In recent years, private investors have claimed more than $1 billion  in NMTCs annually. The Financial Structures of NMTC Investments Have Become More Complex and Less Transparent While Treasury Guidance Covers Only the Simpler Structures

NMTC investors have developed financial structures that increase the  amount of other funding from either private or public sources that are  used with the NMTC—a process that is called increasing the leverage on  the investment. However, they also increase the complexity of the financial structures by  adding more parties and more transactions, which in turn reduces  transparency and may increase the cost in terms of fees and other related  transactions costs. The NMTC financial structures  have become more complex over time. A Majority of NMTC Projects Used Other Public Funds in 2010-2012

Based on our survey of CDEs with projects originating in 2010-2012, the  use of other public sources of funds with the NMTC is widespread (as  shown in Table 1). As a result, 83 percent of the qualified equity  investment on which an investor claimed NMTCs was provided by other  federal and state tax credit programs. Guidance and Controls Do Not Exist to Prevent Above-Market Rates of Return or Unnecessary Duplication and Costs

Internal controls should provide reasonable assurance that operations  and use of resources are efficient. One NMTC control has been Treasury and IRS  guidance on allowable financial structures. For the CDFI Fund, Treasury does not have controls  to limit the risk of cases like the example from the Urban Institute study  where other public funds were used to expand the NMTC base and  apparently generate a 24 percent rate of return for the NMTC investor. Other controls that could be  considered include caps on rate of returns and mechanisms to ensure  competition among NMTC investors sufficient to prevent above-market  rates of return. Without such complete information the Treasury is limited in its  ability to analyze the final net financial benefit of NMTC investments to  low-income community businesses. In this case, low fees may be offset by higher interest  rates. Furthermore, the CDFI data on equity left in the business are  not sufficiently reliable because they are incomplete and not accurate  enough to capture program performance. As a  result, it is not possible to determine from these data the amount of equity  to remain in the low-income community businesses after the 7-year credit  period. However,  refinancing may not be an indicator of distress. In addition, the data were incomplete because  reporting some information was optional. Similarly, the impact of a combination of  assistance from government programs is diluted if in the same cases the  combination of assistance is unnecessarily duplicative. These include the extent  to which fees, interest rates, and other costs reduce the NMTC equity  flowing to low-income community businesses, the amount of equity  available to the low-income community businesses at the end of the 7- year compliance period, and the number of projects that failed or are at  risk of failing. Treasury said that it is considering our recommendations to issue further  guidance on how other government programs can be combined with  NMTCs, and to ensure that adequate controls are in place to limit the  risks of unnecessary duplication and above-market rates of return. Treasury reported that our recommendations would be reviewed in  consultation with a recently formed working group that includes  representatives from the IRS and the CDFI Fund to discuss potential  administrative or regulatory changes. Treasury also  agreed with our recommendation to clarify instructions to CDEs about  reporting loan performance and make this data reporting mandatory. GAO staff who made key contributions to this report are  listed in appendix V.

Appendix I: Objectives, Scope, and Methodology

The objectives of this report were to assess: (1) New Markets Tax Credit  (NMTC) financial structures in terms of their complexity, transparency,  and effect on the size of the federal subsidies going to NMTC projects as  well as controls to ensure that subsidies are not larger than necessary for  the investment; (2) what is known about the types and amounts of fees  and other costs that reduce the amount of equity reaching low-income  community businesses; (3) what is known about the amount of equity left  in the low-income community businesses after the 7-year credit period;  and (4) what is known about NMTC projects that are at risk of failing by  becoming economically nonviable. Appendix II: Other Federal Funding Used in New Markets Tax Credit Projects

In our survey of New Markets Tax Credit (NMTC) projects, we asked  Community Development Entities (CDEs) what other federal sources of  assistance were used (in addition to the NMTC) to fund the project.
Why GAO Did This Study

In recent years, private investors have claimed more than $1 billion in NMTCs annually. The credits are combined with private loans and other public funds to support investments in low-income communities. GAO was asked to review the financial structure of NMTCs.
This report assesses: (1) the complexity and transparency of NMTC financial structures and controls over the size of federal subsidies; (2) what is known about the types and amounts of fees and other costs of the financial structures; (3) what is known about the equity remaining in low-income community businesses after the 7-year credit period; and (4) what is known about NMTC project failure rates. GAO reviewed Treasury NMTC data and surveyed CDEs that allocated credits to 305 projects in 2010-2012.

What GAO Found

The financial structures of New Markets Tax Credit (NMTC) investments have become more complex and less transparent over time. The increased complexity is due, in part, to combining the NMTC with other federal, state, and local government funds. Based on GAO's survey of Community Development Entities (CDEs) an estimated 62 percent of NMTC projects received other federal, state, or local government assistance from 2010 to 2012. While combining public financing from multiple sources can fund projects that otherwise would not be viable, it also raises questions about whether the subsidies are unnecessarily duplicative because they are receiving funds from multiple federal sources. In addition, in some cases the complexity of the structures may be masking rates of return for NMTC investors that are above market rates. For example, a study done for the Department of the Treasury (Treasury) found an investor apparently earning a 24 percent rate of return, which is significantly above market rates of return. In that case, the investor leveraged the NMTCs by using other public funds to increase the base for claiming the NMTC. Treasury and the Internal Revenue Service issued guidance about allowable financial structures in the early years of the NMTC program, but the guidance has not been updated to reflect the subsequent growth in complexity, such as the use of other public money to leverage the NMTC. Treasury also does not have controls to limit the risk of unnecessary duplication in government subsidies or above market rates of returns. Without such guidance and controls the impact of the NMTC program on low-income communities could be diluted.
The costs of complex NMTC financial structures may not be fully reflected in fees charged by CDEs, and they could be reflected in other costs such as higher interest rates. Treasury has taken steps to ensure businesses are better informed about fees and other costs, but is not collecting these additional data itself. Without these data, Treasury is limited in its ability to analyze NMTC program benefits.
GAO also found that the data on equity remaining in businesses after the 7-year credit period were unreliable because, in part, instructions on what to report are unclear. As a result, at this time it is not possible to determine how much equity remains in low-income community businesses after 7 years.
Similarly, data on NMTC project failure rates were unavailable. GAO reviewed data of performance on loans from CDEs to low-income community businesses as an indicator of whether the businesses will be viable over the long term. However, data on loan performance were also incomplete because some reporting of this information by CDEs is optional. As a result, it is not possible to determine, at this time, the NMTC project failure rate with certainty.

What GAO Recommends

Treasury should issue further guidance on how other government programs can be combined with NMTCs; ensure adequate controls to limit the risks of unnecessary duplication and above-market rates of return; and ensure that more complete and accurate data are collected on fees and costs, the equity remaining in the business after 7 years, and loan performance.
Treasury agreed with GAO's recommendations to improve data collection on equity remaining and loan performance. Treasury said that a recently formed working group, that includes representatives from the Community Development Financial Institutions Fund and the Internal Revenue Service, is considering GAO's other recommendations.