Maximizing New York State and Local Financial Incentives for Cross

Report
MAXIMIZING
NEW YORK STATE AND LOCAL
FINANCIAL INCENTIVES FOR
CROSS-BORDER TRANSACTIONS
March 29, 2012
Pietra G. Lettieri, Esq.
Public Finance / Economic Development and Tax Law Practice Groups
Harris Beach PLLC
726 Exchange Street, Suite 1000
Buffalo, New York 14210
[email protected]
(800) 685-1429
(716) 200-5112 (Direct)
(716) 200-5215 (Fax)
Financial Incentives Planning
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Structured Correctly –
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Obtain tax exempt bond financing
Significantly reduce or eliminate NYS Income Tax
Liability
Eliminate NYS Sales Tax liability for project related
costs
Significantly reduce or eliminate NYS Real Property
Taxes for a fixed amount of time
Obtain NYS refundable credits of 10% to 50% of
certain remedial costs and capital investments on
“contaminated” property
Obtain grants and low-cost financing through NYS
programs
Pietra G. Lettieri, Esq.
(716) 200-5112
© Harris Beach PLLC, 2012
2
Financial Incentives – The Usual Suspects
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Federal and New York State Incentives
Industrial Development Agency Incentives
New York State Excelsior Program Incentives
NYS Brownfield Cleanup Program Incentives
Historic Tax Credits – Federal and State
NYS ESD Capital Grant
New York Power Authority and NYSERDA Incentives
Enterprise Communities
Empowerment Zone/Renewal Community Program
New Markets Tax Credit Program
Pietra G. Lettieri, Esq.
(716) 200-5112
© Harris Beach PLLC, 2012
3
Financial Incentive Planning Tip
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Plan early – Get a team in place ASAP and Establish Timelines
- Attorney
- Accountant
- Architect/Engineer
- Lobbyist
- Project Manager/Owner’s Representative
- Community Relations Consultant
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Identify All Incentives Up-Front – Best to identify/analyze all
benefits together
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Overlap: Overlap financial incentive planning with site acquisition,
permitting, lending considerations and timing
- Project description for permits and incentives need to match
- Need to tell a good story and get Community and NYS buy-in
* Job Creation
* Investment
* New Real Property Taxes
* Wealth Creation
Pietra G. Lettieri, Esq.
(716) 200-5112
© Harris Beach PLLC, 2012
4
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Note:
Empire Zone program sunset in June of 2010 and has
been replaced by Excelsior Jobs Program
 Industrial Development Agencies no longer have the
ability to undertake civic facility projects
 All existing Business Tax Credits are deferred for
taxpayers with greater than $2 million in credits
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Pietra G. Lettieri, Esq.
(716) 200-5112
© Harris Beach PLLC, 2012
5
Local Incentives: Industrial Development Agency
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Straight Lease or Bond Financing (Federal Tax Exempt Bonds)
- Use of Local Development Corporations for Not-for-Profits
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Sales Tax Exemption (local and state) on Build-Out Only
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Mortgage Recording Tax Exemption
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Tax Abatement – Payment in Lieu of Taxes (“PILOT”)/tax
stability
Pietra G. Lettieri, Esq.
(716) 200-5112
© Harris Beach PLLC, 2012
6
New York State Incentives – ESD
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Empire State Development ("ESD") is the trade name under which New York
State offers benefits that have been statutorily authorized under the Office of
Economic Development, Job Development and Urban Development Corporation
(d/b/a Empire State Development Corporation).
Through ESD, the State can provide direct loans, capital grants, or interest rate
subsidy grants that result in low-cost financing for the acquisition, construction,
renovation, or improvement of real estate, including both land and buildings, as
well as the acquisition of machinery and equipment and related soft costs. Direct
loans are provided at below-market rates to provide a lower overall blended rate
with conventional sources. Interest rate subsidy grants that reduce the costs of
borrowing from a conventional lender are also available.
Eligible recipients of these loans and grants include industrial companies such
as manufacturers, service providers, assemblers, and distributors, and local
development entities on their behalf, as well as headquarter facilities for a
broader spectrum of businesses.
ESD has implemented the New York State Consolidated Funding Application
(CFA), a single application for multiple sources of state funding. New York State
is soliciting grant applications for funding to advance the priorities of the
Regional Economic Development Councils (REDC). The CFA can be found at
https://apps.cio.ny.gov/apps/cfa/index.cfm . Note that at press time, the CFA
was being revised.
Pietra G. Lettieri, Esq.
(716) 200-5112
© Harris Beach PLLC, 2012
7
New York State Incentives – Excelsior Program Incentives
 Replaces the Empire Zone Program (Expired June, 2010)
 Purpose – to encourage the expansion in, and relocation to New York, of
businesses in certain growth industries
 Credits against personal, corporate, bank and insurance franchise tax
 10 year benefit period
JOB GROWTH TRACK
To Be Eligible – a business must predominately operate in one of
the following Strategic Industries and meet job creation thresholds:
1.
2.
3.
4.
5.
6.
7.
8.
9.
Financial Services center/back office [100 Net New Jobs (“NNJ”)]
Manufacturing (25 NNJ)
Software development (10 NNJ)
Scientific R&D (10 NNJ)
Agriculture (10 NNJ)
Back office expansion (150 NNJ)
Distribution center (150 NNJ)
Significant growth industry (to be designated by the Commissioner)
Regionally Significant Project - a business making significant capital investment
in the state creating 20-500 net new jobs (not limited to any particular industry)
Pietra G. Lettieri, Esq.
