SELLING DEPRECIATION FOR TAX SELLING DEPRECIATION FOR TAX PURPOSES: SHOULD WE BE CONCERNED?PURPOSES: SHOULD WE BE CONCERNED?

Breakout Session:Breakout Session:Toll Road Leasing: Real Issues and Red Herrings Toll Road Leasing: Real Issues and Red Herrings

Jonathan R. Peters, Ph.D.Jonathan R. Peters, Ph.D.The University Transportation Research Center The University Transportation Research Center –– Region II Region II

& The College of Staten Island& The College of Staten Island

Presented at the 7Presented at the 7thth National Conference National Conference on Transportation Asset Management on Transportation Asset Management

New Orleans, LouisianaNew Orleans, LouisianaNovember 7, 2007November 7, 2007

My FocusMy Focus

Doug Lee and William Doug Lee and William AnknerAnkner have have brought a lot of great information onto the brought a lot of great information onto the table table –– so what is left for me to discuss?so what is left for me to discuss?Do Toll Roads have the potential to Do Toll Roads have the potential to generate tax credits and/or create other generate tax credits and/or create other streams of cash flow that increase the streams of cash flow that increase the value of the franchise?value of the franchise?How do toll road operators manage their How do toll road operators manage their tax liabilities?tax liabilities?

DepreciationDepreciation

Depreciation shows as a word search only Depreciation shows as a word search only 25 time in the 2007 TRB Meeting 25 time in the 2007 TRB Meeting Compendium of Papers. Only 3 papers Compendium of Papers. Only 3 papers are related to PPPare related to PPP’’s or privatization. Most s or privatization. Most linked to depreciating fixed assets.linked to depreciating fixed assets.Tax Credits shows only 10 times with no Tax Credits shows only 10 times with no papers related to roads, PPPpapers related to roads, PPP’’s or s or privatizationsprivatizations

New Issues in Private TollingNew Issues in Private TollingSo, it seems that we are in a brave new world.So, it seems that we are in a brave new world.We need to establish standards of conduct and We need to establish standards of conduct and valuation.valuation.We need to understand the new financing and We need to understand the new financing and accounting rules.accounting rules.We should analyze current projects and We should analyze current projects and evaluate the impact on local and national evaluate the impact on local and national finances.finances.We also need to ask: Does it matter to us in We also need to ask: Does it matter to us in terms of infrastructure financing? terms of infrastructure financing?

New IssuesNew Issues

Rate of ReturnRate of ReturnDepreciationDepreciationTax LawTax LawTax ManagementTax ManagementTerms and Conditions of Concession Terms and Conditions of Concession Value of AssetValue of AssetTail ConditionsTail ConditionsComplex Financial RelationshipsComplex Financial Relationships

Finance 101 Finance 101 –– Firm ValueFirm Value

Value of firm is based on:Value of firm is based on:1) Level of Cash Flows1) Level of Cash Flows2) Timing of Cash Flows2) Timing of Cash Flows3) Risk of Cash Flows3) Risk of Cash Flows

So, as we examine toll road concessions, So, as we examine toll road concessions, we need to look at each piece of this we need to look at each piece of this package to understand private firm value.package to understand private firm value.

Financial GoalsFinancial Goals

Maximize inflowsMaximize inflowsMinimize outflowsMinimize outflowsSpeed up inflowsSpeed up inflowsDelay outflowsDelay outflowsIncrease certainty of inflowsIncrease certainty of inflowsReduce risk of outflowsReduce risk of outflowsReduce overall risk of firm to lower costsReduce overall risk of firm to lower costsGoal Goal –– Maximize Shareholder Wealth!!Maximize Shareholder Wealth!!

Some Financial FlowsSome Financial FlowsRevenue from OperationsRevenue from OperationsExpenses from OperationsExpenses from OperationsTaxesTaxesTax CreditsTax CreditsFinancing Inflows Financing Inflows Financing OutflowsFinancing OutflowsRevaluation of AssetsRevaluation of AssetsExchange Rate ImpactsExchange Rate ImpactsSale or purchase of assetsSale or purchase of assetsSome are outlined in concession agreement to Some are outlined in concession agreement to increase value of project.increase value of project.

Finding Cash FlowsFinding Cash Flows

Private capital operators have been known to Private capital operators have been known to look for additional cash inflows not specified in look for additional cash inflows not specified in contract from their asset pool to enhance value:contract from their asset pool to enhance value:

Carts at Airport Carts at Airport -- $4 at Sydney Airport$4 at Sydney AirportAdvertising along HighwayAdvertising along HighwayNaming RightsNaming RightsTax CreditsTax CreditsConcessions at/on Facility Concessions at/on Facility –– gift shopsgift shops

RememberRemember--Lots of Vested PlayersLots of Vested Players

Private FirmsPrivate FirmsConsultantsConsultantsUnionsUnionsState and Local PoliticiansState and Local PoliticiansDOT StaffDOT StaffPolitical AppointeesPolitical AppointeesLocal ResidentsLocal ResidentsWe have to winnow real issues from political We have to winnow real issues from political issues.issues.

"'Revenue Reform' Train Stopped by 'Vested Interests,' 'Local Issues,' 'Trusts,' and other poles" — Political cartoon from 1880–1900 commenting on tax reform.

www.wikipedia.com

Tax Management & CreditsTax Management & Credits

So, we need to take a look at how Privatized Toll So, we need to take a look at how Privatized Toll Roads are financed and how they use tax credits Roads are financed and how they use tax credits and other techniques to minimize their cost of and other techniques to minimize their cost of borrowing and tax burden.borrowing and tax burden.We are going to examine tax credits, lease We are going to examine tax credits, lease capitalization, depreciation, and transfer pricing capitalization, depreciation, and transfer pricing to see if private firms are using tax laws and to see if private firms are using tax laws and shelters to minimize their tax burden.shelters to minimize their tax burden.

Tax ManagementTax Management

Most large profit making firms manage Most large profit making firms manage their tax burdens.their tax burdens.Many have extensive tax planning/tax Many have extensive tax planning/tax sheltering programs to control these costs.sheltering programs to control these costs.Most are reluctant to discuss any aspects Most are reluctant to discuss any aspects of their tax management strategies due to of their tax management strategies due to their desire to maintain current tax their desire to maintain current tax advantages.advantages.

