How To Prudently Maximize the Value of Economic Incentives

It is tempting during economic incentive negotiations for a company to try to obtain as many incentives as possible without considering the true economic value of the benefits or by making idealistic commitments. This is not merely a mistake made by companies, but by a plethora of economic incentive consultants as well. Since many consultants are compensated based on the value of incentives offered, they are motivated to increase an incentive package regardless of the economic incentive’s usefulness or performance standards required by the community. The goal of any economic incentive negotiation should be to ensure the actual realization of the benefits being offered. To do this, a company must understand the value of an incentive, as well as minimize any long-term risk associated with performance standards.

One of the more obvious, yet overlooked, factors is to evaluate the worth of certain incentives. Does the company have tax liability to offset with a credit? If not, is the credit refundable, transferrable or saleable? Is the company being offered a sales tax refund/exemption for items which are statutorily exempt anyway? These questions are important because most jurisdictions run a cost-benefit analysis when they are compiling an offer for a company, and they determine the value of the package without knowledge of whether a particular company can even benefit from a tax credit. That is why it is important to understand what type of assistance is necessary to benefit a project in advance of any negotiations so it can be conveyed to the community or economic development organization.

The majority of tax credits and economic incentive programs require some level of quid pro quo by the company. Moreover, if the company breaches any of its performance standards, a recapture provision or “clawback” may apply. Thus, it is important to thoroughly analyze whether a company will meet its various commitments. The most common commitments required by jurisdictions are:

• Minimum capital investment
• Minimum number of new and/or retained employees
• Minimum average wage and/or payroll
• Set level of health benefits
• Minimum level of taxable sales
• Timing of investment and/or job creation
• Minimum term of occupancy in the jurisdiction
• Partnering with local educational institutions for training benefits

Less obvious performance standards may include:

• Engaging a certain percentage of local, minority and/or women-owned contractors or suppliers
• Requiring a set percentage of new employees to be residents of the subject jurisdiction
• Utilizing local hotels for company business trips
• Charitable participation/contributions to the community

Many economic incentives are earned over a long period of time and it can be difficult to know what the company can commit to with any certainty at the time of negotiations. This is why it is imperative that a company understand the mechanics and nuances of each program. Part of this analysis is reviewing any recapture provisions. 

As an example, assume a particular city has a policy in place that it will offer a property tax abatement for an investment of at least $5 million. Company ABC intends to spend $12 million on its overall project and is eligible for an abatement. Should Company ABC contractually agree with the city to spend a minimum of $12 million? The answer partially depends on whether there is a recapture provision based on not meeting the minimum amount dictated in the agreement or the minimum amount stated in the city’s policy. Oftentimes it is the minimum amount stated in the agreement since this is the contractual document that binds the parties, rather than the $5 million set by policy.

Since Company ABC would qualify for an abatement with $5 million of capital expenditures, it should not commit to spending $12 million and risk falling short and triggering a recapture provision. However, what if Company ABC estimates it will spend $5.2 million? This is a much tougher question. In this instance, because Company ABC is barely meeting the minimum requirement to be eligible for an abatement, Company ABC may consider negotiating with the city to lessen the recapture provisions in exchange for a slightly lower abatement percentage.

Obviously every situation is different, but if Company ABC has any doubts about whether it will meet the $5 million threshold, it would behoove the company to negotiate a recapture provision that possibly only applied to the year in which the value of the investment was less than $5 million or delayed the start of the abatement until it met the minimum investment.

Currently, more economic incentives are being offered based on performance, rather than upfront with backend compliance. This is forcing companies to more accurately predict their long-term commitments.  A company should minimize any risk associated with maximizing the long-term receipt of benefits by being conservative in their commitments and/or accepting a reduced benefit/term, if necessary.