Congress votes tax changes affecting project finance; tax-exempt bonds, us tax deferral, depreciation study

Congress votes tax changes affecting project finance | Norton Rose Fulbright

November 01, 1998 | By Keith Martin in Washington, DC

Congress voted a number of tax law changes that affect segments of the project finance community shortly before adjourning for the November elections.

Tax-Exempt Bonds

It increased the so-called volume cap that limits the amount of tax-exempt bonds that state and local governments can issue each year to finance private projects.

The current limit is $150 million or $50 times the population of the state, whichever is greater. This would increase to the greater of $225 million or $75 times the population, whichever is greater. However, the new ceiling would be phased in over the period 2003 through 2007. Until then, it would remain at current levels.

Developers of independent power projects sometimes tap into the tax-exempt bond market for part of their financing. This gives them a lower borrowing rate. Tax-exempt financing is most common for power plants that use coal, waste coal, garbage and other forms of biomass as fuel. It is also sometimes used for hydroelectric facilities.

US Tax Deferral

US companies engaged in the “active conduct of a banking, financing or similar business” will find it easier to defer US taxes on earnings from offshore lending.

Since the US taxes US companies on worldwide income, but it does not tax foreign corporations on income from foreign operations, US companies typically set up offshore holding companies in tax havens like the Cayman Islands to receive and redeploy their earnings from foreign operations.

However, this strategy does not work to the extent the foreign operations throw off passive income like interest. The US will look through the Cayman holding company and tax the US owners on any passive income. Tax lawyers refer to such passive income as “subpart F income.” This reflects the US view that it will permit deferral only by active offshore businesses in order to prevent tax planning around where taxpayers want to record income from passive business that can be conducted just as easily from the US.

In late 1997, US banks and securities dealers succeeded in getting a special carveout for interest and other passive income from “active conduct of a banking, financing, or similar business.” The banks argued that, even though the returns look passive, this is an active business for them. However, the carveout lasted only one year and was basically available only for income earned from financing transactions in the same country where the offshore business entity of the bank was located.

Congress just extended it for another year to the end of 1999, and also broadened the carveout to allow deferral for returns from cross-border financing transactions. The US Treasury resisted this feature because its view is that US tax deferral should be allowed only as long as US multinationals retain earnings in the country where they are earned. Most US multinationals currently lift foreign earnings to a tax haven and then redeploy them in other countries, to the consternation of the Treasury. The Treasury has now had to concede the issue — at least temporarily — to multinational banks.

Depreciation Study

Congress directed the Treasury to study current depreciation methods and recovery periods and report back to Congress by April 2000 on any changes it recommends. Most power plants are depreciated over 15 or 20 years. It is an interesting question whether the technology is changing so rapidly that this life no longer reflects the true economic life or, perhaps it reflects economic life but there is a more accelerated pattern to loss of value than is reflected in current write-down schedules.

There is little enthusiasm at Treasury for the assignment. Congress instructed Treasury to do essentially the same thing in 1986. Treasury devoted significant resources to the job and sent a number of reports to Congress, but the reports sat largely unread.

Section 29

The end-of-session tax bill may be more notable for what it did not do. Developers of projects to produce synthetic fuel from coal and steel coke had hoped for more time to place remaining projects in service to qualify for section 29 tax credits. The federal government offers a credit of $1.052 per mmBtu for producing unconventional fuels like landfill gas and syncoal. However, all remaining projects had to be in service by June 30, 1998 to qualify. Syncoal companies pushed hard for another eight months to the end of June 1999 and came extraordinarily close, but lost in the final negotiating round.

Section 45

In what may yet turn out to be good news, Congress did not extend a 1.7 cents per kWh tax credit for producing electricity from wind and “closed-loop biomass.” The credit runs for 10 years. Projects must be in service by June next year to qualify.

The chairman of the Senate tax-writing committee, William Roth (R.-Del.), pushed to expand the credit to cover electricity generated from chicken droppings and extend the in-service deadline. Roth said the US produces eight billion chickens a year.

The landfill gas industry has been looking for a new tax credit to encourage landfill gas production now that section 29 credits are expiring. Congress’s failure to extend the section 45 credit this year gives landfill gas producers another shot at hitching a ride on that credit. The House, which resisted doing anything about section 45 this year, has viewed it as an issue for next year.

Keith Martin