Have you been paying attention to the media’s coverage of the accelerating migration of enterprise and internet data center operations into colocation facilities and to the news about the roll out of more and more data centers across the country in service of the internet? If so, you may be up to speed on the exceptional tax “incentives” being offered to data center developers to move into specific states, cities, and counties. Most of the media’s recent attention has been focused on the mega size data center deployments, financed by the large internet and colocation operators in the U.S. But all data center owners, operators, and tenants should be equally mindful of how taxes and “incentives” will affect the tax burden and total cost of ownership (TCO) of a new operating facility, and what all should be considered when developing comprehensive site selection criteria.

The total tax cost of ownership (Tax TCO) calculation represents the tax and incentive component of a TCO calculation and can constitute as much as 8% or 9% of the overall costs of a given data center deployment. And, the variations in tax and legal codes from city to city and state to state can create real challenges for any developer to quickly grasp and compare the costs and benefits of alternate sites. In fact, some have found that opportunistic decisions to quickly select an available site, while failing to fully consider the many variables related to local taxes and incentives, can result in substantial and unnecessary costs in terms of real property, business personal property, and sales tax bills. Sort of like winning the lottery and finding you can’t afford to pay the taxes.

Opportunities to improve upon the tax baselines that you are accustomed to working with can often be found in the detailed assessment of circumstances surrounding your plans, including: i.) tax legislation and negotiated tax incentives; ii.) project development and finance; iii.) purchase and sales agreements; iv.) leases and service level agreements; and v.) a wide range of energy issues, including energy regulation and energy facility development and finance. Areas that deserve special attention include state and local taxation, economic development incentives, project finance, governmental affairs, permitting, and business transaction documentation.

In order to effectively manage your Tax TCO, you should take the time to fully understand the underlying codes and regulations that can affect a new deployment, and determine exactly how each tax and incentive is calculated, and how it is best negotiated. Calculations are often intertwined functions of both the applicable statutory tax framework that applies to your specific deployment (statutory benefits) and the discretionary tax incentives for which your organization may or may not qualify (discretionary benefits). The most substantial component of these two categories is usually the first part of the equation, or the statutory benefits.

STATUTORY BENEFITS

More than a dozen states have recently passed legislation to compete for the commitments of data center operators to move into their territory, bringing the total number to about 25 states that are now aggressively positioned to make attractive offers for your business. Many state laws have created very favorable tax frameworks for the “large single user” deployments, offering exceptional statutory benefits to those who can qualify for this upper echelon user category. The incentives have been so attractive, in some cases, that developers have been known to enlarge the scale of their deployment or add phases to their plans, just to take advantage of the incentives in their selected jurisdiction.

Large single user deployments are defined as facilities with a critical IT power load of over 10 megawatts, which usually translates into a total capital expenditure of $200 million or more for a single deployment. The chart below compares the Tax TCO burden for such a facility at a number of competing jurisdictions, looking solely at the statutory benefits available to them. Statutory benefits are those available, by law, to virtually any developer who wants to locate in the area. They may come in the form of tax rates applied to business personal property taxes, sales, and use taxes and TPT Taxes.

As you can see in the Table 1, the variations from state to state are rather extreme and can influence your decision in a big way. However, statutory benefits represent only part of the picture in most jurisdictions, and most well informed large single users look for other sources of tax benefits to supplement these while comparing alternative sites.

On the other hand, as much as the large single users have dominated the market over the last several years, they now represent a declining portion of the data center real estate deals projected in the future. As more and more enterprises look to “outsource” their IT mission and look for ways to reduce capital expenditures, we expect to see a continued uptick in the rate of migration to colocation facilities, especially in the range of 500 KW and 10 MW of critical IT power load (mid-level user). And, we expect to see continued deployment of internet data centers in the form of smaller edge computing sites and micro data centers, as well. In fact, the large single user category now appears to represent less than a third of the new development activity that is on the horizon while mid-level user deployments are now emerging as the dominant segment of the data center “new development” marketplace.