(716) 200-5112
© Harris Beach PLLC, 2012
8
New York State Incentives – Excelsior Program Incentives
INVESTMENT TRACK
If a business operating in an industry above cannot meet
the job creation requirements, it can still qualify if:
1. It has, and will retain, at least 50 FTEs,
2. Makes a significant capital investment and,
3. Passes a cost-benefit ratio of 10:1 (ratio of total investment,
wages and benefits/tax credits)
Pietra G. Lettieri, Esq.
(716) 200-5112
© Harris Beach PLLC, 2012
9
New York State Incentives – Excelsior Program Incentives
Excelsior Jobs Tax Credit
- Based on salary paid for each net new job
- 6.85% of wages per NNJ
- New to the state
- Refundable
Excelsior Investment Tax Credit
- Equals 2% of cost basis of a qualified investment
- Refundable
Excelsior Research and Development Tax Credit
- Equals 50% of Federal R&D tax credit
- Refundable
Excelsior Real Property Tax Credit
- Must be located in an Investment Zone or be an RSP
- Credit equals 50% of RPT paid in year prior to year accepted into Excelsior Program
- Credit is 40% in year 2, 30% in year 3, 20% in year 4, and 10% in year 5
- Refundable
Pietra G. Lettieri, Esq.
(716) 200-5112
© Harris Beach PLLC, 2012
10
BCP Tax Benefits
Three Refundable New York State Tax Credits:
1. Brownfield Redevelopment Tax Credit (BRTC)
− Refundable investment credit based on cleanup and build out
and equipment costs (site prep, groundwater treatment, tangible
property)
2. Tax Credit for Remediated Brownfields (TCRB)
− Refundable Real Property Tax Benefit
3. Environmental Remediation Insurance Credit (ERIC)
− Refundable insurance premium credit
Pietra G. Lettieri, Esq.
(716) 200-5112
© Harris Beach PLLC, 2012
11
BCP: BRTC is the most Significant
Refundable NYS Tax Credit

2008 BCP Brownfield Redevelopment Tax Credit Amendments
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Recall BRTC consists of (1) Site Preparation, (2) Tangible
Property, and (3) Groundwater Remediation Component
For Projects Accepted After June 23, 2008:
1) Amendments to calculation of BRTC Site Preparation/GW Component
2) Amendments to calculation of BRTC Tangible Property Component
Pietra G. Lettieri, Esq.
(716) 200-5112
© Harris Beach PLLC, 2012
12
BCP Amendments to BRTC Tax Credits
Changes to BCP Site Prep/Ground Water Tax Credit
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Site Preparation and Groundwater Remediation Component increased from
10% to 22% of such costs to 22% to 50%
Cleanup to Soil Cleanup Objectives as follows:
Use
Unrestricted Residential Commercial
Track 1
50%
N/A
N/A
Tracks 2 and 3
N/A
40%
33%
Track 4
N/A
28%
25%
Industrial
N/A
27%
22%
RESULT – More tax credit available/generated for cleaner cleanups
Pietra G. Lettieri, Esq.
(716) 200-5112
© Harris Beach PLLC, 2012
13
Message – Under the new BCP, the key is
Understanding and Maximizing Site Preparation Costs
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Note: Site Preparation Costs Definition Remains Unchanged:
The term "site preparation costs" shall mean all amounts properly chargeable to a
capital account, (i) which are paid or incurred in connection with a site's
qualification for a certificate of completion, and (ii) all other site preparation
costs paid or incurred in connection with preparing a site for the erection of
a building or a component of a building, or otherwise to establish a site as
usable for its industrial, commercial (including the commercial development of
residential housing), recreational or conservation purposes.
Site preparation costs shall include, but not be limited to, the costs of
excavation, temporary electric wiring, scaffolding, demolition costs, and the costs
of fencing and security facilities. Site preparation costs shall not include the cost
of acquiring the site and shall not include amounts included in the cost or
other basis for federal income tax purposes of qualified tangible property,
as described in paragraph three of this subdivision.
NY Tax Law Section 21(b)(2).
Pietra G. Lettieri, Esq.
(716) 200-5112
© Harris Beach PLLC, 2012
14
BCP: Site Preparation (level of cleanup) Component is KEY:
List of Activities Potentially Qualifying as Site Preparation Activities
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Pietra G. Lettieri, Esq.
(716) 200-5112
© Harris Beach PLLC, 2012
Barricades/Fencing
Erosion Control
Post work/signs
Protection of existing utilities
Demolition or removal of utilities
Removal of debris
Demolition of structure
Demolition of Foundation
Remove and relocate rail lines
Dust Control
Demolition of roadways
All soft and hard costs (engineering, architectural, consulting, legal, accounting) related to BCP
New Roadway construction/access Roads
Brush removal and disposal
Topsoil fill, stripping, and stockpiling
Handling processes related to earth materials
Rough site grading
Disposal of regulated waste
Interim remedial measures
Final remediation measures
On-site management of solid non-hazardous wastes
Community are monitoring during earthwork phases
Stormwater management during construction
15
BCP Amendments to BRTC Tax Credits Changes to
BCP Tangible Property Credit Component
1) BRTC for Tangible Property Credit Component increased by additional 2% to
maximum 24% of eligible costs if project is within a BOA (Range 10 to 24%)
2) BRTC Tangible Property Credit Component calculated in same manner
3) BRTC Cap – BRTC that is claimed cannot exceed lesser of :
i) For non-manufacturing project: $35mm or Product of (Site Prep and
groundwater remediation costs) x (3)
ii) For manufacturing project: $45mm or Product of (Site Prep and groundwater
remediation costs) x (6)
SUMMARY - 22% to 50% refund of site prep/cleanup
- $3 or $6 refund for every $1 spent on site pre/cleanup
Pietra G. Lettieri, Esq.
