TESTIMONY OF EDWARD D. KLEINBARD 

CHIEF OF STAFF 

OF THE 

JOINT COMMITTEE ON TAXATION 

AT A HEARING OF THE SUBCOMMITTEE ON ENERGY, NATURAL RESOURCES, 

AND INFRASTRUCTURE OF THE COMMITTEE ON FINANCE ON 

“TAX AND FINANCING ASPECTS OF 

 HIGHWAY PUBLIC-PRIVATE PARTNERSHIPS”1

JULY 24, 2008 

Mr. Chairman, Senator Bunning, members of the Subcommittee, my name is Edward D. 

Kleinbard and I am the Chief of Staff of the Joint Committee on Taxation. I am pleased to have 

the opportunity to appear before you today to discuss the Federal income tax issues raised by the 

use of public-private partnerships2

 to build, manage and own highways in the United States. At 

the request of the Subcommittee, my remarks are focused on “brownfield” highway projects, 

which involve very long-term leases of existing infrastructure from a State or other public owner 

to private parties. I also cover the present law treatment of tax-exempt bond financing for 

highway projects, in the context of both public and private owners of highway infrastructure. 

 1

 This document may be cited as follows: Joint Committee on Taxation, Testimony of Edward D. 

Kleinbard, Chief of Staff of the Joint Committee on Taxation, at a Hearing of the Subcommittee on 

Energy, Natural Resources, and Infrastructure of the Committee on Finance on “Tax and Finance 

Aspects of Highway Public-Private Partnerships” (JCX-62-08), July 24, 2008. This document is 

available at www.jct.gov. 

2

 Although referred to as “public-private partnerships,” the parties generally do not intend the 

arrangement to be treated as a partnership for Federal income tax purposes. The discussion in this 

testimony assumes that this intended treatment is respected. 

JOINT COMMITTEE ON TAXATION 

July 24, 2008 

JCX-62-08 
2

 Overview of public-private partnerships

The Department of Transportation defines public-private partnerships broadly to include 

“contractual agreements formed between a public agency and private sector entity that allow for 

greater private sector participation in the delivery of transportation projects.”3

 The private sector 

historically has participated in the design and construction of United States highways, most 

commonly as contractors to the public sector. A public-private partnership, however, generally 

is understood as shifting more of the economic risks (and attendant rewards) of a transportation 

project to the private sector than would be the case in a traditional public owner-private 

contractor relationship. For example, a public-private partnership might contemplate a private 

firm taking on all the design and construction risks for a new project, or a private firm operating 

a project for a period of years following construction, and obtaining an economic return based on 

the relative success of its management. State and local governments have shown increasing 

interest in public-private partnership arrangements as the cost of infrastructure development and 

maintenance continues to increase.4

Some private firms have acquired economic interests in the financing, maintenance, and 

operation of public highways after they are built.5

 Two well-publicized arrangements, involving 

the Chicago Skyway and the Indiana Toll Road, illustrate how the public-private partnership 

concept can be applied to transfers of economic interests in existing highways from the public 

sector to private firms. In my testimony, I will use the similar structures of these two 

transactions as a template, but my remarks should be understood as generic in nature, and do not 

rely on any taxpayer-specific information not in the public domain. 

The Chicago Skyway and Indiana Toll Road deals were structured as very long-term 

arrangements: 99 years in the former case, and 75 in the latter. For tax purposes, each 

transaction can be seen as comprising three operating relationships, each of which in turn runs 

for the length of the overall arrangement: 

(1) A lease of the existing infrastructure (the highway itself and associated 

improvements) from the public owner to the private firm;6 

 3

 U.S. Department of Transportation, Federal Highway Administration, Public-Private 

Partnership Website, “PPPs Defined,” [http://www.fhwa.dot.gov/PPP/defined.htm]. 

4

 For background on infrastructure investment, see Congressional Budget Office, Issues and 

Options in Infrastructure Investment (May 2008) (public-private partnership discussion at page 32). 

5

 For background on public-private partnerships, see CRS Report RL34567, Public-Private 

Partnerships in Highway and Transit Infrastructure Provision, by William J. Mallett (July 9, 2008); 

GAO, Highway Public-Private Partnerships, More Rigorous Up-front Analysis Could Better Secure 

Potential Benefits and Protect the Public Interest, GAO-08-44 (Washington, DC: February 2008). 

6

 Technically the private party in each case was itself a partnership among several private firms, 

but this point is not relevant to the tax issues considered in my testimony. 
3

(2) A grant by the public owner to the private firm of a right-of-way on the public lands 

underlying that infrastructure; and 

(3) A grant of a franchise from the public entity permitting the private party to collect 

tolls on the highway. 

In return, the private party paid a large up-front amount to the public owner, and agreed 

to operate and maintain the road, to invest specified amounts in future improvements, and to 

accept restrictions on the maximum tolls it could change.7

 An umbrella concession agreement 

sets out the long-term rights and obligations of each party, including dispute resolution 

mechanisms. 

More specifically, in 2004, the City of Chicago leased the Chicago Skyway, a 7.8 mile 

toll road south of downtown Chicago that connects two major highways, in the first long-term 

lease of an existing toll road in the United States. Under the 99-year concession agreement with 

Skyway Concession Company Holdings LLC, a joint venture between Cintra of Madrid, Spain, 

and Macquarie of Sydney, Australia,8

 the City of Chicago received a $1.8 billion up-front 

payment in exchange for granting the private concessionaire the exclusive right to use, possess, 

operate, manage, maintain, rehabilitate, and collect tolls from the Chicago Skyway. 

In 2006, the Indiana Finance Authority (“IFA”) entered into a 75-year concession 

agreement with ITR Concession Company LLC (“ITR”), also a joint venture between Cintra and 

Macquarie, in respect of the Indiana Toll Road. IFA received a $3.8 billion up-front payment in 

exchange for granting ITR the exclusive right to operate, manage, maintain, rehabilitate, and 

collect tolls from the Indiana Toll Road. 

