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LAW ELEVATED — How companies can subsidize project costs with The New Markets Tax Credit Program

THIS ARTICLE ORIGINALLY APPEARED IN THE MISSISSIPPI BUSINESS JOURNAL. CLICK HERE TO VIEW THE ARTICLE IN ITS ENTIRETY.

By now most Mississippians have at least heard of the New Markets Tax Credit (“NMTC”) Program.

On May 23, 2019, the Community Development Financial Institutions Fund (the “CDFI Fund”) awarded 73 Community Development Entities (“CDEs”) $3.5 billion in NMTC allocation authority in the calendar year 2018 round of the NMTC Program. To date, a total of 114 businesses and revitalization projects in Mississippi have received NMTC financing resulting in the creation of more than 22,000 direct and indirect jobs. Given that project financing is difficult to secure in rural, low-income communities, most Mississippi businesses are forced to seek a combination of various incentives to fill financial gaps.

Obtaining certain subsidies, credits or grants in connection with commercial development projects can often times be the financial difference maker for an otherwise viable project. While NMTC transactions involve a competitive marketplace for allocation and sometimes require complicated structured finance, the net benefits are worth the hard work. In fact, state and federal NMTC’s can generate as much as a 35 percent subsidy to the project after payment of fees associated with the financing.

The NMTC Program is a federal tax incentive authorized by Congress under the Community Renewal and Tax Relief Act of 2000 (P.L. 106-554) and most recently extended through calendar year 2019 under the Protecting Americans from Tax Hikes (PATH) Act (Division Q of P.L. 114-113). Jointly administered by the CDFI Fund and the Internal Revenue Service, the NMTC Program is designed to encourage commercial investment in low-income communities (“LICs”).

Investment vehicles known as CDEs, certified by the CDFI Fund, are eligible to apply to the CDFI Fund for NMTC allocation authority. Through a competitive application process, the CDFI Fund allocates tax credit authority to CDEs, which allows CDEs to raise investment capital from private investors in exchange for the right to claim a federal tax credit. In the 15 rounds to date, the CDFI Fund has made 1,178 awards totaling $57.5 billion in NMTC allocation authority.

The NMTC Program attracts private investment by allowing corporate taxpayers to receive a credit against federal income taxes for making qualified equity investments (“QEIs”) in CDEs. The credit received is equal to thirty-nine percent of the QEI and is claimed over a seven-year period (5 percent annually for the first three years and 6 percent for years four through seven). QEIs may be leveraged with various types of secured debt (i.e. conventional lending or bond financing) or affiliate debt, which allows the tax credit investor to receive tax credits on the equity/debt combination. The NMTC Program has proven to be an effective means of stimulating economic growth in LICs, and high-impact real estate projects such as redevelopment projects, retail developments, and mixed-use and transit-oriented developments throughout the country.

In most cases, the NMTC Program utilizes geographic qualifications based on the census tract location of the project. In other words, the first step to identifying if your project qualifies for NMTCs is to determine whether or not the project is located in a “qualified census tract.” Qualifying LICs include census tracts with at least one of the following criteria:  (i) a poverty rate of at least 20 percent; (ii) if located in a metropolitan area, a median family income below 80 percent of the greater statewide or metropolitan area median family income; or (iii) if located outside a metropolitan area, a median family income below 80 percent of the median statewide family income.

NMTC financing can be used to pay for real estate acquisition, site prep, substantial rehab, new construction, tenant build out, equipment and soft costs.  Typically, projects need to have costs of at least $5 million in order to attract adequate interest from CDEs and investors. In a typical transaction, an investor provides an equity investment into a special purpose investment fund in exchange for 100% of the membership interests. A third party or affiliate lender provides a leverage loan to the investment fund. This debt/equity combination generates sufficient funds for the investment fund to make its QEI as a capital contribution to a CDE. The applicable credit allowance for the benefit of the investor is calculated based upon the QEI.

The CDE(s) use the proceeds of the QEI to make loans to a qualified active low-income community business (“QALICB”).  The loans are generally structured to mature or be refinanced in seven years and can be subordinate to senior debt as necessary.  The “A” loan usually mirrors the terms of the Leverage Loan. The “B” loan (which is derived from the tax credit equity less CDE fees) is generally at a below market interest rate with favorable terms such as full or partial loan forgiveness.  Both loans are interest only during the seven-year compliance period. The QALICB uses the proceeds of the loan to finance all or a portion of the project.

In addition, many projects financed in Mississippi utilize the Mississippi Equity Investment Tax Credit Program, which was created as a “piggy back” credit to the NMTC Program. This state credit is a credit against income or insurance premium taxes in an amount equal to 24 percent of the QEI, and it is utilized over a three-year period (eight percent per year). The maximum amount of state credits that can be generated from a single project is $2.4 million or $800,000 per year. Purchase prices vary depending on the current market, but generally speaking, borrowers can expect (assuming a maximum project cost of $10 million) to generate an additional $1.2 million of subsidy.   

In summary, the NMTC is a non-refundable tax credit designed to encourage private investment in eligible LICs. Every dollar generated in equity from the NMTC is a dollar saved for the project borrower. Many of the health care, manufacturing, educational and commercial development projects that have taken place in Mississippi since the early 2000’s have benefited from the NMTC Program. Since State and Federal NMTCs provide a substantial current and long-term subsidy to the construction, development and operation of a project, commercial development projects should consider the NMTC Program and Mississippi Equity Investment Tax Credit Program as alternative sources of financing.