Enterprise Zone Facility Bonds

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 8673]

RIN 1545-AM01

Enterprise Zone Facility Bonds

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

-----------------------------------------------------------------------

SUMMARY: This document contains final regulations relating to

enterprise zone facility bonds issued by State and local governments.

These regulations reflect changes to the law made by the Omnibus Budget

Reconciliation Act of 1993. These regulations affect issuers of

enterprise zone facility bonds.

EFFECTIVE DATE: These regulations are effective May 31, 1996.

For dates of applicability of these regulations to enterprise zone

facility bond issues, see Sec. 1.1394-1(q) of these regulations.

FOR FURTHER INFORMATION CONTACT: Loretta J. Finger, (202) 622-3980 (not

a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

On December 30, 1994, proposed regulations (FI-72-88) were

published in the Federal Register (59 FR 67658) to provide guidance

under sections 141 (relating to private activity bonds and to qualified

bonds), 145 (relating to qualified 501(c)(3) bonds), 148 (relating to

arbitrage), 150 (relating to change of use), and 1394 (relating to

enterprise zone facility bonds). On June 8, 1995, the IRS held a public

hearing on the proposed regulations. Written comments responding to the

proposed regulations were received.

This Treasury decision addresses the issues relating to enterprise

zone facility bonds. Later guidance will be published relating to

sections 141, 145, 148, and 150. After consideration of all the

comments, the proposed regulations under section 1394 (relating to

enterprise zone facility bonds) are adopted as revised by this Treasury

decision. The principal revisions to the proposed regulations under

section 1394 are discussed below.

Explanation of Provisions

Section 1394 applies to bonds issued to provide enterprise zone

facilities in both empowerment zones and enterprise communities

(zones).

A. Period of Compliance

The proposed regulations in general require compliance with the

requirements applicable to enterprise zone facility bonds throughout

the term of the enterprise zone facility bonds. The proposed

regulations provide two exceptions to this general rule: (i) A business

that is first established in connection with the issuance of enterprise

zone facility bonds does not need to meet the requirements of an

enterprise zone business and enterprise zone property until the

``testing date,'' which is the later of one year after the issue date

or one year after the date on which the financed property is placed in

service, and (ii) the issuer and principal user of the facility are

permitted a one-year period to cure noncompliance.

The final regulations modify the general rule to require compliance

with the requirements applicable to enterprise zone facility bonds

throughout the greater of (i) the remainder of the period during which

the zone designation is in effect under section 1391 (zone designation

period), and (ii) the period that ends on the weighted average maturity

date of the enterprise zone facility bonds. The final regulations also

provide that, in general, compliance with the requirements applicable

to enterprise zone facility bonds is not required after the date on

which the last of the enterprise zone facility bonds of the issue cease

to be outstanding.

1. Start of Compliance Period

Commentators requested that the testing date provisions be extended

to all businesses, not just start-up businesses. Commentators also

suggested lengthening the start-up period. The final regulations follow

the recommendation to expand the testing date provisions to all issuers

and principal users of property financed with enterprise zone facility

bonds if the issuer and the principal user reasonably expect that the

requirements will be met by the testing date and proceed with due

diligence to comply with the requirements. The start-up period is

increased to the later of 18 months after the issue date or 18 months

after the date on which the financed property is placed in service.

2. Compliance Period for Certain Requirements

Commentators suggested that compliance with the requirements for an

enterprise zone business should be based only on reasonable

expectations on the issue date. Commentators suggested that,

alternatively, the required compliance period should be reduced to

either (i) three years (similar to the test period for qualified small

issue manufacturing bonds), or (ii) the remainder of the zone

designation period.

Issuers and principal users should be required to meet the

requirements applicable to enterprise zone facility bonds for a

meaningful period of time in order to further the goals of economic

development in the zones. Therefore, for purposes of meeting the

requirements applicable to enterprise zone facility bonds, the final

regulations in general require issuers and principal users of financed

property to meet the requirements throughout the greater of (i) the

remainder of the zone designation period, and (ii) the period that ends

on the weighted average maturity date of the enterprise zone facility

bonds.

