As we all know, the use of strategic government incentives in the site selection process has always been a highly debated topic. Because of this public debate, we are constantly seeing changes being made to the incentive programs offered by government agencies. These changes often significantly affect the types of incentives that are given away, the types of companies that qualify for these incentives, and the processes that one has to go through in order to secure these incentives. Despite all of the modifications to incentive programs, one constant remains: there are more incentives offered today than ever before.  There are two trends to note in the incentive arena. The first trend is the proliferation of the “sellable tax credit,” which is gaining substantial popularity in government circles and prompting changes in the way tax credits are being distributed. The second trend is actually not an incentive program, but an incentive process. The introduction of higher value incentives have led to greater government accountability standards being implemented by agencies all across the United States. While these standards have helped governments justify, track, and control incentive offerings, they have left many companies searching for answers as to how to navigate this increasingly difficult step in the site selection process.

Sellable Tax Credits And Net Operating Losses

One of the other growing trends in site selection has been the targeting of certain high impact businesses for location into a region. The idea of helping industry form clusters in an area is not a new one; however, the use of incentives to accomplish this task has become more refined and thus more successful. One of the hottest segments of the economy that communities are trying to attract is the high technology and R&D businesses.

While there are many merits to attracting these types of companies, most communities found that trying to use legacy incentive programs to entice these companies was a difficult fit. Because these programs were designed for labor and capital intensive processes, knowledge-based firms do not have the same project criteria; therefore, they often cannot meet the thresholds for employment and investment established by these programs.

In addition, the focus of high technology and R&D corporations is very different, as they are sometimes operating with the understanding that they will not be turning a profit for many years. Because these traditional tax credit programs only allow you to offset your tax liabilities should you be turning a profit, they do not provide any useable value on the incentive line. What communities were finding is that these incentives were being completely written off during the site selection process, and something had to change if they wanted an incentive option as an attraction tool.

In order to address this issue, some states, including New Jersey, have been aggressively looking for ways to market their incentive programs to these companies. While New Jersey's programming also utilizes the payroll tax rebate for these firms and assigns bonus points and lower thresholds for qualification for these types of industries, the general feeling was that more needed to be done.  

Therefore, New Jersey's officials developed the tax transfer program, in which high tech and R&D companies could calculate the R&D credit and sell the incentive on the open market to a taxpayer in exchange for cash. New Jersey also permitted qualifying companies with net operating losses to use the program, delivering much needed cash into the hands of the smaller high-tech firms, while also helping reduce the tax liabilities of the state's largest taxpayers. Research indicates that there are many states that either have the ability, or have pending legislation being considered, to enable them to sell tax credits.

But it's not just about selling tax credits. In response to these types of programs, many states have taken a look at their traditional tax credit programs and have made minor modifications to their programs in an effort to provide cash into targeted areas or industries. States such as Georgia allow the jobs tax credit program to be taken as a refundable grant against withholding taxes — if the company meets certain eligibility requirements such as locating in a distressed county or by increasing its port activity. These types of tweaks to legacy tax credit initiatives are increasing their value in the site selection process considerably.

More Accountability

From a total dollar perspective, the surge in incentive use, and modifications allowing them to become useful to more industries, has resulted in an upswing in the total dollar amount allocated each year by government agencies. With the growing numbers associated with incentive programs and with the growing publicity of these awards, comes greater scrutiny. While not a new development in the incentive arena, the last few years have shown a dramatic increase in the number of lawsuits associated with an attempt to discredit or disallow incentives in the United States.

 A byproduct of the intense scrutiny placed on incentives has been the increasing necessity for governments to clearly communicate the effectiveness of the incentives that are granted to corporations. In years past, many economic development agencies (typically local agencies) were offering incentives that delivered cash up front in order to help offset initial capital costs. When a small number of projects failed to live up to their commitments, the ability to go back and recapture the incentives granted became nearly impossible, strengthening the pressure for greater accountability.

The trend in incentives has been to offer incentives that are performance based, helping to prevent issues with recapture. Even in situations in which communities have decided to offer incentives up front or before the economic benefit for these communities are reached, detailed reviews of company financials and/or business plans are conducted to determine if the company will be in a position to repay the incentive if the terms and conditions of the incentive agreement are not met. What this means is that incentives have grown increasingly more complicated after the deal is inked; compliance errors once a company is accepted into a program are a leading cause of failure to collect on these promised dollars. Research shows that more than 50 percent of incentives that are negotiated and approved are never collected, evidence that incentives are becoming increasingly more difficult for companies to administer on the back end.

Take for example the most popular form of “new incentive” — the withholding tax rebate. It is estimated that approximately 20 states are using some form of withholding tax rebate to either attract or retain business investments in their communities. Even in their simplest form, these withholding tax incentives carry heavy administrative burdens, requiring companies to compile massive payroll reports, tracking every person hired, every person who leaves the company, and every person who backfills these positions. Confidential data such as payroll, social security numbers, and employee addresses need to be compiled and submitted to the state, causing major administrative headaches for many companies.

Another trend that is continuing to show up in regard to new incentive programs being offered is the “but-for” clause. This clause is a validation whereby economic development agencies will require a company to certify that the project would not take place “but-for” the incentives being offered. This forces a company to have all of their incentives negotiated before moving forward with the execution of a lease or before breaking ground on a facility. Any move a company makes that ties them to a particular course of action or to a particular site could cause the incentives to evaporate, even if they were previously discussed but not formalized in a written agreement.

Government agencies have taken the “but-for” test to varying degrees, whereby some simply require a signature stating that the incentives factored into the decision, while others require a competitive bid to be presented to the issuing agency before any incentives can be approved. While it may make sense to try and validate the necessity of incentives prior to granting them, forcing a company to solicit a competitive bid from an outside agency will most likely result in a negotiation process that will ultimately cost more in the way of economic subsidies.

In all, the incentive process has become more difficult to navigate. However,  those who are able to navigate the myriad of red tape are certain to find incentives that will not only fit their projects and their needs, but will also help reduce their operating costs for many years to come.

Brian Corde is a partner of Atlas Insight LLC. He can be reached by e-mail at bcorde@atlasinsight.com or by visiting www.atlasinsight.com.