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Soft Money in Hard Times

Soft Money in Hard Times

Articles - Directing

Much to the chagrin of moviemakers,
the financing available for independent films has been drying up
for the past few years. The insurance-backed funding schemes that
were the rage for a while have disappeared after huge claims were
made and protracted litigation ensued. Even top producers have
difficulty securing financing based on pre-sales—and those funds are often contingent on
securing domestic theatrical distribution. Gap financing is in short
supply, too, as banks have grown wary of lending money on the basis
of projections. At most, a producer might be able to secure a gap
loan for 20 percent of the budget in today’s climate. Raising
money from equity investors has always been challenging, but when
the economy is sluggish and high-net-worth individuals have suffered
years of losses, it can seem almost impossible to raise funds for
a risky investment like film. So what’s a moviemaker to do?

Increasingly, american producers are emulating their European
brethren’s long-held tradition of cobbling together government
subsidies and incentives to fund their projects. This is a new
arena for Americans, who are used to operating in a free enterprise
system without any government support. Indeed, the federal government
provides no production incentives, tax breaks or other specific
support for moviemaking (with the exception of some crumbs thrown
to public television producers and meager grants from the National
Endowment for the Arts). This could change if Congress enacts legislation
to combat runaway production, but with the federal budget deficit
at an all-time high, it’s doubtful that Congress will enact substantial
tax breaks anytime soon. Due to its own severe budget crisis, the
state of California suspended all funding for its Film California
First incentive program in 2003.

American moviemakers are increasingly searching
for incentives and other soft monies that may be available to
them. Many  states
and several countries have begun to realize that every dollar spent
locally has a multiplier effect on the economy. And a popular motion
picture can expose millions of people to local attractions and
build tourism. A film like Whale Rider will always
be more effective than a paid commercial, if the aim is to illustrate
the beauty and culture of New Zealand.

At one time, producers who took advantage of production incentives
were considered marginal players. Today, major studios and many
successful producers rely on incentives. A producer would
be foolish not to consider the incentives available when selecting
a location. The incentives most readily available to Americans
are those that only require that you bring your shoot to a location
where you’ll spend your budget. These deals are usually open to
all producers—regardless of nationality or content of the picture.
Examples include the Canadian Production Services Tax Credits,
the British Sale-Leaseback scheme and the German Film Funds. Domestically,
more than 40 states offer film incentives.

Location-based rebates are given to producers based on the amount
they spend in an area. While the benefit may not be paid until
after completion of the production, certain banks may loan the
producer funds with the anticipated benefit as collateral. Canada,
Luxembourg, Iceland and Australia offer such rebates.

Other programs reward film investors. The German Film Funds, the
Netherlands’ CV system of limited liability partnerships, the French
Soficas and the U.K. Sales-Leasebacks are examples.

A few governments, like in the U.K. and Italy, offer producers
loans with favorable terms. Germany has them at the regional level.
The European Investment Bank, a European Union-backed institution,
offers loan guarantees. Here in the U.S., New Mexico has a program
that loans funds to producers without interest.

France, Spain and the Nordic countries all have schemes in which
a small slice of box office revenue is siphoned off to encourage
future production. The EU’s Media Plus program uses box office
revenue to assist distributors and exhibitors.

Sometimes producers are offered reduced prices for locations,
facilities, use of police and permit fees. New York City, for example,
doesn’t charge for permits and provides free police traffic control.

In addition to incentive programs, producers should consider other
benefits that can arise from moving your production. In Eastern
Europe, South Africa and China, the wage scale is so low that crews
and extras can be hired for a fraction of the cost of those in
the United States. Likewise, food, lodging and construction costs
can be a bargain. If a producer can hire crew members or book a
hotel for 20 percent of what those items would cost in the U.S.,
then the producer is receiving a benefit equivalent to an 80 percent
subsidy. The moviemaker also avoids the burden of completing complicated
paperwork and incurring legal and accounting fees. But savings
may be offset by increased travel costs, which may be negligible
for a moviemaker shooting in his own community.

The currency exchange rate is an important factor whenever shooting
abroad. Canada and South Africa are attractive locations because
the American dollar is strong compared to the local currency. On
the other hand, moving to a distant location may have drawbacks.
If your camera breaks down in a remote location, it may take days
to have a replacement shipped in. The availability of experienced
and talented crew members varies greatly, as well.

