About Current Accounts
Welcome to Current Accounts, the Harvard Business Law Review’s biweekly online blog that seeks to keep our readers up to date on key legal and business developments as they occur in real time. Every other week during the academic semester, Current Accounts will publish short articles written and edited by Harvard Law School students. This platform aims to add a unique perspective to scholarship concerning the law governing business organizations and capital markets. We hope to keep our readers engaged and returning to Current Accounts, as well as to the Harvard Business Law Review Online and Print journals.
Will the new opportunity zone law allow investors to have their cake and eat it too?
Although the corresponding final regulations are not yet available, the opportunity zone tax law passed in 2017 has generated significant buzz among investors, business owners, and community groups. The law, codified in Internal Revenue Code Sections 1400Z-1 and 1400Z-2, incentivizes new investment in businesses and real estate in designated low-income communities throughout the United States. The law is expected to unlock significant investment but is also controversial because of the lack of reporting requirements, the open questions surrounding the degree to which low-income people will benefit from the law, and the rich benefits it offers investors. Under the law, investors can receive tax deferral and tax elimination, including the complete elimination of capital gains from qualifying investments held for more than ten years.[i] The law may also provide an added benefit to investors: a way to improve their tax position through the strategic use of debt. Unless regulators restrict the tax benefits available to investors who leverage their opportunity zone equity investments, those investments may produce significant benefits throughout the investment term, not only at disposition.
In the landmark tax case, Crane v. Commissioner (1947),[ii] the Supreme Court held that the amount of a nonrecourse mortgage is included in the basis of a property, a determination significant for calculating a gain on sale or exchange but also for the purpose of determining the amount of depreciation deductions available to a taxpayer. Depreciation deductions allow taxpayers to reduce their income tax liability by deducting from income a portion of an asset’s basis, according to an IRS-allowed depreciation schedule.[iii] But these deductions are not “free”; they are offset by reductions in the property’s basis, increasing the tax liability to the taxpayer upon the disposition of the property. The Crane decision was significant—indeed, opening the door to many forms of tax avoidance—because it allowed taxpayers to obtain major tax benefits by financing investments with debt. By doing so, investors could enjoy depreciation deductions generated by property much more valuable than their own equity investments. Even if a future tax bill were higher because of the reduction in basis, the investors would benefit from years of tax deferral. But the petitioner in the Crane case, Beulah Crane, tried to take this benefit one step further. She used her apartment building’s debt value when calculating depreciation deductions but omitted the debt value when calculating the amount realized when she sold the property.[iv]
While Crane’s attempt to whipsaw the IRS was inconsistent with the Court’s holding—she lost the case—the opportunity zone law may allow investors to accomplish a similar result. Although IRC § 1400Z-2 stipulates that equity investments made in opportunity zone funds shall have a zero basis,[v] the Crane decision suggests that an investor may enjoy a large basis in an opportunity zone investment through the use of debt, since the amount of a mortgage will be included in basis. This is significant because the depreciation deductions would probably not contribute to a higher tax bill in the future, as gains will be excluded as long as the investment is held for more than ten years.[vi] Although the investor’s basis would be reduced each year according to the depreciation deductions taken, the opportunity zone benefit would allow a step up in basis to fair market value at disposition after ten years, [vii] assuming the investor complied with all of the required opportunity zone rules. Assuming investors are able to benefit from leveraged investments in this way, the new law may bring more tax-driven, rather than fundamentals-driven, investment to the designated low-income communities. If this happens, the law’s supposed alignment of interests between investors and communities—through its focus on long-term, fundamentals-driven, equity investments, might be significantly eroded. Final regulations are expected in the coming months. Stay tuned.
[i] See26 U.S.C. § 1400Z-2(c) (2017).
[ii] Crane v. Comm’r of Internal Revenue, 331 U.S. 1 (1947).
[iii] E.g., 26 U.S.C. § 168 (2015).
