Overview of Final Private Activity Bond Tax Regulations
John, Cross, Government Finance Review
Internal Revenue Code Final Regulations, which broadly affect governmental tax-exempt bonds, focus on the level of permissible private business involvement in a bond issue.
This article provides an overview of selected aspects of the recent final private activity bond tax regulations under Section 141 of the Internal Revenue Code (the "Final PAB Regulations").(1) These important rules broadly affect governmental tax-exempt bonds. They focus on the level of permissible private business involvement in a bond issue. Bonds are classified as private activity bonds if they meet a two-part 10 percent private business use test and private payment or security test, or a separate private loan test. Except for tax-exempt financing for certain specific private facilities (e.g., certain exempt facilities, housing mortgages, small issue manufacturing facilities, and certain 501(c)(3) nonprofit organization facilities), tax-exempt bonds generally may be issued only for governmental purposes and are taxable if the level of private business involvement causes them to be private activity bonds. Thus, the goal typically is to fail to be a private activity bond.
Effective Dates and Unfinished Parts. In general, the Final PAB Regulations apply prospectively to bonds issued on or after May 16, 1997. An issuer may elect to apply the Final PAB Regulations in whole, but generally not in part, to outstanding bonds issued earlier. An issuer also may elect to apply certain specific provisions individually to earlier outstanding bond issues, including those on permitted private management contracts, change of use remedies, and research agreements.
Certain parts of the Proposed PAB Regulations were not finalized, including those for output contracts (e.g., electric power contracts) and mixed-use facility allocations. These reserved parts are understood to be well underway.
Selected Highlights. Overall, the Final PAB Regulations adopt more workable standards than previous guidance in many areas. Selected positive highlights include
* more flexible standards for testing private business use, based on ownership, leasing, special legal entitlements to general public use property (e.g., roads), and special economic benefits from property unavailable for general public use (e.g., prisons);
* consideration of private management contracts under all the facts and circumstances, together with broad new safe harbors under Rev. Proc. 97-13 which permit qualified private management contracts for up to 15-year terms at 95 percent fixed fees or up to 10-year terms at 80 percent fixed fees (and 20-year terms in each case for public utility property);
* a broader general public use exception to private business use which focuses on intended and actual 'reasonable availability for use by "natural persons" (regulation code word for human beings);
* a more sensible measure of private business use which generally looks at average use over the entire term of the bond issue;
* more flexible treatment of facilities that can qualify for a general public use exception, including favorable examples for certain airport runways, airport parking, and isolated road facilities;
* more workable treatment of tax assessment bonds, including deletion of certain proposed rules which negatively impacted developer agreements in these financings; and
* change of use remedies which are more workable in certain respects and which permit certain eligible bonds with up to 10 [degrees]-year call provisions to be defeased without further action such as tender offers.
On the other hand, however, the Final PAB Regulations are notable for the sheer number of rules and their complexity. Selected negative highlights include
* a more restrictive private payment or security test, which broadly counts certain payments on tax-exempt bond-financed property during periods of private business use even if not made by a private business user;
* some harsh eligibility conditions on otherwise favorable special rules (e. …