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A Top-Down Approach: Tax Incentives and Their Effect on the Chinese Movie Industry

By Nan Sato and Jacopo Genova, Shimin Law Offices

The overall Chinese economy seems to be slowing down. Certain aspects of the economy, however, are growing fast. Fueled by an expanding middle class and the State government’s effort to transition from a manufacturing economy to a service one, the movie industry is growing at an extraordinary pace despite the downward pressure of the overall economy.

In fact, China is now the world’s second-largest film market and its gross box office sales are likely to surpass those of the U.S. by the end of 2018.  In 2015, China’s box office revenue reached the sum of 6.78 billion USD, recording an increase of 48.7% over 2014 and 349.1% over 2010.  With box office revenue of 11 billion USD in 2015, the U.S. still occupies the top position, but it will not be for much longer given the inverse trend of American and Chinese movies and the potential presented by China’s enormous population.

Although 2015 was a record year for American box office sales, the number of successful movies was unimpressive. “The takeaway is that we ha[d] a record year, but it was concentrated among fewer films. The top 10 films in 2014 represented 24 percent of the pie. The top 10 films [in 2015] represent[ed] 34 percent. There is no bottom anymore.” said Fox domestic distribution president Chris Aronson.  Apart from this, in 2014 the U.S. box office revenue registered a decrease of 5.13% over 2013. On the other side of the Pacific, the cultural and cinematographic movement has recorded a noteworthy development in recent years. Chinese films took an impressive 62% of the market in 2015. In the same year, Stephen Chow’s “The Mermaid” broke all-time records by becoming the first movie in mainland box office history to pass the 3 billion yuan mark.

Further, there is room for many more screens in China. Despite being the country with the second most screens in the world, China’s 1.4 billion population is still underserved. In comparison, the U.S. has about 40,000 screens, which translates to roughly one per 8,000 inhabitants. In order to reach a similar level of density, the Chinese government has promoted a boom of screens and movie theaters construction. Consequently, cinema screens in China increased from 3,527 in 2007 to 31,627 in 2015. That is an average of 22 screens added every single day.  Most of these screens were built in small cities and rural areas to catch up with metropolitan areas. As a result, per capita theater visits are also predicted to increase. Currently, a Chinese goes to movie theaters only 0.8 times a year on average, whereas an average American goes 3.22 times and an average South Korean goes 3.87 times per year.  Such data reveals that great potentials still exist in the Chinese movie industry.

The Film Industry Promotion Law

Even though domestic films were already performing strongly in China, the National People’s Congress issued a draft of the People’s Republic of China Film Industry Promotion Law (“Film Industry Promotion Law”) on November 6, 2015 to further boost China’s exploding film market and bridge the gap between domestic and foreign movies in technologies, capital, talents, and contents.

Concerning the lack of screens and movie theaters, the Congress has promised to increase support for rural film screenings, to continuously improve the capacity of film viewing in rural areas, and to provide the people with exceptional, quick and easy film viewing services.  The local governments are to pay to establish and improve service networks for such screening services.  In addition, local governments are required to “include the construction and reformation of movie theaters into the people’s economic and social development plans, culture industry development plans, overall land use plans and urban and rural overall construction plans.”  

The Film Industry Promotion Law is also aimed at encouraging “financial institutions to provide financial services to those engaged in film activities, (…) to support development of the film industry in terms of credit and other aspects,” as well as requiring “financial security institutions to provide financial guarantees for the film industry in accordance with law.”  Moreover, the State mandates better capital, funding, financial and accounting systems to increase investment in the film industry, and declares to implement “tax incentive policies to promote the prosperous development of the film industry.”

From 2009 to 2014: Previous Tax Measures

The Film Industry Promotion Law captured headlines worldwide. Nonetheless, what has been equally, if not more, important in fostering the growth of the Chinese movie industry is a series of tax incentives implemented since 2009.

Decree No. 31

Decree No. 31 of 2009 introduced exemptions of value added tax (“VAT”) and business tax (“BT”) for qualified enterprises in the film industry.  According to Article 1 of the decree, from January 1, 2009 to December 31, 2013, VAT and BT were exempt on income derived from the transfer of film copyrights,  film distribution and box office revenue earned in rural areas.

In particular, a significant effort was made to support high-tech enterprises specialized in the cultural industry because of their importance in the digital economy. Article 5 of the decree stipulates that the BT of culture-focused high-tech companies “shall be collected at a reduced rate of 15%” and that “research and development costs incurred by cultural enterprises in developing all new technologies, products and techniques are allowed to be deducted from their taxable income in accordance with relevant taxation laws of the State.”  Other provisions introduced VAT rebate policies for exports of movies and completed TV programs,  as well as tax reliefs on unmarketable works by considering them as property losses deductible for corporate income tax (“CIT”) purposes.

Order No. 86

In 2010, the State Administration of Taxation issued Order No. 86, which exempted cultural enterprises established before December 31, 2010 from CIT for three years from the date of their registration.

Decree No. 56

In 2014, Decree No. 56 of the Ministry of Finance extended for four more years (until December 31, 2018) the VAT and BT exemptions initially introduced by Decree No. 31. Furthermore, general VAT taxpayers that provide film-screening services in urban areas can adopt a simplified calculation method.

