Definition of Private Activity Bonds
Federal RegisterDec 30, 1994
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[FI-72-88]
RIN 1545-AM01
Definition of Private Activity Bonds
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking and notice of public hearing.
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SUMMARY: This document contains proposed regulations on the definition
of private activity bonds applicable to tax-exempt bonds issued by
States and local governments. Changes to the applicable law were made
by the Deficit Reduction Act of 1984 (the 1984 Act), the Tax Reform Act
of 1986 (the 1986 Act), the Omnibus Budget Reconciliation Act of 1987,
the Technical and Miscellaneous Revenue Act of 1988, and the Omnibus
Budget Reconciliation Act of 1993. These regulations affect issuers of
tax-exempt bonds and provide guidance for applying the private activity
bond restrictions.
DATES: Written comments must be received by May 1, 1995. Requests to
speak at the public hearing and outlines of oral comments must be
received by Thursday, May 18, 1995.
ADDRESSES: Send submissions to: CC:DOM:CORP:T:R (FI-72-88), room 5228,
Internal Revenue Service, POB 7604, Ben Franklin Station, Washington,
DC 20044. In the alternative, submissions may be hand delivered between
the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:T:R (FI-72-88),
Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue NW,
Washington, DC.
FOR FURTHER INFORMATION CONTACT:
Concerning the regulations, William P. Cejudo, (202) 622-3980;
concerning submissions and the hearing, Michael Slaughter, (202) 622-
7190 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collections of information contained in this notice of proposed
rulemaking have been submitted to the Office of Management and Budget
for review in accordance with the Paperwork Reduction Act (44 U.S.C.
3504(h)). Comments on the collections of information should be sent to
the Office of Management and Budget, Attn: Desk Officer for the
Department of the Treasury, Office of Information and Regulatory
Affairs, Washington, DC 20503, with copies to the Internal Revenue
Service, Attn: IRS Reports Clearance Officer, PC:FP, Washington, DC
20224.
The collections of information are in Secs. 1.141-1(b), 1.141-
1(c)(3), 1.141-1(d), 1.141-13(a), and 1.141-13(b)(3). This information
is required by the IRS to verify compliance with section 141. This
information will be used to document elections made by an issuer,
provide evidence of an issuer's expectations, and notify the Service of
defeasance of bonds. The likely respondents and/or recordkeepers are
States and political subdivisions that issue bonds and entities that
issue bonds on behalf of States or political subdivisions.
Estimated total annual recordkeeping burden: 30,000 hours.
The estimated annual burden per recordkeeper varies from 1 hour to
5 hours, depending on individual circumstances, with an estimated
average of 3 hours.
Estimated number of recordkeepers: 10,000.
Estimated total annual reporting burden: 100 hours.
Estimated average burden per respondent: 1 hour.
Estimated number of respondents: 100.
Estimated frequency of respondents: On occasion.
Background
Explanation of provisions
I. Background of regulations
Section 103 provides generally that interest on certain States or
local bonds (tax-exempt bonds) is excluded from gross income. Section
103(b)(1) provides, however, that private activity bonds (other than
qualified bonds) are not tax-exempt bonds. Section 141 provides that a
bond is a private activity bond if the issue of which the bond is a
part satisfies either the private business tests or the private loan
financing test. The private business tests of section 141(b) are
satisfied if the issue satisfies both the private business use test,
which relates to the use of the bond proceeds, and the private security
or payment test, which relates to the manner in which the issue is
secured or will be repaid. Section 141(c) provides that the private
loan financing test is satisfied if the lesser of $5 million or 5
percent of the proceeds of an issue are to be used to make or finance
loans to persons other than governmental units.
Regulations relating to the private business tests under section
103(b) of the Internal Revenue Code of 1954 (the 1954 Code), the
predecessor to section 141(b), are contained in Sec. 1.103-7 (the
industrial development bond regulations.) These regulations have not
been amended since their finalization shortly after the enactment of
section 103(b) of the 1954 Code. Since 1972 many changes have occurred
in the financing practices of State and local governments. In addition,
the 1984 Act and the 1986 Act made a number of significant changes to
the private business tests. These changes include reductions in the
permissible amounts of private business use and private security or
payments, new limitations for certain types of bonds (for example,
issues for output facilities), and modifications to the private
business use and private security or payment tests. Importantly,
however, the 1986 Act legislative history states that, to the extent
not amended, principles of prior law continue to apply. The industrial
development bond regulations have not been amended to reflect the
changes to the private business tests made in the 1984 Act or the 1986
Act. Finally, the industrial development bond regulations do not
provide guidance on the private loan financing test.
This document proposes to amend the Income Tax Regulations (26 CFR
part 1) by replacing the industrial development bond regulations under
Sec. 1.103-7 with comprehensive regulations addressing the private
business tests and the private loan financing test. This document also
contains proposed regulations that would replace other guidance found
in various pronouncements of the Service (for example, Notice 87-69,
1987-2 C.B. 378, Notice 89-9, 1989-1 C.B. 630, Rev. Proc. 93-17, 1993-1
C.B. 507, and Rev. Proc. 93-19, 1993-1 C.B. 526). This document also
proposes certain related rules in the Income Tax Regulations, including
rules for qualified bonds under section 141(e), qualified 501(c)(3)
bonds under section 145, arbitrage allocation rules under Sec. 1.148-6,
definitions in Sec. 1.150-1, changes in use under section 150 (b) and
(c), and enterprises zone facility bonds under section 1394. In the
process developing the proposed regulations, the Internal Revenue
Service and Treasury considered the public comments received with
respect to the industrial development bond regulations and other
existing guidance.
II. Description of proposed regulations
A. In general
The proposed regulations substantially revise the industrial
development bond regulations to provide more comprehensive guidance,
including numerous examples. Further, in contrast to the industrial
development bond regulations, the rules and definitions in the proposed
regulations, the rules and definitions in the proposed regulations are
coordinated with the rules in the arbitage regulations under section
148 and the rules in section 150 that apply generally for tax-exempt
bond purposes.
B. Section 1.141-1 Definitions and rules of general application
1. In general. The proposed regulations generally provide a number
of definitions that apply for all purposes of section 141. Further, for
many terms, the definitions that apply for arbitrage purposes are made
applicable for purposes of section 141. Selected definitions are
discussed below.
2. Proceeds. The proposed regulations define proceeds as including
sale proceeds, disposition proceeds, and any replaced amounts. Further,
proceeds include earnings on nonpurpose investments that accrue during
the project period but generally exclude sale proceeds used to retire
the issue.
3. Replaced amounts. The industrial development bond regulations do
not specifically address when amounts that are replaced by bond
proceeds are treated as proceeds under section 141. The proposed
regulations provide that certain replacement proceeds (as defined for
arbitrage purposes) are treated as proceeds for purposes of section
141.
4. Disposition proceeds. The industrial development bond
regulations also do not specifically address the application of the
provisions of section 141 after the issue date. The proposed
regulations provide that disposition proceeds, defined as amounts
derived from the sale, exchange, or other disposition of property
financed with the proceeds of an issue, are treated as proceeds of the
issue. Under this approach, the property transferred generally ceases
to be allocable to proceeds of the bonds and is no longer taken into
account under section 141. Instead, the amounts received from the
transfer of the property are treated as proceeds of the issue for
purposes of analyzing continuing compliance with the private activity
bond limitations. In order to provide administrative simplicity for
issuers of large, multiproject financings, the proposed regulations
provide a special exception for property financed with certain general
obligation issues.
5. Partnerships. Under the private business tests, use of proceeds
by any person other than a natural person is treated as trade or
business use. The proposed regulations provide rules for determining
under which circumstances use by a partnership is disregarded and,
instead, treated as use by the partners of that partnership.
C. Section 1.141-2 Private activity bond tests
1. In general. An issue must satisfy both the private business use
test and the private security or payment test for the bonds of the
issue to be private activity bonds under the private business tests of
section 141(b). Alternatively, bonds are private activity bonds if the
private loan financing test of section 141(c) is satisfied.
2. Reasonable expectations and deliberate actions. The industrial
development bond regulations do not specifically address the effect of
actions taken after the issue date. The proposed regulations generally
provide that whether bonds are private activity bonds is determined on
the basis of the issuer's reasonable expectations on the issue date. An
issuer's reasonable expectations are determined in the same manner as
under the arbitrage regulations.
The proposed regulations also provide that a deliberate action by
the issuer occurring subsequent to the issue date and resulting in
satisfaction of the private activity bond tests causes the bonds to be
private activity bonds. Importantly, many post-issuance transfers will
not result in private activity bond characterization if the issuer does
not use the disposition proceeds in an impermissible manner.
D. Section 1.141-3 Definition of private business use
1. General rules. Under the private business tests, a bond is a
private activity bond only if the issue of which it is a part satisfies
the private business use test of section 141(b)(1). The private
business use test of section 141(b)(1) is met if more than 10 percent
of the proceeds of the issue is used in a trade or business carried on
by a nongovernmental person. Any use by a person other than a natural
person is treated as use in a trade or business. The industrial
development bond regulations relating to the private business use test
do not provide specific guidance for many common situations that arise
in municipal financings.
2. General definition of private business use. A principal goal of
the proposed regulations is to provide more complete rules to identify
whether proceeds, or the facilities financed with those proceeds, are
used for a private business use. The proposed regulations provide that
use of proceeds generally results from ownership or leasing of financed
property, a loan of proceeds, or other actual or beneficial use of
financed property under a management or incentive payment contract,
output contract, or other arrangement. As under the industrial
development bond regulations, private business use can result from
either direct or indirect use of the proceeds as well as from either
the ultimate use of the proceeds or an intermediate use of the
proceeds.
3. Discharge of primary legal obligation. The proposed regulations
provide that a bond-financed facility is indirectly used by a
nongovernmental person if the provision of that facility discharges a
primary and unconditional obligation of the nongovernmental person.
4. Management contracts. For management and other incentive payment
contracts, the proposed regulations implement the directive of section
1301(e) of the 1986 Act and liberalize the safe harbors contained in
Rev. Proc. 93-19. The proposed regulations provide that management
contracts other than qualified management contracts result in private
business use of the related facility. The proposed regulations expand
the categories of qualified management contracts to include the
following: (a) Contracts with terms not exceeding the lesser of 15
years or 50 percent of the useful life of the property if all the
compensation is based on a periodic fixed fee; (b) contracts with terms
not exceeding the lesser of 10 years or 80 percent of the useful life
of the property if at least 80 percent of the annual compensation is
based on a periodic fixed fee; (c) contracts with terms not exceeding 5
years if at least 50 percent of the compensation is based on a periodic
fixed fee; and (d) contracts with terms not exceeding 3 years if all of
the compensation is based on a per-unit fee. The proposed regulations
make a number of other changes in the qualified management contract
rules in response to comments received with respect to Rev. Proc. 93-
19.
5. Exception for general public use. The proposed regulations
provide more complete guidance, including certain bright line tests and
numerous examples, for purposes of determining whether use is use as a
member of the general public. These rules include a definition of
general public use, guidance on the circumstances when general public
use is insubstantial, special rules for system improvements, and
guidance for facilities that are integrally related to other
facilities.
6. De minimis exceptions. In order to simplify the application of
the private business use test, the regulations provide that certain de
minimis uses are disregarded. First, leases and similar arrangements
that are not renewed or renewable and have terms of less than 1 year
are generally disregarded. Second, certain temporary use by developers
of property that will be sold to the general public is also disregarded
in applying the private business use test. Third, as under Notice 87-
69, both incidental uses of a financed facility and qualified
improvements of a facility are disregarded. The proposed regulations
revise the qualified improvement exception to simplify the application
of these rules.
E. Section 1.141-4 Private security or payment test
1. General rules. Under the private business tests, a bond is a
private activity bond only if the issue of which it is a part satisfies
the private security or payment test of section 141(b)(2). The private
security or payment test relates to the security for, and the source of
the amounts used to pay, debt service on the bonds.
2. Application. The proposed regulations provide that the private
security or payment test is applied by comparing the present value of
the private payments and security to the present value of the debt
service on the issue. Present values are computed using the yield on
the issue as determined under the arbitrage regulations, with special
rules provided for variable yield issues. The private security or
payment test is generally met if more than 10 percent of the principal
of and interest on the issue in the aggregate is to be secured or
derived from certain property or payments described below.
3. Private payments. The private payments taken into account are
payments, whether to the issuer or any related party, in respect of
property or borrowed money to be used for a private business use.
Generally, any payments made by persons that satisfy the private
business use test are taken into account and the payments taken into
account cannot exceed the corresponding proportion of proceeds used by
that person. In addition, payments from persons that are not private
business users are taken into account if those payments are made in
respect of a private business use. For example, payments by the general
public for use of a facility that is managed by a nongovernmental
person under a management contract that is not a qualified management
contract are taken into account as private payments.
4. Private security test. Private security includes any interest in
property to be used for a private business use or payments in respect
of property or borrowed money to be used for a private business use
that secures principal of and interest on the issue. Unlike private
payments, private security is taken into account if privately used
property is the security for the bonds even if that property is not
financed with the proceeds of the issue.
5. Exception for generally applicable taxes. The proposed
regulations provide that generally applicable taxes are disregarded
under the private security or payment test. Generally applicable taxes
do not include special assessment or payments for a special privilege
granted or service rendered. Generally applicable taxes must have a
general manner of determination and collection. The regulations provide
guidance on whether this requirement is satisfied if the taxpayer makes
special arrangements with respect to the tax (for example, agreements
to be personally liable for a tax).
6. Waste remediation bonds. The proposed regulations incorporate
the guidance in Notice 89-9, relating to bonds issued to finance
certain hazardous waste clean-up activities.
F. Section 1.141-5 Private loan financing test
1. General rules. Under the private loan financing test, a bond is
a private activity bond if issued as part of an issue more than 5
percent of the proceeds of which (or $5 million, if less) are used to
make loans to nongovernmental persons. As with the private business
tests, both direct and indirect uses of proceeds are taken into
account.
2. Definition of loan. Any transaction that is treated as a loan
for federal tax purposes is a loan of proceeds. Generally, transactions
that result in an expenditure of proceeds, such as a grant, do not give
rise to a loan. However, tax increment and similar financings, in which
proceeds are, in form, granted to a nongovernmental person with the
debt service on the bonds to be paid from incremental tax revenues may
be treated as a loan if the recipient of the grant makes special
agreements regarding payment of the taxes (for example, an agreement
not to contest the assessment).
3. Tax assessment bond exception. Section 141(c) provides that
certain tax assessment loans are not treated as loans in applying the
private loan financing test. A tax assessment loan is a loan that
arises from the imposition of a tax or assessment of general
application for specific, essential governmental functions. The
proposed regulations generally define essential governmental function
to have the same meaning as under section 7871. To qualify for this
special exception, owners of business and nonbusiness property must be
eligible to make assessment payments on an equal basis. Guidance is
provided on the types of special arrangements regarding payment of an
assessment that cause the assessment to fail the equal basis
requirement (for example, due-on-sale clauses). The proposed
regulations clarify that loans qualifying under the tax assessment loan
exception may still result in satisfaction of the private business
tests.