The remainder of my testimony provides background on the Federal income tax policy 

issues raised by these arrangements and their tax treatment under present law.9

 7

 See summaries of these arrangements at U.S. Department of Transportation, Federal Highway 

Administration, Public-Private Partnership Website, “PPP Case Studies,” 

[http://www.fhwa.dot.gov/ppp/case_studies.htm]. In addition to the Chicago Skyway and Indiana Toll 

Road arrangements, the Pocahontas Parkway in southern Virginia is being leased through a public-private 

partnership arrangement, and other similar transactions are being considered by State legislatures. The 

Pennsylvania General Assembly, for example, currently is considering a $12.8 billion bid by Citigroup 

and Abertis Infraestructuras for a 75-year lease of the Pennsylvania turnpike, 

[http://www.efinancialnews.com/usedition/index/content/2451015346]. 

8

 “Cintra” and “Macquarie” refer to these companies generally. In the case of Skyway 

Concession Company Holdings LLC, the investment is owned, indirectly, by Cintra Concesiones de 

Infraestructuras de Transporte, SA and Macquarie Infrastructure Group. 

9

 For analysis of other public policy issues raised by public-private partnerships, see CRS Report 

RL34567, Public-Private Partnerships in Highway and Transit Infrastructure Provision, by William J. 

Mallett (July 9, 2008); GAO, Highway Public-Private Partnerships, More Rigorous Up-front Analysis 

Could Better Secure Potential Benefits and Protect the Public Interest, GAO-08-44 (Washington, DC: 

February 2008); U.S. Department of Transportation, Report to Congress on the Costs, Benefits, and 

Efficiencies of Public-Private Partnerships for Fixed Guideway Capital Projects (November 2007); Craig 
4

Characterization of public-private partnerships for tax purposes

The parties to the archetypal brownfield public-private partnerships under consideration 

here enter into an umbrella concession agreement that describes the overall business relationship. 

Very importantly, the deals appear to be carefully structured not to constitute partnerships for tax 

purposes. (If the transaction were characterized as a constructive tax partnership, there would be 

a great many adverse consequences for the parties, including the possible application of Internal 

Revenue Code section 470 and differences in the tax depreciation rules for the brownfield 

assets.)10 Instead, and as described above, the arrangements are intended to be treated for tax 

purposes as transfers of three separate bundles of property rights from the public owner to the 

private firm, all in exchange for the lump sum cash payment: 

(1) A “lease” of the infrastructure assets; 

(2) A lease of the land underlying the infrastructure assets (the right of way); and 

(3) A grant of an intangible “franchise” right to collect tolls. 

The “public-private partnership” label thus generally is a red herring for the tax analysis 

of these transactions. 

 To be clear, it is possible that future transactions might raise more difficult questions of 

whether a constructive tax partnership exists between the public and private entities that enter 

into a brownfield transaction. In particular, transactions that rely more on back-end revenue 

sharing and that contemplate a larger continuing management role for the public entity would 

require analysis. For purposes of this testimony, however, I assume that the transactions will be 

respected according to their form, as outright transfers of the three bundles of property rights 

described above. 

 In turn, under long-established tax principles, the “lease” of the infrastructure assets 

would be expected to be characterized as an outright purchase of those assets by the private firm 

for tax purposes, because the “lessee” has acquired all the benefits and burdens of ownership of 

those assets for a term that significantly exceeds their expected remaining useful life.11 Land, by 

 

L. Johnson, Martin J. Luby, and Shokhrukh I. Kurbanov, Toll Road Privatization Transactions: The 

Chicago Skyway and Indiana Toll Road, September 2007, 

[http://www.cviog.uga.edu/services/research/abfm/johnson.pdf]. 

10 Unless otherwise stated, all section references are to the Internal Revenue Code of 1986, as 

amended (the “Code”) and all regulation references are to the Treasury Regulations promulgated 

thereunder. 

11 To the extent the property under the concession agreement becomes owned directly or 

indirectly by non-U.S. persons, the U.S. business operations related to the property generally should be 

subject to net-basis U.S. taxation in the same manner as if the property were owned by U.S. persons. If 

those U.S. business operations were conducted through a domestic corporation, the corporation would be 

subject to corporate tax on the income from the operations. Sec. 11. Certain payments (such as 

dividends) to foreign owners of the corporation would be subject to U.S. withholding tax (subject to 

reduction or elimination under bilateral income tax treaties). If the U.S. business operations were 
5

contrast, is deemed for tax purposes to have a perpetual useful life, and as a result the long-term 

ground lease would be expected to be characterized as such. 

More specifically, the concession agreement signed by the parties generally is for a 

period much longer than the economic useful life of the highway assets, which (along with 

operating control) is the critical question in determining whether a purported lease should be 

recharacterized as a purchase of assets for tax purposes. The Bureau of Economic Analysis 

estimates the service life of highways and streets to be 45 years,12 while the Chicago Skyway and 

Indiana Toll Road agreements were for terms of 99 and 75 years, respectively. The private 

party’s responsibilities under the agreement may include all operations of the toll road, payment 

of utilities, maintenance, taxes (the private party may not be required to pay certain real estate, 

sales, and other taxes), capital improvements, risk of loss, and liabilities that arise during the 

term.13 Accordingly, while the facts and circumstances of each transaction will control its tax 

treatment, these arrangements will most likely be viewed by the parties as a sale and purchase of 

a trade or business, and the concession agreement can be expected to include a provision 

describing the intended tax treatment in this manner.14

It also follows from the above that tax considerations are very important drivers of the 

long-term nature of these arrangements. Private firms can be expected to want to obtain the tax 

 

conducted through a foreign corporation, the corporation would be subject to U.S. tax on its effectively 

connected income. Sec. 882. Moreover, the foreign corporation could be subject to branch profits tax 

and branch interest tax on, respectively, dividend-like withdrawals from the U.S. business and certain 

interest payments allocable to the business. Sec. 884(a), (f). “Earnings stripping” rules (discussed later in 

the “Financing the acquisition” section of this testimony) also could apply to disallow deductions for 

certain interest payments to related parties and interest payments on debt guaranteed by related parties. 

Finally, the special U.S. tax rules applicable to foreign investment in U.S. real estate (the 

“FIRPTA” rules of section 897) may affect the U.S. tax treatment of foreign investors. We understand 

that some advisors have taken the position that the intangible franchise right is an interest in real property 

for purposes of section 897. Other advisors have taken a contrary view. Treating the franchise right as an 

interest in real property would make it more likely that a domestic corporation that owned the right would 

be a U.S. real property holding corporation under section 897(c)(2) and, therefore, that tax under section 

897 would be triggered by, for example, a sale of the corporation by foreign investors. 

