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Auditor report: millions of real taxpayer dollars paid for imaginary film expenses

October 27, 2010

Before the Iowa Film Tax Credit program exploded in scandal in September 2009, the state had granted $31,967,641 in transferable tax credits to filmmakers. Yesterday the State Auditor reported that $25,576,301 were issued improperly -- a full 80% of the credits granted.

The 127-page report identifies two principal sources of the bad credits: the use of "in kind" expenditures, and double-dipping on the credit computation.

The "in kind" expenditures are best understood as "pretend" expenditures. From the report (page 12):

For certain projects, an expenditure was claimed for goods or services provided by a vendor in exchange for promotional advertising in the production. For example, the film included an acknowledgement such as "This film was produced with help from our sponsor, (sponsor’s name.)"

One production company approached several potential sponsors with proposed agreements for sponsorships valued in the millions of dollars. Here's one example from the report:

Kent Feeds, Inc. (Kent Feeds) is an Iowa-based corporation for which Changing Horses claimed $2,250,000.00 of in-kind expenditures. Of this amount, $1,000,000.00 and $1,250,000.00 were claimed for projects 08-020 and 08-027, respectively. The agreements provided by Changing Horses were signed by Kent Feeds but did not include a value for the services provided.


According to a Kent Feeds representative we spoke with, Mr. Witter [a film credit middleman] initially approached the company to determine if they were interested in purchasing tax credit certificates. When Kent Feeds declined, they were asked if they would be interested in sponsoring a project for Changing Horses. Kent Feeds agreed and a contract was prepared and presented to the company which included a value of $1,000,000.00 for the sponsorship.



According to the Kent Feeds representative, they declined to sign the contract for the first project which included the $1,000,000.00 value. The representative stated he told Mr. Witter the amount was grossly overvalued and they would not sign the contract. After the value was removed, Kent Feeds signed a contract which did not include a value for the sponsorship.

The Kent Feeds representative was not only ethical in this case, he was also shrewd. When you barter services, the tax law treats it as a taxable sale of the services, but you only get to deduct your actual cost of providing the services. If he'd have agreed to the $1 million value, he could have generated $1 million in taxable income to his employer.

The Iowa Department of Revenue's Role

Iowa's tax authorities perhaps inadvertently encouraged the use of pretend dollars in the film business. In a set of e-mails, a top Department of Revenue policymaker signed off on the concept. Tom Wheeler, then the Director of the Iowa Film Office, asked:

For example, a project intends to rent a local package of equipment that would cost $50k. Can the equipment owner provide the equipment free of charge in exchange for a $50k stake in the project?

The Department of Revenue rep replied:

It seems to me that the $50,000 would have to be reported as income, and it would be a qualified cost. However, the vendor could not get both a film investment credit and the qualified expenditure tax credit for the same $50,000.

The Department of Revenue later repudiated this position, issuing rules saying that only cash expenditures qualified. The revised position is probably the right one, as the tax law generally only gives you the benefit for the cost of business expenditures, not their fair market value, when computing a deduction or credit.

Still, the emails were enough to send the film companies off to the races. The Auditor's report (page 26) says the company that approached Kent Feeds claimed tax credits based on $13.4 million of "in kind" expenditures. Millions more of such pretend spending was found for other credit recipients. The Auditor's office didn't have access to any of the tax returns involved, but it would be fascinating to see whether that film company reported $13.4 million in gross income for the value of the "in kind" expenditures "received," or if they issued the required Forms 1099 for the value of the "services" provided.

Next: the double-dip

Links:

The Auditor's report
The Department of Revenue e-mail thread


Other coverage:

Des Moines Register:
Auditor says most Iowa film credits issued improperly

Credit broker's deal-making draws scrutiny

Radio Iowa:

Audits says majority of film office credits improperly awarded
State files lawsuit in film office fiasco

Eastern Iowa Government.com:

Audit uncovers $25.6 million in film tax credits improperly used for 22 projects

Prior Tax Update coverage: Film Fiasco: where was the Iowa Department of Revenue?

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