The Leading Edge - Spring 2010 - PKF - 11

PAnnell Kerr ForsTer of TexAs, P.C.
Certified Public Accountants & Professional Advisors

how companies benefit from sales tax incentives
By Mark Scimemi, J.D.

remember a passage from my high school civics textbook that stated, “Everything is politics;” regardless of the fact many people do not want to “talk politics” or be involved in political debates, politics is ubiquitous. I think about this passage when tax professionals, business owners and financial executives claim “incentives won’t help our business.” In this case, I believe that “everything is incentives.” I am talking about state credits/ statutory credits and incentives/ negotiated incentives. State or statutory credits are created by statute or regulation that may be taken as a matter of right if a taxpayer meets the requirements of the statute. The classic example is research and development credits. Negotiated incentives are the more exotic incentives that state and local government use to drive economic development by rewarding job creation and capital investment within their jurisdiction. Still, I have not explained why “everything is incentives.”
THE LEADIng EDgE

Everything is incentives because incentives are everywhere and have the potential to make an enormous difference in the profitability of a company. For example, almost every state that imposes a sales tax has an exemption for machinery and equipment used directly in the manufacturing process. This is an enormous incentive that many businesses do not understand or overlook. A microwave oven would likely qualify for this incentive because it is used in the manufacture of food. Electricity used in the manufacturing process may also qualify. Many states exempt certain types of property from ad valorem property taxes. In Texas, for example, pollution control equipment qualifies for an exemption from property tax. These incentives are available to businesses without any special action on their part, and carry huge potential; even a small incentive can have a large impact on the business. A business that qualifies for $10,000 in incentives does not just have an extra $10,000; it has the net profit of $10,000 which, on a business with a 5 percent net profit margin, represents a sale of $200,000. How hard would a business work for a $200,000 sale? If the incentive is larger, the net sale impact is larger. How can a company identify potential incentives and take advantage of them? It may sound too good to be true, but the best place to start a search for credits and incentives is Google. Every state and most local governments discuss the statutory credits and negotiated incentives available in their jurisdiction

on the Internet. Unfortunately, although the incentives are discussed on the Web, the descriptions of the incentives are often inaccessible to a novice. In addition, a company should know when it has the right facts to make a significant investment in understanding its incentive profile. Typically, a company should review potential credits and incentives whenever there is a potential for significant capital investment (a new investment greater than $1 million) or meaningful job creation (the hiring of 25 or more employees). Companies with significant head count and training costs also should consider credits and incentives. Statutory credits are easy to capture. Review the credit guidelines, determine if the facts presented meet the credit’s requirements and then determine accessibility. Negotiated incentives, including property tax abatements, tax increment financing, sales tax sharing agreements and other grants, are likely be much more complicated. Unlike statutory credits, negotiated or discretionary incentives are usually awarded when the “but for” test can be met. The “but for” test determines whether the actual incentive offer will make the company decide to expand or locate in a jurisdiction. An incentive offer from most jurisdictions only occurs if a company meets this standard. State and local governments want to use incentives to create growth that may not happen without them, instead of rewarding organic growth. A company thinking of using discretionary incentives must be cautious in how it publicly

discusses its expansion plans. Comments that lead a jurisdiction to believe that the “but for” test cannot be passed may directly impact negotiated incentive awards. I recommend that companies turn to professional advisors and consultants to handle negotiated incentive matters. Professional advisors understand the traps for the unwary in these programs. Professionals are also better able to navigate the political process that sometimes surrounds these matters. A company may also be best served by having a third party with a deep understanding of local and regional issues negotiate with competing jurisdictions. Credits and incentives are available to a greater or lesser degree to every company. Executive leadership and tax advisors should evaluate the potential for these incentives for the enterprise. Where necessary, include consultants who focus on credits and incentives. Always be mindful of the potential for incentives when significant capital investment or job creation may occur. In addition, manage the public profile and announcements surrounding potential capital investment and job creation to maintain maximum leverage in negotiations with competing jurisdictions. In doing this, a company can feel certain that it is harvesting the advantages available to it from statutory credits and negotiated incentives. e Mark Scimemi, J.D., is a senior manager in State and Local Tax for PKF Texas. He can field your questions at (713) 860-5456 or mscimemi@pkftexas.com.

The Leading Edge - Spring 2010 - PKF

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