A $1.7 Billion Tax Crackdown Is Paralyzing China's Film Industry

(Bloomberg) -- One day last July, Fan Bingbing, China’s highest-paid movie star, seemed to vanish from the face of the earth. Her disappearance occurred around the time the government opened an investigation into Chinese film industry tax practices. Both her fans and film executives feared the worst. But in October Fan reappeared as mysteriously as she had vanished. She made a public apology to her fans and agreed to pay more than $100 million in back taxes .

The 37-year-old Fan’s public humiliation unleashed a deep chill in an industry that until recently had been humming along. Every week brought fresh reports of stars and companies under scrutiny. Industry tycoons coughed up a stunning $1.7 billion in back taxes after the government urged them to engage in “self-examination and self-correction.” That, in turn, has prompted a flurry of TV and movie cancellations and even the liquidation of entire companies.

“Some of the biggest stars and directors are being looked at very closely,” says Albert Lee, a former executive at Hong Kong-based Emperor Motion Pictures. “That makes people very, very nervous.”

There have been faint attempts to push back at what many see as unfairly tarnishing an entire industry. In December, a group of prominent directors published a letter accusing the government of forcing law-abiding filmmakers to pay for the sins of a few. “We express greatest anger toward some unfair public opinions that stigmatize the entire industry,” the China Film Directors' Guild wrote.

For the most part, though, movie people have gone into hiding. Production companies canceled or postponed projects while they audit their books and negotiate what they owe in back taxes. Many of the country's biggest actors stopped working, afraid of becoming the next Fan Bingbing. Financing dried up as banks shied away from an industry tainted by scandal.

The crisis has exposed the shortcomings of China’s efforts to build an entertainment industry to rival Hollywood. The government views its domestic film business as an instrument of soft power, influencing how citizens view the country while curbing the influence of outsiders. Where the state once distributed propaganda movies and banned all Western cinema, in recent years the approach has been more sophisticated and ambitious: massive subsidies and state-sponsored bank loans to produce movies, open theaters and build new theme parks.

Between 2008 and 2018, the number of movies produced in China nearly doubled to around 1,000 while the number of movie screens climbed from 4,000 to more than 40,000. The domestic TV business, meanwhile, has surged thanks to billions of new investment from technology companies Alibaba, Tencent and Baidu.

A rising middle class eager to go to the movies also helped transform an industry once known mostly for propaganda films and piracy of Western movies into the world’s second-largest film market. Annual box office sales recently eclipsed 60 billion yuan ($8.8 billion) for the first time, and local Chinese films accounted for more than 60 percent of that total.

The boom minted a new class of media moguls, including brothers Wang Zhongjun and Wang Zhonglei, co-founders of Huayi Brothers. The Beijing-based production company signed Fan to a contract and produced her first breakout film, ``Cell Phone.’’ 

As the company emerged as one of China’s leading entertainment companies, the Wangs indulged their taste for world-class art, amassing works of Pablo Picasso, Vincent Van Gogh, Pierre Auguste Renoir and Camille Pissaro. In 2015, Wang Zhongjun paid $29.9 million for a Picasso from the collection of film producer Samuel Goldwyn Jr. The symbolism couldn’t have been clearer: China’s very own Hollywood had arrived.

But along with the newfound riches came rampant tax evasion, prompting authorities to crack down. Chinese president Xi Jinping, who has spent much of the past decade purging corrupt government officials and political rivals, has found the movie business a rich new target with its famous faces and sky-high salaries. 

Fan is one of the most celebrated actresses in China. For years she’s also been the highest paid: $44 million in 2017 alone. She rose to fame on the TV costume drama ``My Fair Princess,’’ which led to starring roles in hit local films, prizes at Asia’s biggest awards shows and cameos in Hollywood blockbusters “Iron Man 3” and “X-Men: Days of Future Past.’’

A TV newscaster leaked what he said was a copy of her contracts for the upcoming movie``Unbreakable Spirit’’  which prompted a government investigation. The contracts allegedly showed that Fan had employed a sham-dual contract system. Per one contract, Fan made $1.6 million for her work one the movie, according to The Hollywood Reporter. Per another, she earned $7.8 million. Authorities would receive -- and tax her -- for the first contract, while Fan pocketed the larger sum tax-free. Fan initially denied the accusation, but later confessed. Industry insiders say Fan’s behavior is less than shocking: The use of these so-called yin-yang contracts is widespread, they say.

The industry-wide enforcement hits as the Chinese economy is slowing. China recently reported its worst January box office receipts since 2015, while the number of movies produced began to fall last September, a harbinger of leaner times ahead.

Box office sales over the Lunar New Year holiday, China's busiest movie-going week, stagnated this year, climbing just 1 percent. Overall attendance declined. Just last year, sales over the holiday week climbed by 69 percent from the previous year. Chinese regulators blamed piracy for the slowdown.

Already dozens of smaller companies have gone out of business. Even mighty Huayi has had to buy back stock and take a loan from Chinese tech giant Alibaba to reassure investors. Wang Ran, chief executive officer of CEC Capital, predicted the number of Chinese companies in the entertainment business will shrink by as much as a third over the coming year.

Are the current problems caused by the corruption crackdown? Many executives aren’t so sure. It’s true that “the government used some very extreme measures,” says Janet Yang, a veteran producer in China who believes the industry will ultimately benefit from the shakeout. “But there were also good market reasons. There was a feeling that it was a little out of control.”

Of all the out-of-control movie projects, none compares with “Asura.” The 141-minute epic based in a mythical realm from ancient Buddhism, cost more than $100 million to make, among the most ever for a Chinese production. No expense was spared, including hiring the costume designer of “Lord of the Rings’’ and a special-effects wizard known for his work on “Furious 7’’ and “Deadpool,’’ among other pricey talent .

Still, all the visual frills couldn’t paper over the shoddy script: The film was a huge flop and was pulled from theaters nationwide after just a few days. It took in just $7 million in ticket receipts over its opening weekend. “There is a tendency that is specific to China,” says Yang. “Bigger is better.’’ 

Others see it differently, placing the blame squarely on Chinese authorities.``The government thinks the movie and TV industry made a lot of money in the past several years,’’ says Albert Guo. ``When they need money, they go after us.’’ Guo was about to start production on a TV drama when his financiers’ bank account was frozen in the wake of the Fan Bingbang tax scandal. Short $15 million yuan ($2 million), Guo had to call off production. “We are all very angry,’’ he says. “It's unfair.”

To contact the editor responsible for this story: Rick Schine at eschine@bloomberg.net, Mark Schoifet

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