(716) 200-5112
© Harris Beach PLLC, 2012
16
New York Historic Rehabilitation Tax Credit
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Used with Federal Historic Tax Credit
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Equals 20% of Qualified Rehabilitation Expenditures (20%
for Federal purposes and 20% for State purposes)
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Capped at $5,000,000
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Building must be listed on State or National Register of
Historic Places or listed as a building contributing to the
character of the historic district in which it resides
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Must be located in a Distressed Federal Census Tract
Pietra G. Lettieri, Esq.
(716) 200-5112
© Harris Beach PLLC, 2012
17
Thank You
Pietra G. Lettieri
Public Finance Practice Group
For more information, visit www.harrisbeach.com and
download our Economic Development Handbook:
http://www.harrisbeach.com/sites/default/files/brochures/HBPubFinHandbook2010.pdf
Pietra G. Lettieri, Esq.
(716) 200-5112
© Harris Beach PLLC, 2012
18
New York State
Ontario Bar Summit
Presenting Attorney:
Anthony P. Marshall
Harris Beach PLLC
333 West Washington Street
Syracuse, NY 13202
315-423-7100 Phone
315-422-9331 Fax
[email protected]
www.harrisbeach.com
New Markets Tax Credit
Anthony P. Marshall
(315) 423-7100
© Harris Beach PLLC, 2012
20
NEW MARKETS TAX CREDIT (NMTC)
(IRC Section 45D and Regulations Section 1.45D)
NMTC in a nutshell:
CDEs must use substantially all of the proceeds from QEIs to make
QLICIs in QALICBs located in LICs.
Anthony P. Marshall
(315) 423-7100
© Harris Beach PLLC, 2012
21
NEW MARKETS TAX CREDIT (NMTC)
(IRC Section 45D and Regulations Section 1.45D)
1.
2.
NMTC: The NMTC is equal to 39% of the qualified equity investment
(QEI) made by a taxpayer/investor to a CDE, to be taken over a 7 year
period, beginning in the year the QEI is first made. The NMTC is taken
5% in the first 3 years and 6% in the last 4 years.
CDE: A Community Development Entity (CDE) is any treated as a
domestic corporation or partnership for federal income tax purposes which
is certified as a CDE following application for certification, which satisfies
the following two tests and becomes certified as a CDE following
application for certification:
i.
ii.
Anthony P. Marshall
(315) 423-7100
© Harris Beach PLLC, 2012
Primary Mission Test: The primary mission of the CDE must be to serve, or
provide investment capital for, low-income communities (LICs) or low income
persons (LIPs).
Accountability Test: The CDE must maintain accountability to residents of
LICs through their representation on CDE governing or advisory boards (at
least 20% of the members of its board of directors or advisory boards by
representative of the LIC).
22
NEW MARKETS TAX CREDIT (NMTC)
(IRC Section 45D and Regulations Section 1.45D)
3. QEI: A qualified equity investment (QEI) is an investment by a taxpayer for
an equity interest in an entity that is certified as a CDE, acquired at its
original issue solely for cash and substantially all of the QEI is used to
make qualified low income community investments (QLICIs). The tax basis
of a QEI is reduced by the amount of the new markets tax credit taken with
respect to the investment.
4. QLICI: A QLICI is generally any capital or equity investment in, or loan to,
any qualified active low-income community business (“QALICB”). The
QLICI must be made within 12 months of the date the QEI is made.
Certain CDE-to-CDE transactions can constitute QLICIs. No investment or
loan can be a QLICI if the project is entitled to low income housing tax
credits under §42.
Anthony P. Marshall
(315) 423-7100
© Harris Beach PLLC, 2012
23
NEW MARKETS TAX CREDIT (NMTC)
(IRC Section 45D and Regulations Section 1.45D)
5.
QALICB: A QALICB is any corporation (including a nonprofit corporation)
or partnership engaged in the active conduct of a qualified business which,
for the tax year, satisfies the following:
i.
ii.
iii.
Anthony P. Marshall
(315) 423-7100
© Harris Beach PLLC, 2012
Property Test: at least 40% of the use of the QALICB’s property is within a
LIC.
Services Test: at least 40% of the services performed for QALICB by its
employees are performed in a LIC. Where an entity has no employees, this
40% test will be deemed satisfied if the Property Test is met 85% or more.
Gross Income Test: at least 50% of QALICB’s total gross income is derived
from the active conduct of a qualified business (“QB”) within a LIC. This test is
met if either of the Property Test or Services Test is met after substituting 50%
for the 40%.
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NEW MARKETS TAX CREDIT (NMTC)
(IRC Section 45D and Regulations Section 1.45D)
6.
Qualified Business: A qualified business (QB) is any trade or business,
except for the following (note that there is no requirement that employees
of the qualified business be residents of a LIC):
i.
ii.
iii.
iv.
v.
Anthony P. Marshall
(315) 423-7100
© Harris Beach PLLC, 2012
buildings that derive 80% or more of its income from residential dwelling units
(IE, mixed use projects are qualified if residential rents are less than 80% of
total rents);
the rental of unimproved real property;
farming businesses whose aggregate assets owned and leased, valued at the
higher of fair market value or unadjusted basis, exceeds $500,000;
any trade or business consisting predominantly of the development or holding
of intangibles for sale or license; or
any “sin business” (private or public golf course, racetrack or other facility used
for gambling, or any store the principal business of which is the sale of
alcoholic beverages for consumption off premises).
