rp-04-36.pdf

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Part III

Administrative, Procedural, and Miscellaneous

26 CFR 601.105: Examination of returns and claims for refund, credit, or abatement;
determination of correct tax liability.
(Also Part I, §§ 446, 481; 1.446-1.)

Rev. Proc. 2004-36

SECTION 1. PURPOSE

This revenue procedure provides a safe harbor method of accounting under
which a taxpayer within the scope of this revenue procedure may amortize creative
property costs (as defined in section 2.01 below) ratably over a 15-year period. This
revenue procedure also provides procedures for taxpayers to obtain the automatic
consent of the Commissioner of Internal Revenue to change to the safe harbor method
of accounting provided in this revenue procedure.

SECTION 2. DEFINITIONS

The following definitions apply solely for the purpose of this revenue procedure:

.01 Creative property costs
. Costs paid or incurred for federal tax purposes to
acquire and develop screenplays, scripts, story outlines, motion picture production
rights to books and plays, and other similar properties (creative properties) for
purposes of potential future film development, production, and exploitation.

.02 Film
. Feature films, television specials, television series, and similar
products (including animated films and television programming) that are sold, licensed
or exhibited, whether produced on film, videotape, digital, or other video recording
format.

.03 Set for production
. Management, with relevant authority, implicitly or
explicitly authorizes and commits to funding the production of a film, active pre-
production has begun, and the start of principal photography is expected to begin within
6 months of being set for production.

.04 SOP 00-2
. The American Institute of Certified Public Accountants (AICPA)
Statement of Position (SOP) 00-2, “Accounting for Producers or Distributors of Films.”

.05 Initial write-off
. The earliest date on which the taxpayer properly writes off
under SOP 00-2 any creative property costs paid or incurred with respect to a particular
creative property.

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SECTION 3. BACKGROUND

.01 Film studios (studios) routinely incur costs to acquire, produce, and develop
creative properties. Studios may acquire these creative properties with exclusive rights
of ownership, or they may have limited exploitation rights. Sometimes the rights
acquired survive indefinitely while in other situations, the studios may acquire rights with
a limited term. Studios ultimately set for production only a small percentage of the
creative properties acquired. Most of the creative properties set for production are set
within 3 years of acquisition of the property. However, studios set some properties for
production that have been held for longer than 3 years. Studios do not usually discard,
release to the public domain, or otherwise dispose of the creative properties not set for
production or sold. Generally, studios retain these properties indefinitely.

.02 On June 12, 2000, the AICPA issued SOP 00-2, and rescinded Statement of
Financial Accounting Standards No. 53. SOP 00-2 is effective for fiscal years beginning
after December 15, 2000. SOP 00-2 established new generally accepted accounting
principles for financial reporting purposes for the way studios account for creative
property costs. SOP 00-2 states that an entity should periodically review creative
properties in order to determine whether they will be used in the production of a film.
SOP 00-2 states that “[w]hen an entity determines that a property will not be used
(disposed of), it should recognize any loss by a charge to the income statement.” SOP
00-2 further states that it is presumed that an entity will dispose of a property (whether
by sale or abandonment) if it has not been set for production within 3 years from the
time of the first capitalized transaction. Amounts written off should not be subsequently
reestablished as assets.

.03 Section 165(a) of the Internal Revenue Code allows a deduction for any loss
sustained during the taxable year and not compensated for by insurance or otherwise.

.04 Rev. Rul. 2004-58, I.R.B. 2004-24, concludes that a taxpayer may not
deduct the costs of acquiring and developing creative property as a loss under § 165(a)
if the taxpayer does not establish an intention to abandon the property and an
affirmative act of abandonment, or identifiable event(s) evidencing a closed or
completed transaction establishing worthlessness.

