Exempt Facility (Private Use) Tax-Exempt Financing
In addition to traditional tax-exempt finance by authorized issuers (e.g., some governmental entities and instrumentalities thereof) for typical governmental projects, the U.S. Internal Revenue Code (“IRC”) permits such issuers (“Permitted Issuers”) to use tax-exempt financing for certain types of “private activities,” i.e., projects where a private entity is able to take advantage of all or a portion of the benefits of the tax-exempt financing provided that the requirements of the IRC are met. One category of tax-exempt qualified “private activity” financing is “exempt facility” financing. Permitted Issuers can in some circumstances offer to use exempt facilities financing as part of an economic development incentive package. Below are some highlights of the basic requirements for exempt facility financing.
Section 142 of the IRC permits tax-exempt financing with respect to 15 categories of “exempt facilities” with some particular requirements respecting certain categories. The general categories of facilities eligible are:
(2) docks and wharves,
(3) mass commuting facilities,
(4) facilities for the furnishing of water,
(5) sewage facilities,
(6) solid waste disposal facilities,
(7) qualified residential rental projects,
(8) facilities for the local furnishing of electrical energy or gas,
(9) local district heating or cooling facilities,
(10) qualified hazardous waste facilities,
(11) high-speed intercity rail facilities,
(12) environmental enhancements of hydro-electric generating facilities,
(13) qualified public educational facilities,
(14) qualified green building and sustainable design projects, and
(15) qualified highway or surface freight transfer facilities.
See IRC § 142(a).
- Functionally Related Facilities - An exempt facility includes land, buildings or other property “functionally related and subordinate to such facility.” Property is functionally related and subordinate to a facility only if it is of “a character and size commensurate with the character and size of the exempt facility.” Whether the use of proceeds test is satisfied is determined by reference to the “ultimate use of proceeds,” ignoring the use of proceeds by intermediate parties in the transaction (such as lenders). See Treas. Reg. § 1.103-8(a)(3).
- Public Use Requirement - The regulations provide that an exempt facility must satisfy a “public use” test to “serve the public or be available on a regular basis for general public use, or be part of a facility so used.” See Treas. Reg. § 1.103-8(a)(2).
- 95% of Net Proceeds - 95% or more of net proceeds be used to provide the qualifying facility. See IRC § 142(a). “Net proceeds” is defined in Section 150(a)(3) to be the proceeds of an issue less amounts used to fund a reserve fund.
- Excess Bond Proceeds: Remedial Action - Failure to meet the 95% test generally will not cause bonds to be taxable if (i) it was reasonably expected that that test would be met, and (ii) the non-qualified bonds are redeemed or defeased. See Treas. Reg. § 1.142-2.
- Acquisition of Existing Properties - Proceeds may not be used for the acquisition of existing facilities, except for: (a) the acquisition of buildings if the owner incurs rehabilitation expenses in an amount equal to at least 15% of the proceeds used to acquire such building, or (b) the acquisition of structures if the owner incurs rehabilitation expenditures equal to at least 100% of the proceeds used for the acquisition of such facilities. See IRC § 147(d).
- Restrictions on the Acquisition of Land - Not more than 25% of the proceeds may be used for the acquisition of land and none of the proceeds may be used for the acquisition of land for agricultural purposes. This restriction does not apply to land acquired by a governmental unit or issuing authority in connection with an airport, mass commuting facility, high-speed intercity rail facility, dock, or wharf, if such land is acquired for noise abatement or wetland preservation, or for future use as one of the aforementioned facilities. See IRC § 147(c).
- Limitation on Average Maturity - The weighted average maturity of the bonds must not exceed 120% of the weighted averaged expected life of the assets financed with the proceeds of the bonds. For this purpose, the ADR midpoint life of the asset may be used as a safe harbor. Land is not taken into account in determining economic life unless more than 25% of proceeds are used for land, in which case 30 years is used as the economic life for land. See IRC § 147(b).
- Public Approval - There must be appropriate public approval of the bonds. Public approval is normally obtained by approval by an appropriate legislative or executive officer or body after a public hearing has been conducted for which there has been reasonable public notice (normally 14 days). Insubstantial deviations from the public notice will not cause the bonds to fail this requirement. See IRC Section 147(f).
- Substantial User Limitation - Although a bond may be tax-exempt, the interest on such bond will be taxable in the hands of a “substantial user” of the facilities financed with the bond issue or a “related person” thereto. When the bonds are transferred to a third person who is not a substantial user or related person, interest will once again be tax-exempt. See IRC § 147(a).
- Volume Cap – Generally, exempt facility bonds are subject to the volume cap requirement. However, no volume cap is required for exempt facilities that must be governmentally owned (i.e., airports, dock and wharf facilities) or have a specific exemption (i.e., environmental enhancements of hydro-electric generating facilities, qualified public educational facilities, qualified green building and sustainable design projects, and qualified highway or surface freight transfer facilities), and certain other facilities that are governmentally owned (i.e., high speed intercity rail and solid waste disposal facilities). See IRC § 146. The Georgia Department of Community Affairs maintains the bond allocation program in Georgia.
- Issuance Costs Limit - No more than 2% of the proceeds of an issue may be used for costs of issuance. See IRC § 147(g). For this purpose, costs of issuance include underwriters discount, legal fees, financial advisory fees, rating agency fees, trustee’s fees, paying agent fees, accounting fees, printing costs, costs incurred in connection with public approvals, and costs of engineering and feasibility studies necessary to the issuance of the bonds. Costs of issuance do not include fees for any bond insurance or letter of credit that constitutes a “qualified guarantee” for arbitrage purposes. Treas. Reg. § 1.150-1(b). Proceeds (to determine the 2% limit) are generally sales proceeds of the issue (rather than face amount) but exclude pre-issuance accrued interest. Treas. Reg. § 1.141-1(b).