July 01, 2018 Feature

Corporate Tax During 100 Years of IRIS

By David R. Hardy

In the 100-year history of the ABA’s Infrastructure and Regulated Industries Section (IRIS), the increasing complexity and frequency of change in the corporate income tax has been a relative constant. Such changes have increased exponentially over the course of the twentieth century and slowed only slightly by recent legislative gridlock. However, the changing impact of the corporate income tax on infrastructure and regulated industries can be seen more clearly though the lens of the transition of these industries from government-provided services to regulated private ownership and then later to ownership by conglomerates of regulated and unregulated businesses. This progression and development of the infrastructure industries provides the context in which income tax developed from an irrelevance to a predicable expense and, finally, to a significant financial risk as well as a financial planning tool. Accordingly, the significant change in the role played by tax lawyers advising these industries must be considered in relation to these historic developments.

Tax in Early Regulated Industries

Governmental Ownership

In the nineteenth and early twentieth centuries, the infrastructure services that came to be thought of as utilities were provided as essential elements of government service to citizens. During these early times, water, natural gas, and electricity provided to a community were provided by the municipality itself and funded through property and other local tax revenues. At such times, income and property taxes were not imposed on these assets or services and such taxes were not relevant to the operation of these infrastructure assets.

Regulated Companies

Following the ratification in 1913 of the Sixteenth Amendment to the U.S. Constitution permitting unapportioned income tax, the corporate income tax became a much more significant element of the federal government’s fundraising profile. During the same period of time, the increasing capital needs for acquisition of operating assets necessary for the provision of utility services led to the privatization of many of the original infrastructure industries. As electricity and natural gas moved into ownership by investor-owned companies, which possessed “natural economic monopolies,” the government imposed access and service obligations and regulated rates of return upon such companies to prevent favoritism and profit gouging.

In calculating such regulated rates of return, investor-owned utilities were permitted to set the rates at amounts designed to recover their prudent cost of services, including the amortization of their capital cost, and to earn a regulated return on their equity. In that context, the corporate income tax was a cost of service fully recoverable through the rate proceedings that such utilities were frequently required to conduct. As such, the ability to predict accurately the corporate income tax expense of the utility so as to fully recover such cost through rates was critical. In that environment, predictability was the predominant motive of regulated utilities and their tax advisors. Tax planning, as we know it today, played a relatively insignificant role.

Common Carriers

While traditional rate of return regulation served as the paradigm for electricity, natural gas, and telephone, a conceptually distinct type of regulation emerged for common carriers operating in interstate commerce amid increasing competitive alternatives, which included railroads, oil pipelines, and later, commercial aviation. Such industries, like regulated utilities, were deemed to have pricing power warranting regulation to ensure a reasonable rate of return but also were subject to increasing rate-design regulation to constrain economically favored pricing to certain segments of customers. The regulation for such common carriers in part became based upon in nondiscriminatory access to the common carrier’s facilities at just and reasonable rates. Thus “filed rates” served as the foundation for the nondiscriminatory pricing and access. “Just and reasonable” also continued to incorporate the regulated fair rate of return to equity similar to the rate proceedings under state law imposed upon regulated industries described above.

As these industries emerged into the post-World War II era, corporate income taxes represented a recoverable cost of service for which predictability was the essential element.

Tax in Diverse Conglomerates

In the post-War period of 1950s to 1970s, infrastructure businesses and regulated industries faced the significant capital cost of upgrading their equipment. Such costs included the acquisition and construction of commercial aircraft, large coal-fired and nuclear-electricity generating assets, oil and gas pipelines, and other transmission assets. Separately, the U.S. income tax law started to be used by lawmakers as an incentive to induce purchases of new plants and equipment to provide economic stimulus and job creation. Many of these new infrastructure equipment costs were the beneficiaries of federal tax incentives such as investment tax credit and accelerated depreciation. These affected industries became much more adept at structuring their business affairs so as to maximize the economic value of tax incentives by placing them in the hands of owners with predicable tax-benefit appetites. Thus, leveraged leasing of these significant core infrastructure assets became prominent for aircraft, generation, and transmission assets. Banks and Fortune 500 companies became the tax owners of these assets that were leased to and operated by regulated businesses. In the hands of these owners with large tax exposure, investment tax credits, depreciation, and interest deductions had the maximum value.

With this emerging appreciation for the value of tax benefits as facilitators of the efficient acquisition of capital goods, many members of the infrastructure industries began themselves to diversify into unregulated businesses. Using a federal consolidated income tax return, for example, the parent of a regulated business could also own an unregulated equipment leasing subsidiary. In that structure, the depreciation and investment tax credit benefits resulting from equipment ownership might be made available in a consolidated return to offset the tax expense being incurred by a regulated affiliate of the leasing company. In such a structure, the regulated business rate payers might be charged rates for services that included a hypothetical recovery of tax expense that the company might not actually be currently paying due to the tax losses from other affiliates. In this environment, the owners of infrastructure assets and their tax lawyers became significantly more attuned to generating and protecting tax “assets” and managing tax opportunities.

