Last Friday, Pixofactor Entertainment announced that it was the first game developer to be approved by the Michigan Film Office for a 40% refundable tax credit. Pixofactor's project, Ben Hogan's 5 Lessons for the Wii, has a prospective budget of $2.7 million, meaning that Pixofactor could qualify for a refundable tax credit of up to $1.08 million.
While assuredly great news for Pixofactor, this is also great news for us at Developing Concerns because it provides us with an excellent opportunity to present a quick-and-dirty overview of tax credit finance deals.
[Ed. Note: I'm neither a tax lawyer, nor a Michigan lawyer, so please don't construe this post as suggesting either to be the case. Tax law, in general, and Michigan law, in particular, will impact any particular tax credit deal in that are impossible to forecast in the abstract. I have not reviewed Pixofactor's deal or the Michigan codes in detail, and as such I can make no representations about any special knowledge or fact at issue. Any variance between this post and reality is due to my desire to describe tax credit deals in general, not the Pixofactor deal in particular. Now that the lawyering CYA is done, on with the show...].
Every tax credit regime is different, and they all have their own special provisions and requirements. There are, however, a few commonalities when it comes to assignable tax credit incentives. Typically, you start with an idea (as prosaic as that nugget of truth is). You then turn this idea into a business plan and a budget. At this point, you realize you need the money you've forecasted in that budget, so you set about seeking investors. One way to entice these investors is to take advantage of tax credit incentives offered by various states or territories.
Tax credit incentives are offers by states or territories to give you credits against your tax obligation if you conduct specified economic activity within their jurisdiction. Assignable tax credits are tax credits that you can transfer the credit to a third party who isn't conducting the specified activity. In other words, you can sell your right to claim a tax credit of X, and use that money to fund your project.
To take advantage of tax credit incentives, there are (typically speaking) detailed submissions that must be made, approvals that must be obtained, and caveats and exclusions that must be kept in mind. For example, some budgeted activity may qualify for reimbursement, but others may not. Or financing may be achievable only if a certain percentage of the budget has already been secured through other sources. But when it's all said and done, a developer who receives approval for an assignable tax incentive has something of value - a reduction in tax burdens. The developer can then turn this "something of value" into real money by selling it (assigning it) to a third party, often at a discount. Using Pixofactor's numbers, the $1.08 million tax credit deal might sell for $900,000 (using a rough 90% of value as the price for the credit - remember, the investor will need to get something out of the deal as well).
What is everyone left with once the dust clears? The developer got $900,000 in cash that can be used to fund game development (pay salaries, rent office space, conduct QA, etc.). The investor got a net benefit of about $100,000 (a little more than $1 million in tax credits for $900,000) and can use this according to whatever limitations the state placed upon the credits (e.g., use this year only, no carryover, etc.). And finally, the state hopes to get future economic activity that will mean generate greater tax revenue in the future than the cost of the tax credit today.
That is the basic gist of assignable tax credit deals, but as you may imagine, the details get incredibly complex, incredibly quickly. Moreover, tax credit deals have come under some recent criticism about their efficacy in driving future economic growth. But for developers who can work through the credit approval process, tax credit financing can be a valuable means of securing project capital.
If you have questions about tax credit financing for video game development (or film development, as this is the older brother - and much more common use of - tax credit financing than video games), please contact the video games team at Reed Smith.