Author:  Patrick McKenna Chairman, Ingenious Media

Background to Ingenious

Ingenious Media plc acts as the bridge between the media industries and the finance sector, developing investment products that work both for the companies and the investors (many of whom have traditionally been wary of investing in the film industry). Ingenious has five divisions dealing with different types of investment and sectors of the market. One deals exclusively with tax and equity based financing for film production, while others deal with the Corporate Finance, Private Equity, Consulting and Asset Management. Ingenious has put together sale and leaseback deals worth more than £1.2 billion and so far arranged equity financing of some £100 million through its new Inside Track vehicle which was launched last year.

Sale and Leaseback

Sale and leaseback deals are tax deferral schemes which enable investors to reclaim tax previously paid which is then effectively repaid to the Revenue over the 15 year life of the lease. The schemes make use of tax write-off provisions contained in recent Finance Acts. Section 42 relief enables the producer to write off the full cost of their film over three years while section 48 relief allow producers to write off the full cost of any film costing less the £15 million in one year. To qualify for the tax relief, the films have to be certified under the 1985 Films Act as British or be an official co-production. As many producers will not have tax liabilities to write these sums off against, sale and leaseback deals enable them to sell the tax benefit to a third party in return for a contribution to the film's production budget. The market for sale and leaseback products is now very competitive and has become commoditised - ie. deals can now be put together using standard terms whatever the nature of the film or the financial position of the producer.

Sale and leaseback deals are still highly complicated and involve significant leakage of money between the amount the investor puts in and the amount the producer receives. Typically, the benefit to the producer is around 12% to 15% of the budget for films costing up to £15 million and 9% to 10% for films budgeted at over £15 million. One advantage of these schemes is that the cash generated by the deal can be advanced into the production, easing the producer's cash flow concerns. Sale and leaseback finance is now a standard element of the financing package for almost every qualifying film.

The current deal structures have been accepted by the Inland Revenue which means that investors can plan their tax position around these deals with confidence. As a result, sale and leaseback has helped to create a more positive environment for film investment in the City, which is now being converted into interest in other equity investment schemes. However, the underlying legislation for both section 42 and 48 expires in 2005, having already been extended once. Proposals for a replacement scheme are being considered, but it is likely that the more generous section 48 relief may be discontinued.

Equity Funding Mechanisms

Encouraged by the success of sale and leaseback, there is now a growing market for structured equity products in the film sector. Some of these have been based on the section 48 write off provisions, but these are very risky from the investors point of view. Others are based on the application of general accounting principles to film production. In essence what happens is that, in keeping with these principles, the cost of the film is recognised in the year in which it is committed. The value of the asset created by the company is then recorded in the accounts at the lower of its cost and the net realisable value that would be achieved from its exploitation in the market. Since, for a film, this value is often close to zero, almost the entire investment can be written off in the first year.

Ingenious's own Inside Track product combines a sale and leaseback element with an equity investment, wrapped up within a limited liability partnership. Typically, the combined value of these two investment streams will be around 45%, made up of 12% from the sale and leaseback and 33% in equity). The equity position gives the investors a recoupment position entitling them to 33% of the producer's gross revenue corridor up to full recoupment, after which a profit sharing arrangement would be negotiated for each deal. If the film loses money, then the investors will still receive their tax break. But if it generates any revenues, the investors will receive a share of those sale receipts which could generate a return of around 20% for the investor.

The advantages of this scheme are that it enables investors to take advantage of tax losses on unsuccessful films and also to benefit from any positive revenue from more successful films. The scheme also relies on general accounting principles and well established general tax rules so is not likely to be subject to adverse review by the Inland Revenue. The equity partners in the partnership are also able to spread their investment across a portfolio of films making it significantly less risky than investing in a single film. Ingenious are selective about the films that they invest in to give the best chance of an upside to their investors. They look for films with commercial potential, for producers with a good track record (with whom they can develop an ongoing partnership) and for sales and distribution deals with established and respectable agents or partners.

Other Financing

Other financial intermediaries are looking at creating similar equity based vehicles to Inside Track. Companies are also looking at schemes designed to offer relief on print and advertising costs.

Many other countries offer fiscal incentives and other support that may be available to UK producers (generally through developing an official co-production). The most important of these are:

• Isle of Man: up to 25% equity stake (but 70% of the below the line spend has to be on the island)
• Ireland: tax break worth around 12% of Irish spend
• Luxembourg: tax break worth around 23% of Luxembourg spend
• Belgium: up to 30% of budget based on Belgian spend
• France: subsidies based on rebate of box office receipts and enhanced TV sales
• Germany: provincial subsidies and media funds
• Canada: state and federal tax credits based on spend worth around 20% of budget
• Australia: state equity investments in qualifying Australian films and some tax incentives
• New Zealand: proposals currently being considered for a benefit worth 12.5% of qualifying expenditure

Top Tips

• Sale and leaseback finance is now a standard element of the financing package for almost every qualifying film. Typical deals generate around 12 - 15% of the production budget which can in certain cases be advanced into the production.
• Encouraged by the success of sale and leaseback, there is now a growing market for structured equity products in the film sector.
• These products can generate around 33% of the production budget, to which can be added a further 12% from a sale and leaseback deal. However, the equity stake will require a commensurate recoupment position from producer's revenues.
• Producers should consider co-producing their films in order to access subsidies and incentives overseas - but not at the expense of the artistic integrity of the film.