12 U.S. Department of Commerce, Bureau of Economic Analysis, BEA Depreciation Estimates, 

[http://www.bea.gov/national/FA2004/Tablecandtext.pdf]. 

13 We have not reviewed all public-private partnership agreements. The terms will vary 

depending on the particular arrangement. 

14 For example, Section 2.8 of the Indiana Toll Road Concession and Lease Agreement, (April 

12, 2006) states: “This Agreement is intended for U.S. federal and state income tax purposes to be a sale 

of the Toll Road Facilities and Toll Road Assets to Concessionaire and the grant to the Concessionaire of 

an exclusive franchise and license for and during the Term to provide Toll Road Services within the 

meaning of sections 197(d)(1)(D) and (E) of the Internal Revenue Code of 1986, as amended, and 

sections 1.197-2(b)(8) and (10) of the Income Tax Regulations thereunder,” 

[http://www.in.gov/ifa/files/4-12-06-Concession-Lease-Agreement.pdf]. 
6

advantages (in particular, depreciation deductions, as described below) that flow to any owner of 

an asset. At the same time, the public sector participant will wish to maximize the value it 

receives for giving up control of the infrastructure assets, by assisting the private firm in being 

treated as the tax owner of the assets. Because these transactions are nominally leases, the 

private firm participants will want to assure themselves and their advisors that they will control 

the assets for a period that clearly exceeds their expected economic life. The result can be seen 

in the 75 and 99 year terms of the two archetypal transactions considered here. 

Tax policy considerations in public-private partnerships

Any transaction between private parties and the public sector — including a publicprivate partnership with respect to highways or other infrastructure — presents two important 

sets of questions: 

(1) Does the arrangement allow the private party to obtain tax deductions or other tax 

benefits in respect of property that economically is controlled by the public entity, 

or conversely to shield from tax income that belongs economically to the private 

firm by allocating that income to the nontaxable public entity? In other words, are 

the parties engaged in a bona fide commercial transaction, or are they primarily 

trading on the public entity’s tax-exempt status? 

(2) Assuming that the transaction is a bona fide commercial undertaking, are the tax 

consequences to the private party (including the tax aspects of any financing 

opportunities available to the private party) similar to the tax results achieved in 

other economically comparable transactions that take place entirely in the private 

sphere? That is, is the tax law neutral across comparable investments, thereby 

avoiding tax-induced economic distortions? Or does the tax law, through tax 

expenditures, indirectly subsidize this particular activity — and if so, is that subsidy 

intentional (for example, as an instrument of Federal transportation policy)? 

Genuine transaction or trading on tax-exempt status?

Turning to the first question, public-private partnership arrangements of the sort 

considered here as a general matter are genuine commercial transactions. In particular, these 

arrangements do not present the issues raised by “lease-in lease-out” (“LILO”) or “sale-in, leaseout” (“SILO”) transactions, abusive arrangements that have been curtailed by Federal tax 

legislation. 

In a typical LILO or SILO transaction, governmental entities essentially transferred 

nominal ownership (and with it the rights to Federal tax benefits) relating to public infrastructure 

assets, such as sewer systems or subway systems, to taxable parties, and simultaneously leased 

the assets back. Under the complex arrangements between the parties, the original transfer did 

not result in any meaningful change in the use or management of those systems, or in the benefits 

and burdens of ownership of the assets; instead the public entity continued to manage the 

infrastructure, and bear all the attendant economic risks of doing so, through its lease back of the 
7

facility.15 Moreover, the private party, as nominal owner and lessor of the infrastructure assets, 

did not take significant credit risk with respect to the public agency’s rental payments, all of 

which were essentially prefunded. Finally, the arrangements contained complex exit provisions 

that made it very likely that the public entity would reacquire the infrastructure assets at the end 

of its lease term, thereby assuring that the public entity’s economic ownership of the facility 

essentially would remain unbroken. 

Public-private partnership brownfield arrangements of the sort considered here, by 

contrast, generally appear in fact to transfer beneficial ownership of the infrastructure assets to 

the private party. In contrast to the LILO/SILO case, there is no lease back of the assets from the 

private firm to the original public owner. The private firm takes on the operation of the assets, 

the obligation to maintain and improve the assets, and the associated economic risks and 

rewards, for the economic life of the assets. The original public owner receives a large upfront 

payment that, unlike the LILO/SILO case, is available to the original public owner to use for any 

purpose; that is, the sales price is not in turn used to “defease” any continuing financial 

obligations to the private party, because there are none. The original public owner therefore has 

no continuing economic interest in the property over its expected economic life, or at most a 

modest interest in the form of revenue sharing payments. 

While brownfield public-private partnerships of the sort considered here do not raise the 

deeply troubling tax policy issues exemplified by LILO and SILO deals, it must be remembered 

that a “public-private partnership” is an amorphous concept, and future transactions, whether in 

the brownfield arena or elsewhere, conceivably could be structured in more problematic ways. 

Congress has amended the Code (in section 470) to deal systematically with this issue; future 

transactions should be monitored to assure that section 470 is operating to reach those 

transactions that troubled Congress. 

A tax-favored investment?

Assuming that the arrangement is a bona fide commercial transaction, the second relevant 

question is whether the tax consequences to the private party are comparable to the tax results 

achieved in other economically comparable transactions that take place wholly within the private 

sphere. That is, is the tax law neutral across comparable investments, thereby avoiding taxinduced economic distortions? 

Non-tax public policy considerations may affect the answer to this question. Congress 

regularly relies on tax expenditures16 to subsidize certain economic activities but not others, in 

furtherance of non-tax policy goals. Whether in this instance the tax law should favor, disfavor, 

or remain neutral with respect to public-private partnerships therefore may depend in significant 

part on the resolution of Federal transportation policy issues and the extent to which Federal 

 15 See IRS Notice 2005-13, 2005-1 C.B. 630, for a description of a SILO transaction and Rev. 

Rul. 2002-69, 2002-2 C.B. 760, for a description of a LILO transaction. Both of these transactions have 

been identified by the Internal Revenue Service as listed transactions. 

16 For a general discussion of tax expenditures, see Joint Committee on Taxation, 

A Reconsideration of Tax Expenditure Analysis (JCX-37-08), May 12, 2008. 
8

subsidies delivered through the tax system are considered an appropriate instrument of those 

transportation policies. Purely as a matter of economics and tax policy, however, considerations 

of economic efficiency and consistency would dictate that the tax law should be neutral as 

between making this type of investment or another type of investment. 