25
NEW MARKETS TAX CREDIT (NMTC)
(IRC Section 45D and Regulations Section 1.45D)
7.
Other QALICB Rules:
i.
ii.
iii.
Anthony P. Marshall
(315) 423-7100
© Harris Beach PLLC, 2012
An entity will be treated as engaged in the active conduct of trade or business
if, at the time the CDE makes a QLICI, the CDE reasonably expects that the
entity will generate revenues (or, in the case of a non-profit, engage in an
activity that furthers its non-profit purpose) within 3 years after the date the
QLICI is made.
A CDE may treat a portion of any trade or business (“POB”), as a QALICB if (i)
the POB satisfies the tests of QALICB status if it were separately incorporated,
and (ii) it maintains complete and separate books and records are maintained
for the trade or business.
For a business to be a QALICB, its nonqualified financial property (“NQFP”)
must be less than 5% of the average of the aggregate unadjusted basis of all
of its property, where NQFP essentially means cash, cash equivalents, debt,
stock, partnership interests, or other similar property, EXCEPT, the term does
not include reasonable amounts of working capital held in cash, cash
equivalents or debt instruments with a term of 18 months or less. In applying
this rule, (as a default rule) the proceeds of a QLICI that will be expended for
construction of real property within 12 months after the date of the QLICI is
treated as a reasonable amount of working capital.
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NEW MARKETS TAX CREDIT (NMTC)
(IRC Section 45D and Regulations Section 1.45D)
8.
LIC: A low-income community (“LIC”) means any population census tract that:
i.
ii.
iii.
iv.
v.
vi.
Anthony P. Marshall
(315) 423-7100
© Harris Beach PLLC, 2012
has a poverty rate of at least 20%; or
if the tract is located outside of a metropolitan area, the median family income does
not exceed 80% of statewide median family income; or
if the tract is located within a metropolitan area, the median family income does not
exceed 80% of the greater of (i) statewide median family income or (ii) the
metropolitan median family income; or
is in a “high migration county”, which are census tracts which, during the 20-year
period ending in 2000, has a net out-migration of population of at least 10% of the
population of the county at the beginning of such period, if the MFI for the tract does
not exceed 85% of SMI; or
is in a low population tract (less than 2,000) which is also in a federally designated
empowerment zone and contiguous to a LIC as defined in (i)-(iii) above; or
that serves targeted populations (at least 40% of its employees are low income
persons (LIPs), determined at the time of hire; or at least 50% of income is derived
from sales to LIPs; or at least 50% of the entity is owned by LIPs. For non-metro
targeted population areas, a LIP is an individual with family income (adjusted for size)
of not more than 80% of the greater of (i) area MFI or (ii) SMFI.
27
NEW MARKETS TAX CREDIT (NMTC)
(IRC Section 45D and Regulations Section 1.45D)
9.
Reinvestments
i.
ii.
iii.
Anthony P. Marshall
(315) 423-7100
© Harris Beach PLLC, 2012
The QLICI must be maintained as such over the entire seven year credit
period. Any return OF capital during the seven year credit period in an amount
that would fail the substantially all test must be redeployed within 12 months of
receipt, or a recapture event will occur. (Returns ON capital (interest or
dividends) is allowed during the 7 year credit period).
Amounts received by a CDE in re-payment of capital, equity or principal with
respect to a QLICI must be reinvested by the CDE in another QLICI no later
than 12 months from the date of receipt to continue to be treated as
continuously invested in a QLICI for the balance of the 7-year compliance
period.
Reserves not in excess of 5% of the QEI maintained by the CDE for loan
losses or for additional investments in existing QLICIs are treated as invested
in a QLICI.
28
NEW MARKETS TAX CREDIT (NMTC)
(IRC Section 45D and Regulations Section 1.45D)
10.
Recapture
i.
ii.
Anthony P. Marshall
(315) 423-7100
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If, during the 7 years from the original issue date of the QEI in a CDE, a
recapture event occurs, then the tax credit is recaptured. A recapture event
occurs when (i) the entity ceases to be a CDE; (ii) the proceeds of the QEI
cease to be used in a manner which satisfies the substantially-all test; or (iii)
there is redemption or other cash-out of the QEI.
Typically, the CDE is a partnership for federal tax purposes. A pro-rata
distribution by the CDE to its partners each tax year will not be treated as
redemption if the distribution does not exceed the CDE's operating income for
that tax year. In addition, a non-pro rata de minimis distribution by a CDE to a
partner or partners during a tax year will not be treated as a redemption;
where a non-pro rata de minimis distribution may not exceed the lesser of (i)
5% of the CDE's operating income for that tax year, or (ii) 10% of the partner's
capital interest in the CDE. For this rule, operating income is the sum of the
CDE's taxable income determined under §703, with certain adjustments.
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NEW MARKETS TAX CREDIT (NMTC)
(IRC Section 45D and Regulations Section 1.45D)
iii.
The bankruptcy of a CDE is not a recapture event.
iv.
The Service may waive a requirement or extend a deadline relating to
recapture events and its effect on CDE investor and the availability of NMTCs,
provided such waiver or extension does not materially frustrate the purposes of
§45D and Regs. §1.45D-1(e) (relating to recapture). Request for waiver or
extension is made only by the CDE in the form of ruling request consistent with
Rev. Proc. 2005-1.
v.
