Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Rules and Regulations 2275

V should be reported on Form 8594 as

Class IV assets.

Approved: December 20, 1996.

Margaret Milner Richardson,

Commissioner of Internal Revenue.

Donald C. Lubick,

Acting Assistant Secretary of the Treasury.

[FR Doc. 97–656 Filed 1–9–97; 2:53 pm]

BILLING CODE 4830–01–U

26 CFR Parts 1 and 602

[TD 8712]

RIN 1545–AU62

Definition of Private Activity Bonds

AGENCY: Internal Revenue Service (IRS),

Treasury.

ACTION: Final regulations.

SUMMARY: This document contains final

regulations on the definition of private

activity bonds applicable to tax-exempt

bonds issued by state and local

governments. These final regulations

reflect changes to the applicable law

that were made by the Technical and

Miscellaneous Revenue Act of 1988.

These regulations affect issuers of taxexempt bonds and provide needed

guidance for applying the private

activity bond restrictions.

DATES: These regulations are effective

May 16, 1997.

For dates of applicability of these

regulations, see §§ 1.141–15, 1.141–16,

1.148–6(a)(3) and 1.148–6(d)(1)(iii) of

these regulations.

FOR FURTHER INFORMATION CONTACT:

Loretta J. Finger or Nancy M. Lashnits,

(202) 622–3980 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collections of information

contained in these final regulations have

been reviewed and approved by the

Office of Management and Budget in

accordance with the Paperwork

Reduction Act (44 U.S.C. 3507) under

control number 1545–1451. Responses

to these collections of information are

mandatory. Pursuant to comments

received, the collections of information

have been amended, but the estimated

annual burden per respondent/

recordkeeper has not changed.

An agency may not conduct or

sponsor, and a person is not required to

respond to, a collection of information

unless the collection of information

displays a valid control number.

The estimated average annual burden

hours per respondent/recordkeeper: 3

hours.

Comments concerning the accuracy of

this burden estimate and suggestions for

reducing this burden should be sent to

the Internal Revenue Service, Attn: IRS

Reports Clearance Officer, T:FP,

Washington, DC 20024, and 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.

Books or records relating to

collections of information must be

retained as long as their contents may

become material in the administration

of any internal revenue law. Generally,

tax returns and tax return information

are confidential, as required by 26

U.S.C. 6103.

Background

Removal of Existing Regulations for

Repealed Sections

Prior to the enactment of the Tax

Reduction and Simplification Act of

1977 (Pub. L. 95–30), sections 141

through 144 contained provisions of the

Internal Revenue Code of 1954 relating

to the standard deduction. Sections 141

(‘‘Standard Deduction’’), 142

(‘‘Individuals Not Eligible for Standard

Deduction’’), and 144 (‘‘Election of

Standard Deduction’’) were repealed by

section 101(d)(1) of that act. Section 143

(’’Determination of Marital Status’’) was

redesignated section 7703 by section

1301(j)(2) of the Tax Reform Act of 1986

(Pub. L. 99–514). Therefore, existing

regulations §§ 1.141–1, 1.142–1, 1.142–

2, 1.144–1, 1.144–2, and 1.144–3 are

being removed from the Code of Federal

Regulations (CFR), and regulation

§ 1.143–1 is being redesignated

§ 1.7703–1.

Proposed Regulations

On December 30, 1994, proposed

regulations (FI–72–88) were published

in the Federal Register (59 FR 67658) to

provide guidance under the Internal

Revenue Code of 1986 (Code) in

sections 141 (relating to private activity

bonds and to qualified bonds), 142

(relating to exempt-facility bonds), 145

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

147 (relating to other requirements

applicable to certain private activity

bonds), 148 (relating to arbitrage), 150

(relating to change of use), and 1394

(relating to enterprise zone facility

bonds). All subsequent references in

this preamble to Code sections are to the

Internal Revenue Code of 1986. On June

8, 1995, the IRS held a public hearing

on the proposed regulations. Written

comments responding to the proposed

regulations were received.

On May 31, 1996, final regulations

(FI–72–88) were published in the

Federal Register (61 FR 106) to provide

guidance under Code section 1394 to

address the issues relating to enterprise

zone facility bonds. After consideration

of all the comments, certain of the

proposed regulations under Code

sections 141, 142, 144, 145, 147, 148,

and 150 are adopted as revised by this

Treasury decision. The principal

revisions to the proposed regulations are

discussed below.

Explanation of Provisions

Certain commentators suggested that

the proposed regulations, with certain

modifications, be published again as

proposed regulations. A number of other

commentators suggested that the

proposed regulations, with certain

modifications, should be promulgated

as final regulations to provide certainty

at the earliest possible time. After

considering these comments, the IRS

and Treasury concluded that state and

local government issuers would benefit

from the adoption of the proposed

regulations, with certain modifications

made in response to comments, as final

regulations.

A. Section 1.141–1 Definitions and

rules of general application.

Replaced amounts. The proposed

regulations provide that the proceeds

taken into account under the private

activity bond tests include certain

replacement proceeds that are

reasonably expected to be available

during the project period.

The final regulations treat replaced

amounts also as arising to the extent

that the issuer reasonably expects that

the term of the issue will be longer than

is reasonably necessary for the

governmental purposes of the issue, in

the same manner as replacement

proceeds arise under the arbitrage

regulations under Code section 148.

Thus, replaced amounts may arise

under the private activity bond tests if

an issuer reasonably expects that there

will be available amounts during the

period that the bonds remain

outstanding longer than necessary for

the governmental purposes of the issue

and if those amounts are used for

purposes that are inconsistent with the

private activity bond tests.

B. Section 1.141–2 Private activity

bond tests.

1. Clarification of reasonable

expectations test. Under the proposed

regulations the private activity bond

tests depend on both reasonable

expectations as of the issue date and
2276 Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Rules and Regulations

subsequent deliberate actions of the

issuer.

The final regulations clarify that, in

general, the reasonable expectations test

is met only if the issuer reasonably

expects, as of the issue date, that no

action or event during the entire term of

the bonds will cause either the private

business tests or the private loan

financing test to be met. The final

regulations further provide, however,

that, if certain conditions are met, the

period of expected compliance needs to

extend only to a mandatory redemption

date. This special rule is intended to

accommodate issuers that reasonably

expect that bond-financed property may

be used by nongovernmental persons

during the stated term of the issue, but

have not entered into any arrangement

with a nongovernmental person that

will use the property and are unable to

predict the timing of that

nongovernmental use. This special rule

does not permit, however, reasonably

expected ‘‘recycling’’ of disposition

proceeds because the special rule

requires redemption of all nonqualified

bonds.

2. Definition of deliberate action. The

proposed regulations generally provide

that any action within the control of an

issuer is treated as a deliberate action

and that, if the financed property was

designed differently than is reasonably

necessary for the governmental

purposes of the issuer, an action with

respect to that property is treated as

deliberate, even if it is not within the

issuer’s control. Commentators

suggested that deliberate action should

be more narrowly defined.

The final regulations make certain

changes that narrow the scope of the

deliberate action rule to minimize

administrative burden on state and local

governments. First, the special rule for

property that is ‘‘designed differently’’

is deleted. The reasonable expectations

test adequately addresses the concerns

of this special rule. Second, the final

regulations clarify that an action taken

by a state or local government in

response to a regulatory directive of the

federal government is not a deliberate

action. Finally, the final regulations

provide that, if certain conditions are

met, dispositions of personal property

in the ordinary course of an established

governmental program are not treated as

a deliberate action.

3. Special rule for general obligation

bond programs that finance a large

number of separate purposes. The

proposed regulations provide a special

exception to the definition of

disposition proceeds that is intended to

minimize the administrative burden of

tracing the use of proceeds of general

obligation bonds that finance a large

number of projects. Commentators

suggested that this exception should be

available for other types of bonds and

that fewer conditions should apply to

the exception.

The final regulations provide a similar

rule that is broadly stated as an

exception to the rule that a deliberate

action after the issue date can cause an

issue to meet the private activity bond

tests. This exception is intended to

provide relief for ‘‘cash flow’’ general

obligation programs, where issuers use

the proceeds of an issue for a large

number of projects and spend proceeds

promptly. These programs merit special

treatment in part because they further

the purposes of the arbitrage rules.

4. When a deliberate action occurs.

The proposed regulations provide that 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.

Commentators suggested that the

regulations should not treat a deliberate

action as occurring before the date on

which new private business use actually

commences, in part because it may not

be possible to take a remedial action

with disposition proceeds before the

date on which the disposition proceeds

are received.

The final regulations provide in

general that a deliberate action occurs

on the date the issuer enters into a

binding contract with a

nongovernmental person for use of the

financed property that is not subject to

any material contingencies. In most

cases, material conditions to closing a

transaction that results in private

business use will be treated as material

contingencies so that this date will not

occur before the date of receipt of

disposition proceeds.

C. Section 1.141–3 Definition of

private business use.

1. Economic benefit as private

business use. Under the proposed

regulations, economic benefit to a

nongovernmental person may be treated

as private business use, even if the

nongovernmental person has no special

legal rights to use the financed property.

Commentators suggested that the

private business use test should not be

met unless special legal rights are

provided to a nongovernmental person

pursuant to an arrangement, and that

mere economic benefit is insufficient to

give rise to private business use.

The final regulations largely adopt

these suggestions. The final regulations

provide, however, that, if the financed

property is not available for use by the

general public, a nongovernmental

person may be treated as a private

business user of the property based on

all of the facts and circumstances, even

if that nongovernmental person has no

special legal entitlements to use of the

property.

2. Ownership. The proposed

regulations provide that ownership of

property by a nongovernmental person

is private business use of that property.

Commentators suggested that

ownership for this purpose should be

defined to mean ownership for general

federal income tax purposes and that

mere holding of title to property by a

nongovernmental person should not

necessarily give rise to private business

use. Commentators further suggested

that certain customary financing

structures that require a

nongovernmental person to be a

nominal owner of financed property

should be accommodated.

The final regulations adopt these

suggestions.

3. Discharge of a primary legal

obligation. The proposed regulations

provide that the use of bond proceeds to

provide property that discharges a

primary and unconditional legal

obligation of a nongovernmental person

results in private business use of that

property.

Commentators suggested that this rule

be deleted from the final regulations.

Many commentators indicated that this

rule would interfere with traditional tax

assessment bond financings for

governmental projects such as roads and

sidewalks. Some commentators also

indicated that certain state and local

governments may be required or

encouraged under state law to enter into

development agreements with private

developers that could result in private

business use of governmental projects

under the discharge of a primary legal

obligation rule.

The final regulations adopt this

comment by deleting this rule.

4. Management contracts. The

proposed regulations provide that

management contracts other than

qualified management contracts result

in private business use of the managed

property.

Commentators suggested that the

qualified management contract rules

should be safe harbors, not substantive

rules, and that a management contract

should give rise to private business use

only if it transfers a proprietary interest

in financed property to a manager that

is a nongovernmental person.

Commentators suggested that the

permissible contract terms for qualified

management contracts should be further

extended and that limitations on the

contract term based on useful life of the
Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Rules and Regulations 2277

financed property should be deleted. In

addition, commentators suggested that

contracts for incidental services, such as

janitorial and equipment repair services,

should never give rise to private

business use of financed property.

The final regulations provide more

flexible accommodation for

management contracts that implement

cost-saving ‘‘privatization’’ measures for

state and local governments, but

continue to reflect the view that

Congress intended that a management

contract can give rise to private business

use even if it does not in substance

transfer a leasehold or ownership

interest to a nongovernmental person for

general federal income tax purposes.

Thus, the final regulations do not adopt

the rule that a management contract

gives rise to private business use only if

it transfers a proprietary interest to a

nongovernmental service provider. The

final regulations provide that the

determination of whether a management

contract that does not meet the qualified

management contract safe harbors gives

rise to private business use is based on

all of the facts and circumstances. In

general, a management contract gives

rise to private business use if the

compensation under the contract is

based on net profits. The final

regulations further provide, however,

that contracts for services solely

incidental to the primary governmental

function or functions of a financed

facility do not otherwise give rise to

private business use under the

management contract rules. In addition,

the final regulations clarify the

standards to be applied in determining

whether a management contract is

properly characterized as a lease.

A separate revenue procedure

establishes safe harbors which expand

the types of management contracts that

do not result in private business use.

This revenue procedure in particular

permits longer term management

contracts for public utility facilities and

systems, relaxes certain of the

requirements for permitted

compensation arrangements, and deletes

the requirement that the issuer not

control the service provider.

5. Research agreements. The proposed

regulations set forth bright line rules for

determining when corporate-sponsored

research agreements and cooperative

research agreements do not give rise to

private business use. These rules apply

only to basic research.

The final regulations provide a facts

and circumstances rule, and a separate

revenue procedure establishes safe

harbors for determining when corporatesponsored research agreements and

cooperative research agreements do not

give rise to private business use. This

revenue procedure also expands the

definition of basic research, for

purposes of Code section 141, to include

any original investigation for the

advancement of scientific knowledge

not having a specific commercial

objective.

6. Exception for general public use.

The proposed regulations contain

detailed quantitative rules for

determining when use of financed

property by a nongovernmental person

is disregarded because the

nongovernmental person is treated as

using the property as a member of the

general public. The proposed

regulations also provide that use by a

nongovernmental person of financed

property is not treated as general public

use if the property provides a significant

economic benefit to the

nongovernmental person because it is

functionally and integrally related to

other property used by the

nongovernmental person.

Commentators suggested that the

quantitative rules for defining general

public use should be deleted, because

they are not sufficiently flexible to

accommodate the wide variety of state

and local government financings and

because they disproportionately affect

small local governments.

The final regulations largely delete

the quantitative approach in the

proposed regulations for general public

use. Instead, the final regulations adopt

a more qualitative test focusing on

whether financed property is intended

to be available and in fact is reasonably

available for use on the same basis by

natural persons not engaged in a trade

or business. This approach is more

consistent with the requirement in Code

section 141 that any activity carried on

by a person that is not a natural person

is treated as a trade or business activity.

Because the final regulations generally

do not treat mere economic benefit as

private business use, the rules for

functionally and integrally related

property are deleted. In light of this

narrower definition of private business

use, the special system improvement

rules have also been deleted. The final

regulations retain the rule in the

proposed regulations that use under an

arrangement that conveys priority rights

is not used on the same basis as the

general public and clarifies that an

arrangement for long-term use (defined

as more than 180 days) is not treated as

general public use. The final regulations

provide that use of financed property by

a nongovernmental person that is not

general public use is not necessarily

private business use. Under the

approach taken in the final regulations,

the definition of general public use is

significant for determining when

economic benefit alone can give rise to

private business use and for

determining the permitted terms of

short-term arrangements that are not

treated as private business use.

7. Exceptions for short-term

arrangements. The proposed regulations

provide that a lease or similar

arrangement that has a term of 1 year or

less and that is not renewed or

renewable is generally disregarded.

Commentators suggested that longer

term arrangements should be

disregarded.

The final regulations provide different

exceptions for various short-term

contracts. The exceptions for short-term

contracts are based on a hierarchy

depending on how broadly contracts

with the same terms are offered to other

users. Under this approach, a contract

that is available to the general public

may have a term up to 180 days; a

contract not treated as general public

use, but offered on the basis of generally

applicable or uniformly applied rates,

may have a term of up to 90 days; and

a specially negotiated contract that

provides fair market value

compensation may have a term of up to

30 days. In each case, the exception

applies only if the property is not

financed for a principal purpose of

providing that property for use by the

nongovernmental person entering into

the contract. The final regulations delete

the 1-year exception for non-renewable

short-term contracts because the final

regulations adopt a more flexible rule

for measuring private business use, as

discussed below.

8. Exception for temporary use by

developers. The proposed regulations

provide an exception for temporary use

by a developer of an improvement that

carries out an essential governmental

function during an initial development

period not exceeding 3 years.

Commentators suggested that the 3-

year limitation on the exception is too

short for many developments and that a

requirement that development proceed

with reasonable speed should suffice.

The final regulations largely adopt

this comment. This approach focuses

more on whether financed property

serving an essential governmental

function is transferred to a

governmental person with reasonable

speed than on a specific time frame for

development of the property benefited

by the improvement.

9. Exceptions for incidental use and

qualified improvements. The final

regulations remove certain conditions to

exceptions for incidental use and

qualified improvements.
2278 Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Rules and Regulations

10. Measurement of private business

use. The proposed regulations generally

provide that private business use is

measured on an annual basis, except for

private business use of output facilities.

Commentators suggested that private

business use should be measured on an

average or cumulative basis over the

term of an issue. The final regulations

largely adopt the suggestion that private

business use should be measured over

the term of an issue. In general, the

percentage of private business use of

financed property is determined

according to the average annual private

business use of that property over the

measurement period. The measurement

period begins on the later of the issue

date of the issue or the date the property

is placed in service and ends on the

earlier of the last date of the reasonably

expected economic life of the property

or the latest maturity date of any bond

of the issue. For certain bonds that are

issued in contemplation of refinancing,

such as bond anticipation notes, the

measurement period is based on the

final maturity date of any bond of the

refunding issue. Under an anti-abuse

rule, however, if an issuer extends the

term of an issue for a principal purpose

of increasing the permitted amount of

private business use, the Commissioner

may determine the amount of private

business use according to the greatest

percentage of private business use in

any 1-year period. Further, if an issuer

reasonably expects on the issue date

that bonds will be redeemed before the

final maturity of the issue because of a

deliberate action, the measurement

period ends on the reasonably expected

date of redemption. In addition, for

arrangements that result in ownership of

financed property by a

nongovernmental person, the amount of

private business use is the greatest

percentage of private business use in

any 1-year period.

This approach of looking to the

average amount of private business use

over the expected economic life of

financed property is more consistent

with the approach adopted for

measuring private payments and

security, which also in effect looks over

the term of an issue. This approach also

provides issuers with significantly

greater flexibility to spread out de

minimis private business use over the

term of an issue.

