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The Role of Taxes in Corporate Location Decisions

The above- and below-the-line impact of taxes can sway a location decision among otherwise comparable sites.

Q4 2019
Often hotly debated on the floor of federal and local legislatures is the topic of tax policy’s effect on business decisions and economic performance. From supply-side “Reaganomics” and the Laffer curve to current negotiations with China and tariffs, government policies surely drive spirited academic and emotional engagement.

In this article, part one of a series of three, I will discuss the role of taxes in everyday location decisions made in the United States. The subsequent articles will examine the art of negotiating offsetting incentives as well as strategies to ensure those reductions are realized.

Are Taxes Material?

Within any business organization there are multiple influencers. On a local level, there is a local manager whose primary goal is to compete for company resources to ensure the local operation is favored and grows — ensuring a future for him- or herself. On the other end of the spectrum, there may be a new CEO trying to prove him- or herself by making a bold move in a new direction. In the middle there is human resources, concerned about the quality and availability of labor. The director of tax, measured by his or her ability to manage the overall effective tax rate, warns of the dangers of expanding into particularly aggressive or policy-volatile jurisdictions. The CFO tries to figure out the overall financial effect and whether certain options are more or less difficult to finance.

In the most objective exercises, third-party consultants are tasked to establish side-by-side analyses examining the quantitative (e.g., financial) and qualitative (e.g., labor availability) aspects with the goal of identifying a small subset of leading location options. While taxes may often seem to be an afterthought, their above- and below-the-line impact can be profound and certainly sway a location decision among otherwise comparable sites.

Consider a $3.00 per square foot property tax delta between an urban and rural location for a 250,000-square-foot manufacturing plant. That equates to $750,000 in above-the-line impact per year, $7.5 million over a decade. If the same company’s margin is only 5 percent, that equates to an additional $150 million of sales required to achieve the same level of profitability.

Locating across a city or county line can strengthen financial performance and enable better access to debt and equity financing sources. While these “zero-sum-game” decisions are often derided in the court of public opinion, the reality is the public votes with its pocketbook by investing in stocks and funds that represent the winners — the companies able to drive revenue and watch with an eagle eye to control their expenses.

Evolving Role of Taxes on Revenue in the Retail Space
The e-commerce transformation from brick and mortar stores to industrial picking operations, the underlying shift in consumer motives, and structural changes in how states can tax remote operations have fundamentally changed location behaviors.

The prioritization of certain taxes over others is somewhat of an enigma. When the internet was young, speeds slow, and SKUs limited, consumers often purchased large-ticket items online to save taxes — visiting physical stores only to see and touch the product. For that reason, many picking facilities were purposely located in lower sales tax rate jurisdictions.

As browsing speed, product selection, and delivery and ease of returns increased, the consumer began buying online for convenience. The efficiency at which an e-commerce provider can deliver products to the door often exceeds the ability of a consumer to travel and retrieve goods themselves at a physical store. The competitive drive to reduce delivery times, coupled with decreasing consumer sensitivity to sales tax rates (and related refocus to service), has allowed e-commerce to select locations in high sales tax rate jurisdictions heretofore off-limits.

The shift by many states to require collection of sales taxes by in- and out-of-state retailers based on destination has also made the location of the picking facility irrelevant to the imposition of tax. For these reasons, sales tax imposed on the business’s customers is lessening in importance, leaving property and sales tax on things like consumables (e.g., boxes) all the more relevant.

Which Taxes Matter the Most?
The prioritization of certain taxes over others is somewhat of an enigma. Through GAAP (generally accepted accounting principles) and the focus on EBIDTA (earnings before interest, taxes, depreciation, and amortization), leaders are conditioned to focus on above-the-line, non-income–based taxes. These include property tax, employment tax, sales and use tax on purchases, and other mostly transactional types. This is despite the fact every dollar of tax ultimately has the same impact to an investor — whether through the reduction of cash available for dividend to a public shareholder or a loss of a dollar of distribution to a family business owner.

Landmark income tax cases going back to the 1990s, such as Geoffrey and more recently KFC, have validated states’ efforts to tax companies availing themselves of their marketplace without requiring physical presence to do so. This trajectory has rendered some traditional location-based income tax planning largely moot. Although this has arguably leveled the playing field, income taxes still account for a sizable cost for profitable companies — the very companies economic developers desire the most. Tax policies that include of-right or negotiated tax credits can provide a very effective differentiator.

For those companies with low taxable income, perhaps due to depreciation of large investments in technology, non-income–based taxes become relatively more important. Again, property taxes are often the largest tax consideration and affect nearly all businesses. Each industry or use will have its own unique perspective.

For example, how taxes affect a vertically integrated consumer products company will vary by use. At the headquarters, property taxes passed through the lease and sales and use taxes on consumables or leased equipment like copiers can have the biggest impact. When siting manufacturing plants, the existence of an unabated personal property tax can be punitive for investment in machinery and technology. The existence and reach of a manufacturing sales tax exemption on machinery and equipment can differentiate sites. For data centers, where there is typically a very high turnover/refresh rate on expensive technological assets, the same personal property and sales tax consideration can render some locations off-limits without relief.

Considerations for Decision-Makers
In comparing location options, taxes certainly play a significant role and, as previously stated, can be a relatively large differentiator between two otherwise comparable sites. It can be difficult to distinguish between marketing fluff and realizable benefits when evaluating potential offsets in the form of incentives. The amount negotiated versus realized can often be very different.

In the next two articles, we will explore negotiation and monetization strategies that are effective in reducing risk and promoting predictability.

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