Predictably, utility rate payers and rate regulators were uncomfortable with having taxes not actually being paid currently incorporated into rates. Some states by statute or case law began to limit recoverable tax expense to taxes actually paid. The normalization rules set forth in sections 167 and 168 of the Internal Revenue Code were introduced in major part to prevent local state regulators from depriving regulated utilities of the incentives embedded in accelerated depreciation and investment tax credits by limiting the rate of return recovery to taxes actually paid. See former I.R.C. § 167(l) (1986), as amended, regarding assets placed in service before Nov. 6, 1990, and §§ 168(f)(2) and 168(i)(9). These normalization rules effectively required public utility commissions to amortize the front-loaded tax incentives over the entire economic life of the regulated asset. Failure to “normalize” such tax benefits would result in a denial of the accelerated depreciation benefit, thereby protecting the intended economic incentive of such tax benefits.

As the regulated industries progressed into the 1980s, significant deregulation of different historically regulated infrastructure assets began to occur. Commercial aviation was an early example; the prior rate-setting prerogatives of the Civil Aeronautics Board were eliminated, and the aviation business became unregulated. Perhaps not surprisingly, unregulated aviation also became unprofitable. The resulting lack of predictable tax base for commercial aviation companies made the leveraged leasing of their new aircraft from tax-paying corporations all the more important. This same progression of the deregulation movement occurred in the electricity-generation industry in the late 1980s and 1990s, as various states determined that electricity-generation assets should be competitively priced without the need for fixed and guaranteed long-term returns on the costs of the equipment.

Tax as an Exploitable Benefit

The pressure to financially exploit tax assets and incentives has continued and is manifest in different ways. We have seen Berkshire Hathaway acquire a number of previously independent electric utilities and assemble them into a major portion of its diverse portfolio of companies. And in a particularly ironic way, we have seen U.S. regulated companies acquire foreign regulated companies and foreign regulated companies acquire U.S. regulated companies by utilizing and exploiting tax law inconsistencies between countries to increase the tax benefits and reduce their acquisition financing costs. The irony is that international tax would become important to operation of inherently local infrastructure assets.

In the last quarter of the twentieth century, we have witnessed the capital markets’ increasing sophistication in enhancing the value of investment securities by reducing embedded tax expense. Among the examples of this phenomenon was the emergence of real estate investment trusts (REITs), as well as the master limited partnership (MLP). These tax ownership vehicles were largely introduced into the Internal Revenue Code as mutual funds, allowing individual investors to commonly invest in real estate, oil and gas, and passive investment assets without the burden of an entity-level tax. However, certain conventional components of the infrastructure industry were identified as potentially eligible for ownership through these tax-favored vehicles. The tax-favored ownership vehicle will frequently own the infrastructure assets and lease them back to the licensed service provider in exchange for rent. Such assets operate free of entity-level income tax. The regulated licensee’s cost of equipment utilization has been partially reduced by the economic sharing of the tax benefits enjoyed by the ownership vehicle.

These “untaxed” ownership structures certainly provide a more efficient capital funding structure for oil and gas pipelines and processing plants, telephone lines and cellular phone transmission and broadcasting towers, and electric transmission and perhaps distribution lines. The results, however, created a challenge for economic rate-of-return regulators to determine whether such enterprises ought to be entitled to recovery of a notional tax cost. Such tax costs represent, not the income tax cost of the owning entity, but the tax cost of its public shareholders who might be individuals, foreign corporations, or untaxed endowments and pension plans. Recent regulatory pronouncements indicate that notional tax cost may not continue to be recoverable.

The Twenty-First Century

In the last 15 years, major federal tax legislation had been largely blocked by legislative gridlock until the Tax Cut and Job Acts of 2017 (TCJA), Pub. L. No. 115-97, 131 Stat. 2054 (Dec. 22, 2017). Interestingly, as if Congress had been observing infrastructure asset ownership moving to “untaxed” structures, the TCJA dramatically reduced corporate income tax rates (from 35 percent to 21 percent) and permitted full expensing of newly acquired tangible personal property, both new or used, through 2022. Together, the new provisions dramatically reduce corporate income tax for the near term.

In passing the TCJA, Congress seems temporarily to have accepted the notion that corporations and their owners either absorb income tax expense and become less competitive or transmit income tax expense to customers through increased prices of goods and services. It may be premature to view reduced corporate tax rates and full expensing as permanent elements of the U.S. income tax environment. But the legislation, when considered with increasing “untaxed” entity ownership of capital assets, suggests that the markets and the public are becoming more sensitive to corporate income tax as cost borne by customers.


In the new world of infrastructure, the taxation of the ownership and operation of infrastructure services has moved beyond the simple world of regulated companies focused on their obligation to provide the regulated service in exchange for a fair and reliable rate of return. Today, tax expensing, leasing, conglomerate ownership, MLP and REIT ownership, and public-private partnership structures are employed for the acquisition and construction of essential infrastructure assets. In a sense, it is almost as though the infrastructures industries are completing a full circle from untaxed governmental services to lightly taxed businesses. In this increasingly competitive environment, the service provider that must absorb the full corporate income tax will operate at a significant disadvantage when compared to its untaxed or low-taxed competitors.

Over the last century, tax lawyers have become essential advisors to their infrastructure clients attempting to manage and exploit the complexity of tax costs and tax incentives. Those lawyers and their IRIS clients have become increasingly sensitive to tax implications of alternate financial structures and nimble at optimizing strategies to use such structures to minimize effective tax rates.


By David R. Hardy

David R. Hardy (dhardy@osler.com) is a partner in the Taxation department of Osler, Hoskin & Harcourt LLP. Based in New York City, he focuses his practice on corporate and international tax matters, including the tax issues affecting corporations in the energy industry.