It is surprisingly difficult to analyze whether brownfield public-private partnerships are 

treated neutrally as a matter of income tax economics, for the simple reason that they are very 

capital-intensive transactions, and the tax rules for the recovery of investments in all forms of 

real (i.e., non-financial) assets are non-neutral. That is, our depreciation system in particular can 

be argued to grant Federal subsidies for investing in property, plant and equipment, in the form 

of accelerated depreciation deductions.17 The practical question here, therefore, is not whether a 

private investor in a brownfield public-private partnership receives a Federal tax subsidy, when 

compared to an ideal income tax (the answer may well be yes, it does), but rather whether those 

subsidies are in some manner disproportionate to those available in transactions wholly within 

the private sphere. 

To shed any light on that issue, we need to address three sub-questions in particular: 

(1) How is the lump sum paid by the private firm at inception allocated among the 

different property rights it receives? 

(2) How are these allocated amounts recovered for tax purposes (i.e., what are the 

depreciation/amortization rules applicable to them)? 

(3) What tax-favored financing opportunities are available to the private investor in 

such transactions? 

With these questions in mind, I will now turn to the Federal income tax treatment of 

public-private partnership arrangements under present law. State governments are generally not 

subject to Federal income tax, so I will principally focus on the tax consequences to the private 

party lessee upon entering into these arrangements. The next three sections address in turn the 

three questions set out immediately above. 

Allocation of up-front payment

It follows from the above description of the overall tax analysis that the large up-front 

payment made by the private party to the transaction is treated as paid to acquire different 

bundles of business assets. As a result, the parties must allocate the initial consideration to the 

following categories: (1) the acquisition of infrastructure assets, such as land improvements, 

computers, toll booths, and other property used to operate and maintain the highway; (2) a lease 

of the underlying land; and (3) the acquisition of intangible assets, such as a franchise and 

license for the right to collect tolls (along with any generally unstated goodwill or going concern 

value). 

 17 By the same token, an ideal income tax would consider the effect of inflation on the value of 

capital investments. Whether accelerated depreciation roughly compensates for the failure of the income 

tax to address the effects of inflation is a topic beyond the scope of this testimony. 
9

The tax treatment of the assets in each of these categories varies. The tax allocation of 

the consideration therefore will determine the timing of the tax deductions associated with the 

investment. The tax rules are clear that the parties must allocate purchase price in accordance 

with the relative fair market value of the assets acquired.18 The parties to the two large 

transactions used here as templates allocated a substantial part, and perhaps the bulk, of the 

consideration paid to the third category above (intangible assets). Whether this allocation was 

correct is the type of issue that the Internal Revenue Service confronts all the time in the 

examination of large business acquisitions, and is entirely fact-driven. 

It might fairly be observed that the public participant in these sorts of transactions is taxindifferent (because it is not a taxpayer), but eager to maximize the value of the transaction to the 

private sector firm (and thereby to itself as well). There thus is unlikely to be a true adversarial 

negotiation of the allocation of the purchase price. The same observation can be made, however, 

of many transactions that are entirely within the private sphere, either because the seller is taxindifferent in this context (e.g., it is a foreign entity, or has large net operating loss carryovers), 

or because it is a domestic corporation, for which ordinary income and net capital gain are taxed 

at the same rates. 

Recovery of investment (depreciation and amortization)

Depreciation of tangible infrastructure assets

For Federal income tax purposes, a taxpayer is allowed to recover through annual 

depreciation deductions the cost of certain property used in a trade or business or for the 

production of income. The amount of the depreciation deduction allowed with respect to 

tangible property for a taxable year is determined under the modified accelerated cost recovery 

system (“MACRS”). Under MACRS, different types of property generally are assigned 

applicable recovery periods and depreciation methods. The MACRS depreciation categories 

generally are set out in the Internal Revenue Code, and are amplified by Internal Revenue 

Service guidance.19

 The MACRS recovery periods applicable to most tangible personal property range from 

three to 25 years. The depreciation methods generally applicable to tangible personal property 

are the 200-percent and 150-percent declining balance methods, switching to the straight-line 

method for the taxable year in which the taxpayer’s depreciation deduction would be maximized. 

Nonresidential real property and residential rental property are assigned lives of 39 years and 

27.5 years, respectively, using the straight line method. 

 18 Section 1060 sets out detailed rules for the allocation of consideration in certain asset 

acquisitions. 

19 Sec. 168. Rev. Proc. 87-56, 1987-2 C.B. 674. 
10

The most significant tangible infrastructure assets acquired by the private party in a 

public-private partnership are the highway and any related bridges.20 As “land improvements,” 

these assets are generally depreciated under MACRS over a 15-year recovery period using the 

150-percent declining balance method. The roadbed underlying the highway, however, is treated 

as having an indefinite useful life, and therefore its value is not recovered through depreciation at 

all.21 

Other tangible assets that may be acquired include computers, equipment, toll booths, 

building structures, and other tangible assets associated with operating and maintaining a toll 

highway. As with the land improvements, these assets are generally recovered through 

accelerated depreciation under MACRS using various recovery periods, generally five to seven 

years, or through straight line depreciation over 39 years in the case of certain structures. 

It might be argued that 15-year accelerated depreciation is not the appropriate 

depreciation schedule for highways or bridges, and Congress could choose to change that 

recovery period. (The Internal Revenue Service does not have the authority to set MACRS 

recovery periods.22) The MACRS depreciation schedules have their roots in a previous statutory 

depreciation classification scheme, which in turn was based on economic analyses performed 

some 40 years ago. It is not always obvious that the MACRS schedules are internally consistent 

(that is, that they accelerate the depreciable lives of different categories of depreciable assets 

proportionately to their economic lives). Thus, to take some arbitrary examples, railroad beds 

are depreciated over 50 years (straight line), and rail track are depreciated using MACRS 

accelerated depreciation over seven years, while highway roadbeds are not depreciable at all, and 

the highways themselves are depreciated over 15 years. Commercial airplanes are depreciated 

under MACRS over seven years. In the absence of quantitative research into the actual useful 

lives of these (and hundreds of other) asset classes, it is not possible to state as a matter of 

abstract tax policy whether the MACRS classification of highway assets and other land 

improvements is appropriate. 

