Tax Issues And Incentives For Projects On Indian Reservations
Projects on Indian reservations qualify potentially for three federal tax subsidies, but time is running out to take advantage of them. The projects must be operating by December 2003. There is always the possibility that Congress will extend this deadline.
The map on the next page shows the location of Indian reservations across the United States.
The three tax subsidies are rapid tax depreciation, a wage credit tied to the number of Indians hired to work on the project, and the possibility of using tax-exempt financing. President Clinton signed a law on November 6 to set up a commission to look into other possible investment incen-tives. The commission is supposed to report to Congress within a year.
Property that would have to be depreciated over five years if it was built elsewhere – for example, a power plant that burns biomass for fuel and is a “qualifying small power production facility” under the “Public Utility Regulatory Policies Act” – can be depreciated over three years if built on a reservation. Most gas and coal-fired power plants are depreciated over 15 or 20 years today. They would qualify for 9- or 12-year depreciation if built on a reservation. Buildings are normally depreciated over 39 years, but 22 years if built on a reservation.
The difference for most power plants is worth about 6¢ for each dollar in capital cost of the project. For example, depreciating a gas-fired power plant over the standard 15 years generates tax savings with a present value of 18¢ for each dollar of investment. Depreciating the project over nine years produces a tax savings of 24¢ per dollar invested. The difference is an extra 6¢. The same calculation for a power plant that would otherwise be depreciated over 20 years – for example, one that burns coal or a combined-cycle gas plant – leads to the same 6¢ in additional tax savings.
These special depreciation allowances apply to property placed in service during the period 1994 through 2003.
There are a few wrinkles: the property cannot be financed with tax-exempt bonds or be leased or used by a tax-exempt or government entity. The taxpayer cannot acquire the property from a related party.
As a general rule, the property must be on the reservation and “not used or located outside the Indian reservation on a regular basis.” One issue is whether a power plant on a reservation that sells its entire output to a utility elsewhere is “used” on the reservation. A lawyer with the Joint Tax Committee in Congress – when asked about the issue in 1993 within a few days after the provision passed Congress – said an independent power facility qualifies since the facility is used on the reservation, even if the output is not.
There is an exception for “qualified infrastructure property.” It qualifies for the special depreciation allowances even though it is not on the reservation. This might be a hook for claiming rapid depreciation on transmission lines and other related equipment off the reservation, but property off the reservation must satisfy additional tests, including a showing that it “benefits the tribal infrastructure,” “is available to the general public,” and “is placed in service in connection with the taxpayer’s active conduct of a trade or business within an Indian reservation.” These phrases have been left for the Internal Revenue Service to define.
There is also a separate tax credit tied to the number of Indians employed on a reservation. This credit is 20% of wages and employee health insurance costs paid during the year for employees who are enrolled members of Indian tribes and their spouses. “Substantially all” the work the employee does must be on the reservation. He must also live on or near the reservation where the services are performed.
Again, there are wrinkles. The employer must do better than he did in 1993 to qualify for this credit. The credit is calculated against his increase in wages and employee health insurance costs for Indians in 1993. Thus, if he employed no one in the target group in 1993, then his base is zero, and he is in a position to benefit fully from the credit.
The wage credit cannot be claimed on wages and employee health insurance costs for the following workers: anyone paid more than $30,000 a year, and – if a corporation is the employer – anyone who owns more than 5% of the outstanding stock or stock possessing more than 5% of the total combined voting power or stock representing more than 50% of the value of the corporation, or – if a partnership is the employer – anyone who has more than a 5% capital or profits interest in the partnership. No more than $20,000 in wages and employee health insurance costs per employee can be taken into account in calculating the credit, even if the person is paid more. Also, money paid for an employee who is fired within his first year does not count toward the credit, with certain exceptions where the employee was fired for cause.
Ordinarily, an employer is allowed to take a tax deduction for his payroll costs. However, the deduction in this case must be reduced by the amount of the tax credit.
The credit applies to amounts paid through tax years beginning by December 2003.
