Film finance: Lock, stock and over a barrel

Anyone scanning the listings for their local multiplex cannot help but notice that Hollywood rules the Western world's screens. In the week of writing this article, nine of the top 10 films showing in the UK were bankrolled by the Americans, including the film portrayed by the media as a British success, Billy Elliott: British story, British actors, but US money from Universal Studios, and therefore US profits. So in 1997 the newly-elected Labour Government decided to help out the UK film industry by encouraging homegrown investment. This was done by introducing 100 per cent tax concessions for up to £15m investment into films, which had to satisfy certain criteria to be classed as British (see box).

However, the provisions of section 48 of the 1997 Finance Act No 2 are due to run out in 2002, after an initial extension of two years in 1999. Lobbying groups in the film world are gearing up to try to persuade the Government that the concessions are just beginning to have a major effect on the industry, and that to pull the rug out from under its feet now would be disastrous.

Law firms, such as Denton Wilde Sapte, SJ Berwin, The Simkins Partnership, Richards Butler, Olswang and Davenport Lyons, which specialise in film financing, have seen increasing numbers of investors and producers come together to sign the sale and leaseback agreements, and some worry that if the tax concessions go, the amount of film financing work will drop dramatically. If this happens, it is likely to have a major impact on their own businesses. Yet despite this, these firms have not been directly part of the lobbying process.

Denton Wilde Sapte acts for Universal, Warner Brothers, MGM and Paramount, as well as many smaller independent producers. According to Ken Dearsley, a partner at the firm, most of the money that is put into film through sale and leaseback schemes comes from the leasing subsidiaries of the four major clearing banks.

By their nature, banks are cautious, and independent producers often find it difficult to find funding. The other alternative is to go to the BBC or FilmFour, both of which were phenomenally important three years ago, explains Dearsley. “At that time, if you didn't have them on board, then it was impossible to get your film off the ground,” he says. Both are still very influential and tend to provide the earlier money and development funds for producers.

However, everyone in the world of film financing agrees that the tax concessions have been popular with rich individuals, who stand to gain most from such tax shelters, as they pay the highest level of tax. Anthony Gostyn of niche media firm The Simkins Partnership says that his department handles about 8-10 such deals a month.

“There are now new people looking at the industry,” says Dearsley. “People are prepared to put in money on a risk or an opportunity basis. Money is going in on the basis that it may be a good or bad film. This is a new thing, and it's fantastic.” In fact, the scheme has been such a success that there are now more partnerships made up of of rich individuals chasing British films to invest their money in than there are producers strapped for cash.

Olswang film and television partner Jacqueline Hurt says that when the sale and leaseback tax concessions were first introduced the film industry did not enjoy any significant immediate impact. As the deals only take place between completion of the film and delivery of the negative, the money due to the producer, which is a certain percentage of the cost of the film, is only handed over after the film is finished, so none of it can be used towards actuallymaking the film itself.

However, the laws of supply and demand mean that producers are starting to call the shots when signing deals and can now ask for a better fee or “benefit”. “The net benefit that a producer can ask for has gone up from around 6.5 per cent to around 10 per cent [of the total film cost],” explains Hurt. “But in addition, certain partnerships are saying, what we will do is cash flow your net benefit through production, provided you're producing a British film and you sell it to us at the end of the day. That's been an enormous help.”

Also, as there are so many film partnerships around, even if they are not willing to hand over the cash during production of the film, a producer can count on another partnership being willing to invest in their next film and so can carry over some of the net benefit to finance the next production. In addition, the tax concessions have attracted work from the US, as even the largest studios can benefit from the scheme.

Rachel Holroyd, a consultant at London-based Working Title Films, which is owned by Universal Studios, says: “For Universal the concessions are just used as an added extra. Sometimes, if we were going to reshoot in the US but that would mean we'd miss out on the tax concession, then we'll reshoot here. The big change for us is that the US studios are shipping as much work as possible over here because the benefits are fairly sizeable.”

Ironically, this could form part of the Treasury's argument for withdrawing the scheme, if it believes that the main beneficiaries of the tax benefits are the Hollywood behemoths. There is also, of course, the ever-present pressure on public spending, and tax concessions take money out of the state purse.

The British Film Advisory Bureau is currently drawing up its own economic models to try to find out whether, when seen in the bigger picture, the concessions do in fact lose the Government money or whether the increasing amount of film work done here rather than abroad brings in more money through VAT than is lost through tax concessions.

This is an issue which Richard Holmes, managing director of independent film company Civilian Content Film and Television, which was behind Waking Ned and Hideous Kinky, believes should be examined more closely. He points to the Isle of Man, where Waking Ned was filmed. There, the Government will give a producer 25 per cent of the entire film budget as long as the entire film is shot on the island. It has been worked out that the amount of money that comes into the state as a result far outweighs the grant aid given out.

But what will happen if the Government chooses not to listen to the film lobby and does not extend the tax concession scheme?

