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Understanding Incentives in the Automotive Industry

In the competition between states and localities for new automotive jobs and investment, economic development incentives often play an integral role in influencing corporate location decisions.

Incentives -- which can take the form of cash grants;  tax credits, exemptions or abatements; free or discounted land and buildings; and employment training assistance (among others) -- are able to materially offset the large upfront investments required by many production facilities, mitigate risks, and/or reduce projected operating costs. 

However, a full understanding of the commitments involved (there are strings attached) as well as the true, realizable value of the incentive, is paramount to making a sound location decision.

Below are descriptions and examples of the types of incentives that deliver the most value to automotive projects, followed by recommendations for optimizing the value of incentive packages and negotiating with public entities. 

(Note:  A full list of potential state incentives is available here.)

Cash Grants and Deal Closing Funds

To provide direct financial assistance to win highly competitive projects, some state legislatures have set aside large sums of money -- often called “deal closing funds” or “governor’s funds” -- for the purpose of attracting new jobs and investment.  Stipulations such as pay-for-performance measures (under which job creation and investment milestones must be achieved before cash payments are received) are commonplace for these programs.  Cash grant awards can range from several hundred thousand dollars to $10 million (or more) depending on the state and the project.

Perhaps the most well-known cash incentive program is the Texas Enterprise Fund (TEF), with typical awards ranging from $5,000 to $10,000 per job depending on the number of jobs created, average annual wage, capital investment and availability of funds.  These discretionary grants require a minimum of 25 new jobs for projects locating in rural areas and at least 75 new jobs for projects locating in urban areas.  The TEF program was used in 2016 to attract CGT US Limited to New Braunfels, Texas, when the company committing to reshoring its coated fabrics and films manufacturing facility from China -- creating 275 jobs and investing $80 million.  For its commitment, CGT was awarded a $2 million TEF grant. 

Other high-profile automotive projects utilizing TEF include Toyota’s North American Headquarters relocation to Plano in 2014 after receiving an award for $40 million.

The Michigan Business Development Program (MBDP) is another discretionary cash grant program that has been used by the automotive industry quite frequently - with pay-per-performance awards approaching $10,000 per new job created.  The program requires at least 50 new jobs be created in developed counties and at least 25 new jobs created in rural counties.  In 2016, Magna Seating Inc. received a $740,000 MBDP grant for expansion of its Highland Park manufacturing facility after committing to creating 148 new jobs and investing $6 million.

Sales Tax Exemptions/Refunds on Building and Construction Materials

One of the often overlooked upfront costs involved in a new automotive project is the “sales and use” taxes paid on building and construction materials.  While most states offer statutory sales and use tax exemptions on machinery and equipment used in the manufacturing process, only a limited number of states offer discretionary exemptions or refunds on building or construction materials. As with most manufacturing projects, new automotive-related facilities tend to require a large capital outlay at the outset of a project. Forgiveness of the sales tax on construction materials can save a project millions in construction costs at precisely the time when cash flow may be a concern. Programs of this nature typically require minimum job creation and investment thresholds, as well as demonstration of a competitive alternative location for the project.

Kentucky offers a discretionary refund of sales and use taxes (currently 6%) paid on building and construction materials through its Kentucky Enterprise Initiative Act (KEIA).  To receive the incentive, companies must make a minimum investment of $500,000 in building and construction expenditures and can receive the incentive for up to seven years.  As part of a $7.9 million investment in a new Maysville, KY, production facility in 2016, MACA Plastics received a $33,000 KEIA award to renovate a 122,600 square foot, previously vacant facility.  The company also committed to creating 156 new jobs at the facility, which will supply components to the automotive industry.

Real and Personal Property Tax Abatements

For large investments, real and personal property tax abatements can be the most lucrative incentive the project receives. Property tax abatements typically extend for up to ten years at varying abatement percentages over the term of the incentive.  Abatements are typically approved at the local government level and may include approval by county, municipality, school district and special district governments.

Due to statutory limitations, some states only allow for real and personal property tax abatements through a public ownership model, utilizing bond issuances in which a government body takes legal ownership of the real and/or personal property and leases it back to the company. In exchange, the lease payments under this model become equivalent to a reduced property tax levy, often called a fee- or payment-in-lieu-of-taxes (FILOT/PILOT), as the property is legally exempted from property taxation because it is technically government-owned.  Under this abatement model, local government approval is still required.  Dana Light Axle Products (2016) used this same public ownership model under the Missouri “Chapter 100” property tax abatement program, which abated half of the company’s personal property taxes for seven years.  In total, the Chapter 100 program saved the company $1.4 million over the seven year period, while Dana committed to creating 135 new jobs and investing $39 million in machinery and equipment at the company’s Columbia, MO, plant.