While compliance is generally not required after the enterprise

zone facility bonds are retired, the final regulations do require

issuers and principal users to meet the requirements of an enterprise

zone business and enterprise zone property for a minimum compliance

period of at least three years after the initial testing date. The

final regulations permit the issuer to identify an alternative initial

testing date. This alternative initial testing date is a date after the

issue date of the enterprise zone facility bonds and prior to the

initial testing date that would have been otherwise determined under

the final regulations.

Principal users are subject to the change in use penalty of section

1394(e) throughout the greater of (i) the remainder of the zone

designation period, and (ii) the period that ends on the weighted

average maturity date of the enterprise zone facility bonds.

[[Page 27259]]

3. Measurement of Compliance

The proposed regulations provide guidance on meeting the enterprise

zone business definitions. Commentators pointed out several

difficulties in meeting the tests in the proposed regulations and in

curing noncompliance within a one-year period. Commentators also asked

for guidance on how part-time employees are to be treated for the 35

percent resident employee requirement.

In general, each of the enterprise zone business requirements

applies over taxable year periods. The beginning and end of the period

of required compliance, however, may not correspond to the beginning

and ending dates of the principal user's taxable year. The proposed

regulations do not address the treatment of a taxable year only a part

of which falls in a required compliance period. The final regulations

provide that a taxable year is disregarded if the part of the year that

falls in a required compliance period does not exceed 90 days.

Although the final regulations generally require annual compliance

for the requirements under sections 1397B and 1397C, the final

regulations allow a five-year averaging, taking into account only

immediately preceding years going back to the taxable year that

includes the initial testing date. The requirements under sections

1397B and 1397C include requirements relating to location of

performance of employee services, location of tangible and intangible

property, source of gross income from the active conduct of business,

and the residence of employees. The averaging approach permits

principal users who exceed the requirements to provide a cushion for

future unanticipated noncompliance (for example, a non-recurring

extraordinary payment for services performed outside the zone).

The final regulations allow the 35 percent resident employee

requirement to be met on any reasonable basis (for example, on a per-

employee basis or on the basis of employee actual work hours). For

purposes of the per-employee fraction, employees working less than 15

hours a week are not included in the numerator or the denominator. The

principal user must consistently apply the method to determine

compliance with the 35 percent resident employee requirement throughout

the required compliance period.

The final regulations also provide that a zone employee who moves

out of the zone may continue to be treated as a resident of the zone,

provided that employee was a bona fide resident of the zone, that

employee continues to perform services for the principal user in an

enterprise zone business in the zone and substantially all of those

services are performed in the zone, and the principal user hires a

resident of the zone for the next available comparable (or lesser)

position.

The final regulations reduce the ``substantially all'' requirement

for purposes of various tests under sections 1397B and 1397C from 90

percent to 85 percent.

B. Qualified Zone Property Definition

The proposed regulations provide that property that has been

abandoned for more than one year meets the original use requirement.

The final regulations provide that if real property is vacant for at

least a one-year period including the date of zone designation, use

prior to that period is disregarded for purposes of determining

original use.

C. Other Rules

Commentators requested guidance on the appropriate method for

treating activities within the zone as though they constituted a

separately incorporated business for purposes of the enterprise zone

business test.

The final regulations allow a business to treat its activities

within a zone as part of a separately incorporated business if it

allocates income and activities attributable to the business within the

zone using a reasonable allocation method and has evidence of its

allocations sufficient to establish compliance with the various

requirements.

D. Principal User

The proposed regulations do not address the requirement that ``the

principal user'' of the enterprise zone facility bond proceeds be an

enterprise zone business. Commentators suggested that principal user

generally be defined in the same manner as in the regulations

applicable to qualified small issue bonds and qualified 501(c)(3)

bonds, which relate to use of bond proceeds by ``any'' principal user,

but without applying the definition to customers. One commentator

(relying on the definition of a qualifying business) suggested that

financing for commercial real estate owned by a business that is not an

enterprise zone business should be permitted, so long as 50 percent of

the gross rental income comes from lessees that are enterprise zone

businesses.

The final regulations provide that an owner of financed property is

the principal user except that, in the case of commercial real estate,

the lessee may be treated as the principal user if the rental of the

property is a qualified business under section 1397B(d)(2).

