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Texas Tax Talk: Planning For Property Tax Break's Sunset

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Law360 recently published an article by Baker Botts Partners Matt Larsen and Renn Neilson, and Senior Associate Bucky Brannen.

 

A version of this piece can be read on Law360, here.

 

"To the well-organized mind, death is but the next great adventure." — J.K. Rowling

 

For the past two decades, Texas Tax Code Chapter 313 — also known as the Texas Economic Development Act — has been critical for attracting capital investment to Texas by reducing property tax burdens on the state's largest manufacturing developments. Close to 500 Chapter 313 agreements have been entered into since the program's inception.

Chapter 313 is set to expire Dec. 31, 2022, and the Texas Legislature does not meet again in regular session until January 2023. So, the recently concluded regular session was likely the Legislature's last opportunity to extend the program before its sunset.

The Legislature considered many proposed bills that ranged from a simple two-year extension, to robust overhauls of the program. But to the surprise of many, the Texas Senate declined to consider any of the proposed bills, and the regular session ended May 31. The Legislature will convene in special session beginning on July 8, but Chapter 313 has not been listed as an agenda item for the special session.
 

Although the program will likely sunset, it will stay alive for those developers who can meet the application requirements discussed below and enter into a Chapter 313 agreement before the sunset date. And, as described below, the benefits of signing an agreement before the program sunsets are significant — for both developers and school districts.
 

Developers considering a large Texas project should carefully analyze Chapter 313's advantages and requirements and — given the protracted application timeline — be prepared to move forward with an application well in advance of the Dec. 31, 2022, sunset date.

 

Overview of Chapter 313

School district property tax rates make up about half of Texas' total property tax rate and includes two components: maintenance and operation taxes, and debt service and facilities — known as interest and sinking fund, or I&S — taxes.
 

The current version of Chapter 313 allows school districts to place a 10-year value limitation on a qualifying project's appraised value for maintenance and operation property tax purposes. The value limitation differs per school district, ranging from $10 million for the smallest districts to $100 million for the largest. The project still pays full I&S taxes, which cannot be abated under Texas law. There is no other abatement available for school district taxes.
 

Texas schools are mostly funded based on their student count, not the size of their property tax base. So, Chapter 313 agreements generally do not negatively impact school funding at the district level — the state bears this cost.
 

Therefore, by attracting a project that qualifies for value limitation under Chapter 313, school districts enjoy (1) significant supplemental and revenue protection payments under the Chapter 313 agreement — as we discussed in more detail in a previous Law360 article; and (2) additional I&S property tax revenue, all of which are kept by participating districts and used to pay off their debts.

 

Importance of Chapter 313
 

Having a mechanism to reduce the burden of school district taxes has been useful in attracting new capital-intensive manufacturing facilities to Texas. A new facility's cost generally establishes its initial property value assessment, with the value then depreciating over time.

So in the facility's early years — when the company faces construction costs prior to earning profits and budgets are frequently most strained — the project will face its greatest property tax burden.
 

For this reason, many states offer temporary tax incentives to new developments, generally forgoing some property taxes in the early years of a project in exchange for the long-term benefits of capital investment and expansion for their job base.
 

Texas' combined school district, city, county and other taxing unit property tax rates are among the highest in the country. So even though abatements for city and county taxes will continue to be available, the lack of a mechanism to reduce school district taxes will put Texas at a disadvantage with developers comparing property tax costs of alternative sites.
 

For example, developers often compare manufacturing facility locations in Texas and Louisiana.
 

In Louisiana, a facility located in Calcasieu Parish will likely face an effective property tax rate of around 1.7% and will automatically qualify for the state's industrial tax exemption program — which grants 80% property tax abatement of all Louisiana property taxes for 10 years. For a $1 billion facility, this would produce a post-incentives property tax burden of about $29 million for the first 10 years of the facility's operation.
 

In Texas, a similar facility would typically face a materially higher total property tax rate — around 2.5%. Even with the Chapter 313 program, if the project receives maximum property tax incentives1 for 10 years, which is rare, a Texas project would still owe full school district I&S property taxes, school district maintenance and operation taxes on the value limit, and sizeable supplemental payments and revenue protection payments as part of its Chapter 313 agreement.
 

In a school district with a typical 1.05% maintenance and operation rate, 0.40% I&S rate, and $30 million value limitation — the $1 billion project would pay about $47 million of property taxes over the first 10 years of the facility.
 

Without Chapter 313, even with maximum Texas incentives, the facility would owe about $124 million in property taxes over its first 10 years. So, beginning in 2023, to locate a $1 billion project in Texas instead of Louisiana, developers will be forced to convince their investors, financers and company board to pay an additional $100 million in property taxes over the project's first 10 years.