The comparative Tax TCO from state to state is very different for deployments in the mid-level user category with lesser tax incentives offered than are offered for the larger deployments. Table 2 shows how the Tax TCO for a number of key jurisdictions generally stack up when looking solely at statutory benefits for a 1 MW mid-level user deployment. But, with that in mind, a number of states are currently planning to level the playing field by bringing more progressive offerings to the mid-level user. These new programs may start moving so quickly that competitive offering may change within the narrow time frame between the initiation of your assessment and your final site selection decision. So it could pay to stay abreast of the changing tax environment in locations that are of interest to you.

DISCRETIONARY BENEFITS

The other component of tax benefits mentioned above that can have an effect on your Tax TCO, and affect your selection process, are discretionary benefits that are available to some deployments in varying degrees depending upon the circumstances and parties involved in the transaction. These benefits typically involve government programs focused on tax relief for specific locations or for specific legislations intended to encourage growth and prosperity. They usually come in the form of tax abatements or exemptions for business personal property taxes or real property taxes. In some jurisdictions, such as in Texas, you will find that rebate programs can be negotiated with the city and county, where the facility is located, as some form of reduction in local sales taxes on data center technology or other expenditures.

When pursuing discretionary benefits, many circumstances affect the eligibility of the facility and the owner for the various programs available and a variety of unanticipated challenges may need to be managed. The essence of this type of benefit is the discretionary approval needed from local government that may come along with the deal. Approval often involves requirements that are not already well established, and that can take the form of the provision of various services or contributions to the community that need to be negotiated in detail.

While the addition of data center sites can bring many positive attributes to a community, data centers are often not well understood by local governments and some of their characteristics may raise concern in the minds of community leaders. So, when approaching a new community for incentives, it is important to remember that their leaders have a fiduciary duty to protect their revenue sources and quality of life while enhancing the economic opportunities for the people they serve.

When approaching a jurisdiction to seek approval for discretionary benefits, the positive attributes of the data center development need to be highlighted and valued in terms that can be appreciated by that specific community. The total combined spend, inclusive of owners, operators, and tenants, at even mid-level data center or data center campus can easily exceed $100 million. Bringing as much of that money as possible to spend on community services and products providers is a great place to start, but it is just the beginning.

When granting economic development incentives, communities frequently focus on the creation of new jobs. While data centers usually do not create the same order of magnitude of job creation of other facility types, other benefits for the community are often sought. However, the direct jobs created are generally highly skilled and high wage paying opportunities of the community. And, data center development projects also create a large number of highly skilled construction, support, and ancillary jobs along the way.

Two obvious, but significant, drawbacks to incenting a data center to move into the neighborhood are the data center’s power demand and water consumption, so your organization must be prepared to respond accordingly, offering helpful solutions to ease the measure of risk to the utilities that support the community. Working directly with the utilities can often ease those concerns. They can also result in opportunities to reduce data center operating costs by negotiating improved energy and water rates in return for the selection of efficient operating systems and practices.

Data centers also increase fiber network densities as carriers build out more infrastructure to the site to meet the demands of their clients. Data center communities effectively form a digital hub which can attract more investments from other data center developers and other companies in the technology sector, which can greatly multiply opportunities for the host community. This new data center community will also offer new IT services to the enterprises in the region that will help them operate more efficiently and grow to better contribute to the region. All of these factors can be used to enhance the dialogue with the local jurisdiction when discretionary benefits are on the table.

In conclusion, much advanced planning is crucial to the effective negotiation of a Tax TCO that you can live with especially if discretionary benefits make up a significant part of your plans to offset the facility tax burden. Waiting until you are ready to close on a property or until after you sign a lease will not allow time to achieve the most favorable results. So, an overall Tax TCO management plan that allows your organization to understand the statutory benefits of alternative sites and that includes a well thought out strategy to quantify and pursue discretionary benefits should always be incorporated into the site selection process. Such a plan represents the “best practices” model for achieving optimal Tax TCO results.

Jim Grice will soon be contributing his data center blog to Mission Critical Magazine. He plans to present the ten most “legal critical” issues now affecting data center development and operations in the United States. Tune into our upcoming e-newsletters and our online blog content to get all of the details, at http://www.missioncriticalmagazine.com/blogs.