of Recent IRS Revisions for Management Contracts
on Long-Term Public/Private Partnerships
|On January 16, 1997,
the Internal Revenue Service (IRS) removed a long-standing obstacle to public/private
partnerships. These new regulations now make it easier for municipalities to enter into
long-term contracts for the private operation, maintenance and management (OM&M) of
their water and wastewater treatment systems.
Prior IRS regulations limited contract terms to five years. However, the IRS has now provided safe harbor guidelines for municipalities to follow in order to allow them to enter into long-term public/private partnerships.
EXTENDING CONTRACT TERMS
|The IRS also allows for
special arrangements involving designated public utility property. If facilities are
public utility property, the permissible contract term is 20 years, provided an 80 percent
PFF can be met and subject to the 80 percent useful life constraint. Water and wastewater
treatment systems are designated as public utility property. However, a glitch
arose when it was realized that the IRS Code elsewhere defines public utility property as
state-regulated utilities with rates set on a rate-of-return basis. The IRS did not intend
this narrowing effect and is expected to issue a conforming modification.
Note the significance of the up to terminology in defining maximum contract terms. Partners may sign a 4-, 7- or 11-year contract or break down the maximum term into a preliminary contract with successive renewals. Any combination is acceptable as long as the total is less than or equal to the maximum term selected.
It is important to remember that even though IRS regulations now permit 10-, 15- and 20-year contracts, some state laws forbid extended agreements. Each municipality should be sure to check its state law to see if it places limits on contract terms.
Compensation in addition to the PFF is referred to as variable compensation. It may take many forms such as:
Sharing in cost reductions (i.e., through operational changes or capital improvements)
Sharing in increased revenues (i.e., through a meter replacement
Any compensation which reimburses the private provider for costs paid to third parties (i.e., pass-through costs) does not have to be included in the PFF calculation. When including finance obligations in a contract, if a debt reflects internal financing by the service provider, compensation is considered a PFF. On the other hand, if financing is obtained from a third party, the debt service is viewed as a pass-through cost.
EXPANDING CONTRACT SCOPES