To the extent any of these assets were originally constructed or acquired with proceeds of 

tax-exempt bonds,23 depreciation is calculated under the alternative depreciation system (“ADS”) 

using the straight line method generally over longer recovery periods.24 For example, land 

 20 In addition to acquired tangible assets, the private party will incur capital improvement costs 

throughout the lease term. The cost of newly constructed assets will also be recovered through 

depreciation deductions. 

21 Rev. Rul. 88-99, 1988-2 CB 3. In a public-private partnership transaction, the roadbed is 

likely included as part of the right-of-way lease of the underlying land. 

22 Most MACRS recovery periods originally were established through IRS administrative 

guidance (Rev. Proc. 87-56, 1987-2 C.B. 674). In November 1988, however, Congress revoked the 

Secretary’s authority to modify the class lives of depreciable property as part of the Technical and 

Miscellaneous Revenue Act of 1988. Pub. L. No. 100-647, sec. 6253 (1988). 

23 See discussion of tax-exempt bond financing later in this testimony. 

24 Secs. 168(g)(1)(C) and 168(g)(5). 
11

improvements are recovered over 20 years using the straight line method if the project is 

financed with tax-exempt bonds, instead of 15 years under MACRS using the 150-percent 

declining balance method. The treatment of assets as tax-exempt bond financed property in the 

hands of the original owner (resulting in use of the longer recovery periods and the straight line 

method) continues even if the tax-exempt bonds are no longer outstanding or are redeemed.25 

Furthermore, any subsequent owners who acquire the property while the tax-exempt bonds are 

outstanding are also subject to the alternative depreciation system.26 These present-law rules 

tend to prevent taxpayers from arbitraging their tax benefits with tax-subsidized financing. 

Amortization of intangible assets

As previously noted, significant value generally is assigned in public-private partnership 

arrangements to the intangible franchise right; that is, the right of the private party to collect tolls 

from users of the highway. The taxpayer’s rationale for this allocation likely is that the right to 

collect tolls is the main revenue source and is the primary economic driver of the transaction.27

Under section 197 of the Code, when a taxpayer acquires an operating business, any 

value properly attributable to a franchise right is amortizable on a straight-line basis over 15 

years.28 Additionally, any value attributable to licenses, permits, and other rights granted by 

governmental units is subject to 15-year amortization, even if the right is granted for an 

indefinite period or is reasonably expected to be renewed indefinitely.29 Goodwill and going 

concern value similarly are amortized on the same schedule. However, interests in land, 

including leases, easements, grazing rights, and mineral rights granted by a government, may not 

 25 Treas. Reg. sec. 1.168(i)-4(d)(2)(ii)(B). 

26 H.R. Rep. No. 97-760, 516 (1982). State and local governments may redeem outstanding taxexempt bonds prior to the public-private partnership arrangement so that the acquired assets are not 

subject to ADS rules. To the extent State and local governments retire tax-exempt bonds and taxable 

bonds are issued or other taxable debt is incurred to finance the private party payment pursuant to a 

public-private partnership arrangement, the migration from tax-exempt to taxable financing may result in 

increased Federal tax receipts. 

27 There also may be some value in a license by the government for the right of the private party 

to use the name of the highway. 

28 Secs. 197(d)(1)(F) and 197(f)(4). A franchise is defined “an agreement which gives one of the 

parties to the agreement the right to distribute, sell, or provide goods, services, or facilities, within a 

specified area.” Sec. 1253(b)(1). 

29 Sec. 197(d)(1)(D). Examples include a liquor license, a taxi-cab medallion, an airport landing 

or take-off right, a regulated airline route, or a television or radio broadcasting license. Renewals of such 

governmental rights are treated as the acquisition of a new 15-year asset. Treas. Reg. sec. 1.197-2(b)(8). 

A license, permit, or other right granted by a governmental unit is a franchise if it otherwise meets the 

definition of a franchise. Treas. Reg. sec. 1.197-2(b)(10). Section 197 intangibles do not include certain 

rights granted by a government not considered part of the acquisition of a trade or business. Sec. 

197(e)(4)(B) and Treas. Reg. sec. 1.197-2(c)(13). 
12

be amortized over the 15-year period provided in section 197, but instead must be amortized over 

the period of the grant of the right.30

Section 197’s 15-year straight-line amortization period applies to a broad class of 

intangible assets, without regard to whether a different useful life might be determinable.31 Prior 

to the enactment of section 197 in 1993, there was a tremendous amount of controversy between 

the Internal Revenue Service and taxpayers relating to the assignment of value to intangibles 

acquired as part of a trade or business.32 Most of the controversy involved the valuation assigned 

to goodwill, which could not be amortized under prior law. Other disputes in this area addressed 

the difficulty in ascertaining the lives of intangible assets, including licenses and franchises 

granted by governmental agencies, and the allocation of consideration to intangible assets with 

no ascertainable useful life (and thus no amortization). 

The 15-year amortization period specified in section 197 is not intended to reflect the 

actual useful life of any particular intangible asset for which that period is prescribed. Some of 

those intangibles might have a much longer useful life, others much shorter. The same 

amortization period is required for all because of concern that taxpayers buying a business that 

includes numerous intangible assets, all of which together contribute to the success and value of 

a business, could seek to allocate a disproportionate amount of the value of the ongoing business 

to shorter-lived intangible assets. The rules of section 197 are designed to minimize the extent to 

which the Internal Revenue Service must devote resources to review these allocations, given the 

history of disputes in the area. 

Some might argue that 15-year amortization of the franchise is too generous in the 

context of a toll road, where questions might arise over the appropriate amount to be allocated to 

the franchise as opposed to the land and easement right-of-way. However, the arrangements may 

be viewed as no different than many other situations where a government grants a license or right 

to operate a franchise that might be expected to continue indefinitely (even though such rights 

might or might not also involve a grant of an interest in land). Moreover, even a monopoly right 

to collect tolls on a road, with contractual protection against any party being granted a right to 

build any competing road, might arguably lose value over an unpredictable period of time if 

economic conditions change (for example, if fewer customers use the road or the economy 

cannot support high tolls). 