[iv] Crane, 331 U.S. at 1. Although this was the fact pattern leading up to the case, Crane’s legal arguments to the Court were different; in her brief, she did not defend her attempts to whipsaw the IRS. Brief for Petitioner, Crane v. Comm’r of Internal Revenue, 331 U.S. 1 (1947) (No. 68).
[v] See26 U.S.C. § 1400Z-2(b)(2)(B)(i) (2017).
[vi] See26 U.S.C. § 1400Z-2(c) (2017).
Consequences of a Negotiated Departure for the Scope of Brexit Negotiations
The United Kingdom is scheduled to leave the European Union on March 29th. This date is the consequence of Article 50 of the Consolidated Version of the Treaty on European Union (Treaty on European Union), which establishes that the date in which a state shall cease to be a member of the European Union is either the date of entry into force of a withdrawal agreement negotiated by the European Council and the withdrawing member, or, lacking such an agreement, two years after notification by the state of its intention to withdraw.[i]In other words, European Union law sets an outer temporal limit to a negotiated departure.
[i]Consolidated Version of the Treaty on European Union art. 50, Oct. 26, 2012, 2012 O.J. (C 326) 13 [hereinafter Treaty on European Union].
In the past two years, the two sides have been negotiating just that. The result is the Agreement on the Withdrawal of the United Kingdom of Great Britain and Northern Ireland from the European Union and the European Atomic Energy Community (Withdrawal Agreement),[ii]which establishes, broadly:
- that European Union citizens and United Kingdom citizens may reside in the other’s territory;[iii]
- a transition period during which European Union law would continue to apply to the United Kingdom although the latter would have ceased to be a part of the former;[iv]
- the creation of a single customs territory between the European Union and the United Kingdom in the even that no further agreement on trade relations is reached prior to the expiration of the transition period;[v]
- that any disputes about the interpretation of the Withdrawal Agreement may be referred to binding arbitration.[vi]
But to enter into force, the Withdrawal Agreement needs to be ratified by both the European Union and the United Kingdom. Failure to ratify the Withdrawal Agreement would still result in the United Kingdom leaving the European Union on March 29th due to the automatic nature of the mechanism created by Article 50. In such case, one of two outcomes is likely. While there technically is a third scenario that temporarily extends membership of the European Union through a request for an extension unanimously approved by the European Council,[vii]this option would merely delay the earlier two scenarios.
First, the United Kingdom could permanently remain in the European Union. In a recent preliminary reference, the European Union’s highest court established that the United Kingdom has the option of deciding to do so unilaterally, on grounds that departure cannot be forced on a member state who does not wish to leave.[viii]Nevertheless, such a decision must be “unequivocal and unconditional,” suggesting that it may not be used tactically to obtain a negotiating advantage.[ix]In brief, the United Kingdom could decide to remain in the European Union only if it truly intended to remain.
Second, agreements alternative to the Withdrawal Agreement could be concluded. Indeed, the underlying need for the provisions of the Withdrawal Agreement remains, suggesting that alternative agreements equivalent to the portions of the Withdrawal Agreement on which political agreement can be reached could be negotiated. Taken together, such agreements could result in a substantial replication of the Withdrawal Agreement.
It should however be noted that the Withdrawal Agreement is in large part an attempt at facilitating a further negotiation, that of the mechanics of the relation between the United Kingdom and the European Union, by ensuring that European Union law would continue to apply while such negotiations take place. Failure to agree on an equivalent to the Withdrawal Agreement’s transitional period would mean that consequences arising out of the cessation of application of European Union law to the United Kingdom would become immediately relevant without negotiations on such issues having happened. Put differently, the lack of a transitional period would immediately expand the scope of negotiations to all issues arising out of the end of the application of European Union law.
This is possibly best illustrated through an example. European Union law currently allows investment firms authorized to operate in one European Union member state to freely provide such services in another member state.[x]During a transitional period, this would continue to be the case, and an alternative of such a provision could potentially be negotiated before the end of the transitional period. On the contrary, the lack of a transitional period would make it immediately necessary to negotiate a replacement.