ImplicationsImplicationsIRS estimates that companies reduced their IRS estimates that companies reduced their federal income taxes by about $12,000,000,000 federal income taxes by about $12,000,000,000 in 2004 through the use of abusive tax in 2004 through the use of abusive tax transactions. Some say more.transactions. Some say more.Many firms claim any tax savings are just the Many firms claim any tax savings are just the happy byproduct of normal business happy byproduct of normal business transactions.transactions.Complex corporate transactions that serve no Complex corporate transactions that serve no business purpose other than to reduce taxes are business purpose other than to reduce taxes are considered improper tax shelters.considered improper tax shelters.

Corporate Tax BurdenCorporate Tax Burden

Federal Statutory Rate Federal Statutory Rate –– 35%35%Average State Income Taxes Average State Income Taxes –– 6.9%6.9%Some States have No Corporate Tax on Some States have No Corporate Tax on certain income.certain income.So the opportunity exists to shift income, So the opportunity exists to shift income, expenses and revenue between states to expenses and revenue between states to minimize tax burden.minimize tax burden.This opportunity also exists on the This opportunity also exists on the international level international level –– between countries.between countries.

Federal Corporate Tax RatesFederal Corporate Tax RatesTaxable Income ($) Tax RateTaxable Income ($) Tax Rate

0 to 50,000 15%0 to 50,000 15%50,000 to 75,000 25%50,000 to 75,000 25%75,000 to 100,000 34%75,000 to 100,000 34%

100,000 to 335,000 39%100,000 to 335,000 39%335,000 to 10,000,000 34%335,000 to 10,000,000 34%

10,000,000 to 15,000,000 35%10,000,000 to 15,000,000 35%15,000,000 to 18,333,333 38%15,000,000 to 18,333,333 38%18,333,333 and up 35%18,333,333 and up 35%

Example: WalExample: Wal--Mart Mart -- IICurrently engaged in an extensive fight with Currently engaged in an extensive fight with North Carolina with regards to their tax North Carolina with regards to their tax management strategies. management strategies. Wall Street Journal calls the case Wall Street Journal calls the case ““a rare window a rare window into accountantsinto accountants’’ role in generating tax reduction role in generating tax reduction ideas at one major companyideas at one major company””Paying an effective overall state tax rate of about Paying an effective overall state tax rate of about 3.75% versus 6.9% for the average firm.3.75% versus 6.9% for the average firm.Operated a Operated a ““Tax Shelter RoomTax Shelter Room”” at Corporate at Corporate Headquarters.Headquarters.

WalWal Mart Mart -- IIIIExtended Request for Proposals in 2001 to accounting Extended Request for Proposals in 2001 to accounting firms firms ““for professional tax advice and related implementation services for professional tax advice and related implementation services in in connection with the minimization of state income taxes in the foconnection with the minimization of state income taxes in the following states: llowing states: Arizona, California, Florida, Illinois, Indiana, Michigan, MinneArizona, California, Florida, Illinois, Indiana, Michigan, Minnesota, and Pennsylvania.sota, and Pennsylvania.””

Ernst & Young Ernst & Young –– provided 37 page tax management provided 37 page tax management proposal with 27 potential tax strategies proposal with 27 potential tax strategies –– many tailored many tailored to a particular stateto a particular state’’s tax code. $2,500,000+ fees tax code. $2,500,000+ feeHas had an active strategy for over 10 years.Has had an active strategy for over 10 years.Strategy changes as states changes laws and attack Strategy changes as states changes laws and attack existing approaches to tax sheltering.existing approaches to tax sheltering.Called Called ““domestic restructuring projectdomestic restructuring project”” as opposed to as opposed to ““tax projecttax project”” at Ernst & Young to avoid paper trail.at Ernst & Young to avoid paper trail.

Transfer PricingTransfer PricingTransfer pricing is a key to these strategies.Transfer pricing is a key to these strategies.Transfer pricing is the pricing for transfer of goods, Transfer pricing is the pricing for transfer of goods, intangibles and services within multinational enterprises.intangibles and services within multinational enterprises.So, you take costs in high tax areas and transfer value to So, you take costs in high tax areas and transfer value to low tax areas.low tax areas.WalWal--Mart had ownership of its brand names (Such as Mart had ownership of its brand names (Such as SamSam’’s Club) in a Delaware (low tax state) unit and s Club) in a Delaware (low tax state) unit and charged other units for the use of these brand names charged other units for the use of these brand names ––deducting these costs as expenses in the other states. deducting these costs as expenses in the other states. Same process can and is used on an international level.Same process can and is used on an international level.Ernst & Young served WalErnst & Young served Wal--Mart as both tax advisor as Mart as both tax advisor as well as outside auditor.well as outside auditor.

Tax CreditTax Credit

A instrument that is recognized as partial A instrument that is recognized as partial payment for taxes due a government payment for taxes due a government entity.entity.In some cases may be a tradable asset.In some cases may be a tradable asset.More valuable than deductions, as they More valuable than deductions, as they are a direct reduction in tax paymentare a direct reduction in tax paymentDeductions typically only worth tax rate Deductions typically only worth tax rate times deduction or say 35% of deduction.times deduction or say 35% of deduction.

Who Gets CreditsWho Gets Credits

If firm has excess tax credits, they can in some If firm has excess tax credits, they can in some cases sell them to other corporations who want cases sell them to other corporations who want to reduce their tax bill.to reduce their tax bill.It appears that credits sell at approximately 60It appears that credits sell at approximately 60--65% of their face value.65% of their face value.There is some risk in purchasing credits, as laws There is some risk in purchasing credits, as laws might change, so they trade at a discount.might change, so they trade at a discount.Tax credits can also be used as part of the Tax credits can also be used as part of the equity value in a transaction.equity value in a transaction.