G. Sections 1.141-3 and 1.141-6 Measurement of use and allocation and
accounting rules
1. Measurement of private business use. The proposed regulations
provide specific rules regarding the measurement of private use. For
facilities that are simultaneously used for both private business use
and government use, the regulations generally permit the use of
reasonable methods of measuring the private business use. Thus, for a
building with separate portions used for private business use and
government use, the amount of private business use is based on the
relative portion of useable space used for a private business use. If
the private use occurs at different times, the private business use is
based on a comparison of private business use to total use.
Except as described below for output facilities, annual periods are
used to measure the amount of private business use and the private
business use is equal to the greatest amount of private business use in
any annual period. As under the industrial development bond
regulations, the proposed regulations do not provide that private
business use is measured over the entire term of the issue, except for
output facilities. For example, a stadium that is used for private
business use 30 days out of a total use of 200 days in one year
generally meets the 10 percent private business use test (regardless of
the use of the facility in other years).
2. Financing a portion of a mixed use facility. If a facility is
used for private business use in an amount that would cause the bonds
to be private activity bonds, in many circumstances the proposed
regulations permit tax-exempt bonds to be issued for the government use
portion without causing the bonds to meet the private business use
test. This special rule applies only if the government use portion of
the facility is a separate and discrete portion of a facility (such as
a floor of a building), or an undivided ownership interest in an output
or similar utility facility. In applying this rule, an allocable
portion of the cost of common areas may be financed as government use.
Generally, if the private business use of facility does not occur
in a separate and discrete portion of the facility or in an output or
similar utility facility, the proposed regulations do not permit tax-
exempt financing of any portion of that facility. For example, for a
stadium used 30 percent of the time for private business use, tax-
exempt bonds may not be issued to provide 70 percent of the cost of
that stadium.
3. Allocation of proceeds to expenditures. The proposed regulations
provide that the allocation of proceeds to expenditures for purposes of
section 141 must be made in the same manner as and consistently with
allocations of proceeds for arbitrage purposes under Sec. 1.148-6. As
further described below, the proposed regulations would amend
Sec. 1.148-6 to provide significant flexibility regarding when these
allocations are required to be made.
H. Section 1.141-7 Special rules for output facilities
1. General rule. The proposed regulations adopt the approach of the
industrial development bond regulations providing special rules for the
determination of whether the purchase of the output of an output
facility by a nongovernmental person causes the bonds to be private
activity bonds. These rules apply the private business use test to
output contracts by comparing the amount of output purchased by
nongovernmental persons under take or take or pay contracts to the
available output of the facility. The proposed regulations provide
certain additional clarifications. For example, the proposed
regulations clarify that certain requirements contracts are treated as
take or take or pay contracts. Transitional rules are provided for
existing contracts. In modifying the rules for output facilities, the
Service and Treasury recognize that, as a result of the Energy Policy
Act of 1992, significant regulatory changes are occurring regarding
electric generation and transmission facilities. In this regard, the
proposed regulations attempt to address the changing nature of this
industry. For example, the proposed regulations provide guidance on
allocations of use of transmission facilities.
2. De minimis exceptions. The proposed regulations contain several
de minimis exceptions under which output contracts are disregarded.
First, in lieu of the 3 percent de minimis rule in the industrial
development bond regulations, the proposed regulations adopt a 1
percent de minimis rule. The proposed regulations also incorporate the
safe harbors in the 1986 Act legislative history relating to pooling,
exchange, and spot sale agreements. Special rules are also provided for
use of transmission facilities. Finally, contracts with terms not
exceeding 1 year may be disregarded in certain circumstances.
3. Allocation of output contracts. The proposed regulations provide
specific guidance on allocations of output sold under a contract among
particular facilities. Generally, these determinations are made on a
facts and circumstances basis taking into account certain physical and
contractual factors.
I. Section 1.141-8 $15 million limitation for output facilities
1. General rules. Section 141(b)(4) provides a special private
activity bond limitation for issues used to finance output facilities,
under which the permissible private business use and private security
or payments are limited to $15 million. Further, this $15 million
limitation for an issue is reduced by the amount of private business
use and private security or payments in other outstanding tax-exempt
bonds financing the same project.
2. Definition of project. The proposed regulations define project
for purposes of the $15 million output limitation. Generating units not
located at the same site or not placed in service within 3 years are
not part of the same project. In addition, improvements made more than
3 years after a generating unit is placed in service are treated as a
separate project. For transmission facilities, a project includes
functionally related or contiguous property placed in service during a
single 24-month period.
J. Section 1.141-9 Unrelated or disproportionate use test
Under section 141(b)(3), an issue meets the private business tests
if the amount of private business use and private security or payments
attributable to any unrelated or disproportionate private business use
exceeds 5 percent of the proceeds. The proposed regulations provide
that whether private business use is related to a government use of the
proceeds of an issue is determined on a case-by-case basis, emphasizing
the operational relationship of the financed facilities. Generally,
facilities used for a private business use are related to a government
use only if the private use occurs in the same facility or an adjacent
facility. The proposed regulations also provide that a single facility
that is used for both a government use and a private business use of
the same type (for example, governmental and private parking) generally
does not result in unrelated use.
Disproportionate private business use occurs when the amount of
proceeds used for a private business use exceeds the amount of proceeds
used for the related government use. The proposed regulations provide
allocation rules designed to simplify the application of the
disproportionate use rules. For example, where a private business use
relates to more than one government use, in determining the amount of
disproportionate use the private business use may be allocated either
entirely to the government use to which it primarily relates or among
each of the government uses. A number of examples are provided
illustrating the application of the unrelated and disproportionate use
rules.
K. Section 1.141-12 Special rules for qualified bonds
The proposed regulations provide certain limited guidance for
purposes of applying the provisions of section 141(e), relating to
qualified private activity bonds (private activity bonds that qualify
as tax-exempt bonds). Thus, generally, continued compliance throughout
the term of the issue is required for bonds to be qualified bonds. The
proposed regulations provide, however, that certain of the remedial
actions under proposed Sec. 1.141-13 apply for this purpose.
L. Section 1.141-13 Deliberate actions and related remedial actions
1. Remedial actions. Although a post-issuance deliberate action by
an issuer may cause bonds to be private activity bonds, the proposed
regulations provide a number of remedial actions that will prevent
bonds from ceasing to be tax-exempt bonds. In order to be eligible for
these remedial actions the issue must satisfy certain conditions.
First, the issuer must covenant in the bond documents that it will not
take any action that would cause the bonds to be private activity
bonds, and must establish reasonable procedures to ensure compliance
with this covenant. Second, the terms of any agreement that would cause
the bonds to be private activity bonds must be arm's-length. Third, as
under the arbitrage regulations, the issuer must certify its
expectations as of the issue date regarding the amount and use of the
proceeds. If, however, the possibility that a deliberate action would
be taken is not remote as of the issue date, remedial actions are
generally not available unless the bonds provide for redemption within
6 months of the deliberate action.
2. Permitted remedial actions. The proposed regulations contain
several remedial actions that are available in the event of a
deliberate action. First, the issuer can redeem or defease the
nonqualifying bonds. Second, the issuer is permitted to use the amounts
received on the disposition of a facility for a use that would qualify
for tax-exempt financing as qualified 501(c)(3) bonds. Similarly, in
certain circumstances, if the transferred facility would itself
continue to be eligible for tax-exempt bond financing, that use is
treated as a qualifying remedial actions. For this purpose, in applying
section 55 through 59, 141 through 147, 149, and 150, the bonds are
treated as reissued on the date of the deliberate action. Treasury and
the Service are considering alternative ways in which the requirements
of section 55 through 59 could be satisfied for this purpose (for
example, a closing agreement with the issuer similar to the one
described below). These rules are based on, but are more flexible than,
the safe harbors in Rev. Porc. 93-17. For example, qualifying
alternative uses of the financed facility would include uses under
section 142. Finally, the proposed regulations provide the Commissioner
with the authority to provide additional remedial actions by
publication in the Internal Revenue Bulletin.
3. Consideration of alternative remedial action. Defeasing bonds
generally results in an issuer foregoing much of the ongoing benefit
provided by tax-exempt financing. In lieu of providing for defeasing as
a remedial action, a more direct remedial action is being considered.
Treasury and the Service are considering the issuance of a revenue
procedure pursuant to which an issuer may request a closing agreement
with respect to outstanding bonds. Under the closing agreement, the
issuer would make a payment to the Service to prevent the interest on
bonds from being includable in gross income of bondholders as a result
of a deliberate action that results in satisfaction of the private
activity bond test. Generally, the closing agreement would be
conditioned upon satisfying the requirements of Sec. 1.141-13(a)
(relating to conditions for remedial action). If this procedure is
adopted, defeasance of bonds would no longer be a permissible remedial
action.
The issuer would be required to make the payment within 30 days of
the execution of the closing agreement. The amount of the payment would
equal the present value of the interest rate differential (as described
below) multiplied by the amount of nonqualified bonds that will be
outstanding for each annual period (or shorter period) subject to the
closing agreement.
The interest rate differential would equal an appropriate factor
multiplied by the difference between the applicable federal rate under
section 1274(d) (the applicable taxable rate) and the applicable
federal rate under section 1288(b) (the applicable tax-exempt rate).
The factor would reflect that the applicable taxable rate is based on
obligations of the United States. The rates used would be those in
effect on the date the deliberate action occurs. Each rate (that is,
the short-term, mid-term, or long-term rate) would be based on the
remaining weighted average maturity of the nonqualified bonds.
The amount of the payment would be increased by 20 percent in cases
where (1) the bond may be redeemed in accordance with its terms or (2)
the establishment of a defeasance escrow would not satisfy the
requirements of Sec. 1.141-13(b)(4) (relating to defeasance of
nonqualified bonds) as proposed.
Nonqualified bonds would have the same meaning as in Sec. 1.141-
13(g)(1), except that in the case of a transfer for cash as defined in
Sec. 1.141-13(b)(1), the determination of the nonqualified bonds would
be based on an amount equal to the disposition proceeds. Nonqualified
bonds that continue to be treated as tax-exempt because of a
permissible remedial action under Sec. 1.141-13 (b), (c), or (d) (for
example, because of a permissible redemption) would not be treated as
nonqualified bonds for purposes of the closing agreement.
To enter into the agreement, the issuer also would have to agree to
(1) redeem the nonqualified bonds on the earliest date on which the
bonds may be redeemed under their terms, (2) not make any payment under
the closing agreement from bond proceeds as described in section 103(a)
of the Code, and (3) comply with Sec. 1.141-14 with respect to any
refunding of the nonqualified bonds. In limited situations where it is
foreseeable that the issuer, using its best efforts, will be unable to
redeem the bonds at the earliest date, the Commissioner may permit the
bonds to remain outstanding until a later date.
Finally, for cases in which the conditions of Sec. 1.141-13(a) are
not satisfied, the amount required to be paid under the closing
agreement would be based on the highest marginal individual income tax
rate at the time of the deliberate action and the interest paid or
accrued on the nonqualified bonds from the issue date. If the
noncompliance occurred or was expected to occur as of the issue date,
the nonqualified bonds would include all the bonds of the issue.
M. Section 1.141-14 Refunding Issues
1. General rules. The industrial development bond regulations
provide only limited guidance on the application of the private
activity bond limitations to refunding issues. The proposed regulations
provide guidance regarding the application of the private activity bond
test to refunding issues, including guidance regarding whether an issue
to refund a qualified bond is a qualified bond.
2. Private activity bond status. The proposed regulations generally
provide that refunding issues are retested to determine if those bonds
are private activity bonds. These tests are applied based on the use of
the proceeds of the refunded issue.
3. Qualified bond status. The proposed regulations also generally
provide that refunding issues are retested to determine if those bonds
are qualified bonds. These tests are applied based on the use of the
proceeds of the refunded issue.
N. Section 1.141-15 Anti-abuse Rules
The proposed regulations contain an anti-abuse rule to ensure that
the regulations are applied consistently with the purposes of section
141. In the case of a transaction entered into for a principal purpose
of transferring to a nongovernmental person significant benefits of
tax-exempt financing in a manner that is inconsistent with the purposes
of section 141, the Commissioner may take any action to reflect the
substance of the transaction. The proposed regulations provide several
examples illustrating the application of the anti-abuse rule.
O. Section 1.145-1 Qualified 501(c)(3) Bonds
The proposed regulations provide certain limited guidance for
purposes of applying the provisions of section 145, relating to
qualified private 501(c)(3) bonds. Thus, generally, as under section
141, compliance with section 145 is determined based on the issuer's
reasonable expectations as of the issue date, although deliberate
actions may cause the bonds to fail to be qualified bonds. The proposed
regulations also provide that the remedial actions under proposed
Sec. 1.141-13 apply for this purpose.
P. Section 1.148-6 Arbitrage Allocation and Accounting Rules
The proposed regulations provide additional guidance regarding when
expenditures of proceeds must be allocated and accounted for under the
arbitrage regulations. The proposed regulations provide that if an
issuer fails to account for the expenditure of bond proceeds, the
proceeds of the issue are accounted for under a specific tracing
method. An issuer would be required to account for the allocation of
proceeds to expenditures not later than 18 months after the later of
the payment of the expenditure and the date the project financed by the
issue is placed in service. In no event may the allocation occur after
the first arbitrage rebate installment payment would be due for the
issue.
Q. Section 1.150-1 General Definitions for Purposes of All Tax-Exempt
Bond Rules
The proposed regulations revise the existing definition of issue
that applies for all purposes of sections 103 and 141 through 150 to
clarify the circumstances under which taxable and tax-exempt bonds are
treated as part of a single issue.
R. Section 1.1394-1 Enterprise Zone Facility Bonds
1. In general. The proposed regulations provide guidance on certain
aspects of the provisions of section 1394, relating to enterprise zone
facility bonds.
2. Limit on amount of bonds. Guidance is provided on the
application of section 1394(c), which contains a $3 million and a $20
million limitation on the amount of outstanding tax-exempt enterprise
zone facility bonds. These limitations are applied on the basis of the
issue price of an issue. The proposed regulations also provide that in
applying these limitations, the lender in a loans-to-lenders program
may be disregarded.
3. Good faith compliance. Under the proposed regulations, an issue
is treated as satisfying certain of the requirements of section 1394 if
the issuer and each principal user in good faith attempt to meet those
requirements throughout the term of the issue, and any failure to
comply with these requirements is corrected within a reasonable period
after the failure is first discovered. The proposed regulations provide
guidance on the application of this good faith standard. Generally,
correction of noncompliance within one year of discovery is reasonable
if the issuer and principal user are using their best efforts to
correct the noncompliance.
4. Other rules. The proposed regulations also provide guidance on
the definition of qualified zone property, including the original use
requirement. Finally, the proposed regulations provide special rules
for purposes of applying the maturity limitation of section 147 to
these bonds.
Effective Dates
The regulations are proposed to apply to bonds issued on or after
the date 60 days after the adoption of final regulations. The
regulations do not apply to bonds issued on or after the effective date
to refund a bond that was not subject to these private activity bond
regulations unless the refunding issue extends the weighted average
maturity of the financing. Under various transition rules, issuers may
apply certain of the proposed rules on earlier dates. Before the
adoption of the regulations, the Service will continue to consider
requests for rulings in the case of changes of use in which the safe
harbors provided in Rev. Proc. 93-17 are not satisfied.
