NEW MARKETS TAX CREDITS AND OTHER FEDERAL INCENTIVES FOR NEW PROJECTS

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1 NEW MARKETS TAX CREDITS AND OTHER FEDERAL INCENTIVES FOR NEW PROJECTS WV Tax Institute Annual Meeting Charleston WV October 24, 2016 Martha Groves Pugh McDermott Will & Emery LLP Boston Brussels Chicago Düsseldorf Frankfurt Houston London Los Angeles Miami Milan Munich New York Orange County Paris Rome Seoul Silicon Valley Washington, D.C. Strategic alliance with MWE China Law Offices (Shanghai) 2013 McDermott Will & Emery. The following legal entities are collectively referred to as "McDermott Will & Emery," "McDermott" or "the Firm": McDermott Will & Emery LLP, McDermott Will & Emery AARPI, McDermott Will & Emery Belgium LLP, McDermott Will & Emery Rechtsanwälte Steuerberater LLP, McDermott Will & Emery Studio Legale Associato and McDermott Will & Emery UK LLP. These entities coordinate their activities through service agreements. This communication may be considered attorney advertising. Previous results are not a guarantee of future outcome.

2 New Markets Tax Credit Opportunities New Markets Tax Credit ( NMTC ) program Created to encourage investment in low-income communities and grow businesses, create jobs, and sustain healthy local economies Uses federal tax incentives (a 39% tax credit over a 7 year period) to attract private capital 5% tax credit in Years 1 through 3; 6% tax credit in Years 4 through 7 Large banks are generally the investors receiving the tax credits and the qualified businesses that receive the favorable financing A structured program in which certified entities (Community Development Entities) receive an allocation of tax credits from the U.S. Treasury and then match-up investors with qualified businesses 2

3 New Markets Tax Credit Opportunities New Markets Tax Credit ( NMTC ) program Simplified structure: Investor Equity Investment NMTCs Return of Capital Community Development Entity Favorable Financing Qualified Business (Low Income Community) Loan Repayment (Restrictive Covenants) 3

4 Example Leveraged Lender Interest & Principal Loan $7M Qualified Equity Investment (QEI) $10M (less fees) Loan or Equity Investment $10M (less fees) Equity Investment $3M $10M Investment Fund Sub Community Development Entity (Sub CDE) Qualified Active Low- Income Community Business (QALICB) NMTC & Return of Capital Interest Payment NMTC Equity Investor (Bank) Fees $10M Allocation 39% NMTC & Interest/Return of Capital ($3.9 Million Tax Credit) Community Development Entity (CDE) In this example, the NMTC equity investor invests $3 million and a traditional lender invests the other $7 million* Therefore, the Investment Fund can make the $10 million QEI (less transaction fees) into a certified CDE with a low interest rate The CDE then has 12 months to either lend or make an equity investment in a QALICB Because of the tax credits, the additional $3 million loan to the QALICB may be on favorable terms. The Bank traditionally puts interest in the CDE to the QALICB for $1000. The QALICB may have COD income. *These values are for illustrative purposes only.

5 New Markets Tax Credit Opportunities Community Development Entities ( CDEs ) A domestic corporation or partnership Primary mission is to serve or provide investment capital for low-income communities Maintains accountability to residents of low-income communities through representation on any governing board of the CDE or any advisory board to the CDE Is certified as being a qualifying CDE 5

6 New Markets Tax Credit Opportunities Qualified Business Earns at least 50% of its total gross income from the active conduct of a qualified business within a low-income community A qualified business is broadly defined and most businesses qualify with the exception of so-called sin businesses (e.g. gambling or liquor store) and residential housing The qualified business may use the funding to finance a new headquarters, expand current location, open a new location, etc. The address of the business will determine if it is located in a qualified census track (i.e., a low-income community) A portion of a business may qualify if such separate trade or business would qualify if it were separately incorporated 6

7 New Markets Tax Credit Opportunities Low-Income Community ( LIC ) A census tract with a poverty rate of at least 20% A census tract where the median family income does not exceed 80% of the statewide or metropolitan area median family income A census tract located in a high migration rural county where the median family income does not exceed 85% of the statewide median family income A high migration rural county is one that has a net out-migration from the county of at least 10% during the prior 20-year period A census tract with a population of less than 2,000 if it is within a federally designated empowerment zone and is contiguous to one or more LICs 7

8 New Markets Tax Credit Opportunities Targeted Populations If a qualified business is not located in a LIC but it otherwise serves a targeted population, the business may also qualify Targeted populations include low-income persons An individual is considered low-income if the individual s family income, is not more than 80% of the applicable area median family income, provided the project is located in a population census tract where the area median family income exceeds 120% of the applicable area median family income 8

9 New Markets Tax Credit Opportunities Favorable Financing for Qualified Businesses Qualified Businesses can receive favorable financing from community development enterprises Must maintain status as qualified business Make representations/covenants regarding qualification as a qualified business and the purpose for the financing Example Restrictions Can t repay loans within 7 years Can t sell interests in projects financed through NMTC program Can t materially change nature of business May be required to indemnify investor in event of default (caused by actions of Qualified Business) that results in the recapture of NMTCs 9

