WASHINGTON — The National Association of Water Companies wants the Treasury Department to clarify tax rules so that state and local governments can ensure the tax-exempt bonds they used to finance their water and wastewater facilities will not become taxable if they enter into public-private partnerships.
NAWC, a trade group for private water operating companies, asked for the clarifications in a letter sent last month that was signed by the association's executive director, Michael Deane.
The group pointed out that the guidance "would be fully consistent with the President's policy of promoting investment in U.S. infrastructure." President Obama signed a water bill in June that "envisions P3s" and his fiscal 2015 budget includes a proposal to exempt water and sewer private-activity bonds from state volume caps, the letter noted.
Local governments are increasingly interested in financing upgrades to their water and wastewater systems through P3 arrangements in which private companies lease certain infrastructure assets from the governments for a 30 to 40 year period. The governments often retain ownership of the facilities and the concessionaires generally are responsible for operating, maintaining and improving the facilities, according to the letter.
If a government issues governmental bonds to finance water facilities and then later enters into a long-term lease, concession or operating agreement with a private company, the lease would create private business use. As a result, the bonds could become taxable private-activity bonds unless the issuer takes one of the permissible remedial actions described in Treasury regulations.
There are three possible types of remedial actions. However, two of these actions are impractical for issuers and Treasury would need to clarify that the third action applies in the case of P3 concessions, NAWC said.
One remedial action would be for the issuer to defease and redeem the bonds. But the group said that wouldn't make sense in the current low-interest rate environment. "To defease bonds bearing an interest rate of 5% or 6% by creating an escrow account to pay those bonds and funding it with Treasury securities yielding 1% or less would require a capital outlay substantially exceeding the principal balance of the outstanding debt," NAWC said. "We estimate that defeasance could reduce as much as 15% of the value of typical transactions to the communities undertaking them."
Another remedial action would be for issuers to treat the bonds as reissued tax-exempt exempt-facility bonds, a type of private-activity bond. But the bonds would have to satisfy all the PAB rules at the time of reissuance, which could be difficult, NAWC said. For example, the issuer would have to receive an allocation of state volume cap equal to the amount of the outstanding bonds, which can be an "insurmountable problem" for P3s "because of the difficulty in receiving assurance from state officials that sufficient volume cap will be made available at the time the P3 transaction is closed," NAWC said.
The third remedial action would allow an issuer to have its bonds remain tax-exempt if it has a cash sale or "other disposition" of the bond-financed facility. The issuer would have to reasonably expect to use the cash for other governmental purposes within two years of the disposition. However, according to the letter, it is unclear if long-term lease or concession arrangements can be considered "dispositions," and, if so, how payments made during the duration of the arrangement should be dealt with.
NAWC wants Treasury to revise the definition of "disposition proceeds" to include payments from a concession, so long as the arrangement doesn't transfer tax ownership of the property to the private party. The group also wants the regulations to state that transactions other than sales can be a disposition that allows the bonds to remain tax-exempt if they involve cash paid either at the time of the transaction or later as provided by the terms of the agreement between the issuer and the private company.
The association is asking Treasury and the IRS to allow concessions to meet the remedial action requirements if the issuer reasonably expects to spend the disposition proceeds within three years of executing the P3 arrangement or within one year of receiving any payment under that arrangement. And it also wants Treasury to clarify that the disposition proceeds can be used to pay debt service on other of the issuers' bonds or to make contributions to public pension funds.
"The regulations clearly were originally intended to provide state and local governments a reasonable path for preserving the tax-exempt status of bonds in cases of transfers of facilities financed by the bonds, particularly where those facilities could have qualified for tax-exempt private-activity bond financing," NAWC said. "The above guidance would provide precisely such a path with respect to transfers of facilities through the standard type of P3 arrangement used today — concessions."