The recaptured credit will increase the tax for the year the recapture event
occurs in an amount equal to the amount of the credits claimed, plus interest
on the resulting underpayment from the due date of the return for the year in
which the credit was initially taken. The interest is non-deductible, and the
resulting tax cannot be reduced by any other available credits in that year.
Anthony P. Marshall
(315) 423-7100
© Harris Beach PLLC, 2012
30
NEW MARKETS TAX CREDIT (NMTC)
(IRC Section 45D and Regulations Section 1.45D)
11.
Other Federal Tax Benefits
Federal tax benefits that do not limit the availability of the NMTCs include:
i.
ii.
iii.
Anthony P. Marshall
(315) 423-7100
© Harris Beach PLLC, 2012
The rehabilitation credit under §47 (IE, the HTC may be coupled with NMTCs
in the same transaction to further leverage NMTC equity);
All deductions under §167 and 168, including the first year depreciation under
§168(k) and the expense deduction for certain depreciable property under
§179;
All tax benefits relating to certain designated areas, such as empowerment
zones, enterprise communities, renewal communities and the New York
Liberty Zone under §1400L.
31
NEW MARKETS TAX CREDIT (NMTC)
(IRC Section 45D and Regulations Section 1.45D)
12.
Obtaining/Accessing an NMTC Allocation
CDE must file an Allocation Application each year upon the Fund’s issuance of
a Notice of Allocation Availability (NOAA) each year. A very competitive
application process.
To gain access to NMTC allocations, proposed QALICBs must shown that its
project:
i.
ii.
a)
b)
c)
d)
Anthony P. Marshall
(315) 423-7100
© Harris Beach PLLC, 2012
Complies with the CDE’s Allocation Agreement and its business strategy;
Meets the “but for” test (the project capital gap requires the NMTC equity);
Is essentially ready to close at the time request for allocation is made (has other needed
debt, a credit investor, site control, approvals, etc.); and
Exhibits strong community impact (jobs, spurs other development, environmental
sustainability; etc.).
32
NEW MARKETS TAX CREDIT (NMTC)
(IRC Section 45D and Regulations Section 1.45D)
13. Leverage Loan Transactional Structure (see charts on following slides)
i.
Equity (or Leveraged) Model. The IRS has ruled (Revenue Ruling 2003-20)
that a QEI can include the proceeds of a loan in leverage of equity which
acquires the NMTCs. This is referred to a "leveraged" transaction.
ii.
Interest Subsidy Model. Where the CDE, lender and credit investor are within
an affiliated group.
Anthony P. Marshall
(315) 423-7100
© Harris Beach PLLC, 2012
33
Leverage Loan Model
Anthony P. Marshall
(315) 423-7100
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34
Interest Subsidy Model
Anthony P. Marshall
(315) 423-7100
© Harris Beach PLLC, 2012
35
Interest Charge-Domestic International
Sales Corporation (IC-DISC)
Anthony P. Marshall
(315) 423-7100
© Harris Beach PLLC, 2012
36
Interest Charge-Domestic International
Sales Corporation (IC-DISC)
1.
BASIC TAXATION AND GENERAL RULES:
a.
b.
c.
d.
e.
f.
Anthony P. Marshall
(315) 423-7100
© Harris Beach PLLC, 2012
IC-DISC is not subject to US corporate income tax in that it does not pay US
tax on its commission income from a manufacturer. [IRC 991]
DISC shareholders are taxed on deemed dividend distributions equal to the
taxable income of the DISC in excess of $10 million. [IRC 995(b)]
The manufacturer deducts the commission.
DISC pays a dividend to its shareholders, taxed at the applicable dividend rate
(currently 15% US).
If the manufacturer is a pass through entity (LLC or S-corporation), the tax
savings is 20% (assume 35% tax bracket of pass through taxpayers, less the
15% DISC dividend rate).
If the manufacturer is a C-corporation, the tax savings is 29.75% (assume Ccorporation rate of 35%, and the net C-corporation dividend is taxed at 15%).
37
Interest Charge-Domestic International
Sales Corporation (IC-DISC)
g.
h.
i.
The interest charge aspect of an IC-DISC is essentially a low interest loan from the
US Treasury. The charge is on the shareholder’s deferred tax liability, which equals
the difference between the shareholder’s tax computed with the accumulated (nondistributed) IC-DISC income and then without. The interest rate is the 52-week TBill rate. [IRC 995(f)(2)]
Given that the rate of tax on dividends is only 15% (and Congress could always
change that), shareholders of an IC-DISC should always distribute the dividend
each year. If distributed, no interest charge is due and no deemed dividend
distribution tax is due.
While most IC-DISCs are commission DISCs, it can be a so-called “buy-sell” ICDISC. Here, the DISC will actually take title to the export property from a US
manufacturer before the export sale takes place and sell the export property. All
export sale contracts must move to the DISC. Given these logistical complications,
this form of DISC may occur where a seller of a branded, upscale product line
desires to sell an inferior, unbranded line and wishes to avoid confusion or impact
on its upscale line. There is no difference in the determination or calculation of the
DISC benefit in either form.
Anthony P. Marshall
(315) 423-7100
© Harris Beach PLLC, 2012
38
Interest Charge-Domestic International
Sales Corporation (IC-DISC)
2.
ORGANIZATION FORMALITIES:
a.
b.
c.
d.
Anthony P. Marshall
(315) 423-7100
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Analyze export sale history and determine likely IC-DISC tax benefits. These
benefits should exceed the cost of formation and operating the DISC.
Incorporate under the laws of any State prior to applicable export sales.
Taxpayer cannot obtain the DISC benefit for sales occurring prior to formation.
