Dean J. Uminski, CEcD, Principal, Crowe Horwath (Feb/Mar 08)
Companies planning to relocate or expand their facilities often find that much of the financial equation comes down to the availability of tax incentives. These incentives can provide a business with a strong return on investment (ROI) and a competitive advantage.
Many state and local governments are eager to negotiate incentives with companies that might revitalize the area's economy. But incentives are not without risk for companies. A large incentives package will lose value if the company is unable take advantage of all of it. And clawbacks may undermine a project if the company fails to satisfy job-creation or capital-investment targets or other commitments made during negotiation.
To secure the most beneficial incentives package, a company must understand the types of incentives available and how best to negotiate with the appropriate governmental agencies.
Understanding Tax Incentives
Every state and most municipalities offer tax incentives to attract businesses that make capital investments or create jobs or both. The incentive packages typically consist primarily of state incentives, with local support in the form of tax abatements. Some of the tax incentives are statutory, while others are discretionary.
Statutory tax incentives include income and franchise tax credits, such as job tax credits, investment tax credits, and research and development tax credits; sales and use tax credits; apportionment factor adjustments and tax-base modifications; and incentives for locating in targeted economic development areas. Statutory incentives are available to any company that engages in qualified activity and meets the applicable requirements.
Incentive requirements, which might relate to minimum job creation or capital investments, are enacted by state legislatures and vary accordingly. In Indiana, a statutory incentive calls for the creation of 25 net new jobs. The legislature in Michigan, on the other hand, demands 75 net new jobs.
Discretionary tax incentives are awarded on a case-by-case basis to entice particularly desirable employers to relocate or expand in the area. Examples might include certain state tax credits, enterprise zone benefits, property tax abatements, sales and use tax exemptions, and monies for infrastructure improvements and human resource needs.
Discretionary incentives are secured through a process that begins with an application outlining the project, including job creation, capital investment, and additional relevant information about the company. The incentives are generally negotiated prior to the proposed relocation or expansion and usually require pre-certification that the company will fulfill its commitments. The process concludes with an incentives agreement.
State and local governments also offer a broad range of discretionary, nontax incentives, such as direct grants; low-interest financing and bonds; infrastructure grants; real estate cost reductions; utility-rate reductions; and training subsidies, credits, and grants.
For instance, an economic development agency may provide training incentives to companies that will create new jobs or invest in a new technology that requires training; or incentives might be granted to support ongoing training necessary to satisfy certain guidelines, like OSHA standards.
Training incentives are likely to gain popularity as states realize the critical role training plays in increasing the marketability of the local work force. States also may use these incentives to appease existing companies, as replacing an existing company that shuts down or moves is much more difficult than taking care of companies that are already invested in the area.
Preliminary Negotiation Considerations
Negotiation is an art, and the negotiation of incentives should not be taken lightly. States can be quite competitive with each other in the race to recruit major employers, and the ability to negotiate effectively with the different players is essential.
In one recent case, five states were vying to land a major manufacturing facility. The initial incentive offers ranged from $7 million to about $30 million. By the time negotiations had concluded, the final package had climbed to approximately $80 million.
It's important to know which resources the various contenders bring to the table. For example, some states can tap the 1998 multistate tobacco settlement as a source for discretionary incentives. While much of the nearly $250 billion that states will receive from tobacco companies over the first 25 years has been earmarked for public-health expenditures, a substantial amount remains available for other purposes - including economic development.
Companies should determine which significant income and property tax incentives might apply to their projects. They need to look beyond the incentives' face value to consider every component that could affect the bottom line. Are the tax credits refundable if the company does not incur sufficient tax liability to benefit from them? Which incentives come with clawbacks? What type of compliance reporting is required, and what kind of resources will the reporting require? Do time lines apply, and are they open to negotiation?
At the same time, a company must remember that the economic development agency might have other options, and a take-it-or-leave-it approach is unlikely to succeed. The company should instead market its proposed package to the agency, as if asking the community to become a stakeholder. In order for both sides to win, a company should demonstrate its commitment to be a good corporate citizen and positively involved in the community.
Ideally, when the project launches, the company and interested governmental agencies can work as a partnership. A robust and sustainable project will increase the company's ROI and, in turn, the community's tax base.
Steps to Successful Negotiations
Companies should take several steps to maximize the odds of obtaining the best available incentive package:
Quantify eligible credits and incentives. Identify the estimated amount
and duration of the potential local and state credits, incentives, and
grants that may be available for a proposed project.
a proposed work plan for securing the appropriate incentives. The plan
should include an analysis of the company's current framework for
capturing required data related to the project.
compelling application packages. The applications should document the
benefits - including ancillary benefits like construction jobs and
sales tax revenues - that the state or local government will enjoy by
attracting the company to its jurisdiction.
4. Research and
analyze cross-state tax and incentive comparisons. While preliminary
negotiations are under way, the company should determine the most
cost-effective location for its circumstances. The analysis should
encompass all of the tax and business incentives for each site as well
as a net-present-value analysis of future cash flows.
Maintain confidentiality. To maintain negotiating leverage, companies
should refrain from making any public announcement of plans for
expansion or relocation until the incentives package has been finalized
and comprehensive due diligence has been performed.
cases, companies find it advisable to retain an independent consultant
to help gather the necessary information, conduct the required
analyses, and participate in the negotiations. Consultants can also
assist in documenting, compiling, and submitting the information
necessary to comply with the terms of the incentives package.
Keeping Up Your End of the Bargain
and local governments are increasingly incorporating performance
requirement provisions in their offers of tax incentives. The
provisions mandate the satisfaction of capital-investment and
job-creation targets as a condition for receiving certain incentives.
must file annual reports with the appropriate agencies, and local
governments may reconcile headcount and wage information with state
unemployment records. To document capital investments, companies are
often required to provide detailed invoices. In many cases, independent
consultants must certify the companies' reports.
do not live up to their commitments may be obliged to return their
incentives. However, if the failure is due to circumstances beyond the
company's control - a sudden downturn in the market or the banning of a
key product, for example - renegotiation of the package may be possible.
One Cog in the Wheel
tax incentives and other benefits are vital elements when selecting a
location for relocation or expansion, they should not determine the
ultimate decision. An incentive package can rarely transform a poor
site into a winning location. Factors like transportation costs and
proximity to customers or suppliers should carry far greater weight in
the evaluation process.
Nevertheless, companies owe it to
themselves and their shareholders to thoroughly investigate all
potential incentives. The competition among jurisdictions for corporate
expansion and relocation is intense. Savvy companies that know how to
play the incentives game can gain a valuable strategic advantage.
J. Uminski is an executive specializing in state and local tax issues
with Crowe Chizek and Company LLC in South Bend, Ind. He can be reached