10 NMTC Financing NMTC Recapture In certain circumstances, NMTCs may be recaptured from investors during the 7-year credit period A recapture occurs if The CDE ceases to qualify as a CDE The investment is redeemed by the CDE Substantially all of the investment by a CDE is not used to make a qualifying LIC investment Less than 85% of the investment is used for a qualifying LIC investment The qualifying business fails to qualify A qualifying investment is not made within the required 1-year period To our knowledge (and that of the New Market Tax Credit Coalition), there have been no recorded events of an NMTC recapture. 10

11 NMTC Financing Recent NMTC Deal Funding used by a teaching hospital to fund a portion of the cost of purchasing a neighboring property, expanding the hospital, and remodeling the pre-existing facilities Financing acquired on favorable terms (generally interest only payments for first 7 years at favorable interest rate) Expected to provide substantial additional equity Other NMTC Funding In addition to hospital and medical facilities, NMTCs have also been used to fund commercial and industrial facilities and other retail and mixed-use properties, including biotech research facilities 11

12 NMTC Financing Particular Considerations for NMTC Transactions NMTC financing requires consideration of current debt covenants Extensive amounts of planning, inclusion of multiple participants, and legal advice is required However, NMTC deals result in better financing and equity, even after fees, than more traditional lending 12

13 Getting Started This is a good year to consider NMTC Financing The largest round of NMTC allocation is expected to be released in late October or early November. This is the ideal time to do the preparation work to explore a possible transaction and to prepare materials to attract interest from CDEs for funding in 2017 Consider any upcoming capital expenditures Expansions Updates to Existing Facilities New Facilities Location, Location, Location Location in a Qualified Census tract is generally easy to determine 13

14 Investment Tax Credits The Section 48 investment tax credit ( ITC ) is a tax credit based upon the amount of capital investment for the following qualifying projects: solar - geothermal fuel cell - combined heat and power microturbine facilities One-time credit taken in the year the facility is placed in service. Initial credit amount is 30% of eligible costs for most technologies; however, the credit amount is subject to a phaseout. Credit amount is 10% for combined heat and power, microturbines and geothermal projects. ITC is subject to recapture for the 5-year period starting on the placed-in-service date. Recapture would occur if the property is disposed of, becomes tax-exempt use property or is foreign use property. Sections 48 and 45 permit taxpayers that place in service PTC (discussed below) eligible property to elect to receive an ITC in lieu of the PTC. 14

15 Production Tax Credits Production tax credits (PTCs) are available to the following projects: wind - small irrigation geothermal - municipal waste biomass - hydrokinetic The PTC is a credit of 2.3 cents (for wind) on each kilowatt hour of electricity generated for a period of ten years beginning on the placed in service date of the facility. PTCs are generally claimed by either the 100% owner of a project or by the partners in a flip partnership transaction structure. PTCs are not subject to the same recapture rules as the ITC. To be eligible for the PTC, the facility must continue producing electricity. 15

16 Key Dates for Solar ITC Qualification for solar A solar project must begin construction before January 1, The solar ITC is subject to a phaseout: 30% ITC for projects where construction begins before January 1, % ITC for projects where construction begins in % ITC for projects where construction begins in % ITC for solar projects where construction begins before 2022 but are not placed in service before

17 Key Dates for Wind PTC/ITC Qualification for Wind A wind farm must begin construction before January 1, 2020 The PTC for wind is subject to a phaseout. The PTC amount is reduced by the following percentages for the following dates: 20% if construction begins after December 31, 2016, and before January 1, % if construction begins after December 31, 2017, and before January 1, % if construction begins after December 31, 2018, and before January 1, 2020 Same phaseout rules apply to ITC amount if ITC is elected 17

18 Key Dates for Other Technologies Construction must begin before January 1, 2017 for the following projects: Biomass (closed and open-loop) Geothermal Landfill gas Trash facilities Hydropower Marine and hydrokinetic May see extension for these technologies in an extenders bill 18

19 Beginning of Construction Methods Construction can begin by either of the following: Physical work of a significant nature Continuous Construction Test A taxpayer must continue physical work until placed in service to meet the physical work test. 5% Safe Harbor Continuous Efforts Test A taxpayer must make continuous efforts to advance to completion to meet the safe harbor. Under previous IRS guidance, if a facility is placed in service within two years of the beginning of construction, the IRS would presume that the taxpayer has met the Continuous Construction Test and the Continuous Efforts Test, as applicable. Continuity Safe Harbor 19

20 Key Points from 2016 Beginning of Construction Guidance (Notice ) Extension and modification of Continuity Safe Harbor to 4 years from beginning of construction Additional Physical Work examples Clarification of application of Continuity Safe Harbor to projects that consists of multiple separate facilities Application of 5% Safe Harbor to retrofitted or repowered ( 80/20 Facilities ) facilities IRS will not rule on beginning of construction Additional solar-specific guidance expected 20