Can have only class of stock with a minimum par value of $2,500 [IRC
992(a)(1)(c)]. It is advisable to capitalize at $3,000 to avoid any circumstance
where par value could drop below $2,500. Each DISC shareholder would
contribute their respective pro-rata share of the total capitalization.
File Form 4876-A with IRS within 90 days after beginning of 1st tax year.
39
Interest Charge-Domestic International
Sales Corporation (IC-DISC)
e.
f.
g.
h.
Anthony P. Marshall
(315) 423-7100
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Execute a Commission Agreement between the IC-DISC and exporter, drafted
with maximum flexibility, allowing the exporter to chose which foreign sales
can run through the DISC. Agreement should be dated upon formation; but if
not, can be executed after formation with an effective date back to formation.
Shareholders of IC-DISC may require commonality of ownership with the
manufacturer entity under gift tax rules, in that value is being transferred by
the DISC commission payment.
Note that the DISC is not required to be affiliated with a manufacturer. An
exporter/distributor can establish a DISC and receive the same tax benefits.
The IC-DISC is not required to have any operations, nor have any employees.
40
Interest Charge-Domestic International
Sales Corporation (IC-DISC)
3.
IC-DISC QUALIFICATION REQUIREMENTS:
To qualify as an IC-DISC, the domestic corporation must satisfy 2 tests:
a.
Qualified Exports Receipts (QER) test
At least 95% of the DISC’s gross receipts must be qualified export receipts.
[IRC 992(a)(1) and 993(d),(f)]. For purposes of this test:
1.
2.
“Gross receipts” means gross income from all sources; and
“Qualified export receipts” includes gross receipts from:
A.
B.
C.
D.
Anthony P. Marshall
(315) 423-7100
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Sales of export property;
Lease of export property outside the US;
Services related to export sales;
Engineering or architectural services for construction projects located outside the US.
41
Interest Charge-Domestic International
Sales Corporation (IC-DISC)
b.
Qualified Exports Assets (QEA) test:
At least 95% of the DISC’s assets must be qualified export assets. [IRC
992(a)(1) and 993(d),(f)]. For purposes of this test, “qualified export assets”
include:
1.
Any asset used primarily in connection with the sale or lease of export property, or
performance of engineering or architectural services for construction projects located
outside the US.
2.
Accounts receivable of the DISC
3.
Temporary investments of the DISC
Note: If the IC-DISC were to distribute all of its commission income each year, its only
asset will be its par value (IE, the $3,000 initially capitalized upon formation). Under the
diminis rules under the regulations [(1.993-2(c)(3)(iii)], this par value is considered a
temporary investment. As 100% of the IC-DISC’s assets are QEA, it satisfies the QEA
test.
4.
Anthony P. Marshall
(315) 423-7100
© Harris Beach PLLC, 2012
Producer loans are loans made to a person engaged in the manufacturing, production,
growing or extraction of export property in the US.
42
Interest Charge-Domestic International
Sales Corporation (IC-DISC)
4.
SALES OF EXPORT PROPERTY
a.
There are 3 requirements for an IC-DISC to receive commission income from
the sale of export property: [IRC993(c)]
1.
Manufacturing: property must be manufactured, produced, grown or extracted in the US
by other than the DISC;
2.
Destination: export property held primarily for sale or lease for direct use, consumption
or disposition outside the US; AND
3.
US Content: export property must have at least 50% US content.
Note: While export property is typically thought of as newly manufactured property, the
property can be used equipment or even scrap.
Anthony P. Marshall
(315) 423-7100
© Harris Beach PLLC, 2012
43
Interest Charge-Domestic International
Sales Corporation (IC-DISC)
b.
Manufacturing Requirement:
1.
2.
3.
Anthony P. Marshall
(315) 423-7100
© Harris Beach PLLC, 2012
The export property must be manufactured in the US, and not by the IC-DISC (the
manufacturer will form the IC-DIDSC to capture the export sales).
Property is manufactured in the US if:
A. 20% of its conversion costs are incurred in the US;
B. There is a substantial transformation in the US; OR
C. The operations in the US are generally considered to constitute manufacturing. [IRC
1.993-3(c)]
Substantial transformation: Examples include converting tuna to canned tuna; pulp to
paper; and curiously assembly of components of eyeglasses (lenses, wings, screws,
etc.) is a substantial transformation. Curiously still is a case involving GE: assembly of
a manufacturer product (IE, jet engines) into another manufacturer product (jet airplanes)
is generally not considered manufacturing. Stated another way, affixing a completed
product to another completed product may not constitute manufacturing. [General
Electric v. Commissioner, 245 F3d (2d Cir. 2001)]
44
Interest Charge-Domestic International
Sales Corporation (IC-DISC)
c.
Destination Requirement:
1.
2.
3.
Export property must be held for sale or lease in the ordinary course of business for
direct use, disposition or consumption outside the US. [IRC 993(c)(1)(B)]
Delivery of property directly to a foreign purchaser satisfies this test. Delivery of property
to a freight forwarder for ultimate shipment abroad satisfies this test. [IRC 1.9933(d)(2)(i)(a)]
Sales of property to a US distributor satisfy this test if:
A.
B.
The property does not undergo further manufacturing by the purchaser prior to its
export; and
The property is shipped abroad within 1 year of purchase. [IRC 1.993-3(d)(2)(i)(b)]
Note: In the referenced GE v Commissioner case, GE sold jet engines to Boeing (a US
seller), who sold to foreign purchasers. Since Boeing’s affixing of the jet engines sold
by GE was determined not to be further manufacturing, GE received the DISC
benefit. That was the crux of that case.
