When the “Tax Man” Can Actually Help
Case Study: How a Distribution-Based Business Realized Considerable Tax Incentives by Leveraging Specialized Tax Expertise
Rob Gray June 22, 2015
FUNCTIONAL INSIGHTS
CONSULTING FOR THE MIDDLE MARKET
™
The fin an cial ben efits that can be gain ed by relying on quality tax expertise and some “elbow grease ” can help middle market compan ies who are in an expansion mode realiz e con siderable tax in centives an d ben efits. This case study outlin es how a distribution cent er con solidation resulted in millions in savings.
Meris Consulting, LLC When the “Tax Man” Can Actually Help June 2015
WHEN THE “TAX MAN” ACTUALLY CAN
HELP
CASE STUDY: HOW A DISTRIBUTION-BASED BUSINESS REALIZED CONSIDERABLE TAX INCENTIVES BY LEVERAGING SPECIALIZED TAX EXPERTISE
AN INTRODUCTION TO TAX AND INCENTIVE BE NEFITS
Often overlooked, companies may achieve significant tax savings and improve earning potential from the guidance of an experienced, astute tax expert who specializes in maximizing site selection incentives, credits, and strategies. Through discovering and utilizing prudent statutory and discretionary incentives and activation strategies,
expanding or consolidating operations in particular locations can realize significant benefits presently and in years to come. In addition, a well-researched, devised and executed plan, based on judicious tax analysis, may assist in winning bids for retaining current customers or adding new business through cost or price reductions or produce improved profitability. So, let’s take a look at the details of two cases which highlights many of the above-mentioned points and, possibly, consider this important avenue when developing strategic location or relocation plans.
VENDOR & SITE SELECTION POSSIBILITIES
A Company had pursued business with a large retailer (Customer) that was doing business in the State of Pennsylvania with another business partner. The Customer desired to leave its current business arrangement, which included contracting of warehouse logistics services. Thus, the Customer provided bid information to consolidate its warehouse operations to one location in a handful of possible states. The bid information was sent to a few competitors, including the Company, who then passed its information to key strategic departments within the Company. One such department, the industrial
engineering (IE) team developed a financial model that included labor costs, rent for warehouse space, costs for equipment, and any other cost associated with the project.
STATE TAX ANALYSIS & INCENTIVES
Financial information from the IE team was used by the Tax Department to complete a tax comparison by state. The comparison listed the various taxes for each targeted state with an estimated tax based on the
capital investment, labor cost, gross receipts, and net profit. The indirect taxes estimate total proved close to the actual amount, while the income tax amount was roughly estimated based on the net profit for the location by the
Meris Consulting, LLC When the “Tax Man” Can Actually Help June 2015 provided, though taxes from the operation that could have been problematic were unsurfaced.
While performing the analysis of taxes from the different state locations, noticeable and substantial differences regarding the ways states regulate and execute taxes for business were discovered. For example, the State of Pennsylvania had the highest income tax rate; the State of Indiana had a personal property tax on inventory; the State of Illinois had an income tax, but no personal property tax; and the State of Ohio had a gross receipts tax but no income or personal property tax. After comparing tax rates and tax types, Ohio had the lowest tax costs compared to the other states being considered for the project. Since, warehouses hold a large amount of
property, the apportionment factor could have figured considerably, and possibly shifting the impact of taxes from state to state. In this case, relocating to a state other than Pennsylvania (its current location) and to Ohio was found to reduce the income tax for the Customer.
Members of the Tax Department had made inquiries to and met with representatives of business tax oversight in the targeted state of Ohio, introducing the project and ensuring a budget existed to support incentives for the project. States may offer statutory or discretionary incentives or both incentives based on the project and competition for the project. Statutory incentives are available to all projects that meet the requirements of the incentive program and are approved by the state. Discretionary incentives have to be requested and are offered based on the size of the project, capital investment, number of new jobs, wage rates, and community impact. The purpose of the initial discussion determined if incentives were available and which incentives could be considered for the project.
INCENTIVES & COMMERCIAL STRATEGY
Based on the incentive programs that were available for the project, a calculation was done to determine the potential incentives for the project based on the estimated capital investment, labor cost, gross receipts and net income. The incentive amount was combined with the state taxes to determine which state had the lowest overall
taxes. However, the estimated incentive amount was not part of the Financial Model for the project. A footnote was made in the bid to describe potential savings that could be realized sometime in the future. This was done because the awarding of incentives is uncertain, until they are formally approved by the taxing jurisdictions. Not revealing all incentives during the bid process allowed the Company to achieve cost savings in the future to offset unexpected costs.
Once all the relevant Company departments had submitted the bid information to the project team, the bid was submitted to the customer. (It generally takes a few weeks up to a month to find out who won the bid.) In this instance, when the Company won the bid after a wait of several weeks, the participating Company
departments started the process of implementing the work already planned for the project. Pertinent bid information accumulated from Company departments, and site location specifics were required on the state applications for incentives, before they could be finalized. An application fee of $500 was paid to the State of Ohio which permitted filing. Numbers were adjusted down to ensure that project expectations could be met. If a higher incentive was received from the state, the numbers could have been easily and happily adjusted up.
Meris Consulting, LLC When the “Tax Man” Can Actually Help June 2015 Approval time for state and local incentives are dependent upon when the applications are filed with the state. It took about 30 days to get on the agenda to get the project approved. Project approval took place at a public meeting with the State of Ohio. Just prior to the formal meeting, minor adjustments were made to the project to increase the potential benefit amount. This particular project had already exceeded requirements for the
program, so to receive state approval, the project needed some form of local incentive or support. In this case, the project location was in a zone that provided a real property tax abatement satisfying the local support
requirement.