.05 Thus, taxpayers generally are required under the Code and regulations to
capitalize creative property costs and, unless a film is produced from the creative
property, are not permitted to recover those costs through deductions for depreciation or
amortization.
See
Rev. Rul. 79-285, 1979-2 C.B. 91. However, to minimize disputes
regarding the accounting for creative property costs, the Internal Revenue Service, as a
matter of administrative convenience, will allow a taxpayer that complies with the
requirements of this revenue procedure to use the safe harbor amortization method
described in section 5 of this revenue procedure for these costs.

SECTION 4. SCOPE

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This revenue procedure applies to taxpayers engaged in the trade or business of
film production that choose to account for creative property costs under the safe harbor
method provided in section 5 of this revenue procedure.

SECTION 5. SAFE HARBOR METHOD

.01 In general
. The Service will not challenge the use of this safe harbor method
of accounting by a taxpayer within the scope of this revenue procedure provided the
taxpayer follows all of the requirements of this section 5 and, if the taxpayer is changing
from another method to the safe harbor method, the provisions of section 6 of this
revenue procedure regarding changes in method of accounting. Under the safe harbor
method, the taxpayer must amortize creative property costs properly written off by the
taxpayer under SOP 00-2 ratably over an amortization period of 15 years beginning on
the first day of the second half of the taxable year in which the taxpayer properly writes
off the costs under SOP 00-2. For example, for a calendar-year taxpayer with a full 12-
month taxable year, the first day of the second half of the taxable year is July 1
st
. All
creative property costs that the taxpayer begins to amortize under this safe harbor
method in the same taxable year are treated as a single asset. Creative property costs
that the taxpayer amortizes under this safe harbor method must not be subsequently
reestablished as assets, even if a particular creative property is set for production
subsequent to the initial write-off. See section 5.02 of this revenue procedure for rules
regarding creative property costs paid or incurred subsequent to the initial write-off,
whether or not the creative property has been set for production subsequent to the initial
write-off. Except as provided in section 5.03 and 5.04 of this revenue procedure, no
disposition or other event accelerates recovery of the creative property costs that the
taxpayer has begun to amortize under this safe harbor method.

.02 Costs paid or incurred subsequent to the initial write-off
.

(1) Property not set for production. Creative property costs that are (a)
associated with a particular creative property that has not been set for production and
(b) paid or incurred by the taxpayer subsequent to the initial write-off must be amortized
by the taxpayer (in accordance with section 5.01 of this revenue procedure) ratably over
an amortization period of 15 years beginning on the first day of the second half of the
taxable year in which the taxpayer pays or incurs those costs.

(2) Property set for production
. Creative property costs that are (a)
associated with a particular creative property that has been set for production
subsequent to the initial write-off and (b) paid or incurred by the taxpayer after the
property is set for production must be capitalized by the taxpayer from the time the
property is set for production and depreciated using an allowable depreciation method
for produced films (for example, income forecast method) at the time the property is
placed in service by the taxpayer.

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.03 Costs associated with property upon disposition
. If, during the 15-year
amortization period, creative property rights are disposed of, the taxpayer must
nevertheless continue to amortize the creative property costs over the remainder of the
15-year period. A disposition includes the sale, exchange, abandonment, or destruction
of creative property or the rights relating thereto. A disposition also occurs upon the
expiration of a taxpayer’s rights to a particular creative property. Immediately before a
disposition, the creative property or creative property rights are treated as having an
adjusted basis of zero for purposes of § 1011. Therefore, no loss shall be realized upon
a disposition. Any amount realized on a disposition shall be recognized as ordinary
income (notwithstanding any other provision of the Code). However, these rules do not
apply if a taxpayer disposes of all of its creative properties, for example, as a result of a
sale (not including elective recognition of gain or loss transactions under § 338(h)(10))
of its entire trade or business. Thus, in the case of a disposition of an entire trade or
business, any gain from the disposition of creative property rights, the costs for which
were accounted for using this safe harbor method, will be treated as ordinary income to
the extent of the amortization allowed under this safe harbor method.

