Washington Subway Funding Derailed By Tax Shelter?

by Mike Godfery, Tax-News.com, Washington

30 June 2009

A senior Republican Senator has expressed concern that a tax sheltering arrangement entered into between the Washington Metropolitan Area Transit Authority (WMATA) and a foreign bank contributed to a funding shortfall in the transit system, compromising safety to the extent that it was a major factor in the recent fatal subway crash.

Senator Chuck Grassley of Iowa, the ranking member of the Senate Finance Committee, has written to House Majority Leader Steny Hoyer urging him to include language in any proposal to give the Washington Metropolitan Area Transit Authority more funds to ensure that the money would be used for safety improvements and not to pay off transit agencies’ obligations to corporations, including foreign corporations, who use the agreements as tax shelters. He has also written to the American Public Transportation Association to ask how many other public transit systems may be constrained from making equipment upgrades by tax-advantaged leases.

“It would seem… that WMATA disregarded risks to passenger safety in order to fulfil a contract entered into as an accommodation party to a tax shelter,” Grassley wrote in the letter to Hoyer. “By entering into tax shelter contracts, the WMATA appears to have allowed banks – rather than experts on passenger safety - to dictate what kind of trains Metro riders use and for how many years they are in service.”

“As you contemplate providing WMATA with USD3 billion of funding, I ask that you prohibit payments to the bank with which WMATA entered into the tax shelter from any WMATA funds,” he added.

Grassley said the leasing transactions in question are known as SILOs (sale-in lease-out), where transit agencies (and other public infrastructure companies) have sold public assets such as railcars, only to lease them back from purchasers, with the result of providing tax depreciation deductions to the purchasers.

“Such transactions were motivated solely by collection of fees on one side and tax benefits on the other, rather than any change to the services provided by transit agencies,” says Grassley.

While he was Chairman of the Finance Committee in 2004, Grassley won passage of legislation to shut down such tax shelters. However, whilst his original reform was retroactive, it was watered down during conference negotiations to apply only prospectively.

According to Grassley, in 2006, WMATA rejected recommendations made by the National Transportation Safety Board to retire or do a heavy overhaul on the 1000 Series railcars reportedly involved in the recent fatal crash because “WMATA is constrained by tax advantaged leases, which require that WMATA keep the 1000 Series cars in service at least until the end of 2014.”

Grassley and others opposed a bailout for the transit agencies involved in tax shelter deals because, he argued, it would have perpetuated the tax shelter. The proposal was included as part of the auto bailout, but failed to pass in the Senate. “I don’t want any new money in the pipeline for Metro today to potentially go to a foreign bank using a SILO deal as a tax shelter,” he said.

The legislation enacted in 2004 established section 470 of the Internal Revenue Code, which effectively shuts down the tax benefits of entering into SILO transactions. Separate, subsequent legislation established Internal Revenue Code Section 4965, which designates certain transactions as prohibited tax shelter transactions and includes new entity-level and manager-level excise taxes and disclosure rules applicable to prohibited tax shelter transactions to which a tax-exempt entity is a party.

In between these two acts of Congress, the IRS issued Notice 2005-13 ‘Tax-Exempt Leasing Involving Defeasance.’ The Notice describes “transactions in which a taxpayer enters into a purported sale-leaseback arrangement with a tax-indifferent person in which substantially all of the tax-indifferent person’s payment obligations are economically defeased and the taxpayer’s risk of loss from a decline, and opportunity for profit from an increase, in the value of the leased property are limited.”

The Notice identifies these transactions, and substantially similar transactions, as listed transactions for purposes of section 1.6011-4(b)(2) of the Income Tax Regulations and IRC sections 6111 and 6112. In August 2008, the IRS announced a settlement initiative for parties to these transactions to unwind the tax benefits from these transactions.

It is said that WMATA entered into the SILO arrangement with a Belgium-based bank. WMATA subsequently agreed a settlement regarding the fees owed by the transit authority to the bank as a result of its default on its tax-shelter contract. However, the details of this have not been publicly disclosed.

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