Write-Offs Ride Off Into The Sunset

Politicians of all stripes agree: Film funds and other shelters for the rich must go

Germany's deadlocked political parties can't agree on who should be Chancellor, but film producer David Groenewold knows that whoever gets the job will be intent on destroying his business.

Not film production per se, but the business of selling investment funds to finance new films. Since the late 1990s so-called media funds have been a popular tax shelter in Germany, allowing investors to write off 100% of their money up front. These investment vehicles have financed not just local films but also overseas titles such as The Human Stain, Whale Rider, and the new Pierce Brosnan vehicle, The Matador. "Whoever comes to power, one of the first orders of business will be to kill all forms of film funds," says Groenewold, a former production assistant on The Late Show with David Letterman who is now managing director of Berlin's GFP Media Funds, with some $360 million under management.

Desperate to rein in Germany's budget deficit, politicians of every stripe agree that plugging tax loopholes for the rich is a noncontroversial way to boost revenues. There's an irony here: Left-of-center pols booed flat-tax advocate Paul Kirchhof from the national stage after Christian Democratic Union Chancellor candidate Angela Merkel named him shadow finance minister. But they secretly concur with one of the pillars of Kirchhof's creed: the elimination of rules that encourage people to invest more for the tax savings than the inherent return.

That's why the politicians are eyeing not just film funds but also funds that invest in ships, wind farms, and even the development of cancer drugs. Film funds, though, attract the most scrutiny. Critics of the shelters, which raised $1.8 billion last year, stress that too often the money finances foreign-made movies such as Monster, starring Charlize Theron. The 2003 Oscar-winning picture was bankrolled by VIP Group, based in the Munich suburb of Grünwald. "There are some funds that only invest in German productions, but that's still marginal compared with what flows to Hollywood," says Hermann Scharnhoop, director of the film section at Germany's Commission for Cultural and Media Affairs.

For some funds the crackdown has already begun. On Sept. 27, Munich prosecutors began to investigate whether two VIP media funds are eligible for the tax breaks investors were promised. In a statement, a lawyer for VIP said the accusation is inaccurate. But the firm suspended sales of two guarantee funds, so named because the principal is guaranteed by banks.

Investors have flocked to film funds because of a quirk in German tax regulations, which treat film investments as "immaterial goods." That means investors can deduct 100% of the money they put into a fund, paying taxes only on whatever return they get after a film's release. They can even borrow some of the cash for their investment, yet deduct the full amount. That way they can push the write-off well above 100% of the actual cash they put down. Assuming the investors are in Germany's top tax bracket, the tax revenue lost in 2004 from media funds was around $750 million.

A rearguard action is being fought by the tax-shelter industry. A group of media funds and producers is lobbying to continue tax breaks for films that are either made entirely in Germany or have substantial German involvement. That could help struggling production centers such as Studio Babelsberg, the source of such classics as The Blue Angel.

If any of these funds do survive, the old ploy of taking up-front write-offs probably won't. Instead, media funds will have to lure investors via absolute returns, i.e. profits. Germany's ship funds have reacted to increased scrutiny by focusing more on actual dividends based on a cargo vessel's commercial life. Earlier ship funds relied on paper losses to generate huge write-offs. A similar strategy will be tough for the film business, where profits can be elusive. But the glamour days of movie write-offs are fading.

By Jack Ewing in Frankfurt

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