Navigating the EU’s incentives landscape has always been a challenge for resource-constrained companies. Now, stricter Brussels rules regarding the financial framework governing state aid, effective as of July 1, only serve to further complicate the horizons of companies already struggling to demystify a labyrinthine system.
The latest diktats impose stricter limits on the amount of grant aid member states are allowed to employ in an effort to entice corporate investors to set up, expand or even safeguard existing facilities. They also raise the bar by insisting investors demonstrate that state aid is a significant, contributory factor in their investment strategies.
Even companies with plans to expand at existing locations, through job creation or capital expenditure programmes, are subject to fresh constraints, which insist that any expansion falls within a redefined sphere of economic activity.
What is more, building on previous frameworks, the new terms and conditions are intended to discriminate disproportionately against large multinationals and, instead, favour small and medium-sized enterprises.
The concept of state aid
For a long time, the EU argued that incentives distort the market and that curbing state aid is crucial to maintaining open, competitive and free enterprise. Notably, this is in stark contrast to locations across the Americas and Asia, where communities openly court and compete for investment by crafting incentives packages and enacting helpful legislation.
The EU has coined the concept of ‘state aid intensity’ to describe the cap that member states must abide by when using incentives to entice prospective corporate investors. And, as an additional complication, the maximum award towards eligible project costs – taking in capital expenditure and payroll – not only varies by country, but also by region.
The catch 22 for investors is the highest state aid intensity levels are reserved for poorer regions on the EU periphery, which lag behind not only in terms of economic development, but also in pools of educated talent, infrastructure and business climate.
The new changes are exemplified in Poland. Under previous rules, the Polish government could offer a large multinational a package worth up to 40% of project costs for an investment into Wroclaw – an area popular with outsourcing and captive service centres – whereas in lesser developed locations, such as Lodz, aid intensity was set to 50%. Today, the permitted state aid ceiling has been reduced to 25% in Wroclaw and 40% in Lodz.
Despite these rule changes, there is some good news, as the appetite among EU governments to offer grants remains steadfast, with most recognising that the long-term value corporate investment generates far outweighs the cost of incentives.
This means that, providing EU parameters are respected, member states retain a certain degree of latitude in interpreting the guidelines and are free to develop their own incentives programmes.
Depending on the specific economic development priorities of each region, an array of fiscal and non-fiscal instruments may be put at the disposal of prospective investors to mitigate investment and recurring costs. These include corporate income tax abatements, capital- and job-creation grants, contributions towards training and up-skilling, interest-free loans, the mitigation of infrastructure and site development costs.
In some EU countries, where recent budgetary constraints have bitten hard, governments are forced to be more circumspect. In Slovakia, for instance, whereas investors were previously presented with a choice of fiscal and non-fiscal instruments, today’s preference is to offer fiscal packages.
Meanwhile, in the Czech Republic, non-fiscal incentives are now reserved for very large investments into designated sectors, but the Czechs boast that they are one of the few countries to have enshrined in law the right to a corporate income tax holiday.
Room to negotiate
Beyond regulations, hurdles and budgetary constraints, there still remains ample room to negotiate attractive deals. As a caveat, however, prospective investors are strongly advised to:
● Prepare thoroughly: ensure that all incentives programmes are painstakingly explored at each and every level of government – EU, national, regional and municipal. For instance, companies often miss out on incentives, such as breaks on property-related taxes, which may only be available via a local municipality.
● Maintain competitive leverage: committing to a location by signing a lease or hiring staff before an agreement is in place is a cardinal error. Letting it be known that there is keen competition from elsewhere for the investment greatly strengthens bargaining position.
● Remember to negotiate: often operating under severe time pressures, companies lose out unnecessarily during the negotiating process by agreeing too quickly to a deal. Multiple rounds of negotiation are often required before a ‘best and final offer’ is achieved.
● Trumpet the added value: emphasise the positive impact the project will have in terms of its multiplier effects on a candidate location’s wider community both directly (i.e. job creation, up-skilling, tax receipts, etc) and indirectly (procurement of local services, suppliers, etc).
● Do not overlook training and research and development aid: innovation and up-skilling are key priorities for the EU. Funding for training programmes are often cap-exempt from state aid rules and can be accessed during the lifespan of the investment, not merely at the outset.
● Set realistic expectations: while incentives awards can be lucrative, remember that a higher state aid intensity ceiling does not necessarily equate to more money. Based on past experience, the gap between the state aid ceiling and the actual award can be sizeable. So while the theoretical maximum aid intensity level across Poland’s voivodships (administrative subdivisions) ranges from 15% to 50%, investors will do well to negotiate a package which exceeds 8% of eligible project costs. In Slovakia, state aid intensity levels reach as high as 35% in some parts, but securing an award which exceeds 20% of eligible project costs is a considerable achievement. Many German states, by contrast, tend to honour the full aid intensity level depending on the suitability of the project.
● Institute proper governance: although the bureaucracy and paperwork that accompanies the process is tedious, it is important to commit to the initiative fully with buy-in and representation from finance, human resources, real estate and procurement departments. Set the tone from the outset by tightly controlling and choreographing internal and external communications. Once negotiations are completed, assign a designated responsible person or team to oversee monitoring and securing of benefits (many companies lose out after securing the award through failure to draw down on benefits or fall foul of clawback provisions).
Here is a vital five-step process to improve prospects for obtaining aid:
1. Fact find: establish availability and qualification criteria for incentives programmes; form a view on the probability of qualifying for support; gauge the likelihood of funds being available to support the project.
2. Position project: identify appropriate counterparties and commence informal discussions with candidate locations by setting out project plans including ramp up, capital expenditure programmes and the value delivered to the local community.
3. Prepare for negotiations: develop negotiation strategies and obtain management agreements; agree communications protocols; submit formal requests for proposal to candidate locations.
4. Conduct negotiations: conduct multiple rounds of negotiations and establish best and final offers; finalise negotiations and formalise offers via letters of intent or an equivalent document.
5. Implement agreement: complete administration and legal reviews; secure benefits and monitor draw down on funds under applicable programmes.
Value to be found
Tackling incentives in EU countries can be a daunting part of site selection for resource-constrained companies. While the EU forbids subsidies in prosperous jurisdictions and limits their scope in other developing regions, savvy investors can still conclude attractive deals. Investors need to weigh likely returns against the investment in time, resources and the obligations that are ultimately tied to an agreement.
There is a certain irony in the demands the EU makes of investors to demonstrate that incentives are essential to realising a project. While there is no doubting the need to respect this diktat, privately it should be acknowledged that incentives should never be regarded as the key enabler for an investment. The augmentative effect they have on the business case should be viewed in a proper context against other more meaningful location considerations, such as quality, scalability and sustainability of workforce, infrastructure, business climate and risk.
Alex Ash is a director at JLL and leads the business and location consulting practice.