Indian tribes have the authority to issue tax-exempt bonds just like state and local governments, but their authority is more limited and would take imagination – and perhaps an assist from Congress – to finance a power plant.
The authority has had a colorful history since it was first granted in 1982. Initially, Congress said tribes could only issue bonds to finance public facilities – like roads, schools or hospitals – and these had to serve an “essential governmental function.” It specifically ruled out any so-called “private activity bonds” – that is, bonds that go to finance private property like a power plant that will be privately owned or to finance public property that will be put to private use like a power plant that is owned by the tribe but whose output is dedicated under long-term contract to a private company.
Soon after, the IRS issued surprisingly generous regulations. The IRS said a tribe was fulfilling an “essential governmental function” as long as its borrowing was for a public facility that qualified for financial support from the Bureau of Indian Affairs. The BIA will support practically any project that brings some economic benefit to Indians. This interpretation opened the door to abuse. For example, the IRS ruled privately in 1986 that regular commercial banking is an essential governmental function and could be supported by tax-exempt borrowing as long as the bank was owned and operated by the tribe. It was not long before Indian tribes were issuing bonds to acquire tribal businesses off the reservation and to finance housing projects and factories while arguing that these served an “essential governmental function.”
In 1987, Congress declared that the IRS regulations were “invalid.” It said that the IRS had misinterpreted the law and that, when Congress authorized tax-exempt borrowing for essential governmental functions, it meant only to allow it for “activities that are customarily financed with governmental bonds (e.g., schools, roads, government buildings, etc.).”
At the same time that Congress limited what public projects could be financed this way, it opened the door to tax-exempt financing for other projects that do not serve an essential governmental function. The 1987 law allows Indian tribes to issue bonds for projects that can jump through six hoops. Power plants will have trouble getting through three of them. The six hoops are
- the project must be considered a “manufacturing facility” within the meaning of section 144(a)(12)(C) of the Internal Revenue Code. A power plant probably is, but the IRS has never addressed the issue.
- The tribe that issues the bonds must be on an approved list published by the Treasury Department. There are procedures for tribes not on this list to gain approval.
- The project must be on land that has been held in trust by the United States for the benefit of the tribe for at least five years.
- It must be “owned and operated” by the tribe.
- The project cannot be put to more than 10% “private business use,” or – in the case of a power plant – the share of the bond proceeds put to private use cannot exceed the lesser of 10% or $15 million.
- The face amount of the bonds cannot be more than 20 times the annual payroll for Indians who work at the project.
Senator Max Baucus (D.-Montana) made a low-key effort in 1992 to persuade Congress to waive the last three requirements in the case of power plants that use coal or other fuel found on the reservation. Baucus was acting at the request of an independent power company that was looking at building a power plant on a Northern Cheyenne reservation in Montana. Baucus will be the most senior Democrat on the Senate tax-writing committee in the new Congress that convenes in January and in a much better position to effect such changes.
There is no “volume cap” on bonds issued by Indian tribes. State and local governments are limited in the amount of bonds they can issue each year to support private projects – so-called “private activity bonds.” The limit is $50 times the population of the state or $150 million, whichever is greater. These limits to do not apply to Indian bonds.
However, there is a tradeoff whenever tax-exempt financing is used. The project must forfeit rapid tax depreciation. In this case, not only would it not qualify for the special allowances for projects on Indian reservations, but it would also have to be depreciated on a straight-line basis over the “class life” of the project. The “class life” for a power plant that burns coal or a combined-cycle gas plant is 28 years. It is 22 years for other gas-fired power plants. It is 10 years for power plants that run on waste fuels.
President Clinton signed a new law in early November creating a 21-member commission – called the “Regulatory Reform and Business Development on Indian Lands Authority” – that is charged with reviewing all laws and regulations that affect investment on Indian lands and reporting back to Congress by November 2001. The main focus of the commission is to identify rules that inhibit investment. However, there is nothing to rule out recommending new incentives. The US Secretary of Commerce has until January 6 to appoint the members.
by Keith Martin, in Washington