THE INLAND REVENUE'S DECISION TO CLOSE A TAX LOOPHOLE THREATENS TO PLUNGE THE UK FILM INDUSTRY INTO CRISIS AS PRODUCTIONS FAIL TO GET OFF THE GROUND.

THIS HAS MEANT A BUSY TIME FOR LAWYERS, REPORTS GRANIA LANGDON-DOWN

While the UK film industry continues to make its mark at the Oscars, with Cold Mountain garnering seven nominations and international plaudits, the Inland Revenue's sudden announcement last month that it was closing down tax-avoidance schemes, which were being used to finance several films, has cast a chill over the party.

The Paymaster-General, Dawn Primarolo, said the schemes exploited tax relief for trading losses through partnerships.

But the move has meant several big productions have stalled, with producers warning they may have to make the films outside the UK or close them down, prompting furious lobbying within the industry for some form of transitional relief.

Richard Philipps, a partner in City firm Richards Butler's media group, says: 'Everyone is obsessed with the issue.

Nobody anticipated there would be a complete scything of the industry at the knees without any transitional relief.

It has left a number of producers in really dire straits.

'I think the government decided that more tax relief was being allowed than originally intended.

But it wasn't a case of exploiting a loophole - these were legitimate deals.'

He predicts that the Revenue's decision will be damaging on two levels.

'It will reduce the volume of production, which will mean less work for an enormous number of people.

It is also damaging in terms of the degree of security foreign investors and producers feel about locating their productions here.'

Up until six years ago, films were generally financed by pre-sales, with distributors buying off the drawing board after looking at the script and cast.

The government then introduced an enhanced film-specific tax relief (section 48 of the Finance Act 1997), allowing 100% relief on the first year of expenditure for a British-qualifying film with a budget under 15 million.

That relief expires in 2005 and the government is expected to announce a replacement in the budget, possibly in the form of transferable tax credits.

According to Lisbeth Savill, head of London-based Olswang's film team, the current crisis has arisen over a financing scheme, developed over the past two years, which relied on general-trading relief rather than film-specific relief.

Typically, a limited liability partnership (LLP) would be set up with a 70% loan from a corporate lender and investors adding the rest in cash.

She says: 'Without warning, the Revenue then added a new test that if individual investors were spending less than ten hours a week on the LLP's business, they could only get relief on the cash they put in, not on the full 100%.

'It is not the end of the world as we know it.

But we are in a period of uncertainty.

Those schemes brought in hundreds of millions of pounds in additional production to this country.

We are also still waiting to see what the government will use to replace section 48.'

Ms Savill says that certainty is needed.

'Productions are planned months ahead and you can't plan if the basis of that planning can disappear in the twinkling of an eye.

What we want is something entrenched in our tax system, which doesn't end up being controversial or being revoked or expiring.'

Jonathan Blair, head of City firm Addleshaw Goddard's audio-visual group, is also concerned about the long-term impact of the Revenue's move.

'The sector was looking very bullish but now I am not so sure.

There is no question that some companies were exploiting the existing rules.

But what the government did not consider was that by reacting so completely insensitively, the Revenue may have put off both foreign and domestic investors for a long time, which will have a destabilising effect on the UK film industry.'

One of the spin-offs from the use of different financing models has been an enormous increase in work for lawyers.

Michael Maxtone-Smith, a partner with Richards Butler, explains: 'The impact of the tax structures means more parties are involved in the financing, with much more complicated documentation.

Producers are saying to lawyers "you are now charging us at least twice as much", but the reason is that the deals are twice as complicated.

They also have unrealistic expectations about how quickly you can close a deal.

If you were lucky, you used to be able to close a deal in four weeks, but that has now almost doubled.'

The UK Film Council is understood to be so concerned about spiralling legal costs that it is planning a meeting with leading lawyers to try to standardise certain procedures.

James Shirras, director of legal and business affairs for Film Finances Ltd, which provides completion guarantees, says: 'There is a move to try and control this apparently unstoppable growth in legal complexity, and simplify some procedures so we don't have to reinvent the wheel every time.

Whether anything comes out of it, remains to be seen.'

But Jonathan Berger, an entertainment and media partner in the City office of US firm Salans, questions whether lawyers are solely to blame.

'Are deals too lawyer-intensive? Possibly, but it is inevitable given the complexity of the deals and the numerous financing sources needing to be represented.'

The buoyancy of the UK's film industry and the complexity of the deals has created a thriving practice area.

Mr Shirras says: 'The legal sector has responded with more people engaged in this line than ever before - not more firms, but more people within the firms active in this area.'

Mr Berger says the Revenue move may lead to a fall in private practitioners.

'Fewer films will be made but perhaps they shouldn't have been made in the first place - you have to question whether films relying on so much tax-based money are being made for the right commercial reasons.

But, while there may be fall-out, it won't be calamitous.

The good people with a broader-based practice will still be there.'

Whatever happens, there is no shortage of recruits wanting to work in this area.

However, Ms Savill offers a dose of reality.

'Working in the film industry has its glamorous side - I go to the BAFTAs, Cannes, film premieres.

But, for the last couple of years, I have also worked a lot of 70-hour weeks.

'This is not "touchy feely" work - it is tax driven.

You need to know about banking, insolvency, employment and contractual issues.

You need a good grasp of a hell of a lot of areas of legal practice.

Everyone wants to work in this area - we have to fight them off in droves.

What we have to do is take the stars out of their eyes.'

Mr Berger agrees: 'I have had some glamorous experiences - being flown to Los Angeles first-class to go to a premiere is very enjoyable.

But when you are stuck in a heavily complicated tax deal with masses of paper, e-mails pinging and it is 2am - is that glamorous?

'What is important to me is that I like the product, so I am interested in seeing the process through - more so, with all respect to my colleagues, than if the end result was a supermarket.'

For Tim Johnson, a partner with City firm SJ Berwins' commercial media group, the UK film sector is 'strong and interesting' for lawyers.

'The principal skill required of film lawyers is that they can take a variety of different financing sources, some of which are complimentary and some conflicting, and meld them into a structure than can be "closed".'

However, it is not all hard slog.

Mr Maxtone-Smith has twice been an extra - in a crowd scene in 'Richard III' and as a cigar-smoking journalist in David Mamet's 'The Winslow Boy'.

He recalls: 'The attention to detail in getting my costume right for the crowd scene was absolute, even though I was on screen for less than a second.

It is instructive as you realise just how diligent and how very good these people are.'

Grania Langdon-Down is a freelance journalist