By international treaty, some countries encourage their nationals
to collaborate with others by allowing them to aggregate incentives.
Canada has treaties with 60 countries. These agreements allow their
producers to pool financial, creative and technical resources with
other nationals. The treaties lower the requirements that normally
must be met for each producer to access incentives in their home
country, and may reduce administrative burdens.

It bears noting that the United States is not a party to any international
co-production treaties. Nevertheless, U.S. moviemakers can enter
into co-production agreements with foreign nationals. Even if an
American producer is fully financing a film, a knowledgeable resident
line producer can be invaluable in securing the best deals and
ensuring compliance with local rules. An American production that
features a local director or star may enhance the commercial value
of the film in that country.

To be eligible for some incentives, the film may need to employ
cast members from certain countries. It is not unusual for an American
producer to shoot abroad and bring along one or two American stars
to enhance the value of the film. These American stars are almost
always members of SAG, while the locally employed actors are not
(although the local actors may have membership in a local union).
SAG’s Rule One does not allow SAG members to work for producers
who are not SAG signatories. In the past, SAG didn’t enforce this
rule when a SAG actor worked abroad. As of May 1, 2002, however,
SAG has announced that it intends to strictly enforce Rule One,
threatening disciplinary action against any SAG actors that work
for non-signatory companies. This will force producers who are
shooting abroad to either employ exclusively non-SAG actors or
become a SAG signatory with its accompanying obligations, including
rules on working conditions and contributions to pension and health
insurance payments.

When parties from different nations co-produce a film, they need
to carefully consider the tax consequences of their collaboration.
Careful structuring of the collaboration may significantly reduce
the tax burden on the parties. For example, a co-production between
two parties may be considered a partnership for tax purposes. As
a partner engaged in a trade or business in the United States,
a foreign national may be subject to U.S. income tax, and the partnership
may be required to pay withholding tax on the foreign national’s
share of income. Since the U.S. tax rate may exceed what the foreign
national is taxed in his country, this may be an undesirable consequence.
If the deal is fashioned so that the foreign investor retains non-U.S.
distribution rights and has no U.S. trade or business, it may avoid
paying U.S. tax from income derived from the film outside the U.S.

Incentive Programs in the United States

New mexico offers producers a choice of two incentives. A gross
receipts tax deduction allows moviemakers to avoid sales tax for
certain production costs, including the cost of a script, salaries
for talent, construction, wardrobe, sound, lighting, editing, location
fees, rental of facilities and equipment (not including lodging)
and rental of vehicles or catering. Sales tax is 5 to 7 percent,
depending on the location where the sale is made. Moviemakers can
obtain NTTC certificates so that the sales tax is not assessed
by suppliers.

Alternatively, a moviemaker could elect to receive a 15 percent
film production tax credit. This credit applies against the moviemaker’s
New Mexico income taxes. This applies to New Mexico-based production
expenditures that are taxable in New Mexico. In order to qualify,
production companies need to register with the New Mexico Film
Office and they may only take advantage of one incentive for each
purchase.

New Mexico waives location fees for the use of state-owned buildings.
There are approximately 800 such buildings, including the now shuttered
state penitentiary, a 1940s-era, maximum-security prison facility.

The state is willing to invest or loan funds to producers meeting
certain criteria. Under the New Mexico Film Investment Program,
up to $7,500,000 can be invested in a NM film private equity fund
or NM film project. The motion picture must be substantially shot
in the state, needs to have a distribution agreement in place with
a reputable company, employ mostly state residents as crew (60
percent) and post a completion bond. The amount of the state’s
equity participation is negotiable depending on how risky the project
is. If a loan is given, the state can take an equity investment
instead of charging interest.

The state is not willing to take much risk. First-time producers
are not acceptable unless they are affiliated with seasoned producers
who are actively involved. The state usually must be in first position
for recoupment of its capital. Indeed, New Mexico’s requirements
are not much different from what a bank would require, which means
that most low-budget indie moviemakers will not qualify. The primary
advantage is that New Mexico is willing to accept back-end profit
participation rather than charge interest for the use of its money.

Hawaii recently enacted some very impressive and generous tax
incentives. Hawaii’s high-tech investment tax credit provides a
100 percent return on cash investments in a qualified high-tech
business (QHTB) over five years (35 percent credit in the first
year of investment, 25 percent in the second, 20 percent in the
third and 10 percent in the fourth and fifth years following).
Qualified research activities include performing arts products
such as motion pictures. The credit is designed to give a 100 percent
return for investments up to $2 million per year, per taxpayer.
The credit applies against Hawaii income tax liability only. The
credit can be taken by individuals or corporations paying Hawaii
income tax, and by banks and insurance companies against their
franchise and insurance premium tax.

