New markets tax credits can provide a good financing structure for growing businesses that need funding for real estate development or capital equipment purchases. NMTCs require a sophisticated legal structure and the involvement and coordination of multiple parties, but in the right circumstances they can assist in supporting company growth through financing on favorable terms. The federal policy goal of the NMTC program is to stimulate economic activity in economically disadvantaged areas.
A brief summary of the legal structure involved in a typical NMTC loan transaction is a good starting point for understanding how NMTCs work. Congress considers whether to extend the program each year, so there is no guarantee that NMTCs will be available on an ongoing basis. If they are available, NMTCs are "allocated" by a fund that is established by the federal government to parties that apply to receive the credits. Recipients of the credits are known as "allocatees."
Once a potential project is identified, an allocatee typically enters into a partnership arrangement with an investing party that will contribute cash to the partnership, normally a bank. The allocatee contributes the tax credits to the investment entity partnership and the investor contributes cash. Often, a leverage lender will also provide a second source of cash to the investor for transfer to the investment entity. The investment entity allocates most of the new markets tax credits to the investor based upon its ownership interest in the investment entity, so the tax credits essentially pass from the allocatee to the investor. The investment entity provides cash loans to the business that is borrowing the funds. The borrower is known as a qualified active low income community business, or QALICB, and must apply the funds that it receives through the NMTC loan in an economically disadvantaged geographical area.
Each party to the NMTC structure receives a benefit. The QALICB receives financing on terms that it would not otherwise be able to obtain absent the tax credits. The investor receives the tax credits and interest on its capital contribution, with the tax credits typically causing the transaction to provide a favorable return on investment for the investor. Finally, the allocatee receives a fee for its participation in the transaction.
The underlying policy behind the structure of the NMTC program is to create a hybrid public/private system for encouraging economic development in economically distressed geographical areas. The federal government provides the tax credit incentive and awards the credits to applicants that demonstrate the best track record for successfully creating economic development. The allocatees partner with investors that are willing to provide the best terms for application of the credits. QALICBs receive funding on terms that they likely would not otherwise be able to achieve without the benefit of the tax credits applying to create an acceptable return on investment for the investor.
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