New Guidelines for Closed-End Film and TV Funds Retain Tax Advantages

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The tax advantage for German private investors in closed-end film funds consists of an attribution of book losses in the year of film production, up to the amount subscribed by the individual investor. The attributed losses may, within certain limits, be set off immediately against the investor's other taxable income, effectively reducing the personal tax burden.

Loss attribution has its ultimate cause in an accounting prohibition for self-created intangible fixed assets (film rights) and the tax transparency of film funds generally structured as limited partnerships (Kommanditgesellschaft). The accounting prohibition presupposes that the film fund qualifies as the maker of the film for accounting purposes. The Second Film and TV Funds Circular concerns the film fund's qualification as the filmmaker. In comparison to previous administrative practices, it lists tougher conditions for the fund's recognition as the filmmaker and demands greater investor influence on film productions.

Marginal 9 of the First Film and TV Funds Circular stipulates that a film or TV fund is the filmmaker if it bears the entire risk of making the film or, by way of coproduction, carries out a film project under its own (shared) responsibility with the (shared) assumption of risks and opportunities stemming from the film project.

However, that regulation has been amended to say that a closed-end film fund is not regarded as the filmmaker, but rather as the buyer of the film, according to the principles of Federal Tax Court judgments on the income tax treatment of equity brokering commissions and other fees, if the contracts relevant for the establishment and operation of the film fund are prepared by the film fund's initiator and the investors have no likelihood of exerting influence on those contracts.

Marginals 10 and 11 of the First Film and TV Funds Circular also have been completely replaced in the Second Film and TV Funds Circular. According to the latter, if contracts required for the establishment and operation of the film fund (including master agreements with service providers and/or coproducers) have been developed by the initiator of the fund (generally a film distribution company, investment adviser, or leasing firm), it is crucial, in order to qualify as the filmmaker, that the film fund (that is, the investors, in their legal capacity as partners of the fund company) has substantial influence on film production, and bears the commercial consequences, or shares in bearing them (in the case of coproductions).

This rule applies if the fund's potential influence has direct ramifications on the entire implementation of the film project, through completion, and if that influence extends in time over the phase before the start of shooting, during shooting, and after filming is finished (postproduction). These conditions must be applied separately to every film.

Because of the special conception of closed-end funds, it is necessary that the investors' rights of influence go beyond the rights generally required for recognition of coentrepreneurship under section 15, paragraph 1, sentence 1, no. 2 of the German Income Tax Act. The Second Film and TV Funds Circular provides that the substantial potential of asserting influence does not come about simply by having the initiator act as a partner or managing director of the fund. The potential to assert influence must be provided to the investors themselves, and they may exercise that potential within the fund in their legal capacity as partners of the fund company. Representation by third parties (such as trustees and advisory board members) conceptually established in advance will not suffice, according to the second circular. Neither the initiator, nor any person close to the initiator, may be a member of an advisory board elected from among the investors themselves or a similar body. Only the investors may decide on setting up and filling positions on an advisory board or similar body, and then only after at least 50 percent of the film fund's capital, to be collected from the investors according to the film fund's prospectus, has been paid up.

The potential for influence will be sufficient if the fund is legally and actually in a position to change essential parts of the film's concept. That can be affirmed if decisionmaking alternatives are offered for the essential film components — specifically, the plot, the screenplay, the cast, the calculation of costs incurred, the filming schedule, and financing. Consent to the film concepts or contract drafts submitted by the initiator does not, in itself, signify a sufficient degree of influence, according to the second circular. Rather, the investors must be able to make their own decisions regarding the essential features of the relevant contracts and their execution. The implementation of the essential film components and any divergence from them must be fully documented.

The basic principles cited above also apply, under the second circular, to investors joining after filmmaking has begun, but before the film is finished. Whether the expenditures of investors joining later on are to be considered production costs (whereby the accounting prohibition for self-created intangible fixed assets would apply) or as purchase costs (whereby the accounting prohibition for self-created intangible fixed assets would not apply) must be judged according to general tax principles established in relation to the date when the investor joins.

According to tax authorities, the making of a film basically begins with the conclusion of contracts ensuring that the fund is entitled to all material rights required for the production and commercialization of the film. In connection with the conclusion of those contracts (normally within three months), other measures must be taken relating to filmmaking (such as the conclusion of contracts with actors, directors, and producers, the leasing of studio space, the commissioning of a service provider, and so forth). If further measures related to filmmaking do not occur in timely proximity to the conclusion of the contracts, the beginning of filmmaking will be deemed to occur on the date on which those additional measures occur. The making of a film ends when the product from which copies will be made for performances (including the time of so-called postproduction) is finished.

The second circular will apply in all cases in which no final tax assessment is yet available. If the application of these principles entails more stringent taxation when compared with previously applied administrative practices, the principles are not to be applied, provided that marketing of the fund interests started before 1 September 2002, and the taxpayer joined the fund before 1 January 2004.

With these new regulations for film funds, the continued existence of so-called coproducer funds (genuine filmmaker funds) has been ensured. By way of contrast, lease-type fund structures in which the fund's film rights are licensed long-term for a specific fee to a partner in the film industry no longer will be eligible for the tax advantages.

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Published by AMANNLawyers & Tax Accountants, Munich, Germany, a Germanlaw and tax accountingfirm.

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