Friday 3 July 2009

SILOs --more action needed?

Tax advantaged "sale-leasebacks" with strapped-for-cash municipalities (SILOs, in the ever-present tax acronym set) came back to light when the Washington Metro train crashed a week ago. The cars were ones that were involved in the metro authority's SILO deals with various banks, and the authority didn't have any spare money left to fund replacements. See this A Taxing Matter posting on the Metro SILOs, Jun 25, 2009.I won't go over the entire discussion of SILOs covered there. Just note that the transportation SILO deals were contrived to permit banks to "buy" the federal income tax reduction deductions on municipal equipment. The municipalites couldn't use the deductions, since municipalities are tax-exempt entities. The buying corporations were subject to US tax (usually, a bank) and they were looking for every way possible to avoid paying tax--they would essentially pay a fee to the municipalities, sharing part of their tax savings, for portion as an accommodation party in these deals. They "purchased" the municipalities' property with nonrecourse debt, and then had "lease income" that was offset by both interest deductions and reduction deductions, generating artificial losses from the accelerated depreciation. Most of the purchase price was set aside to defease the seller's obligation under the lease, with the excess the fee for accommodating the tax shelter.Jim Lehrer covered transportation agency SILOs in the March NewsHour, depicting a lot of of the transportation agencies as enthused by their desperate need for capital--and encouraged by the federal Dept. of Transportation to use these means to get some. So there is a vicious double circle of irony here, that as states and localities cut taxes during the GOP years, under the faulty assumption that lower taxes means senior revenues, the states and municipalities also cut back on the funding needed by these important public service agencies, and an arm of the federal administration encouraged these transportation agencies to enter these deals, and at smallest amount 30 of them did, portion as accommodation parties in tax shelter deals with banks, consequently that banks would pay even less taxes than they already did.Future SILOs were generally undone by new section 470, single of the a small number of income raising provisions in the 2004 tax act. (The 2004 Act otherwise amounted to a pile of tax breaks for US corporations, such as the rate cut on repatriating offshore profits. It was misleadingly labeled the "American Jobs Creation Act" to signal the purported justification for all the corporate tax breaks. It didn't lead to the creation of a lot of jobs.) The new section disallowed to U.S. taxpayers a "tax-exempt loss", distinct as the excess of deductions previous than interest and interest deductions allocable to tax exempt use property over the aggregate income from the property. Exceptions authorized certain "true" leases--essentially, ones in which the obligation of the seller-renter had not been defeased by the sum from the buyer and where the buyer had in fact put some even-handedness into the deal (the stipulation requires only 20% of genuine, at-risk equity). There are fewer tax benefits to true leases, consequently even with the exception, the stipulation deters leasing deals. One hitch--the act only applied prospectively, and the transportation deals (just single of the varieties of SILOs that were being complete at the time of the 2004 change) got special treatment, in that any deals in the pipeline were authorized to be grandfathered in as long as they were complete by 2006!The IRS pursued the old deals with pre-2004 Act tools and won SILO (and LILO--the earlier "lease in, rent out" deals) cases against Fifth Third Bank, BB&T, PNC and previous banks. See, e.g., IRS Wins AWG SILO Tax Shelter Case, TaxProf Blog (May 28, 2008) (dealing with the Ohio court's decision in 2008-1 USTC 50,370, in favor of the IRS in a SILO case involving two US national banks' "purchase", with nonrecourse loans from German banks whose profits were second-hand by the "seller" to defease the rent obligation, of a German waste facility second-hand to acquire beneficial tax deductions); Ohio Judge Rejects Tax Claims on $423 Million Alleged Purchase of German Facility Made by Cleveland & Pittsburgh-Based Banks, DOJ (May 30, 2008); DOJ, Ohio Jury Finds Cincinnati-based Bank not Entitled to $5.6 Million Tax Refund (LILO transctions); BB&T