Special Analyses
It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in EO 12866. Therefore,
a regulatory assessment is not required. It also has been determined
that section 553(b) of the Administrative Procedure Act (5 U.S.C.
chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do
not apply to these regulations, and, therefore, a Regulatory
Flexibility Analysis is not required. Pursuant to section 7805(f) of
the Internal Revenue Code, this notice of proposed rulemaking will be
submitted to the Chief Counsel for Advocacy of the Small Business
Administration for comment on its impact on small business.
Comments and Public Hearing
Before these proposed regulations are adopted as final regulations,
consideration will be given to any written comments that are submitted
timely (preferably a signed original and eight copies) to the IRS. All
comments will be available for public inspection and copying.
A public hearing has been scheduled for Thursday, June 8, 1995, at
10 a.m. in the Auditorium, Internal Revenue Building, 1111 Constitution
Avenue NW, Washington, D.C. Because of access restrictions, visitors
will not be admitted beyond the Internal Revenue Building lobby more
than 15 minutes before the hearing starts.
The rules of 26 CFR 601.601(a)(3) apply to the hearing.
Persons that wish to present oral comments at the hearing must
submit written comments by May 1, 1995 and submit an outline of the
topics to be discussed and the time to be devoted to each topic by May
18, 1995.
A period of 10 minutes will be allotted to each person for making
comments.
An agenda showing the scheduling of the speakers will be prepared
after the deadline for receiving outlines has passed. Copies of the
agenda will be available free of charge at the hearing.
Comment is solicited on all aspects of the proposed regulations. In
addition, comment is specifically solicited on the following topics:
(1) the desirability of adopting the closing agreement procedure
for noncompliance in lieu of providing for defeasance, other situations
in which the closing agreement procedure, if adopted, should apply, and
whether other procedures should be available to issuers;
(2) the condition that, in order to take certain remedial actions,
certain bonds must contain early redemption provisions;
(3) additional limitations on the application of the disposition
proceeds rules to reduce administrative burdens on issuers and whether
the disposition proceeds rules should apply for purposes of section
148;
(4) problems resulting from rules binding an issuer to the form of
its transaction (see, for example, New York City v. Commissioner, 103
T.C. No. 27 (1994));
(5) the application of the private security or payment test to
variable yield issues;
(6) other circumstances in which issuers should be permitted to
finance the government use portion of a mixed use facility;
(7) the required consistency between arbitrage and private activity
bond allocations of proceeds;
(8) the treatment of requirements contracts as output contracts;
and
(9) safe harbors for provisions of the regulations requiring
determinations of reasonableness or fair market value.
Drafting Information
The principal author of these regulations is William P. Cejudo of
the Office of Assistant Chief Counsel (Financial Institutions and
Products). However, other personnel from the Service and Treasury
Department participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, 26 CFR part 1 is proposed to be amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 is amended by adding
an entry in numerical order to read as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.148-6 also issued under 26 U.S.C. 148(f), (g), and (i).
Section 1.150-4 also issued under 26 U.S.C. 150(c)(5) * * *
Section 1.1394-1 also issued under 26 U.S.C. 1397D * * *
Sec. 1.103-7 [Removed]
Par. 2. Section 1.103-7 is removed.
Sec. 1.141-1 [Redesignated as Sec. 1.141-20]
Par. 3. Section 1.141-1 is redesignated as Sec. 1.141-20.
Par. 4. Sections 1.141-0 through 1.141-16 are added to read as
follows:
Sec. 1.141-0 Table of contents.
This section lists the captioned paragraphs contained in
Secs. 1.141-1 through 1.141-16.
Sec. 1.141-1 Definitions and rules of general application.
(a) In general.
(b) Definitions.
(c) Disposition proceeds.
(1) Definition.
(2) Amount of disposition proceeds.
(3) Exception for general obligation programs.
(4) Below market transfers and authority of Commissioner.
(d) Elections.
(e) Treatment of partnerships.
(1) General rule.
(2) Certain partnerships disregarded.
(f) Related parties.
Sec. 1.141-2 Private activity bond tests.
(a) Overview.
(b) Scope.
(c) General definition of private activity bond.
(d) Reasonable expectations and deliberate actions.
(1) In general.
(2) Deliberate actions defined.
(3) Certain remedial actions.
(4) Examples.
Sec. 1.141-3 Definition of private business use.
(a) General rule.
(1) In general.
(2) Indirect use.
(3) Ultimate and intermediate use.
(4) Aggregation of private business use.
(b) General definition of private business use.
(1) In general.
(2) Use of proceeds.
(3) Agents and employees.
(4) Ownership.
(5) Leases.
(6) Management contracts.
(7) Output facilities.
(8) Discharge of primary legal obligation.
(9) Research agreements.
(10) Other actual or beneficial use.
(c) Qualified management contracts.
(1) In General.
(2) General compensation requirements.
(3) Permissible arrangements.
(4) No related parties or common control.
(5) De minimis exception for functionally related use.
(6) Definitions.
(d) Research agreements.
(1) General rule.
(2) Corporate-sponsored research.
(3) Cooperative research agreements.
(4) Basic research.
(e) Exception for general public use.
(1) General public use.
(2) Intended for use by the general public.
(3) Use on the same basis.
(4) Special rule for system improvements.
(5) Examples.
(f) De minimis exceptions.
(1) Short-term leases and similar arrangements.
(2) Temporary use by developers.
(3) Incidental use.
(4) Qualified improvements.
(g) Special rule for tax assessment bonds.
(h) Examples.
(i) Measurement of private business use.
(1) General rule.
(2) Determining average of use.
(3) Use of a portion of a facility.
(4) Allocation of neutral costs.
(5) Commencement of private business use.
(6) Examples.
Sec. 1.141-4 Private security or payment test.
(a) General rule.
(1) Private security or payment.
(2) Aggregation of private payments and security.
(b) Measurement of private payments and security.
(1) Scope.
(2) General rule.
(3) Present value measurement.
(c) Private payments.
(1) In general.
(2) Payments taken into account.
(3) Allocation of payments.
(d) Private security.
(1) In general.
(2) Security taken into account.
(3) Pledge of unexpended proceeds.
(4) Secured by any interest in property or payments.
(5) Payments in respect of property.
(6) Allocation of security among issues.
(e) Generally applicable taxes.
(1) General rule.
(2) Definition of generally applicable taxes.
(3) Special charges.
(4) Manner of determination and collection.
(f) Certain waste remediation bonds.
(1) Scope.
(2) Persons that are not private users.
(g) Examples.
Sec. 1.141-5 Private loan financing test.
(a) In general.
(1) General rule.
(2) Direct and indirect us of proceeds determinative.
(3) Measurement of test.
(b) Definition of loan.
(1) General federal tax principles apply.
(2) Exception if no use of bond proceeds.
(3) Hazardous waste remediation bonds.
(4) Prepayments.
(5) Grants.
(c) Tax assessment bond exception.
(1) General rule.
(2) Tax assessment loan defined.
(3) Mandatory tax or other assessment.
(4) Specific essential governmental function.
(5) Equal basis requirement.
(6) Coordination with private business tests.
(d) Nonpurpose investment exception.
(e) Examples.
Sec. 1.141-6 Allocation and accounting rules.
(1) Allocation of proceeds to expenditures generally.
(b) Special rules for mixed use facilities.
(1) Allocation of expenditures to mixed use facilities.
(2) Mixed use facility defined.
(c) Allocation of disposition proceeds.
(d) Allocation of common areas.
(e) Allocation of proceeds to bonds.
Sec. 1.141-7 Special rules for output facilities.
(a) Private business use and private security or payments test.
(1) General rule.
(2) Application of benefits and burdens test.
(3) Special rules and definitions.
(4) Benefits and burdens test not exclusive.
(b) Pooling, exchange, spot sales, and wheeling arrangements.
(1) Swapping and pooling arrangements.
(2) Certain conduit parties disregarded.
(3) Spot sales.
(4) Wheeling.
(c) Certain short term contracts.
(d) Allocations of output facilities and systems.
(1) Facts and circumstances analysis.
(2) Factors.
(3) Allocations among users.
(4) Electric transmission facilities.
(5) Conservation facilities.
(e) Examples.
Sec. 1.141-8 $15 million limitation for output facilities.
(a) In general.
(1) General rule.
(2) Reduction in $15 million output limitation for outstanding
issues.
(3) Benefits and burdens test applicable.
(b) Definition of project.
(1) General rule.
(2) Separate ownership.
(3) Generating property.
(4) Transmission.
(5) Subsequent improvements.
(6) Conservation.
(7) Replacement property.
(c) Examples.
Sec. 1.141-9 Unrelated or disproportionate use test.
(a) General rules.
(1) Description of test.
(2) Application of unrelated and disproportionate use test--.
(b) Unrelated use.
(1) In general.
(2) Parallel related and unrelated uses.
(c) Disproportionate use.
(1) Definition of disproportionate use.
(2) Aggregation of related uses.
(3) Allocation rule.
(d) Maximum use taken into account.
(e) Examples.
Sec. 1.141-10 Coordination with volume cap.
Sec. 1.141-11 Acquisition of nongovernmental output property.
Sec. 1.141-12 Special rules for qualified bonds.
(a) Actual compliance required.
(b) Remedial actions available.
(1) In general.
(2) Nonqualified use.
(c) Limitation on remedial action.
(1) Failure to spend proceeds.
(2) Amount of nonqualified bonds.
Sec. 1.141-13 Deliberate actions and related remedial actions.
(a) Remedial action.
(1) Required covenants.
(2) Fair market value consideration.
(3) Expectations must be certified.
(4) No abuse.
(b) Redemption of nonqualified bonds.
(1) Transfer for cash.
(2) Other deliberate actions.
(3) Notice of defeasance.
(4) Special limitation.
(5) Defeasance escrow defined.
(c) Alternative use of facility.
(d) Alternative use of disposition proceeds.
(e) Authority of Commissioner to provide for additional remedial
actions.
(f) Effect of remedial action on continuing compliance.
(g) Definition and special rules.
(1) Definition of nonqualified bonds.
(2) Section 147.
(h) Examples.
Sec. 1.141-14 Refunding issues.
(a) Private activity bond status.
(1) In general.
(2) Rules of application.
(3) Optional treatment as continuation of prior issue.
(b) Qualified bonds.
(1) In general.
(2) Discontinued use in certain qualified bonds.
Sec. 1.141-15 Anti-abuse rules.
(a) Authority of Commissioner to reflect substance of
transactions.
(b) Examples.
Sec. 1.141-16 Effective dates.
(a) Scope.
(b) Effective dates.
(c) Refunding bonds.
(d) Permissive application of regulations.
(e) Permissive retroactive application of certain sections.
Sec. 1.141-1 Definitions and rules of general application.
(a) In general. For purposes of Secs. 1.141-1 through 1.141-16, the
definitions and rules in this section, the definitions in Sec. 1.150-1,
and the following definitions under Sec. 1.148-1 apply: bond year,
commingled fund, higher yielding investment, investment proceeds,
investments, investment-type property, issue price, nonpurpose
investment, qualified guarantee, qualified hedge, reasonable
expectations, reasonably required reserve or replacement fund, rebate
amount, replacement proceeds, reserve or replacement fund, sale
proceeds, and yield.
(b) Definitions.
Common areas means portions of a facility that are equally
available to all users of a facility on the same basis for uses that
are incidental to the primary use of the facility. For example,
hallways and elevators generally are treated as common areas if they
are used by the different lessees of a facility in connection with the
primary use of that facility.
Consistently applied means applied uniformly to account for
proceeds and other amounts.
Essential governmental function is defined in Sec. 1.141-5(c)(4).
Financed means constructed, reconstructed, or acquired with
proceeds of an issue.
Governmental bond means a bond issued as part of an issue no
portion of which consists of private activity bonds.
Governmental person means a State or local governmental unit as
defined in Sec. 1.103-1 or any instrumentality thereof or any entity
issuing obligations on behalf thereof. It does not include the United
States or any agency or instrumentality thereof.
Hazardous waste remediation bonds is defined in Sec. 1.141-4(f).
Mixed use facility is defined in Sec. 1.141-6.
Nongovernmental person means a person other than a governmental
person.
Nonqualified amount means the lesser of--
(1) The sale proceeds of an issue used for any private business use
under Sec. 1.141-3, or
(2) The sum of the sale proceeds of the issue for which there are
payments taken into account as private payments under Sec. 1.141-4(c)
and the sale proceeds of the issue secured by an interest in property
or payments in respect of property taken into account as private
security under Sec. 1.141-4(d).
Output facility, except as otherwise provided in Secs. 1.141-7a),
includes electric and gas generation, transmission, and related
facilities, but not (1) sewage or solid waste disposal facilities, or
(2) water collection, storage, or distribution facilities.
Private business tests means the private business use test and the
private security or payment test of section 141(b).
Proceeds means the sale proceeds, disposition proceeds, and any
replaced amounts. Proceeds also include any investment proceeds from
investments that accrue during the project period (net of rebate
amounts attributable to the project period). Proceeds of an issue do
not include sale proceeds (other than those deposited in a reasonably
required reserve or replacement fund) used to retire bonds of the
issue.
Project period means the period beginning on the issue date and
ending on the date that the construction, reconstruction, or
acquisition of the project financed is substantially complete. In the
case of a multipurpose issue, the issuer may elect to treat the project
period for the entire issue as ending on either the expiration of the
temporary period described in Sec. 1.148-2(e)(2) or the end of the
fifth bond year after the issue date.
Replaced amounts means replacement proceeds that are or are
reasonably expected to be available during the project period other
than sinking funds, pledged funds, and other replacement proceeds (as
defined in Sec. 1.148-1(c) (2) through (4), respectively).
Term of an issue means the period beginning on the issue date and
ending on the final maturity date of the issue, except that if the term
of an issue is extended and the primary purpose for that extension is
not a governmental purpose, the term of the issue is determined as if
the issue had a final maturity equal to the average maturity date of
the issue.
Transfer is defined in paragraph (c)(1) of this section.
Weighted average economic life is determined under the rules in
section 147(b). The reasonably expected useful life of a facility may
be determined by reference to the class life of the property under
section 168.
Weighted average maturity is determined under the rules in section
147(b).
(c) Disposition proceeds--(1) Definition. Disposition proceeds are
any amounts (including property) derived from the sale, exchange, or
other disposition (transfer) of property (other than investments)
financed with the proceeds of an issue. Except as provided in paragraph
(c)(4) of this section, if there are disposition proceeds, any proceeds
of the issue allocable to the transferred property cease to be treated
as proceeds of the issue.
(2) Amount of disposition proceeds. Regardless of the amount
received in connection with the transfer, the amount of disposition
proceeds is treated as equal to the proceeds of the issue that had been
allocable to the transferred property immediately prior to the
transfer. See Sec. 1.141-13(h), Example 1.
