1. Case Study: Dream Works LLC To beget something out of nothing, what matters is… 2016.03.25 @Kyushu Univ. Jun Saito rev.4 1

2. Contents 0. FYI: What is an LLC, limited liability company? 1.SKG and Allen startup DW in 1994. 1,000M$ + 3 talents 2.Profits interest is different from cash contribution. 3.inside basis 4.non-recognition rule 5.DW has earned 1994 – 2006. 6.Paramount buyout DW in 2006 @1600M$ dissolution, liquidation, redemption, and distribution 7.At least, SKG talents pay for 300M$. 8.To beget something out of nothing, what matters is… 2

3. 0. Background information. What is an LLC, limited liability company? An LLC is an evolved partnership in US. Traditionally, a partnership used to enjoy freedom of contract (freedom of accounting) but not have limited liability. On the other hand, a corporate, the same then as now, enjoys liberty of contract (mandatory accrual accounting) and limited liability. However in late 1970’s, the evolution of partnership has started. The people have invented “at-risk amount” to simply define the limited liability of a partnership. And, it has been enabled to enjoy both limited liability and freedom of contract (freedom of accounting). This newly developed partnership is called as an LLC, limited liability company. Naturally, an LLC does not have to comply with corporate taxation but can enjoy partnership taxation, as is explained. 3

4. 1. SKG and Paul Allen startup DW in 1994. 1,000M$ + three artist talents Spielberg A film director Katzenberg A film producer Geffen A musician Paul Allen A money contributor 700M$ SKG stands for the three artists 4

5. 2. Profits interest is different from cash contribution in freedom of accounting. 5

6. 3. inside basis Inside basis: SKG talents are internally evaluated to be 50% of profits interest. 6

7. 50% 500M$ 4. non-recognition rule ”a rule of partnership taxation” “a mere change in the form of the taxpayer’s investment” “not yet realized profits” But for a non-recognition rule, SKG’s 50% inside basis would be evaluated to be 500M$, a realized profit, and, the tax authority (US-IRS) would levy income taxes on SKG right after the start-up. 7

8. In fact, in Japan… In Japan, we don’t have such a clear non-recognition rule. Even J-LLC and J-LLP are mandated to use an accrual accounting, which has a rule of “not realized but recognized”(*) revenue. So, regardless of whether the company is organized in a form of J-LLC, J-LLP, or K.K., such an exchange of a promise to input talents and a return of profits interest is highly probably recognized as “income” and levied income tax immediately after the start-up. 8 (*) not realized by the company but recognized by the tax authority

9. non-recognition rule (cont.) “not yet distributed profits” Profits, after realized and distributed to the partners, are recognized and levied income tax. On the other hand, realized but not yet distributed profits are not recognized nor levied income taxes. A partnership can retain its realized profits all in its internal reserve. In other words, realized but not yet distributed profits could be tax-exempted as long as you like. 9

10. a term company or an at-will company However, a partnership is not a going concern but a term company or an at-will company, both which must have a dissolution, liquidation and final distribution. So, profits, if any, realized in its duration are necessarily recognized in the final distribution and levied income taxes by the tax authority. However, a partnership, a not-going concern, is enabled to continue fully enlarged reinvestments repeatedly as long as its limited duration lasts. 10

11. If you like, interim distribution… Before the final distribution, If you (a partner) like, you can let your partnership interimly distribute a portion of profits to you. In this case you must pay the reasonable income tax. And at the same time, your partnership loses a portion of profits. So, fully enlarged reinvestments cycle becomes impossible. And the growth rate would become low. But anyway… 11

12. 5. In its duration, 1994 -2006, DW has earned, earned, and earned. Interim profits are distributed occasionally. 60% to SKG, 30% to Allen. 12

13. 6. Paramount buyout DW in 2006 @1600M$ The corporeal asset of DW LLC: 1000M$ in its startup becomes 1600M$ in its dissolution. DreamWorks LLC: dissolution, liquidation, redemption, and final distribution in 2006. Redemption (Repayment of principal amount): 100M$ to SKG, 600M$ to Paul Allen. Final distribution: profits = 1600 – 1000 = 600M$ to SKG = 600 x 60% = 360M$ (to SKG talents = 600 x 50% = 300M$) to Allen = 600 x 30% = 180M$ 13

14. 7. At least, SKG talents pay for 300M$ 14 In addition to the interim profits distribution as shown below: In the final distribution, SKG talents pays for 300M$. Something out of nothing.

15. 8. To beget something out of nothing, what matters is… In thinking this, you must keep to look for not the superficial cause but the root cause. For instance, if your answer is “non recognition rule”, then you have to plow deep into why US partnership taxation has such a rule, what is the underlying reason. One right after the other, repeat this cycle until you can’t go further. Challenge to dive into the very bottom and find the root cause. This concludes my talk. Thanks. 15