Businesses making location/expansion decisions for manufacturing, distribution and other facilities are very familiar with economic incentives such as property tax abatements, grants, tax-exempt bonds and state credits that are offered by state and local governments. One financial incentive that sometimes gets overlooked is the availability of loans subsidized with New Markets Tax Credits (NMTCs). This Legal Insight provides a summary of the basic benefits of financing subsidized with NMTCs.
The NMTC program was enacted to spur economic development in low-income and impoverished communities and is administered by the U.S. Department of Treasury. NMTCs are provided to investors (NMTC Investors) who contribute capital to community development entities (CDEs) that are certified by the Community Development Financial Institutions Fund of the Treasury Department (the CDFI Fund) and have been awarded NMTC authority pursuant to a competitive application process administered by the CDFI Fund. The amount of NMTCs available to an NMTC Investor is 39% of the qualified equity investment (QEI) made in the CDE but only if the CDE subsequently uses substantially all of the QEI to make loans to, or equity investments in, businesses that are located in or otherwise have a substantial presence in a low-income community (LIC). Such businesses - which can be a real estate project or an operating business – that are located in a LIC are referred to as qualified active low-income community businesses (QALICBs) and the loans to, or investments in, a QALICB that are made by a CDE are referred to as qualified low-income community investments (QLICIs).
It is important to remember that the owner of a QALICB that receives a NMTC-subsidized loan does not benefit directly by claiming NMTCs – in fact, NMTC program requirements prohibit the NMTC Investor from being related to the QALICB that receives NMTC-subsidized loans. Because NMTC Investors can receive an economic return on their investment in the CDE solely from the NMTCs that they earn over the 7-year compliance period, however, the incremental funds raised from the NMTC Investor are made available to the QALICB on very favorable terms, and with structures that can result in the NMTC Investor never requiring repayment of its original investment.
The requirements of the NMTC program are detailed and complicated, and NTMC transaction structures typically involve multiple tiers of entities, a variety of documents that are unique to NMTC transactions and a number of income tax issues. The benefits of NMTCs and the structuring basics can be summarized in a simplified manner by reference to the diagram at the end of this Legal Insight and the following discussion. (For a more detailed discussion of NMTC program requirements, go to http://www.agg.com/New-Markets-Tax-Credits-02-07-2014/.) The diagram reflects the usual means by which an NMTC Investor makes an investment in a CDE - through a fund (the Leverage Fund) that is wholly-owned by the NMTC Investor, with the Leverage Fund making the QEI in the CDE that qualifies for NMTCs. The Leverage Fund raises amounts to make the QEI from two sources - an equity investment from the NMTC Investor (NMTC Equity), and a loan (the Leverage Loan) to the Leverage Fund from a lender (the Leverage Lender) that typically is an affiliate of the QALICB. The Leverage Lender, in turn, raises the funds used to make the Leverage Loan from some combination of (a) equity that otherwise would have been contributed to the QALICB; (b) amounts that have previously been invested in the project and are refinanced through a “day loan” structure whereby a portion of the QLICI proceeds reimburse the amounts previously invested; and (c) grants/loans to the Leverage Lender from 3rd parties/government entities. Using the Leverage Loan to fund a portion of the QEI enables the NMTC Investor to qualify for NMTCs with respect to both its NMTC Equity and the Leverage Loan proceeds and provides the NMTC Investor with an overall economic return solely from the NMTCs, permitting the QALICB to benefit from the NMTC Equity at minimal incremental cost.
The diagram assumes that the CDE will receive an investment of $20M from the Leverage Fund, and that the CDE will use 100% of that amount to make QLICI loans to the QALICB. For purposes of the diagram and this discussion we have assumed that the NMTC Investor agrees to provide $0.80 of NMTC Equity per $1 of NMTCs, which results in NMTC Equity of $6.24M ($7.8M of NMTCs * $0.80). CDEs that receive awards of NMTC authority will typically charge both an upfront CDE Sponsor Fee that is paid at closing, as well as annual Management Fees that are usually calculated as a percentage of the QEI amount. To address requirements under the NMTC Program, the CDE Sponsor Fee is often paid by the Leverage Fund. Management Fees for the 7-year NMTC compliance period are often required to be paid from a reserve that is established by the QALICB from the QLICI proceeds and pledged as security for the QLICI. For purposes of the diagram and this discussion we have assumed a Sponsor Fee of 3% of the QEI ($600K) that is paid by the Leverage Fund, and an annual Management Fee of 50 basis points, or $100K per year (total of $700K during the 7-year compliance period).