Proofs: Require as part of the sale that the US distributors provide information that the
product was exported (such as export bill of lading or a shipper’s export
declaration).
Anthony P. Marshall
(315) 423-7100
© Harris Beach PLLC, 2012
45
Interest Charge-Domestic International
Sales Corporation (IC-DISC)
4. Example: Company manufactures windshield wipers with US materials. Company’s ICDISC sells the wipers to a US car manufacturer, which affixes them to its cars that are
exported to Canada. Affixing the wipers is not further manufacturing, so the property
retains its export property character. As the final destination of the cars is outside the
US, the sale of the wipers to the US manufacturer is an export property sale. Require
documentation from the manufacturer of the export.
5. Sales of property to a foreign purchaser in Toronto, who then sells the property in
Buffalo, are not entitled to the DISC benefit.
6. Note that an exporter can receive IC-DISC benefits on sales to a foreign subsidiary, but
only on the sale by the exporter to its foreign subsidiary (and not on subsequent sales by
its foreign subsidiary).
d.
US Content:
1.
All export property may have no more than 50% of the value of the final costs
attributable to foreign components, where value is determined based on the dutiable
value of the foreign components. [IRC 1.993-3(e)(4)(i)]
2.
Final cost includes both labor and material.
Anthony P. Marshall
(315) 423-7100
© Harris Beach PLLC, 2012
46
Interest Charge-Domestic International
Sales Corporation (IC-DISC)
5.
DETERMINING THE IC-DISC BENEFIT
The amount of the commission payable to either a commission or buy-sell
an IC-DISC from sales of export property is calculated based on either:
a.
Qualified exports receipts method [IRC 994(a)(1)]: This method allocates
4% of the qualified exports receipts from the export sales to the IC-DISC.
Rule of thumb: The qualified exports receipts method provides the larger
commission income when net pre-tax margin is less than 8% (IE, low margin),
producing a benefit of approximately $8,000 per $1 million of qualified exports
receipts. (Note in the above example that $48,000 was the savings on $6
million of qualifying export sales).
b.
Combined Taxable Income Method [IRC 994(a)(2)]: This method allocates
50% of the taxable income from export sales to the IC-DISC.
Rule of thumb: The combined taxable income method provides the larger
commission income when exports have a net pre-tax margin of 8% or greater
(IE, high margin), producing a benefit of approximately $100,000 per $1 million
of combined taxable income. (Note in the above example that $100,000 was
the savings on $1 million of qualifying export sales).
Anthony P. Marshall
(315) 423-7100
© Harris Beach PLLC, 2012
47
Interest Charge-Domestic International
Sales Corporation (IC-DISC)
6.
MAXIMIZING THE IC-DISC BENEFIT
In the context of calculating the commission using the combined taxable
income method, there are 3 techniques for increasing the IC-DISC’s
taxable income: grouping, marginal costing and expense allocations.
a.
General concepts:
1.
2.
3.
Anthony P. Marshall
(315) 423-7100
© Harris Beach PLLC, 2012
An IC-DISC is permitted to apply the qualified exports receipts or combined taxable
income method on a product line-to- product line basis, transaction-by-transaction, and
can change methods year-to-year or transaction-by-transaction. [IRC 1.994-1(c)(7)]
Product line groupings are accepted if the groupings conform to recognized trade or
industry usage or the 2-digit major groups of standard industrial classification (SIC)
codes. [IRC 1.994-1(c)(7)(ii)]
An exporter can maximize IC-DISC commission income by ignoring loss sales. [IRC
1.994-1(e)(1)]
48
Interest Charge-Domestic International
Sales Corporation (IC-DISC)
b.
Grouping: Grouping allows an exporter to maximize the IC-DISC’s
commission by segregating high margin sales from low margin sales.
Marginal Costing [IRC 994(b)(2) and 1.994-2(c)]:
c.
1.
2.
3.
4.
5.
Full costing combined taxable income (FCCTI) equals qualified export receipts, less total
direct and indirect costs attributable to exports sales. [IRC 1.994-1(c)(3)]
Under marginal costing, only marginal costs (IE, direct material and direct labor costs)
are taken into account in computing combined taxable income. All other indirect costs
(selling, general administrative, interest expense, etc.) are ignored in computing marginal
costing combined taxable income (MCCTI). [IRC 1.994-2(b)(2)]
Marginal costing allows a taxpayer to increase combined taxable income by excluding
the indirect costs related to export sales.
Use of marginal costing requires only that MCCTI exceed FCCTI. [IRC 1.994-2(b)(1)]
Limitation: An “overall profit percentage” (OPP) limitation restricts the combined taxable
income of an exporter to an amount equal to:
A.
B.
Anthony P. Marshall
(315) 423-7100
© Harris Beach PLLC, 2012
FCCTI from all sales (domestic and foreign), times
The ratio of qualified export receipts to total receipts (domestic and foreign). [IRC 1.9942(b)(3)]
49
Interest Charge-Domestic International
Sales Corporation (IC-DISC)
d.
Expense Allocations: A taxpayer can increase combined taxable income
(which increases the IC-DISC commission) by allocating fewer indirect costs
against qualified export receipts, with the intent being to allocate as much
indirect costs to domestic sales. Allocations can be based on relative
(domestic vs. foreign) sales, gross profit, units produced, units sold.
