New Markets tax credits offer lower-cost source of development capital
Granite State businesses and towns looking for debt or equity financing for real estate acquisitions or development, plant expansion or other capital projects should consider whether they qualify for financing under the federal New Markets Tax Credit Program.
The program is administered by the Community Development Financial Institutions Fund of the U.S. Treasury Department to increase the flow of financial resources to businesses operating in low-income communities. The program works by funneling credits against federal income tax liability to investors in specialized community development entities (CDEs) organized to provide debt and equity financing to businesses operating in low income communities.
The CDEs in turn must deploy “substantially all” of the proceeds of these investments in loans to and equity investments in low income community businesses.
Because the tax credit subsidy reduces the CDE’s cost of funds, these loans and investments typically are at lower cost and/or on more flexible terms than could be obtained from conventional financing sources.
The New Markets Tax Credit Program unlocks capital for low-income community businesses by providing attractive returns to banks and other institutional taxpayers. Equity investors in a CDE receive a nonrefundable tax credit equal to 39 percent of their investments over a seven-year period. For an institutional taxpayer with a 33 percent marginal rate, every $1 in such tax credits provides an after-tax return equivalent to $1.50 in pre-tax earnings. Combining debt and equity elements in a single leveraged New Markets financing structure, an investor can achieve both tax credit returns on equity invested and current interest income on credit extended.
Bank investors also can receive regulatory credit for their New Markets tax credit investments under the Community Reinvestment Act.
To be eligible for New Markets financing, a business must be a qualified active low-income community business (QALICB), as defined by program regulations.
Generally, this means that the business must be engaged in qualified business activities, and either itself be physically located in or primarily serve customers who are located in one or more census tracts designated as “low income.” Generally, any active business — other than managing and renting residential real estate (for which a separate federal tax credit is available), farming, operating a country club or golf course, massage parlor, tanning facility, racetrack, package liquor store or gambling facility — is a “qualified business” for the New Markets program, provided that no more than a small percentage of the business’ assets are in the form of intangibles, collectibles or financial instruments.
Timber harvesting, lumber milling and finishing, furniture manufacture and sales, boat or motor vehicle sales, providing inn, motel or other hospitality services, electric power generation and community health services are all examples of qualified businesses. A business is regarded as satisfying the geographic location or service criteria for QALICB designation if a majority of its tangible assets, employees or customers are located in one or more census tracts designated as “low income.”
A business entity need not be for profit or already up and running to be QALICB-eligible for New Markets financing. Recently, the town of Errol successfully utilized a special-purpose nonprofit entity to obtain New Markets financing for the acquisition of a strategic tract of forestland. The Appalachian Mountain Club is another nonprofit that was able to utilize New Markets financing.
The “low income” designation is based on the median family income in the state or metropolitan area in which the census tract is located. A census tract in a nonmetropolitan area qualifies as “low income” if the median family income in the census tract is not more than 80 percent of statewide median family income as determined by the U.S. Census Bureau.
In New Hampshire, all of Coos County and substantial portions of Grafton, Carroll and Strafford counties qualify. In addition, scattered census tracts in the southern portions of the state also qualify. (The CDFI Fund Web site includes mapping software to determine whether a particular address or community will qualify under the low-income criteria of the New Markets program.)
The first task for a business that believes it meets the QALICB criteria and is looking for loan or equity financing is to identify a CDE that has an allocation of New Markets tax credits and serves businesses in the local area. A CDE is an organization that has been certified by the Internal Revenue Service as meeting the statutory eligibility criteria for participation in the New Markets Tax Credit program.
To be certified as a CDE, an organization must have formal legal existence, have as its primary mission serving low-income communities or individuals, and be accountable to the communities it serves through representation on its governing or advisory board. A list of CDEs serving a particular state or local area can be obtained online through the CDFI Fund Web site, cdfifund.gov.
To participate, a CDE must receive an allocation of New Markets tax credits from the CDFI Fund. The CDFI Fund is authorized to award allocations of tax credits for a total of $16 billion in equity investments over the life of the program. This includes $1 billion specifically earmarked for investments in CDEs serving New Orleans and other communities affected by Hurricane Katrina.
The CDFI Fund allocation process is highly competitive; only about one-sixth of CDEs that apply are actually awarded allocations of New Markets tax credits. In the three rounds of awards completed to date (2002, 2003-2004, 2005), the CDFI Fund has made 170 New Markets tax credit awards, covering up to $8 billion in qualified equity investments. The CDFI Fund is expected to announce shortly the 2006 round of awards, providing incentives for up to $3.5 billion in qualified equity investments.
According to the CDFI Fund Web site, in the 2002 and 2003-2004 rounds of awards, New Markets tax credits were allocated to four CDEs serving the Granite State. These allocations provided tax credit incentives for qualified equity investments of up to $209 million, which the CDEs would in turn make available to QALICBs in the form of lower-cost or more flexible debt or equity financing.
In the third round, no CDEs that identified New Hampshire as within their target market were awarded an allocation of tax credits.
A New Hampshire business that believes it qualifies for New Markets financing also should consider national market CDEs as a potential source. And, with any luck, one or more of the awards in the 2006 round of New Markets Tax Credit allocations will be to CDEs serving low-income community business in the Granite State.
Kevin Handly is an attorney in the Boston office of Gallagher Callahan & Gartrell of Concord and a member of the adjunct faculty of Boston University Law School, where he lectures on financial institutions law.