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Infrastructure Investors ‘Make Out Like Bandits’ in IRS Guidance (1)

Dec. 5, 2018, 7:58 PMUpdated: Dec. 5, 2018, 10:40 PM

The IRS shielded public-private infrastructure partnerships from one of the 2017 tax overhaul’s less business-friendly provisions—and those projects’ investors are poised to rake in the benefits.

New Internal Revenue Service guidance spares those heavily debt-financed public-private partnerships, or P3s, from the restriction by classifying them as “real property trades or businesses.” The IRS released the guidance Nov. 26, along with more than 400 pages of proposed rules for the law’s limit on debt interest payment write-offs (REG-106089-18).

The move effectively keeps the cost of debt from rising under a tax law change for consortiums of companies that pay to take control of a road, bridge, or other piece of public infrastructure and then design, refurbish, and operate it, often over the course of decades, depending on the terms of the entity’s contract with the state or local government. Such protection is vital for those consortiums of companies, as they tend to depend on debt to finance the expensive projects.

“It’s clearly good for construction companies,” said Andrew Silverman, a Bloomberg Intelligence tax policy analyst. “But the companies that make out like bandits are the banks and alternative lenders.”

Construction and engineering giants, such as Fluor Corp. and Jacobs Engineering Group Inc., could be among those reaping the rewards. Other possible beneficiaries may include foreign infrastructure investment conglomerates—such as Cintra SA, Meridiam SAS, Ferrovial SA, Transurban Group, and Macquarie Group Ltd., whose U.S. infrastructure finance arms often take on a leading role in P3 consortiums.

But the real winners are the investors in these projects, such as private equity funds, as the lower cost of debt will boost their return on investment and cash flow, tax professionals said. Banks, some noted, are also likely to get more business as loans remain an attractive financing tool for P3s.

Electing Out

The tax overhaul amended tax code Section 163(j) to constrict the amount of debt interest expense a company can write off at 30 percent of adjusted taxable income. Interest used to be generally deductible. The new cap generally applies to companies with more than $25 million in annual gross receipts.

“Real property trades or businesses,” however, can elect out, at the cost of losing access to the law’s coveted expensing allowance.

The ability to elect out of the restriction should lower the cost of the project for private consortiums of companies, and will be particularly helpful to the groups of companies paying state and local governments for contractual control of highways, bridges, and waste disposal facilities, said Darren McHugh, a shareholder of Stradling Yocca Carlson & Rauth PC in Denver.

It’s “pretty clear” that the guidance “was precipitated by market participants,” said McHugh, who specializes in debt issuances and lease financings.

But given the propensity of P3s to finance their public asset purchase and design and construction work with debt, as well as the byzantine accounting and interest allocation rules recently proposed for the restriction by the IRS, they’ll more than likely opt for the election to exempt themselves from Section 163(j), tax professionals said.

The Lobbying Push

The guidance, Revenue Procedure 2018-59, followed a lobbying effort from trade groups and companies advocating for such an exception. Among them is the CEO of advocacy group Business Roundtable, whose members include Stephen Schwarzman, the CEO of Blackstone Group LP, which boasts a Saudi-supported multi-billion-dollar infrastructure fund. Jacobs Engineering CEO Steve Demetriou and construction multinational Kiewit Corp. CEO Bruce Grewcock are also members, according to the group’s website.

The group is “pleased that the Treasury Department agreed that this particular tax limitation was not intended to apply to infrastructure-related public-private partnerships,” a spokeswoman said.

In May, eight infrastructure-oriented trade groups—including the Associated General Contractors of America and the Association for the Improvement of American Infrastructure—wrote Treasury Secretary Steven Mnuchin asking for the same exception his department would later afford P3s.

If P3s aren’t considered “real property trades or businesses,” the groups wrote in the May 10 letter, “Section 163(j) would result in a skyrocketing of the effective tax rate on P3s by restricting the P3 project company’s deductions for interest payments.”

Without the exception, the letter continued, a P3 with $100 million in income and $80 million in infrastructure expense wouldn’t be able to write off $50 million from its taxable income it would have been able to deduct absent the tax law passed late last year.

“This certainly shows the strong lobbying power of the infrastructure groups,” said Linda Schakel, a partner at Ballard Spahr LLP in Washington and former attorney adviser in the Treasury Department’s Office of Tax Policy.

The guidance allowing P3s to elect out of the restriction categorizes myriad activities—such as designing, managing, or operating the public infrastructure—as “real property trade or businesses” as long as they’re conducted as part of one of those P3 contracts, she noted.

Uncommon Elements

The revenue procedure states that it is “based on the proposed eligibility parameters for public infrastructure projects for purposes of the private activity bond proposals described in the ‘Legislative Outline for Rebuilding Infrastructure in America,’” a February report laying out the administration’s P3 goals said.

It’s unusual, though not unprecedented, for a piece of guidance to reference a White House legislative plan, tax professionals told Bloomberg Tax.

“It indicates the interest that this administration and Treasury have in this class of investments,” said Stephen Butler, a tax partner at Kirkland & Ellis LLP who focuses on real estate and infrastructure. He added that the guidance nonetheless “certainly wasn’t expected by practitioners.”

The administration already greenlighted the use of tax-exempt bonds to fund infrastructure projects when it issued proposed rules (REG-106977-18) in June that would shield investors in such projects from rebates for any excess earnings they receive over the tax-exempt proceeds.

It’s likewise unusual, but not unheard-of, for a revenue procedure with an application as narrow as the guidance on P3s to be released alongside a set of proposed regulations for the same legislative change, tax professionals said.

The use of a revenue procedure allows the IRS to skip the comment period and finalization process required for regulations and implement its interpretation of the revamped tax code immediately, tax professionals said.

“There is always some uncertainty with proposed regulations,” Butler said. “This particular one is effective Dec. 10,” he said, adding that it’s applicable for tax years starting in calendar year 2018, and “effective until the IRS changes its mind, which could be never.”

(Updates the fifth and 13th paragraphs)

To contact the reporter on this story: Lydia O'Neal in Washington at

To contact the editors responsible for this story: Meg Shreve at; Colleen Murphy at