In the coming weeks or months, depending on whether an extension of European Union membership is agreed upon, clarity will be made on which of these options the United Kingdom will choose. Ratification of the Withdrawal Agreement would result in two years of intense negotiations on the mechanics of future United Kingdom relations with the European Union. Failure to do so and failure to agree on a transitional period would result in the necessity to have such negotiations immediately.
Elio Gaarthuis is an LL.M. at Harvard Law School and a Senior Editor of the Harvard Business Law Review
[i]Consolidated Version of the Treaty on European Union art. 50, Oct. 26, 2012, 2012 O.J. (C 326) 13 [hereinafter Treaty on European Union].
[ii]Agreement on the Withdrawal of the United Kingdom of Great Britain and Northern Ireland from the European Union and the European Atomic Energy Community, Feb. 19, 2019, 2019 O.J. (C 66 I) 1 [hereinafter Withdrawal Agreement].
[iii]Id. at art. 13.
[iv]Id. at art. 127.
[v]Protocol on Ireland/Northern Ireland art. 6, Feb. 19, 2019, 2019 O.J. (C 66 I) 85.
[vi]Withdrawal Agreement, supranote 2, art. 170.
[vii]SeeTreaty on European Union, supranote 1, art. 50(2).
[viii]SeeCase C‑621/18, Wightman & Others v. Sec’y of State for Exiting the European Union, 2018 EUR-Lex CELEX LEXIS 999 (Dec. 10, 2018).
[ix]Id. at ¶ 74.
[x]European Parliament and CouncilDirective 2014/65, art. 34, 2014 O.J. (L 173) 349.
Climate Change Regulation, Stranded Assets, and American Investors
“‘Stranded assets’ are assets that have suffered from unanticipated premature write-downs, devaluations or conversions to liabilities.”
With a non-binding proposal for a Green New Deal (“GND”) that would “achieve net-zero greenhouse gas emissions” introduced in Congress,climate change policy is at the forefront of a national conversation with familiar arguments. Those in favor of a GND describe the proposal as an appropriate response to an existential threat posed by climate changewhile those opposed characterize it as a very expensive way to destroy jobs.
Regardless of position, GND-style or other climate-related regulations, such as a carbon tax favored by major petroleum producers,will have a dramatic effect on the economy. However, policy makers are not addressing the potential impact of sudden regulatory changes on Americans’ investments. Americans and financial institutions have hundreds of billions of dollars invested in carbon-intensive industries.These exposures are compounded by investments in (other) financial institutions that have similar, if not nearly identical, holdings.Additionally, $1.4 trillion worth of commercial and residential property is located within one-eighth of a mile of the U.S. coast.
This leads to the idea of stranded assets. Any attempt to mitigate the impact of climate change will result in the devaluation of certain businesses and assets. By one estimation, “a third of [global] oil reserves, half of [global] gas reserves and over 80 per cent of current coal reserves should remain unused from 2010 to 2050” to hit the United Nations’ target of keeping the average global temperature below that of the pre-industrial era average by 2°C.Under this somewhat extreme scenario, the assets used to extract these resources, as well as the fossil-fuel-related equity and debt securities, become virtually worthless as cash flows dwindle.
Financial losses caused by stranded assets will not be limited to firms with fossil-fuel related capital expenditures and their investors and creditors. For many Americans, the most significant investment is their home.Natural disasters obviously pose a threat to the $882 billion in residential property at risk of projected sea level rise by 2100.However, there is evidence that markets for housing at risk of flooding are not efficient. Less sophisticated owner-occupiers, rather than more sophisticated investors, are not discounting property values in real estate transactions to account for rising sea levels, leaving them vulnerable to financial shock.A subtler effect concerns insurance. Of the eleven million structures in FEMA flood zones, less than half carry catastrophe insurance.Similarly, one-fifth of National Flood Insurance Program policies are officially subsidized and charge less than the full risk level.Any regulation that alters the current flood insurance scheme, especially one that requires owners to purchase insurance or that alters subsidies, could force holders to more significantly internalize their own risk, affecting real estate values.