Special Analyses

It has been determined that this Treasury decision 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,

the notice of proposed rulemaking preceding these regulations was

submitted to the Small Business Administration for comment on its

impact on small business.

Drafting Information. The principal author of these regulations

is Loretta J. Finger, Office of Assistant Chief Counsel (Financial

Institutions and Products). However, other personnel from the IRS

and Treasury Department participated in their development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

Accordingly, 26 CFR part 1 is 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 1.1394-1 also issued under 26 U.S.C. 1397D.

Par. 2. Sections 1.1394-0 and 1.1394-1 are added under the

undesignated centerheading ``DEFINITIONS; SPECIAL RULES'' to read as

follows:

Sec. 1.1394-0 Table of contents.

This section lists the major paragraph headings contained in

Sec. 1.1394-1.

Sec. 1.1394-1 Enterprise zone facility bonds.

(a) Scope.

(b) Period of compliance.

(1) In general.

(2) Compliance after an issue is retired.

(3) Deemed compliance.

(c) Special rules for requirements of sections 1397B and 1397C.

(1) Start of compliance period.

(2) Compliance period for certain prohibited activities.

(3) Minimum compliance period.

(4) Initial testing date.

[[Page 27260]]

(d) Testing on an average basis.

(e) Resident employee requirements.

(1) Determination of employee status.

(2) Employee treated as zone resident.

(3) Resident employee percentage.

(f) Application to pooled financing bond and loan recycling

programs.

(g) Limitation on amount of bonds.

(1) Determination of outstanding amount.

(2) Pooled financing bond programs.

(h) Original use requirement for purposes of qualified zone

property.

(i) Land.

(j) Principal user.

(1) In general.

(2) Rental of real property.

(3) Pooled financing bond program.

(k) Treatment as separately incorporated business.

(l) Substantially all.

(m) Application of sections 142 and 146 through 150.

(1) In general.

(2) Maturity limitation.

(3) Volume cap.

(4) Remedial actions.

(n) Continuing compliance and change of use penalties.

(1) In general.

(2) Coordination with deemed compliance provisions.

(3) Application to pooled financing bond and loan recycling

programs.

(4) Section 150(b)(4) inapplicable.

(o) Refunding bonds.

(1) In general.

(2) Maturity limitation.

(p) Examples.

(q) Effective dates.

(1) In general.

(2) Elective retroactive application in whole.

Sec. 1.1394-1 Enterprise zone facility bonds.

(a) Scope. This section contains rules relating to tax-exempt bonds

under section 1394 (enterprise zone facility bonds) to provide

enterprise zone facilities in both empowerment zones and enterprise

communities (zones). See sections 1394, 1397B, and 1397C for other

rules and definitions.

(b) Period of compliance--(1) In general. Except as provided in

paragraphs (b)(2) and (c) of this section, the requirements under

sections 1394(a) and (b) applicable to enterprise zone facility bonds

must be complied with throughout the greater of the following--

(i) The remainder of the period during which the zone designation

is in effect under section 1391 (zone designation period); and

(ii) The period that ends on the weighted average maturity date of

the enterprise zone facility bonds.

(2) Compliance after an issue is retired. Except as provided in

paragraph (c)(3) of this section, the requirements applicable to

enterprise zone facility bonds do not apply to an issue after the date

on which no enterprise zone facility bonds of the issue are

outstanding.

(3) Deemed compliance--(i) General rule. An issue is deemed to

comply with the requirements of sections 1394(a) and (b) if--

(A) The issuer and the principal user in good faith attempt to meet

the requirements of sections 1394(a) and (b) throughout the period of

compliance required under this section; and

(B) Any failure to meet these requirements is corrected within a

one-year period after the failure is first discovered.

(ii) Exception. The provisions of paragraph (b)(3)(i) of this

section do not apply to the requirements of section 1397B(d)(5)(A)

(relating to certain prohibited business activities).

(iii) Good faith. In order to satisfy the good faith requirement of

paragraph (b)(3)(i)(A) of this section, the principal user must at

least annually demonstrate to the issuer the principal user's

monitoring of compliance with the requirements of sections 1394(a) and

(b).

