Company testing Brit's flexibility with tax law

LONDON – A new company, Evolution Films, has set alarm bells ringing across the British film industry by using tax breaks to pour millions of pounds directly into production.

Since it launched last April, Evolution, which is based in Chester, near Manchester, has raised £23 million ($33 million) from private investors to produce seven British films and one short. It now is raising another $85 million to shoot 20 more films over the next year.

And if that sounds too good to be true, read on. Evolution’s critics say its creative interpretation of tax law will test the boundaries of what the government will accept.

Some even fear that controversy over the company’s financing methods could jeopardize the campaign for renewal of the 100% tax writeoff for British production, which is due to expire in April 2002.

Evolution, however, sees it differently. “We are doing what the legislation was intended to do. We are putting money into making films,” says managing director Andrew Tate. “Our ambition is to do a huge amount this year and to float the business next year.”

Tate, a chartered accountant, founded Evolution after becoming frustrated with conventional sale-and-leaseback deals.

Under the Evolution scheme, private investors put up 25% of the budget for a film in cash. The remainder is covered by deferrals, fees to be paid later out of revenues. In theory, investors then can claim 40% tax relief on the full budget, giving them an immediate profit regardless of whether the film is sold or released.

Evolution typically budgets its pics at around $20 million, close to the maximum allowable for tax relief. That means investors are putting up $5 million cash and getting $8 million straight back from the taxman.

But to the naked eye, it is hard to see how that startlingly high budget squares with the minor TV talent and the subject matter involved in Evolution’s current slate.

The films so far shot by Evolution include “Mrs. Caldicot’s Cabbage War,” about an elderly lady (Pauline Collins, star of feature “Shirley Valentine”) who becomes a celebrity when she leads a revolt at her old folks home; “Al’s Lads,” a comedy set in 1927 Chicago but shot in Liverpool about three Liverpool lads who get entangled with Al Capone, featuring Richard Roundtree (yes, the original “Shaft”); and “Arthur’s Dyke,” a $14 million project starring sitcom actress Pauline Quirke as a mother who leaves her family to walk the length of the Welsh border.

Another pic, “The Revenge of the Swedish Bikini Team,” a kind of “Charlie’s Angels” spoof with a cameo by Roger Moore, is about to start lensing.

But the big question is whether Evolution can persuade the Dept. of Culture and the Inland Revenue to accept such massive deferrals for the purposes of tax relief. Contrary to some impressions, such official approval has not yet been granted.

Evolution has not yet even submitted any of its movies to scrutiny by the Dept. of Culture; it will start to do so in the coming weeks when they are completed.

To pass muster, the company will have to prove the deferrals are not only legitimate, but also have a “reasonable probability” of being paid in full. That would normally mean getting a reputable sales agent to provide sales estimates sufficient to cover the whole budget.

Under Evolution’s terms, 50% of all revenues will go to pay off deferrals (10% goes in fees and 40% tax is paid). So a $22 million pic would need sales estimates of $33 million to support its tax claim.

That’s the kind of figure usually associated with Hollywood blockbusters. For example, last year’s most successful wholly independent Brit pic, “Saving Grace,” took $25 million gross at the worldwide box office.

Tate says he has secured a $33 million sales estimate from L.A.-based A-Plus Entertainment for “Swedish Bikini Team.” No sales agents are yet attached to the other projects.

But he also claims that since the deferrals are contractually guaranteed — in other words, the financiers are legally committed to pay them regardless of revenues — such estimates are not essential.

Nonetheless, government sources say that in such cases, they look very closely at where the money will come from to cover the liability before agreeing to certify the films as British to qualify for the tax break.

Guaranteed deferrals also mean the talent will be taxed on the full amount, not just their cash fee. And if for any reason the deferral is not paid, the investors will have to pay back their tax rebate for that portion of the budget, even assuming the Inland Revenue has granted tax relief on the whole budget in the first place.

“Out of 100 British films, how many ever pay off even modest deferrals? Probably a couple,” observes one tax expert. “So how likely is it that all of Evolution’s films will manage it?”

Tate is used to banging his head against such industry skepticism. He admits that, as a newcomer in a hurry to finish a certain volume of pics in the current tax year, he didn’t have the pick of the best scripts or talent.

But he declares himself confident that at least three films on his current slate – “Al’s Lads,” “Swedish Bikini Team” and a thriller, “Endgame” — have real commercial prospects.

Evolution is in discussions to set up its own sales and distribution arm, and also wants to buy its own production facilities.

Prompted by bullish investors who want more of the upside, it also has started to provide 100% cash finance for some films, including “The Guv’nor,” a $10 million gangster project starring Vinnie Jones (“Snatch”). That’s a business that carries more risk but doesn’t suffer from the legal uncertainties of using deferrals.

One fan of Evolution is Mick Southworth, head of distribution at Winchester Films. “I’m generally very impressed by their portfolio,” he comments. “There’s nothing very esoteric; they want to make the most commercially-minded movies.”

Other distribs and PR agents who have come into contact with the projects are less complimentary. Sales agent Vic Bateman of Victor Films says, “The script they sent me, ‘Endgame,’ was awful. I told them we never put up estimates to accommodate a budget. My estimate for this would have been zero.”

But who knows? One or all of Evolution’s current pics might indeed defy industry wisdom and turn out to be the next “Full Monty.”

Let’s hope so. The British film industry certainly doesn’t need another glut of movies nobody wants. And if the government were to disallow tax claims on a large percentage of the $22 million budgets, any investors who thought they were onto a sure thing would find themselves praying to box office gods for their money back.

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