Uncertainty about the future effects of climate change, the prospects of future climate-related regulation, and the form of such regulation(s), if any, prevents market forces from efficiently pricing assets at risk of becoming stranded due to environmental concerns. To prevent financial shock, any regulation addressing climate change or its risks should be enacted quickly, deliberately, and in such a way that allows maximum possible predictability for markets to adjust.
Ben Caldecott et al., Stranded Assets and Scenarios(2014) (discussion paper), https://www.smithschool.ox.ac.uk/research/sustainable-finance/publications/Stranded-Assets-and-Scenarios-Discussion-Paper.pdf.
H.R. Res. 109, 116th Cong. (2019); S. Res. 59, 116th Cong. (2019).
See Thomas L. Friedman, The Green New Deal Rises Again, N.Y. Times(Jan. 8, 2019), https://www.nytimes.com/2019/01/08/opinion/green-new-deal.html.
The Editorial Board, Vote on the Green New Deal, Wall St. J.(Feb. 11, 2019), https://www.wsj.com/articles/vote-on-the-green-new-deal-11549931107.
Oliver Milman, Exxon, BP and Shell back carbon tax proposal to curb emissions, TheGuardian(Jun. 20, 2017), https://www.theguardian.com/environment/2017/jun/20/exxon-bp-shell-oil-climate-change.
Stefano Battiston et al., A climate stress test of the financial system, 7 Nature Climate Change283, 285 (2017).
Duff Wilson et al., In metro Houston, an uphill fight to build a Texas-size defense against the next big storm, Reuters(Nov. 24, 2014), https://www.reuters.com/investigates/special-report/waters-edge-the-crisis-of-rising-sea-levels/(Part 3: Grand Designs).
Christophe McGlade & Paul Ekins, The geographical distribution of fossil fuels unused when limiting global warming to 2 ºC, 517 Nature187, 187 (2015). But see, ExxonMobil, 2018 Outlook for Energy: A View to 2040 12-13(2018), https://corporate.exxonmobil.com/en/Energy-and-environment/Energy-resources/Outlook-for-Energy/Energy-demand(projecting that natural gas will grow “the most of any energy type, reaching a quarter of all demand”).
See FT Alphachat: Climate change is not a business cycle, Fin. Times(Feb. 8, 2019) (downloaded using iTunes).
The median American net worth drops from $68,828 to $16,942 when home equity is excluded. This figure over-simplifies, presuming that the same median American has both a $68,828 net worth and$51,886 in home equity. U.S. Census Bureau, Wealth, Asset Ownership, & Debt of Households Detailed Tables: 2014, Survey of Income and Program Participation(2014), https://www.census.gov/topics/income-poverty/wealth/data/tables.html.
Krishna Rao, Climate Change and Housing: Will a Rising Tide Sink All Homes?, Zillow(Jun. 2, 2017), https://www.zillow.com/research/climate-change-underwater-homes-12890/.
Asaf Bernstein et al., Disaster on the Horizon: The Price Effect of Sea Level Rise, J. Fin. Econ.5 (forthcoming).
David M. Harrison et al., Environmental Determinants of Housing Prices: The Impact of Flood Zone Status, 21 J. of Real Est. Res.1, 4 (2001).
Laura A. Bakkenson & Lint Barrage, Flood Risk Belief Heterogeneity and Coastal Home Price Dynamics: Going Under Water?31 (Nat’l Bureau of Econ. Research, Working Paper No. 23854, 2018).
Id. at 4 (finding that “benchmark results imply that coastal housing prices currently exceed fundamentals by 10%”).
See Frederick van der Ploeg, Professor of Economics and Research Director, Oxford Centre for The Analysis of Resource Rich Economies, Climate Policy and Stranded Carbon Assets: A Financial Perspective, Keynote Address at the EAERE conference on Climate Policy & Stranded Assets: A Public Finance and Financial Economics Perspective (Jun. 27–28, 2017) (arguing that, because climate change regulations are unavoidable, financial markets can be characterized as a carbon bubble).