Corp, 2008-1 USTC 50,306 (4th Cir.) (striking down tax treatment of financial service company's rent of Swedish wood-pulp manufacturing kit as a LILO shelter); DOJ, Statement of Assistant Attorney General Nathan J. Hochman on Today's Decision in BB&T Corporation v. United States (Apr. 29, 2008).After the court victories, the IRS offered a SILO settlement for these deals that legal them to keep 20% of their claimed tax losses and waived the penalties, if they ended the transactions. IRS Commissioner's Remarks Regarding LILO/SILO Settlement Initiative (Aug. 6, 2008); Donmoyer, IRS Offers to Settle 45 leasing Tax-Shelter Disputes, Bloomberg.com (Aug. 6, 2008); Service Launces LILO, SILO Settlement Initiative, J. Acct. (Oct. 13, 2008). It later announced that "hundreds of taxpayers established alike cases involving tens of billions of dollars." DOJ, Justice Department Highlights FY 2008 Tax Enforcement Results (Apr. 13, 2009). On leaving office, Korb statedthat "taxpayers representing over 80 percent of the dollars involved have elected to take benefit of the settlement initiative." See Korb Interview. (Dec. 19, 2008).The settlement offer required taxpayers to end the transactions by Dec. 31, 2008, also they would be deemed ended by that date, with taxpayers still able to claim the partial loss benefit through the actual stop date if they ended the deal by Dec. 31, 2010. That's a fairly strong incentive for termination, but the municipalities might be on the hook for heavy stop payments under their contracts. Even worse, the AIG situation provided a perfect trigger for causing a technical default to apply. AIG certain these deals, consequently when its credit score went down, the transportation agencies are in technical default and liable for heavy penalty payments. (see NewsHour video, above).There are real problems here, including the idea of single agency of the administration partisan its "clients" (transit agents of municipalities) towards the inside into deals like this that result in corporate tax cheats robbing the administration of important revenues. Another problem is the idea of the banks that were instrumental in causing the fiscal crisis--by risky, tentative behavior that unnoticed the systemic risks--using AIG's collapse because of that fiscal mess as an excuse to get municipalities that are especially cash-strapped because of the fiscal crisis (and finding their ability to have a loan of or get tax revenues harshly restricted) to pay over large penalty amounts under their shelter contracts. It seems like an unfair bonus for tax cheating Big Banks at the cost of the people.And of course, just extending the 2004 stipulation to make grandfathered SILO/LILO transactions unlawful and their tax deductions disallowed doesn't solve this problem, since these are windfalls that the tax cheaters would get under their "lease" contracts.Rep. Menendez of NJ has future a potential solution--the "Close the SILO/LILO Loophole Act" S. 1341, introduced in late June. His bill, he says, would "help defend WMATA and previous transportation agencies who are being endangered by banks seeking to gain a bonus from the current economic climate while potentially putting transportation agencies at risk." See press release, As Lease-Back Deals Are Raaised as an Issue in Metro Crash, Menendez Says legislation Can help Unwind Deals, PolitickerNJ.com (Jun 26, 2009); Davis, Bill Would Tax Banks that Sue Agencies , Star Ledger (Jun 24, 2009); Letter from Menendez to Hoyer (Jun 26, 2009) (noting a need to "protect transportation agencies from banks who are seeking to exploit a technicality that would result in agencies having to pay banks millions of dollars that could otherwise be second-hand to shore up kit and ensure safe operations, even though they have not missed a single sum to the bank"). The bill imposes an excise tax equal to 100% of any "ineligible amount" composed by "any person previous than a SILO/LILO lessee" as a party to a SILO/LILO transaction. Ineligible amounts are profits from terminations, rescissions, or remedial actions in excess of those under defeasance arrangements. The bill also would deny deductions for lawyer fees and previous costs attributable to seeking to recover ineligible amounts.It's messy, but it does end up with the right results, it seems. I note, though, that there are negative extra co-sponsors at this time. Doesn't look like Congress is hopping on the bandwagon.
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