Anthony P. Marshall
(315) 423-7100
© Harris Beach PLLC, 2012
50
Examples of Calculation of
DISC Commission
Anthony P. Marshall
(315) 423-7100
© Harris Beach PLLC, 2012
51
Examples of Calculation of DISC Commission
Qualified exports receipts method [IRC 994(a)(1)]: This method allocates
4% of the qualified exports receipts from the export sales to the IC-DISC.
Example: Manufacturer is a disregarded LLC which has $6 million of qualifying
export sales through its IC-DISC. Manufacturer will deduct a commission of $240,000
(4% of $6 million), reducing its tax by $84,000 (assume personal tax rate of 35%,
times $240,000). Assuming the IC-DISC distributes the commission to its
shareholder, a tax of $36,000 is due (15% times $240,000). Total tax savings is
$48,000 ($84,000 saved, less $36,000 due).
Combined Taxable Income Method [IRC 994(a)(2)]: This method allocates
50% of the taxable income from export sales to the IC-DISC.
Example: Manufacturer is a disregarded LLC which has $1 million of combined
taxable income from export sales. Manufacturer will deduct a commission of
$500,000 (50% of $1 million of combined taxable income), reducing its tax by
$175,000 (assume personal tax rate of 35%, times $500,000). Assuming the ICDISC distributes the commission to its shareholder, a tax of $75,000 is due (15%
times $500,000). Total tax savings is $100,000 ($175,000 saved, less $75,000 due).
Anthony P. Marshall
(315) 423-7100
© Harris Beach PLLC, 2012
52
Examples of Calculation of DISC Commission
Ways to maximize Combined Taxable Income
Grouping: segregate high margin sales from low margin sales.
Example: Exporter exports domestically produced beer and wine. The annual gross
qualified export receipts and combined taxable income from these export sales are as
follows:
Beer
Wine
Total
Receipts
$5,000,000
$5,000,000
$10,000,000
Combined T.I.
$1,000,000
$ 200,000
$1,200,000
Net pre-tax margin
20%
4%
12%
Calculation of IC-DISC commission:
Combined taxable income method:
50% of $1,200,000 = IC-DISC commission of $600,000
Qualified export receipts method:
4% of $5,000,000 = IC-DISC commission of $200,000
Result of Grouping:
Beer (high margin): use 50% of combined taxable income method 50% of
$1,000,000 = $500,000 commission to the IC-DISC
Wine (low margin): use qualified export receipts method
4% of $5,000,000 = $200,000 commission to the IC-DISC.
Anthony P. Marshall
(315) 423-7100
© Harris Beach PLLC, 2012
Total commission income = $700,000
53
Examples of Calculation of DISC Commission
Marginal Costing: increase combined taxable income by excluding the indirect
costs related to export sales.
Example: Exporter exports widgets through its IC-DISC. The widgets constitute qualified
export property. Results from operations for its year just ended are as follows:
Sales
Direct material and labor
costs
MCCTI
Indirect costs
FCCTI
Export sales
$10,000,000
$ 5,000,000
US sales
Total Sales
$15,000,000 $25,000,000
$ 8,000,000 $13,000,000
$ 5,000,000
$ 3,000,000
$ 2,000,000
$ 7,000,000 $12,000,000
$ 3,000,000 $ 6,000,000
$ 4,000,000 $ 6,000,000
OPP Limitation:
$6,000,000 (FCCTI from all sales, times)
40% (qualified export receipts ($10MM) ÷ total receipts ($25MM)
$2,400,000 = OPP limited combined taxable income
50%
Marginal costing results in an additional IC-DISC commission of $200,000
$1,200,000 = IC-DISC commission
$2,000,000 = FCCTI
50%
$1,000,000 = IC-DISC commission
Anthony P. Marshall
(315) 423-7100
© Harris Beach PLLC, 2012
Qualified export receipts method: 4% of $10,000,000=$400,000
54
Examples of Calculation of DISC Commission
Expense Allocations: increase combined taxable income by allocating fewer
indirect costs against qualified export receipts. based on relative (domestic vs.
foreign) sales, gross profit, units produced, units sold.
Example: Assume the following results of operations, which include $10 million of indirect
costs on all sales, which (based on known data) can be allocated to export sales based on
sales or gross profits:
Allocation of indirect costs based on Sales:
Domestic
Foreign
Total
Sales
Direct Costs
Gross Profit
$24,000,000
$12,000,000
$36,000,000
$ 9,000,000
$ 7,000,000
$16,000,000
$15,000,000
$ 5,000,000
$20,000,000
Indirect Cost
as allocated
based on
relative sales
$ 6,700,000
$ 3,300,000
$10,000,000
Combined
Taxable
Income
$ 8,300,000
$ 1,700,000
$10,000,000
Allocation of indirect costs based on Gross Profit:
Anthony P. Marshall
(315) 423-7100
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Domestic
Foreign
Total
Sales
Direct Costs
Gross Profit
$24,000,000
$12,000,000
$36,000,000
$ 9,000,000
$ 7,000,000
$16,000,000
$15,000,000
$ 5,000,000
$20,000,000
55
Indirect Cost
as allocated
based on
relative
gross profit
$ 7,500,000
$ 2,500,000
$10,000,000
Combined
Taxable
Income
$ 7,500,000
$ 2,500,000
$10,000,000
Examples of Calculation of DISC Commission
a. Combined taxable income method (based on sales):
50% of $1,700,000 = $850,000 commission
b. Combined taxable income method (based on gross profit):
50% of $2,500,000 = $1,250,000 commission
c. Qualified export receipts method:
4% of $12,000,000 =$480,000 commission
Anthony P. Marshall
(315) 423-7100
© Harris Beach PLLC, 2012
56

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