Tax Credit and Road FinancingTax Credit and Road FinancingMerrill Lynch reports that a major component of Merrill Lynch reports that a major component of toll road financing recently provides for toll road financing recently provides for ““an an exchange of tax losses for a lower cost of exchange of tax losses for a lower cost of funding debt.funding debt.””““This is achieved by the concession company This is achieved by the concession company deriving a margin for the use of tax losses.deriving a margin for the use of tax losses.””““The borrower pays a lower rate of interest on its The borrower pays a lower rate of interest on its bank debt, but use up its tax losses quickly.bank debt, but use up its tax losses quickly.””““Moreover, the ability to exchange these losses Moreover, the ability to exchange these losses for a lower cost of debt ultimately increases the for a lower cost of debt ultimately increases the efficiency of project financing.efficiency of project financing.””Source U.S Toll Road Privatization, Merrill Lynch, March 2006Source U.S Toll Road Privatization, Merrill Lynch, March 2006

Net EffectsNet Effects

Corporate Buyer lowers tax payment to Corporate Buyer lowers tax payment to government government –– pays reduced fee for creditspays reduced fee for creditsToll road leaser gets extra income from Toll road leaser gets extra income from credits credits –– boosts profit (or lowers borrowing boosts profit (or lowers borrowing costs).costs).Government Government –– gains by extra tax from toll gains by extra tax from toll road minus reduction from corporate buyerroad minus reduction from corporate buyerAdverse selection Adverse selection –– buyers will tend to be buyers will tend to be heaviest tax burden firms.heaviest tax burden firms.

TaxcreditsTaxcredits llc.comllc.comFirm that provides consulting services to film companies Firm that provides consulting services to film companies looking to sell their special tax credits.looking to sell their special tax credits.

““Legislation providing for Legislation providing for tradeabletradeable tax credits allows companies tax credits allows companies who earn credits to sell them to other taxpaying companies or who earn credits to sell them to other taxpaying companies or individuals. Because of the significant economic benefits, many individuals. Because of the significant economic benefits, many states have recently enacted Film Production Tax Credit Programsstates have recently enacted Film Production Tax Credit Programsto lure filmto lure film--making to their states. In most cases, production making to their states. In most cases, production companies do not have sufficient tax liability to utilize the crcompanies do not have sufficient tax liability to utilize the credits. So, edits. So, they call upon us The Placement Specialists, to locate a suitablthey call upon us The Placement Specialists, to locate a suitable e buyer. Their tax credits are then sold at a discount for cash, abuyer. Their tax credits are then sold at a discount for cash, and the nd the benefit to the buyer is tax savings. The following states have benefit to the buyer is tax savings. The following states have tradeabletradeable tax credit programs (of varying types and attributes): tax credit programs (of varying types and attributes): ArizonaArizona,, ConnecticutConnecticut, , GeorgiaGeorgia, , IllinoisIllinois, , IowaIowa, , LouisianaLouisiana, , MassachusettsMassachusetts, , MissouriMissouri, , New JerseyNew Jersey, , PennsylvaniaPennsylvania, , Puerto Puerto RicoRico, and , and Rhode IslandRhode Island with more expected in the coming months.with more expected in the coming months.””

Are Selling Tax Credits the Issue?Are Selling Tax Credits the Issue?

It does not appear that tax credits are a It does not appear that tax credits are a major issue in toll road privatization.major issue in toll road privatization.However, capital management including However, capital management including valuation and depreciation are key issues.valuation and depreciation are key issues.Depreciation of both owned assets as well Depreciation of both owned assets as well as leases can create significant nonas leases can create significant non--cash cash expenses for a firm. These expenses expenses for a firm. These expenses lower the profit subject to taxation. lower the profit subject to taxation.

Key Component Key Component -- DepreciationDepreciationA key component of many tax management A key component of many tax management strategies is depreciation.strategies is depreciation.Depreciation it typically taken on capital assets Depreciation it typically taken on capital assets based on some type of depreciation schedule.based on some type of depreciation schedule.Straight Line = Capital/Useful LifeStraight Line = Capital/Useful LifeMACRS = Capital/MACRS ScheduleMACRS = Capital/MACRS ScheduleFirms generally can select method of Firms generally can select method of depreciation based on their goals.depreciation based on their goals.MACRS allows firm to swap current tax burden MACRS allows firm to swap current tax burden for future tax burden.for future tax burden.

IRS RulesIRS RulesYou may depreciate property that meets all five of the You may depreciate property that meets all five of the following tests. following tests. It must be property you own. It must be property you own. It must be used in a business or other incomeIt must be used in a business or other income––producing producing activity. activity. It must have a determinable useful life. It must have a determinable useful life. It must be expected to last more than one year. It must be expected to last more than one year. It must not be excepted property. Excepted property (as It must not be excepted property. Excepted property (as described in Publication 946, described in Publication 946, How to Depreciate How to Depreciate PropertyProperty) includes certain intangible property, certain ) includes certain intangible property, certain term interests, and property placed in service and term interests, and property placed in service and disposed of in the same year. disposed of in the same year.

Tax Vs Accounting DepreciationTax Vs Accounting Depreciation

Rules of the Game:Rules of the Game:There is generally no requirement that treatment There is generally no requirement that treatment of depreciation for tax and accounting purposes of depreciation for tax and accounting purposes be identical. Where depreciation is shown on be identical. Where depreciation is shown on accounting statements, the figure usually does accounting statements, the figure usually does not relate to depreciation for tax purposes. not relate to depreciation for tax purposes. Private Toll Road operators may shift the Private Toll Road operators may shift the depreciation method to MACRS to improve their depreciation method to MACRS to improve their tax burden. tax burden.

Are Public Agency Toll Roads Are Public Agency Toll Roads Using Depreciation Now?Using Depreciation Now?

In line with the Governmental Accounting In line with the Governmental Accounting Standard Board (GASB) Statement No. 34 Standard Board (GASB) Statement No. 34 most toll authorities should be reporting most toll authorities should be reporting depreciation numbers for their capital depreciation numbers for their capital facilities.facilities.The intent of Statement No. 34 is to The intent of Statement No. 34 is to encourage governmental agencies to encourage governmental agencies to provide a better estimate of the general provide a better estimate of the general state of the condition of public capital.state of the condition of public capital.

