The following is for informational purposes only and does not purport to render legal or accounting advice. 

Participants in a New Markets Tax Credit Transaction

Transactions using NMTC subsidies involve a series of transactions designed to meet the requirements of United States Internal Revenue Code of 1986, as Amended.  The key participants in a NMTC transaction are:  The Allocatee, The Tax Credit Investor, The Leveraged Lender, and the Qualified Active Low Income Community Business (“QALICB”).  The critical role of Confluence Advisors, Inc.  in these transactions is the identification of these parties and brining them and their different interests and objectives together to complete a transaction. 

Allocatees are entities known as Community Development Entities (“CDEs”), which are awarded allocations of NMTCs from the Department of the Treasury by means of a competitive allocation process.  The awarding of an NMTC allocation technically gives the CDE the right to issue equity under Section 45D of the Internal Revenue Code.  In order to complete a transaction, the CDE will establish a number of “Sub CDEs,” which are special purpose entities established to complete specific transactions.  The Sub CDEs are clean entities that are also partnerships for federal income tax purposes.  In summary, the CDE does not bring cash to a transaction.  The CDE only brings a Sub CDE with an allocation of NMTCs and is paid a sub-allocation fee which can range from 3% to 8% of the amount of the NMTC allocation used.

The Tax Credit Investor (“the TCI”) provides equity to the transaction which is represented as a discounted purchase of the par value of the credits to be received.  In recent transactions Confluence Advisors has completed, the pricing of the credits has ranged from $.68 to $.73.  The TCI derives its entire return by means of realizing the par value of the NMTCs over the seven-year allowance period.  The return is independent of the underlying performance of the project.  The only risk to the TCI is recapture, and the transactions will be structured to render the risk of recapture to an infinitesimally small percentage.

The NMTC regulations state that the credits are exchanged for cash only.  The role of the Leveraged Lender (“LL”) , which is usually an affiliate of the Project Sponsor supplies the difference between the tax credit equity and the amount of the QEI.  For purposes of this transaction, it is assumed that PRC or an affiliated entity will be the LL.

QALICB

The Qualified Active Low Income Community Business is the entity which receives the NMTC enhanced financing.  In some cases, the QALICB can be a “portion of a business” whereby of the entity as a whole does not qualify as a QALICB, the “portion of the business that is situated in the low income community” can be a QALICB if a separate set of books and records is maintained for the portion of the business located in a low income community.  For the purposes of this transaction, it is assumed that the headquarters facility in Louisiana will maintain a separate set of books (portion of a business) if the project is not separately incorporated.

Allocatee                                 An entity or organization that has received an allocation of New Markets Tax Credits from the United States Department of the Treasury.  In summary, the Allocatee and its approved Sub-Allocatees have the right to issue tax credit-based equity under Section 45D of the United States Internal Revenue Code of 1986 as Amended.

CDE                                        Community Development Entity, which is any corporation or partnership with a primary mission of community development that is approved as such by the NMTC program.

Compliance Period                  Seven Years

Low Income Community        Census tracts which are qualified for NMTC investments. NMTC Eligible Census tracts include those that have either (1) Median Family Income at or below 80% of Area Median Income (AMI) in 2000 or (2) Poverty Rate of 20% or greater in 2000.

Project Sponsor                       The primary owner of the Qualified Active Low Income Community Business (QALICB).  The developer who is sponsoring the project being financed by the NMTC.

QEI                                         Qualified Equity Investment as defined under Section 45D(b) of the Code.  Summary definition is the investment of equity into a CDE.

QLICI                                     Qualified Active Low Income Community Investment as defined under Section 45D(b) of the Code.  This is the investment made by the CDE to the underlying business (the QALICB).

QALICB                                 Qualified Active Low Income Community Business as defined by Section 45D(d)(2) of the Code

The Code                                United States Internal Revenue Code of 1986, as Amended

Structure

The primary structure in which NMTC transactions are created is based on IRS Revenue Ruling 2003-20, and is outlined in the following graphic.  Also, please note, the following is an example which uses placeholder amounts for the pricing of the credits and the sub-allocation fee.

a.    The $2,948,400 in this example is equal to a $10,500,000 Qualified Equity Investment multiplied by the 39% tax credit, and again multiplied by $.72, which is the assumed pricing of the credits.

 b.    The TCI will earn these credits, which is a fixed return, regardless of the underlying performance of the project.  Failure of the QALICB is NOT a recapture event.

 c. The amount of the tax credit equity is the origin of the subsidy to be provided.

2.  In most cases, the remaining funds will be loaned to the project by an affiliate of the Project Sponsor / QALICB.

 a.  One of the recapture events is the failure of the funds to remain fully invested during the seven-year NMTC compliance period.  A foreclosure could result in funds not being fully invested.

          i.      For this reason, the TCI will require that the Leverage Lender forebear from any foreclosure action during the NMTC compliance period.

 b. The Leverage Lender is also prohibited from having a direct security interest in the underlying project/QALICB.

            i.      The Leverage Lender will typically have a pledge of the membership interests in the Sub CDE, LLC, which is 99.99% owned by the Investment Fund as security.

 3.   The Investment Fund, LLC is a placeholder name in the above example.  A separate Investment Fund, LLC will be formed for each transaction.

a. The sole purpose of the Investment Fund is to invest the tax credit equity and the loan proceeds from the leveraged lender into the Sub-CDE, LLC.

 b. The Investment Fund is 100% owned by and managed by the TCI.

 4.   The Sub CDE is initially a wholly owned subsidiary of the Allocatee.  The Sub-CDE will have the CDE designation from the Department of the Treasury and will (in the above example) been Sub-Allocated $10,500,000 from the Allocatee to facilitate one particular transaction.

 a.   After the Sub CDE, LLC receives the $10,500,000 from the Investment Fund, the Investment Fund owns 99.99% of the Sub CDE.

 i.      The Allocatee is the Manager of the Sub CDE and will own the .01% interest.

b.  The $10,500,000 from the Investment Fund also effects the $4,095,000 of federal income tax credits (39% of the $10,500,000).

 5. The Allocatee is compensated by means of charging a sub-allocation fee.  These fees typically range from 3% to 8% of the QEI amount.  In this example, the sub-allocation fee is expected to be 5% of the QEI.

6.  After paying the sub-allocation fee, the reaming capital will be loaned to the Project, LLC in the form of two loans:  Loan B will be equal to the tax credit equity less the sub-allocation fee, and Loan A will track to the Leverage Loan.

7.  At the end of the Seven-Year NMTC Compliance Period, the Fund will “put” the Investment Fund, which owns 99.99% of the Sub-CDE, to the Project Sponsor (or its designee) for a nominal amount.  At this point, the Project Sponsor effectively owes the Loan B to himself and the loan is effectively forgiven.