The final regulations adopt the

measurement-over-the-term rule for

private business use, however, only for

purposes of determining whether an

issue has no more than the permitted

amount of private business use (that is,

in most cases, the 10 percent threshold).

This general approach reflects the view

that adoption of the measurement-overthe-term rule for purposes other than

the de minimis rules would be unduly

complex to administer and could distort

the economic substance.

This general approach also simplifies

the regulations by providing a single

rule for measuring private business use

that applies to both output facilities and

other governmental facilities. The final

regulations reflect the view that all

governmental facilities generally would

benefit from more flexible private

business use measurement rules.

11. Determining average use within an

annual period. The proposed

regulations generally provide that the

average amount of private business use

within a year is based on the amount of

time financed property is actually used

for private business use as a percentage

of total time for all actual use, provided

that significant differences in fair

market value of different times of use

must be taken into account.

Some commentators suggested that

the average amount of private business

use should be based on a comparison of

time of private business use to time the

financed property is available for use,

not to time it is actually used.

The final regulations continue to

determine private business use for

certain purposes as a percentage of

actual use. This method more accurately

reflects economic substance. The final

regulations also clarify that, in certain

cases, the determination of fair market

value of private business use must take

into account the amount of private

payments for that use.

D. Section 1.141–4 Private security or

payment test.

1. Payments not directly made by

private business users. The proposed

regulations provide that payments made

with respect to property used for a

private business use are taken into

account under the private payment test,

even if not made by persons that are

private business users of proceeds.

Commentators suggested that payments

by persons that are not private business

users should be taken into account only

if they can be imputed to a private

business user of proceeds.

The final regulations retain the

general rule in the proposed regulations

but clarify that only payments made for

the period of private business use are

taken into account. The definition of

private business use in the final

regulations narrows the application of

this general rule.

2. Allocation of private payments to

different sources of funding. The

proposed regulations provide that a

payment from a private business user of

property may be allocated first to repay

any costs of the property paid by the

issuer from a source other than a

borrowing (‘‘equity’’). The proposed

regulations also provide, however, that,

if a payment is made for property

financed with two or more issues

(including issues that are not taxexempt), the payment must be allocated

among those issues according to the

relative amount of proceeds of those

issues used to finance the property.

Commentators generally favored the

rule permitting allocations first to

equity, but suggested that the same rule

should apply to costs financed with

taxable bonds.

The final regulations provide a more

general facts and circumstances test for

the allocation of private payments that

looks to the nexus between the private

payment and both the property financed

and the source of funding. Thus, under

the approach of the final regulations,

allocations of private payments first to

equity before other sources of funding

are generally permitted only to the

extent that there is a specific nexus

between the payment and a prior

expenditure. The final regulations do

not adopt the recommendation that

issuers also be permitted in all cases to

allocate private payments first to

repayment of taxable bonds, but treat

the obligation to pay debt service in

future years under the taxable debt as

establishing a nexus to future private

payments. The final regulations retain

the rule that allocations of private

payments among issues according to

relative amounts of those sources of

funding that are expended on the

property is generally appropriate, but

the final regulations provide issuers

with more flexibility to match these

allocations to debt service payments

associated with various sources of

funding.

3. Allocation of private security

among issues. The proposed regulations

provide that, for bonds other than parity

bonds, property or payments securing

more than one issue must be fully

allocated to each issue under the private

security test. Commentators suggested

that the rule for allocation of private

security among issues should

reasonably reflect foreclosure and

default scenarios under the bond

documents. The final regulations in

general adopt this comment.

4. Limitations on private security. The

proposed regulations provide that any

property that is used for a private

business use is taken into account under

the private security test if it secures

payment of debt service on an issue.

The final regulations provide that
Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Rules and Regulations 2279

only financed property and property

that is provided directly or indirectly by

a nongovernmental person that is

treated as a user of proceeds are taken

into account under the private security

test.

5. Exception for generally applicable

taxes. The proposed regulations contain

specific rules for when a special

agreement with respect to a generally

applicable tax may cause tax payments

to be treated as private payments.

In response to comments, the final

regulations are more flexible for

arrangements that reduce the amount of

tax paid and permit a wider range of tax

equivalency payments. The final

regulations also clarify that an

impermissible agreement entered into

by one taxpayer does not affect whether

payments made by other taxpayers are

treated as generally applicable taxes.

E. Section 1.141–5 Private loan

financing test.

1. Definition of proceeds for purposes

of the private loan financing test. The

proposed regulations provide that the

private loan financing test is met if more

than the lesser of 5 percent of the

‘‘proceeds’’ or $5 million of ‘‘sale

proceeds’’ is used to make or finance

loans to nongovernmental persons.

Commentators suggested that the

definition of proceeds for purposes of

the test should be consistent.

The final regulations apply the

general private activity bond definition

of ‘‘proceeds’’ to both parts of the test.

This approach reflects the view that

investment proceeds that are used to

make or finance loans should be taken

into account in determining whether the

private loan financing test is met.

2. Requirements for the ‘‘tax

assessment loan’’ exception. The

proposed regulations provide that a

number of special requirements apply to

the exception in Code section 141(c)(2)

from the private loan financing test for

loans that enable the borrower to

finance a governmental tax or

assessment of general application for a

specific essential governmental

function. Commentators suggested that

these requirements would improperly

restrict traditional special tax and

assessment tax-exempt financing for

governmental infrastructure in some

states.

In general, special state law

restrictions (for example, state

constitutional limitations on issuing

general obligation bonds) should not

necessarily foreclose state and local

governments from access to tax-exempt

financing for traditional governmental

infrastructure projects. Accordingly, the

final regulations relax the requirements

for the tax assessment bond exception.

The requirement that a tax or

assessment of general application be

proportionate to the benefit to the

taxpayer is deleted. Further, the

definition of improvements that serve

essential governmental functions is

expanded. Under the new definition, all

improvements to utilities and systems

that are owned by a governmental

person and that are available for use by

the general public serve essential

governmental functions for this

purpose. In addition, the final

regulations provide that guarantees

provided by persons treated as

borrowers in most cases will not cause

taxes or assessments to fail to qualify for

the tax assessment bond exception.

F. Section 1.141–6 Allocation and

accounting rules.

1. Allocations of proceeds to

expenditures. The proposed regulations

in general provide that proceeds must

be allocated to expenditures

consistently for private activity bond

purposes and arbitrage purposes.

Commentators suggested that, in light of

the different purposes of the private

activity bond rules and the arbitrage

rules, this consistency should not be

required.

The final regulations continue the

approach of the proposed regulations.

Final regulations are also adopted under

Code section 148 clarifying that

allocations of proceeds to expenditures

for both purposes must be made by a

definite time (in no event later than the

date that rebate is, or would be, due).

2. Other allocation rules. The

proposed regulations contain detailed

rules in §§ 1.141–1 and 1.141–6 for

allocations of proceeds and bonds,

including rules for mixed use facilities

and partnerships.

The final regulations reserve these

provisions. The IRS and Treasury are

considering more flexible rules to

accommodate public/private

partnerships.

G. Section 1.141–7 Special rules for

output contracts.

The proposed regulations contain

detailed rules in § 1.141–7 for

determining the private business use

and private payments resulting from

output contracts.

Regulatory changes are dramatically

affecting the electric power industry. In

order to further consider the issues

raised by these changes, the final

regulations reserve this section. The

final regulations, however, otherwise

apply to bonds issued to finance output

facilities.

H. Section 1.141–8 $15 million

limitation for output facilities.

Clarification of computation of

nonqualified amount. The proposed

regulations provide guidance on the

special $15 million limitation on output

facilities of Code section 141(b)(4). The

final regulations reserve this section.

I. Section 1.141–12 Remedial actions.

1. Remedial actions generally. The

proposed regulations provide that an

action that causes the private business

tests or the private loan financing test to

be met is not treated as a deliberate

action if the issuer takes an appropriate

remedial action.

The final regulations clarify that a

remedial action affects only compliance

with the private activity bond rules

relating to use of proceeds and does not

affect compliance with rules relating to

security or payment. This clarification is

important for purposes of determining

the amount of ‘‘nonqualified bonds’’

with respect to which a remedial action

must be taken.

2. Relationship of disposition

proceeds and remedial actions. The

proposed regulations contain separate

rules for use of proceeds derived from

the disposition of bond-financed

property (‘‘disposition proceeds’’) and

remedial actions. Commentators

suggested that the relationship between

the disposition proceeds rules and the

remedial action rules should be clarified

and that, in particular, additional rules

should be provided indicating when it

is appropriate to treat an issue as

financing disposition proceeds rather

than the transferred property.

The final regulations take the view

that, if an issuer disposes of bondfinanced property, it is generally

appropriate under Code section 141 for

the Commissioner to treat the issue as

financing either the transferred property

or the disposition proceeds. This is

because any disposition of bondfinanced property has the potential to

transfer the benefits of tax-exempt

financing to the purchaser, and the

private activity bond rules extend to

transactions that have significant

potential to transfer these benefits, as

well as transactions that actually

transfer these benefits. As a matter of

administrative convenience, however,

the final regulations in certain cases

permit an issuer to choose to treat an

issue as financing either the transferred

property or the disposition proceeds,

provided that certain conditions are met

that protect against abuse. The final

regulations accordingly treat the

disposition proceeds rules as conditions

to taking certain remedial actions. For
2280 Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Rules and Regulations

example, in order for an issue to be

eligible for a remedial action, the

disposition proceeds of an issue must

generally be treated as proceeds for

purposes of the arbitrage regulations.

3. Conditions to taking a remedial

action. The proposed regulations

provide that an issuer may take a

remedial action to prevent bonds of an

issue from becoming private activity

bonds only if it made certain covenants

and certifications on the issue date.

Commentators suggested that these

specific requirements should be deleted

because they are unnecessary in light of

standard industry practice to require

similar covenants and certifications.

The final regulations adopt this

comment.

4. Maturity limitations and remedial

actions. The proposed regulations

provide that an issuer cannot take

advantage of certain favorable rules

involving disposition proceeds if the

weighted average maturity of an issue is

greater than 120 percent of the

economic life of the financed property.

Commentators suggested that use of this

120 percent maturity limitation as a

condition to favorable treatment in

taking remedial actions is burdensome

for issuers of governmental bonds.

The final regulations provide that an

issue is eligible for the remedial action

rules only if the term of the issue is not

longer than is reasonably necessary for

the governmental purposes of the issue.

To determine whether the term of an

issue is unreasonably long, the final

regulations adopt the same standard that

is used for purposes of determining

whether replacement proceeds arise

because the term of an issue is

unreasonably long under § 1.148–

1(c)(4). This standard provides that the

120 percent maturity limitation is a safe

harbor, rather than a requirement in all

cases.

5. Special rules for identifying

disposition proceeds. Under the

proposed regulations, many of the rules

for remedial actions depend on

identification of disposition proceeds.

The final regulations clarify how

disposition proceeds are to be allocated

to an issue when the transferred

property has been financed with

different sources of funding. In general,

the final regulations provide that

disposition proceeds should be

allocated first to the outstanding bonds

that financed the property (both taxexempt and taxable) in proportion to the

outstanding principal amounts of those

outstanding bonds. Only amounts in

excess of these outstanding principal

amounts may be allocated to other

sources of funding, such as equity of an

issuer or bonds that are no longer

outstanding.

6. Redemption and defeasance as

remedial actions. The proposed

regulations generally provide that

redemption and defeasance of

nonqualified bonds are permitted

remedial actions. In cases where the

disposition is exclusively for cash, only

the disposition proceeds need to be

used to redeem or defease bonds; in

other cases, the entire amount of

nonqualified bonds is required to be

redeemed or defeased. The proposed

regulations also provide, however, that

defeasance of bonds to a date that is

more than six months from the date of

a deliberate action is permitted only if

the possibility of a disposition was

remote as of the issue date of the bonds.

Commentators suggested that this

special limitation should be deleted

because the remoteness standard is

vague and would require governmental

issuers to use special call provisions

that would substantially increase

borrowing costs.

The final regulations delete the

‘‘remote possibility’’ limitation on use of

defeasance as a remedial action. Instead,

the final regulations permit defeasance

as a remedial action only if the first call

date of the nonqualified bonds is not

greater than 101⁄2 years from the issue

date. This limitation presents an

administrable standard that will not

unduly interfere with customary

financing practices of state and local

governments, while at the same time

preventing improper use of defeasance

as a remedial action for bonds that

cannot be called for an extended period

of time.

7. Alternative qualifying use of a

facility as a remedial action. The

proposed regulations provide that

alternative qualifying use of a bondfinanced facility is a permitted remedial

action if the facility is used in a manner

that meets the requirements for any type

of qualified private activity bonds and

the bonds are treated as reissued as of

the date of the deliberate action for

purposes of the tax-exempt bond rules

concerning use of bond-financed

property. Commentators suggested that

for purposes of determining whether

bonds that are treated as reissued as of

the date of the deliberate action satisfy

all of the applicable requirements for

qualified bonds, the rules contained in

Code section 146 relating to volume cap

and the rules contained in Code sections

55 and 57 should not apply.

Commentators also suggested that the

regulations should clarify whether any

limitations are placed on an issuer’s use

of disposition proceeds when it chooses

to use this remedial action.

The final regulations provide that, in

order to qualify for this remedial action,

an issuer must deposit any disposition

proceeds that it receives into a yieldrestricted escrow to pay the

nonqualified bonds. This requirement is

different than the defeasance remedial

action, because an issuer is permitted to

leave bonds outstanding until maturity

(rather than the first call date) and is not

subject to the special 10 1⁄2-year call

protection limitation on the defeasance

remedial action. Also, if an issuer

chooses to use this rule, it may receive

compensation in installments and use

any payments received either to pay

debt service or to deposit into a yieldrestricted escrow to pay debt service.

This requirement is appropriate because

it establishes the necessary nexus

between the new user and the

nonqualified bonds. In effect, the new

user is treated, as far as is reasonably

practicable, as if it were the conduit

borrower of the bond proceeds.

The final regulations also clarify that,

for purposes of determining whether

nonqualified bonds that are deemed to

be reissued meet all of the requirements

for qualified private activity bonds, the

law in effect on the date of the

deliberate action applies. The final

regulations do not adopt the suggestion

that the rules contained in Code section

146 relating to volume cap and the rules

contained in Code sections 55 and 57

should not apply. The IRS and Treasury

are issuing a revenue procedure

(discussed in paragraph 10 below) to

address the change in status of bonds

from governmental bonds to qualified

private activity bonds and the

application of the alternative minimum

tax provisions. The final regulations

provide that the rules contained in Code

section 147(d) relating to the acquisition

of existing property do not apply to this

remedial action.

8. Nonqualified bonds. The proposed

regulations permit an issuer to take a

remedial action with respect to a

portion of the bonds of an issue, rather

than the entire issue. In general, the

proposed regulations require that these

‘‘nonqualified bonds’’ be a pro rata

portion (among the maturities) of the

outstanding bonds of an issue.

Commentators suggested that issuers

should have greater flexibility to

allocate uses of proceeds to bonds when

a deliberate action occurs.

The final regulations permit an issuer

to redeem or defease bonds with longer

maturities than the nonqualified bonds

in a remedial action, but in general

continue to require that nonqualified

bonds be identified on a pro rata basis.

Issuers have significant flexibility to

allocate bonds of an issue to separate
Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Rules and Regulations 2281

purposes on or before the issue date

under § 1.150–1(c)(3).

Under the final regulations, the

percentage of outstanding bonds that are

nonqualified bonds is equal to the

highest percentage of private business

use in any 1-year period commencing

with the deliberate action.

9. Effect of deliberate actions and

remedial actions on bonds that have

been advance refunded. The proposed

regulations do not specifically address

how deliberate actions and remedial

actions affect bonds that have been

advance refunded. Commentators

suggested that a deliberate action should

not affect the status of an advance

refunded bond under Code section 141.

The final regulations provide that a

remedial action taken with respect to

advance refunding bonds

proportionately ‘‘cures’’ the bonds that

have been advance refunded.

10. Remedial payment revenue

procedure. The preamble to the

proposed regulations indicates that the

IRS and Treasury are considering

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 IRS to prevent the

interest on bonds from being includible

in gross income of bondholders as a

result of a deliberate action that results

in satisfaction of the private activity

bond test. In general, the payment

would be based on the difference

between applicable federal rates for

taxable and tax-exempt obligations. The

preamble to the proposed regulations

indicates that this revenue procedure is

being considered in lieu of permitting

defeasance as a remedial action.

Commentators generally favored the

publication of such a revenue procedure

but suggested that it should apply in

addition to defeasance as a remedial

action.

Commentators also suggested that an

issuer should be permitted to make a

payment to the IRS in those cases where

the bonds were issued as governmental

bonds, the interest on which was not

treated as an item of tax preference for

purposes of the alternative minimum

tax provisions, but the bonds become

qualified private activity bonds, the

interest on which is treated as an item

of tax preference for purposes of the

alternative minimum tax provisions as a

consequence of a remedial action taken

by the issuer.

The IRS and Treasury are issuing a

revenue procedure in addition to

permitting defeasance as a remedial

action. Under this revenue procedure

the amount of the remedial payment is

based on a factor that roughly

approximates revenue loss to the United

States rather than the difference

between taxable and tax-exempt

applicable federal rates. While this

approach may in many cases require

greater remedial payments than under

the approach described in the proposed

regulations, the fluctuation in the

difference between taxable and taxexempt applicable federal rates would

result in inconsistent treatment of

issuers. Further, a more rigorous

standard for determining the remedial

payment is appropriate because the

revenue procedure is adopted in

addition to all of the remedial actions

set forth in the final regulations.

In response to comments, this revenue

procedure also provides that an issuer

may make a payment to prevent the

application of the alternative minimum

tax provisions to interest payable on

bonds that were issued as governmental

bonds but, as a consequence of a

remedial action taken by an issuer, are

qualified private activity bonds. This

approach recognizes the difficulty state

and local government issuers may have

in notifying bondholders of this change

in status.