Straight Line Depreciation IStraight Line Depreciation I

Accounting standards appear to give the Accounting standards appear to give the following asset lives in transportation:following asset lives in transportation:Delaware River Port AuthorityDelaware River Port AuthorityBridges, Freeways & Tunnels Bridges, Freeways & Tunnels 100 Years100 YearsBuildings, Stations & Bridge Buildings, Stations & Bridge ComponCompon.. 3535--50 Years50 YearsElectrical, Signals and Communication 30Electrical, Signals and Communication 30--40 Years40 YearsTransit Cars, Machinery & EquipTransit Cars, Machinery & Equip 1010--25 Years25 Years

Straight Line Depreciation IIStraight Line Depreciation II

Massachusetts Turnpike AuthorityMassachusetts Turnpike Authority

InfrastructureInfrastructure 50 Years50 YearsBuildingsBuildings 30 Years30 YearsImprovements to roadways and tunnels Improvements to roadways and tunnels 30 Years30 YearsEquipmentEquipment 55--12 Years12 Years

Golden Gate Bridge Highway and Golden Gate Bridge Highway and Transportation District: SL IIITransportation District: SL III

Depreciation Depreciation -- is calculated on theis calculated on the straightstraight--line method line method over the estimated useful over the estimated useful lives of the assets, as follows:lives of the assets, as follows:Bridge structural components 100 yearsBridge structural components 100 yearsBridge buildings, toll plaza structure, deck and approach roadwaBridge buildings, toll plaza structure, deck and approach roadways and sidewalks 20 ys and sidewalks 20 -- 50 years50 yearsBuses 12 Buses 12 -- 16 years16 yearsFerry boats 25 Ferry boats 25 -- 30 years30 yearsOther transit properties 5 Other transit properties 5 -- 50 years50 yearsEffective July 1, 2005, the District changed its estimates of Effective July 1, 2005, the District changed its estimates of FasTrakFasTrak transponder transponder useful lives from a maximum of 8 years to 5 years. The District useful lives from a maximum of 8 years to 5 years. The District made this change to made this change to better reflect the estimated period during which the District mabetter reflect the estimated period during which the District maintained its intained its FasTrakFasTrakcustomer service center. This change had the effect of increasincustomer service center. This change had the effect of increasing depreciation g depreciation expense and operating loss by $1,760,000 in fiscal year 2006. expense and operating loss by $1,760,000 in fiscal year 2006. Effective July 1, 2004, the District changed its estimates of thEffective July 1, 2004, the District changed its estimates of the ferry boatse ferry boats’’ useful useful lives from a maximum life of 40 years to 25 years for highlives from a maximum life of 40 years to 25 years for high--speed ferry boats and 30 speed ferry boats and 30 years for all other ferry boats. The District made this change tyears for all other ferry boats. The District made this change to better reflect the o better reflect the estimated periods during which the ferry boats will remain in seestimated periods during which the ferry boats will remain in service. This change had rvice. This change had the effect of increasing depreciation expense and operating lossthe effect of increasing depreciation expense and operating loss by $5,522,000 in by $5,522,000 in fiscal year 2005.fiscal year 2005.

Port Authority of NY & NJPort Authority of NY & NJStraight Line IVStraight Line IV

3. Significant Accounting Policies3. Significant Accounting Policiesa. a. Facilities are carried at costFacilities are carried at cost. The costs for facilities include net interest expense incurred. The costs for facilities include net interest expense incurred from from the date of issuance of the debt to finance construction until tthe date of issuance of the debt to finance construction until the capital project is completed and he capital project is completed and ready for its intended use. Generally, costs in excess of $100,0ready for its intended use. Generally, costs in excess of $100,000 for additions, asset 00 for additions, asset replacements and/or asset improvements that benefit future accoureplacements and/or asset improvements that benefit future accounting periods or are expected to nting periods or are expected to prolong the service lives of assets beyond their originally assiprolong the service lives of assets beyond their originally assigned lives are capitalized (see Note gned lives are capitalized (see Note B). Facilities do not include regional programs undertaken at thB). Facilities do not include regional programs undertaken at the request of the Governor of the e request of the Governor of the State of New Jersey or the Governor of the State of New York (seState of New Jersey or the Governor of the State of New York (see Note H).e Note H).b. b. Depreciation of facilities is computed using the Depreciation of facilities is computed using the straightstraight--line methodline method during the estimated useful during the estimated useful lives of the related assets (see Note B).lives of the related assets (see Note B).The useful lives of assets are developed by the various related The useful lives of assets are developed by the various related disciplines in the Port Authoritydisciplines in the Port Authority’’s s Engineering Department utilizing past experience, standard indusEngineering Department utilizing past experience, standard industrial expectations, and external trial expectations, and external sources such as consultants, manufacturers and contractors. Usefsources such as consultants, manufacturers and contractors. Useful lives are reviewed ul lives are reviewed periodically for each specific type of asset class. Asset lives periodically for each specific type of asset class. Asset lives used in the calculation of depreciation used in the calculation of depreciation are generally as follows:are generally as follows:Buildings, bridges, tunnels and other structures 25 to 100 yearsBuildings, bridges, tunnels and other structures 25 to 100 yearsMachinery and equipment 5 to 35 yearsMachinery and equipment 5 to 35 yearsRunways, roadways and other paving 10 to 20 yearsRunways, roadways and other paving 10 to 20 yearsUtility infrastructure 20 to 40 yearsUtility infrastructure 20 to 40 yearsAssets located at facilities leased by the Port Authority from oAssets located at facilities leased by the Port Authority from others are depreciated over the lesser thers are depreciated over the lesser of the remaining term of the facility lease or the asset life stof the remaining term of the facility lease or the asset life stated above.ated above.

IRS 334IRS 334If property you acquire to use in your business is If property you acquire to use in your business is expected to last more than one year, you expected to last more than one year, you generally cannot deduct the entire cost as a generally cannot deduct the entire cost as a business expense in the year you acquire it. You business expense in the year you acquire it. You must spread the cost over more than one tax must spread the cost over more than one tax year and deduct part of it each year on Schedule year and deduct part of it each year on Schedule C. This method of deducting the cost of business C. This method of deducting the cost of business property is called depreciation. property is called depreciation.

Source : IRS Publication 334Source : IRS Publication 334

IRS Rules 535IRS Rules 535

Roads and driveways.Roads and driveways. The cost of The cost of building a private road on your business building a private road on your business property and the cost of replacing a gravel property and the cost of replacing a gravel driveway with a concrete one are capital driveway with a concrete one are capital expenses you may be able to depreciate. expenses you may be able to depreciate. The cost of maintaining a private road on The cost of maintaining a private road on your business property is a deductible your business property is a deductible expense. expense.

Assets Held at Purchase PriceAssets Held at Purchase Price

Accounting standards would dictate that Accounting standards would dictate that investments in facilities be held at cost investments in facilities be held at cost –– aka aka Book Value.Book Value.Costs include expenses related to the bond Costs include expenses related to the bond issuing as well as administrative and legal issuing as well as administrative and legal expenses related to the item.expenses related to the item.Given the lifespan of some transportation capital Given the lifespan of some transportation capital items, it is likely that the market value of these items, it is likely that the market value of these items are significantly different than the recorded items are significantly different than the recorded book value.book value.

