Contractors and investors in P3s can continue taking a full tax deduction for interest on debt under recent IRS guidance (Revenue Procedure 2018-59, issued November 26). Many P3s are highly leveraged, and the interest deduction is a valuable tax benefit for developers. Were this deduction restricted, P3 developers’ (and by extension governments’) costs would rise; potential investors would demand higher rates of return; and infrastructure projects would be more costly. Without this guidance, the 2017 tax law would otherwise severely restrict the interest deduction for businesses. The IRS’ position is welcome (and a relief) and caps an intense letter-writing campaign by industry groups – including the Design-Build Institute of America, Associated General Contractors of America, Performance Based Building Coalition, and Association for the Improvement of American Infrastructure – to the IRS and Treasury.
The deduction restriction (new section 163(j)) emerged from last year’s Tax Cuts and Jobs Act (“TCJA”) and generally caps a business’ interest deductions at 30% of “adjusted taxable income” (which is similar to, but not the same as, EBITDA or EBIT). “Real property trades or businesses” can elect out of these new deduction limits, but at the price of less-generous depreciation for their buildings and other improvements. The actual section 163(j) language is a good deal more complicated, and the Treasury proposed regulations accompanying the IRS guidance consist of 400-plus pages trying to explain everything.
Revenue Procedure 2018-59 provides a safe harbor – which most P3s should meet – under which a P3 will be a “real property trade or business.” As a result, companies and investors in a P3 can elect out of the restricted interest deduction rules – and, because the tax-exempt government agency in a P3 usually owns the improvements which otherwise give rise to depreciation deductions, giving up the more generous depreciation treatment usually is not an issue. Because Revenue Procedure 2018-59 is an administrative promulgation and not a regulation, it is effective immediately and not subject to the comment period and other delays with the accompanying Treasury proposed section 163(j) regulations.
Revenue Procedure 2018-59 follows a trend of mostly favorable treatment for infrastructure by the IRS and Congress, including continuing to allow an exemption for interest on private activity bonds used to funds P3s and proposed regulations issued in June clarifying that investment of bond proceeds in infrastructure projects will not trigger rebates to the government under the Code’s exempt bond arbitrage provisions.