 30 Sec. 197(e)(2). Treas. Reg. sec. 1.197-2(c)(3). An interest in land does not include an airport 

landing or takeoff right, a regulated airline route, or a franchise to provide cable television service. The 

cost of acquiring a license, permit, or other land improvement right, such as a building construction or use 

permit, is taken into account in the same manner as the underlying improvement. Treas. Res. Sec. 1.197-

2(c)(3). 

31 Pub. L. No. 103-66, sec. 13261(a) (1993). 

32 The GAO estimated in 1989 that the IRS had 1,509 open issues relating to intangible asset 

amortization deductions with total proposed adjustments of $8 billion. See GAO, Issues and Policy 

Proposals Regarding Tax Treatment of Intangible Assets, GGD-91-88 (Washington, DC: August 1991). 
13

It is the case, however, that section 197’s 15-year amortization period was itself 

somewhat arbitrary (or alternatively, a blend of many different economic useful lives from a 

wide range of types of intangible assets). As such, Congress could decide to impose a different 

rule for long-term franchises of toll roads, or of public infrastructure assets generally, without 

doing any violence to the internal logic of the Code. On the other hand, if consideration were 

given to lengthening the amortization period for intangible assets associated with toll road 

infrastructure projects, any such proposal would have to be assessed in relation to its potential for 

complexity, increased disputes between taxpayers and the IRS, and its ultimate effectiveness, in 

light of the history of section 197 and the potential for a “next generation” of transactions 

designed to avoid the new rule.33

The franchise element of public-private partnerships is similar to other common 

franchises (e.g., fast-food restaurants, convenience stores, and hotels) in many ways, and the tax 

treatment of the investment is the same. The rights and restrictions on operating practices, such 

as the amount of permitted toll increases and required capital improvements, have similarities to 

the franchisor-franchisee relationship in other franchise settings. One of the main differences 

between some of the publicly described toll road arrangements and some traditional business 

format franchises is that the latter typically requires payment of an ongoing royalty, usually 

based on sales, whereas the toll road agreements may provide for only an up-front lump-sum 

payment. 

Some toll road transactions have been reported to include revenue sharing provisions not 

unlike the royalty payments of the typical business franchise. These revenue sharing provisions 

are viewed by some as a method for the public party to share in possible future economic upside 

from toll collections.34 To the extent payments are made by the private party pursuant to the 

arrangement, the revenue sharing payments may be considered “contingent serial payments” and 

deductible in the year paid or incurred.35 If a payment does not meet the requirements for 

contingent serial payments, the amount may be treated as contingent purchase price allocated to 

the franchise and recovered over the remaining life of the franchise intangible asset.36

 33 For example, if a life longer than 15 years, such as the life of the contract, were required to be 

used for the intangible rights associated with toll road infrastructure projects, then taxpayers might create 

contracts of a shorter duration that nevertheless are regularly renewed. As another example, if a specified 

longer life were designated for toll road franchises, taxpayers might attempt to add business rights in 

addition to the toll road rights under the contracts, and attempt to allocate greater value to those rights 

with a shorter life. 

34 GAO, Highway Public-Private Partnerships, More Rigorous Up-front Analysis Could Better 

Secure Potential Benefits and Protect the Public Interest, GAO-08-44 (Washington, DC: February 2008), 

44. 

35 Sec. 1253(d)(1). 

36 Treas. Reg. sec. 1.197-2(f)(2). 
14

Recovery of investment in lease of land

The amount of any up-front consideration allocated to the lease of land is generally 

deductible to the lessee for tax purposes over the term of the lease under the complex regime of 

section 467. Very generally, those rules take time value of money concepts into account, and 

effectively convert the lump sum payment into a constructive loan used to fund a stream of level 

rent payments.37 

In most cases, the lease deductions are the least desirable from a present value 

perspective, because of their longer recovery period (i.e., the term of the lease). For this reason, 

the Internal Revenue Service can be expected to review carefully the allocation of value as 

between the less tax-favored assets (the land and possibly the tangible assets, such as highways 

and bridges) and the more tax-favored assets (the intangible assets, such as the franchise). 

Financing the acquisition

The private sector participant in a brownfield public-private partnership arrangement can 

be expected to obtain debt financing to fund a significant part (perhaps 60 percent) of the large 

up-front payment common to these transactions, and to fund the remainder with equity.38 To the 

extent that the private firm issues genuine indebtedness, a tax deduction generally is permitted 

for interest paid or accrued during the taxable year.39 The Code contains several limitations, 

both timing and permanent in nature, that could affect the taxpayer’s ability to claim interest 

deductions. For example, to the extent interest costs are allocable to capital improvements, 

capitalization may be required as part of the cost of the improvements and recovered through 

depreciation deductions.40 Additionally, interest expense may be disallowed under “interest 

stripping” provisions if the borrowing is from foreign related parties or if there is a disqualified 

guarantee under a financing arrangement.41 The facts and circumstances of the arrangement 

determine the proper tax treatment of interest on indebtedness. 

All of these rules apply with equal force to financing an acquisition that takes place 

wholly within the private sphere. Brownfield public-private highway partnerships add the 

additional possibility of using tax-exempt financing for some or all of the debt that the private 

firm must issue to fund the up-front payment. 

 37 Sec. 467(a). 

38 For this reason, the private participant itself often is a partnership that can raise equity capital 

from a number of institutional investors. 

39 Sec. 163(a). 

40 Sec. 263A(f). 

41 Sec. 163(j). 
15

Tax-exempt financing: Overview

Tax-exempt bond financing has historically been used by State and local governments to 

raise funds for infrastructure projects. The remainder of my testimony describes the present law 

treatment of these instruments.42

Interest paid on bonds issued by State and local governments generally is excluded from 

gross income for Federal income tax purposes. Because of this income exclusion, investors 

generally are willing to accept a lower rate on tax-exempt bonds than they might otherwise 

accept on a taxable investment. This, in turn, lowers the borrowing cost for the beneficiaries of 

such financing. 

Bonds issued by State and local governments may be classified as either governmental 

bonds or private activity bonds. Governmental bonds are bonds the proceeds of which are 

primarily used to finance governmental functions or which are repaid with governmental funds. 

Private activity bonds are bonds in which the State or local government serves as a conduit 

providing financing to nongovernmental persons (e.g., private businesses or individuals). The 

income exclusion for interest paid on State and local bonds does not apply to private activity 

bonds, unless the bonds are issued for certain permitted purposes (“qualified private activity 

bonds”) and other Code requirements are met. 