(3) Exception for general obligation programs. Unless the issuer
elects otherwise, disposition proceeds do not arise on the transfer of
property financed with the proceeds of a general obligation program if
the requirements of this paragraph (c)(3) are satisfied. A general
obligation program is an issue of general obligation bonds issued by a
general purpose governmental unit that finances more than 75 discrete
facilities or projects. The requirements of this paragraph (c)(3) are
satisfied if--
(i) The transferred property had an original cost not in excess of
the greater of $3,000,000 and 2.5 percent of the issue price of the
issue;
(ii) The transferred property is sold for its fair market value in
a transaction other than an installment sale;
(iii) The aggregate amount of the disposition proceeds (determined
without regard to this paragraph (c)(3)) of the issue to which this
paragraph (c)(3) applies does not exceed 10 percent of the issue price;
and
(iv) The amounts received are deposited in a commingled fund with
substantial tax or other revenues from governmental operations of the
transferor and the amounts are reasonably expected to be spent for
governmental purposes within 6 months from the date of the commingling.
(4) Below market transfers and authority of Commissioner. The
Commissioner may treat the proceeds as allocable to either the
transferred property or the disposition proceeds, whichever allocation
produces the greater amount of private business use and private
security or payments, if--
(i) The financed property is transferred for less than its fair
market value;
(ii) The weighted average maturity of the issue to which the
disposition proceeds are allocable exceeds 120 percent of the
reasonably expected weighted average economic life of the property
financed by that issue before the disposition;
(iii) The issuer does not expend the disposition proceeds or
deposit those amounts in a defeasance escrow (as defined in Sec. 1.141-
13(b)(5)) within 2 years of the transfer; or
(iv) The transfer is designed to avoid the provisions of section
141.
(d) Elections. Elections must be made in writing on or before the
issue date and retained as part of the bond documents, and, once made,
may not be revoked without the permission of the Commissioner.
(e) Treatment of partnerships--(1) General rule. Except as
otherwise provided in this paragraph (e), a partnership is treated as a
separate entity under the private business tests and the private loan
financing test. Thus, any use of proceeds or other action by a
partnership is an action of a nongovernmental person.
(2) Certain partnerships disregarded. A partnership is disregarded
(that is, treated as an aggregate of its partners) so that the
partnership's actions are treated as the actions of the partners for
purposes of the private business tests and private loan financing test
if--
(i) The partnership could validly elect under section 761(a)(2) to
be excluded from the application of Subchapter K of the Code and all
allocations to partners are consistent with each partner being
allocated the same distributive share of each item of income, gain,
loss, deduction, credit, and basis, and this share remains the same
during the entire period that the person is a partner; or
(ii) Each of the partners is a governmental person and all of the
partnership's income is excludable from gross income under section 115.
(f) Related parties. Except as otherwise provided, all related
parties are treated as one person and any reference to ``person''
includes any related party.
Sec. 1.141-2 Private activity bond tests.
(a) Overview. Interest on a private activity bond is not excludable
from gross income under section 103(a) unless the bond is a qualified
bond. The purpose of the private activity bond tests of section 141 is
to limit the volume of tax-exempt bonds that finance the activities of
nongovernmental persons, without regard to whether a financing actually
transfers benefits of tax-exempt financing to a nongovernmental person.
The private activity bond tests serve to identify arrangements that
have the potential to transfer the benefits of tax-exempt financing, as
well as arrangements that actually transfer these benefits. The
regulations under section 141 may not be applied in a manner that is
inconsistent with these purposes.
(b) Scope. Sections 1.141-1 through 1.141-16 apply generally for
purposes of the private activity bond limitations under section 141. In
addition, as specifically provided, certain provisions of Secs. 1.141-1
through 1.141-16 apply for purposes of other limitations on tax-exempt
bonds under sections 142 through 150.
(c) General definition of private activity bond. Under section 141,
bonds are private activity bonds if they meet either (1) the private
business use and private payment or security tests of section 141(b) or
(2) the private loan financing test of section 141(c). The private
business use and private security or payment tests are described in
Secs. 1.141-3 and 1.141-4. The private loan financing test is described
in Sec. 1.141-5.
(d) Reasonable expectations and deliberate actions--(1) In general.
An issue is an issue of private activity bonds if the issuer reasonably
expects, as of the issue date, that the issue will meet either (i) the
private business tests, or (ii) the private loan financing test. An
issue is also an issue of private activity bonds if the issuer takes a
deliberate action, subsequent to the issue date, that causes the
conditions of either the private business tests or the private loan
financing test to be met.
(2) Deliberate actions defined. In general, a deliberate action is
any action taken by the issuer that is within its control. An intent to
violate the requirements of section 141 is not necessary for an action
to be deliberate. Except as otherwise provided in the next sentence of
this paragraph (d)(2), an action that would be treated as involuntary
under section 1033 is not a deliberate action. Any action is treated as
a deliberate action if the financed facility was designed differently,
sized larger, built sooner, or constructed in a more costly manner than
is reasonably necessary for the governmental purposes of the issuer. A
deliberate action occurs on the earlier of the date the parties agree
on the consideration for the new use or the date on which the new use
occurs.
(3) Certain remedial actions. See Sec. 1.141-13 for certain
remedial actions that prevent a deliberate action from causing the
related bonds to cease to be treated as tax-exempt bonds.
(4) Examples. The following examples illustrate the application of
this section:
Example 1. City B issues bonds to finance the purchase of land.
On the issue date, B reasonably expects that it will be the sole
user of the land for the entire term of the bonds. Subsequently, the
federal government acquires the land in a condemnation action. B
sets aside the condemnation proceeds to pay debt service on the
bonds but does not redeem them on their first call date. The bonds
are not private activity bonds because B has not taken a deliberate
action after the issue date.
Example 2. The facts are the same as in Example 1, except that B
uses all the condemnation proceeds to make a loan to Corporation T,
a nongovernmental person. The bonds are private activity bonds
because B has taken a deliberate action after the issue date.
Sec. 1.141-3 Definition of private business use.
(a) General rule--(1) In general. The private business use test
relates to the use of the proceeds of an issue. The 10 percent private
business use test of section 141(b)(1) is met if more than 10 percent
of the proceeds of an issue is used in a trade or business carried on
by a nongovernmental person. For this purpose, the use of financed
property is treated as the use of proceeds. This section also applies
to the private business use test under sections 141(b)(3) (unrelated or
disproportionate use), 141(b)(4) ($15 million limitation for output
facilities), and 141(b)(5) (the coordination with the volume cap where
the nonqualified amount exceeds $15 million).
(2) Indirect use. In determining whether an issue meets the private
business use test, indirect as well as direct use of the proceeds is
taken into account. For example, the issuer's use of the proceeds to
engage in a series of financing transactions for property to be used by
nongovernmental persons in their trades or businesses may cause the
private business use test to be met. In addition, proceeds are treated
as used in the trade or business of a nongovernmental person in
situations involving other arrangements, whether in a single
transaction or in a series of related transactions, whereby a
nongovernmental person uses property acquired with the proceeds of an
issue in its trade or business.
(3) Ultimate and intermediate use. In determining whether an issue
meets the private business use test, both the ultimate and intermediate
uses of proceeds are taken into account. For example, a facility is
treated as being used for a private business use if it is leased to a
governmental person and then subleased to a nongovernmental person or
if it is leased to a governmental person and subleased to a
governmental person, provided in each case that the nongovernmental
person's use is in a trade or business.
(4) Aggregation of private business use. The use of proceeds by all
nongovernmental persons is aggregated to determine whether the private
business use test is satisfied.
(b) General definition of private business use--(1) In general.
Proceeds are used for a private business use if they are used in a
trade or business carried on by a nongovernmental person. For this
purpose, any activity carried on by a person other than a natural
person is treated as a trade or business. See Sec. 1.141-1(e) relating
to certain partnerships.
(2) Use of proceeds. As further described in this paragraph (b) and
except as otherwise provided in this section, a person uses proceeds,
for purposes of the private business use test, if it (i) owns or leases
financed property, (ii) is loaned those proceeds, or (iii) has actual
or beneficial use of financed property under a management or incentive
payment contract, output contract, or other arrangement.
(3) Agents and employees. Use of proceeds by nongovernmental
persons in their capacity as agents or employees of a governmental
person is not use for purposes of the private business use test.
(4) Ownership. Except as provided in paragraph (b)(3) of this
section, ownership of financed property is treated as use of their
property for purposes of the private business use test.
(5) Leases. Except as provided in paragraphs (b)(3) or (f) of this
section, the lease of a financed facility is treated as a use of that
facility for purposes of the private business use test. For this
purpose, any arrangement, such as a management contract, that is
properly characterized is a lease for federal income tax purposes is
treated as a lease.
(6) Management contracts. A management contract (as defined in
paragraph (c)(6) of this section) results in use of the financed
property if--
(i) The contract is not a qualified management contract (as defined
in paragraph (c) of this section); or
(ii) The service provider is treated as the lessee of the financed
property for federal income tax purposes.
(7) Output facilities. See Sec. 1.141-7 for special rules under
which contracts for purchase of output of output facilities result in
use of the financed facility.
(8) Discharge of primary legal obligation--(i) General rule. In
general, a nongovernmental person is treated as a user of a financed
facility if the financing of that facility discharges a primary and
unconditional legal obligation of that nongovernmental person, even if
the nongovernmental person has no possession or control of the
facility. Further, the use resulting from the discharge of a primary
legal obligation is not use as a member of the general public within
the meaning of paragraph (e) of this section. A primary legal
obligation does not include a law of general application (for example,
an ordinance requiring that all businesses properly dispose of
hazardous waste). An obligation imposed on the owner of a facility is
not the primary obligation of any other user of that facility.
(ii) Example. The following example illustrates the application of
this paragraph (b)(8) (see also Example 12 of paragraph (e) of this
section):
Example. As a condition to obtaining a permit to construct an
industrial development, Developer N unconditionally agrees that it
will construct governmentally owned streets and sidewalks in its
development. N and several other developers undertake to create
District, a political subdivision. District issues its tax
assessment bonds, the proceeds of which are used, in part, to
construct the street and sidewalk improvements that N is obligated
to construct. N's obligation to construct the improvements is
unconditional and, therefore, the discharge of that obligation
results in private business use of the proceeds used to construct
those improvements.
(9) Research agreements. As provided in paragraph (d) of this
section, an agreement by a nongovernmental person to sponsor research
performed by a governmental person may result in use of the related
property for purposes of the private business use test.
(10) Other actual or beneficial use. For purposes of the private
business use test, use includes any other actual or beneficial use of a
financed facility other than use as a member of the general public (as
defined in paragraph (e) of this section).
(c) Qualified management contracts--(1) In general. A management
contract is a qualified management contract if it meets the
requirements of paragraphs (c)(2), (c)(3), and (c)(4) of this section.
See also paragraphs (c)(5) and (e) of this section for de minimis
exceptions.
(2) General compensation requirements. The contract must provide
for reasonable compensation for services rendered with no compensation
based, in whole or in part, on a share of net profits from the
operation of the facility. Reimbursement of the service provider for
actual and direct expenses paid by the service provider to unrelated
parties is not by itself treated as compensation.
(i) Compensation based on
(A) a percentage of gross revenues (or adjusted gross revenues) of
a facility or a percentage of expenses from a facility, but not both,
(B) a capitation fee, or
(C) a per-unit fee is generally not considered to be based on a
share of net profits.
(ii) Similarly, a productivity reward equal to a stated dollar
amount based on increases or decreases in gross revenues, reductions in
total expenses, but not both, generally does not cause the compensation
to be based on a share of net profits.
(3) Permissible arrangements. The management contract must be
described in paragraph (c)(3)(i), (ii), (iii), (iv), or (v) of this
section.
(i) 100 percent periodic fixed fee arrangements. All of the
compensation for services during the term of the contract is based on a
period fixed fee and the term of the contract, including all renewal
options, does not exceed the lesser of 50 percent of the expected
useful life of the related property and 15 years. For purposes of this
paragraph (c)(3)(i) and paragraph (c)(3)(ii) of this section, a fee
does not fail to qualify as a periodic fixed fee as a result of a
single incentive award provision under which compensation automatically
increases when a gross revenue or expense target (but not both) is
reached if that award is equal to a single, stated dollar amount.
(ii) 80 percent periodic fixed fee arrangements. At least 80
percent of the compensation for services for each annual period during
the term of the contract is based on a periodic fixed fee. The term of
the contract must not exceed the lesser of 80 percent of the expected
useful life of the related property and 10 years.
(iii) 50 percent periodic fixed fee arrangements. Either at least
50 percent of the compensation for services for each annual period
during the terms of the contract is based on a periodic fixed fee or
all of the compensation for services is based on a capitation fee or a
combination of a capitation fee and a periodic fixed fee. The term of
the contract must not exceed 5 years, including all renewal options.
The contract must be terminable by the governmental persons upon
reasonable notice at the end of the third year of the contract term,
without penalty or cause.
(iv) Per-unit fee arrangements in certain 3-year contracts. All of
the compensation for services is based on a per-unit fee or a
combination of a per-unit fee and a periodic fixed fee. The contract
has a term, including renewal options, that is not longer than 3 years.
The contract must be terminable, by the governmental person on
reasonable notice, without penalty or cause, at the end of the second
year of the contract term. The amount of the per-unit fee must be
specified in the contract or otherwise specifically limited by the
government person or an independent third party, such as the
administrator of the Medicare program.
(v) Percentage of revenue or expense fee arrangements in certain 2-
year contracts. All the compensation for services is based on a
percentage of fees charged or a combination of a per-unit fee and a
percentage of revenue or expense fee. During the start-up period,
however, compensation may be based on a percentage of either gross
revenues, adjusted gross revenues, or expenses of a facility. The
contract must have a term, including renewal options, that is not
longer than 2 years. The contract must be terminable by the
governmental person on reasonable notice, without penalty or cause, at
the end of the first year of the contract term. This paragraph
(c)(3)(v) applies only to contracts under which the service provider
primarily provides services to third parties (for example, radiology
services), or service contracts involving a facility during an initial
start-up period for which there have been insufficient operations to
establish a reasonable estimate of the amount of the annual gross
revenues and expenses (for example, a contract for general management
services for the first year of operations).
(4) No related parties or common control. The service provider must
not have any role or relationship with the governmental person that, in
effect, substantially limits the governmental person's ability to
exercise its rights, including cancellation rights, under the contract.
This requirement is satisfied if--
(i) Not more than 20 percent of the voting power of the governing
body of the governmental person in the aggregate is vested in the
service provider and its directors, officers, shareholders, and
employees;
(ii) Except in the case of a contract for physician services to
patients or similar contracts, not more than 20 percent of the voting
power of the governing body of the service provider in the aggregate is
vested in the governmental person and its directors, officers,
shareholders, and employees;
(iii) Overlapping board members do not include the chief executive
officers of the service provider or its governing body or the
governmental person or its governing body; and
(iv) The governmental person and the service provider under the
contract are not related parties.
(5) De minimis exception for functionally related use. The use of a
financed facility pursuant to a qualified management contract does not
result in use of the financed facility for purposes of the private
business use test if that use is functionally related and subordinate
to that management contract and that use is not, in substance, a
separate contractual agreement (for example, a separate lease of a
portion of the financed facility). Thus, for example, exclusive use of
storage areas by the manager for equipment that is necessary for it to
perform its required activities does not give rise to private business
use.
(6) Definitions. For purposes of this paragraph (c), the following
definitions apply:
(i) Adjusted gross revenues means gross revenues of all or a
portion of a facility, less allowances for bad debts and contractual
and similar allowances.