J. Section 1.141–13 Refunding issues.

The final regulations reserve on the

treatment of refunding bonds under

Code section 141.

K. Section 1.141–14 Anti-abuse rules.

Application of the rule to override

specific tracing. The proposed

regulations provide that if an issuer

enters into a transaction or series of

transactions with a principal purpose of

transferring to nongovernmental persons

(other than as members of the general

public) significant benefits of taxexempt financing in a manner that is

inconsistent with the purposes of Code

section 141, the Commissioner may take

any action to reflect the substance of the

transaction or transactions.

The final regulations adopt this rule

and add examples to clarify that it may

be invoked in appropriate cases to

override specific tracing of the use of

proceeds.

L. Section 1.145–1 Special rules for

qualified 501(c)(3) bonds.

1. Application of private activity bond

rules to Code section 145(a). The

proposed regulations provide that the

regulations under Code section 141

interpreting the private activity bond

tests apply for purposes of Code section

145(a)(2).

The final regulations in general

continue this approach but also provide

that certain provisions under Code

section 141, which are intended to

apply only to governmental programs,

do not apply to qualified 501(c)(3)

bonds. The final regulations also clarify

that regulations under Code section 141

apply in the same manner to the

ownership test of Code section 145(a)(1)

and to the modified private activity

bond test of Code section 145(a)(2).

2. Application of deliberate action

and remedial action rules to other

provisions of Code section 145. The

proposed regulations provide that the

deliberate action rules of § 1.141–2 and

the remedial action rules of § 1.141–12

generally apply to Code section 145.

The final regulations do not apply to

Code sections 145(b), (c), or (d). The

$150 million limitation on bonds other

than hospital bonds of Code sections

145(b) and (c) involves a number of

special considerations, which the IRS

and Treasury believe would be more

appropriate to consider in a project

comprehensively interpreting the

operation of the special volume cap

rules. Similarly, the restrictions on

bonds used to provide residential rental

housing for family units of Code section

145(d) involve a number of special

considerations, which the IRS and

Treasury believe would be more

appropriate to consider in a project

comprehensively interpreting the

special rules for bonds financing

residential rental housing.

M. Special rules for other qualified

bonds.

1. General standard for compliance.

The proposed regulations provide that

the requirements for qualified bonds

(other than qualified 501(c)(3) bonds)

generally must be actually met

throughout the term of an issue.

Commentators suggested that this rule

should be deleted because the

compliance standard for each type of

qualified bond should be separately

considered. Other commentators

suggested that the compliance standard

applicable to governmental bonds,

looking to reasonable expectations and

deliberate actions, is generally

appropriate for qualified bonds.

The final regulations do not address

the general compliance standard for

qualified bonds (other than qualified

501(c)(3) bonds). The IRS and Treasury

believe that further consideration

should be given to whether special rules

apply to different types of qualified

bonds. Accordingly, the final

regulations address only whether

remedial actions may be taken to

prevent certain types of qualified bonds

from failing to meet requirements

relating to use of proceeds. Thus, no

implication is intended that the
2282 Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Rules and Regulations

measurement-over-the-term rule for

private business use under Code

sections 141 and 145 applies in any

manner to other qualified bonds.

2. Remedial actions for change in use.

The proposed regulations in general

provide that, if an action results in

nonqualified use of proceeds, the

remedial actions that apply to

governmental bonds also apply to

qualified bonds. The permitted remedial

actions include redemption and

defeasance of bonds and alternative

qualifying use of a facility.

The final regulations address only

whether remedial actions may be taken

for exempt facility bonds under Code

section 142 and qualified small issue

bonds under Code section 144(a) and

with respect to certain provisions of

147. The final regulations continue to

provide that redemption and defeasance

are permitted remedial actions for these

types of issues, under rules that are

similar to the remedial action rules that

apply to governmental bonds. The

requirements for these types of qualified

bonds focus on the use of a particular

facility for a particular qualifying use,

and, unlike governmental bonds and

qualified 501(c)(3) bonds, do not

generally focus on the status of the

borrower. For this reason, the final

regulations generally do not permit an

issuer of exempt facility bonds or

qualified small issue bonds to take a

remedial action based on use of

disposition proceeds. Accordingly, the

final regulations clarify that the amount

of bonds required to be redeemed or

defeased under a remedial action is not

limited to the amount of disposition

proceeds. For administrative

convenience, however, the final

regulations permit the use of disposition

proceeds from the sale of personal

property that is incidental to a

qualifying facility to replace the

personal property that is sold. The final

regulations do not permit alternative

qualifying use of a facility as a remedial

action for exempt facility bonds or

qualified small issue bonds.

3. Remedial actions for failure to

spend proceeds. The proposed

regulations provide that a remedial

action may be taken to correct a failure

to spend proceeds as required under

Code sections 142 and 144. This rule

replaces Rev. Proc. 79–5, 1979–1 C.B.

485, and Rev. Proc. 81–22, 1981–1 C.B.

692, which provide guidance on how

the requirement in the predecessor to

Code section 142 that substantially all of

the proceeds be spent for a qualifying

purpose is met when excess bond

proceeds remain on hand after

acquisition or construction has been

completed.

The final regulations clarify that the

requirements for remedial action in the

case of failure to spend proceeds for a

qualifying purpose are comparable to

the requirements for remedial action in

the case of change in use of a qualifying

facility. Accordingly, the final

regulations require that nonqualified

bonds must be redeemed at their first

call date, regardless of the amount of

call premium that is required to be paid,

and that defeasance is permitted only if

the first call date is no later than 101⁄2

years after the issue date.

4. Refundings of qualified bonds. The

final regulations reserve on the

treatment of refundings of qualified

bonds.

N. Section 1.150–4 Statutory change of

use rules for qualified private activity

bonds.

The proposed regulations provide that

the change of use provisions of Code

section 150(b) apply even if an issuer

takes a remedial action that enables an

issue of qualified private activity bonds

to continue to meet use of proceeds

requirements. Commentators suggested

that a remedial action that preserves the

tax-exempt status of a qualified private

activity bond should also prevent

application of the interest deduction

denial and imputed unrelated business

income provisions of Code section

150(b).

The final regulations more

specifically address the effect of each

type of remedial action on the

application of the Code section 150(b)

consequences. In general, defeasance of

bonds does not prevent application of

Code section 150(b). If other remedial

actions are taken promptly after the date

of the remedial action, however, Code

section 150(b) does not apply.

O. Effective dates.

The final regulations generally apply

to bonds issued after May 16, 1997. To

promote compliance, the final

regulations generally permit elective,

retroactive application of the regulations

in whole, but not in part, to outstanding

issues. In addition, the final regulations

permit elective, retroactive application

to outstanding issues of any of the

following sections of the regulations:

§1.141–12 (the remedial action rules);

§1.141–3(b)(4) (the management

contract rules); and §1.141–3(b)(6) (the

research agreement rules).

Effect on Other Documents

In part because the existing industrial

development bond regulations under

§1.103–7 may continue to apply to

refunding bonds issued after the

effective date of the private activity

bond regulations, §1.103–7 is not being

removed from the Code of Federal

Regulations.

For bonds to which the final

regulations apply, the following

publications are obsolete:

Notice 87–69, 1987–2 C.B. 378.

Notice 89–9, 1989–1 C.B. 630.

For actions that occur on or after May

16, 1997, the following publications are

obsolete:

Rev. Proc. 93–17, 1993–1 C.B. 507.

Rev. Proc. 81–22, 1981–1 C.B. 692.

Rev. Proc. 79–5, 1979–1 C.B. 485.

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) does not apply to these

regulations, and because the notice of

proposed rulemaking preceding the

regulations was issued prior to March

29, 1996, the Regulatory Flexibility Act

(5 U.S.C. chapter 6) does not apply.

Pursuant to section 7805(f) of the

Internal Revenue Code, the notice of

proposed rulemaking preceding these

regulations was submitted to the Chief

Counsel for Advocacy of the Small

Business Administration for comment

on its impact on small business.

Drafting Information

The principal authors of these

regulations are Michael G. Bailey,

Loretta J. Finger, and Nancy M.

Lashnits, Office of Assistant Chief

Counsel (Financial Institutions and

Products), and Linda B. Schakel of the

Office of Tax Legislative Counsel.

However, other personnel from the IRS

and Treasury Department participated

in their development.

List of Subjects

26 CFR Part 1

Income taxes, Reporting and

recordkeeping requirements.

26 CFR Part 602

Reporting and recordkeeping

requirements.

Adoption of Amendments to the

Regulations

Accordingly, 26 CFR parts 1 and 602

are 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 * * *
Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Rules and Regulations 2283

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). * * *

Par. 2. The center heading immediately

preceding §1.141–1 is revised to read as

follows:

Tax Exemption Requirements for State

and Local Bonds

Par. 3. Section 1.141–1 is revised.

§1.143–1 [Redesignated as §1.7703–1]

Par. 4. Section 1.143–1 is

redesignated as §1.7703–1.

§1.144–3 [Removed]

Par. 5. Section 1.144–3 is removed.

Par. 6. Sections 1.141–0 and 1.141–2

through 1.141–16 are added.

The revised and added sections read

as follows:

§1.141–0 Table of contents.

This section lists the captioned

paragraphs contained in §§ 1.141–1

through 1.141–16.

§1.141–1 Definitions and rules of general

application.

(a) In general.

(b) Certain general definitions.

(c) Elections.

(d) Related parties.

§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) Reasonable expectations test.

(3) Deliberate action defined.

(4) Special rule for dispositions of personal

property in the ordinary course of an

established governmental program.

(5) Special rule for general obligation bond

programs that finance a large number of

separate purposes.

(e) When a deliberate action occurs.

(f) Certain remedial actions.

(g) Examples.

§ 1.141–3 Definition of private business use.

(a) General rule.

(1) In general.

(2) Indirect use.

(3) Aggregation of private business use.

(b) Types of private business use

arrangements.

(1) In general.

(2) Ownership.

(3) Leases.

(4) Management contracts.

(5) Output contracts.

(6) Research agreements.

(7) Other actual or beneficial use.

(c) Exception for general public use.

(1) In general.

(2) Use on the same basis.

(3) Long-term arrangements not treated as

general public use.

(4) Relation to other use.

(d) Other exceptions.

(1) Agents.

(2) Use incidental to financing

arrangements.

(3) Exceptions for arrangements other than

arrangements resulting in ownership of

financed property by a nongovernmental

person.

(4) Temporary use by developers.

(5) Incidental use.

(6) Qualified improvements.

(e) Special rule for tax assessment bonds.

(f) Examples.

(g) Measurement of private business use.

(1) In general.

(2) Measurement period.

(3) Determining average percentage of

private business use.

(4) Determining the average amount of

private business use for a 1-year period.

(5) Common areas.

(6) Allocation of neutral costs.

(7) Commencement of measurement of

private business use.

(8) Examples.

§1.141–4 Private security or payment test.

(a) General rule.

(1) Private security or payment.

(2) Aggregation of private payments and

security.

(3) Underlying arrangement.

(b) Measurement of private payments and

security.

(1) Scope.

(2) 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.

(5) Payments in lieu of taxes.

(f) Certain waste remediation bonds.

(1) Scope.

(2) Persons that are not private users.

(3) Persons that are private users.

(g) Examples.

§1.141–5 Private loan financing test.

(a) In general.

(b) Measurement of test.

(c) Definition of private loan.

(1) In general.

(2) Application only to purpose

investments.

(3) Grants.

(4) Hazardous waste remediation bonds.

(d) Tax assessment loan 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.

(e) Examples.

§1.141–6 Allocation and accounting rules.

(a) Allocation of proceeds to expenditures.

(b) Allocation of proceeds to property.

[Reserved]

(c) Special rules for mixed use facilities.

[Reserved]

(d) Allocation of proceeds to common

areas. [Reserved]

(e) Allocation of proceeds to bonds.

[Reserved]

(f) Treatment of partnerships. [Reserved]

(g) Examples. [Reserved]

§ 1.141–7 Special rules for output contracts.

[Reserved]

§ 1.141–8 $15 million limitation for output

facilities.

[Reserved]

§ 1.141–9 Unrelated or disproportionate use

test.

(a) General rules.

(1) Description of test.

(2) Application of unrelated or

disproportionate use test.

(b) Unrelated use.

(1) In general.

(2) Use for the same purpose as

government use.

(c) Disproportionate use.

(1) Definition of disproportionate use.

(2) Aggregation of related uses.

(3) Allocation rule.

(d) Maximum use taken into account.

(e) Examples.

§ 1.141–10 Coordination with volume cap.

[Reserved]

§ 1.141–11 Acquisition of nongovernmental

output property.

[Reserved]

§ 1.141–12 Remedial actions.

(a) Conditions to taking remedial action.

(1) Reasonable expectations test met.

(2) Maturity not unreasonably long.

(3) Fair market value consideration.

(4) Disposition proceeds treated as gross

proceeds for arbitrage purposes.

(5) Proceeds expended on a governmental

purpose.

(b) Effect of a remedial action.

(1) In general.

(2) Effect on bonds that have been advance

refunded.

(c) Disposition proceeds.

(1) Definition.

(2) Allocating disposition proceeds to an

issue.

(3) Allocating disposition proceeds to

different sources of funding.

(d) Redemption or defeasance of

nonqualified bonds.

(1) In general.

(2) Special rule for dispositions for cash.

(3) Notice of defeasance.

(4) Special limitation.

(5) Defeasance escrow defined.

(e) Alternative use of disposition proceeds.

(1) In general.
2284 Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Rules and Regulations

(2) Special rule for use by 501(c)(3)

organizations.

(f) Alternative use of facility.

(g) Rules for deemed reissuance.

(h) Authority of Commissioner to provide

for additional remedial actions.

(i) Effect of remedial action on continuing

compliance.

(j) Nonqualified bonds.

(1) Amount of nonqualified bonds.

(2) Allocation of nonqualified bonds.

(k) Examples.

§ 1.141–13 Refunding issues.

[Reserved]

§ 1.141–14 Anti-abuse rules.

(a) Authority of Commissioner to reflect

substance of transactions.

(b) Examples.

§ 1.141–15 Effective dates.

(a) Scope.

(b) Effective dates.

(c) Refunding bonds.

(d) Permissive application of regulations.

(e) Permissive retroactive application of

certain sections.

§ 1.141–16 Effective dates for qualified

private activity bond provisions.

(a) Scope.

(b) Effective dates.

(c) Permissive application.

§ 1.141–1 Definitions and rules of general

application.

(a) In general. For purposes of

§§ 1.141–0 through 1.141–16, the

following definitions and rules apply:

the definitions in this section, the

definitions in § 1.150–1, the definition

of placed in service under § 1.150–2(c),

the definition of grant under § 1.148–

6(d)(4)(iii), the definition of reasonably

required reserve or replacement fund in

§ 1.148–2(f), and the following

definitions under § 1.148–1: bond year,

commingled fund, fixed yield issue,

higher yielding investments,

investment, investment proceeds, issue

price, issuer, nonpurpose investment,

purpose investment, qualified

guarantee, qualified hedge, reasonable

expectations or reasonableness, rebate

amount, replacement proceeds, sale

proceeds, variable yield issue, and

yield.

(b) Certain general 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.

Deliberate action is defined in

§ 1.141–2(d)(3).

Discrete portion means a portion of a

facility that consists of any separate and

discrete portion of a facility to which

use is limited, other than common areas.

A floor of a building and a portion of a

building separated by walls, partitions,

or other physical barriers are examples

of a discrete portion.

Disposition is defined in § 1.141–

12(c)(1).

Disposition proceeds is defined in

§ 1.141–12(c)(1).

Essential governmental function is

defined in § 1.141–5(d)(4)(ii).

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

§ 1.103–1 or any instrumentality thereof.

It does not include the United States or

any agency or instrumentality thereof.

Hazardous waste remediation bonds

is defined in § 1.141–4(f)(1).

Measurement period is defined in

§ 1.141–3(g)(2).

Nongovernmental person means a

person other than a governmental

person.

Output facility means electric and gas

generation, transmission, distribution,

and related facilities, and water

collection, storage, and 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 of

an issue (other than those sale proceeds

used to retire bonds of the issue that are

not deposited in a reasonably required

reserve or replacement fund). Proceeds

also include any investment proceeds

from investments that accrue during the

project period (net of rebate amounts

attributable to the project period).

Disposition proceeds of an issue are

treated as proceeds to the extent

provided in § 1.141–12. The

Commissioner may treat any replaced

amounts as proceeds.

Project period means the period

beginning on the issue date and ending

on the date that the project is placed in

service. 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 § 1.148–

2(e)(2) or the end of the fifth bond year

after the issue date.

Public utility property means public

utility property as defined in section

168(i)(10).

Qualified bond means a qualified

bond as defined in section 141(e).

Renewal option means a provision

under which either party has a legally

enforceable right to renew the contract.

Thus, for example, a provision under

which a contract is automatically

renewed for 1-year periods absent

cancellation by either party is not a

renewal option (even if it is expected to

be renewed).

Replaced amounts means

replacement proceeds other than

amounts that are treated as replacement

proceeds solely because they are sinking

funds or pledged funds.

Weighted average maturity is

determined under section 147(b).

Weighted average reasonably

expected economic life is determined

under section 147(b). The reasonably

expected economic life of property may

be determined by reference to the class

life of the property under section 168.

(c) 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.

(d) Related parties. Except as

otherwise provided, all related parties

are treated as one person and any

reference to ’’person’’ includes any

related party.

§ 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 taxexempt 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 1.141–0 through

1.141–16 apply generally for purposes

of the private activity bond limitations

under section 141.

(c) General definition of private

activity bond. Under section 141, bonds

are private activity bonds if they meet

either the private business use test and

private security or payment test of
Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Rules and Regulations 2285

section 141(b) or the private loan

financing test of section 141(c). The

private business use and private

security or payment tests are described

in §§ 1.141–3 and 1.141–4. The private

loan financing test is described in

§ 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 the private business tests or

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) Reasonable expectations test—(i)

In general. In general, the reasonable

expectations test must take into account

reasonable expectations about events

and actions over the entire stated term

of an issue.