.04 Special rule for certain transfers
. In the case of any creative property
transferred in a transaction described in §§ 332, 351, 361, 721, 731, 1031, or 1033, and
in any transaction between members of the same affiliated group during any taxable
year for which a consolidated return is made by the group, the transferee shall be
treated as the transferor for purposes of applying the safe harbor method as described
in section 5 of this revenue procedure with respect to so much of the adjusted basis in
the hands of the transferee as does not exceed the adjusted basis in the hands of the
transferor. However, this section 5.05 does not apply in the case of a termination of a
partnership under section 708(b)(1)(B).

SECTION 6. CHANGE IN METHOD OF ACCOUNTING AND AUDIT PROTECTION

.01 Change in method of accounting
. A change in a taxpayer’s treatment of
creative property costs is a change in method of accounting to which §§ 446(e) and 481
apply. If a taxpayer within the scope of this revenue procedure wants to change to the
safe harbor method provided in this revenue procedure for creative property costs
properly written off under SOP 00-2, the taxpayer must follow the automatic change in
method of accounting provisions in Rev. Proc. 2002-9, 2002-1 C.B. 327 (as modified by
Rev. Proc. 2002-19, 2002-1 C.B. 696 and Rev. Proc. 2002-54, 2002-2 C.B. 432, and as
modified and clarified by Announcement 2002-17, 2002-1 C.B. 561) or any successor,
with the following modifications:

(1) The scope limitations in section 4.02 of Rev. Proc. 2002-9 do not
apply to a taxpayer that wants to change to the safe harbor method described in section
5 of this revenue procedure for either its first or second taxable year ending on or after
December 31, 2003;

(2) A taxpayer that wants to change to the safe harbor method described
in section 5 of this revenue procedure for its first taxable year ending on or after

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December 31, 2003, and that on or before July 12, 2004, files its original federal income
tax return for that year, and that did not change to the safe harbor method described in
section 5 of this revenue procedure on that return is not required to comply with the
filing requirement in section 6.02(3)(a) of Rev. Proc. 2002-9, provided the taxpayer
complies with the following filing requirements. The taxpayer must instead complete
and file the Form 3115, Application for Change in Accounting Method, in duplicate. The
original Form 3115 must be attached to an amended federal income tax return for the
taxpayer’s first taxable year ending on or after December 31, 2003. This amended
return must be filed no later than November 29, 2004. The copy of the Form 3115 must
be filed with the national office (see section 6.02(6) of Rev. Proc. 2002-9 for the
address) no later than when the taxpayer’s amended return is filed; and

(3) For purposes of Line 1a of Form 3115, the designated number for the
automatic accounting method change authorized by this revenue procedure is "85."

.02 Audit protection
. If a taxpayer within the scope of this revenue procedure
currently uses a method consistent with the safe harbor method described in section 5
of this revenue procedure, the method of accounting for the taxpayer’s creative property
costs will not be raised as an issue by the Service in a taxable year that ends before
December 31, 2003. Also, if a taxpayer currently uses a method consistent with the
safe harbor method described in section 5 of this revenue procedure, and its use of that
method is an issue under consideration (within the meaning of section 3.09 of Rev.
Proc. 2002-9) in examination, before an appeals office, or before the U.S. Tax Court for
any taxable year that ends before December 31, 2003, that issue will not be further
pursued by the Service.

SECTION 7. EFFECT ON OTHER DOCUMENTS

Rev. Proc. 2002-9 is modified and amplified to include this change in method of
accounting in section 2 of the APPENDIX.

SECTION 8. EFFECTIVE DATE

This revenue procedure is effective for taxable years ending on or after
December 31, 2003.

DRAFTING INFORMATION

The principal author of this revenue procedure is Lauren Ross Taylor of the
Office of Associate Chief Counsel (Passthroughs and Special Industries). For further
information regarding this revenue procedure, contact Ms. Taylor at (202) 622-3040 (not
a toll free call).