Sale of Assets Brings Price to Sale of Assets Brings Price to Market ValueMarket Value

Selling a capital item would then move the Selling a capital item would then move the valuation from a book value to the market valuation from a book value to the market value.value.This may result in a significant increase in This may result in a significant increase in the value that is recorded on the financial the value that is recorded on the financial statements.statements.At this point, depreciation could occur At this point, depreciation could occur based on the new market value.based on the new market value.

Value of Golden Gate BridgeValue of Golden Gate Bridge

Golden Gate Bridge is currently on the books of Golden Gate Bridge is currently on the books of the Golden Gate Bridge, Highway and the Golden Gate Bridge, Highway and Transportation District at about $253,770,000 Transportation District at about $253,770,000 without including accumulated depreciation.without including accumulated depreciation.If we priced the $84,970,839 dollars in revenue If we priced the $84,970,839 dollars in revenue from 2006 with similar terms as was the revenue from 2006 with similar terms as was the revenue on the Chicago Skyway, we could have a lease on the Chicago Skyway, we could have a lease value of over $3,273,000,000.value of over $3,273,000,000.12x Increase in book asset value.12x Increase in book asset value.

Book Versus Market ValueBook Versus Market Value

Some assets will be held on a firmSome assets will be held on a firm’’s books s books at historical purchase price.at historical purchase price.Others are held at current market price.Others are held at current market price.Price should be based on Price should be based on ““arms length arms length transactionstransactions”” or market prices.or market prices.Assets held for long periods (10 plus Assets held for long periods (10 plus years) tend to have book prices that are years) tend to have book prices that are significantly different then their market significantly different then their market prices. prices.

Example Example ––Macquarie Infrastructure Group Use of RevaluationMacquarie Infrastructure Group Use of Revaluation

Under Australian Accounting Standards the Under Australian Accounting Standards the valuations of valuations of MIGMIG’’ss nonnon--controlled assets are controlled assets are reflected in the MIG accounts, while reflected in the MIG accounts, while MIGMIG’’sscontrolled assets are carried at historical cost controlled assets are carried at historical cost (less any associated depreciation and (less any associated depreciation and amortisationamortisation). Details of the accounting ). Details of the accounting standards under which the revaluations are standards under which the revaluations are carried out are provided in the guide to the MIG carried out are provided in the guide to the MIG accounts on the previous page. accounts on the previous page.

Source : Macquarie Financial StatementsSource : Macquarie Financial Statements

Macquarie Rules IMacquarie Rules IIn the accounts that follow, In the accounts that follow, all nonall non--controlled MIG toll controlled MIG toll road investments are recorded at fair value in road investments are recorded at fair value in accordance with Australian Accounting Standard AASB accordance with Australian Accounting Standard AASB 139139. Fair value accounting is used by most traditional . Fair value accounting is used by most traditional unit trusts, life companies, general insurers and super unit trusts, life companies, general insurers and super funds because it is the best way to show changes in the funds because it is the best way to show changes in the value of their investments in any period. value of their investments in any period.

The use of fair value accounting sometimes produces The use of fair value accounting sometimes produces large positive results in the income statement because large positive results in the income statement because the increases in asset values are recorded as profits. the increases in asset values are recorded as profits. Conversely, there have been occasions where MIG has Conversely, there have been occasions where MIG has reported losses as a result of asset write downs. reported losses as a result of asset write downs.

Macquarie Rules IIMacquarie Rules IIWhere MIG has a controlling interestWhere MIG has a controlling interest (where MIG is able to (where MIG is able to dominate the major decisions made by an entity) in a toll road, dominate the major decisions made by an entity) in a toll road, the the assets and liabilities and results of that toll road are consoliassets and liabilities and results of that toll road are consolidated dated into the results of MIG. into the results of MIG. These assets and liabilities are recorded at These assets and liabilities are recorded at historical costhistorical cost (less any associated depreciation and (less any associated depreciation and amortisationamortisation) in ) in accordance with the requirements of accounting standards and areaccordance with the requirements of accounting standards and arenot revalued. Consequently, the accounts do not reflect the not revalued. Consequently, the accounts do not reflect the directorsdirectors’’ estimates of the fair value of these assets.estimates of the fair value of these assets.

At 30 June 2007 MIG holds a controlling interest in the M6 Toll At 30 June 2007 MIG holds a controlling interest in the M6 Toll in the in the UK and nonUK and non--controlling interests in toll roads in Australia, Canada, controlling interests in toll roads in Australia, Canada, Portugal, Germany, France and the USA. Portugal, Germany, France and the USA.

At 30 June 2006 MIG held controlling interests in the M6 Toll, DAt 30 June 2006 MIG held controlling interests in the M6 Toll, Dulles ulles Greenway, Eastern Distributor, M4 Motorway and South Bay Greenway, Eastern Distributor, M4 Motorway and South Bay Expressway.Expressway.

Selling Between Profit Making Selling Between Profit Making FirmsFirms

Selling a capital item would result in a Selling a capital item would result in a cash inflow to the selling firm.cash inflow to the selling firm.The sale price minus the depreciated The sale price minus the depreciated value of the asset would be charged as value of the asset would be charged as taxable income.taxable income.Purchasing firm would be allowed to Purchasing firm would be allowed to depreciate asset at market value.depreciate asset at market value.

Value of LeaseValue of LeaseLeases can also be a source of depreciation.Leases can also be a source of depreciation.Value of lease is based on the present value of Value of lease is based on the present value of the streams of income that will be realized from the streams of income that will be realized from the lease.the lease.So, we can capitalize lease based on expected So, we can capitalize lease based on expected cash flows and an appropriate rate of return.cash flows and an appropriate rate of return.This value can then be depreciated for tax This value can then be depreciated for tax purposes if certain conditions are met.purposes if certain conditions are met.Key component is that lease covers 75% of the Key component is that lease covers 75% of the economic life of asset economic life of asset –– so 75 years for bridges.so 75 years for bridges.

Case Study Case Study -- MacquarieMacquarie

Much has been written about toll road Much has been written about toll road privatization.privatization.Macquarie is one of the dominant firms in Macquarie is one of the dominant firms in this industry.this industry.Macquarie operates it toll road Macquarie operates it toll road concessions through multiple corporate concessions through multiple corporate entities.entities.Many of these entities have extensive Many of these entities have extensive interinter--relationships.relationships.

