Tax incentives are intended to spur economic growth which may have not otherwise occurred. More specifically, these grants and tax breaks are usually offered to convince businesses to relocate, hire, and/or invest within a state’s or community’s borders. But what happens when a company doesn’t make good on their commitments?
Many states seek repayment of incentives known as a clawback. A clawback is a provision in an economic development agreement that requires a company to repay any financial benefit gained for which it did not meet certain performance thresholds, such as job targets, capital investment levels or project timelines.
The existence of clawback provisions is not new, but such provisions are being initiated more frequently and becoming more stringent. States such as Indiana, Tennessee, and North Carolina are also instituting new clawback provisions into incentive deals.
It is important to note that many states are also issuing an annual report to publically track the status of repayments owed by companies.
When negotiating or complying with incentives, companies should consider the following items to help prevent and/or remediate clawback provisions:
- Define key terms early in the negotiation process. Companies often don’t fully understand what they are agreeing to when signing incentive agreements or completing applications. Be sure to understand all key terms and how they relate to the project such as what counts as a “new job.” A best practice is to review any required ongoing compliance reports with program administrators before entering into an incentive agreement.
- Set realistic commitments and timelines. Consider the best and worst case scenarios for the operations. Allow for flexibility in the timeline to account for unforeseen circumstances such as not being able to recruit and fill open positions or a delay in construction.
- Opt for incentives which don’t include strict clawback provisions. Sales tax incentives and training grants typically have fewer clawback provisions than grants, loans and tax credits.
- Accurately complete compliance reports. Many compliance reports contain vague instructions that can be easily misinterpreted. Understand the reporting period and what should be included in the amounts reported. Reference the tax credit agreement when completing reports and ask questions to the program administrators.
- Proactively renegotiate, if necessary. In most cases, the earlier a company notifies the jurisdiction that it may not meet its contractual obligations whether due to changes in internal operations, fluctuations in the economy, or a merger or acquisition, the easier it may be for the jurisdiction to renegotiate the agreement terms.
The bottomline is that when it comes to clawbacks, it’s complicated! Arguments can be made both ways on when and how clawbacks should come into play. On the one hand, some people believe companies who do not meet commitments should be held accountable for repaying any and all incentives. On the other hand, many incentive programs are performance-based meaning until jobs are created, companies are not eligible to receive incentive anyways. Moreover, total tax revenues generated from the project usually outweighs any incentives the companies realized.
Regardless of your viewpoint, economic incentives are here to stay and clawback provisions will likely impact more companies as states work harder to track their return on incentive investments.