Moreover, if money from outside Hawaii is invested, the tax benefits
can be allocated in such a manner so that the Hawaiian investors
can obtain more than a 100 percent return. So for example, if a
Hawaii investor put up $500,000 and an Arkansas investor put up
$500,000, the parties could agree to allocate all the tax credits
to the Hawaii investor (since the Arkansas investor doesn’t pay
taxes in Hawaii they are worthless to him anyway). Under this scenario,
the Hawaii investors could receive a 200 percent return over five
years. In return, the Arkansas investor could be given preferred
recoupment or a greater share of the profits.

“The Hawaiian incentive is the most impressive effort of any state,
by far,” says producer Doug Mankoff (The Big Empty), who
is opening a Hawaiian subsidiary. “A program that eliminates financial
risk for Hawaiian investors, and gives the other investors a priority
return, is tremendously attractive to producers.”

The production entity would be required to spend 75 percent of
the budget in Hawaii. In order to qualify, companies need to stay
in business in Hawaii for at least five years and should have copyright
ownership of the picture. The downside of shooting in paradise
is that it’s more costly than many other locations, it’s a union
state and indies will likely need to negotiate with IATSE and the
Teamsters.

Two movies have been made with this incentive: Blue Crush and The
Big Bounce
. The grant of tax credits for Blue Crush was
quite controversial as this Imagine/Universal production was
planning to shoot in Hawaii anyway. They received an estimated
benefit of $15 to $18 million. The purpose of this law was to
build movie industry infrastructure in Hawaii. Imagine and Universal
shot the picture and departed without putting down any roots.
The tax department will no longer issue tax comfort rulings on

International Incentive Programs

Canada has been very successful in luring American productions
to shoot in Canada. Toronto and Vancouver have a deep reservoir
of skilled and experienced crew members, so numerous productions
can shoot simultaneously.
A favorable exchange rate with the U.S. dollar lets American producers stretch
their resources by buying goods and services for less.

Canada offers a variety of programs designed to support both Canadian
and foreign producers. A distinction is made between Canadian content
films, which receive a generous tax credit, and those films which
do not possess Canadian content, which are eligible for a substantial
but lesser credit. Both programs are jointly administered by the
Canadian Audio-Visual Certification Office (CAVCO) and the Canadian
Customs and Revenue Agency (CCRA). Producers cannot receive benefits
under both programs simultaneously, but they may combine these
production incentives with those offered by Canada’s provincial
governments.

To be eligible for Canadian content incentives, the company must
be owned or controlled by Canadian citizens or permanent residents.
Either the director or screenwriter and one of the two highest
paid actors must be Canadian. The production must also earn at
least six points based on key personnel being Canadian. Seventy-five
percent of production costs must be paid to Canadians. The company
will receive a tax credit of 25 percent of labor expenditures (which
usually amounts to 12 percent of total production costs). Labor
expenditures include payments to non-Canadians for services provided
in Canada.

For productions that do not meet the criteria for Canadian content,
the Production Services Tax Credit is available. This is a federal
refundable tax credit to promote production in Canada. The applying
corporation can be a production services company that has contracted
with the copyright owner. Americans can benefit from this credit,
but it only applies to movies with budgets of at least $1 million
Canadian (approximately $678,000 U.S.). Certain financiers will
advance monies to a producer on the basis of an expected tax credit.

Although American producers do not benefit from any co-production
treaty, Americans can qualify as a certified co-venture that is
eligible for enhanced broadcast license fees as Canadian programs.
To be certified, the co-venture must meet the six point and 75
percent spend requirements for Canadian content films. Canadian
provinces provide additional incentives.

The United Kingdom provides many types of support to encourage
moviemaking. The government provides funds for education and training,
lottery monies for production and tax credits, as well as participating
in European programs such as Media Programme that provides additional
resources.

The British Government set up the Film Council in April 2000 to
provide public funding to assist British film production. The Film
Council has supported such recent films as Gosford Park, Bloody
Sunday
and The Magdalene Sisters. Bend it Like Beckham,
for example, received £1 million from the lottery.  MM

A listing of production incentives is available at Entertainment
Legal Resources (www.marklitwak.com). As the rules and regulations
governing incentives and subsidies frequently change, contact the
appropriate agency to obtain detailed requirements.

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