Hollywood Accounting — How Harry Potter Loses Money

An anonymous reader writes "Techdirt has the details on how it was possible for the last Harry Potter movie to lose $167 million while taking in nearly $1 billion in revenue. If you ever wanted to see 'Hollywood Accounting' in action, take a look. The article also notes two recent court decisions that may raise questions about Hollywood's ability to continue with these kinds of tricks. For example, the producers of 'Who Wants To Be A Millionaire' now have to pay $270 million for its attempt to get around paying a partner through similar tricks."

Comments

Peter Jackson

[jjohnson]

Peter Jackson had to sue New Line Cinema to get paid for LotR. New Line claimed they lost money on the trilogy.

Re:Peter Jackson

[HungryHobo]

I'm guessing it may have been arranged something like-

Person P has a contract with company N for x% of the gross that company N earns from the film.

Company N sells everything to company M for 1 dollar making a total gross profit of 1 dollar.

Company M then goes on to release the film and make a pile of money big enough to swim around in but person P has no contract with company M so gets no cut of that.

P is paid almost nothing.
M and N are owned by the same parent company.

of course this is just my uneducated guess.

Re:Peter Jackson

[virtualchoirboy]

A cut of the *gross* may not even work. If I'm reading the various blogs correctly, what the movie studios do is set up a new company for the production of each movie, lend that new company a ton of cash for the creation of the movie. The studio then has to get paid back before any net or gross calculations are performed because it's a loan repayment, not a cost of production. Since it's a loan, they also get to charge interest. Thus, with a big enough initial "loan" and corresponding interest rate, it's possible to rig things so that no movie ever turns a profit - regardless of the quality or box office draw. /props for the creative way of avoiding payouts //still think it's equivalent to stealing

Babylon 5

[Y-Crate]

JMS Posted:

The show, all in, cost about $110 million to make. Each year of its original run, we know it showed a profit because they TOLD us so. And in one case, they actually showed us the figures. It's now been on the air worldwide for ten years. There's been merchandise, syndication, cable, books, you name it. The DVDs grossed roughly half a BILLION dollars (and that was just after they put out S5, without all of the S5 sales in). So what does my last profit statement say? We're $80 million in the red. Basically, by the terms of my contract, if a set on a WB movie burns down in Botswana, they can charge it against B5's profits.

Re:Babylon 5

[kidgenius]

See, the head company makes money, but your contract is with the smaller company that was created. So in this case, you work for Babylon 5 Incorporated. Babylon 5 Inc lost money, tons of it, but they aren't publicly traded or owned. This smaller company is wholly owned by Warner, Fox, etc., who charge the Babylon 5 LLC tons of money for the show. Things like loans, distribution fees, advertising, etc. Warner then gets that money and reports that on their books to their shareholders, which are open, and everything works out quite nicely.

Re:Not Hollywood alone

[phantomfive]

No, this trick won't work for tax purposes. The IRS isn't that dumb (and when they are dumb it is never in your favor). The reason they are able to get away with it from a tax perspective is they actually do pay taxes on it.

What they are doing is setting up a separate corporation for each movie. The corporation is the one that makes contracts with the actors/directors/whoever. Then the studio charges the corporation a (bankrupting, in this case) amount for distributing the movie. Much more than actually distributing the movie cost, but of course the corporation pays it, and ends up making no profit on the movie. The studio still has to pay taxes.

Now, as an average person, you can try to do that, and set up your own personal corporation so you can deduct 'business expenses,' but the IRS will still make you pay a full amount. The studios also still have to pay the full amount in taxes, just not to other people (unless other people sue).

Studios will still continue to do this kind of thing, because while on highly profitable movies, juries might not favor them, on less profitable movies it will be easier to get away with. Obviously it is fraud, but I don't know if it is close enough to the legal definition to press legal charges.

Re:"It's okay for us to be dishonest.....

[iluvcapra]

Without debating the merits of pirating copyright material, I'd point out that the people who sign on the dotted line for "net" deals know exactly what they're getting, which is nothing -- writers, actors, directors and "staff" (of which I guess I'm one) sign their contracts with the advice of a lawyer and a manager, and all of these people know exactly what "defined net" is, and how it's defined is completely clear in the contract. We should respect contracts, right? I can assure you whoever is complaining about their deal in TFA isn't J.K. Rowling, she's getting gross points.

The only revenue sharing deals that ever pay off are "first-dollar gross" or "dollar breakeven" deals, where the money directly from the box office is split. Net deals have always been a fantasy -- it was true when Art Buckwald sued Paramount over to Coming to America in 1990 and it's still true now. In this particular case of Harry Potter, what WB appears to have done is borrowed the money to make Order of the Phoenix at a high rate of interest, and is paying off its note so slowly that the negative cost of the film keeps going up relative to the revenue. What isn't mentioned is that Warner Bros. probably borrowed the money from AOL Time-Warner, it's parent, in the first place. :)

Re:Not a new trick

[Jeremy Erwin]

Darth Vader actor David Prowse warns beware of small print

Re:Forest Gump

[nedlohs]

http://www.nytimes.com/2005/06/27/business/media/27movie.html is the really old initial lawsuit article.

But basically Jackson had a gross cut contract, and claimed that New Line sold some of the rights to things like DVD distribution to other Time Warner companies for lower than market value - which of course reduces their gross (and hence Jackson's cut).

I think they settled, but I didn't really follow it closely - it's a pretty obvious technique though bound to get you sued...

Once a Thief, Always...

[Nom du Keyboard]

Once a thief, always a thief. Remember that Hollywood itself was created to escape Thomas Edison's patent enforcers. In California the land was cheap (at that time), the sun was usually shining (free lighting), and they were a very long way away from the east coast and Edison.

Win, win, win!

Re:Not Hollywood alone

[hey!]

Sure it's perfectly legal and moral to set up shell corporations. It's what you do with them that matters.

I do happen to know a little something about corporate accounting. I actually once recommended that a company be split into two captive parts. The reason was that it had highly profitable software half and a very unprofitable hardware sales half. Splitting the company in two had a legitimate purpose: it made it easier to sell the software business by making its value more clear. Eventually it was sold to a company that already had a hardware business and it's co-joined hardware twin simply folded. That was all completely above board.

In accounting you are constantly making up fictional "expenses", but they are offset by fictional income. You do this in order to make the financial performance of your various business structures more clear. What you CANNOT do is make up expenses to mask changes in owner's equity.

I know that stuff that looks like this happens all the time, and there are lots of borderline cases where legal corporations are created in order to take advantage of various angles in tax law. Many of those schemes are probably illegal, but are allowed de facto because nobody has the time to unravel them. That's why certain politicians always try to understaff the IRS. It's not to defend Joe Blow, who can't hide any significant income. It's to protect the guy who can play the "blind them with bullshit" game with armies of lawyers and accountants.

The situation is different for taxes (which are an exaction in which you have no say) and business deals (which are supposed to be negotiated in good faith). When you enter into a profit sharing contract, you can't take a chunk of revenue, move it from your left pocket to your right and call that an "expense". The proper name for that is "fraud". It doesn't matter how formally correct you make the transaction appear. Substance matters in accounting, and if the substance of a transaction is fraudulent, it's fraud.

In fact, that is the very essence of skillful fraud: to make that which is unconscionable seem superficially correct in every form. You can't pass a counterfeit bill and use "it's such a good copy it is indistinguishable from the real thing." You can't engage in a fraudulent transaction and say, "But all the incorporation papers, purchase orders and invoices are in order."