Corporate EntitiesCorporate EntitiesMacquarie has numerous corporate entities located Macquarie has numerous corporate entities located in a number of countries that are involved in Private in a number of countries that are involved in Private Toll Roads:Toll Roads:Macquarie Bank: MBLMacquarie Bank: MBLMacquarie Infrastructure Group: MIGMacquarie Infrastructure Group: MIGMacquarie Infrastructure Group International Ltd: MIGILMacquarie Infrastructure Group International Ltd: MIGILMacquarie Infrastructure Trust I : MIT (I)Macquarie Infrastructure Trust I : MIT (I)Macquarie Infrastructure Trust II : MIT (II)Macquarie Infrastructure Trust II : MIT (II)Macquarie Infrastructure Partners: MIPMacquarie Infrastructure Partners: MIPMacquarie Infrastructure Invest. Mgt. Ltd. MIIMLMacquarie Infrastructure Invest. Mgt. Ltd. MIIMLMacquarie Investment Management UK: MIMUKMacquarie Investment Management UK: MIMUKMacquarie Infrastructure (UK) Limited: MIUKMacquarie Infrastructure (UK) Limited: MIUKMacquarie European Infrastructure Limited: MEI Macquarie European Infrastructure Limited: MEI Both MIUK and MEI are 100% owned subsidiaries of Both MIUK and MEI are 100% owned subsidiaries of MIGILMIGIL

Macquarie Acquisition RulesMacquarie Acquisition RulesFuture opportunities for investment should:Future opportunities for investment should:Generate a forecast return that: Generate a forecast return that: –– Is accretive to Is accretive to MIG'sMIG's portfolio internal rate of return determined by its portfolio internal rate of return determined by its

security pricesecurity price–– Implies an equity risk premium at or above the level required toImplies an equity risk premium at or above the level required to

compensate for its asset and financing riskscompensate for its asset and financing risks

Be consistent with the distribution policy of sustainability witBe consistent with the distribution policy of sustainability with increasing h increasing coverage of operating cash flows available for distributioncoverage of operating cash flows available for distribution

Offer potential for increasing value through active management oOffer potential for increasing value through active management of f operations and capital structureoperations and capital structure

Be located in OECD or OECDBe located in OECD or OECD--like countrieslike countries

Offer sustainable competitive advantage in a traffic corridorOffer sustainable competitive advantage in a traffic corridor..

Source: Source: Macquarie.comMacquarie.com

Tolling Concessions Tolling Concessions Intangible assets Intangible assets -- tolling concessionstolling concessionsTolling concessions are intangible assets and Tolling concessions are intangible assets and represent the right to levy tolls in respect of represent the right to levy tolls in respect of controlled motorways.controlled motorways.Tolling concessions have a finite useful life and Tolling concessions have a finite useful life and are carried at cost less accumulated are carried at cost less accumulated amortisationamortisation and impairment losses. and impairment losses. AmortisationAmortisation is calculated using the straight line is calculated using the straight line method to allocate the cost of tolling method to allocate the cost of tolling concessions over the concession term.concessions over the concession term.Source: MIGIL Financial Statements 6Source: MIGIL Financial Statements 6--3030--07 pg 1007 pg 10

MIGIL Financials 2007 MIGIL Financials 2007 -- II

(e) Property, plant and equipment (cont(e) Property, plant and equipment (cont’’d)d)Asset Description Asset Classification Estimated Useful Life DepAsset Description Asset Classification Estimated Useful Life Depreciation reciation basisbasisRoad Infrastructure M6 Toll Road Road Infrastructure M6 Toll Road 50 years 50 years Vehicle usage basisVehicle usage basisRoadbaseRoadbase M6 Toll Road M6 Toll Road 15 years 15 years Vehicle usage basisVehicle usage basisWearing Course M6 Toll Road Wearing Course M6 Toll Road 8 years 8 years Vehicle usage basisVehicle usage basisRoad Buildings InfrastructureRoad Buildings Infrastructure 50 years 50 years Straight line basisStraight line basisNon Road Buildings incl. Non Road Buildings incl. ServServ AreaArea 50 years 50 years Straight line basisStraight line basisMasts and Columns Plant, Mach.Masts and Columns Plant, Mach. 12 years 12 years Straight line basisStraight line basisOffice Furniture and FittingsOffice Furniture and Fittings 10 years 10 years Straight line basisStraight line basisSignage Plant and Machinery Signage Plant and Machinery 6 years 6 years Straight line basisStraight line basisVehicles and Maintenance Equip.Vehicles and Maintenance Equip. 5 years 5 years Straight line basisStraight line basisIT Equipment Plant and Machinery IT Equipment Plant and Machinery 3 years 3 years Straight line basisStraight line basisToll Collection System Toll Collection System 3 years 3 years Straight line basisStraight line basisSource: MIGIL Financial Statement 6Source: MIGIL Financial Statement 6--3030--07 p 1107 p 11

MIGIL Financials MIGIL Financials -- IIIIAmortization of Toll Concessions:Amortization of Toll Concessions:

$ 1,079,000 AUS in 2007$ 1,079,000 AUS in 2007Depreciation Expense:Depreciation Expense:

$ 31,867,000 AUS in 2007$ 31,867,000 AUS in 2007Profits: Profits:

$1,389,843,000 AUS in 2007$1,389,843,000 AUS in 2007Taxes PaidTaxes Paid

$ 407,000 AUS in 2007$ 407,000 AUS in 2007

Source MIGIL Financial Statement 6Source MIGIL Financial Statement 6--3030--07 p. 5,17 07 p. 5,17

MIGIL Financials MIGIL Financials -- IIIIII

Revenue from Continuing Activities (Tolls, Revenue from Continuing Activities (Tolls, Interest, etc):Interest, etc):$ 210,047,000 AUS in 2007$ 210,047,000 AUS in 2007Revenue from Revaluation and Exchange Revenue from Revaluation and Exchange Rates:Rates:$1,574,641,000 AUS in 2007$1,574,641,000 AUS in 2007Total Revenue:Total Revenue:$1,747,729,000 AUS in 2007$1,747,729,000 AUS in 2007