An Introduction to California’s Consumer Privacy Act
In June of 2018, the California legislature passed the California Consumer Privacy Act of 2018, establishing a new system of privacy regulation that has never before been seen in the United States. Specifically, the provisions of the CCPA allow consumers five rights: (1) the right to know what personal information a company has; (2) the right to know whether information is sold or disclosed; (3) the right to opt-out or say no to the sale of personal information; (4) the right to access the information; and (5) the right to equal pricing if these rights are exercised.[i] The law provides for private action regarding privacy and personal data, providing for damages as detailed in the statute of $100 to $750 per incident.[ii] The law has developed as new regulations have been put in place across the pond in Europe and is in part modeled after some of the legislative and judicial advancements in privacy that came with the establishment of GDPR[iii]and the “right to be forgotten”[iv]in the European Union.
While the CCPA has already been passed by the California legislature, the provisions of the law will not be enforced until 2020. In preparation for the passage of this act, key definitions will be important to analyze to fully understand the scope of the law and the protections it provides. The current version of the law applies to residents of California and includes a broad definition of personal information with an enumerated list that includes geolocations, biometric information, and data regarding protected classifications. As California continues to grow and advance the tech industry and companies continue to collect and store data, the CCPA’s application to private sector businesses grows in importance. Updates and clarifications the CCPA may be announced by the California Attorney General closer to the date of enforcement implementation. Additional clarifications may provide more detailed information regarding the definition of “personal information,” the protected consumers, and the businesses that will ultimately have to comply with the CCPA’s provisions.
Planning for compliance with the CCPA may prove less cumbersome for larger organizations that have been forced to comply with privacy regulation across other jurisdictions. Following the Google Spain v. Agencia Espanola de Proteccion de Datos and Mario Costeja Gonzalez[v]case from the Court of Justice, Google Spain was required to respond to take down requests for storage of personal information on their website and servers. Google convened an Advisory Councilof professors, practitioners, and lawyers to analyze the implications of removal of information and the correct procedures to receive requests.[vi]While the rights triggered under this decision are not perfectly analogous and covered a very different rights regime where First Amendment implications did not exist, the groundwork to develop a compliance process has already been set in motion. While early stage and emerging firms in the tech sector with access to consumer data may be more nimble to adapt to the CCPA, complying with the law may create new impacts to the sector that will continue to emerge as the law comes into effect and the Attorney General provides greater clarity on the provisions.
As California’s data privacy protections expand, key legal questions will continue to emerge regarding the applicability of California’s law on technology and data collection that can be “borderless.” A state by state solution may ultimately lead to inconsistencies in the laws governing data collection and privacy and have an outsized effect on companies seeking to target markets across the United States. For example, the Illinois Biometric Information Privacy Act,[vii]governing the collection, use, and storage of biometric data requires written consent for the use of biometric data, and the Illinois Supreme Court has recently ruled that no harm, other than a violation of a legal requirement of the statute is needed.[viii] The Business Roundtable, a group of CEOs from leading American companies,[ix]has issued a policy perspectivecalling for a national consumer privacy regime. Their recommendations seek to create consistency and uniformity for consumers and businesses as the business of privacy continues to develop and expand.
Daniel Moubayed is a 2L at Harvard Law School and the Deputy Managing Editor of Harvard Business Law Review Online
[i]Cal. Civ. Code § 1798.175
[iii]EU General Data Protection Regulation(GDPR): Regulation (EU) 2016/679 of the European Parliament and of the Council of 27 April 2016 on the protection of natural persons with regard to the processing of personal data and on the free movement of such data, and repealing Directive 95/46/EC (General Data Protection Regulation), OJ 2016 L 119/1.
[iv]See generally Steven C. Bennett, The “Right to Be Forgotten”: Reconciling EU and US Perspectives, 30 Berkeley J. of Int’l L. 161 (2012)
[vi]Advisory Council to Google on the Right to be Forgotten, “Final Report,” Jan 2015.
[vii]740 ILCS 14/1.
[viii]SeeRosenbach v. Six Flags Entm’t Corp., 2019 IL 123186.