(ii) Special rule for issues with

mandatory redemption provisions. An

action that is reasonably expected, as of

the issue date, to occur after the issue

date and to cause either the private

business tests or the private loan

financing test to be met may be

disregarded for purposes of those tests

if—

(A) The issuer reasonably expects, as

of the issue date, that the financed

property will be used for a

governmental purpose for a substantial

period before the action;

(B) The issuer is required to redeem

all nonqualifying bonds (regardless of

the amount of disposition proceeds

actually received) within 6 months of

the date of the action;

(C) The issuer does not enter into any

arrangement with a nongovernmental

person, as of the issue date, with respect

to that specific action; and

(D) The mandatory redemption of

bonds meets all of the conditions for

remedial action under § 1.141–12(a).

(3) Deliberate action defined—(i) In

general. Except as otherwise provided

in this paragraph (d)(3), 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.

(ii) Safe harbor exceptions. An action

is not treated as a deliberate action if—

(A) It would be treated as an

involuntary or compulsory conversion

under section 1033; or

(B) It is taken in response to a

regulatory directive made by the federal

government.

(4) Special rule for dispositions of

personal property in the ordinary course

of an established governmental

program—(i) In general. Dispositions of

personal property in the ordinary course

of an established governmental program

are not treated as deliberate actions if—

(A) The weighted average maturity of

the bonds financing that personal

property is not greater than 120 percent

of the reasonably expected actual use of

that property for governmental

purposes;

(B) The issuer reasonably expects on

the issue date that the fair market value

of that property on the date of

disposition will be not greater than 25

percent of its cost; and

(C) The property is no longer suitable

for its governmental purposes on the

date of disposition.

(ii) Reasonable expectations test. The

reasonable expectation that a

disposition described in paragraph

(d)(4)(i) of this section may occur in the

ordinary course while the bonds are

outstanding will not cause the issue to

meet the private activity bond tests if

the issuer is required to deposit

amounts received from the disposition

in a commingled fund with substantial

tax or other governmental revenues and

the issuer reasonably expects to spend

the amounts on governmental programs

within 6 months from the date of

commingling.

(iii) Separate issue treatment. An

issuer may treat the bonds properly

allocable to the personal property

eligible for this exception as a separate

issue under § 1.150–1(c)(3).

(5) Special rule for general obligation

bond programs that finance a large

number of separate purposes. The

determination of whether bonds of an

issue are private activity bonds may be

based solely on the issuer’s reasonable

expectations as of the issue date if all of

the requirements of paragraphs (d)(5) (i)

through (vii) of this section are met.

(i) The issue is an issue of general

obligation bonds of a general purpose

governmental unit that finances at least

25 separate purposes (as defined in

§ 1.150–1(c)(3)) and does not

predominantly finance fewer than 4

separate purposes.

(ii) The issuer has adopted a fund

method of accounting for its general

governmental purposes that makes

tracing the bond proceeds to specific

expenditures unreasonably burdensome.

(iii) The issuer reasonably expects on

the issue date to allocate all of the net

proceeds of the issue to capital

expenditures within 6 months of the

issue date and adopts reasonable

procedures to verify that net proceeds

are in fact so expended. A program to

randomly spot check that 10 percent of

the net proceeds were so expended

generally is a reasonable verification

procedure for this purpose.

(iv) The issuer reasonably expects on

the issue date to expend all of the net

proceeds of the issue before expending

proceeds of a subsequent issue of

similar general obligation bonds.

(v) The issuer reasonably expects on

the issue date that it will not make any

loans to nongovernmental persons with

the proceeds of the issue.

(vi) The issuer reasonably expects on

the issue date that the capital

expenditures that it could make during

the 6-month period beginning on the

issue date with the net proceeds of the

issue that would not meet the private

business tests are not less than 125

percent of the capital expenditures to be

financed with the net proceeds of the

issue.

(vii) The issuer reasonably expects on

the issue date that the weighted average

maturity of the issue is not greater than

120 percent of the weighted average

reasonably expected economic life of

the capital expenditures financed with

the issue. To determine reasonably

expected economic life for this purpose

an issuer may use reasonable estimates

based on the type of expenditures made

from a fund.

(e) When a deliberate action occurs. A

deliberate action occurs on the date the

issuer enters into a binding contract

with a nongovernmental person for use

of the financed property that is not

subject to any material contingencies.

(f) Certain remedial actions. See

§ 1.141–12 for certain remedial actions

that prevent a deliberate action with

respect to property financed by an issue

from causing that issue to meet the

private business use test or the private

loan financing test.

(g) Examples. The following examples

illustrate the application of this section:

Example 1. Involuntary action. 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. See,

however, § 1.141–14(b), Example 2.

Example 2. Reasonable expectations test—

involuntary action. The facts are the same as

in Example 1, except that, on the issue date,

B reasonably expects that the federal

government will acquire the land in a

condemnation action during the term of the

bonds. On the issue date, the present value

of the amount that B reasonably expects to
2286 Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Rules and Regulations

receive from the federal government is

greater than 10 percent of the present value

of the debt service on the bonds. The terms

of the bonds do not require that the bonds

be redeemed within 6 months of the

acquisition by the federal government. The

bonds are private activity bonds because the

issuer expects as of the issue date that the

private business tests will be met.

Example 3. Reasonable expectations test—

mandatory redemption. City C issues bonds

to rehabilitate an existing hospital that it

currently owns. On the issue date of the

bonds, C reasonably expects that the hospital

will be used for a governmental purpose for

a substantial period. On the issue date, C also

plans to construct a new hospital, but the

placed in service date of that new hospital is

uncertain. C reasonably expects that, when

the new hospital is placed in service, it will

sell or lease the rehabilitated hospital to a

private hospital corporation. The bond

documents require that the bonds must be

redeemed within 6 months of the sale or

lease of the rehabilitated hospital (regardless

of the amount actually received from the

sale). The bonds meet the reasonable

expectations requirement of the private

activity bond tests if the mandatory

redemption of bonds meets all of the

conditions for a remedial action under

§ 1.141–12(a).

Example 4. Dispositions in the ordinary

course of an established governmental

program. City D issues bonds with a

weighted average maturity of 6 years for the

acquisition of police cars. D reasonably

expects on the issue date that the police cars

will be used solely by its police department,

except that, in the ordinary course of its

police operations, D sells its police cars to a

taxicab corporation after 5 years of use

because they are no longer suitable for police

use. Further, D reasonably expects that the

value of the police cars when they are no

longer suitable for police use will be no more

than 25 percent of cost. D subsequently sells

20 percent of the police cars after only 3

years of actual use. At that time, D deposits

the proceeds from the sale of the police cars

in a commingled fund with substantial tax

revenues and reasonably expects to spend the

proceeds on governmental programs within 6

months of the date of deposit. D does not

trace the actual use of these commingled

amounts. The sale of the police cars does not

cause the private activity bond tests to be met

because the requirements of paragraph (d)(4)

of this section are met.

§ 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 of a

nongovernmental person. For this

purpose, the use of financed property is

treated as the direct use of proceeds.

Any activity carried on by a person

other than a natural person is treated as

a trade or business. Unless the context

or a provision clearly requires

otherwise, 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 certain 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, it is necessary to look

to both the indirect and direct uses of

proceeds. For example, a facility is

treated as being used for a private

business use if it is leased to a

nongovernmental person and subleased

to a governmental person or if it is

leased to a governmental person and

then subleased to a nongovernmental

person, provided that in each case the

nongovernmental person’s use is in a

trade or business. Similarly, 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 if a

nongovernmental person, as a result of

a single transaction or a series of related

transactions, uses property acquired

with the proceeds of an issue.

(3) Aggregation of private business

use. The use of proceeds by all

nongovernmental persons is aggregated

to determine whether the private

business use test is met.

(b) Types of private business use

arrangements—(1) In general. Both

actual and beneficial use by a

nongovernmental person may be treated

as private business use. In most cases,

the private business use test is met only

if a nongovernmental person has special

legal entitlements to use the financed

property under an arrangement with the

issuer. In general, a nongovernmental

person is treated as a private business

user of proceeds and financed property

as a result of ownership; actual or

beneficial use of property pursuant to a

lease, or a management or incentive

payment contract; or certain other

arrangements such as a take or pay or

other output-type contract.

(2) Ownership. Except as provided in

paragraph (d)(1) or (d)(2) of this section,

ownership by a nongovernmental

person of financed property is private

business use of that property. For this

purpose, ownership refers to ownership

for federal income tax purposes.

(3) Leases. Except as provided in

paragraph (d) of this section, the lease

of financed property to a

nongovernmental person is private

business use of that property. For this

purpose, any arrangement that is

properly characterized as a lease for

federal income tax purposes is treated as

a lease. In determining whether a

management contract is properly

characterized as a lease, it is necessary

to consider all of the facts and

circumstances, including the following

factors—

(i) The degree of control over the

property that is exercised by a

nongovernmental person; and

(ii) Whether a nongovernmental

person bears risk of loss of the financed

property.

(4) Management contracts—(i) Facts

and circumstances test. Except as

provided in paragraph (d) of this

section, a management contract (within

the meaning of paragraph (b)(4)(ii) of

this section) with respect to financed

property may result in private business

use of that property, based on all of the

facts and circumstances. A management

contract with respect to financed

property generally results in private

business use of that property if the

contract provides for compensation for

services rendered with compensation

based, in whole or in part, on a share

of net profits from the operation of the

facility.

(ii) Management contract defined. For

purposes of this section, a management

contract is 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 contract for the

provision of management services for an

entire hospital, a contract for

management services for a specific

department of a hospital, and an

incentive payment contract for

physician services to patients of a

hospital are each treated as a

management contract.

(iii) Arrangements generally not

treated as management contracts. The

arrangements described in paragraphs

(b)(4)(iii) (A) through (D) of this section

generally are not treated as management

contracts that give rise to private

business use.

(A) Contracts for services that are

solely incidental to the primary

governmental function or functions of a

financed facility (for example, contracts

for janitorial, office equipment repair,

hospital billing, or similar services).

(B) The mere granting of admitting

privileges by a hospital to a doctor, even

if those privileges are conditioned on

the provision of de minimis services, if

those privileges are available to all
Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Rules and Regulations 2287

qualified physicians in the area,

consistent with the size and nature of its

facilities.

(C) A contract to provide for the

operation of a facility or system of

facilities that consists predominantly of

public utility property, if the only

compensation is the reimbursement of

actual and direct expenses of the service

provider and reasonable administrative

overhead expenses of the service

provider.

(D) A contract to provide for services,

if the only compensation is the

reimbursement of the service provider

for actual and direct expenses paid by

the service provider to unrelated parties.

(iv) Management contracts that are

properly treated as other types of private

business use. A management contract

with respect to financed property results

in private business use of that property

if the service provider is treated as the

lessee or owner of financed property for

federal income tax purposes, unless an

exception under paragraph (d) of this

section applies to the arrangement.

(5) Output contracts. See § 1.141–7 for

special rules for contracts for the

purchase of output of output facilities.

(6) Research agreements—(i) Facts

and circumstances test. Except 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 private business

use of the property used for the

research, based on all of the facts and

circumstances.

(ii) Research agreements that are

properly treated as other types of private

business use. A research agreement with

respect to financed property results in

private business use of that property if

the sponsor is treated as the lessee or

owner of financed property for federal

income tax purposes, unless an

exception under paragraph (d) of this

section applies to the arrangement.

(7) Other actual or beneficial use—(i)

In general. Any other arrangement that

conveys special legal entitlements for

beneficial use of bond proceeds or of

financed property that are comparable

to special legal entitlements described

in paragraphs (b) (2), (3), (4), (5), or (6)

of this section results in private

business use. For example, an

arrangement that conveys priority rights

to the use or capacity of a facility

generally results in private business use.

(ii) Special rule for facilities not used

by the general public. In the case of

financed property that is not available

for use by the general public (within the

meaning of paragraph (c) of this

section), private business use may be

established solely on the basis of a

special economic benefit to one or more

nongovernmental persons, even if those

nongovernmental persons have no

special legal entitlements to use of the

property. In determining whether

special economic benefit gives rise to

private business use it is necessary to

consider all of the facts and

circumstances, including one or more of

the following factors—

(A) Whether the financed property is

functionally related or physically

proximate to property used in the trade

or business of a nongovernmental

person;

(B) Whether only a small number of

nongovernmental persons receive the

special economic benefit; and

(C) Whether the cost of the financed

property is treated as depreciable by any

nongovernmental person.

(c) Exception for general public use—

(1) In general. Use as a member of the

general public (general public use) is

not private business use. Use of

financed property by nongovernmental

persons in their trades or businesses is

treated as general public use only if the

property is intended to be available and

in fact is reasonably available for use on

the same basis by natural persons not

engaged in a trade or business.

(2) Use on the same basis. In general,

use under an arrangement that conveys

priority rights or other preferential

benefits is not use on the same basis as

the general public. 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—

(i) Different rates apply to different

classes of users, such as volume

purchasers, if the differences in rates are

customary and reasonable; or

(ii) A specially negotiated rate

arrangement is entered into, but only if

the user is prohibited by federal law

from paying the generally applicable

rates, and the rates established are as

comparable as reasonably possible to

the generally applicable rates.

(3) Long-term arrangements not

treated as general public use. An

arrangement is not treated as general

public use if the term of the use under

the arrangement, including all renewal

options, is greater than 180 days. For

this purpose, a right of first refusal to

renew use under the arrangement is not

treated as a renewal option if—

(i) The compensation for the use

under the arrangement is redetermined

at generally applicable, fair market

value rates that are in effect at the time

of renewal; and

(ii) The use of the financed property

under the same or similar arrangements

is predominantly by natural persons

who are not engaged in a trade or

business.

(4) Relation to other use. Use of

financed property by the general public

does not prevent the proceeds from

being used for a private business use

because of other use under this section.

(d) Other exceptions—(1) Agents. Use

of proceeds by nongovernmental

persons solely in their capacity as

agents of a governmental person is not

private business use. For example, use

by a nongovernmental person that

issues obligations on behalf of a

governmental person is not private

business use to the extent the

nongovernmental person’s use of

proceeds is in its capacity as an agent

of the governmental person.

(2) Use incidental to financing

arrangements. Use by a

nongovernmental person that is solely

incidental to a financing arrangement is

not private business use. A use is solely

incidental to a financing arrangement

only if the nongovernmental person has

no substantial rights to use bond

proceeds or financed property other

than as an agent of the bondholders. For

example, a nongovernmental person

that acts solely as an owner of title in

a sale and leaseback financing

transaction with a city generally is not

a private business user of the property

leased to the city, provided that the

nongovernmental person has assigned

all of its rights to use the leased facility

to the trustee for the bondholders upon

default by the city. Similarly, bond

trustees, servicers, and guarantors are

generally not treated as private business

users.

(3) Exceptions for arrangements other

than arrangements resulting in

ownership of financed property by a

nongovernmental person—(i)

Arrangements not available for use on

the same basis by natural persons not

engaged in a trade or business. Use by

a nongovernmental person pursuant to

an arrangement, other than an

arrangement resulting in ownership of

financed property by a

nongovernmental person, is not private

business use if—

(A) The term of the use under the

arrangement, including all renewal

options, is not longer than 90 days;

(B) The arrangement would be treated

as general public use, except that it is

not available for use on the same basis

by natural persons not engaged in a

trade or business because generally

applicable and uniformly applied rates
2288 Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Rules and Regulations

are not reasonably available to natural

persons not engaged in a trade or

business; and

(C) The property is not financed for a

principal purpose of providing that

property for use by that

nongovernmental person.

(ii) Negotiated arm’s-length

arrangements. Use by a

nongovernmental person pursuant to an

arrangement, other than an arrangement

resulting in ownership of financed

property by a nongovernmental person,

is not private business use if—

(A) The term of the use under the

arrangement, including all renewal

options, is not longer than 30 days;

(B) The arrangement is a negotiated

arm’s-length arrangement, and

compensation under the arrangement is

at fair market value; and

(C) The property is not financed for a

principal purpose of providing that

property for use by that

nongovernmental person.

(4) Temporary use by developers. Use

during an initial development period by

a developer of an improvement that

carries out an essential governmental

function is not private business use if

the issuer and the developer reasonably

expect on the issue date to proceed with

all reasonable speed to develop the

improvement and property benefited by

that improvement and to transfer the

improvement to a governmental person,

and if the improvement is in fact

transferred to a governmental person

promptly after the property benefited by

the improvement is developed.

(5) Incidental use—(i) General rule.

Incidental uses of a financed facility are

disregarded, to the extent that those

uses do not exceed 2.5 percent of the

proceeds of the issue used to finance the

facility. A use of a facility by a

nongovernmental person is incidental

if—

(A) Except for vending machines, pay

telephones, kiosks, and similar uses, the

use does not involve the transfer to the

nongovernmental person of possession

and control of 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 displays, and use

for television cameras, but incidental

uses may not include output purchases.

(6) 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 1 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); and

(iv) No more than 15 percent of the

improved building is used for a private

business use.

(e) Special rule for tax assessment

bonds. In the case of a tax assessment

bond that satisfies the requirements of

§1.141–5(d), 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 met. However, the

use of the loan proceeds is not

disregarded in determining whether the

private business use test is met.

(f) Examples. The following examples

illustrate the application of paragraphs

(a) through (e) of this section. In each

example, assume that the arrangements

described are the only arrangements

with nongovernmental persons for use

of the financed property.

Example 1. Nongovernmental ownership.

State A issues 20-year bonds to purchase

land and equip and construct a factory. A

then enters into an arrangement with

Corporation X to sell the factory to X on an

installment basis while the bonds are

outstanding. The issue meets the private

business use test because a nongovernmental

person owns the financed facility. See also

§ 1.141–2 (relating to the private activity

bond tests), and § 1.141–5 (relating to the

private loan financing test).