 

Not Dead Yet — Planning for Chapter 313's Sunset

Texas Tax Code Section 313.171 provides that Chapter 313 agreements executed before Dec. 31, 2022, will continue in effect under Chapter 313 as the law existed on Dec. 31, 2022. So a developer that can successfully navigate the application and agreement approval process before this date may take full advantage of the 10-year value limitation, despite the program's sunset.
 

Accordingly, developers with projects on the horizon — even if distant — should determine whether an application should be submitted in time to qualify for the program, taking into account the following timetables and considerations.

 

Application and Approval Process and Timetable

The developer must submit an application to the school district using the form provided by the Texas Comptroller of Public Accounts. The application requires significant detail about the project, including the project site, to-be-constructed improvements, improvement values, construction timing, and job and wage projections.
 

If the school district elects to move forward with the process — and they almost always do — it sends the application to the comptroller. The comptroller then determines whether the application is complete. The date on which completion is determined is referred to as the application review start date.
 

Within 90 days of the application review start date, the comptroller must perform an economic impact evaluation and — if the project meets the criteria to qualify for Chapter 313 — issue a certificate of limitation for the project.
 

The developer and school district must negotiate and submit for comptroller approval an agreement setting forth the terms of the program and the developer's obligations. The comptroller has 20 business days to approve the agreement.
 

After comptroller approvals discussed above have been obtained, the school district's board must approve the agreement in a public meeting. This approval must occur within 150 days of the application review start date, although extensions of this deadline may sometimes be obtained.

 

Legal and Strategic Considerations

To ensure completion of the review and approval period before the Dec. 31, 2022, sunset date, it will be critical to submit an application early. Prudent applicants would ideally begin initial coordination with the school district in the first quarter of 2022 — and the earlier the better.

Delays could result from the need to educate school boards and superintendents on the program before submitting the application. Once the application is submitted, the comptroller has no deadline for making the initial determination that the application is complete, so this phase could be prolonged, particularly if there is a last-minute swell of applications.
 

Developers who do not receive a comptroller certificate of limitation until late in 2022 may face the unenviable task of convincing school boards to call special meetings during the holiday season to rush the necessary formal approval before year-end. If the comptroller's office cannot complete its review in time, or if the school board does not vote to finalize the agreement in December 2022, then the developer will be locked out of Chapter 313.
 

In preparing applications and agreements, developers will need to coordinate with school boards, the district's lawyers and financial consultants, and the comptroller's office. Expertise in navigating this process, including providing the level of specificity needed for application approval and avoiding issues that could lead to application delays, will be critical in finalizing an agreement before the sunset date.
 

The comptroller has historically provided some flexibility to amend project details, including construction schedules, after agreement approval, but because it is unclear to what extent the comptroller will maintain its current operating policies and procedures after the program sunsets, it will be important to achieve the right balance between providing sufficient detail and preserving project flexibility.
 

Chapter 313 requires project owners to make a minimum capital investment2 in their projects during the qualifying time period, which by default means the period that begins on the date of agreement approval and includes the next two full calendar years. Developers may, however, elect to defer the start of their qualifying period up until Jan. 1 of the fourth calendar year beginning after the agreement is approved.
 

Thus, an agreement finalized in 2022 could defer its qualifying period to as late as 2026-2027. And, if the agreement is one of multiple agreements related to the same closely related project, i.e., part of a series, the qualifying period could qualify for a six-year deferral, to as late as 2028-2029.
 

The 10-year value limitation period may begin on the first Jan. 1 following either (1) the application date, (2) the qualifying time period, or (3) the commencement of commercial operations. If, for example, an agreement defers the qualifying time period until 2026-2027, the 10-year tax limitation period could be 2028-2037. And if the limitation period is based on a project's commercial operations date, the tax limitation period could begin even later.
 

The 10-year value limitation is not limited to property constructed during the qualifying time period. Taxes are reduced for all qualified property placed in service after the application review start date through the end of the 10-year limitation period.
 

Even if a project is speculative as of 2022, a developer would still be well served to consider applying for the program. The risk of investing time and expense to investigate project sites and submit a Chapter 313 application that ultimately goes unused is likely dwarfed by the tax benefits of a Chapter 313 agreement if the project does move forward in Texas.
 

Given the foregoing considerations, a developer should have a significant flexibility to negotiate a Chapter 313 agreement that would achieve tax savings prior to the sunset date — even for a project that may not be constructed for several years. Achieving optimal benefits, however, will require an application and agreement strategy that takes into account all the program's complex financial elements.

 


 

Matthew L. Larsen and Renn G. Neilson are partners, and Bucky Brannen is a senior associate, at Baker Botts LLP.

 

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

 

1 That is, 100% property tax abatement by the city, county, and all special taxing units such as hospital, college, or water districts, as well as a 313 agreement.
2 The minimum qualified investment requirement ranges from $10 million to $100 million depending on the school district.

 

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