While a mechanism for financing a portion of the cost of eligible hotel and tourism projects in Virginia commonly referred to as the “Tourism Development Financing Program” (the “Program”) began slowly, the use of this Program is now on the rise. Several developers and municipalities across the Commonwealth, including notably the iconic oceanfront Cavalier Hotel in Virginia Beach, plan on using the Program for development or redevelopment of their hotel projects. In essence, the Program provides a source of “tax rebate” financing to pay down the debt associated with not greater than 20 percent of a qualifying project’s cost. Accordingly, the Program is designed to promote the development of hotels, motels and related tourism projects that might not be financially feasible without the cash flow enhancement available through the Program. The Program is codified at VA § 58.1-3851.1 in 2011 and is administered by the Virginia Tourism Corporation in conjunction with the Virginia Resource Authority.
The Program acts very much like a tax increment financing district for conventional real estate. Provided the proposed hotel or other tourism project satisfies the qualifying criteria, a portion of the state sales and use tax applied to “transactions taking place on the premises” (e.g., the hotel “room” tax) and an equal portion of local tax revenues (note the local matching portion is not limited to the sales and use or “room” tax) can be “rebated” to the project developer to allow the project developer to finance 20 percent or less of the qualified development cost of the project. By this mechanism, the statute provides a revenue stream to support “gap” financing of not more than 20 percent of the shortfall in project funding between the expected development cost of an authorized tourism project and the debt and equity capital provided by the developer of the project.
There are several hurdles to be overcome before a proposed project qualifies for the tax rebate subsidy. First, to be eligible, the locality must authorize and create a “tourism zone” where the proposed project is located, and designate by ordinance that the proposed project located within that zone is entitled to receive the tax benefits of VA § 58.1-3851.1. Second, the municipality must create a “Tourism Development Plan,” which must stipulate how the proposed project meets an identified deficiency and is approved by the Virginia Tourism Corporation. Third, the developer must “match” the local and state subsidy through the use of an “Access Fee” (described below). Finally, the entire arrangement must be documented by use of a “Comprehensive Agreement” amongst the developer, the municipality and any related municipal entities (such as an economic development authority) involved in administering the Program.
The funding stream available under the Program begins with a state tax rebate equal to 1 percent of the “sales and use” tax assessed against “transactions taking place on the premises,” the bulk of which would generally be the state portion of the “room” tax assessed on a visitor’s hotel bill. The sales and use tax is currently 5.3 percent in Virginia (6 percent in Hampton Roads and in Northern Virginia), thus 1 percent of the 5.3 percent is rebated by the state to the municipality’s economic development authority and ultimately to the project for purposes of paying the debt service for any debt incurred to provide for the “gap financing.” The state’s 1 percent is then matched by the locality from its revenue sources. While many localities enact their own local room tax, the statute does not provide that the locality match necessarily come from a “room tax.” Rather, the locality’s matching 1 percent has to be in “an equivalent amount of other local tax revenue”; therefore, other local taxes, such as a meals tax and property tax, are available for the locality match. Finally, the developer itself must provide an Access Fee that is also equal to the 1 percent state and local tax subsidy, thus assuring its participation in the transaction.
In a simple example, if the proposed hotel generated $1,000,000 in annual revenues from its room occupancy and related transactions subject to the sales and use tax, then 1 percent , or $10,000 of the $53,000 in sales tax the state would otherwise be entitled to collect, would be rebated to defray project financing costs; together with a 1 percent or $10,000 contribution by the municipality; together with a $10,000 or 1 percent match or access fee by the project developer. Under this example, an income stream of $30,000 would be created, which could be pledged or otherwise assigned to support the “gap” financing loan. From the developer’s perspective, two-thirds of the income stream is provided by a tax rebate incentive and can further bolster the revenue generated from the project, above and beyond actual cash collected off the project site. The sums collected under the Program must be applied to the fund debt service for an identified “gap” financing shortfall, as defined in the statute. The definition of the “gap” financing shortfall is fairly liberal, with the only significant proviso being that 80 percent of the funding for the project must be in place through debt or equity provided by the developer of the project. Note also that the access fee and the tax rebate funds are required to be used solely to make payments of principal and interest on the “qualified gap funding,” and if the amount collected exceeds the required amounts of principal and interest, then the excess is to be paid as principal repayment on the loan. Once the debt is paid, the tax rebate is discontinued. If there is a shortfall in the funding stream, the developer must make up the deficiency or risk putting its “gap” funding loan in default.
The entire arrangement requires approval by the Virginia Tourism Corporation and is underwritten by the Virginia Resource Authority in cooperation with the local municipality and its Economic Development Authority. Virginia is believed to be the first state to promulgate such a tax rebate program; however, since its enactment, several states, including Tennessee, have copied the Program.