Example 2. Lease to a nongovernmental

person. (i) The facts are the same as in

Example 1, except that A enters into an

arrangement with X to lease the factory to X

for 3 years rather than to sell it to X. The

lease payments will be made annually and

will be based on the tax-exempt interest rate

on the bonds. The issue meets the private

business use test because a nongovernmental

person leases the financed facility. See also

§ 1.141–14 (relating to anti-abuse rules).

(ii) The facts are the same as in Example

2(i), except that the annual payments made

by X will equal fair rental value of the facility

and exceed the amount necessary to pay debt

service on the bonds for the 3 years of the

lease. The issue meets the private business

use test because a nongovernmental person

leases the financed facility and the test does

not require that the benefits of tax-exempt

financing be passed through to the

nongovernmental person.

Example 3. Management contract in

substance a lease. City L issues 30-year

bonds to finance the construction of a city

hospital. L enters into a 15-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 provides for reasonable fixed

compensation to M for services rendered

with no compensation based, in whole or in

part, on a share of net profits from the

operation of the hospital. However, the

contract also provides that 30 percent of the

capacity of the hospital will be exclusively

available to M’s members and M will bear the

risk of loss of that portion of the capacity of

the hospital so that, under all of the facts and

circumstances, the contract is properly

characterized as a lease for federal income

tax purposes. The issue meets the private

business use test because a nongovernmental

person leases the financed facility.

Example 4. Ownership of title in substance

a leasehold interest. Nonprofit corporation R

issues bonds on behalf of City P to finance

the construction of a hospital. R will own

legal title to the hospital. In addition, R will

operate the hospital, but R is not treated as

an agent of P in its capacity as operator of

the hospital. P has certain rights to the

hospital that establish that it is properly

treated as the owner of the property for

federal income tax purposes. P does not have

rights, however, to directly control operation

of the hospital while R owns legal title to it

and operates it. The issue meets the private

business use test because the arrangement

provides a nongovernmental person an

interest in the financed facility that is

comparable to a leasehold interest. See

paragraphs (a)(2) and (b)(7)(i) of this section.

Example 5. Rights to control use of

property treated as private business use—

parking lot. Corporation C and City D enter

into a plan to finance the construction of a

parking lot adjacent to C’s factory. Pursuant

to the plan, C conveys the site for the parking

lot to D for a nominal amount, subject to a

covenant running with the land that the

property be used only for a parking lot. In

addition, D agrees that C will have the right

to approve rates charged by D for use of the

parking lot. D issues bonds to finance

construction of the parking lot on the site.

The parking lot will be available for use by

the general public on the basis of rates that

are generally applicable and uniformly

applied. The issue meets the private business

use test because a nongovernmental person

has special legal entitlements for beneficial

use of the financed facility that are

comparable to an ownership interest. See

paragraph (b)(7)(i) of this section.

Example 6. Other actual or beneficial use—

hydroelectric enhancements. J, a political

subdivision, owns and operates a

hydroelectric generation plant and related

facilities. Pursuant to a take or pay contract,

J sells 15 percent of the output of the plant
Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Rules and Regulations 2289

to Corporation K, an investor-owned utility.

K is treated as a private business user of the

plant. Under the license issued to J for

operation of the plant, J is required by federal

regulations to construct and operate various

facilities for the preservation of fish and for

public recreation. J issues its obligations to

finance the fish preservation and public

recreation facilities. K has no special legal

entitlements for beneficial use of the

financed facilities. The fish preservation

facilities are functionally related to the

operation of the plant. The recreation

facilities are available to natural persons on

a short-term basis according to generally

applicable and uniformly applied rates.

Under paragraph (c) of this section, the

recreation facilities are treated as used by the

general public. Under paragraph (b)(7) of this

section, K’s use is not treated as private

business use of the recreation facilities

because K has no special legal entitlements

for beneficial use of the recreation facilities.

The fish preservation facilities are not of a

type reasonably available for use on the same

basis by natural persons not engaged in a

trade or business. Under all of the facts and

circumstances (including the functional

relationship of the fish preservation facilities

to property used in K’s trade or business)

under paragraph (b)(7)(ii) of this section, K

derives a special economic benefit from the

fish preservation facilities. Therefore, K’s

private business use may be established

solely on the basis of that special economic

benefit, and K’s use of the fish preservation

facilities is treated as private business use.

Example 7. Other actual or beneficial use—

pollution control facilities. City B issues

obligations to finance construction of a

specialized pollution control facility on land

that it owns adjacent to a factory owned by

Corporation N. B will own and operate the

pollution control facility, and N will have no

special legal entitlements to use the facility.

B, however, reasonably expects that N will be

the only user of the facility. The facility will

not be reasonably available for use on the

same basis by natural persons not engaged in

a trade or business. Under paragraph (b)(7)(ii)

of this section, because under all of the facts

and circumstances the facility is functionally

related and is physically proximate to

property used in N’s trade or business, N

derives a special economic benefit from the

facility. Therefore, N’s private business use

may be established solely on the basis of that

special economic benefit, and N’s use is

treated as private business use of the facility.

See paragraph (b)(7)(ii) of this section.

Example 8. General public use—airport

runway. (i) City I issues 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, including general

aviation operators who are natural persons

not engaged in a trade or business. It is

reasonably expected that most of the actual

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.

These leases for the use of terminal space

provide no priority rights or other

preferential benefits to the air carriers for use

of the runway. Moreover, under the leases

the lease payments are determined without

taking into account the revenues generated

by runway landing fees (that is, the lease

payments are not determined on a ‘‘residual’’

basis). Although the lessee air carriers receive

a special economic benefit from the use of

the runway, this economic benefit is not

sufficient to cause the air carriers to be

private business users, because the runway is

available for general public use. The issue

does not meet the private business use test.

See paragraphs (b)(7)(ii) and (c) of this

section.

(ii) The facts are the same as in Example

8(i), except that the runway will be available

for use only by private air carriers. The use

by these private air carriers is not for general

public use, because the runway is not

reasonably available for use on the same

basis by natural persons not engaged in a

trade or business. Depending on all of the

facts and circumstances, including whether

there are only a small number of lessee

private air carriers, the issue may meet the

private business use test solely because the

private air carriers receive a special economic

benefit from the runway. See paragraph

(b)(7)(ii) of this section.

(iii) The facts are the same as in Example

8(i), except that the lease payments under the

leases with the private air carriers are

determined on a residual basis by taking into

account the net revenues generated by

runway landing fees. These leases cause the

private business use test to be met with

respect to the runway because they are

arrangements that convey special legal

entitlements to the financed facility to

nongovernmental persons. See paragraph

(b)(7)(i) of this section.

Example 9. General public use—airport

parking garage. City S issues bonds and uses

all of the proceeds to finance construction of

a city-owned parking garage at the cityowned airport. S reasonably expects that

more than 10 percent of the actual use of the

parking garage will be by employees of

private air carriers (both charter airlines and

commercial airlines) in connection with their

use of the airport terminals leased by those

carriers. The air carriers’ use of the parking

garage, however, will be on the same basis as

passengers and other members of the general

public using the airport. The leases for the

use of the terminal space provide no priority

rights to the air carriers for use of the parking

garage, and the lease payments are

determined without taking into account the

revenues generated by the parking garage.

Although the lessee air carriers receive a

special economic benefit from the use of the

parking garage, this economic benefit is not

sufficient to cause the air carriers to be

private business users, because the parking

garage is available for general public use. The

issue does not meet the private business use

test. See paragraphs (b)(7)(ii) and (c) of this

section.

Example 10. Long-term arrangements not

treated as general public use—insurance

fund. Authority T deposits all of the proceeds

of its bonds in its insurance fund and invests

all of those proceeds in tax-exempt bonds.

The insurance fund provides insurance to a

large number of businesses and natural

persons not engaged in a trade or business.

Each participant receives insurance for a

term of 1 year. The use by the participants,

other than participants that are natural

persons not engaged in a trade or business,

is treated as private business use of the

proceeds of the bonds because the

participants have special legal entitlements

to the use of bond proceeds, even though the

contractual rights are not necessarily

properly characterized as ownership,

leasehold, or similar interests listed in

paragraph (b) of this section. Use of the bond

proceeds is not treated as general public use

because the term of the insurance is greater

than 180 days. See paragraphs (b)(7)(i) and

(c)(3) of this section.

Example 11. General public use—port

road. Highway Authority W uses all of the

proceeds of its bonds to construct a 25-mile

road to connect an industrial port owned by

Corporation Y with existing roads owned and

operated by W. Other than the port, the

nearest residential or commercial

development to the new road is 12 miles

away. There is no reasonable expectation that

development will occur in the area

surrounding the new road. W and Y enter

into no arrangement (either by contract or

ordinance) that conveys special legal

entitlements to Y for the use of the road. Use

of the road will be available without

restriction to all users, including natural

persons who are not engaged in a trade or

business. The issue does not meet the private

business use test because the road is treated

as used only by the general public.

Example 12. General public use of

governmentally owned hotel. State Q issues

bonds to purchase land and construct a hotel

for use by the general public (that is, tourists,

visitors, and business travelers). The bond

documents provide that Q will own and

operate the project for the term of the bonds.

Q will not enter into a lease or license with

any user for use of rooms for a period longer

than 180 days (although users may actually

use rooms for consecutive periods in excess

of 180 days). 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 the hotel is intended

to be available and in fact is reasonably

available for use on the same basis by natural

persons not engaged in a trade or business.

See paragraph (c)(1) of this section.

Example 13. General public use with rights

of first refusal. Authority V uses all of the

proceeds of its bonds to construct a parking

garage. At least 90 percent of the spaces in

the garage will be available to the general

public on a monthly first-come, first-served

basis. V reasonably expects that the spaces

will be predominantly leased to natural

persons not engaged in a trade or business

who have priority rights to renew their

spaces at then current fair market value rates.

More than 10 percent of the spaces will be

leased to nongovernmental persons acting in

a trade or business. These leases are not

treated as arrangements with a term of use
2290 Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Rules and Regulations

greater than 180 days. The rights to renew are

not treated as renewal options because the

compensation for the spaces is redetermined

at generally applicable, fair market value

rates that will be in effect at the time of

renewal and the use of the spaces under

similar arrangements is predominantly by

natural persons who are not engaged in a

trade or business. The issue does not meet

the private business use test because at least

90 percent of the use of the parking garage

is general public use. See paragraph (c)(3) of

this section.

Example 14. General public use with a

specially negotiated rate agreement with

agency of 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 specially negotiated

rate agreement. Under the specially

negotiated rate agreement, 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. F is prohibited by

federal law from paying for the services

based on those standard district charges and

tax levies. The use of G’s facilities by F is on

the same basis as the general public. See

paragraph (c)(2)(ii) of this section.

Example 15. Arrangements not available

for use by natural persons not engaged in a

trade or business—federal use of prisons.

Authority E uses all of the proceeds of its

bonds to construct a prison. E contracts with

federal agency F to house federal prisoners

on a space-available, first-come, first-served

basis, pursuant to which F will be charged

approximately the same amount for each

prisoner as other persons that enter into

similar transfer agreements. It is reasonably

expected that other persons will enter into

similar agreements. The term of the use

under the contract is not longer than 90 days,

and F has no right to renew, although E

reasonably expects to renew the contract

indefinitely. The prison is not financed for a

principal purpose of providing the prison for

use by F. It is reasonably expected that

during the term of the bonds, more than 10

percent of the prisoners at the prison will be

federal prisoners. F’s use of the facility is not

general public use because this type of use

(leasing space for prisoners) is not available

for use on the same basis by natural persons

not engaged in a trade or business. The issue

does not meet the private business use test,

however, because the leases satisfy the

exception of paragraph (d)(3)(i) of this

section.

Example 16. Negotiated arm’s-length

arrangements—auditorium reserved in

advance. (i) City Z issues 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. Z reasonably

expects that the auditorium will be used by

schools, church groups, sororities, and

numerous commercial organizations.

Corporation H, a nongovernmental person,

enters into an arm’s-length arrangement with

Z to use the auditorium for 1 week for each

year for a 10-year period (a total of 70 days),

pursuant to which H will be charged a

specific price reflecting fair market value. On

the date the contract is entered into, Z has

not established generally applicable rates for

future years. Even though the auditorium is

not financed for a principal purpose of

providing use of the auditorium to H, H is

not treated as using the auditorium as a

member of the general public because its use

is not on the same basis as the general public.

Because the term of H’s use of the auditorium

is longer than 30 days, the arrangement does

not meet the exception under paragraph

(d)(3)(ii) of this section.

(ii) The facts are the same as in Example

16(i), except that H will enter into an arm’slength arrangement with Z to use the

auditorium for 1 week for each year for a 4-

year period (a total of 28 days), pursuant to

which H will be charged a specific price

reflecting fair market value. H is not treated

as a private business user of the auditorium

because its contract satisfies the exception of

paragraph (d)(3)(ii) of this section for

negotiated arm’s-length arrangements.

(g) Measurement of private business

use—(1) In general. In general, the

private business use of proceeds is

allocated to property under §1.141–6.

The amount of private business use of

that property is determined according to

the average percentage of private

business use of that property during the

measurement period.

(2) Measurement period—(i) General

rule. Except as provided in this

paragraph (g)(2), the measurement

period of property financed by an issue

begins on the later of the issue date of

that issue or the date the property is

placed in service and ends on the earlier

of the last date of the reasonably

expected economic life of the property

or the latest maturity date of any bond

of the issue financing the property

(determined without regard to any

optional redemption dates). In general,

the period of reasonably expected

economic life of the property for this

purpose is based on reasonable

expectations as of the issue date.

(ii) Special rule for refundings of

short-term obligations. For an issue of

short-term obligations that the issuer

reasonably expects to refund with a

long-term financing (such as bond

anticipation notes), the measurement

period is based on the latest maturity

date of any bond of the last refunding

issue with respect to the financed

property (determined without regard to

any optional redemption dates).

(iii) Special rule for reasonably

expected mandatory redemptions. If an

issuer reasonably expects on the issue

date that an action will occur during the

term of the bonds to cause either the

private business tests or the private loan

financing test to be met and is required

to redeem bonds to meet the reasonable

expectations test of §1.141–2(d)(2), the

measurement period ends on the

reasonably expected redemption date.

(iv) Special rule for ownership by a

nongovernmental person. The amount

of private business use resulting from

ownership by a nongovernmental

person is the greatest percentage of

private business use in any 1-year

period.

(v) Anti-abuse rule. If an issuer

establishes the term of an issue for a

period that is longer than is reasonably

necessary for the governmental

purposes of the issue for a principal

purpose of increasing the permitted

amount of private business use, the

Commissioner may determine the

amount of private business use

according to the greatest percentage of

private business use in any 1-year

period.

(3) Determining average percentage of

private business use. The average

percentage of private business use is the

average of the percentages of private

business use during the 1-year periods

within the measurement period.

Appropriate adjustments must be made

for beginning and ending periods of less

than 1 year.

(4) Determining the average amount

of private business use for a 1-year

period—(i) In general. The percentage of

private business use of property for any

1-year period is the average private

business use during that year. This

average is determined by comparing the

amount of private business use during

the year to the total amount of private

business use and use that is not private

business use (government use) during

that year. Paragraphs (g)(4) (ii) through

(v) of this section apply to determine the

average amount of private business use

for a 1-year period.

(ii) Uses at different times. For a

facility in which actual government use

and private business use occur at

different times (for example, different

days), the average amount of private

business use generally is based on the

amount of time that the facility is used

for private business use as a percentage

of the total time for all actual use. In

determining the total amount of actual

use, periods during which the facility is

not in use are disregarded.

(iii) Simultaneous use. In general, for

a facility in which government use and

private business use occur

simultaneously, the entire facility is

treated as having private business use.

For example, a governmentally owned

facility that is leased or managed by a

nongovernmental person in a manner
Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Rules and Regulations 2291

that results in private business use is

treated as entirely used for a private

business use. If, however, there is also

private business use and actual

government use on the same basis, the

average amount of private business use

may be determined on a reasonable

basis that properly reflects the

proportionate benefit to be derived by

the various users of the facility (for

example, reasonably expected fair

market value of use). For example, the

average amount of private business use

of a garage with unassigned spaces that

is used for government use and private

business use is generally based on the

number of spaces used for private

business use as a percentage of the total

number of spaces.

(iv) Discrete portion. For purposes of

this paragraph (g), measurement of the

use of proceeds allocated to a discrete

portion of a facility is determined by

treating that discrete portion as a

separate facility.

(v) Relationship to fair market value.

For purposes of paragraphs (g)(4) (ii)

through (iv) of this section, if private

business use is reasonably expected as

of the issue date to have a significantly

greater fair market value than

government use, the average amount of

private business use must be

determined according to the relative

reasonably expected fair market values

of use rather than another measure, such

as average time of use. This

determination of relative fair market

value may be made as of the date the

property is acquired or placed in service

if making this determination as of the

issue date is not reasonably possible (for

example, if the financed property is not

identified on the issue date). In general,

the relative reasonably expected fair

market value for a period must be

determined by taking into account the

amount of reasonably expected

payments for private business use for

the period in a manner that properly

reflects the proportionate benefit to be

derived from the private business use.

(5) Common areas. The amount of

private business use of common areas

within a facility is based on a reasonable

method that properly reflects the

proportionate benefit to be derived by

the users of the facility. For example, in

general, a method that is based on the

average amount of private business use

of the remainder of the entire facility

reflects proportionate benefit.

(6) 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.

(7) Commencement of measurement

of private business use. Generally,

private business use commences on the

first date on which there is a right to

actual use by the nongovernmental

person. However, if an issuer enters into

an arrangement for private business use

a substantial period before the right to

actual private business use commences

and the arrangement transfers

ownership or is an arrangement for

other long-term use (such as a lease for

a significant portion of the remaining

economic life of financed property),

private business use commences on the

date the arrangement is entered into,

even if the right to actual use

commences after the measurement

period. For this purpose, 10 percent of

the measurement period is generally

treated as a substantial period.