(ii) Capitation fee means a fixed periodic amount for each person
for whom the service provider or the governmental person assumes the
responsibility to provide all needed services for a specified period so
long as the quantity and type of services actually provided to covered
persons varies substantially. For example, a capitation fee includes a
fixed dollar amount payable per month to a medical service provider for
each member of a health maintenance organization plan for whom the
provider agrees to provide all needed medical services for a specified
period. A capitation fee may include a variable component of up to 20
percent of total compensation designed to protect the service provider
against risks such as catastrophic loss.
(iii) Periodic fixed fee means a stated dollar amount for services
rendered for a specified period of time. For example, a stated dollar
amount per month is a periodic fixed fee. The stated dollar amount may
automatically increase according to a specified, objective, external
standard that is not linked to the output or efficiency of a facility.
For example, the Consumer Price Index and similar external indices that
track increases in prices in an area or increases in revenues or costs
in an industry are objective external standards. Capitation fees and
per-unit fees are not periodic fixed fees.
(iv) Per-unit fee means a fee based on a unit of service provided.
For example, a stated dollar amount for each specified medical
procedure performed, car parked, or passenger mile is a per-unit fee.
(v) Renewal option means a provision under which the service
provider has a legally enforceable right to renew the contract. Thus,
for example, a provision under which a contract is automatically
renewed for one-year periods absent cancellation by either party is not
a renewal option (even if it is expected to be renewed).
(vi) Management contract means a management, service, or incentive
payment contract between a governmental person and a service provider
under which the service provider provides services involving all, a
portion of, or any function of, a facility. For example, a management
or incentive payment service contract includes a contract for the
provision of management services for an entire hospital, management
services for a specific department of a hospital, or an incentive
payment contract for physician services to patients of a hospital.
Management contracts do not include a customary contract for janitorial
or similar services. The mere granting of admitting privileges by a
hospital to a doctor does not result in a management contract even if
those privileges are conditioned on the provision of de minimis
services, if those privileges are available to all qualified physicians
in the area, consistent with the size and nature of its facilities. A
contract to provide for the operation of a mixed use facility described
in Sec. 1.141-6(b)(2)(i)(B) (relating to certain undivided ownership
interests) is not a management contract if the only compensation is the
reimbursement of actual and direct expenses paid by the service
provider.
(vii) Service provider means any person other than a governmental
person that provides services under a contract to or for the benefit of
a governmental person.
(viii) Penalties for terminating a contract include a limitation on
the governmental person's right to compete with the service provider; a
requirement that the governmental person purchase equipment, goods, or
services from the service provider; and a requirement that the
governmental person pay liquidated damages for cancellation of the
contract. In contrast, a requirement effective on cancellation that the
governmental person reimburse the service provider for ordinary and
necessary expenses or a restriction on the governmental person against
hiring key personnel of the service provider is generally not a
contract termination penalty. The existence of another contract between
the service provider and the governmental person, such as a loan or
guarantee by the service provider, constitutes a contract termination
penalty if that contract contains terms that are not customary or
arm's-length that could operate to prevent the governmental person from
terminating the contract (for example, provisions under which the
contract terminates if the service contract is terminated or that place
substantial restrictions on the selection of a substitute service
contract provider).
(d) Research agreements)--(1) General rule. A research agreement
described in either paragraph (d)(2) or (d)(3) of this section does not
result in private business use.
(2) Corporate-sponsored research. A research agreement relating to
a facility used for basic research supported or sponsored by a
nongovernmental person is described in this paragraph (d)(2) if any
license or other use of resulting technology by the sponsor is
permitted only on the same terms as the recipient would permit that use
by any unrelated, nonsponsoring party (that is, the sponsor must pay a
competitive price for its use), with the price paid for that use
determined at the time the license or other resulting technology is
available for use. Although the recipient need not permit persons other
than the sponsor to use any license or other resulting technology, the
price paid by the sponsor must be no less than the price that would be
paid by any non-sponsoring party.
(3) Cooperative research agreements. A research agreement relating
to a facility used pursuant to a joint industry-university cooperative
research arrangement is described in this paragraph (d)(3) if--
(i) Multiple, unrelated sponsors agree to fund university-performed
basic research;
(ii) The research to be performed and the manner in which it is to
be performed (for example, selection of the personnel to perform the
research) is determined by the university;
(iii) Title to any patent or other product incidentally resulting
from the basic research lies exclusively with the university; and
(iv) Sponsors are entitled to no more than a nonexclusive, royalty-
free license to use the product of any of that research.
(4) Basic research. For purposes of this paragraph (d), basic
research has the same meaning as under section 41(e)(7)(A) (that is,
any original investigation for the advancement of scientific knowledge
not having a specific commercial objective, except that this term does
not include basic research conducted outside the United States or basic
research in the social sciences, arts, or humanities). Basic research
does not include applied or practical research, product development, or
similar activities.
(e) Exception for general public use--(1) General public use--(i)
In general. Private business use does not include use as a member of
the general public (general public use). Use of a financed facility by
nongovernmental persons in their trades or businesses is treated as
general public use only if--
(A) The facility is intended for use by the general public; and
(B) The use by those nongovernmental persons is reasonably expected
to be on the same basis as use by other members of the general public.
(ii) Relation to other use. Use of a financed facility by the
general public does not prevent the proceeds from being used for a
private business use because of other use under this section.
(2) Intended for use by the general public. (i) Number of users. A
facility is not intended for use by the general public if less than 25
percent of the reasonably expected direct use of the facility is by
persons that individually account for no more than 1 percent of the use
of the facility.
(ii) Persons constituting the general public. Although the general
public ordinarily includes natural persons not engaged in trades or
businesses, the general public may consist entirely of a large number
of nongovernmental persons engaged in different types of trades or
businesses. The general public cannot consist predominately of a large
number of nongovernmental persons engaged in the same type of trade or
business. For example, an electric transmission line used by a large
number of electric utilities is not used by the general public. See,
however, Example 6 of paragraph (h) of this section.
(3) Use on the same basis--(i) Use related to other facilities--(A)
General rule. The use of a financed facility by a nongovernmental
person is not on the same basis as use by the general public if the
financed facility is functionally and integrally related to another
facility that is used by that nongovernmental person (the primary
facility) and significant economic benefits with respect to the primary
facility arise from the use of the related facility that are not
available to the general public. If more than 75 percent of the use of
the related facility is by the general public and not use in connection
with the primary facility, the benefits to the primary facility are
treated as insignificant for this purpose.
(B) Functionally and integrally related. Generally, a facility is
not functionally and integrally related to a primary facility for this
purpose if it is not a necessary component of the primary facility.
Examples of facilities that are typically functionally and integrally
related to other facilities in a manner that results in significant
economic benefits are parking lots at airports, stadiums, and shopping
centers, and utility and other infrastructure improvements for a new
development, stadium, or airport. On the other hand, a parking lot in a
large urban business district where there are many separate businesses
typically does not produce significant benefits to any particular
person.
(ii) Priority rights or other preferential benefits. Use under an
arrangement that conveys priority rights or other preferential benefits
is not use on the same basis as the general public. Arrangements for a
term of more than one month generally convey preferential benefits.
Arrangements providing for use that is available to the general public
at no charge or on the basis of rates that are generally applicable and
uniformly applied do not convey priority rights or other preferential
benefits. For this purpose, rates may be treated as generally
applicable and uniformly applied even if--
(A) Different rates apply to different classes of users, such as
volume purchasers, if the differences in rates are customary and
reasonable;
(B) Users are permitted to reserve short-term or incidental use in
advance;
(C) Existing users, each using less than 1 percent of a financed
facility, possess rights of first refusal to renew their use at
generally applicable, fair market value rates that are in effect at the
time of renewal; and
(D) A specially negotiated arrangement is entered into, but only if
the user is prohibited by federal law from paying the generally
applicable rates, and the terms of the arrangement are as comparable as
reasonably possible to the generally applicable rates.
(4) Special rules for system improvements. For improvements to
existing public utility or infrastructure systems such as roads or
sewers, but not discrete structures such as parking facilities (system
improvements), whether the use of a system improvement is general
public use may be determined by reference to the system as a whole if
the system improvement is insubstantial, based either on aggregate cost
or scope relative to the system as a whole within the jurisdiction of
the issuer. Except in the case of improvements to roads, a system
improvement is insubstantial for this purpose if the cost of the system
improvement is less than 5 percent of the cost of the system as a
whole. In addition, in determining whether the use of a system
improvement by the general public is insubstantial, paragraph (e)(3)(i)
of this section (relating to use related to other facilities) does not
apply.
(5) Examples. The following examples illustrate the application of
this paragraph (e):
Example 1. Governmentally owned and operated hotel. State C
issues its bonds to purchase land and construct a hotel for use by
the general public (that is, tourists, visitors, business travelers,
etc.). The bond documents provide that C will own and operate the
project for the period required to redeem the bonds. Use of the
hotel by hotel guests who are travelling in connection with trades
or businesses of nongovernmental persons is not a private business
use of the hotel by these persons because it is general public use.
Example 2. Toll road. State D issues its bonds to finance the
construction of a toll road and the cost of erecting related
facilities such as gasoline service stations and restaurants. These
related facilities represent less than 10 percent of the total cost
of the project and are to be leased or sold to nongovernmental
persons. The road is to be owned and operated by D. The bonds do not
satisfy the private business use test since less than 10 percent of
the proceeds is to be used, directly or indirectly, in the trades or
businesses of nongovernmental persons. The fact that vehicles owned
by nongovernmental persons engaged in their trades or businesses may
use the road in common with, or as a part of, the general public, is
not material.
Example 3. Contract with United States. G, a sewage collection
and treatment district, operates facilities that were financed with
its bonds. F, an agency of the United States, has a base located
within G. Approximately 20 percent of G's facilities are used to
treat sewage produced by F under a contract under which G uses its
best efforts to charge F as closely as possible the same amount for
its use of G's services as its other customers pay for the same
amount of services, although those other customers pay for services
based on standard district charges and tax levies. The use of G's
facilities by F is general public use.
Example 4. Parking garage. Authority P uses all the proceeds of
its bond issue to construct a parking garage containing more than
100 spaces located in the central business district of a large urban
area. At least 90 percent of the spaces in the garage will be
available to the general public on an hourly, daily, or monthly
first-come, first-served basis and the Authority reasonably expects
that at least 25 of the spaces will be leased by unrelated
individuals. Individual lessees of monthly parking spaces may renew
their spaces at then current fair market value rates. The bonds do
not satisfy the private business use test because at least 90
percent of the use of the parking garage is general public use.
Example 5. Road improvements for stadium. H, a political
subdivision, issues its bonds to finance construction of a new exit
and entrance ramp from an existing highway onto an adjacent street
that will front a newly constructed stadium. The existing highway
and street are part of systems that are used on the same basis by
members of the general public. The stadium is owned by
nongovernmental persons. Although the improvements to the highway
and the local street are available to the general public and not
limited to persons going to the stadium, more than 75 percent of the
use of the ramp will be used in connection with the stadium (that
is, employees, spectators, and other users of the stadium). Thus,
these improvements are functionally and integrally related to the
stadium. Under these facts, however, the ramp qualifies as an
insubstantial system improvement and, therefore, the proceeds of H's
bonds are not used for a private business use.
Example 6. Airport runway. Airport Authority I, a political
subdivision, issues its bonds and uses all of the proceeds to
finance construction of a runway at a new city-owned airport. The
runway will be available for take-off and landing by any operator of
an aircraft desiring to use the airport. It is reasonably expected
that more than 25 percent of the use of the runway (that is, direct
use of the runway) will be by private air carriers (both charter
airlines and commercial airlines) in connection with their use of
the airport terminals leased by those carriers. Use of the runways
by the private carriers is not on the same basis as the general
public because their lease of property that is functionally and
integrally related to the runways (the terminals) results in
significant economic benefits from runway use that are not available
to other users. The use by these private air carriers is not general
public use, and the proceeds of I's bonds are used for a private
business use.
Example 7. Airport parking lot. The facts are the same as in
Example 6, except that several months after the issuance of the
bonds to finance the construction of the runway, I issues bonds all
of the proceeds of which are used to construct a parking lot at the
airport. The parking lot will be used entirely by employees of the
airport, employees of the airlines and other businesses that are
private business users of the airport terminal, and persons
traveling by airplane that depart from the airport. The use of the
parking lot by the airlines and other private business users of the
airport terminal is not treated as general public use for the same
reasons as in Example 6.
Example 8. Federal use of prisons. Authority P uses all of the
proceeds of its bonds to construct a prison. P contracts with a
federal agency F to house federal prisoners on a space-available,
first-come, first-served basis, pursuant to which the federal agency
will be charged approximately the same amount for each prisoner as
other governmental persons that enter into similar transfer
agreements. It is reasonably expected that other governmental units
will enter into similar agreements. P may terminate the contract on
90 days notice. it is reasonably expected that during the term of
the contract, federal prisoners will constitute more than 10 percent
of the prisoners at the prison. The bonds satisfy the private
business use test because F and any governmental persons using the
prison under similar agreements are not members of the general
public.
Example 9. Business insurance fund. Authority deposits all of
the proceeds of its bonds in its hazardous business insurance fund
and invests all of those proceeds in tax-exempt bonds. The hazardous
business insurance fund provides liability insurance to more than
100 operators of different types of hazardous businesses within the
meaning of State law. Each of the insured persons is required under
State law to obtain this type of insurance as a condition to their
trade or business operations. Each participant receives insurance
for a term of one year, and it is expected that the fund will be
available for renewals. The participants are not treated as members
of the general public because the term of the insurance conveys
preferential benefits.
Example 10. Port road. Highway Authority W uses all $200 million
of the proceeds of its bonds to construct a 25-mile road to connect
an industrial port owned by Corporation C with existing roads owned
and operated by W that are all located within City T. Other than the
port, the nearest residential or commercial development to the new
road is 12 miles away. Although there may be additional development
in the area surrounding the new road, there is no reasonable
expectation that the development will occur within the 3-year period
following the issuance of the bonds. W does not reasonably expect
that more than 25 percent of the use of the new road will be by
persons other than employees and other persons doing business with
C. The bonds satisfy the private business use test because the road,
although available for use by the general public, will have
insubstantial general public use and will not qualify as an
insubstantial system improvement because the cost of the project is
not insubstantial.
Example 11. Connecting road. The facts are the same as in
Example 10, except that the road extends beyond the port to a new
residential development. Persons residing in this development will
account for more than 25 percent of the use of both segments of the
road. The bonds do not satisfy the private business use test because
the use of the road is general public use.
Example 12. Fish ladder. J, a political subdivision, owns and
operates a hydro-electric generation plant and related facilities.
Pursuant to a take or pay contract having a term equal to the useful
life of the facility, J sells 15 percent of the output of the plant
to Corporation K, an investor-owned utility. Under the license
issued to J for operation of the plant, J is required by federal
regulations to construct various facilities for the preservation of
fish and for public recreation. J issues its obligations to finance
the fish preservation and public recreation facilities. The financed
facilities provide no direct benefits to J or the purchasers of the
electricity produced by the plant. Because K has no primary legal or
contractual obligation to provide the financed facilities, the
facilities are not used for a private business use by K under
paragraph (b)(8) of this section. Under this paragraph (e), however,
the fish preservation facilities, but not the public recreation
facilities, are treated as used by K because they are functionally
and integrally related to the generation plant.
