Member Article

As Congress begins to work on the Moving Ahead for Progress in the 21st Century Act (“MAP 21”), the bill to reauthorize highway funding for the next five years, policy makers are confronting the challenge of how to bridge the estimated $400 billion gap in funding between federal revenues and transportation infrastructure investment needs.1 The Obama Administration recently made clear that it does not support a comprehensive vehicle mile tax or an increase in the excise tax on gasoline during the current recession.2 That leaves few options on the table.

One option that appears to remain in favor with the new Administration, however, is attracting private investment capital through public-private partnerships (“P3s”). Transportation Secretary Ray LaHood endorsed the P3 approach unequivocally when he approved $600 million in low-interest loans for the I-595 project in Florida under the Transportation Infrastructure Finance and Innovation Act (“TIFIA”). He called the deal “part of the Obama Administration’s commitment to reviving the economy.” Later, when asked by Senator Frank Lautenberg how he would close the massive shortfall in infrastructure funding, Secretary LaHood said, “The highway trust fund is simply not going to allow us to do all the things that we want to do . . . And so we need to think about public-private partnership.”3

Treasury Advanced Notice of Proposed Rulemaking

While the Administration’s transportation policy seems to support private investment as a partial solution, its tax policy on P3s remains unclear. In fact, there are troubling signs that the Administration may inadvertently adopt a tax policy at odds with its transportation policy. Last November, the Treasury Department issued an Advanced Notice of Proposed Rulemaking suggesting that it wants to evaluate whether a government license to collect tolls is an interest in real property or an intangible right.4 There are several adverse domestic and international tax consequences that could flow from the conclusion that the right to collect tolls on a public highway is a real property right.

                (a) FIRPTA

First, Treasury itself observed that foreign investors might be subject to the Foreign Investment in Real Property Tax Act (“FIRPTA”) if toll rights are a type of real property. The purpose of FIRPTA was to ensure that foreign investors would not be able to escape federal income tax on gains from trading in U.S. real property.5 And, under this law enacted in 1980, the sale by a foreign investor of a U.S. real property interest is subject to a withholding tax.6 The withholding tax could be expanded to cover toll collection rights in some cases under Treasury’s reasoning. In addition, because toll rights will often exceed 50% of the value of the assets in a P3 deal,7 the conclusion that such rights are U.S. real property will in some cases result in a withholding tax on sales of the stock of U.S. corporations formed to hold P3 rights,8 limiting the attractiveness of P3 investment opportunities to foreign investors.

                (b) Depreciation of Intangible Assets

Correspondingly, if a license to collect revenue is a type of real property right, it might be subject to a different depreciation regime. As intangible rights are depreciable over 15 years,9 while leased infrastructure is written off over the life of the lease, this expansion of the depreciation period is a far more significant consequence. Curiously, Treasury says absolutely nothing about general depreciation rules in its Advanced Notice, but perhaps that is because the Department recognizes that there is case law and precedent contrary to the view that government licenses are real property rights, even when they enhance the value of real estate.

In the past, the IRS has maintained that licenses such as racing or liquor licenses are intangibles, not real property interests,10 and it has been the assumption of the parties to major recent P3 transactions where the investor leased existing toll roads that the right to collect tolls on a public highway under applicable state law is an intangible asset. In many cases, P3 projects require an act of the legislature that grants the P3 concessioner the right to collect tolls for each specific deal. This grant is independent of the land and infrastructure, although it may be observed that the right cannot be used without possession of the infrastructure.

An analogous situation is a license to conduct business as a retail store. The business cannot sell goods to the public without the real estate that houses its inventory and showroom, but few would argue that the license to conduct business is real estate itself, even if it enhances the real estates’s value. Another close analogy might be a lease to operate a food concession in a mall’s food court. The lease itself is an interest in property, but the lease is likely to be nearly worthless without a license to operate a food business. Like the right to collect tolls, the license to sell food to the public is a separate right. It enhances the lease, but it is separate and distinct from it.

In nearly all states, the owners of private highways are not entitled to collect tolls under state law without express permission.11  The right to collect tolls is not included in the title to real property, and under the longstanding rule that state law creates and defines property for federal tax purposes,12 rights such as the right to collect tolls that are specifically excluded under state law should not be included in the definition of real property under FIRPTA or for any other federal tax purpose, in the absence of overriding legislation to the contrary.

Bingaman Legislation

At least one powerful member of the Senate Finance Committee has taken a particular interest in the tax aspects of P3 infrastructure deals. Last summer, U.S. Senator Jeff Bingaman, the Chairman of the Senate Finance Committee Subcommittee on Energy, Natural Resources, and Infrastructure, held a hearing on the tax and financing aspects of highway public-private partnerships. In his opening statement, Chairman Bingaman called the 15-year amortization period for intangible assets acquired in a P3 transaction a “taxpayer subsidy.” More recently, he circulated draft legislation that would make the amortization period for toll rights in certain P3 highway deals coextensive with the term of the lease. In other words, if a private investor leases existing transportation infrastructure for a term of 75 years, the Bingaman legislation would require the toll rights to be depreciated over 75 years for tax purposes.

Senator Bingaman’s concern is limited to so-called brownfield projects, where the infrastructure has been used — but not necessarily tolled — prior to the initiation of the lease. In addition, it does not appear that the Bingaman legislation would extend to P3 deals where the private investor acquires shadow toll rights,13 or is paid directly by the state or local government based on some other measure of performance. Finally, the legislation is limited to highway infrastructure P3s. Nevertheless, in its current form, the legislation will limit the options of some states with brownfield assets at a time when states are searching for every possible source of revenue. Moreover, the Bingaman bill could serve as a model for broader legislation that would cover new construction. Without a tax policy team in place at the Treasury Department, the Obama Administration has yet to make its views known on the Bingaman proposal.

Possible Effect on P3 Investment

The ability to treat the right to collect tolls as an intangible asset depreciable over 15 years is critical to the economics of most P3 infrastructure transactions. Unfortunately, a cloud of tax uncertainty has emerged from the international regulation writing team at the IRS and the Treasury Department. In this environment, prudent investors will be forced to factor this tax uncertainty into their deal pricing, thereby reducing the revenues available to governmental entities. If the Administration is serious about promoting P3s as a way to bridge the gap in funding, it should act quickly to clarify the tax rules in this area. A rule such as that proposed by Senator Bingaman would not necessarily slow the pace of P3 development if it remains confined to brownfield projects, but as long as its specifics remain in flux, it will cast a shadow on all P3 infrastructure development in the United States.