United States: Georgia Ad Valorem Tax Incentives Through Bond-Lease Transactions In GA

All Georgia communities can provide partial relief, and some can provide full exemptions, from ad valorem taxes for certain privately-used facilities through bond-lease transactions. This ability can be used as an incentive to induce the location of a new business or the expansion of an existing business in the community. This incentive can be provided whether or not the project qualifies for tax-exempt bond financing.

An absolute waiver of ad valorem taxes would be illegal under the Georgia Constitution as well as under basic principles of uniformity of taxation and equal protection of the laws. Ga. Const. of 1983, art. 7, sect. 1, para. 3; See also, e.g., Sheet Metal Workers' Intern. Ass'n v. Lynn, 488 U.S. 347, 109 S.Ct. 639, 102 L.E.2d 700 (1989) (holding that the systematic undervaluation by state officials of other taxable property in the same class "contravenes the constitutional right of one taxed upon the full value of his property"); Hillsborough v. Cromwell, 326 U.S. 620, 623, 66 S.Ct. 445, 448, 90 L.E.2d 358 (1946) (stating that the "equal protection clause . . . protects the individual from state action which selects him out for discriminatory treatment by subjecting him to taxes not imposed on others of the same class"). However, if a development authority owns the property and leases it to a private business, the property is in a different class and can be taxed advantageously.

To create a property tax incentive through a bond-lease transaction, a development authority issues tax-exempt or taxable bonds to acquire a facility that it will lease to a private company. (For more information on tax-exempt bonds, request our "Overview of Private Activity Bonds and Incentives," or on taxable bonds, our memorandum "Taxable Versus Tax-Exempt Bonds.") The lease payments amortize the bonds, and the company typically will own the facility at the end of the lease. The types of facilities that can enjoy this treatment are described in the particular statute or constitutional amendment governing the locality's development authority.

Using the proceeds of the bonds that it issues, the development authority acquires title to the project to which the incentive will apply. The lease of the property to the lessee company calls for annual rental payments equal to debt service on the bonds. The bonds are payable solely from the lease payments. This lease is a triple-net financing lease passing income tax ownership of the property and usually includes a purchase option exercisable for a nominal sum when the bonds are paid. The lessee company normally acts as the development authority's agent to contract for, oversee and acquire the property to be leased. The lessee company may advance the costs of the property and be reimbursed from the proceeds of the bonds. The lessee normally is entitled to depreciation, is responsible for insurance, taxes and maintenance, has freedom with respect to design and construction, and may be regarded as the project "owner" for all other practical purposes. During the term of the financing, the lessee has essentially the same control over the project as under conventional financing. Furthermore, covenants and security devices usual in conventional lending normally can be incorporated in the bond transaction. Frequently, although the bonds and lease have a term of at least the period which has been agreed upon for the tax incentive, the documents provide that the lessee company can require the bonds to be paid early. Upon payment of the bonds the purchase option is effective and the lessee can obtain full legal title to the project without restriction.

The lessee company may arrange for the sale of the bonds to provide for the financing of the project. However, many lessee companies prefer not utilize the bonds for actual financing, but to purchase the bonds themselves in what is sometimes referred to as a "phantom bond" or self-purchased bond transaction. Because the lessee pays the annual debt service and receives the funds back as a payment of debt service on the bonds on a same day basis, there is no real financial or accounting impact in such a transaction. Because the funds used to purchase the bonds typically are received back as a reimbursement (often on the same day) for costs expended on the project, the lessee/bondholder's only investment is in the project itself. The bond framework provides a vehicle to put the legal title to the assets in the development authority, to access ad valorem tax incentives.

Some communities have developed policies on when such property tax incentives will be made available. Other communities have not, but can be approached, usually through the local development authority, about making the incentives available in a particular case. However, a bond-lease transaction may violate the state constitutional requirement of uniform taxation and the state statutory requirement that all property be returned for taxation at its fair market value if other taxpayers in the same county who leased similar property financed by bonds had not obtained a similar reduction. (Coweta County Bd. of Tax Assessors v. Ego Products, Inc., 241 Ga. App. 85, 526 S.E.2d 133 (1999)). The Coweta County case emphasizes that the lease should be clear in describing the property to be subject to the tax incentive and that the county tax assessor's office should be made aware of and acquiesce in the development authority's incentive policy or activities.

There are three types of Georgia development authorities with differing powers regarding ad valorem tax leasing transactions:

  • Authorities created by general statute, such as the Development Authorities Law and the Downtown Development Authorities Law, which can only provide reduced taxes on the lease.
  • Authorities created by constitutional amendment with power only to provide reduced taxes on the lease.
  • Authorities created by constitutional amendment with power to provide complete or partial tax exemption.

Bond-lease financing through authorities in the first two categories results in a tax on the value of the lease only. The value of the leasehold estate must be determined by the local tax commissioner. Given the terms and other characteristics of the lease, taxation of the leasehold will be less than taxation of the ownership interest. See, e.g., Delta Airlines, Inc. v. Coleman, 219 Ga. 12, 131 S.E. 2d 768 (1963) and DeKalb County Board of Tax Assessors v. W.C. Harris & Co., 248 Ga. 277, 282 S.E.2d 880 (1981).