(f) De minimis exceptions--(1) Short-term leases and similar
arrangements. Use by a nongovernmental person pursuant to a lease,
management contract, or similar arrangement does not result in private
business use if--
(i) The agreement may not be renewed or extended beyond the period
described in this paragraph (f)(1);
(ii) Following the expiration of that agreement the facility
subject to the agreement is not used for a private business use
(determined without regard to this paragraph (f)(1));
(iii) The term (or in the case of an agreement entered into prior
to, and not in connection with, the issuance of the bonds, the
remaining term) of the agreement does not exceed the least of (A) 1
year, (B) 10 percent of the remaining economic life of the financed
facility (determined at the time the arrangement is entered into), and
(C) 10 percent of the remaining term of the bonds; and
(iv) Except in the case of a lease, management contract, or similar
agreement entered into prior to the issue date (or contemplated
issuance) of bonds financing the acquisition of the property, the
agreement must be an arm's-length, fair market value agreement.
(2) Temporary use by developers. Use by a developer of an
improvement that carries out an essential governmental function during
an initial development period does not result in private business use
if--
(i) The issuer and the developer reasonably expect on the issue
date to proceed with all reasonable speed to develop and sell the
related property to members of the general public and covenant in the
bond documents to do so with due diligence;
(ii) The issuer and the developer reasonably expect on the issue
date that the related property will be sold to members of the general
public within 3 years of the issue date; and
(iii) Bonds of the issue are not required to be retired in
connection with the developer's sale of property to members of the
general public.
(3) Incidental use--(i) General rule. Incidental use of a financed
facility is disregarded to the extent that that use doe not exceed 2.5
percent of the proceeds of the entire issue. A use of a facility by a
person is incidental if--
(A) The use does not involve the transfer to the person of
possession and control over space that is separated from other areas of
the facility by walls, partitions, or other physical barriers, such as
a night gate affixed to a structural component of a building (a
nonpossessory use);
(B) The nonpossessory use is not functionally related to any other
use of the facility by the same person (other than a different
nonpossessory use); and
(C) All nonpossessory uses of the facility do not, in the
aggregate, involve the use of more than 2.5 percent of the facility.
(ii) Illustrations. Incidental uses may include pay telephones,
vending machines, advertising, use for television cameras, etc., but
not output purchases.
(4) Qualified improvements. Proceeds that provide a governmentally
owned improvement to a governmentally owned building (including its
structural components and land functionally related and subordinate to
the building) are not used for a private business use if:
(i) The building was placed in service more than one year before
the construction or acquisition of the improvement is begun;
(ii) The improvement is not an enlargement of the building or an
improvement of interior space occupied exclusively for any private
business use;
(iii) No portion of the improved building or any payments in
respect of the improved building are taken into account under section
141(b)(2)(A) (the private security test);
(iv) No more than 15 percent of the improved building is used for a
private business use; and
(v) The improvement (and any related improvements) does not
increase the fair market value of the building by more than 5 percent.
This requirement is treated as satisfied if the improvement is to
common areas (such as the roof, heating, ventilation, and air
conditioning system, or elevators), and the improvement is not made as
part of a substantial rehabilitation of the building.
(g) Special rule for tax assessment bonds. In the case of a tax
assessment bond that satisfies the requirements of Sec. 1.142-5(c), the
loan (or deemed loan) of the proceeds to the borrower paying the
assessment is disregarded in determining whether the private business
use test is satisfied. Thus, the private business use of those proceeds
is determined on the basis of the use of the property improved with the
tax assessment loan and any other use of the proceeds used for that
assessment.
(h) Examples. The following examples illustrate the application of
paragraphs (b) through (g) of this section:
Example 1. Long-term lease with nongovernmental person. State A
and Corporation X enter into an arrangement under which A is to
provide a factory that X will lease for 20 years. The arrangement
provides that A will issue $10 million of bonds, the proceeds of the
bond issue will be used to purchase land and to construct and equip
a factory in accordance with X's specifications, X will rent the
facility (land, factory, and equipment) for 20 years at an annual
rental equal to the amount necessary to amortize the principal of
and pay the interest on the outstanding bonds, and the payments by X
and the facility itself will be the security for the bonds. The
bonds are private activity bonds under section 141(b)(1) and (2)
since they are part of an issue (1) all of the proceeds of which are
to be used (by purchasing land and constructing and equipping the
factory) in a trade or business by a nongovernmental person, and (2)
the payment of the principal of and interest on which is secured by
the facility and payments to be made with respect to the facility.
See Sec. 1.141-5 (relating to the private loan financing test) and
Sec. 1.141-4 (relating to the private security or payment test).
Example 2. Sale to nongovernmental person. The facts are the
same as in Example 1 except that X will purchase the facility, and
annual payments equal to the amount necessary to amortize the
principal of and pay the interest on the outstanding bonds will be
made by X. The bonds are private activity bonds under section 141(b)
(1) and (2) for the reasons set forth in Example 1. See Sec. 1.141-5
(relating to the private loan financing test) and Sec. 1.141-4
(relating to the private security or payment test).
Example 3. Private payments not based on debt service. The facts
are the same as in Example 1 except that the annual payments
required to be made by Corporation X are equal to the fair rental
value of the facility and exceed the amount necessary to amortize
the principal of and pay the interest on the outstanding bonds. The
bonds are private activity bonds for the reasons set forth in
Example 1. The requirement that Corporation X pay an amount equal to
fair market value, which is in excess of the amount necessary to pay
the principal of and interest on the bonds, does not affect the
status of the bonds as private activity bonds. Similarly, if the
present value of the annual payments required to be made by X
exceeded 10 percent of the present value of the debt service on the
outstanding bonds, the bonds would be private activity bonds under
section 141(b) (1) and (2) for the reasons set forth in Example 1.
See Sec. 1.141-2(a) and Sec. 1.141-4.
Example 4. Private lease of portion of building. (i) State D and
Corporation Y enter into an agreement under which Y will lease for
20 years one floor of a 10-story office building to be constructed
by D on land that it will acquire. D will occupy the street level
floor and the remaining eight floors of the building. The portion of
the costs of acquiring the land and constructing the building that
are allocated to the space to be leased by Y is not in excess of 10
percent of the total costs of acquiring the land and constructing
the building. These costs, whether attributable to the acquisition
of land or the construction of the building, were allocated to
leased space in the same proportion that the reasonable rental value
of that leased space bears to the reasonable rental value of the
entire building. From the facts and circumstances presented, it is
determined that that allocation was reasonable. D issues $10 million
of bonds, the proceeds of which will be used to purchase land and
construct the office building. The arrangement does not, by itself,
cause the private business use test to be met because not more than
10 percent of the proceeds is to be used, directly or indirectly, in
the trade or business of a nongovernmental person. See Sec. 1.141.6.
(ii) If Corporation Y instead leases 2 floors, and the costs
allocated to these floors are in excess of 10 percent of D's
investment in the land and building, the arrangement causes the
private business use test to be met because more than 10 percent of
the building is to be used in the trade or business of a
nongovernmental person.
Example 5. Numerous private leases. The facts are the same as in
Example 4 except that, instead of leasing any space to Corporation
Y, State D leases the two floors to numerous unrelated private
businesses to be used in their trades or businesses. No lease will
have a term in excess of 2 years. The bonds meet the private
business use test for the reasons set forth in Example 4.
Example 6. Municipal auditorium. City G issues its obligations
to finance the construction of a municipal auditorium that it will
own and operate. The use of the auditorium will be open to anyone
who wishes to use it for a short period of time on a rate-scale
basis. The rights of such a user are only those of a transient
occupant, rather than the full legal possessory interest of a
lessee. It is anticipated that the auditorium will be used by
schools, church groups, fraternities, and numerous commercial
organizations. The revenues from the rentals of the auditorium and
the auditorium itself will be the security for the bonds. The bonds
are not private activity bonds because none of the uses constitute
use in the trade or business of a nongovernmental person.
Example 7. Long-term lease of municipal auditorium. The facts
are the same as in Example 6 except that one nongovernmental person
engaged in a trade or business will have a 10-year rental agreement
providing for exclusive use of the entire auditorium for 6 weeks of
each year at a rental comparable to that charged short-term users.
The bonds satisfy the private business use test since use of the
auditorium for 6 weeks each year is more than 10 percent of the use
of the auditorium and the agreement is not disregarded as a de
minimis use under paragraph (f) of this section. Thus, more than 10
percent of the proceeds of the issue will be used in a trade or
business of a nongovernmental person. See also paragraph (i) of this
section.
Example 8. Management contract in substance a lease. City L
issues bonds to finance the construction of a city hospital. L
enters into a 5-year contract with M, a nongovernmental person that
operates a health maintenance organization relating to the treatment
of M's members at L's hospital. The contract meets the conditions
for qualified management contracts under paragraph (c) of this
section. However, the contract also provides that L will guarantee M
that 20 percent of the capacity of the hospital will be exclusively
available to members of M's health maintenance organizations at
special rates so that the contract is properly characterized as a
lease for federal income tax purposes. Therefore, the issue meets
the private business use test.
(i) Measurement of private business use--(1) General rule. The
private business use of proceeds allocated to a facility under
Sec. 1.141-6 is determined according to the use of that financed
facility during each one-year period beginning from the later of the
issue date or the date the facility is placed in service. The private
business use of a facility is equal to the greatest percentage of
private business use for any one year period. The private business use
of a facility for any one year period is equal to the average private
business use during that year.
(2) Determining average of use. The average of the private business
use of a facility is determined by comparing the amount of private
business use of that facility during a year to the total amount of
private business use and government use during that year. In
determining the total amount of use, periods during which the facility
is not in use are disregarded. In determining the average amount of
private business use, the following rules apply:
(i) Uses at different times. For a facility in which the government
use and private business use occur at different times (for example, on
different days), the average amount of private business use is based on
the amount of time that the facility is used for private business use
as a percentage of total time for all use. If, however, the use of a
facility during different times has significantly different value, this
determination must take into account those different values.
(ii) Simultaneous use. For a facility in which government use and
private business use occur simultaneously, the entire facility is
treated as having private business use. If, however, the private
business use and government use is on the same basis, the average
amount of private business use may be determined on a reasonable basis
(for example, relative value of use, relative amount of time used). For
example, a governmentally owned facility that is leased or managed by a
nongovernmental person in a manner that results in private business use
is treated as entirely used for a private business use. On the other
hand, a garage with unassigned spaces that is used for government use
and private business use is only partially used for a private business
use.
(iii) Combined use. If a facility has private business use that is
described in both paragraphs (i)(2)(i) and (1)(2)(ii) of this section,
the amount of private business use is determined according to whichever
method produces the greatest amount of private business use. See,
however, Sec. 1.141-6 for special rules for common areas of a discrete
portion of a mixed use facility.
(3) Use of a portion of a facility--(i) Discrete portion. For
purposes of this paragraph (i), measurement of the use of proceeds
allocated to a discrete portion of a mixed use facility is determined
by treating the discrete portion as a separate facility.
(ii) Common areas. The amount of private business use of common
areas within a mixed use facility is based on the average amount of
private business use of the remainder of the entire facility.
(4) Allocation of neutral costs. Proceeds that are used to pay
costs of issuance, invested in a reserve or replacement fund, or paid
as fees for a qualified guarantee or a qualified hedge must be
allocated ratably among the other purposes for which the proceeds are
used.
(5) Commencement of private business use. Generally, private
business use commences on the first date on which there is actual use
by the nongovernmental person. If, however, the issuer and a
nongovernmental person enter into an arrangement to transfer a financed
facility, private business use commences on the date of that
arrangement if that arrangement was entered into substantially in
advance of the transfer and the transfer will occur during the final
year of the term of the issue or after the retirement of the issue.
(6) Examples. The following examples illustrate the application of
this paragraph (i):
Example 1. Research facility. University U is a state owned and
operated university. As part of its activities, U owns and operates
a bond-financed research facility. U enters into sponsored research
agreements with nongovernmental persons that result in private
business use. The research otherwise conducted by U (government use)
and the private research will take place simultaneously in all
laboratories within the research facility. All laboratory equipment
will be available continuously for use by workers who will perform
both types of research. A researcher will often use a single
laboratory to perform identical research that may meet the
objectives of U's research and the obligations under the research
contracts. Under this section, the nongovernmental persons are using
the facility for a private business use. The private business use
results from a use of the facility, the research, that is on the
same basis as government use of the facility. Therefore, the portion
of the facility that is used for a private business use may be
determined on a reasonable basis. If more than 10 percent of the use
of the facility is private business use, no portion of the facility
can be financed with tax-exempt bonds.
Example 2. Stadium. City L issues its obligations and uses all
of the proceeds to construct a stadium. L enters into a long-term
contract with a professional sports team T under which T will use
the stadium 20 times during each year. These uses will occur on
weeknights and weekends. L reasonably expects that the stadium will
be used more than 180 other times each year, none of which will give
rise to private business use. This expectation is based on a
feasibility study and historical use of the old stadium that is
being replaced by the new stadium. There is no significant
difference in the value of T's uses when compared to the other uses
of the stadium. Assuming no other private business use, the
obligations do not satisfy the private business use test of section
141(b)(1) on the issue date since not more than 10 percent of the
use of the facility is for a private business use.
Example 3. Stadium with significant private business use. The
facts are the same as in Example 2, except that L reasonably expects
that more than 10 percent of the use of the stadium will be for a
private business use. The obligations satisfy the private business
use test. Further, since the stadium is not a mixed use facility
under Sec. 1.141-6, any obligations issued to finance any portion of
the stadium are treated as having private business use in excess of
10 percent. Therefore, no portion of the stadium can be financed
with tax-exempt bonds.
Sec. 1.141-4 Private security or payment test.
(a) General rule. (1) Private security or payment. The private
security or payment test relates to the nature of the security for, and
the source of, the payment of debt service on an issue. The private
payment portion of the test takes into account the payment of the debt
service on the issue that is directly or indirectly to be derived from
payments (whether to the issuer or any related party) in respect of
property, or borrowed money, used or to be used for a private business
use. The private security portion of the test takes into account the
payment of the debt service of the issue that is directly or indirectly
secured by any interest in (i) property used or to be used for a
private business use, or (ii) payments in respect of property used or
to be used for a private business use.
(2) Aggregation of private payments and security. For purposes of
the private security or payment test, payments taken into account as
private payments and payments or property taken into account as private
security are aggregated. However, the same payments are not taken into
account as both private security and private payments. For example, the
10 percent private security or payment test is met if, in the
aggregate, the payments taken into account as private payments and the
property or payments taken into account as private security exceed 10
percent of the debt service on the bonds, provided no payment is taken
into account under both portions of the test.
(b) Measurement of private payments and security--(1) Scope. This
paragraph (b) contains rules that apply to both private security and
private payment.
