Written by Salem Desir, Esq.
One of the areas that has a significant influence on data center development does not get enough attention because of its lack of “sexiness”. Tax law plays a major part, through government incentives and regulations, in the financial viability and location of data centers.[i] Just like most other major real estate deals, tax policies can make or break any capital-intensive data center development deal.[ii] One single missed tax incentive could potentially cost a project millions of dollars, and an optimized tax structure can significantly increase the ROI for investors.
The Impact of Tax Incentives
State and local governments offer numerous tax incentives to attract data center development.[iii] It can be inferred that these incentives are designed to stimulate economic growth, widen the local tax bases, and bring in more jobs. The most common tax incentives promoted are:
· Sales and Use Tax Exemptions
Several states offer a sales and use tax exemption on the purchase of IT equipment, including cooling systems, for data centers.[iv] We can all see that inflation is affecting everything in our daily lives, and the same holds true for data center equipment.
· Income and Franchise Tax Credits
Companies that build or expand data centers within certain jurisdictions can take advantage of credits against corporate income or franchise taxes.[v] For the most part, these credits are based on how much capital is invested or the number of jobs created.[vi]
· Property Tax Abatements
Some local governments may offer data center developers or investors an opportunity for little or no property taxes on their investment for a set period.[vii] This would be a chance for data center operators to lower their long-term operational costs.
Data center developers and investors should find these incentives attractive because they significantly lower the total cost of owning a data center. Total cost is a key factor in site selection, and jurisdictions like Virginia, Texas, and Oregon have a concentration of centers because of their favorable tax policies. For example, the Virginia Data Center Sales and Use Tax Exemption is a tax policy that provides an exemption eliminating state and local sales tax on the purchase of expensive computer equipment, including servers, routers, and cooling systems. This translates to huge savings, lowering the overall cost of developing and operating a data center in Virginia.[viii]
Regulatory Challenges
Data Centers are unique in that they are real property and a hub for personal property. Furthermore, while incentives are a major catalyst, tax law also presents some challenges.[ix] Some key challenges are:
· Depreciation and Valuation
The relatively fast depreciation of IT equipment and the high cost of building a data center can produce valuation challenges for property tax reasons. Tax assessors have to find out the fair market value for a facility, which can be difficult.[x]
· Nexus and Multistate Taxation
Bigger companies operating or owning data centers in multiple states must maneuver a plethora of state and local tax laws. Nexus, which aids in the determination of whether a company has sufficient presence to be taxed in a state, is complex for data centers. To be clear, the presence of servers in a state can create a tax nexus regardless of a company’s main operations existing elsewhere.[xii]
These factors all exist on the same plane and require data center developers to do extensive due diligence and work closely with tax professionals to optimize their financial strategies. The changing nature of both tech and tax law means this is a constantly evolving landscape. The rise of AI and its power demands will lead to new tax regulations, and as a result, tax law in relation to data centers is a crucial area for professionals to watch.
– Salem Desir