(c) Special rules for requirements of sections 1397B and 1397C--(1)

Start of compliance period. Except as provided in paragraph (c)(2) of

this section, the requirements of sections 1397B (relating to

qualification as an enterprise zone business) and 1397C (relating to

satisfaction of the rules for qualified zone property) do not apply

prior to the initial testing date (as defined in paragraph (c)(4) of

this section) if--

(i) The issuer and the principal user reasonably expect on the

issue date of the enterprise zone facility bonds that those

requirements will be met by the principal user on or before the initial

testing date; and

(ii) The issuer and the principal user exercise due diligence to

meet those requirements prior to the initial testing date.

(2) Compliance period for certain prohibited activities. The

requirements of section 1397B(d)(5)(A) (relating to certain prohibited

business activities) must be complied with throughout the term of the

enterprise zone facility bonds.

(3) Minimum compliance period. The requirements of sections

1397B(b) or (c) and 1397C must be satisfied for a continuous period of

at least three years after the initial testing date, notwithstanding

that--

(i) The period of compliance required under paragraph (b)(1) of

this section expires before the end of the three-year period; or

(ii) The enterprise zone facility bonds are retired before the end

of the three-year period.

(4) Initial testing date--(i) In general. Except as otherwise

provided in paragraph (c)(4)(ii) of this section, the initial testing

date is the date that is 18 months after the later of the issue date of

the enterprise zone facility bonds or the date on which the financed

property is placed in service; provided, however, it is not later

than--

(A) Three years after the issue date; or

(B) Five years after the issue date, if the issue finances a

construction project for which both the issuer and a licensed architect

or engineer certify on or before the issue date of the enterprise zone

facility bonds that more than three years after the issue date is

necessary to complete construction of the project.

(ii) Alternative initial testing date. If the issuer identifies as

the initial testing date a date after the issue date of the enterprise

zone facility bonds and prior to the initial testing date that would

have been determined under paragraph (c)(4)(i) of this section, that

earlier date is treated as the initial testing date.

(d) Testing on an average basis. Compliance with each of the

requirements of section 1397B(b) or (c) is tested each taxable year.

Compliance with any of the requirements may be tested on an average

basis, taking into account up to four immediately preceding taxable

years plus the current taxable year. The earliest taxable year that may

be taken into account for purposes of the preceding sentence is the

taxable year that includes the initial testing date. A taxable year is

disregarded if the part of the taxable year that falls in a required

compliance period does not exceed 90 days.

(e) Resident employee requirements--(1) Determination of employee

status. For purposes of the requirement of section 1397B(b)(6) or

(c)(5) that at least 35 percent of the employees are residents of the

zone, the issuer and the principal user may rely on a certification,

signed under penalties of perjury by the employee, provided--

(i) The certification provides to the principal user the address of

the employee's principal residence;

(ii) The employee is required by the certification to notify the

principal user of a change of the employee's principal residence; and

(iii) Neither the issuer nor the principal user has actual

knowledge that the principal residence set forth in the certification

is not the employee's principal residence.

(2) Employee treated as zone resident. If an issue fails to comply

with the requirement of section 1397B(b)(6) or (c)(5) because an

employee who initially resided in the zone moves out of the

[[Page 27261]]

zone, that employee is treated as still residing in the zone if--

(i) That employee was a bona fide resident of the zone at the time

of the certification described in paragraph (e)(1) of this section;

(ii) That employee continues to perform services for the principal

user in an enterprise zone business and substantially all of those

services are performed in the zone; and

(iii) A resident of the zone meeting the requirements of section

1397B(b)(5) or (c)(4) is hired by the principal user for the next

available comparable (or lesser) position.

(3) Resident employee percentage. For purposes of meeting the

requirement of section 1397B(b)(6) or (c)(5) that at least 35 percent

of the employees of an enterprise zone business are residents of a

zone, paragraphs (e)(3)(i) and (ii) of this section apply.

(i) The term employee includes a self-employed individual within

the meaning of section 401(c)(1).

(ii) The resident employee percentage is determined on any

reasonable basis consistently applied throughout the period of

compliance required under this section. The per-employee fraction (as

defined in paragraph (e)(3)(ii)(A) of this section) or the employee

actual work hour fraction (as defined in paragraph (e)(3)(ii)(B) of

this section) are both reasonable methods.

