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By Lydia O’Neal
Regulated utilities excluded from a major tax overhaul perk may be able to benefit from it indirectly—with the help of banks, which would be the biggest winners.
Banks could buy equipment, fully and immediately write off its cost, and lease it to a public utility at a reduced price, if the IRS allows. The agency is planning to address the issue in upcoming guidance.
It’s no wonder Bank of America Corp. is asking about it: Banks take up close to half of the general equipment leasing market, according to the Equipment Leasing and Finance Association, an industry group.
“There would be a market impact” if the IRS decided not to allow it, said Andrew Fishburn, ELFA’s vice president of government relations, adding that how significant the effect would be remained an open question. “Trucks, because of their relatively short depreciation schedule, are one thing, but if it’s a large generator, a turbine, or something like that—that’s a much longer recovery period, and so 100 percent bonus would make a bigger difference from a time value of money perspective.”
The 2017 tax overhaul (Pub. L. No. 115-97) amended tax code Section 168(k) to allow companies to fully expense assets acquired and placed into service after Sept. 27, 2017. But the allowance, also known as 100 percent bonus depreciation, doesn’t apply to public utility property. The exclusion was part of a bargain for utilities under which they are exempted from the cap on deduction of debt interest payments.
In recent proposed regulations (REG-104397-18) for the full-expensing perk, the IRS didn’t address the question of whether another business, such as a bank, could immediately write off capital costs if the property is leased to a public utility. The conference committee report didn’t do so either.
In an Oct. 8 public comment letter, Fishburn asked the IRS to make it clear that lessors qualify for the benefit, even when leasing to excluded businesses like public utilities.
Bank of America would also like to know if the IRS plans on giving them the go-ahead.
“Absent confirming guidance, lessees and lessors are uncertain about the bonus eligibility of property leased to a public utility entity,” James Carlisle, senior vice president of government relations at Bank of America, wrote in an email to Treasury Department officials in mid-August. He said Bank of America was “working with our trades on written comments” on the proposed rules for amended Section 168(k), but wanted to flag the issue for regulators in advance.
Through a Bank of America spokesperson, Carlisle said he wanted clarification, not confirmation, on the policy, and declined to comment further on the emails, which were released recently under the Freedom of Information Act.
Beyond those comments, the spokesperson for Bank of America—which lobbied Congress and Treasury on several tax issues, including the “bonus depreciation provisions” of the tax act, earlier this year—deferred to Treasury when asked for further comment. The spokesperson said the bank had “no preference” as to whether equipment leased to a public utility qualifies for full expensing.
Ellen Martin, a tax policy adviser in Treasury’s Office of Tax Policy who responded to the bank’s emails, told Bloomberg Tax that the department would address the issue in coming guidance. She said officials “had heard in general” about the ambiguity, but that Bank of America was the first to send comments.
“They’re a big lessor,” she said.
“‘Reciprocity’ is the leasing industry term for it—I’m getting depreciation, so I’m going to charge you a lower rate for it,” said David Burton, a partner in Mayer Brown LLP’s Tax Transactions & Consulting practice in New York who focuses on project finance and the energy sector.
A utility might buy a set of trucks on its own for $100,000 and write off bits of that amount over five years under the modified accelerated cost recovery system, a slower depreciation schedule, he said. But, if allowed, a leasing company or bank could instead buy it and deduct the full $100,000 from its taxable income upfront, while the utility would have only been able to write off $20,000 in the first year of ownership.
“The leasing company charges materially lower rents than it would otherwise due to its ability to claim bonus depreciation and the large deferred tax liability,” Burton said, “which is like an interest-free loan from the IRS in economic terms.”
While renting assets can come with its own tax credits, the payoff may not be so simple for a regulated utility. Utilities must factor any tax benefits into the rates they charge customers, and buying equipment may in some cases prove a more worthwhile investment, practitioners said.
“It’s not clear to me that bonus tips the scale enough toward leasing, but it does tip the scale in that direction,” said Keith Martin, an energy lobbyist at Norton Rose Fulbright.
The indirect benefit may be a better alternative to full expensing for public utilities, as “they are buried in” net operating losses, said Brad Seltzer, a partner at Eversheds Sutherland (US) LLP in Washington.
Use of NOLs to lower the amount of income subject to tax can force a regulated utility to lower its rates, and therefore its revenue, under rules known as normalization. If a utility pushes off depreciation of assets—rather than speeding it up and expensing things upfront, as the amended Section 168(k) allows—it can “burn through those NOLs sooner” and restore their rates sooner, Seltzer said.
“I think it’s largely the banks that benefit,” as they’ll get to immediately deduct the cost of the asset they’re leasing, he added.
As David Gillespie, a partner at Winston & Strawn LLP in New York, noted: “Obviously, there’s some demand for it, or they wouldn’t be raising this.”
Previous regulations suggest the IRS could restrict leases of equipment to public utilities. The absence in the tax law’s text of any reference to a subsection of the code limiting similar lease deals points to the agency’s potential approval. The lack of any mention of the issue in the conference committee report and proposed regulations leaves the IRS with plenty of discretion over the outcome, tax professionals said.
The text of the tax law didn’t refer to restrictions on certain leases to tax-exempt entities under Section 168(h), Burton said, which “suggests to me that Congress didn’t intend the public utility rules to apply” to leases to regulated utility companies.
Others aren’t so sure. The IRS could easily point to existing rules restricting the use of tax credits if it decides this issue in final regulations, Gillespie said.
Treasury Regulation Section 1.46-3(g)(3) explicitly describes “public utility property” as “property leased by a lessor, where the leasing is not part of a public utility activity, to a lessee who uses such property predominantly in a public utility activity.”
Allowing 100 percent bonus on equipment leased to regulated utilities “would go against prior regulations,” Gillespie said.
Eversheds’ Seltzer said the law and previous rules refer to use of the property when outlining terms of eligibility for expensing, and that prior cases have found the term “used by” to not include ownership. But he said Treasury and the IRS could decide to allow the benefit in this instance simply because they want to.
“Who can object?” he said. “In my mind, it’s an oversight. This, like a lot of other things, sort of fell through the cracks in the rush to get this done.”
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