Holmes is ebullient, saying that independent producers always muscle through somehow, but that by withdrawing the concessions, the Government will also undermine the confidence of those who had begun to put their money into the industry.

Nigel Palmer, partner at SJ Berwin, who has drawn up financing deals including the concessions for Lock, Stock and Two Smoking Barrels, Sliding Doors and the All Saints' film Honest, believes there is a strong chance that the concessions could go. “The film industry people are never content with what they've got,” he says. “My own personal view is that the Labour Party saw the film industry before the election as its natural constituency and ensured that the film industry could cash the rain cheque for the election. But now the rain cheque is fully encashed and I wouldn't be at all surprised if the Treasury decides that enough is enough.” As to what the effect will be on the industry, opinions are mixed.

Hurt remains optimistic that the impact will be minimal. “I'm not sure whether it will affect the industry significantly, partly because it only affects around 10 per cent of the budget, which in any event will go to the producer rather than to the industry as a whole,” she argues, adding that in the grand scheme of things a tenth of the budget is not that great an amount.

Hurt also believes that while there are many partnerships bankrolling films for the tax benefits involved, there are many others that have now become fascinated by the industry and will continue to invest in it even if the tax shelter goes. “I know of one guy who financed a £650,000 film. The budget was so low [the tax concessions only kick in after £1m] that it didn't qualify for tax relief, and he's unlikely to get the money back, but he invested because he was interested.”

But not everyone is quite so confident. “[Withdrawing the concessions] would be a real retrograde step,” says Dearsley. “The producers have really benefited from being able to gain 10 per cent of their budget. That 10 per cent is now factored into a film's budget.” He adds that if the tax concession is axed in the UK, film makers will move to other countries such as Australia and Canada, which have similar schemes.

Palmer agrees. He is dismissive of Hurt's argument that people will invest just for the enjoyment of being involved in the glamorous world of the silver screen. He believes that it is just about conceivable that some may do, but that most still want to ensure they will make money from the deal. He argues that part of the reason why the concessions were so popular is that there are very few other 100 per cent tax concession schemes available to those with heavy pockets. “Film finance is an inherently unstable investment because a number of things can go wrong,” he points out. “If tax relief is withdrawn, then it's not going to be very attractive. Also, foreign companies are not going to be so interested in making so-called British films as when the tax concessions are available.”

So, in a worst case scenario, how will the British film industry cope?

One option that has already been successful is the scheme where money is given to films by the National Lottery's good causes fund. Christopher Hanson, a Denton Wilde Sapte partner who works with Dearsley, says that this initiative has already had some success, mainly because it is putting money into a film while it is being made, rather than after it has been completed.

“[Lottery] money only went to films that would have a release, so the consortiums had to go and secure exhibition space in order to trigger the film's financing,” says Hanson, raising one of the central arguments voiced within the industry, that pouring money into film production is useless unless support is also given to the distributors who must find screen time to air the product.

“All of those films have had a theatrical release and some exposure. But with cinema releases, if people want to see the latest Hollywood blockbuster, then nothing can be done. It comes down to the point of what sorts of films the British film industry makes.There are a lot of demands on screen space,” he says.

And trying to squeeze in British films around the Hollywood “sausage machine” is tough, adds Dearsley. Many distributors are tied in to the US studios, and Hollywood also has the track record to allow it to pre-sell the product.

One offshoot of the concessions has been that the City and the banks are now looking more favourably on the UK film industry. The Hermes Pension Fund has invested in Kenneth Branagh's brainchild Renaissance Films, in a move which has yet to be replicated, but which is seen as encouraging by many film financers.

Dearsley reports that many of the banks brought into the fold by Denton Hall's merger with Wilde Sapte are now actively looking at how to become involved in the sector. “There's a lot more dialogue between the two sides,” he says. “There used to be a standoff between the industry and the banks. The trouble with the industry is that it is not dependable, and banks tend to focus on the ones that go wrong. But what's great now is that the producers are much more aware of what the banks want. The discussions from both sides are now much more mature. Producers are now able to see that banks need to know how they are going to pay the money back and are looking intelligently at financing. For example, there is more understanding that £1 payable now is not the same as £1 payable in a year's time.”

But Holmes believes that the City and banks are not interested in films, nor should they be. “It's not their place to invest; they should be lending against assets,” he concludes.

On a positive note, with the vast expansion of outlets for film work in cable and satellite networks, along with other new media opportunities, the buyers in the industry are constantly on the lookout now for good-quality products. But Palmer argues that the Government, and ultimately the tax payer or lottery ticket buyer, will have to decide whether the country needs a film industry. “Because it's struggling in a world marketplace which is dominated by the Americans, if you want a viable film industry you have to ask yourself whether you're willing to pay for it,” says Palmer. “It's like the Royal Opera House – it couldn't have raised the money for its restoration on its own to the standard that's been achieved. I think the same might be true of a British film.”