Tax break on the brink

Gov't cracks down sale-leaseback plan that aids ad buys

Creative accounting has long been comedy material in Hollywood. But as year-over-year price increases for such expenses as TV advertising have pushed the cost of marketing a film past the $60 million mark for some tentpoles, studios are very serious about finding a little extra cash.

Increasingly, the majors have embraced an arcane-sounding — ansd so entirely legal so far — tax-avoidance scheme, the sale-and-lease-back deal, as a way to get more discretionary funding for such endeavors as media buying.

In a nutshell, these arrangements — known as sale-in-lease-outs (SILOs) — are a way to sell a future tax break for immediate cash. Here’s a simplified model of how it works in the movie biz:

Fictitious Films has just completed $100 million production “Tentpole.” Under tax laws in places like the U.S. and U.K., the film is a depreciating asset, and Fictitious can write off that depreciation over a period of years.

But Fictitious could sure use that cash up front for, say, buying spots during the network TV upfront to promote “Tentpole.” As it happens, Blighty Partners, a small group of high-net-worth individuals in England, is looking for a tax break.

So Blighty takes out a loan and buys the negative outright from Fictitious for $100 million, then leases the film back to the studio.

About $85 million of that never actually makes it to Fictitious — it goes right into the bank. The $85 million, plus interest it earns over the span of the lease agreement (usually 15 years), will cover what Fictitious owes on the lease.

Nothing actually changes for “Tentpole”: The two companies have an ironclad agreement, so Fictitious keeps total control of the film, gets all the revenue from it and has the right to buy it back at the end of the lease.

In fact, nothing happens but a lot of paperwork. Still, incurring only the out-of-pocket expenses of legal and administrative fees, Blighty’s members now have the sizable first-year depreciation of a major motion picture as a tax writeoff.

And for its part, Fictitious has an extra $15 million to advertise “Tentpole” — or do anything else it wants.

If the whole thing sounds, well, a bit fictitious, it’s not. SILOs are surprisingly common, and federal governments — which are the ones that lose out in these deals — are beginning to crack down on them. In March, U.K. officials outlawed several SILO funds that were in the process of amassing $700 million to bankroll P&A costs for movies from Universal, Disney and MGM.

No new tax shelters

The SILO is actually a well-established practice in other industries. It first caught on when tax-exempt entities, such as cities, discovered they could sell their depreciable infrastructure to a private company that pays federal taxes, then lease it back, and get some extra cash at the expense of the treasury.

In Los Angeles, for example, public buses have been sold to and are leased back from tobacco giant RJ Reynolds.

In the private sector, unprofitable companies realized that though they may not be paying enough in taxes to fully benefit on the depreciation of their assets, through a SILO, they could better capitalize on their tax breaks by selling them.

For a profitable movie studio, the benefit of the SILO is in the timing — a tax break derived from a film’s depreciation is cashed in when it’s most needed to ensure the movie’s box office success, not years later after insufficient promotion rendered it a flop.

“The hard part for the studios in marketing movies inside and outside the U.S. is whether their proportional spend is smart money,” says Chris Tricarico, a partner at Katten, Muchin, Zavis, Rosenman, a law firm with experience in setting up SILOs. “If they can reduce their proportional spend, they’re going to do that.”

In the film industry, SILOs have most often paired American studios with buyer/lessors in the U.K and Germany, because tax laws in those countries — at least until now — have favored the practice. “When there was a lot of money in Germany, there were film funds that allowed dentists and doctors and other professionals to buy tax credits to offset their income,” Tricarico says.

Meanwhile, besides transforming their long-term tax benefits on depreciation into immediate cash, the mobility of SILOs allows studios to capitalize on tax breaks wherever they might be. For example, with the U.K. offering tax incentives to lure film production, films that are American-owned, but include the right British qualifications — labor, casting, location use, etc. — have become prime SILO beneficiaries, according to Paul White of the London office of Orrick, Herrington & Sutcliffe, another law firm with SILO experience in the film biz.

“Bend It Like Beckham” and “What a Girl Wants” are just a few examples of the many films shot primarily in the U.K. that used sale/leaseback financing.

In some cases, films involved with these U.K.-based sale/leasebacks even credit the bank that facilitated the deal, White notes.

And movie-related SILOs are just starting to catch on in the U.S., says Kelly Longwell, of New Orleans law firm McGlinchey, Stafford.

New Mexico, for example, has recently instituted aggressive tax incentives to lure film production. Since the state legislature hasn’t made these benefits transferable to those operating outside the New Mexico, studios are using lease-back deals to seize the benefits.

If all of this sounds like money for nothing, the federal government — operating in an environment of rising deficits and rampant corporate scandal — has begun to think so, too. Or as one Washington, D.C.-based lawyer notes, “If a lease-back of a physical asset is ephemeral, a lease-back of an intangible asset (like a film) looks even worse.”

Besides the instance in which the U.K. government banned funds that were specifically set up to finance American films, in the U.S., there’s legislation before Congress to tighten the rules on SILOs. Even the tax-averse Bush White House is in favor.

The legislation’s sponsor, Sen. Charles Grassley (R-Iowa), has been outspoken SILO critic. “In return for sizable tax savings, the architects of these abusive tax shelters are making a fortune, and the taxpayers are subsidizing it,” he said in a statement.

But in fact, the SILO is deeply rooted in tax law, and it’s unlikely to go away. “You’ve always been allowed to transfer the tax benefits associated with the sale of assets to another person,” says the D.C.-based attorney. “It’s been going on for decades.”