No hiring or contractual agreements were signed prior to the state approval meeting. This created a delay in pursuing the first steps to opening a new location - securing property, entering into agreements to purchase equipment, and hiring management for the project, yet was a necessary and prudent decision. The manager of the operation transferred from another location, which eliminated all of the potential training benefits or hiring credits for that position.
COMMERCIAL CONSIDERA TIONS
The Company’s policy was to pass incentives on to the Customer. This strategy helped to reduce overall cost while increasing exit costs to the Customer for termination of the project agreement with the Company. Tax incentive agreements generally last 5 to 10 years in
length compared to logistics agreements whose terms are 3 to 5 years. Thus, there were potential risks to consider. If the Customer eliminated or changed the Company contracted for logistics services, the incentive agreement would have terminated, thereby forfeiting future benefits. Closing a location prior to
expiration of the incentive agreement could have resulted in the need to pay back a portion of or all of the benefit received. In order for the customer to receive the incentives, the Customer had to agree to repay the Company for any repayment of the incentives it may have to make to the
state or local authority. This provision helped the Company reduce risk in this complicated, start-up, service offering with this customer and when contracting with other customers.
BID ACCEPTANCE / INCENTIVE NOTIFICA TION
After the Company won the bid, the Company informed the Customer of the incentives and started to develop a plan to address some of the contractual terms and the publicity opportunity upon the state’s approval of the incentives. The Customer chose to make an announcement and promote its brand the day the state approval came in order to manage content, rather than let it fall to the state or media, though, inconvenient, coinciding with its busy season.
The State of Ohio had approved the project and granted a $450,000 refundable Job Creation Tax Credit and a $50,000 Job Training Grant. The training grant amount was locked in, but the Refundable Job Creation Tax credit was an estimate, based on actual project performance.
Meris Consulting, LLC When the “Tax Man” Can Actually Help June 2015 Prior to this project, the Company’s Tax Department had been tasked with working with various states to capture additional benefits or to reduce operating costs for the business. Discussions had already begun to secure a sales and use tax exemption on warehouse equipment for logistic companies. This was not an unrealistic request, as retailers that owned and operated warehouses in the State of Ohio had already been granted a sales and use tax exemption on warehouse equipment. The State of Ohio was hesitant to provide such a broad exemption that could compromise their budget for current and future years. With full knowledge of this upcoming capital investment for a fulfillment center, a proposal was submitted for an exemption to be granted for a fulfillment center. The state of Ohio approved the exemption for this new project. This project required $26 million in warehouse equipment to store, sort, and process orders for the entire United States market for the Customer. The estimated exemption for the initial project was just under $1.8 million. Another $300,000 in sales and use tax exemptions would be recognized during the second phase in year two of the project. The sales and use tax exemption on warehouse equipment for logistics companies had resulted in a timely and lucrative gain for the Company and the Customer.
ACTIVATION & REALIZATION OF JOB CREATION CREDIT
The official start date of a project is the date when formal approval is granted by the state. Incentives can be activated the same day or another date after the approval date. Making the activation date for this project January 1 of the following year, resulted in capturing Job Creation Tax Credits for 12 months instead of 4 months. The additional benefit was $150,000. Resulting in the actual amount of the Job Creation Tax Credit being higher, well over $600,000 over the 6 year period, rather than the $450k originally projected. In addition, there was no
adverse impact from delaying the start date for the Job Creation Tax Credits. The training grant of $50k was captured within a 24 month period.
This project required the hiring of 1,000 temporary or part time employees for peak months of the year. The additional labor resulted in higher Job Creation Tax Credits for those that worked over 40 hours per week and worked more than half the year. The additional hiring and the timing of the activation both had contributed to a higher incentive total compared to the initial projection. To obtain the credit a Job Creation Tax Credit annual report had to be filed by March 1 with an expected tax certificate coming in June. The tax certificate could be used to reduce or create a refund when filing the Commercial Activity Tax return. Once the Company received the benefit from the State of Ohio, the credit was again passed on to the Customer.
SUCCESS & SAVINGS
This project was a big “Win” to the Company, the Customer, and to the State of Ohio. The State of Ohio now has numerous fulfillment centers located within its borders. The Company and Customer of this project summarized above realized significant savings. The credits, incentives, exemptions, and grants realized were: $600k – Job
Meris Consulting, LLC When the “Tax Man” Can Actually Help June 2015 Creation Tax Credits; $50k – Job Training Grant; approximately $2.1 MM - Sales & Use Tax Exemption - totaling nearly a whopping $2.7 MM in savings.
CONCLUSION
Relying upon tax experts who are experienced in the site selection process who can provide astute research, option analysis, discovery of and application for various tax incentives and credits, and effective negotiation skills could give your business a competitive edge and satisfy customers. Expert pre-build and implementation work as noted above could reap substantial rewards. This may just warrant a-look-see for your next location or relocation project and ensuing decisions for achieving real current and future benefits.
AUTHOR
Rob Gray is a Tax Incentive Manager /Consultant with Meris Consulting, LLC, a full-service consulting firm dedicated to helping middle market leaders and their teams flourish. Rob’s business career spans over 20 years, and includes managing accounting and tax functions for transportation & logistics, retail, and hospitality enterprises and more. He has worked extensively with indirect taxes (sales/use, personal property, business license, gross receipts and excise taxes) and specializes in compliance, audits, financial analysis, tax planning, financial reporting, and tax research. His skills include negotiating and appropriating tax abatements and incentives which have resulted in significant savings, immediate and long-term, for his employers and clients.
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