Effective dates

The effective dates of these provisions have been described above. In general, the rules with respect to the general rule for the future and the 90-percent method apply to films placed in service in taxable years beginning after December 31, 1974. In general, taxpayers may use either the 90-percent or the 40-percent method for all prior years, but may alternatively elect to use the general rule for the future for all section 50 property.

Revenue effect

It is estimated that the provisions of this section will result in a revenue cost of $37 million for fiscal year 1977, $18 million for fiscal year 1978, and $3 million for fiscal year 1981 and each year thereafter.

5. Investment Tax Credit in the Case of Certain Ships (sec. 805 of the Act and sec. 46(g) of the Code)

Prior law

The tax on income deposited into a capital construction fund (established under section 21 of the Merchant Marine Act of 1970) for the construction of certain vessels is deferred until funds are withdrawn from the fund for certain purposes. When the funds are withdrawn to purchase, construct, or reconstruct a qualified vessel, there is no tax basis in the purchased vessel to the extent of the withdrawal. Under

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