(A) The term per-employee fraction means the fraction, the

numerator of which is, during the taxable year, the number of employees

who work at least 15 hours a week for the principal user, who reside in

the zone, and who are employed for at least 90 days, and the

denominator of which is, during the same taxable year, the aggregate

number of all employees who work at least 15 hours a week for the

principal user and who are employed for at least 90 days.

(B) The term employee actual work hour fraction means the fraction,

the numerator of which is the aggregate total actual hours of work for

the principal user of employees who reside in the zone during a taxable

year, and the denominator of which is the aggregate total actual hours

of work for the principal user of all employees during the same taxable

year.

(f) Application to pooled financing bond and loan recycling

programs. In the case of a pooled financing bond program described in

paragraph (g)(2) of this section or a loan recycling program described

in paragraph (m)(2)(ii) of this section, the requirements of paragraphs

(b) through (e) of this section apply on a loan-by-loan basis. See also

paragraphs (g)(2) (relating to limitation on amount of bonds), (m)(2)

(relating to maturity limitations), (m)(3) (relating to volume cap),

and (m)(4) (relating to remedial actions) of this section.

(g) Limitation on amount of bonds--(1) Determination of outstanding

amount. Whether an issue satisfies the requirements of section 1394(c)

(relating to the $3 million and $20 million aggregate limitations on

the amount of outstanding enterprise zone facility bonds) is determined

as of the issue date of that issue, based on the issue price of that

issue and the adjusted issue price of outstanding enterprise zone

facility bonds. Amounts of outstanding enterprise zone facility bonds

allocable to any entity are determined under rules contained in section

144(a)(10)(C) and the underlying regulations. Thus, the definition of

principal user for purposes of section 1394(c) is different from the

definition of principal user for purposes of paragraph (j) of this

section.

(2) Pooled financing bond programs--(i) In general. The limitations

of section 1394(c) for an issue for a pooled financing bond program are

determined with regard to the amount of the actual loans to enterprise

zone businesses rather than the amount lent to intermediary lenders as

defined in paragraph (g)(2)(ii) of this section. This paragraph (g)(2)

applies only to the extent the proceeds of those enterprise zone

facility bonds are loaned to one or more enterprise zone businesses

within 42 months of the issue date of the enterprise zone facility

bonds or are used to redeem enterprise zone facility bonds of the issue

within that 42-month period.

(ii) Pooled financing bond program defined. For purposes of this

section, a pooled financing bond program is a program in which the

issuer of enterprise zone facility bonds, in order to provide loans to

enterprise zone businesses, lends the proceeds of the enterprise zone

facility bonds to a bank or similar intermediary (intermediary lender)

which must then relend the proceeds to two or more enterprise zone

businesses.

(h) Original use requirement for purposes of qualified zone

property. In general, for purposes of section 1397C(a)(1)(B), the term

original use means the first use to which the property is put within

the zone. For purposes of section 1394, if property is vacant for at

least a one-year period including the date of zone designation, use

prior to that period is disregarded for purposes of determining

original use. For this purpose, de minimis incidental uses of property,

such as renting the side of a building for a billboard, are

disregarded.

(i) Land. The determination of whether land is functionally related

and subordinate to qualified zone property is made in a manner

consistent with the rules for exempt facilities under section 142.

(j) Principal user--(1) In general. Except as provided in paragraph

(j)(2) of this section, the term principal user means the owner of

financed property.

(2) Rental of real property--(i) A lessee as the principal user. If

an owner of real property financed with enterprise zone facility bonds

is not an enterprise zone business within the meaning of section 1397B,

but the rental of the property is a qualified business within the

meaning of section 1397B(d)(2), the term principal user for purposes of

sections 1394(b) and (e) means the lessee or lessees.

(ii) Allocation of enterprise zone facility bonds. If a lessee is

the principal user of real property under paragraph (j)(2)(i) of this

section, then proceeds of enterprise zone facility bonds may be

allocated to expenditures for real property only to the extent of the

property allocable to the lessee's leased space, including expenditures

for common areas.

(3) Pooled financing bond program. An intermediary lender in a

pooled financing bond program described in paragraph (g)(2) of this

section is not treated as the principal user.