While not always labelled as an incentive, it is important to consider statutory property tax exemptions when making location decisions. States such as Illinois, Michigan, and Ohio do not levy property taxes on manufacturing personal property.

Employee Payroll Incentives

In an effort to entice job creation, some states offer discretionary tax incentives based on the incremental employee payroll created by the project, allowing for the retention or refund of all or a portion of the incremental withholding tax. Some states alternatively offer refundable and non-refundable corporate income tax credits based on incremental employee withholding taxes.

An example of employee payroll incentives which have benefitted the automotive industry is the Missouri Works Program – which offers a payroll benefit of up to 7% of new employee payroll for up to six years. The payroll benefit is offered in the form of retention of employee withholding taxes, combined with fully refundable and transferable tax credits, to equal the total annual payroll benefit awarded. New or expanding projects must meet minimum job creation, investment, and average wage thresholds, which vary by county. In 2014, Martinrea, a manufacturer of plastic injection-molded components for the automotive industry, utilized the program when it received a $3.2 million award from the Missouri Works Program after announcing a new 275,000 square foot facility in Riverside.  The company will invest $51.6 million and supply the nearby GM OEM plant.

Infrastructure Grants

Grants for public infrastructure improvements are widely used throughout the Midwest and Southeast. One method for providing these grants is a funding mechanism by which state governments transfer allocated funds to local governments for economic development purposes. Local governments use the funds to implement infrastructure improvements to benefit the community and attract new investment. While these projects can provide general benefits, they can also be focused on efforts to attract a specific project and/or facilitate expansion of an existing operation. Funding can be used to partially, or sometimes entirely, finance improvements to water and sewer, road, waterway, pipeline and rail infrastructure. In some cases, funds can also be used for site preparation. Tax increment financing by local governments are another mechanism used to finance similar infrastructure projects.

The Mississippi Development Infrastructure Grant Program is an example of a state infrastructure grant program where counties or municipalities apply on behalf of a new or expanding company for state funding. Projects are evaluated based on their job creation and retention, investment and public infrastructure needs. Tennessee offers a similar grant program through its FastTrack Infrastructure Development Program which automotive supplier companies such as DENSO Manufacturing Inc. have utilized. In 2015, DENSO expanded its Maryville, TN, production facility, investing $400 million and creating 500 new jobs. The company received a $5 million FastTrack grant for adjacent land acquisition and site preparation in anticipation of the expansion.

Job Creation and Investment Tax Credits

Job creation tax credits which award a statutory amount of tax credits per job created have traditionally been used to attract manufacturing operations. States such as Georgia and South Carolina provide non-refundable job creation tax credits that vary in amount by county.  LINDE + WIEMANN received an estimated $3 million in Georgia Jobs Tax Credit for its new 63,500 square foot manufacturing facility and office that located in Hart County in 2016.  The company invested $35 million and committed to creating 200 new jobs. 

Many, if not most, tax credit programs are based on job creation (or, alternatively, payroll creation), but some offer tax credits in exchange for investment. Automotive and other manufacturing projects, which are becoming less labor-intensive, will be well-served to inquire about these types of credits.

As a complement to its existing employee payroll incentive, Indiana offers a tax credit incentive to attract projects which are more capital-intensive through its Hoosier Business Investment Tax Credit. The non-refundable tax credit is equal to ten percent of qualifying capital investment and offers a carry forward for up to nine years.

Note regarding all tax credits:  If the credit is non-refundable, it only has value if the company has a tax liability against which to use the credit. 

Utility Incentives

Utility/energy incentives should not be overlooked, nor oversimplified.  Many electric providers offer “economic development riders” establishing a lower rate per kWh for qualified projects. The incentives offered by utility companies generally range from two to five years, with a few lasting longer. Most discounts depreciate over the term of the incentive, and most have minimum kW demand or kWh threshold requirements (determined as new load or incremental load increase), as well as minimum job creation and/or investment targets. The kW demand requirements may be as low as 10 - 25 kW or as high as 1,000 kW, but the majority require a total demand of 200 kW or more. Operations with high load factors (i.e., high AND constant usage levels) may be eligible for additional savings.

However, utility incentives are not limited to the kWh rate. Power companies will have varying line extension and cost-to-serve policies, with some providing incentives for sharing/forgiveness of infrastructure development costs.  Additionally, a few utilities – like the Tennessee Valley Authority (TVA) – are able to offer performance grants and low-interest loans for qualifying projects.