Like other activities carried out and paid for by State and local governments, the 

construction, renovation, and operation of governmental transportation infrastructure projects 

such as public highways or governmental mass commuting systems (e.g., rail and bus) are 

eligible for financing with the proceeds of governmental bonds. In addition, certain privatelyused transportation infrastructure projects may be financed with qualified private activity bonds. 

Tax-exempt debt to fund infrastructure

Present law does not limit the types of facilities that can be financed with governmental 

bonds. Thus, State and local governments can issue tax-exempt governmental bonds to finance a 

broad range of transportation infrastructure projects, including highways, railways, and airports. 

These debt instruments in turn can be secured by the infrastructure assets, or can be “general 

obligation” debt of the issuer. 

One tax policy consideration that follows from the availability of tax-exempt financing to 

governmental owners of infrastructure is that, when attempting to quantify the cost to the Federal 

government of the Federal tax subsidies available to public-private partnerships, a complete 

analysis would also take into account, on the other side of the ledger, the Federal tax subsidy (the 

exemption from income tax) available to wholly public infrastructure projects, to the extent they 

are funded with tax-exempt debt. 

 42 A description of tax-exempt bonds for transportation projects generally can be found in Joint 

Committee on Taxation, Overview of Selected Tax Provisions Relating to the Financing of Surface 

Transportation Infrastructure, (JCX-56-08), July 8, 2008. 
16

While the types of projects eligible for governmental bond financing are not 

circumscribed, present law does impose restrictions on the parties that may benefit from such 

financing. For example, present law limits the amount of governmental bond proceeds that can 

be used by nongovernmental persons. Where bond proceeds are used to finance property, the 

use of such property is treated as a use of the bond proceeds. Use of bond proceeds by 

nongovernmental persons in excess of amounts permitted by present law may result in such 

bonds being treated as taxable “private activity bonds,” rather than governmental bonds. 

As applied to the archetypal transactions under consideration here, a fundamental 

consequence of the transfer of the highway infrastructure assets to a private firm is that a 

purported tax-exempt bond offering used to finance or refinance the acquisition (for example, if 

the State or local issuer were to lend the proceeds of a governmental debt offering to the private 

firm and the debt service on the private loan used to service the governmental debt), would be 

treated as a private activity bond. In the absence of a special qualifying rule, as described below, 

such an offering therefore would not qualify as a tax-exempt financing. 

Private activity bonds

The Code defines a private activity bond as any bond that satisfies (1) the private 

business use test and the private security or payment test (“the private business test”); or (2) “the 

private loan financing test.”43 Generally, private activity bonds are taxable unless issued as 

qualified private activity bonds. 

Private business test.–Under the private business test, a bond is a private activity bond if 

it is part of an issue in which: 

a. More than 10 percent of the proceeds of the issue (including use of the bondfinanced property) are to be used in the trade or business of any person other 

than a governmental unit (“private business use”); and 

b. More than 10 percent of the payment of principal or interest on the issue is, 

directly or indirectly, secured by (a) property used or to be used for a private 

business use or (b) to be derived from payments in respect of property, or 

borrowed money, used or to be used for a private business use (“private 

payment test”).44

Both parts of the private business test (i.e., the private business use test and the private 

payment test) must be met for a bond to be classified as a private activity bond. Thus, a facility 

that is 100 percent privately used does not cause the bonds financing such facility to be private 

activity bonds if the bonds are not secured by or paid with private payments. 

 43 Sec. 141. 

44 The 10 percent private business test is reduced to five percent in the case of private business 

uses (and payments with respect to such uses) that are unrelated to any governmental use being financed 

by the issue. 
17

Private loan financing test.–A bond issue satisfies the private loan financing test if 

proceeds exceeding the lesser of $5 million or five percent of such proceeds are used directly or 

indirectly to finance loans to one or more nongovernmental persons. Private loans include both 

business and other (e.g., personal) uses and payments by private persons; however, in the case of 

business uses and payments, all private loans also constitute private business uses and payments 

subject to the private business test. 

Changes in use.–A bond issue is an issue of private activity bonds if, (1) as of the issue 

date, the issuer reasonably expects that the issue will meet either the private business tests or the 

private loan financing test, or, (2) subsequent to the issue date, the issuer takes deliberate action 

that causes the private business tests or private loan financing test to be met.45 A deliberate 

action affects the taxability of interest from the issuance date, even though it occurs subsequent 

to issuance. If certain conditions are satisfied, the Treasury regulations allow an issuer to cure a 

deliberate action by taking a remedial action provided for in the Treasury regulations.46 Such 

remedial actions include redemption or defeasance of bonds, alternative use of disposition 

proceeds, and alternative use of bond financed facilities. 

As an example, assume State A issued governmental bonds to build a public toll road and 

expects that it will be owned and operated by a governmental authority for the entire period that 

the bonds are outstanding. Five years later, while the bonds are still outstanding, it sells the toll 

road to a private company. The change in ownership would be considered a deliberate action 

that affects the tax-exempt status of the bonds. To prevent the bonds from becoming taxable 

private activity bonds retroactive to the issuance date, State A could use the proceeds from the 

sale to retire the bonds within 90 days of the deliberate action, or use such sale proceeds to 

establish a defeasance escrow within 90 days of the deliberate action to retire the bonds at their 

earliest call date.47 

Qualified private activity bonds

Qualified private activity bonds are tax-exempt bonds issued to provide financing for 

specified privately used facilities. The definition of a qualified private activity bond includes an 

exempt facility bond, or qualified mortgage, veterans’ mortgage, small issue, redevelopment, 

501(c)(3), or student loan bond.48

 45 Treas. Reg. sec. 1.141-2(d)(1). 

46 Treas. Reg. sec. 1.141-12. There are five conditions that are required to be met (1) the 

reasonable expectations test, (2) the maturity cannot be unreasonably long, (3) the terms of the 

arrangement that satisfies the private business tests or private loan financing test must be bona fide and 

arm’s length, and the new user pays fair market value for the use of the financed property, (4) disposition 

proceeds are treated as gross proceeds for arbitrage purposes and (5) the proceeds of the issue that are 

affected by the deliberate action were expended on a governmental purpose before the date of the 

deliberate action. 