(k) Treatment as separately incorporated business. For purposes of

section 1394(b)(3)(B), a trade or business may be treated as separately

incorporated if allocations of income and activities attributable to

the business conducted within the zone are made using a reasonable

allocation method and if that trade or business has evidence of those

allocations sufficient to establish compliance with the requirements of

paragraphs (b) through (f) of this section. Whether an allocation

method is reasonable will depend upon the facts and circumstances. An

allocation method will not be considered to be reasonable unless the

allocation method is applied consistently by the trade or business and

is consistent with the purposes of section 1394.

(l) Substantially all. For purposes of sections 1397B and 1397C(a),

the term substantially all means 85 percent.

(m) Application of sections 142 and 146 through 150--(1) In

general. Except as provided in this paragraph (m), enterprise zone

facility bonds are treated as exempt facility bonds that are described

in section 142(a), and all regulations generally applicable to exempt

facility bonds apply to enterprise zone facility bonds. For this

[[Page 27262]]

purpose, enterprise zone businesses are treated as meeting the public

use requirement. Sections 147(c)(1)(A) (relating to limitations on

financing the acquisition of land), 147(d) (relating to financing the

acquisition of existing property), and 142(b)(2) (relating to

limitations on financing office space) do not apply to enterprise zone

facility bonds. See also paragraph (n)(4) of this section.

(2) Maturity limitation--(i) Requirements. An issue of enterprise

zone facility bonds, the proceeds of which are to be used as part of a

loan recycling program, satisfies the requirements of section 147(b)

if--

(A) Each loan satisfies the requirements of section 147(b)

(determined by treating each separate loan as a separate issue); and

(B) The term of the issue does not exceed 30 years.

(ii) Loan recycling program defined. A loan recycling program is a

program in which--

(A) The issuer reasonably expects as of the issue date of the

enterprise zone facility bonds that loan repayments from principal

users will be used to make additional loans during the zone designation

period;

(B) Repayments of principal on loans (including prepayments)

received during the zone designation period are used within six months

of the date of receipt either to make new loans to enterprise zone

businesses or to redeem enterprise zone facility bonds that are part of

the issue; and

(C) Repayments of principal on loans (including prepayments)

received after the zone designation period are used to redeem

enterprise zone facility bonds that are part of the issue within six

months of the date of receipt.

(3) Volume cap. For purposes of applying section 146(f)(5)(A)

(relating to elective carryforward of unused volume limitation),

issuing enterprise zone facility bonds is a carryforward purpose.

(4) Remedial actions. In the case of a pooled financing bond

program described in paragraph (g)(2) of this section or a loan

recycling program described in paragraph (m)(2)(ii) of this section, if

a loan fails to meet the requirements of paragraphs (b) through (f) of

this section, within six months of noncompliance (after taking into

account the deemed compliance provisions of paragraph (b)(3) of this

section, if applicable), an amount equal to the outstanding loan

principal must be prepaid and the issuer must--

(i) Reloan the amount of the prepayment; or

(ii) Use the prepayment to redeem an amount of outstanding

enterprise zone facility bonds equal to the outstanding principal

amount of the loan that no longer meets those requirements.

(n) Continuing compliance and change of use penalties--(1) In

general. The penalty provisions of section 1394(e) apply throughout the

period of compliance required under paragraph (b)(1) of this section.

(2) Coordination with deemed compliance provisions. Section

1394(e)(2) does not apply during any period during which the issue is

deemed to comply with the requirements of section 1394 under the deemed

compliance provisions of paragraph (b)(3) of this section.

(3) Application to pooled financing bond and loan recycling

programs. In the case of a pooled financing bond program described in

paragraph (g)(2) of this section or a loan recycling program described

in paragraph (m)(2)(ii) of this section, section 1394(e) applies on a

loan-by-loan basis.

(4) Section 150(b)(4) inapplicable. Section 150(b)(4) does not

apply to enterprise zone facility bonds.