MIGIL Shareholders & ControlMIGIL Shareholders & ControlThe rights attaching to each class of shares of the Company are The rights attaching to each class of shares of the Company are as follows:as follows:�� Ordinary sharesOrdinary sharesHolders of ordinary shares are entitled to one vote per share onHolders of ordinary shares are entitled to one vote per share on all matters all matters except the appointment and removal of directors in respect of whexcept the appointment and removal of directors in respect of whom the om the right to appoint or remove is vested in the A special shareholderight to appoint or remove is vested in the A special shareholder or the B r or the B special shareholder. The shares are participating and non redeemspecial shareholder. The shares are participating and non redeemable.able.�� A special shareA special shareThe A special share is to be held by the Advisor, its successorsThe A special share is to be held by the Advisor, its successors or or assignees. The shareholder is assignees. The shareholder is entitled to appoint up to 50% of the directorsentitled to appoint up to 50% of the directorsof the Company and to appoint any one of such directors to be maof the Company and to appoint any one of such directors to be managing naging director. The A special shareholder has no rights of participatidirector. The A special shareholder has no rights of participation in the on in the profits of the Company and assets of the Company on a winding upprofits of the Company and assets of the Company on a winding up..

�� B special shareB special shareThe B special share is to be held by the MIT(II) Trustee, its suThe B special share is to be held by the MIT(II) Trustee, its successors or ccessors or assignees. The shareholder is assignees. The shareholder is entitled to appoint up to 25% of the directorsentitled to appoint up to 25% of the directorsof the Company. The B special shareholder has no rights of partiof the Company. The B special shareholder has no rights of participation incipation inthe profits of the Company and assets of the Company on a windinthe profits of the Company and assets of the Company on a winding up.g up.

MIGIL Advisor FeesMIGIL Advisor FeesAdvisorAdvisorThe adviser of MIGIL is Macquarie Investment Management (UK) The adviser of MIGIL is Macquarie Investment Management (UK) Limited (MIMUK or the Adviser), Limited (MIMUK or the Adviser), a wholly owned subsidiary of a wholly owned subsidiary of Macquarie Bank Limited (MBL)Macquarie Bank Limited (MBL). The registered office of the advisor . The registered office of the advisor is No 1 is No 1 RopemakerRopemaker Street, London EC2Y 9HD.Street, London EC2Y 9HD.

Under the terms of the Management Agreement between MEI and Under the terms of the Management Agreement between MEI and MIMUK as manager and between the Company and MIMUK as MIMUK as manager and between the Company and MIMUK as Advisor, fees paid or payable to MIMUK by the Group were: Advisor, fees paid or payable to MIMUK by the Group were:

30 June 2007 30 June 2007 -- Base fees $Base fees $65,169,000 AUS 65,169,000 AUS The base fee is calculated as 1.25% per annum of the first $3 biThe base fee is calculated as 1.25% per annum of the first $3 billion llion of MIG adjusted market of MIG adjusted market capitalisationcapitalisation and at 1.00% per annum on and at 1.00% per annum on MIG adjusted market MIG adjusted market capitalisationcapitalisation over $3 billion at the end of each over $3 billion at the end of each quarter.quarter.Source MIGIL Financial Report 30 Source MIGIL Financial Report 30 –– June 30, 2007 p. 31June 30, 2007 p. 31

IRS Rule 334IRS Rule 334You can deduct the costs of running your business. You can deduct the costs of running your business. These costs are known as business expenses. These These costs are known as business expenses. These are costs you do not have to capitalize or include in the are costs you do not have to capitalize or include in the cost of goods sold. cost of goods sold. To be deductible, a business expense must be both To be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that ordinary and necessary. An ordinary expense is one that is common and accepted in your field of business. is common and accepted in your field of business. A A necessary expense is one that is helpful and appropriate necessary expense is one that is helpful and appropriate for your business.for your business. An expense does not have to be An expense does not have to be indispensable to be considered necessary.indispensable to be considered necessary.For more information about the general rules for For more information about the general rules for deducting business expenses, see chapter 1 in deducting business expenses, see chapter 1 in Publication 535, Business Expenses. Publication 535, Business Expenses.

MIGIL Tax SituationMIGIL Tax Situation

Under current Bermudian law, MIGIL will Under current Bermudian law, MIGIL will not be subjected to any income, not be subjected to any income, withholding or capital gains taxes in withholding or capital gains taxes in Bermuda. Controlled entities of MIGIL that Bermuda. Controlled entities of MIGIL that are subject to taxes in their jurisdictions are subject to taxes in their jurisdictions recogniserecognise income tax using the balance income tax using the balance sheet approach of tax effect accounting.sheet approach of tax effect accounting.Source : MIGIL 2007 Financial Report 30Source : MIGIL 2007 Financial Report 30

June 30, 2007 p. 13June 30, 2007 p. 13

Arms Length Transaction?Arms Length Transaction?Macquarie Infrastructure Group Sale of 50% Macquarie Infrastructure Group Sale of 50% interest of US Toll Roads to Macquarie interest of US Toll Roads to Macquarie Infrastructure PartnersInfrastructure Partners““MIG advises that it has received notice from Macquarie MIG advises that it has received notice from Macquarie Infrastructure Partners (MIP) that MIP has obtained adequate Infrastructure Partners (MIP) that MIP has obtained adequate financing to complete the above mentioned transaction. This was financing to complete the above mentioned transaction. This was a a condition to completion of the transaction as noted in condition to completion of the transaction as noted in MIGMIG’’ss Notices Notices of Meeting dated 30 October 2006. The transaction is anticipatedof Meeting dated 30 October 2006. The transaction is anticipated to to close in mid December 2006 and is still subject to other conditiclose in mid December 2006 and is still subject to other conditions, ons, which include approval by MIG security holders.which include approval by MIG security holders.””Booked at 988 Million Dollars by MIG. MIP is Booked at 988 Million Dollars by MIG. MIP is managed by MIP (Delaware) managed by MIP (Delaware) –– owned by MBL.owned by MBL.Source: MIG Press release Source: MIG Press release

AuditorsAuditors

Macquarie (MIT) pays Macquarie (MIT) pays PriceWaterhousePriceWaterhouse Cooper Cooper LLP $514,000 AUS for tax advisory services.LLP $514,000 AUS for tax advisory services.PriceWaterhousePriceWaterhouse Coopers LLP also serves a Coopers LLP also serves a auditor at Macquarie Infrastructure Group (MIG).auditor at Macquarie Infrastructure Group (MIG).PriceWaterhousePriceWaterhouse Coopers LLP is also auditor of Coopers LLP is also auditor of MIGILMIGILMacquarie Bank (MBL) paid Macquarie Bank (MBL) paid PriceWaterhousePriceWaterhouseCoopers about 18 Million dollars in Auditing and Coopers about 18 Million dollars in Auditing and Advising fees in 2006Advising fees in 2006