Article 2 and Article 5 of Decree No.56 aimed at establishing special funds to support the production of films and the construction of movie theaters. The former requires the Central Treasury to arrange a special fund of 100 million yuan to promote the production of five to ten influential films dealing with special themes.  The latter is focused on bridging the gap between China’s rural areas and big metropolitan areas, such as Shanghai and Beijing, by introducing special funds to support the “construction of digital movie theaters in county-level cities, in central and western China as well as in the needy regions in eastern China.”

Decree No. 56 also strives to increase the degree of government investment in the movie industry and support financial assistance to film enterprises. Banking institutions are encouraged to create and expand the offering of financial products, such as lease loans, pledge financing of receivables, and equity pledge loans, that cater to the characteristics and needs of the film industry. At the same time, movie enterprises are spurred to go public by issuing corporate securities, set up collective trusts and offer other financing instruments.

Circular No. 85

In 2014, the government issued Circular No. 85 to extend for another four years the reduced tax rate and tax deductions for high-tech companies initially introduced by Article 5 of Decree No. 31 in 2009.  The circular also introduced certain VAT exemptions on film production, distribution and screening services provided outside China and rebates on the exportation of completed films.

2016: A Special Rebate

In 2016, the Provincial Committee for the National Film Industry Development Special Fund issued Decision No. 3.  According to this decision, movie theaters which generate at least 2/3 of their revenues from the screening of Chinese movies will receive a 50% rebate on their payment of the Film Development Special Fund Tax.

Currently, movie theaters collect a 5% tax on all ticket sales which is paid into the “Film Development Special Fund” established by the State Administration of Press, Publication, Radio, Film and Television of the People’s Republic of China (SAPPRFT). To explain it better, a nationally-imposed VAT of 3.36% is first applied to the overall box office ticket sales. The 5% Film Development Special Fund tax is subsequently applied to the remaining amount, in order to subsidize the making of special-themed films and support the renovation/construction of movie theaters.  After this further deduction, the net box office amount is allocated according to previous agreements between the theater (or theater chain) and the production/distribution company.   

 


Thanks to the new tax rebate, theaters which meet the abovementioned requisite will be able to keep half of the 5% tax they usually pay on ticket sales. For instance, in the case of an after-VAT box office revenue of 1 million yuan, only 25,000 yuan (i.e. 2.5% of 1 million) must be paid as Film Development Special Fund Tax instead of 50,000 yuan (5% of 1 million).   

 


        
To qualify for the rebate, Chinese cinemas must ensure that imported movies generate no more than 1/3 of the box office for the full year, as well as provide a certificate of clean regulatory record showing no history of box office under-reporting, fraud or other illegal activities.  

An Undeniable Impact

To what extent has the Chinese movie industry benefited from the abovementioned tax incentives? The graphs below show that there is a positive correlation between the tax incentives introduced between 2009 and 2015 and the upward trend of the Chinese movie industry, taking into consideration the total number of movies produced by Chinese companies and the corresponding worldwide income they generated.


Source: http://www.the-numbers.com/China/movies#tab=year


In 2011, two years after the first session of tax measures, 33 Chinese movies were produced, recording a rise of 371.43% over 2010. Throughout the same year, the worldwide box office generated by Chinese movies increased from 127 to 457 million USD. The tax measures of 2014 created a similar effect by increasing the number of movies produced by 140% and the worldwide income by 189.35% in merely one year’s time.

The sharp increases in 2015 were illustrative of how important the tax incentives leading up to that year had been.  The continuous tax incentives since 2009 have built faith and predictability for Chinese movie companies. In fact, these initiatives are no longer perceived as isolated and provisional, but rather as part of a long-term plan aimed at promoting the domestic movie industry.

Conclusion

It is evident that the aggressive tax incentives have boosted the Chinese movie industry. These incentives have had a significative impact on two different levels. The measures ranging from 2009 to 2014 aimed to improve the quantity and the quality of Chinese films.  These incentives provided financial support to movie, high-tech and cultural enterprises in order to promote the domestic film industry. The year 2016, however, has represented a turning point. The Chinese government introduced tax incentives to help local cinemas and theaters. By acting in this way, the focus was switched from movie producers and distributors to theater operators.

In that sense, the government’s strategy can be expressed as “from the top (movie enterprises) to the bottom (customers).” So far, the growth of the Chinese film industry has concentrated on the quantity and the quality of movies, without affecting to a noticeable extent the average number of theater visits per capita. A new series of tax incentives may pave the way to a cinema construction boom and to attracting more citizens to the cinemas.  When this new stage of the government’s plan succeeds, China’s movie industry will finally become a real gold mine.


Nan Sato

Nan Sato

Shimin Law Offices, Shanghai, China
Office Philadelphia, USA
T: +1 267 519 8196
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Jacopo Genova

Jacopo Genova

Shimin Law Offices
W: www.shiminlaw.com

Nan Sato is a Partner of Shimin Law Offices, a Shanghai-based firm with a strong focus on providing high-quality Chinese legal services to international clients. She concentrates her practice in sports law, cross-border mergers and acquisitions, corporate structuring and restructuring, and Asia-related inbound and outbound investment.

Jacopo Genova is a visiting attorney at Shimin Law Offices. He concentrates his practice in the areas of tax, intellectual property and corporate law. After graduating from University of Teramo in 2015, he worked as real estate consultant and trainee lawyer at an Italian law firm. In 2014, he attended the Charles University in Prague where he developed his dissertation about tax issues in web companies’ business.


Published: August 2016 l Photo: Colourbox.de

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