The results of Area Development's 2009 Corporate Survey illustrated the importance of taxation when companies select locations for new operations. Tax exemptions and corporate tax rate were two of the top five site selection factors. Such ratings acknowledge the complexity and variability of the U.S. tax landscape, and the challenges companies face in assessing taxation's effects on projects.
Because every facility has a direct impact on a company's profits and losses, a thorough analysis of taxes is critical before deciding where to locate. Until the tax analysis is complete, a company will not understand the true cost of operating in a given jurisdiction, the difference in costs between jurisdictions, and the benefits economic development incentive programs represent.
Sales Throwback Provisions affect the calculation of the Sales Factor in income apportionment. When a state applies a Throwback, sales made from a location in the taxing state to a purchaser in a state where the taxpayer is not subject to corporate income or franchise tax are added back into the sales numerator of the taxing state. The impact of such a provision can have a notable impact on income tax liability, particularly for companies that do not have nexus (a taxable presence) in many locations.
Figure 1 demonstrates the impact of apportionment formulas and throwback rules.
The final consideration for income tax liability is Corporate Tax Structure. There are multiple components of the Corporate Tax Structure that must be understood when conducting a tax analysis. Some of these components include:
• Type of entity that will be filing in each state (i.e. Corporation, Limited Liability Company, Partnership, Joint Venture);
• Whether the entity is disregarded for federal income tax purposes;
• Whether the state permits consolidated filings; and
• Determining which entity will lease or own the facility and which entity will hold the employees. Many times, investment and employment must be in the same entity to qualify for incentives.
Some states charge franchise taxes to corporations with nexus within the state. Franchise taxes are a sort of privilege tax imposed on a corporation for doing business or organizing in the state. The tax can be imposed on limited partnerships, a limited liability company, and business trusts. Most franchise taxes are based on the net worth of a taxpayer rather than income. Typically, the number of shares a company issues or, the amount of its assets, is used to determine the franchise tax.
Not all states impose a franchise tax, and each state calculates it differently. Tennessee calculates franchise tax on .25 percent of the greater of net worth or real and tangible property in Tennessee. The North Carolina franchise tax rate is $1.50 per $1,000 and is applied to the largest of Capital Stock, Surplus and Undivided Profit; Investment in Tangible Property in North Carolina; and Appraised Valuation of Tangible Property.
Figure 2 illustrates how franchise tax liability may be determined.
Sales and Use Tax
Sales tax is a consumption tax charged at the point of purchase for certain goods and services. The tax is usually calculated by applying a percentage rate to the taxable price of a sale. Use tax is a type of excise tax assessed upon otherwise tax-free tangible personal property purchased by a resident of the assessing state for use, storage, or consumption of goods (not for resale) in that state, regardless of where the purchase took place.
Sales tax can affect multiple components of a project, and may apply to construction materials, purchases of machinery and equipment, utility costs, and other items. In certain states, leases are also subject to sales tax. The tax liability can be substantial for a company that is either building a new facility or is a capital-intensive industry. Recognizing the potential burden on new investments, states have implemented various tax credits, rebates, and exemptions against sales tax as an economic development tool. Some of the most universal exemptions include the exemptions for manufacturing equipment.
Figure 3 illustrates the difference between the sales tax liability that would be incurred in two locations, assuming an investment of a new $20 million facility containing $80 million of machinery and equipment.
Property tax is an ad valorem tax that an owner must pay on the value of real (land or improvements, such as buildings) and sometimes personal (machinery and equipment or inventory) property.
Critical factors of property tax liability include:
• Millage rate: the rate expressed in parts per thousand applied to the assessed value of a property when calculating liability.
• Assessed Value: the taxable value of the property, usually an amount less than the market value of the property.
• Market Value: the value of the property in the market.
• Depreciation Schedule: the rate and duration over which the value of the property can be depreciated for tax purposes.
Critical factors of inventory tax include:
• Freeport Exemption: exemption from taxes on eligible inventory if transported out of the state.
• Geographic Scope of Exemption: extent to which different taxing authorities participate in Freeport exemption programs.
Of the considerations affecting property tax, assessed value has become increasingly important in incentive negotiations. Many U.S. communities are using assessed value as a requirement for qualifying for tax incentives, with several communities requiring companies to meet assessed value requirements as opposed to capital investment requirements. Both the real property and personal property investments must be evaluated separately.
Real property is one of the largest components of a project, and can be the amount of investment in real property, or facilities. This figure is even more critical when a project is considering a build-to-suit real estate option. The investment is typically presented to the state and communities on a direct investment basis, representing how much the company intends to spend. For communities that have assessed value requirements, it is important to understand how much of the investment in the building can be deemed personal property, and therefore depreciated.
Personal property can include, furniture, fixtures, equipment, computer hardware, computer software, and telephony. Each Tax Assessor's office will depreciate business personal property based on the depreciation schedules provided by the Assessor's office. For instance, furniture will have a longer life for property tax purposes than computer hardware, which is typically replaced more frequently. It is important to work with the Tax Assessor's office to understand the respective depreciation schedules prior to making an investment.
The effect of assessed value on property tax calculations is illustrated in Figure 4, which is based on the following depreciation schedule for computer equipment:
Year 1 - 68 percent
Year 2 - 44 percent
Year 3 - 28 percent
Year 4 - 10 percent
Year 5 - 5 percent
The Assessed Value Calculation above illustrates the need to understand the difference between capital spending and assessed value. While the company may spend $100 million over a three-year period, the assessed values for the taxing authorities (the way the taxing authorities generate their revenue) do not get above $44 million.
A Variable Landscape
The different methods for how state and local governments generate tax revenue translates into a highly variable tax landscape for companies seeking a location for new operations. The differences can be significant enough to merit a detailed assessment of each major tax. The most important taxes a company must understand in detail include income, franchise, sales and use, and property. The type of taxes and their effects vary according to the nature of the facilities within the state, as well as the company's corporate tax structure. The combined liability associated with such taxes can have a notable impact in a project's profits and losses, and there is never a better time to understand the effects of taxation on a project than before a location decision is made.