Hollywood Accounting and Democratic Politics

Bloomberg News reports that Celador International Ltd., a small, closely-held British TV production firm, won a lawsuit against Walt Disney Co.  Celador invented the popular TV show, "Who Wants to be a Millionaire" and sold Disney the right to adapt it to the American audience in return for half the profits.

Walt Disney Co. was found liable for not paying the U.K. creators of "Who Wants to Be a Millionaire" their share of profits from the quiz show broadcast on Disney's ABC network.

A jury in Riverside, California, today awarded $269.4 million in damages to Celador International Ltd. The jurors agreed that Disney's Buena Vista Television and ABC breached an agreement that entitled Celador to 50 percent of the profits from the show, which first aired in the U.S. in 1999 and helped lift the network to first place from third in audience ratings.  [emphasis added]

Wow!  Any reasonable juror would think that a TV show which "helped lift the network to first place" would have to have made a lot of money.  Yet Disney's accountants said that the show didn't make any money so they didn't owe Celador anything.

It's pretty old news that studios cook the books so that movies which take in millions of dollars never make a dime, at least not for profit-sharing purposes.  I remember reading 30 years ago that writers and authors shouldn't sign contracts giving them a share of the profits because there generally wouldn't be any profit no matter how much the picture or TV show actually made.  Various magazines have noted that major stars such as Brad Pitt and Angelina Jolie now insist on getting a share of the gross, which is a lot harder to fake.

Where's the Beef?

This is an example of how a purchaser can make profits disappear.  Suppose you have a farm in Minnesota and discover iron ore on your property.  You make a deal with a steel company to sell them the ore at, say, 10% of the profits.

They build a wharf near your farm and start digging the ore out.  Many tons later, you get your first check, and it's a pittance.  You protest.  Your auditor finds out that indeed, they only made 10 cents per ton of profit, so your check for a penny a ton is just what the contract called for.

What your auditor can't find out is that they also wrote contracts with 2 or 3 other companies.  As the ore starts to ride up the conveyor belt to be dropped into the ship, it's sold to a company in the Cayman Islands at a profit of 10 cents per ton.  That's the statement your auditor sees.

As the ore falls off the conveyor and flies through the air on its way into the hold, it's sold to another company in Bermuda or some other tax haven at a profit of 50 cents per ton.  As the ore hits bottom, it's sold to yet a third company at a profit of 50 more cents per ton.  Thus, the total profit per ton was $1.10, but the company who bought the ore from you shows only 10 cents profit.  That's what they tell you and that's what they tell the IRS.

This isn't a contrived example - it's from a long-ago US tax court case which the IRS won.  The tax people argued that there was no "constructive business purpose" in selling the ore to all those companies; the only purpose of selling it while it was flying through the air was to avoid taxation.  In winning the case, the IRS got to tax the entire $1.10 instead of taxing only the 10 cents.

What does "constructive business purpose" mean?  That's something lawyers are more than willing to help you argue about, particularly when there's millions of dollars worth of profits at stake.  Bloomberg outlined what Celador said that Disney did in order to seem that they had a constructive business purpose in moving all the profits away from the company that actually produced the show:

Closely held Celador sued Disney in 2004, claiming Buena Vista and ABC "through a complex web of self-dealing transactions" allowed ABC to keep the advertising revenue and pay Buena Vista only a licensing fee equal to the cost of producing the show. That kept Buena Vista from earning a profit from "Millionaire" that it would have had to share, Celador said.

It takes a complex web of self-dealing transactions to hide $200 million in profit.  It didn't help Disney's case that Celador found a couple of significant emails:

Former Disney Chief Executive Officer Michael Eisner said in a 1999 e-mail introduced by Celador as evidence in the trial that "Who Wants to Be a Millionaire" was as important to Disney's ABC network as its deal with the National Football League.

Eisner estimated the value of the rights to the game show at $1 billion and said it would turn ABC around, according to a separate 1999 e-mail message forwarded to Disney's board of directors.

The Disney boss tells the board of directors that he estimates that the show is worth $1 billion, tells them that it will turn the entire network around, and then claims that this turnaround show doesn't show a profit?  Yeah, right.

Hollywood studios are reluctant to settle any such cases because this sort of arrangement for concealing profits from their "partners" goes way, way back.  They're afraid that if they admit that they're hiding profits, everybody who's dealt them for the last 50 years will sue.

Hollywood and Politics

This sort of shenanigan not only hides profits from partners, it also conceals profits from the IRS.  That's why the IRS sued the mining company which transferred iron ore from one international shell company to another while it flew through the air.  Hollywood doesn't want their games uncovered because not only will their partners sue them, the IRS will come after them.

Historically, one of the best ways to keep the IRS at bay is to cozy up to big-time Democrats.  When Mr. Obama was trying to put together a cabinet, most of the people whom he first nominated had failed to pay their taxes.  Instead of going to jail as Republicans do, these Democrats were made OK simply by paying the back taxes after being found out.

One of our theories why wealthy people might support Democrats is that they know that Democratic policies will keep smaller companies from starting up and challenging them.  Microsoft would rather Google didn't exist, for example, and one way to make sure that no new Googles come after you is to support Democrats whose job-killing policies will kill most start-ups.

This revelation from Bloomberg gives us another reason why Hollywood would support Democrats - they're vulnerable to IRS audits.  If a jury could see through the accounting smokescreen, read Mr. Eisner's valuation of the show at $1 billion, and assume that it had to have made a profit, so can the IRS.

If all the self-dealing shell companies are located in the US, all the profit ended up in the US and was taxed at some point, but how likely is that?  If you're going to set up shell companies to hide profits from someone who might sue you, there's no reason not to set them up in tax havens so you can hide the profits from the IRS as well.  Having the books kept overseas make life difficult for someone who sues you, and even more so for the IRS.

As many writers have noted, Barack Obama is by far the least experienced president America has ever had.  This has caused all sorts of problems in all kinds of ways, but at least one problem is poetic justice: he hasn't learned the fundamental rule of not stomping on your biggest donors.

BP, for example, was one of the very largest contributors to the Obama campaign, yet it hasn't stopped him from all but taking them over.  The same is true of Wall Street and many other wealthy contributors.

In what should have been a predictable result, donations to Democrats from usually reliable Wall Streeters are down 65% this year.  Maybe they're learning not to feed the mouth that bites them?  How long will it take Hollywood to catch on?

Though, thankfully, it will probably be a while before someone makes the movie Death of a President II: Barack Takes a Bullet.