(8) Examples. The following examples

illustrate the application of this

paragraph (g):

Example 1. Research facility. University U,

a state owned and operated university, owns

and operates a research facility. U proposes

to finance general improvements to the

facility with the proceeds of an issue of

bonds. U enters into sponsored research

agreements with nongovernmental persons

that result in private business use because

the sponsors will own title to any patents

resulting from the research. The

governmental research conducted by U and

the research U conducts for the sponsors take

place simultaneously in all laboratories

within the research facility. All laboratory

equipment is available continuously for use

by workers who perform both types of

research. Because it is not possible to predict

which research projects will be successful, it

is not reasonably practicable to estimate the

relative revenues expected to result from the

governmental and nongovernmental research.

U contributed 90 percent of the cost of the

facility and the nongovernmental persons

contributed 10 percent of the cost. Under this

section, the nongovernmental persons are

using the facility for a private business use

on the same basis as the government use of

the facility. The portions of the costs

contributed by the various users of the

facility provide a reasonable basis that

properly reflects the proportionate benefit to

be derived by the users of the facility. The

nongovernmental persons are treated as using

10 percent of the proceeds of the issue.

Example 2. Stadium. (i) City L issues

bonds 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

nights 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, taking into account the payments

that T is reasonably expected to make for its

use. Assuming no other private business use,

the issue does not meet the private business

use test because not more than 10 percent of

the use of the facility is for a private business

use.

(ii) The facts are the same as in Example

2(i), except that L reasonably expects that the

stadium will be used not more than 60 other

times each year, none of which will give rise

to private business use. The issue meets the

private business use test because 25 percent

of the proceeds are used for a private

business use.

Example 3. Airport terminal areas treated

as common areas. City N issues bonds to

finance the construction of an airport

terminal. Eighty percent of the leasable space

of the terminal will be leased to private air

carriers. The remaining 20 percent of the

leasable space will be used for the term of the

bonds by N for its administrative purposes.

The common areas of the terminal, including

waiting areas, lobbies, and hallways are

treated as 80 percent used by the air carriers

for purposes of the private business use test.

§ 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 or not 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 on the issue that is directly or

indirectly secured by any interest in

property used or to be used for a private

business use or payments in respect of

property used or to be used for a private

business use. For additional rules for

output facilities, see § 1.141–7.

(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.

(3) Underlying arrangement. The

security for, and payment of debt

service on, an issue is determined from

both 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
2292 Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Rules and Regulations

be determined on the basis of all of the

facts and circumstances surrounding the

issuance of the bonds. For example, 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 meets the private

security or payment test.

(b) Measurement of private payments

and security—(1) Scope. This paragraph

(b) contains rules that apply to both

private security and private payments.

(2) 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

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 § 1.148–4(f) and is

adjusted to take into account payments

and receipts on qualified hedges under

§ 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. See, however, § 1.141–13 for

special rules for refunding bonds.

(B) Fixed yield issues. For a fixed

yield issue, yield is determined on the

issue date and is not adjusted to take

into account subsequent events.

(C) 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. A deliberate action requires

a recomputation of the yield on the

variable yield issue to determine the

present value of payments under that

arrangement. In that case, the issuer

must use the yield determined as of the

date of the deliberate action for

purposes of determining the present

value of payments under the

arrangement causing the deliberate

action. See paragraph (g) of this section,

Example 3.

(iv) Application to private security.

For purposes of determining the present

value of debt service that is secured by

property, the 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

are taken into account as private

payments only to the extent that they

are made for the period of time that

proceeds are used for a private business

use. 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 financed property if those

payments are directly allocable to other

property being directly used by the

person making the payment and those

payments represent fair market value

compensation for that other use. See

paragraph (g) of this section, Example 4

and Example 5. See also paragraph (c)(3)

of this section for rules relating to

allocation of payments to the source or

sources of funding of property.

(B) Payments not to exceed use.

Payments with respect to proceeds that

are used for a private business use are

not taken into account to the extent that

the present value of those payments

exceeds the present value of debt

service on those proceeds. Payments

need not be directly derived from a

private business user, however, to be

taken into account. Thus, if 7 percent of

the proceeds of an issue is used by a

person over the measurement period,

payments with respect to the property

financed with those proceeds 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

during the year pays $500 for ordinary

and necessary expenses properly

allocable to the operation and

maintenance of that space and $400 for

general overhead and general

administrative expenses properly

allocable to 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. 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 the present

value of the payments taken into

account as private payments for the

refunding issue bears to the present

value of the debt service to be paid on

the refunding issue. 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 payments

that arise from 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 § 1.150–1(d)(2)(i) (relating to

certain payments of interest).

(3) Allocation of payments—(i) In

general. Private payments for the use of

property are allocated to the source or

different sources of funding of property.

The allocation to the source or different

sources of funding is based on all of the

facts and circumstances, including

whether an allocation is consistent with

the purposes of section 141. In general,

a private payment for the use of

property is allocated to a source of

funding based upon the nexus between

the payment and both the financed

property and the source of funding. For

this purpose, different sources of

funding may include different taxexempt issues, taxable issues, and

amounts that are not derived from a

borrowing, such as revenues of an issuer

(equity).

(ii) Payments for use of discrete

property. Payments for the use of a

discrete facility (or a discrete portion of

a facility) are allocated to the source or
Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Rules and Regulations 2293

different sources of funding of that

discrete property.

(iii) Allocations among two or more

sources of funding. In general, except as

provided in paragraphs (c)(3)(iv) and (v)

of this section, if a payment is made for

the use of property financed with two or

more sources of funding (for example,

equity and a tax-exempt issue), that

payment must be allocated to those

sources of funding in a manner that

reasonably corresponds to the relative

amounts of those sources of funding that

are expended on that property. If an

issuer has not retained records of

amounts expended on the property (for

example, records of costs of a building

that was built 30 years before the

allocation), an issuer may use

reasonable estimates of those

expenditures. For this purpose, costs of

issuance and other similar neutral costs

are allocated ratably among

expenditures in the same manner as in

§ 1.141–3(g)(6). A payment for the use of

property may be allocated to two or

more issues that finance property

according to the relative amounts of

debt service (both paid and accrued) on

the issues during the annual period for

which the payment is made, if that

allocation reasonably reflects the

economic substance of the arrangement.

In general, allocations of payments

according to relative debt service

reasonably reflect the economic

substance of the arrangement if the

maturity of the bonds reasonably

corresponds to the reasonably expected

economic life of the property and debt

service payments on the bonds are

approximately level from year to year.

(iv) Payments made under an

arrangement entered into in connection

with issuance of bonds. A private

payment for the use of property made

under an arrangement that is entered

into in connection with the issuance of

the issue that finances that property

generally is allocated to that issue.

Whether an arrangement is entered into

in connection with the issuance of an

issue is determined on the basis of all

of the facts and circumstances. An

arrangement is ordinarily treated as

entered into in connection with the

issuance of an issue if—

(A) The issuer enters into the

arrangement during the 3-year period

beginning 18 months before the issue

date; and

(B) The amount of payments reflects

all or a portion of debt service on the

issue.

(v) Allocations to equity. A private

payment for the use of property may be

allocated to equity before payments are

allocated to an issue only if—

(A) Not later than 60 days after the

date of the expenditure of those

amounts, the issuer adopts an official

intent (in a manner comparable to

§ 1.150–2(e)) indicating that the issuer

reasonably expects to be repaid for the

expenditure from a specific

arrangement; and

(B) The private payment is made not

later than 18 months after the later of

the date the expenditure is made or the

date the project is placed in service.

(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 an issue 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 an

issue provides private security. Private

security (other than financed property

and private payments) for an issue is

taken into account under section 141(b),

however, only to the extent it is

provided, directly or indirectly, by a

user of proceeds of the issue.

(3) Pledge of unexpended proceeds.

Proceeds qualifying for an initial

temporary period under § 1.148–2(e)(2)

or (3) or deposited in a reasonably

required reserve or replacement fund (as

defined in § 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.

(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. Except as

otherwise provided in this paragraph

(d)(5) and paragraph (d)(6) of this

section, the rules in paragraphs

(c)(2)(i)(A) and (B) and (c)(2)(ii) 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. Thus,

payments made by members of the

general public for use of a facility used

for a private business use (for example,

a facility that is the subject of a

management contract that results in

private business use) are taken into

account as private security to the extent

that they are made for the period of time

that property is used by a private

business user.

(6) Allocation of security among

issues. In general, property or payments

from the disposition of that property

that are taken into account as private

security are allocated to each issue

secured by the property or payments on

a reasonable basis that takes into

account bondholders’ rights to the

payments or property upon default.

(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 or a payment in lieu of tax that is

limited to the property or persons

benefited 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 to the

extent that one or more taxpayers make

any impermissible agreements relating

to payment of those taxes. An

impermissible 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. For

example, 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 the

tax imposed on that taxpayer not to be

treated as a generally applicable tax, the
2294 Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Rules and Regulations

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 on a

tax that does not generally impose

personal liability, 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; a right

of a grantor to rescind the grant if

property taxes are not paid; and an

agreement to reduce or limit the amount

of taxes collected to further a bona fide

governmental purpose. For example, an

agreement to abate taxes to encourage a

property owner to rehabilitate property

in a distressed area is a permissible

agreement.

(5) 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—

(i) The payment is commensurate

with and not greater than the amounts

imposed by a statute for a tax of general

application; and

(ii) The payment is designated for a

public purpose and is not a special

charge (as described in paragraph (e)(3)

of this section). For example, a payment

in lieu of taxes made in consideration

for the use of property financed with

tax-exempt bonds is treated as a special

charge.

(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 (directly or indirectly) the

payment of principal of, or interest on,

the bonds under the terms of the bonds.

This paragraph (f)(2) applies only if the

payments are made pursuant to either a

generally applicable state or local taxing

statute or 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 (directly

or indirectly) the payment of principal

of, or interest on, the bonds under the

terms of the bonds, 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) In the case when a judgment (but

not a final judgment) has been entered

by the issue date against a

nongovernmental person, 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. In addition,

Corporation X leases 1 floor of the building

for the term of the bonds. Under all of the

facts and circumstances, it is reasonable to

allocate 10 percent of the proceeds to that 1

floor. 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 meet 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. Under all of the facts and

circumstances, the private business use test

will be met with respect to each issue that

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 businesses.

Nongovernmental persons will make

payments for these sales and leases. 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 the interest on, each

issue. Although not directly pledged under

the terms of the bond documents, the leases

and sales are underlying arrangements. The

payments relating to these leases and sales

are taken into account as private payments to

determine whether each issue of bonds meets

the private security or payment test.

Example 3. Computation of payment in

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. The yield

that the interest index would produce on the

issue date is 6 percent. M leases 1 floor of

the office building to Corporation T, a

nongovernmental person, for the term of the

bonds. Under all of the facts and

circumstances, T is treated as using more

than 10 percent of the proceeds. 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
Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Rules and Regulations 2295

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 Example 3(i),

except that 5 years after the issue date M

leases a second floor to Corporation S, a

nongovernmental person, under a long-term

lease. Because M has taken a deliberate

action, the present value of the lease

payments must be computed. 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 thencurrent rate on the variable yield bonds. M

uses this 5.5 percent yield as the discount

rate. 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 the lease payments made by

S is 3 percent. The bonds are private activity

bonds because the present value of the

aggregate private payments is greater than 10

percent of the present value of debt service.

Example 4. Payments not in respect of

financed property. In order to further public

safety, City Y issues 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 company for the undergrounding are,

however, taken into account as private

payments.

Example 5. Payments from users of

proceeds that are not private business users

taken into account. 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 §1.141–

3. P will use the revenues from the hospital

(after the required payments to D and the

payment of operation and maintenance

expenses) to pay the debt service on the

bonds. The bonds meet 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. Limitation of amount of

payments to amount of private business 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. Q enters into a 5-year lease

with Corporation R under which R is treated

as a user of 11 percent of the proceeds. 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 meet 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 of the bonds.

Example 7. Allocation of payments to

funds not derived from a borrowing. 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. Within 60

days of the date of purchase, Z declared its

intent to sell the property pursuant to a

redevelopment plan and to use that amount

to reimburse its redevelopment fund. The

bonds are secured only by the incremental

property taxes attributable to the increase in

value of the property from the planned

redevelopment of the property. Within 18

months after the issue date, Z sells the

financed property to Developer M for

$250,000, which Z uses to reimburse the

redevelopment fund. The property that M

uses is financed both with the proceeds of

the bonds and Z’s redevelopment fund. The

payments by M are properly allocable to the

costs of property financed with the amounts

in Z’s redevelopment fund. See paragraphs

(c)(3) (i) and (v) of this section.

Example 8. Allocation of payments to

different sources of funding—improvements.

In 1997, City L issues bonds with proceeds

of $8 million to finance the acquisition of a

building. In 2002, L spends $2 million of its

general revenues to improve the heating

system and roof of the building. At that time,

L enters into a 10-year lease with Corporation

M for the building providing for annual

payments of $1 million to L. The lease

payments are at fair market value, and the

lease payments do not otherwise have a

significant nexus to either the issue or to the

expenditure of general revenues. Eighty

percent of each lease payment is allocated to

the issue and is taken into account under the

private payment test because each lease

payment is properly allocated to the sources

of funding in a manner that reasonably

corresponds to the relative amounts of the

sources of funding that are expended on the

building.

Example 9. Security not provided by users

of proceeds not taken into account. 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 the

proceeds of the obligations to make a grant

to Corporation Y for the construction of a

factory that Y will own. Y makes no

payments to W, directly or indirectly, for its

use of proceeds, and Y has no relationship

to the users of the leased building. 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. However, because the property

is not provided by a private business user

and is not financed property, the obligations

do not meet the private security or payment

test.

Example 10. Allocation of payments

among issues. 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 1997, L issues

another series of bonds under the resolution

to finance additional facilities. L leases 20

percent of the new facilities for the term of

the 1997 bonds to 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 1997 bonds. L will

commingle all of the revenues from all its

bond-financed facilities in its revenue fund.

The present value of the portion of the lease

payments from nongovernmental lessees of

the new facilities allocable to the 1997 bonds

under paragraph (d) of this section is less

than 10 percent of the present value of the

debt service on the 1997 bonds because the

bond documents provide that the bonds are

equally and ratably secured. Accordingly, the

1997 bonds do not meet the private security

test. The 1997 bonds meet the private

payment test, however, 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). See

paragraph (c) of this section.

Example 11. Generally applicable tax. (i)

Authority N issues 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. 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 the debt service on N’s

bonds. The bonds meet the private security

or payment test. The ticket tax is not a

generally applicable tax and, to the extent

that the tax receipts relate to X’s events, the

taxes are payments in respect of property

used for a private business use.

(ii) The facts are the same as Example 11(i),

except that the ticket tax is imposed by N on
2296 Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Rules and Regulations

tickets purchased for events at a number of

large entertainment facilities within the N’s

jurisdiction (for example, other stadiums,

arenas, and concert halls), some of which

were not financed with tax-exempt bonds.

The ticket tax is a generally applicable tax

and therefore the revenues from this tax are

not payments in respect of property used for

a private business use. The receipt of the

ticket tax does not cause the bonds to meet

the private security or payment test.

§ 1.141–5 Private loan financing test.

(a) In general. Bonds of an issue are

private activity bonds if more than the

lesser of 5 percent or $5 million of the

proceeds of the issue is to be used

(directly or indirectly) to make or

finance loans to persons other than

governmental persons. Section 1.141–

2(d) applies in determining whether the

private loan financing test is met. 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.

(b) 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.

(c) Definition of private loan—(1) In

general. Any transaction that is

generally characterized as a loan for

federal income tax purposes is a loan for

purposes of this section. In addition, a

loan may arise from the direct lending

of bond proceeds or may arise from

transactions in which indirect benefits

that are the economic equivalent of a

loan are conveyed. Thus, the

determination of whether a loan is made

depends on the substance of a

transaction rather than its form. For

example, a lease or other contractual

arrangement (for example, a

management contract or an output

contract) may in substance constitute a

loan if the arrangement transfers tax

ownership of the facility to a

nongovernmental person. Similarly, an

output contract or a management

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) Application only to purpose

investments—(i) In general. A loan may

be either a purpose investment or a

nonpurpose investment. A loan that is

a nonpurpose investment does not cause

the private loan financing test to be met.

For example, proceeds invested in

loans, such as obligations of the United

States, during a 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 are defined in

§ 1.148–1 or § 1.148–2) are generally not

treated as loans under the private loan

financing test.

(ii) Certain prepayments treated as

loans. Except as otherwise provided, a

prepayment for property or services is

treated as a loan for purposes of the

private loan financing test if a principal

purpose for prepaying is to provide a

benefit of tax-exempt financing to the

seller. A prepayment is not treated as a

loan for purposes of the private loan

financing test if—

(A) The prepayment is made for a

substantial business purpose other than

providing a benefit of tax-exempt

financing to the seller and the issuer has

no commercially reasonable alternative

to the prepayment; or

(B) Prepayments on substantially the

same terms are made by a substantial

percentage of persons who are similarly

situated to the issuer but who are not

beneficiaries of tax-exempt financing.

(3) Grants—(i) In general. A grant of

proceeds is not a loan. Whether a

transaction may be treated as a grant or

a loan depends on all of the facts and

circumstances.

(ii) Tax increment financing—(A) In

general. Generally, a grant using

proceeds of an issue that is secured by

generally applicable taxes attributable to

the improvements to be made with the

grant is not treated as a loan, unless the

grantee makes any impermissible

agreements relating to the payment that

results in the taxes imposed on that

taxpayer not to be treated as generally

applicable taxes under § 1.141–4(e).

(B) Amount of loan. If a grant is

treated as a loan under this paragraph

(c)(3), the entire grant is treated as a

loan unless the impermissible

agreement is limited to a specific

portion of the tax. For this purpose, an

arrangement with each unrelated

grantee is treated as a separate grant.