(o) Refunding bonds--(1) In general. An issue of bonds issued after

the zone designation period to refund enterprise zone facility bonds

(other than in an advance refunding) are treated as enterprise zone

facility bonds if the refunding issue and the prior issue, if treated

as a single combined issue, would meet all of the requirements for

enterprise zone facility bonds, except the requirements in section

1394(c). For example, the compliance period described in paragraph

(b)(1) of this section is calculated taking into account any extension

of the weighted average maturity of the refunding issue compared to the

remaining weighted average maturity of the prior issue. The proceeds of

the refunding issue are allocated to the same expenditures and purpose

investments as the prior issue.

(2) Maturity limitation. The maturity limitation of section 147(b)

is applied to a refunding issue by taking into account the issuer's

reasonable expectations about the economic life of the financed

property as of the issue date of the prior issue and the actual

weighted average maturity of the combined refunding issue and prior

issue.

(p) Examples. The following examples illustrate paragraphs (a)

through (o) of this section:

Example 1. Averaging of enterprise zone business requirements.

City C issues enterprise zone facility bonds, the proceeds of which

are loaned by C to Corporation B to finance the acquisition of

equipment for its existing business located in a zone. On the issue

date of the enterprise zone facility bonds, B meets all of the

requirements of section 1397B(b), except that only 25% of B's

employees reside in the zone. C and B reasonably expect on the issue

date to meet all requirements of section 1397B(b) by the date that

is 18 months after the equipment is placed in service (the initial

testing date). In each of the first, second, and third taxable years

after the initial testing date, 35%, 40% and 45%, respectively, of

B's employees are zone residents. In the fourth year after the

testing date, only 25% of B's employees are zone residents. B

continues to meet the 35% resident employee requirement, because the

average of zone resident employees for those four taxable years is

approximately 36%. The percentage of zone residents employed by B

before the initial testing date is not included in determining

whether B continues to comply with the 35% resident employee

requirement.

Example 2. Measurement of resident employee percentage.

Authority D issues enterprise zone facility bonds, the proceeds of

which are loaned to Sole Proprietor F to establish an accounting

business in a zone. In the first year after the initial testing

date, the staff working for F includes F, who works 40 hours per

week and does not live in the zone, one employee who resides in the

zone and works 40 hours per week, one employee who does not reside

in the zone and works 20 hours per week, and one employee who does

not reside in the zone and works 10 hours per week. F meets the 35%

resident employee test by calculating the percentage on the basis of

employee actual work hours as described in paragraph (e)(3)(ii)(B)

of this section. If F uses the per-employee basis as described in

paragraph (e)(3)(ii)(A) of this section to determine if the resident

employee test is met, the percentage of employees who are zone

residents on a per-employee basis is only 33% because F must exclude

from the numerator and the denominator the employee who works only

10 hours per week. If F calculates the resident employee test as a

percentage of employee actual work hours as described in paragraph

(e)(3)(ii)(B) of this section in the first year, F must calculate

the resident employee test as a percentage of employee actual work

hours each year.

Example 3. Active conduct of business within the zone. State G

issues enterprise zone facility bonds and loans the proceeds to

Corporation H to finance the acquisition of equipment for H's mail

order clothing business, which is located in a zone. H purchases the

supplies for its clothing business from suppliers located both

within and outside of the zone and expects that orders will be

received both from customers who will reside or work within the zone

and from others outside the zone. All orders are received and filled

at, and are shipped from, H's clothing business located in the zone.

H meets the requirement that at least 80% of its gross income is

derived from the active conduct of business within the zone.

Example 4. Enterprise zone business definition. City J issues

enterprise zone facility bonds, the proceeds of which are loaned to

Partnership K to finance the acquisition of equipment for its

printing operation located in the zone. All orders are taken and

completed, and all billing and

[[Page 27263]]

accounting activities are performed, at the print shop located in

the zone. K, on occasion, uses its equipment (including its trucks)

and employees to deliver large print jobs to customers who reside

outside of the zone. So long as K is able to establish that its

trucks are used in the zone at least 85% of the time and its

employees perform at least 85% of services for K in the zone, K

meets the requirements of sections 1397B(b)(3) and (5).

