KPMG report: Tax-exempt bonds, private activity restrictions in final regulations

Tax-exempt bonds

Final regulations issued in late October 2015 address the allocation and accounting rules for purposes of the “private activity bond” restrictions under section 141 as applied to tax-exempt bonds issued by state and local governments—including qualified section 501(c)(3) bonds.

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The following discussion briefly summarizes provisions included in the final regulations. Read text of the final regulations [PDF 241 KB]

Background

Proposed regulations were issued in 2006 regarding the allocation and accounting rules for tax-exempt bond proceeds. The proposed regulations included special rules for mixed-use projects and rules regarding the treatment of partnerships for purposes of section 141.

Final regulations

The final regulations withdraw certain provisions of the 2006 proposed regulations and clarify other portions of those regulations.  Among the changes and clarifications made, the final regulations: 

  • Clarify that an issuer’s allocation of proceeds to expenditures for purposes of the arbitrage investment restrictions under section 148 also applies to expenditures for purposes of the private activity bonds.
  • Adopt the proposed regulation provisions that bond proceeds and other funds (i.e., “qualified equity”) allocated to capital expenditures for a capital project are treated as allocated ratably throughout the project in proportion to the relative amounts of proceeds and other funds spent on that project, and are allocated to both governmental use and private business use of the project in proportion to the relative amounts of each source of funding spent.  In sum, the bond proceeds and qualified equity are allocated “pro rata” across the project.
  • Simplify the definition of “project” to cover all facilities or capital projects financed in whole or in part with proceeds of a single issue of bonds.  The approach provides the issuer with flexibility to identify, in its bond documents, all of the bond-financed properties financed by an issue that are considered a single project.  The final regulations also clarify that improvements financed with a later issue are a separate project.
  • Clarify that each undivided ownership interest in an output facility be treated separately for purposes of applying the allocation rules.
  • Eliminate the discrete portion method for allocating proceeds and other sources to the uses of a mixed-use project and make the undivided portion allocation methodology (“floating allocations method”) the exclusive method for eligible mixed-use projects.
  • Adopt a definition of “qualified equity” as set forth in the proposed regulations except that the term “qualified equity” does not include any tax-advantage bond, but does include certain amounts spent for early redemptions of bonds in anticipation of private business use.  
  • Clarify that “same plan of financing” has the same meaning as contained in Reg. section 1.150-1(c)(1)(ii) and further clarify when qualified equity is considered part of the same plan of financing.  
  • Provide for the aggregate treatment of all partnerships operating bond financed facilities and provide a mechanism to measure private business use when there is a nongovernmental partner(s) in partnership operating a bond-financed facility.  
  • Expand the definition of qualified equity to include certain anticipatory redemptions in advance of a deliberate action that would cause the private business use test to be met.   
  • Permit an issuer who chooses to redeem or defease nonqualified bonds to only redeem or defease sufficient bonds such that the remaining bonds would not meet the private business use or private loan test, rather than requiring the issuer to defease or redeem sufficient bonds to remediate all such nonqualified uses.    

KPMG observation

Overall, the final regulations permit additional flexibility in allocating proceeds and expenditures to bond financed facilities and provide additional needed guidance concerning what constitutes qualified equity.  It is expected these regulations will encourage issuers to better define their projects in their bond documents that in turn will assist with the identification of facilities and assets that require ongoing tracking.  

 

For more information, contact the Managing Director-in-Charge of KPMG's Washington National Tax Exempt Organizations Tax group:

D. Greg Goller | (703) 286-8391 | greggoller@kpmg.com

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