47 Treas. Reg. sec. 1.141-12(d). 

48 Sec. 141(e). 
18

To qualify as an exempt facility bond, 95 percent of the net proceeds must be used to 

finance an eligible facility.49 Generally, qualified private activity bonds are subject to a number 

of restrictions that do not apply to governmental bonds. For example, the aggregate volume of 

most qualified private activity bonds is restricted by annual State volume limitations (the “State 

volume cap”).50 For calendar year 2008, the State volume cap, which is indexed for inflation, 

equals $85 per resident of the State, or $262.09 million, if greater. 

Qualified private activity bonds also are subject to additional limitations on issuance cost 

and length of maturity. In addition, the interest income from qualified private activity bonds 

(other than qualified 501(c)(3) bonds) issued after August 7, 1986, is a preference item for 

purposes of calculating the alternative minimum tax.51

Qualified highway or surface freight transfer facility bonds

In 2005, the Safe, Accountable, Flexible, Efficient Transportation Equity Act: A Legacy 

for Users, added a new category of exempt facility bonds, bonds for qualified highway or surface 

freight transfer facilities.52 Bonds for qualified highway or surface freight transfer facilities are 

 49 Sec. 142(a). Business facilities eligible for this financing include transportation (airports, 

ports, local mass commuting, high-speed intercity rail facilities, and qualified highway or surface freight 

transfer facilities); privately owned and/or operated public works facilities (sewage, solid waste disposal, 

water, local district heating or cooling, and hazardous waste disposal facilities); privately-owned and/or 

operated residential rental housing; and certain private facilities for the local furnishing of electricity or 

gas. Bonds issued to finance environmental enhancements of hydro-electric generating facilities, 

qualified public educational facilities, and qualified green building and sustainable design projects also 

may qualify as exempt facility bonds 

50 The following private activity bonds are not subject to the State volume cap: qualified 

501(c)(3) bonds, exempt facility bonds for airports, docks and wharves, environmental enhancements for 

hydroelectric generating facilities, and exempt facility bonds for solid waste disposal facilities that is to be 

owned by a governmental unit. The State volume cap does not apply to 75 percent of exempt facility 

bonds issued for high speed intercity rail facilities, 100 percent if the high speed intercity rail facility is to 

be owned by a governmental unit. Qualified veterans mortgage bonds, qualified public educational 

facility bonds, qualified green building and sustainable project design bonds, and qualified highway or 

surface freight transfer facility bonds also are not subject to the State volume cap, but the Code subjects 

such bonds to volume limitations specific to the category of bonds. 

51 Sec. 57(a)(5). Special rules apply to exclude refundings of bonds issued before August 8, 

1986, and to certain bonds issued before September 1, 1986. 

52 Pub. L. No. 109-59, sec. 11143 (2005). The Administration's budget for Fiscal Year 2005 

(released in February 2004), proposed allowing the Secretary of Transportation to allocate $15 billion of 

tax-exempt bond authority to finance highway projects and rail-truck transfer facilities. In describing the 

proposal, the Department of the Treasury noted that "[e]conomic growth and productivity depend on a 

modern, well-connected national transportation network. Allowing a limited amount of tax-exempt 

private activity bonds to be issued for highway projects and surface freight transfer facilities would 

encourage private sector investment in these projects." Department of the Treasury, General 

Explanations of the Administration’s Fiscal Year 2005 Revenue Proposals (February 2004) at 161. The 

proposal also was included as part of the Administration’s Fiscal Year 2006 budget proposals. See, 
19

qualified private activity bonds, the interest on which is tax-exempt. A qualified highway 

facility or surface freight transfer facility is: 

a. Any surface transportation or international bridge or tunnel project (for which 

an international entity authorized under Federal or State law is responsible) 

which receives Federal assistance under title 23 of the United States Code, or 

b. Any facility for the transfer of freight from truck to rail or rail to truck which 

receives Federal assistance under title 23 or title 49 of the United States Code. 

Qualified highway or surface freight transfer facility bonds are not subject to the State 

volume cap. Rather, the Secretary of Transportation is authorized to allocate a total of $15 

billion of issuance authority to qualified highway or surface freight transfer facilities in such 

manner as the Secretary determines appropriate.53

The Code imposes a special redemption requirement for qualified highway or surface 

freight transfer facility bonds. Under present law, the proceeds of qualified highway or surface 

freight transfer facility bonds must be spent on qualified projects within five years from the date 

of issuance of such bonds. Proceeds that remain unspent after five years must be used to redeem 

outstanding bonds. 

Qualified highway or surface freight transfer facility bonds may be used as financing for 

public-private partnership arrangements. However, some commentators have argued that in 

addition to other limitations, the required use of ADS cost recovery (i.e., straight line 

depreciation over longer recover periods), as discussed earlier in this testimony, makes these 

 

Department of the Treasury, General Explanations of the Administration’s Fiscal Year 2006 Revenue 

Proposals (February 2005) at 139. 

53 As of July 14, 2008, the Department of Transportation had made the following allocations of 

the $15 billion in qualified highway or surface freight transfer facility bond authority: 

Project Allocation 

Port of Miami Tunnel, Consortium Miami Access Tunnel $980,000,000 

Missouri DOT Safe and Sound Bridge Improvement Project $700,000,000 

Knik Arm Crossing, Alaska $600,000,000 

Virginia I-495 Capital Beltway HOT Lanes $589,000,000 

Texas Department of Transportation Interstate Highway 635 

(LBJ Freeway) $288,000,000 

Pennsylvania Turnpike Capital Improvements $2,000,000,000 

Ambassador Bridge Gateway Project - Phase I (Detroit, Michigan 

-Windsor, Ontario, Canada $212,600,000 

 Total approved allocations as of 7/14/08 $5,369,600,000 

Source: Federal Highway Administration 
20

bonds a less attractive financing option, and that a legislative proposal should be considered to 

allow accelerated depreciation in these cases.54

Conclusion

I hope that my testimony provides useful information on the tax policy issues raised by 

public-private partnerships with respect to the lease of existing highway infrastructure and their 

present law tax treatment. I am pleased to answer any questions that the Subcommittee may 

have at this time or in the future. 

 54 Humberto Sanchez, Roadblocks for P3 PABs; Current Laws Put Curbs on Widespread Use, 

Bond Buyer (New York, NY: April 12, 2007). Vol. 360, Iss. 32608, p.1.