(4) 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 establish that

the transaction is a loan for purposes of

this section. This paragraph (c)(4)

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 § 1.141–4(f)(3).

(d) Tax assessment loan exception—

(1) General rule. For purposes of this

section, a tax assessment loan that

satisfies the requirements of this

paragraph (d) is not a loan for purposes

of the private loan financing test.

(2) Tax assessment loan defined. A

tax assessment loan is a loan that arises

when a governmental person permits or

requires property owners to finance any

governmental tax or assessment of

general application for an essential

governmental function that satisfies

each of the requirements of paragraphs

(d) (3) through (5) of this section.

(3) Mandatory tax or other

assessment. The tax or assessment must

be 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). Taxes

and assessments do not include fees for

services. The tax or assessment must be

imposed pursuant to a state law of

general application that can be applied

equally to natural persons not acting in

a trade or business and persons acting

in a trade or business. For this purpose,

taxes and assessments that are imposed

subject to protest procedures are treated

as enforced contributions.

(4) Specific essential governmental

function—(i) In general. A mandatory

tax or assessment that gives rise to a tax

assessment loan must be imposed for

one or more specific, essential

governmental functions.

(ii) Essential governmental functions.

For purposes of paragraph (d) of this

section, improvements to utilities and

systems that are owned by a

governmental person and that are

available for use by the general public

(such as sidewalks, streets and streetlights; electric, telephone, and cable

television systems; sewage treatment

and disposal systems; and municipal

water facilities) serve essential

governmental functions. For other types

of facilities, the extent to which the

service provided by the facility is

customarily performed (and financed

with governmental bonds) by

governments with general taxing powers

is a primary factor in determining

whether the facility serves an essential

governmental function. For example,

parks that are owned by a governmental

person and that are available for use by

the general public serve an essential

governmental function. Except as

otherwise provided in this paragraph

(d)(4)(ii), commercial or industrial

facilities and improvements to property

owned by a nongovernmental person do

not serve an essential governmental
Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Rules and Regulations 2297

function. Permitting installment

payments of property taxes or other

taxes is not an essential governmental

function.

(5) Equal basis requirement—(i) In

general. Owners of both business and

nonbusiness property benefiting from

the financed improvements must be

eligible, or required, to make deferred

payments of the tax or assessment

giving rise to a tax assessment loan on

an equal basis (the equal basis

requirement). A tax or assessment does

not satisfy the equal basis requirement

if the terms for payment of the tax or

assessment are not the same for all taxed

or assessed persons. For example, the

equal basis requirement is not met if

certain property owners are permitted to

pay the tax or assessment over a period

of years while others must pay the

entire tax or assessment immediately or

if only certain property owners are

required to prepay the tax or assessment

when the property is sold.

(ii) General rule for guarantees. A

guarantee of debt service on bonds, or

of taxes or assessments, by a person that

is treated as a borrower of bond

proceeds violates the equal basis

requirement if it is reasonable to expect

on the date the guarantee is entered into

that payments will be made under the

guarantee.

(6) Coordination with private business

tests. See §§ 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.

(e) Examples. The following examples

illustrate the application of this section:

Example 1. Turnkey contract not treated as

a loan. 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

notes 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 costunderruns. For purposes of section 141(c),

this transaction does not involve a private

loan.

Example 2. Essential government function

requirement not met. City D creates a special

taxing district consisting of property owned

by nongovernmental persons that requires

environmental clean-up. D imposes a special

tax on each parcel within the district in an

amount that is related to the expected

environmental clean-up costs of that parcel.

The payment of the tax over a 20-year period

is treated as a loan by the property owners

for purposes of the private loan financing

test. The special district issues bonds, acting

on behalf of D, that are payable from the

special tax levied within the district, and

uses the proceeds to pay for the costs of

environmental clean-up on the property

within the district. The bonds meet the

private loan financing test because more than

5 percent of the proceeds of the issue are

loaned to nongovernmental persons. The

issue does not meet the tax assessment loan

exception because the improvements to

property owned by a nongovernmental

person are not an essential governmental

function under section 141(c)(2). The issue

also meets the private business tests of

section 141(b).

§ 1.141–6 Allocation and accounting rules.

(a) Allocation of proceeds to

expenditures. For purposes of §§ 1.141–

1 through 1.141–15, the provisions of

§ 1.148–6(d) apply for purposes of

allocating proceeds to expenditures.

Thus, allocations generally may be

made using any reasonable, consistently

applied accounting method, and

allocations under section 141 and

section 148 must be consistent with

each other.

(b) Allocation of proceeds to property.

[Reserved]

(c) Special rules for mixed use

facilities. [Reserved]

(d) Allocation of proceeds to common

areas. [Reserved]

(e) Allocation of proceeds to bonds.

[Reserved]

(f) Treatment of partnerships.

[Reserved]

(g) Examples. [Reserved]

§ 1.141–7 Special rules for output

contracts. [Reserved]

§ 1.141–8 $15 million limitation for output

facilities. [Reserved]

§ 1.141–9 Unrelated or disproportionate

use test.

(a) General rules—(1) Description of

test. Under section 141(b)(3) (the

unrelated or disproportionate use test),

an issue meets the private business tests

if the amount of private business use

and private security or payments

attributable to unrelated or

disproportionate private business use

exceeds 5 percent of the proceeds of the

issue. For this purpose, the private

business use test is applied by taking

into account only use that is not related

to any government use of proceeds of

the issue (unrelated use) and use that is

related but disproportionate to any

government use of those proceeds

(disproportionate use).

(2) Application of unrelated or

disproportionate use test—(i) Order of

application. The unrelated or

disproportionate use test is applied by

first determining whether a private

business use is related to a government

use. Next, private business use that

relates to a government use is examined

to determine whether it is

disproportionate to that government

use.

(ii) Aggregation of unrelated and

disproportionate use. All the unrelated

use and disproportionate use financed

with the proceeds of an issue are

aggregated to determine compliance

with the unrelated or disproportionate

use test. The amount of permissible

unrelated and disproportionate private

business use is not reduced by the

amount of private business use financed

with the proceeds of an issue that is

neither unrelated use nor

disproportionate use.

(iii) Deliberate actions. A deliberate

action that occurs after the issue date

does not result in unrelated or

disproportionate use if the issue meets

the conditions of § 1.141–12(a).

(b) Unrelated use—(1) In general.

Whether a private business use is

related to a government use financed

with the proceeds of an issue is

determined on a case-by-case basis,

emphasizing the operational

relationship between the government

use and the private business use. In

general, a facility that is used for a

related private business use must be

located within, or adjacent to, the

governmentally used facility.

(2) Use for the same purpose as

government use. Use of a facility by a

nongovernmental person for the same

purpose as use by a governmental

person is not treated as unrelated use if

the government use is not insignificant.

Similarly, a use of a facility in the same

manner both for private business use

that is related use and private business

use that is unrelated use does not result

in unrelated use if the related use is not

insignificant. For example, a privately

owned pharmacy in a governmentally

owned hospital does not ordinarily

result in unrelated use solely because

the pharmacy also serves individuals

not using the hospital. In addition, use

of parking spaces in a garage by a

nongovernmental person is not treated

as unrelated use if more than an

insignificant portion of the parking
2298 Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Rules and Regulations

spaces are used for a government use (or

a private business use that is related to

a government use), even though the use

by the nongovernmental person is not

directly related to that other use.

(c) Disproportionate use—(1)

Definition of disproportionate use. A

private business use is disproportionate

to a related government use only to the

extent that the amount of proceeds used

for that private business use exceeds the

amount of proceeds used for the related

government use. For example, a private

use of $100 of proceeds that is related

to a government use of $70 of proceeds

results in $30 of disproportionate use.

(2) Aggregation of related uses. If two

or more private business uses of the

proceeds of an issue relate to a single

government use of those proceeds, those

private business uses are aggregated to

apply the disproportionate use test.

(3) Allocation rule. If a private

business use relates to more than a

single use of the proceeds of the issue

(for example, two or more government

uses of the proceeds of the issue or a

government use and a private use), the

amount of any disproportionate use may

be determined by—

(i) Reasonably allocating the proceeds

used for the private business use among

the related uses;

(ii) Aggregating government uses that

are directly related to each other; or

(iii) Allocating the private business

use to the government use to which it

is primarily related.

(d) Maximum use taken into account.

The determination of the amount of

unrelated use or disproportionate use of

a facility is based on the maximum

amount of reasonably expected

government use of a facility during the

measurement period. Thus, no

unrelated use or disproportionate use

arises solely because a facility initially

has excess capacity that is to be used by

a nongovernmental person if the facility

will be completely used by the issuer

during the term of the issue for more

than an insignificant period.

(e) Examples. The following examples

illustrate the application of this section:

Example 1. School and remote cafeteria.

County X issues bonds with proceeds of $20

million and uses $18.1 million of the

proceeds for construction of a new school

building and $1.9 million of the proceeds for

construction of a privately operated cafeteria

in its administrative office building, which is

located at a remote site. The bonds are

secured, in part, by the cafeteria. The $1.9

million of proceeds is unrelated to the

government use (that is, school construction)

financed with the bonds and exceeds 5

percent of $20 million. Thus, the issue meets

the private business tests.

Example 2. Public safety building and

courthouse. City Y issues bonds with

proceeds of $50 million for construction of a

new public safety building ($32 million) and

for improvements to an existing courthouse

($15 million). Y uses $3 million of the bond

proceeds for renovations to an existing

privately operated cafeteria located in the

courthouse. The bonds are secured, in part,

by the cafeteria. Y’s use of the $3 million for

the privately operated cafeteria does not meet

the unrelated or disproportionate use test

because these expenditures are neither

unrelated use nor disproportionate use.

Example 3. Unrelated garage. City Y issues

bonds with proceeds of $50 million for

construction of a new public safety building

($30.5 million) and for improvements to an

existing courthouse ($15 million). Y uses $3

million of the bond proceeds for renovations

to an existing privately operated cafeteria

located in the courthouse. The bonds are

secured, in part, by the cafeteria. Y also uses

$1.5 million of the proceeds to construct a

privately operated parking garage adjacent to

a private office building. The private

business use of the parking garage is

unrelated to any government use of proceeds

of the issue. Since the proceeds used for

unrelated uses and disproportionate uses do

not exceed 5 percent of the proceeds, the

unrelated or disproportionate use test is not

met.

Example 4. Disproportionate use of garage.

County Z issues bonds with proceeds of $20

million for construction of a hospital with no

private business use ($17 million);

renovation of an office building with no

private business use ($1 million); and

construction of a garage that is entirely used

for a private business use ($2 million). The

use of the garage is related to the use of the

office building but not to the use of the

hospital. The private business use of the

garage results in $1 million of

disproportionate use because the proceeds

used for the garage ($2 million) exceed the

proceeds used for the related government use

($1 million). The bonds are not private

activity bonds, however, because the

disproportionate use does not exceed 5

percent of the proceeds of the issue.

Example 5. Bonds for multiple projects. (i)

County W issues bonds with proceeds of $80

million for the following purposes: (1) $72

million to construct a County-owned and

operated waste incinerator; (2) $1 million for

a County-owned and operated facility for the

temporary storage of hazardous waste prior to

final disposal; (3) $1 million to construct a

privately owned recycling facility located at

a remote site; and (4) $6 million to build a

garage adjacent to the County-owned

incinerator that will be leased to Company T

to store and repair trucks that it owns and

uses to haul County W refuse. Company T

uses 75 percent of its trucks to haul materials

to the incinerator and the remaining 25

percent of its trucks to haul materials to the

temporary storage facility.

(ii) The $1 million of proceeds used for the

recycling facility is used for an unrelated use.

The garage is related use. In addition, 75

percent of the use of the $6 million of

proceeds used for the garage is allocable to

the government use of proceeds at the

incinerator. The remaining 25 percent of the

proceeds used for the garage ($1.5 million)

relates to the government use of proceeds at

the temporary storage facility. Thus, this

portion of the proceeds used for the garage

exceeds the proceeds used for the temporary

storage facility by $0.5 million and this

excess is disproportionate use (but not

unrelated use). Thus, the aggregate amount of

unrelated use and disproportionate use

financed with the proceeds of the issue is

$1.5 million. Alternatively, under paragraph

(c)(3)(iii) of this section, the entire garage

may be treated as related to the government

use of the incinerator and, under that

allocation, the garage is not disproportionate

use. In either event, section 141(b)(3) limits

the aggregate unrelated use and

disproportionate use to $4 million. Therefore,

the bonds are not private activity bonds

under this section.

§ 1.141–10 Coordination with volume cap.

[Reserved]

§ 1.141–11 Acquisition of

nongovernmental output property.

[Reserved]

§ 1.141–12 Remedial actions.

(a) Conditions to taking remedial

action. An action that causes an issue to

meet the private business tests or the

private loan financing test is not treated

as a deliberate action if the issuer takes

a remedial action described in

paragraph (d), (e), or (f) of this section

with respect to the nonqualified bonds

and if all of the requirements in

paragraphs (a) (1) through (5) of this

section are met.

(1) Reasonable expectations test met.

The issuer reasonably expected on the

issue date that the issue would meet

neither the private business tests nor the

private loan financing test for the entire

term of the bonds. For this purpose, if

the issuer reasonably expected on the

issue date to take a deliberate action

prior to the final maturity date of the

issue that would cause either the private

business tests or the private loan

financing test to be met, the term of the

bonds for this purpose may be

determined by taking into account a

redemption provision if the provisions

of § 1.141–2(d)(2)(ii) (A) through (C) are

met.

(2) Maturity not unreasonably long.

The term of the issue must not be longer

than is reasonably necessary for the

governmental purposes of the issue

(within the meaning of § 1.148–1(c)(4)).

Thus, this requirement is met if the

weighted average maturity of the bonds

of the issue is not greater than 120

percent of the average reasonably

expected economic life of the property

financed with the proceeds of the issue

as of the issue date.

(3) Fair market value consideration.

Except as provided in paragraph (f) of

this section, the terms of any

arrangement that results in satisfaction
Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Rules and Regulations 2299

of either the private business tests or the

private loan financing test are bona fide

and arm’s-length, and the new user pays

fair market value for the use of the

financed property. Thus, for example,

fair market value may be determined in

a manner that takes into account

restrictions on the use of the financed

property that serve a bona fide

governmental purpose.

(4) Disposition proceeds treated as

gross proceeds for arbitrage purposes.

The issuer must treat any disposition

proceeds as gross proceeds for purposes

of section 148. For purposes of

eligibility for temporary periods under

section 148(c) and exemptions from the

requirement of section 148(f) the issuer

may treat the date of receipt of the

disposition proceeds as the issue date of

the bonds and disregard the receipt of

disposition proceeds for exemptions

based on expenditure of proceeds under

§1.148–7 that were met before the

receipt of the disposition proceeds.

(5) Proceeds expended on a

governmental purpose. Except for a

remedial action under paragraph (d) of

this section, the proceeds of the issue

that are affected by the deliberate action

must have been expended on a

governmental purpose before the date of

the deliberate action.

(b) Effect of a remedial action—(1) In

general. The effect of a remedial action

is to cure use of proceeds that causes the

private business use test or the private

loan financing test to be met. A remedial

action does not affect application of the

private security or payment test.

(2) Effect on bonds that have been

advance refunded. If proceeds of an

issue were used to advance refund

another bond, a remedial action taken

with respect to the refunding bond

proportionately reduces the amount of

proceeds of the advance refunded bond

that is taken into account under the

private business use test or the private

loan financing test.

(c) Disposition proceeds—(1)

Definition. Disposition proceeds are any

amounts (including property, such as an

agreement to provide services) derived

from the sale, exchange, or other

disposition (disposition) of property

(other than investments) financed with

the proceeds of an issue.

(2) Allocating disposition proceeds to

an issue. In general, if the requirements

of paragraph (a) of this section are met,

after the date of the disposition, the

proceeds of the issue allocable to the

transferred property are treated as

financing the disposition proceeds

rather than the transferred property. If a

disposition is made pursuant to an

installment sale, the proceeds of the

issue continue to be allocated to the

transferred property. If an issue does not

meet the requirements for remedial

action in paragraph (a) of this section or

the issuer does not take an appropriate

remedial action, the proceeds of the

issue are 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.

(3) Allocating disposition proceeds to

different sources of funding. If property

has been financed by different sources

of funding, for purposes of this section,

the disposition proceeds from that

property are first allocated to the

outstanding bonds that financed that

property in proportion to the principal

amounts of those outstanding bonds. In

no event may disposition proceeds be

allocated to bonds that are no longer

outstanding or to a source of funding

not derived from a borrowing (such as

revenues of the issuer) if the disposition

proceeds are not greater than the total

principal amounts of the outstanding

bonds that are allocable to that property.

For purposes of this paragraph (c)(3),

principal amount has the same meaning

as in §1.148–9(b)(2) and outstanding

bonds do not include advance refunded

bonds.

(d) Redemption or defeasance of

nonqualified bonds—(1) In general. The

requirements of this paragraph (d) are

met if all of the nonqualified bonds of

the issue are redeemed. Proceeds of taxexempt bonds must not be used for this

purpose, unless the tax-exempt bonds

are qualified bonds, taking into account

the purchaser’s use of the facility. If the

bonds are not redeemed within 90 days

of the date of the deliberate action, a

defeasance escrow must be established

for those bonds within 90 days of the

deliberate action.

(2) Special rule for dispositions for

cash. If the consideration for the

disposition of financed property is

exclusively cash, the requirements of

this paragraph (d) are met if the

disposition proceeds are used to redeem

a pro rata portion of the nonqualified

bonds at the earliest call date after the

deliberate action. If the bonds are not

redeemed within 90 days of the date of

the deliberate action, the disposition

proceeds must be used to establish a

defeasance escrow for those bonds

within 90 days of the deliberate action.

(3) Notice of defeasance. The issuer

must provide written notice to the

Commissioner of the establishment of

the defeasance escrow within 90 days of

the date the defeasance escrow is

established.