Example 5. Treatment as a separately incorporated business. The

facts are the same as in Example 4 except that six years after the

issue date of the enterprise zone facility bonds, K determines to

expand its operations to a second location outside of the boundaries

of the zone. Although the expansion would result in the failure of K

to meet the tests of 1397B(b), K, using a reasonable allocation

method, allocates income and activities to its operations within the

zone and has evidence of these allocations sufficient to establish

compliance with the requirements of paragraphs (b) through (f) of

this section. The bonds will not fail to be enterprise zone facility

bonds merely because of the expansion.

Example 6. Treatment of pooled financing bond programs.

Authority L issues bonds in the aggregate principal amount of

$5,000,000 and loans the proceeds to Bank M pursuant to a loans-to-

lenders program. M does not meet the definition of enterprise zone

business contained in section 1397B. Prior to the issue date of the

bonds, L held a public hearing regarding issuance of the bonds for

the loans-to-lenders program, describing the projects of identified

borrowers to be financed initially with $4,000,000 of the proceeds

of the bonds. The applicable elected representative of L approved

issuance of the bonds subsequent to the public hearing. The loan

agreement between L and M provides that the other proceeds of the

bonds will be held by M and loaned to borrowers that qualify as

enterprise zone businesses, following a public hearing and approval

by the applicable elected representative of L of each loan by M to

an enterprise zone business. None of the loans will be in principal

amounts in excess of $3,000,000. The loans by M will otherwise meet

the requirements of section 1394. The bonds will be enterprise zone

facility bonds.

Example 7. Original use requirement for purposes of qualified

zone property. City N issues enterprise zone facility bonds, the

proceeds of which are loaned to Corporation P to finance the

acquisition of equipment. P uses the proceeds after the zone

designation date to purchase used equipment located outside of the

zone and places the equipment in service at its location in the

zone. Substantially all of the use of the equipment is in the zone

and is in the active conduct of a qualified business by P. The

equipment is treated as qualified enterprise zone property under

section 1397C because P makes the first use of the property within

the zone after the zone designation date.

Example 8. Principal user. State R issues enterprise zone

facility bonds and loans the proceeds to Partnership S to finance

the construction of a small shopping center to be located in a zone.

S is in the business of commercial real estate. S is not an

enterprise zone business, but has secured one anchor lessee,

Corporation T, for the shopping center. T would qualify as an

enterprise zone business. S will derive 60% of its gross rental

income of the shopping center from T. S does not anticipate that the

remaining rental income will come from enterprise zone businesses. T

will occupy 60% of the total rentable space in the shopping center.

S can use enterprise zone facility bond proceeds to finance the

portion of the costs of the shopping center allocable to T (60%)

because T is treated as the principal user of the enterprise zone

facility bond proceeds.

Example 9. Remedial actions. State W issues pooled financing

enterprise zone facility bonds, the proceeds of which will be loaned

to several enterprise zone businesses in the two enterprise

communities and one empowerment zone in W. Proceeds of the pooled

financing bonds are loaned to Corporation X, an enterprise zone

business, for a term of 10 years. Six years after the date of the

loan, X expands its operations beyond the empowerment zone and is no

longer able to meet the requirements of section 1394. X does not

reasonably expect to be able to cure the noncompliance. The loan

documents provide that X must prepay its loan in the event of

noncompliance. W does not expect to be able to reloan the prepayment

by X within six months of noncompliance. X's noncompliance will not

affect the qualification of the pooled financing bonds as enterprise

zone facility bonds if W uses the proceeds from the loan prepayment

to redeem outstanding enterprise zone facility bonds within six

months of noncompliance in an amount comparable to the outstanding

amount of the loan immediately prior to prepayment. X will be denied

an interest expense deduction for the interest accruing from the

first day of the taxable year in which the noncompliance began.

(q) Effective dates--(1) In general. Except as otherwise provided

in this section, the provisions of this section apply to all issues

issued after July 30, 1996, and subject to section 1394.

(2) Elective retroactive application in whole. An issuer may apply

the provisions of this section in whole, but not in part, to any issue

that is outstanding on July 30, 1996, and is subject to section 1394.

Approved: May 22, 1996.

Margaret Milner Richardson,

Commissioner of Internal Revenue.

Leslie Samuels,

Assistant Secretary of the Treasury.

[FR Doc. 96-13718 Filed 5-30-96; 8:45 am]

BILLING CODE 4830-01-U