NMTC: can a leverage structure alleviate investors' concerns?

• Author: Stevenson, Annette L.
• Position: New markets tax credit

In December 2000, Congress established the New Markets Tax Credit (NMTC) program as part of the Community Renewal Tax Relief Act of 2000. It intended the program to attract $15 billion in private equity investment in low-income or distressed communities over a seven-year period. While the program has noble goals, it is fraught with risk for the investor. In comparing it to similar tax credit investment vehicles, potential investors raised concerns as to the risks associated with recapture, the complex compliance issues facing qualified entities and the uncertainty caused by the program's newness. As a result, practitioners began to develop various structurings to apply the concepts of leveraging without violating the NMTC rules. On Jan. 23, 2003, the IRS issued Rev. Rul. 2003-20, which addresses a specific leverage structure.

Background

A detailed analysis of the NMTC program appeared in the June and July 2002 issues of The Tax Adviser; see Lederman, "Will the New Markets Tax Credit Stimulate Low-Income Communities? (Part I)" TTA, June 2002, p. 390; (Part II), TTA, July 2002, p. 454. To summarize, the program allows investors to take a 39% Federal tax credit over a seven-year period on the equity invested in qualified entities, known as community development entities (CDEs).The investor claims the credit at a 5% rate in years one through three and at 6% in years four through seven, on its original equity investment in the CDE. The CDE uses the equity proceeds to make qualified low-income community investments in the form of loans, equity investments or financial counseling and other services provided to low-income community businesses.

Program administration is the responsibility of the Community Development Financial Institutions Fund (CDFI), a branch of Treasury. In April 2001, the CDFI published initial guidance, and, in December 2001, the IRS issued temporary regulations to assist CDEs and investors; see Temp. Regs. Sec. 1.45D-1T. Each year, the CDFI specifies the amount of tax credits available and awards it through a competitive application process. In March 2003, it awarded the first round of tax credit allocations to 66 CDEs, for $2.5 billion of equity investment. It has combined the 2003 and 2004 allocations, which total $3.5 billion. Applications for this round are likely due in fall 2003; the CDFI will most likely announce the awards in spring 2004.

Investment Risks

Although the NMTC incentive was supposed to attract investment...