Additional utility incentives include energy efficiency programs, renewable energy programs and renewable electric commodity options.

Customized Workforce Training

Anyone in the automotive industry is aware of the increasingly concerning “skills gap” in the US manufacturing sector. This topic is of such importance that BLS & Co. will be addressing workforce training and labor force skills in greater detail in a later article. Until then, readers interested in learning about workforce training programs widely regarded as best-in-class should review Georgia’s Quick Start and South Carolina’s readySC programs. Both provide extremely flexible and customized training to prospective workers, thus mitigating the talent risk involved in the start-up of a manufacturing operation.

Special Legislation and Extraordinary Incentives

Should state or local governments want to further attract particular projects which offer significant job creation, capital investment or emerging technology, special legislation can be used to create a customized offer outside of the existing statutory menu of incentives. Benefits may involve reduced corporate income and franchise tax liability for an extended period of time, and property tax abatements extending beyond existing statutory limits. Local governments can also provide certain extraordinary incentives such as free or reduced price land acquisition, or significant private and public infrastructure improvements.

The recent high-profile Tesla announcement offers an example of the use of special legislation incentives. In 2014 Tesla announced it will build a “gigafactory” just outside of Sparks, Nevada, which will create 6,500 new jobs and invest $10 billion. The incentive deal, estimated at a total of $1.3 billion, required special legislation from the Nevada Legislature and consists of a twenty-year sales tax exemption, property tax exemptions over ten years, reduced corporate taxes over ten years, transferable job creation and investment tax credits, incentivized utility rates, infrastructure improvements, and legislation that allows the company to sell its cars directly to consumers.

Another special legislative deal was announced in Mississippi last year for Continental Tire to establish a commercial vehicle tire manufacturing plant in Clinton. Incentives valued at $596 million were used to attract 2,500 new jobs and $1.45 billion in capital investment. The total incentive package, which required special legislation from the Mississippi Legislature and the local county legislative body, consisted of grants for site acquisition and preparation, reduced corporate income tax liability over a twenty-five year period, property tax abatements, and retention of employee withholding taxes.

Value Optimization

Some mistakenly identify the objective of an incentive negotiation as achieving the largest dollar amount. To the contrary, value is optimized not by a large dollar award alone, but rather by the realizable value, which is a function of multiple complex factors including flexibility, usability and scalability.  The most obvious illustration is to consider the value of non-refundable tax credits in excess of actual liability – the value is $0.

Compatibility of programs is another consideration, as there are often legal prohibitions against combining certain programs to benefit the same project.

Companies must also pay very close attention to the legal and operational nuances of timing and scalability when setting target investment and job counts, as a mistake in this area can result in not being able to claim incentives to the fullest extent of eligibility, or even in a complete loss of benefits. 

Additionally, incentive agreements, if not properly negotiated, can unintentionally constrict a company’s ability to respond to future market conditions through overly stringently compliance requirements concerning job counts, continued operations, investment requirements, ownership, and other issues. 

A host of other factors – such as the definition of a “new job” (Do contract employees count?  Part-time employees?) and the ability for benefits to pass through a lessor to a lessee – affect the ultimate value of an incentive package. Thus, the objective of the incentives negotiation is to align all of these elements in a way that optimizes the realizable value.

Negotiating with Public Entities

Negotiating incentives requires discussion with public organizations during a period in which the company probably wants anything but a public process. It typically also requires the sharing of certain financial information and strategic market information. While economic development organizations are generally highly professional and discreet, open records laws – which differ by state – must be considered and appropriate precautions taken through non-disclosure agreements and operational procedures. For these reasons, many companies like the added protection of a project code name and/or a third party intermediary in order to postpone identifying the company until as late in the process as possible.

Of utmost importance is meticulous attention to maintaining “but for” status until all requisite incentive approvals have been achieved. Many incentive programs have a “but for” requirement meaning that “but for the incentive” the project would not go forward. If a company misinterprets an incentive offer as an incentive approval, and moves forward too quickly, it runs the very real risk of making itself ineligible for benefits. Timing of real estate acquisitions, equipment purchase orders, hiring, and public announcements is paramount to maintaining eligibility for most incentive programs. 

Think your next project might be eligible for incentives?  Check out our website to see if you may qualify for incentives on your next project! 
This is the second piece in a series of six short articles on location economics for automotive companies. Check out the first article here.  Future topics include Labor Costs, Infrastructure, Global Market Considerations, and Workforce Training/Skills.
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