(2) General rule. The security for, and payment of debt service on
an issue is determined from the terms of the bond documents and on the
basis of any underlying arrangement. An underlying arrangement may
result from separate agreements between the parties or may be
determined on the basis of all the facts and circumstances surrounding
the issuance of the bonds. If the payment of debt service on an issue
is secured by both a pledge of the full faith and credit of a State or
local governmental unit and any interest in property used or to be used
in a private business use, the issue satisfies the private security or
payment test. For special rules for output facilities, see Sec. 1.141-
7.
(3) Present value measurement--(i) Use of present value. In
determining whether an issue meets the private security or payment
test, the present value of the payments or property taken into account
is compared to the present value of the debt service to be paid over
the term of the issue.
(ii) Debt service--(A) Debt service paid from proceeds. Debt
service does not include any amount paid or to be paid from sale
proceeds or investment proceeds. For example, debt service does not
include payments of capitalized interest funded with bond proceeds.
(B) Adjustments to debt service. Debt service is adjusted to take
into account payments and receipts that adjust the yield on an issue
for purposes of section 148(f). For example, debt service includes fees
paid for qualified guarantees under Sec. 1.148-4(f) and is adjusted to
take into account payments and receipts on qualified hedges under
Sec. 1.148-4(h).
(iii) Computation of present value--(A) In general. Present values
are determined by using the yield on the issue as the discount rate and
by discounting all amounts to the issue date. For a fixed yield issue,
yield is determined on the issue date and is not adjusted to take into
account subsequent events.
(B) Variable yield issues. The yield on a variable yield issue is
determined over the term of the issue. To determine the reasonably
expected yield as of any date, the issuer may assume that the future
interest rate on a variable yield bond will be the then-current
interest rate on the bonds determined under the formula prescribed in
the bond documents. Unless a change in interest rate results in a new
issuance, changes in interest rates do not constitute deliberate
actions.
(iv) Application to private security. For purposes of determining
the present value of debt service that is secured by property, property
is valued at fair market value as of the first date on which the
property secures bonds of the issue.
(c) Private payments--(1) In general. This paragraph (c) contains
rules that apply to private payments.
(2) Payments taken into account--(i) Payments for use--(A) In
general. Both direct and indirect payments made by any nongovernmental
person that is treated as using proceeds of the issue are taken into
account as private payments to the extent allocable to the proceeds
used by that person. Payments for a use of proceeds include payments
(whether or not to the issuer) in respect of property financed
(directly or indirectly) with those proceeds, even if not made by a
private business user. Payments are not made in respect of property
financed with proceeds if those payments are directly allocable to
other property being directly used by the person making the payment,
but only to the extent that those payments are reasonable compensation
for that other use. See Example 4 and Example 5 in paragraph (g) of
this section.
(B) Payments not to exceed use. Payments by a person for a use of
proceeds are allocable to the payment of the debt service on the
proceeds used by that person (or with respect to property used by that
person) to the extent that the present value of those payments does not
exceed the present value of the debt service on those proceeds. Thus,
if 7 percent of the proceeds of an issue is used by a person, payments
by that person are taken into account as private payments only to the
extent that the present value of those payments does not exceed the
present value of 7 percent of the debt service on the issue.
(C) Payments for operating expenses. Payments by a person for a use
of proceeds do not include the portion of any payment that is properly
allocable to the payment of ordinary and necessary expenses (as defined
under section 162) directly attributable to the operation and
maintenance of the financed property used by that person. For this
purpose, general overhead and administrative expenses are not directly
attributable to those operations and maintenance. For example, if an
issuer receives $5,000 rent during the year for use of space in a
financed facility and pays $500 during the year for ordinary and
necessary expenses properly allocable to the operation and maintenance
of that space, $500 of the $5,000 received would not be considered a
payment for the use of the proceeds allocable to that space (regardless
of the manner in which that $500 is actually used).
(ii) Refinanced debt service. (A) Payments of debt service on an
issue to be made from proceeds of a refunding issue are taken into
account as private payments in the same proportion that--
(1) the present value of the payments taken into account as private
payments for the refunding issue, bears to
(2) the present value of the debt service to be paid on the
refunding issue.
(B) For example, if all the debt service on a note is paid with
proceeds of a refunding issue, the note meets the private security or
payment test if (and to the same extent that) the refunding issue meets
the private security or payment test. This paragraph (c)(2)(ii) does
not apply to deliberate actions that occur more than 3 years after the
retirement of the prior issue that are not reasonably expected on the
issue date of the refunding issue. For purposes of this paragraph
(c)(2)(ii), whether an issue is a refunding issue is determined without
regard to Sec. 1.150-1(d)(2)(i) (relating to certain payments of
interest).
(iii) Use. For purposes of determining the amount of private
payments, all related uses of proceeds of an issue by one person are
treated as one use. For example, proceeds used to make a grant and a
loan to the same person to be used to construct a facility are
aggregated in determining the portion of the loan repayments taken into
account as private payments.
(3) Allocation of payments--(i) Allocations among issues. If a
payment is made for a facility financed with two or more issues, that
payment must be allocated among those issues according to the relative
amounts of proceeds of each of those issues that are allocated to that
property.
(ii) Repayments of equity. A payment from a private business user
of property may be allocated first to repay the issuer for any equity
investment of the issuer in that property (that is, amounts invested by
the issuer that do not, directly or indirectly, involve an expenditure
of amounts borrowed).
(d) Private security--(1) In general. This paragraph (d) contains
rules that relate to private security.
(2) Security taken into account. The property that is the security
for, or the source of, the payment of debt service on a bond need not
be property financed with proceeds. For example, unimproved land or
investment securities used, directly or indirectly, in a private
business use that secures a bond provides private security.
(3) Pledge of unexpended proceeds. Proceeds qualifying for an
initial temporary period under Sec. 1.148-2(e) (2) or (3) or on deposit
in a reasonably required reserve or replacement fund (as defined in
Sec. 1.148-2(f)(2)(i)) are not taken into account under this paragraph
(d) before the date on which those amounts are either expended or
loaned by the issuer to an unrelated party.
(4) Secured by any interest in property or payments. Property used
or to be used for a private business use and payments in respect of
that property are treated as private security if any interest in that
property or payments secures the payment of debt service on the bonds.
For this purpose, the phrase any interest in is to be interpreted
broadly and includes, for example, any right, claim, title, or legal
share in property or payments. However, in order for an interest in
property or payments to be taken into account as private security, that
interest must secure the payment of debt service on the bonds.
(5) Payments in respect of property. The payments taken into
account as private security are payments in respect of property used or
to be used for a private business use. Thus, to be taken into account
as private security, payments need not be made by the private business
user. Therefore, payments made by members of the general public for use
of a facility used for a private business use may be taken into account
as private security (for example, payments by persons using a facility
that is the subject of a management contract that results in private
business use). Except as otherwise provided in this paragraph (d)(5)
and paragraph (d)(6) of this section, the rules in paragraph (c) of
this section apply to determine the amount of payments treated as
payments in respect of property used or to be used for a private
business use.
(6) Allocation of security among issues. If any property or
payments are taken into account as private security for two or more
issues that are equally and ratably secured (parity bonds), the
property or payments securing those issues must be allocated among
those issues on a reasonable basis that takes into account the relative
amounts of debt service on each of the issues. For this purpose, any of
the ratable allocation methods specified in Sec. 1.148-6(e)(6)
(relating to allocations of commingled reserve or sinking funds for
arbitrage purposes) are treated as reasonable. For bonds other than
parity bonds, property or payments that are taken into account as
private security (but not as private payments) are fully allocated to
each issue secured by the property or payments.
(e) Generally applicable taxes--(1) General rule. For purposes of
the private security or payment test, generally applicable taxes are
not taken into account (that is, are not payments from a
nongovernmental person and are not payments in respect of property used
for a private business use).
(2) Definition of generally applicable taxes. A generally
applicable tax is an enforced contribution exacted pursuant to
legislative authority in the exercise of the taxing power that is
imposed and collected for the purpose of raising revenue to be used for
governmental purposes. A generally applicable tax must have a uniform
tax rate that is applied to all persons of the same classification in
the appropriate jurisdiction, and a generally applicable manner of
determination and collection.
(3) Special charges. A payment for a special privilege granted or
service rendered is not a generally applicable tax. Special assessments
paid by property owners benefiting from financed improvements are not
generally applicable taxes. For example, a tax that is limited to the
property or persons benefitted by an improvement is not a generally
applicable tax.
(4) Manner of determination and collection--(i) In general. A tax
does not have a generally applicable manner of determination and
collection if one or more taxpayers make any special agreements
relating to payment of those taxes. A special agreement relating to the
payment of a tax is taken into account whether or not it is reasonably
expected to result in any payments that would not otherwise have been
made. On the other hand, if an issuer uses proceeds to make a grant to
a taxpayer to improve property, agreements that impose reasonable
conditions on the use of the grant do not cause a tax on that property
to fail to be a generally applicable tax. If an agreement by a taxpayer
causes a tax to fail to have a generally applicable manner of
determination and collection, the entire tax paid by that taxpayer is
treated as a special charge, unless the agreement is limited to a
specific portion of the tax.
(ii) Impermissible agreements. The following are examples of
agreements that cause a tax to fail to have a generally applicable
manner of determination and collection: an agreement to be personally
liable, to provide additional credit support such as a third party
guarantee, or to pay unanticipated shortfalls; an agreement regarding
the minimum market value of property subject to property tax; and an
agreement not to challenge or seek deferral of the tax.
(iii) Permissible agreements. The following are examples of
agreements that do not cause a tax to fail to have a generally
applicable manner of determination and collection: an agreement to use
a grant for specified purposes (whether or not that agreement is
secured); a representation regarding the expected value of the property
following the improvement, an agreement to insure the property and, if
damaged, to restore the property; and a right of a grantor to rescind
the grant if property taxes are not paid.
(iv) Payments in lieu of taxes. A tax equivalency payment and any
other payment in lieu of a tax is treated as a generally applicable tax
if--
(A) The payment is measured by and equal to the amounts imposed by
a regular statute for a tax of general application;
(B) The payment is imposed by a specific statute (even if another
agreement, such as a lease, is used as the vehicle for collection); and
(C) The payment is designated for a public purpose rather than for
a privilege, service or regulatory function, or for any other local
benefit tending to increase the value of the property with respect to
which the payments are made.
(f) Certain waste remediation bonds--(1) Scope. This paragraph (f)
applies to bonds issued to finance hazardous waste clean-up activities
on privately owned land (hazardous waste remediation bonds).
(2) Persons that are not private users. Payments from
nongovernmental persons who are not (other than coincidentally) either
users of the site being remediated or persons potentially responsible
for disposing of hazardous waste on that site are not taken into
account as private security. This paragraph (f)(2) applies to payments
that secure the payment of principal of, or interest on, the bonds
(directly or indirectly) under the terms of the bonds. This paragraph
(f)(2) applies only if the payments are made pursuant to either (i) a
generally applicable state or local taxing statute, or (ii) a state or
local statute that regulates or restrains activities on an industry-
wide basis of persons who are engaged in generating or handling
hazardous waste, or in refining, producing, or transporting petroleum,
provided that those payments do not represent, in substance, payment
for the use of proceeds. For this purpose, a state or local statute
that imposes payments that have substantially the same character as
those described in Chapter 38 of the Code are treated as generally
applicable taxes.
(3) Persons that are private users. If payments from
nongovernmental persons who are either users of the site being
remediated or persons potentially responsible for disposing of
hazardous waste on that site do not secure the payment of principal of,
or interest on, the bonds (directly or indirectly) under the terms of
the bond, the payments are not taken into account as private payments.
This paragraph (f)(3) applies only if at the time the bonds are issued
the payments from those nongovernmental persons are not material to the
security for the bonds. For this purpose, payments are not material to
the security for the bonds if--
(i) The payments are not required for the payment of debt service
on the bonds;
(ii) The amount and timing of the payments are not structured or
designed to reflect the payment of debt service on the bonds;
(iii) The receipt or the amount of the payment is uncertain (for
example, as of the issue date, no final judgment has been entered into
against the nongovernmental person);
(iv) The payments from those nongovernmental persons, when and if
received, are used either to redeem bonds of the issuer or to pay for
costs of any hazardous waste remediation project; and
(v) If a judgment (but not a final judgment) has been entered
against a nongovernmental person by the issue date, there are, as of
the issue date, costs of hazardous waste remediation other than those
financed with the bonds that may be financed with the payments.
(g) Examples. The following examples illustrate the application of
this section:
Example 1. Aggregation of payments. State B issues bonds with
proceeds of $10 million. B uses $9.7 million of the proceeds to
construct a 10-story office building. B uses the remaining $300,000
of proceeds to make a loan to Corporation Y to finance unrelated
privately owned facilities. In addition, X leases 1 floor of the
building for a significant period that is less than the term of the
bonds. As a percentage of the present value of the debt service on
the bonds, the present value of Y's loan repayments is 3 percent and
the present value of X's lease payments is 8 percent. The bonds
satisfy the private security or payment test because the private
payments taken into account are more than 10 percent of the present
value of the debt service on the bonds.
Example 2. Indirect private payments. J, a political subdivision
of a state, will issue several series of bonds from time to time and
will use the proceeds to rehabilitate urban areas. More than 10
percent of the proceeds of each issue will be used for the
rehabilitation and construction of buildings that will be leased or
sold to nongovernmental persons for use in their trades or business.
Nongovernmental persons will make payments for these sales and
leases that have an aggregate present value that is more than the
present value of debt service on 10 percent of each issue. There is
no limitation either on the number of issues or the aggregate amount
of bonds that may be outstanding. No group of bondholders has any
legal claim prior to any other bondholders or creditors with respect
to specific revenues of J, and there is no arrangement whereby
revenues from a particular project are paid into a trust or
constructive trust, or sinking fund, or are otherwise segregated or
restricted for the benefit of any group of bondholders. There is,
however, an unconditional obligation by J to pay the principal of
and interest on each issue. The bonds meet the private security or
payment test because all of the private payments are counted.
Example 3. Allocations of payments. City Z purchases property
for $1,250,000 using $1,000,000 of proceeds of its tax increment
bonds and $250,000 of other revenues that are in its redevelopment
fund. The bonds are secured only by the incremental property taxes
on the property attributable to the increase in value of the
property from the planned redevelopment of the property. Z will
reimburse the redevelopment fund from amounts paid from the resale
of the property. After clearing the property, Z sells it to
Developer M for $250,000, an amount not in excess of the fair market
value of the land, which Z uses to reimburse the redevelopment fund.
Although M uses the property financed with the proceeds of the
bonds, it also directly uses property that was not financed with
those proceeds. The payments by M are properly allocable to the
property financed with the amounts in Z's redevelopment fund.
Accordingly, the issue does not meet the private security or payment
test because of M's $250,000 payment. See paragraph (c)(3)(ii) of
this section.
Example 4. Payments in respect of bond financed property. In
order to further public safety, City Y issues $5,000,000 of its tax
assessment bonds the proceeds of which are used to move existing
electric utility lines underground. Although the utility lines are
owned by a nongovernmental utility company, that company is under no
obligation to move the lines. The debt service on the bonds will be
paid using assessments levied by City Y on the customers of the
utility. Although the utility lines are privately owned and the
utility customers make payments to the utility company for the use
of those lines, the assessments are payments in respect of the cost
of relocating the utility line. Thus, the assessment payments are
not made in respect of property used for a private business use. Any
direct or indirect payments to Y by the utility are, however, taken
into account as private payments.