The Harris case in particular discussed how the tax assessors are to discharge their duty to determine the value of the leasehold subject to tax. The Court indicated that there may be a variety of methods that are acceptable and approved the particular method utilized. The method approved in that case involved determining the fair market value of the leasehold (by analyzing market rents), deducting the assumed value of the property (determined by capitalizing the annual bond payments), and adding the value of the reversionary interest of the lessee (presumably, the "equity" accumulated toward the acquisition of the project through rental payments). Thus, the taxable assessment increased annually based upon increases in market value of the property and the portion of rental payments applied to principal of the bonds.

The challenger in the Harris case argued that the leasehold should be taxable as if the property were owned entirely by the lessee company, based upon the assertion that the lessee had all practical ownership over the property and would obtain title upon paying a nominal sum when the lease terminated. In rejecting this argument, the Court noted that the lease contained significant restrictions on the lessee, making its interest less than fee simple ownership. For example, the lease required the lessee to operate the project throughout the term for the sole purpose of continuing its business operations, limited the expenditures which the lessee could make on the leased property, required any plans for modifications to the property to be submitted to the development authority, and gave the authority a right to inspect the premises. Under the lease, the lessee was required to maintain its corporate existence and, if the premises were to be sublet, would still be primarily responsible for the rental payments and the premises would have to be operated for the same purposes. The lessee agreed not to convey its interest during the lease term, and, upon the occurrence of an event of default, the authority could terminate the lease and exclude the lessee from possession.

Many counties, following the general outline of the Harris valuation method, routinely value bond leases in annually-increasing increments, corresponding to the percentage of principal repaid on the bonds. In other words, for a ten-year project where principal of the bonds is repaid in equal periodic payments, 10% of the fee simple valuation will be applied after one year, 20% after two years, etc. until the full fee simple valuation applies after the ten-year bond maturity. Different results may be obtainable when repayment of the bonds is hastened or delayed.

Assessments are required by law to reflect the market value of property. Although the Harris case provides one method of valuation, particular assessors can and do apply different methods. For example, some counties assess the leasehold at one-half the value of the full ownership interest. An incentive tends to lose effectiveness if its impact is uncertain. Unfortunately, because the Georgia ad valorem tax abatement incentive derives from this tax assessment treatment rather than a statutory scheme, businesses receiving these incentives frequently are forced to rely upon "gentlemen's agreements" or informal understandings and past practice concerning the future assessments they will receive.

With constitutional authorities in the third category, the lease will be fully exempt from tax. The Constitution of 1983 outlawed local constitutional amendments, so new constitutional authorities may not be created. See Ga. Const. of 1983, art 9, sect. 1, para. 1. Two Georgia Supreme Court decisions, McMillan v. Jacobs, 249 Ga. 117, 288 S.E.2d 211 (1982), and Hart County Board of Tax Assessors v. Dunlop Tire & Rubber Co., 252 Ga. 479, 314 S.E.2d 188 (1984), have held that the interest of lessees from development authorities of this type obtained in bond-lease arrangements were entirely free of ad valorem taxation. The Court emphasized in each case that the pertinent constitutional amendment stated not only that the development authority was not subject to property tax but that the property of the development authority was not subject to tax. Thus, the Court concluded that the exemption from taxation extended to a leasehold interest in the property held by a lessee under the authority.

In the several jurisdictions that have constitutional authorities exempting all property of the authority from taxation, as in the McMillan and Hart County cases, businesses can be assured that they will receive the incentive. Because the abatement resulting from the lease is for 100% of the value of leased property, such an incentive might provide more tax relief than is desired by the community. A practice has emerged requiring the business and the development authority to enter into a payment in lieu of taxes ("PILOT") agreement that requires the company receiving the tax abatement incentive to make payments in lieu of taxes in accordance with an agreed-upon schedule. Alternatively, or in addition, the agreement may require the business to make payments based on some percentage of the tax abatement received to the extent the business does not live up to its commitments to increase investments, provide employment, and so forth. Such arrangements should be enforceable against the business, so long as they are clear and the development authority has given adequate consideration for the agreement, which consideration can be found in the authority's agreement to enter into the bond-lease transaction.

Ordinarily a contract in which a city or county agrees to waive taxes or to accept stated amounts in lieu of taxes is void. See, e.g., Georgia Presbyterian Homes, Inc. v. Decatur, 165 Ga. App. 395, 299 S.E. 2d 900 (1983). However, a private party enjoying a valid tax exemption, as described above, may agree to pay amounts in lieu of taxes if the agreement is supported by consideration and does not otherwise violate state law. A PILOT agreement may be useful to refine the ad valorem tax incentive arrangement or to reconcile a situation in which the ad valorem tax incentive is intended to be shorter than the period over which the project is to be financed with the bonds. For example, the PILOT agreement can call for the partial payments in lieu of tax to be made over an initial 5- or 10-year incentive period, for full payments in lieu of tax to be made after the end of the incentive period and until the bonds are paid in full and title to the project is transferred to the lessee, or for payments ("claw-backs") to be made by the lessee if it fails to meet agreed-upon criteria for level of investment, number of jobs, length of operation or similar matters.

Communities should carefully consider their ad valorem tax incentives and tailor a uniform policy that appropriately encourages the type and location of businesses that are desired. The policy should weigh the forgone taxes against the broader benefits that the community will receive in terms of jobs, future tax base, increase in allied economic activity and taxes, and increased property values. As described above, the incentive policy must be tailored to the laws governing the particular jurisdiction and should be uniformly applied.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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