Audit & Other ServicesAudit & Other ServicesMacquarie Infrastructure Trust (MIT) paid Macquarie Infrastructure Trust (MIT) paid PriceWaterhousePriceWaterhouse Cooper LLP $514,000 AUS for Cooper LLP $514,000 AUS for tax advisory services in 2007.tax advisory services in 2007.PriceWaterhousePriceWaterhouse Coopers LLP also serves at Coopers LLP also serves at

auditor at Macquarie Infrastructure Group (MIG).auditor at Macquarie Infrastructure Group (MIG).Macquarie Bank (MBL) employs Macquarie Bank (MBL) employs PriceWaterhousePriceWaterhouse Coopers and their related Coopers and their related firms as auditors and other advisory services. firms as auditors and other advisory services. Their combined fee in 2007 was $17,950,000 Their combined fee in 2007 was $17,950,000 AUS.AUS.

MIG? Corporate StructureMIG? Corporate StructureMacquarie Infrastructure Group (MIG) comprises Macquarie InfrastMacquarie Infrastructure Group (MIG) comprises Macquarie Infrastructure ructure Trust (I) ARSN 092 863 780 (MIT(I)), Macquarie Infrastructure TrTrust (I) ARSN 092 863 780 (MIT(I)), Macquarie Infrastructure Trust (II) ust (II) ARSN 092 863 548 (MIT(II)) and Macquarie Infrastructure Group ARSN 092 863 548 (MIT(II)) and Macquarie Infrastructure Group International Limited ARBN 112 684 885 (MIGIL).International Limited ARBN 112 684 885 (MIGIL).Macquarie Infrastructure Investment Management Limited ACN 072 6Macquarie Infrastructure Investment Management Limited ACN 072 609 09 271 (MIIML) is the responsible entity of MIT(I) and MIT(II). 271 (MIIML) is the responsible entity of MIT(I) and MIT(II). MIIML is aMIIML is a wholly wholly owned subsidiary of Macquarie Bankowned subsidiary of Macquarie Bank Limited ACN 008 583 542 (Limited ACN 008 583 542 (MBLMBL). The ). The registered office of the Responsible Entity is No.1 Martin Placeregistered office of the Responsible Entity is No.1 Martin Place, Sydney , Sydney NSW 2000.NSW 2000.Macquarie Investment Management (UK) Limited (MIMUK) registered Macquarie Investment Management (UK) Limited (MIMUK) registered number 3976881 is the adviser to MIGIL. number 3976881 is the adviser to MIGIL. MIMUK is a wholly owned MIMUK is a wholly owned subsidiary of MBLsubsidiary of MBL..MIIML, as responsible entity of the trusts comprised in MIG and MIIML, as responsible entity of the trusts comprised in MIG and MIMUK as MIMUK as the advisor to MIGIL are entitled to fees for so acting. MBL andthe advisor to MIGIL are entitled to fees for so acting. MBL and its related its related corporations (including MIIML and MIMUK) together with their offcorporations (including MIIML and MIMUK) together with their officers and icers and directors and officers and directors of MIGIL hold stapled securdirectors and officers and directors of MIGIL hold stapled securities in the ities in the MIG from time to time.MIG from time to time.Source: Macquarie Infrastructure Trust Concise Financial Report Source: Macquarie Infrastructure Trust Concise Financial Report June 30, June 30, 20072007

Dividend TransferDividend Transfer

The depreciation deductions both for The depreciation deductions both for capital owned as well as the capitalized capital owned as well as the capitalized lease for roads creates a nonlease for roads creates a non--cash cash expense for the firm.expense for the firm.These funds are available to pay dividends These funds are available to pay dividends to owners of the firm.to owners of the firm.

Conclusions IConclusions I

Tax strategies appear to be a key Tax strategies appear to be a key component in maximizing profits from toll component in maximizing profits from toll road concessionsroad concessionsFirms appear to be taking advantage of Firms appear to be taking advantage of various types of tax shelters and programs various types of tax shelters and programs to reduce their taxable incometo reduce their taxable incomeTransfer pricing and corporate fees also Transfer pricing and corporate fees also appear to be a part of the overall strategy appear to be a part of the overall strategy at Macquarie.at Macquarie.

Conclusions IIConclusions IIBut are these matters of significant concern to But are these matters of significant concern to the transportation community?the transportation community?Perhaps the structure of leases needs to be Perhaps the structure of leases needs to be examined in light of the additional value that is examined in light of the additional value that is created by the tax advantages of the lease created by the tax advantages of the lease terms.terms.The overall cost burden on road users and their The overall cost burden on road users and their communities are important as well, given that communities are important as well, given that profit making firms are looking to develop a profit making firms are looking to develop a contract that controls much of the risk in the contract that controls much of the risk in the contract (toll escalation clauses, noncontract (toll escalation clauses, non--compete compete clauses, etc.). Are we giving up too much?clauses, etc.). Are we giving up too much?

Conclusions IIIConclusions III

Perhaps our biggest concern is that the Perhaps our biggest concern is that the complexity of these transactions make it hard to complexity of these transactions make it hard to interpret the true costs and benefits of a interpret the true costs and benefits of a particular privatization.particular privatization.Also, these financial transactions appear to not Also, these financial transactions appear to not be always based on be always based on ““arms lengtharms length”” valuations.valuations.In addition, the fee structures and interIn addition, the fee structures and inter--relationships between firms appears to offer the relationships between firms appears to offer the potential for abuse of fair valuations and fees.potential for abuse of fair valuations and fees.

Final ThoughtsFinal Thoughts

The complexity of the financial transactions and The complexity of the financial transactions and the continued use of a single audit and tax the continued use of a single audit and tax consulting firm in multiple corporate entities consulting firm in multiple corporate entities appears to open the door for abuse and fraud.appears to open the door for abuse and fraud.If this market has any disruption based on these If this market has any disruption based on these issues, it could impact the ability to finance issues, it could impact the ability to finance reasonable and appropriate projects.reasonable and appropriate projects.Enron anyone? Enron anyone?