Example 5. Management contract. City P issues general obligation
bonds to finance the renovation of a hospital that it owns. The
hospital is operated for P by D, a nongovernmental person, under a
management contract that results in private business use under
Sec. 1.141-3. P will use the revenues from the hospital (after the
required payments to D) to pay the debt service on the bonds. The
bonds satisfy the private security or payment test because the
revenues from the hospital are payments in respect of property used
for a private business use.
Example 6. Lease financing. (i) County W issues certificates of
participation in a lease of a building that W owns and covenants to
appropriate annual payments for the lease. A portion of each payment
is specified as interest. More than 10 percent of the building is
used for private business use. None of the proceeds of the
obligations are used with respect to the building. W uses more than
10 percent of the proceeds of the obligations to construct a stadium
that is to be used for a private business use. If W defaults under
the lease, the trustee for the holders of the certificates of
participation has a limited right of repossession under which the
trustee may not foreclose but may lease the property to a new tenant
at fair market value. The obligations are secured by an interest in
property used for a private business use and, therefore, the
obligations satisfy the private security for payment test.
(ii) The facts are the same as in part (i) of this Example 6
except that, under the terms of the lease, in the event of a default
by W, the trustee's only rights are to sue W for any failure to make
payments pursuant to the lease. Thus, the trustee has no rights to
the building and no limited right of repossession. The right to
receive lease payments is not an interest in the leased property
and, therefore, this right does not provide private security.
Example 7. Limitation of payments to use not determined
annually. City Q issues bonds with a term of 15 years and uses the
proceeds to construct an office building. The debt service on the
bonds is level throughout the 15-year term. O enters into a 5-year
lease of 11 percent of the building with Corporation R under which R
will make lease payments equal to 20 percent of the annual debt
service on the bonds for each year of the lease. The present value
of R's lease payments is equal to 12 percent of the present value of
the debt service over the entire 15-year term of the bonds. If,
however, the lease payments taken into account as private payments
were limited to 11 percent of debt service paid in each year of the
lease, the present value of these payments would be only 8 percent
of the debt service on the bonds over the entire term of the bonds.
The bonds satisfy the private security or payment test, because R's
lease payments are taken into account as private payments in an
amount not to exceed 11 percent of the debt service on the bonds
over the term of the bonds (rather than 11 percent per year).
Example 8. Parity bonds. University L, a political subdivision,
issued three separate series of revenue bonds during 1989, 1991, and
1993 under the same bond resolution. L used the proceeds to
construct facilities exclusively for its own use. Bonds issued under
the resolution are equally and ratably secured and payable solely
from the income derived by L from rates, fees, and charges imposed
by L for the use of the facilities. The bonds issued in 1989, 1991,
and 1993 are not private activity bonds. In 1995, L issues another
series of bonds under the resolution to finance additional
facilities. L enters into 10-year leases for 20 percent of the new
facilities with nongovernmental persons who will use the facilities
in their trades or businesses. The present value of the lease
payments from the nongovernmental users will equal 15 percent of the
present value of the debt service on the 1995 bonds. L will
commingle all of the revenues from all its bond-financed facilities
in its revenue fund. The portion of the lease payments from
nongovernmental lessees of the new facilities allocable to the 1995
bonds under Sec. 1.148-6(e)(6) is less than 10 percent of the
present value of the debt service on the 1995 bonds. The 1995 bonds
will meet the private security or payment test because the private
lease payments for the new facility are properly allocated to those
bonds (that is, because none of the proceeds of the prior issues
were used for the new facilities).
Example 9. Variable yield issues. (i) City M issues general
obligation bonds with proceeds of $10 million to finance a 5-story
office building. The bonds bear interest at a variable rate that is
recomputed monthly according to an index that reflects current
market yields. They yield that the interest index would produce on
the issue date is 6 percent. M leases one floor of the office
building to Corporation T, a nongovernmental person, for the term of
the bonds. Using the 6 percent yield as the discount rate, M
reasonably expects on the issue date that the present value of lease
payments to be made by T will be 8 percent of the present value of
the total debt service on the bonds. After the issue date of the
bonds, interest rates decline significantly, so that the yield on
the bonds over their entire term is 4 percent. Using this actual 4
percent yield as the discount rate, the present value of lease
payments made by T is 12 percent of the present value of the actual
total debt service on the bonds. The bonds are not private activity
bonds because M reasonably expected on the issue date that the bonds
would not meet the private security or payment test and because M
did not take any subsequent deliberate action to meet the private
security or payment test.
(ii) The facts are the same as part (i) of this Example 9,
except that 5 years after the issue date M leases a second floor to
Corporation S, a nongovernmental person, under a long-term lease. On
the date this lease is entered into M reasonably expects that the
yield on the bonds over their entire term will be 5.5 percent, based
on actual interest rates to date and the then-current rate on the
variable yield bonds. Using this 5.5 percent yield as the discount
rate, as a percentage of the present value of the debt service on
the bonds, the present value of lease payments made by T is 9
percent and the present value of the lease payments made by S is 2
percent. The bonds are private activity bonds because M has taken a
subsequent deliberate action that causes the bonds to meet the
private security or payment test.
Example 10. Stadium ticket tax. (i) Authority issues its bonds
to finance the construction of a stadium. Under a long-term lease,
Corporation X, a professional sports team, will use more than 10
percent of the stadium. Corporation X will not, however, make any
payments for this private business use. The security for the bonds
will be a ticket tax imposed on each person purchasing a ticket for
an event at the stadium. The portion of the ticket tax attributable
to tickets purchased by persons attending X's events will, on a
present value basis, exceed 10 percent of the present value of
Authority's bonds. The bonds satisfy the private security or payment
test. The ticket tax is not a tax of general application and, to the
extent that the tax receipts relate to X's events, the taxes
constitute payments in respect of property used for a private
business use.
(ii) The facts are the same as in part (i) of this Example 10,
except that the ticket tax is imposed by Authority on tickets
purchased for events at a number of large entertainment facilities
within the jurisdiction of Authority (for example, other stadiums,
arenas, concert halls, etc.), some of which were not financed with
tax-exempt bonds. The ticket tax is a tax of general application and
therefore the revenue from this tax are not payments in respect of
property used for a private business use. Therefore, the bonds do
not satisfy the private security or payment test.
Sec. 1.141-5 Private loan financing test.
(a) In general--(1) General rule. Bonds of an issue are private
activity bonds if more than the lesser of 5 percent of the proceeds or
$5 million of the sale proceeds of the issue is to be used (directly or
indirectly) to make or finance loans to persons other than governmental
units. Section 1.141-2(d) applies in determining whether the private
loan financing test is met.
(2) Direct and indirect use of proceeds determinative. In
determining whether the proceeds of an issue are used to make or
finance loans, indirect, as well as direct, use of the proceeds is
taken into account. Any use of proceeds by a governmental person that
results in the expenditure of those proceeds (rather than the
acquisition of investment property), such as a grant, is treated as the
ultimate use of those proceeds. For purposes of this paragraph (a)(2),
investment property has the meaning in Sec. 1.148-1, except that tax-
exempt bonds may be treated as investment property. See Sec. 1.148-6
for rules to determine when proceeds are expended.
(3) Measurement of test. In determining whether the private loan
financing test is met, the amount actually loaned to a nongovernmental
person is not discounted to reflect the present value of the loan
repayments.
(b) Definition of loan--(1) General federal tax principles apply.
Any transaction that, for federal income tax purposes generally, is
characterized as a loan is a loan for purposes of this section. Thus,
the determination of whether a loan is made depends on the substance of
a transaction. For example, a lease or other contractual arrangement
(for example, a management contract) may in substance constitute a loan
if the arrangement transfers tax ownership of the facility to a
nongovernmental person. Similarly, an output contract with respect to a
financed facility generally is not treated as a loan of proceeds unless
the agreement in substance shifts significant burdens and benefits of
ownership to the nongovernmental purchaser or manager of the facility.
(2) Exception if no use of bonds proceeds. Any use of proceeds that
does not, treating the user as a nongovernmental person that is not a
natural person, give rise to private business use, is not a loan of
proceeds. See Sec. 1.141-3.
(3) Hazardous waste remediation bonds. In the case of an issue of
hazardous waste remediation bonds, payments from nongovernmental
persons that are either users of the site being remediated or persons
potentially responsible for disposing of hazardous waste on that site
do not indicate a loan for purposes of this section. This paragraph
(b)(3) applies only if those payments do not secure the payment of
principal of, or interest on, the bonds (directly or indirectly), under
the terms of the bonds and those payments are not taken into account
under the private payment test pursuant to Sec. 1.141-4(f)(3).
(4) Prepayments. A prepayment does not result in a loan of proceeds
if the prepayment is not investment-type property. In applying the
definition of investment-type property under Sec. 1.148-1, providing
the benefits of tax-exempt financing to the seller of the property or
service is treated as an investment return to the issuer.
(5) Grants--(i) In general. A grant of proceeds is not a loan.
Whether a transaction is a grant or a loan depends on all the facts and
circumstances.
(ii) Tax increment financing--(A) In general. Generally, a loan
does not result from the making of a grant using proceeds of an issue
that is secured by generally applicable taxes attributable to the
improvements to be made with the grant unless the grantee makes any
special agreements relating to the payment that results in those taxes
failing to be generally applicable under Sec. 1.141-4(e).
(B) Amount of loan. If a grant is treated as a loan under this
paragraph (b)(5), the entire grant is treated as a loan unless the
special agreement is limited to a specific portion of the related tax.
(c) Tax assessment bond exception--(1) General rule. For purposes
of this section, a tax assessment loan that meets the requirements of
this paragraph (c) is not a loan.
(2) Tax assessment loan defined--(i) In general. A tax assessment
loan is a loan that arises for federal tax purposes when a governmental
unit permits or requires its residents to pay a tax or assessment over
a period of years. The tax assessment loan exception may apply if the
assessed property is used by a nongovernmental person in its trade or
business (whether or not private business use) or for nonbusiness
purposes. In addition, a tax assessment loan must satisfy the following
requirements:
(A) Mandatory tax or assessment. The loan must arise from the
imposition of a mandatory tax or other assessment of general
application.
(B) Essential governmental function. The mandatory tax or
assessment (collectively, assessments) must be imposed for one or more
specific, essential governmental functions (as opposed to installment
payments of property taxes or other taxes);
(C) Equal basis requirement. If the property that is subject to the
tax or assessment is used by a nongovernmental person, owners of both
business and nonbusiness property benefiting from the financed
improvements are eligible or required to make deferred payments of the
assessment on an equal basis (the equal basis requirement).
(ii) [Reserved]
(3) Mandatory tax or other assessment. An assessment is an enforced
contribution that is imposed and collected for the purpose of raising
revenue to be used for a specific purpose (that is, to defray the
capital cost of an improvement). Assessments must be levied on a
property frontage basis, an ad valorem basis, or any other comparable
method that results in equivalent mandatory assessment to all residents
benefiting from the improvements in an amount proportionate to the
benefit to the assessed property. Assessments do not include fees for
services.
(4) Specific essential governmental function. For this purpose, in
general, the term essential governmental function has the same meaning
as under section 7871. An essential governmental function does not
include any function to the extent that it is not customarily performed
(and financed with governmental bonds) by governments with general
taxing powers. In determining whether an activity is customarily
performed by a governmental unit, isolated instances of bond financing
are disregarded. Examples of specific essential governmental functions
for purposes of this section include street paving and street-light
installation, sewage treatment and disposal, and municipal water
facilities, but not commercial or industrial ventures. A specific
essential governmental function does not include permitting installment
payments of property taxes or other taxes or any improvement to
property owned by a nongovernmental person.
(5) Equal basis requirement--(i) In general. An assessment does not
satisfy the equal basis requirement if the terms for payment of the
assessment are not the same for all assessed persons (for example, if
certain residents are permitted to pay the assessment over a period of
years while others must pay the entire assessment immediately or if the
assessment is required to be prepaid when the property is sold). In
addition, the amounts payable and the rates used to determine those
amounts must be determined on the basis of non-discriminatory criteria.
Thus, for example, an assessment does not satisfy the equal basis
requirement if imposed on a different basis for business and non-
business beneficiaries. The equal basis requirement is not, however,
violated solely because an assessment varies on the basis of the
relative benefit conferred.
(ii) Additional security. The equal basis requirement is not
violated as a result of one benefitted party acquiring a guaranty of a
third party to pay debt service on bonds if it is not reasonably
expected that payments will be made because of the additional
assurances that otherwise not have been made and the guarantor's
recourse is limited to the assessments and the benefitted property.
(6) Coordination with private business tests. See Secs. 1.141-3 and
1.141-4 for rules for determining whether tax assessment loans cause
the bonds financing those loans to be private activity bonds under the
private business use and the private security or payment tests.
(d) Nonpurpose investment exception. Any loan that is a nonpurpose
investment is not treated as a loan for purposes of this section. Thus,
for example, proceeds invested in loans such as obligations of the
United States during any available temporary period, as part of a
reasonably required reserve or replacement fund, as part of a refunding
escrow, or as part of a minor portion (as each of those terms is
defined under Sec. 1.148-1(b)) are not loans for purposes of this
section. This paragraph (d) does not apply to any nonpurpose investment
acquired pursuant to a plan to avoid the limitations of section 141(c)
and this section.
(e) Examples. The following examples illustrate the application of
this section:
Example 1. State agency Z and federal agency H will each
contribute to rehabilitate a project owned by Z. H can only provide
its funds through a contribution to Z to be used to acquire the
rehabilitated project on a turnkey basis from an approved developer.
Under H's turnkey program, the developer must own the project while
it is rehabilitated. Z issues its notes to provide funds for
construction. A portion of the notes will be retired using the H
contribution, and the balance of the notes will be retired through
the issuance by Z of long-term bonds. Z lends the proceeds of its
note to Developer B as construction financing and transfers title to
B for a nominal amount. The conveyance is made on condition that B
rehabilitate the property and reconvey it upon completion, with Z
retaining the right to force reconveyance if these conditions are
not satisfied. B must name Z as an additional insured on all
insurance. Upon completion, B must transfer title to the project
back to Z at a set price, which price reflects B's costs and profit,
not fair market value. Further, this price is adjusted downward to
reflect any cost-underruns. For purposes of section 141(c), this
transaction does not involve a private loan.
Example 2. Assessment district U issues bonds the proceeds of
which are used to construct water and sewer improvements in the
district. At the time that the bonds are issued, all of the property
in the district is owned by several developers, each of which is in
the trade or business of developing the property in the district for
residential use. In accordance with the procedures required by
applicable State law, U imposes assessments on each parcel in the
district. U requires that, at the time that a developer sells a
residential parcel, the developer must prepay the remaining amount
of the assessment. The assessments do not satisfy the equal basis
requirement, because the payment terms are not the same for all
assessed persons.
Sec. 1.141-6 Allocation and accounting rules.
(a) Allocation of proceeds to expenditures generally. For purposes
of Secs. 1.141-1 through 1.141-16, the provisions of Sec. 1.148-6(d)
apply for purposes of allocating proceeds to ex
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