(4) Special limitation. The

establishment of a defeasance escrow

does not satisfy the requirements of this

paragraph (d) if the period between the

issue date and the first call date of the

bonds is more than 10 1/2 years.

(5) Defeasance escrow defined. A

defeasance escrow is an irrevocable

escrow established to redeem bonds on

their earliest call date in an amount that,

together with investment earnings, is

sufficient to pay all the principal of, and

interest and call premium on, bonds

from the date the escrow is established

to the earliest call date. The escrow may

not be invested in higher yielding

investments or in any investment under

which the obligor is a user of the

proceeds of the bonds.

(e) Alternative use of disposition

proceeds—(1) In general. The

requirements of this paragraph (e) are

met if—

(i) The deliberate action is a

disposition for which the consideration

is exclusively cash;

(ii) The issuer reasonably expects to

expend the disposition proceeds within

two years of the date of the deliberate

action;

(iii) The disposition proceeds are

treated as proceeds for purposes of

section 141 and are used in a manner

that does not cause the issue to meet

either the private business tests or the

private loan financing test, and the

issuer does not take any action

subsequent to the date of the deliberate

action to cause either of these tests to be

met; and

(iv) If the issuer does not use all of the

disposition proceeds for an alternative

use described in paragraph (e)(1)(iii) of

this section, the issuer uses those

remaining disposition proceeds for a

remedial action that meets paragraph (d)

of this section.

(2) Special rule for use by 501(c)(3)

organizations. If the disposition

proceeds are to be used by a 501(c)(3)

organization, the nonqualified bonds

must in addition be treated as reissued

for purposes of sections 141, 145, 147,

149, and 150 and, under this treatment,

satisfy all of the applicable requirements

for qualified 501(c)(3) bonds. Thus,

beginning on the date of the deliberate

action, nonqualified bonds that satisfy

these requirements must be treated as

qualified 501(c)(3) bonds for all

purposes, including sections 145(b) and

150(b).

(f) Alternative use of facility. The

requirements of this paragraph (f) are

met if—

(1) The facility with respect to which

the deliberate action occurs is used in

an alternative manner (for example,

used for a qualifying purpose by a

nongovernmental person or used by a
2300 Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Rules and Regulations

501(c)(3) organization rather than a

governmental person);

(2) The nonqualified bonds are treated

as reissued, as of the date of the

deliberate action, for purposes of

sections 55 through 59 and 141, 142,

144, 145, 146, 147, 149 and 150, and

under this treatment, the nonqualified

bonds satisfy all the applicable

requirements for qualified bonds

throughout the remaining term of the

nonqualified bonds;

(3) The deliberate action does not

involve a disposition to a purchaser that

finances the acquisition with proceeds

of another issue of tax-exempt bonds;

and

(4) Any disposition proceeds other

than those arising from an agreement to

provide services (including disposition

proceeds from an installment sale)

resulting from the deliberate action are

used to pay the debt service on the

bonds on the next available payment

date or, within 90 days of receipt, are

deposited into an escrow that is

restricted to the yield on the bonds to

pay the debt service on the bonds on the

next available payment date.

(g) Rules for deemed reissuance. For

purposes of determining whether bonds

that are treated as reissued under

paragraphs (e) and (f) of this section are

qualified bonds—

(1) The provisions of the Code and

regulations thereunder in effect as of the

date of the deliberate action apply; and

(2) For purposes of paragraph (f) of

this section, section 147(d) (relating to

the acquisition of existing property)

does not apply.

(h) Authority of Commissioner to

provide for additional remedial actions.

The Commissioner may, by publication

in the Federal Register or the Internal

Revenue Bulletin, provide additional

remedial actions, including making a

remedial payment to the United States,

under which a subsequent action will

not be treated as a deliberate action for

purposes of §1.141–2.

(i) Effect of remedial action on

continuing compliance. Solely for

purposes of determining whether

deliberate actions that are taken after a

remedial action cause an issue to meet

the private business tests or the private

loan financing test—

(1) If a remedial action is taken under

paragraph (d), (e), or (f) of this section,

the private business use or private loans

resulting from the deliberate action are

not taken into account for purposes of

determining whether the bonds are

private activity bonds; and

(2) After a remedial action is taken,

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 disposition. See paragraph (k) of

this section, Example 5.

(j) Nonqualified bonds—(1) Amount

of nonqualified bonds. The percentage

of outstanding bonds that are

nonqualified bonds equals the highest

percentage of private business use in

any 1-year period commencing with the

deliberate action.

(2) Allocation of nonqualified bonds.

Allocations to nonqualified bonds must

be made on a pro rata basis, except that,

for purposes of paragraph (d) of this

section (relating to redemption or

defeasance), an issuer may treat bonds

with longer maturities (determined on a

bond-by-bond basis) as the nonqualified

bonds.

(k) Examples. The following examples

illustrate the application of this section:

Example 1. Disposition proceeds less than

outstanding bonds used to retire bonds. On

June 1, 1997, City C issues 30-year bonds

with an issue price of $10 million to finance

the construction of a hospital building. The

bonds have a weighted average maturity that

does not exceed 120 percent of the

reasonably expected economic life of the

building. On the issue date, C reasonably

expects that it will be the only user of the

building for the entire term of the bonds. Six

years after the issue date, C sells the building

to Corporation P for $5 million. The sale

price is the fair market value of the building,

as verified by an independent appraiser. C

uses all of the $5 million disposition

proceeds to immediately retire a pro rata

portion of the bonds. The sale does not cause

the bonds to be private activity bonds

because C has taken a remedial action

described in paragraph (d) of this section so

that P is not treated as a private business user

of bond proceeds.

Example 2. Lease to nongovernmental

person. The facts are the same as in Example

1, except that instead of selling the building,

C, 6 years after the issue date, leases the

building to P for 7 years and uses other funds

to redeem all of the $10 million outstanding

bonds within 90 days of the deliberate act.

The bonds are not treated as private activity

bonds because C has taken the remedial

action described in paragraph (d) of this

section.

Example 3. Sale for less than fair market

value. The facts are the same as in Example

1, except that the fair market value of the

building at the time of the sale to P is $6

million. Because the transfer was for less

than fair market value, the bonds are

ineligible for the remedial actions under this

section. The bonds are private activity bonds

because P is treated as a user of all of the

proceeds and P makes a payment ($6 million)

for this use that is greater than 10 percent of

the debt service on the bonds, on a present

value basis.

Example 4. Fair market value determined

taking into account governmental

restrictions. The facts are the same as in

Example 1, except that the building was used

by C only for hospital purposes and C

determines to sell the building subject to a

restriction that it be used only for hospital

purposes. After conducting a public bidding

procedure as required by state law, the best

price that C is able to obtain for the building

subject to this restriction is $4.5 million from

P. C uses all of the $4.5 million disposition

proceeds to immediately retire a pro rata

portion of the bonds. The sale does not cause

the bonds to be private activity bonds

because C has taken a remedial action

described in paragraph (d) of this section so

that P is not treated as a private business user

of bond proceeds.

Example 5. Alternative use of disposition

proceeds. The facts are the same as in

Example 1, except that C reasonably expects

on the date of the deliberate action to use the

$5 million disposition proceeds for another

governmental purpose (construction of

governmentally owned roads) within two

years of receipt, rather than using the $5

million to redeem outstanding bonds. C treats

these disposition proceeds as gross proceeds

for purposes of section 148. The bonds are

not private activity bonds because C has

taken a remedial action described in

paragraph (e) of this section. After the date

of the deliberate action, the proceeds of all

of the outstanding bonds are treated as used

for the construction of the roads, even though

only $5 million of disposition proceeds was

actually used for the roads.

Example 6. Alternative use of financed

property. The facts are the same as in

Example 1, except that C determines to lease

the hospital building to Q, an organization

described in section 501(c)(3), for a term of

10 years rather than to sell the building to P.

In order to induce Q to provide hospital

services, C agrees to lease payments that are

less than fair market value. Before entering

into the lease, an applicable elected

representative of C approves the lease after a

noticed public hearing. As of the date of the

deliberate action, the issue meets all the

requirements for qualified 501(c)(3) bonds,

treating the bonds as reissued on that date.

For example, the issue meets the two percent

restriction on use of proceeds of finance

issuance costs of section 147(g) because the

issue pays no costs of issuance from

disposition proceeds in connection with the

deemed reissuance. C and Q treat the bonds

as qualified 501(c)(3) bonds for all purposes

commencing with the date of the deliberate

action. The bonds are treated as qualified

501(c)(3) bonds commencing with the date of

the deliberate action.

Example 7. Deliberate action before

proceeds are expended on a governmental

purpose. County J issues bonds with

proceeds of $10 million that can be used only

to finance a correctional facility. On the issue

date of the bonds, J reasonably expects that

it will be the sole user of the bonds for the

useful life of the facility. The bonds have a

weighted average maturity that does not

exceed 120 percent of the reasonably

expected economic life of the facility. After

the issue date of the bonds, but before the

facility is placed in service, J enters into a

contract with the federal government

pursuant to which the federal government

will make a fair market value, lump sum

payment equal to 25 percent of the cost of the
Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Rules and Regulations 2301

facility. In exchange for this payment, J

provides the federal government with

priority rights to use of 25 percent of the

facility. J uses the payment received from the

federal government to defease the

nonqualified bonds. The agreement does not

cause the bonds to be private activity bonds

because J has taken a remedial action

described in paragraph (d) of this section. See

paragraph (a)(5) of this section.

Example 8. Compliance after remedial

action. In 1997, City G issues bonds with

proceeds of $10 million to finance a

courthouse. The bonds have a weighted

average maturity that does not exceed 120

percent of the reasonably expected economic

life of the courthouse. G uses $1 million of

the proceeds for a private business use and

more than 10 percent of the debt service on

the issue is secured by private security or

payments. G later sells one-half of the

courthouse property to a nongovernmental

person for cash. G immediately redeems 60

percent of the outstanding bonds. This

percentage of outstanding bonds is based on

the highest private business use of the

courthouse in any 1-year period commencing

with the deliberate action. For purposes of

subsequently applying section 141 to the

issue, G may continue to use all of the

proceeds of the outstanding bonds in the

same manner (that is, for both the courthouse

and the existing private business use)

without causing the issue to meet the private

business use test. The issue, however,

continues to meet the private security or

payment test. The result would be the same

if D, instead of redeeming the bonds,

established a defeasance escrow for those

bonds, provided that the requirement of

paragraph (d)(4) of this section was met.

§ 1.141–13 Refunding issues. [Reserved]

§ 1.141–14 Anti-abuse rules.

(a) Authority of Commissioner to

reflect substance of transactions. If an

issuer enters into a transaction or series

of transactions with respect to one or

more issues with a principal purpose of

transferring to nongovernmental persons

(other than as members of the general

public) significant benefits of taxexempt 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 or series of transactions,

including—

(1) Treating separate issues as a single

issue for purposes of the private activity

bond tests;

(2) Reallocating proceeds to

expenditures, property, use, or bonds;

(3) Reallocating payments to use or

proceeds;

(4) Measuring private business use on

a basis that reasonably reflects the

economic benefit in a manner different

than as provided in § 1.141–3(g); and

(5) Measuring private payments or

security on a basis that reasonably

reflects the economic substance in a

manner different than as provided in

§ 1.141–4.

(b) Examples. The following examples

illustrate the application of this section:

Example 1. Reallocating proceeds to

indirect use. City C issues bonds with

proceeds of $20 million for the stated

purpose of financing improvements to roads

that it owns. As a part of the same plan of

financing, however, C also agrees to make a

loan of $7 million to Corporation M from its

general revenues that it otherwise would

have used for the road improvements. The

interest rate of the loan corresponds to the

interest rate on a portion of the issue. A

principal purpose of the financing

arrangement is to transfer to M significant

benefits of the tax-exempt financing.

Although C actually allocates all of the

proceeds of the bonds to the road

improvements, the Commissioner may

reallocate a portion of the proceeds of the

bonds to the loan to M because a principal

purpose of the financing arrangement is to

transfer to M significant benefits of taxexempt financing in a manner that is

inconsistent with the purposes of section

141. The bonds are private activity bonds

because the issue meets the private loan

financing test. The bonds also meet the

private business tests. See also §§ 1.141–

3(a)(2), 1.141–4(a)(1), and 1.141–5(a), under

which indirect use of proceeds and payments

are taken into account.

Example 2. Taking into account use of

amounts derived from proceeds that would

be otherwise disregarded. County B issues

bonds with proceeds of $10 million to

finance the purchase of land. On the issue

date, B reasonably expects that it will be the

sole user of the land. Subsequently, the

federal government acquires the land for $3

million in a condemnation action. B uses this

amount to make a loan to Corporation M. In

addition, the interest rate on the loan reflects

the tax-exempt interest rate on the bonds and

thus is substantially less than a current

market rate. A principal purpose of the

arrangement is to transfer to M significant

benefits of the tax-exempt financing.

Although the condemnation action is not a

deliberate action, the Commissioner may

treat the condemnation proceeds as proceeds

of the issue because a principal purpose of

the arrangement is to transfer to M significant

benefits of tax-exempt financing in a manner

inconsistent with the purposes of section

141. The bonds are private activity bonds.

Example 3. Measuring private business use

on an alternative basis. City F issues bonds

with a 30-year term to finance the acquisition

of an industrial building having a remaining

reasonably expected useful economic life of

more than 30 years. On the issue date, F

leases the building to Corporation G for 3

years. F reasonably expects that it will be the

sole user of the building for the remaining

term of the bonds. Because of the local

market conditions, it is reasonably expected

that the fair rental value of the industrial

building will be significantly greater during

the early years of the term of the bonds than

in the later years. The annual rental

payments are significantly less than fair

market value, reflecting the interest rate on

the bonds. The present value of these rental

payments (net of operation and maintenance

expenses) as of the issue date, however, is

approximately 25 percent of the present

value of debt service on the issue. Under

§ 1.141–3, the issue does not meet the private

business tests, because only 10 percent of the

proceeds are used in a trade or business by

a nongovernmental person. A principal

purpose of the issue is to transfer to G

significant benefits of tax-exempt financing

in a manner inconsistent with the purposes

of section 141. The method of measuring

private business use over the reasonably

expected useful economic life of financed

property is for the administrative

convenience of issuers of state and local

bonds. In cases where this method is used in

a manner inconsistent with the purposes of

section 141, the Commissioner may measure

private business use on another basis that

reasonably reflects economic benefit, such as

in this case on an annual basis. If the

Commissioner measures private business use

on an annual basis, the bonds are private

activity bonds because the private payment

test is met and more than 10 percent of the

proceeds are used in a trade or business by

a nongovernmental person.

Example 4. Treating separate issues as a

single issue. City D enters into a development

agreement with Corporation T to induce T to

locate its headquarters within D’s city limits.

Pursuant to the development agreement, in

1997 D will issue $20 million of its general

obligation bonds (the 1997 bonds) to

purchase land that it will grant to T. The

development agreement also provides that, in

1998, D will issue $20 million of its tax

increment bonds (the 1998 bonds), secured

solely by the increase in property taxes in a

special taxing district. Substantially all of the

property within the special taxing district is

owned by T or D. T will separately enter into

an agreement to guarantee the payment of tax

increment to D in an amount sufficient to

retire the 1998 bonds. The proceeds of the

1998 bonds will be used to finance

improvements owned and operated by D that

will not give rise to private business use.

Treated separately, the 1997 issue meets the

private business use test, but not the private

security or payment test; the 1998 issue

meets the private security or payment test,

but not the private business use test. A

principal purpose of the financing plan

including the two issues is to transfer

significant benefits of tax-exempt financing

to T for its headquarters. Thus, the 1997 issue

and the 1998 issue may be treated by the

Commissioner as a single issue for purposes

of applying the private activity bond tests.

Accordingly, the bonds of both the 1997

issue and the 1998 issue may be treated as

private activity bonds.

Example 5. Reallocating proceeds. City E

acquires an electric generating facility with a

useful economic life of more than 40 years

and enters into a 30-year take or pay contract

to sell 30 percent of the available output to

investor-owned utility M. E plans to use the

remaining 70 percent of available output for

its own governmental purposes. To finance

the entire cost of the facility, E issues $30

million of its series A taxable bonds at

taxable interest rates and $70 million series
2302 Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Rules and Regulations

B bonds, which purport to be tax-exempt

bonds, at tax-exempt interest rates. E

allocates all of M’s private business use to the

proceeds of the series A bonds and all of its

own government use to the proceeds of the

series B bonds. The series A bonds have a

weighted average maturity of 15 years, while

the series B bonds have a weighted average

maturity of 26 years. M’s payments under the

take or pay contract are expressly determined

by reference to 30 percent of M’s total costs

(that is, the sum of the debt service required

to be paid on both the series A and the series

B bonds and all other operating costs). The

allocation of all of M’s private business use

to the series A bonds does not reflect

economic substance because the series of

transactions transfers to M significant

benefits of the tax-exempt interest rates paid

on the series B bonds. A principal purpose

of the financing arrangement is to transfer to

M significant benefits of the tax-exempt

financing. Accordingly, the Commissioner

may allocate M’s private business use on a

pro rata basis to both the series B bonds as

well as the series A bonds, in which case the

series B bonds are private activity bonds.

Example 6. Allocations respected. The

facts are the same as in Example 5, except

that the debt service component of M’s

payments under the take or pay contract is

based exclusively on the amounts necessary

to pay the debt service on the taxable series

A bonds. E’s allocation of all of M’s private

business use to the series A bonds is

respected because the series of transactions

does not actually transfer benefits of taxexempt interest rates to M. Accordingly, the

series B bonds are not private activity bonds.

The result would be the same if M’s

payments under the take or pay contract were

based exclusively on fair market value

pricing, rather than the tax-exempt interest

rates on E’s bonds. The result also would be

the same if the series A bonds and the series

B bonds had substantially equivalent

weighted average maturities and E and M had

entered into a customary contract providing

for payments based on a ratable share of total

debt service. E would not be treated by the

Commissioner in any of these cases as

entering into the contract with a principal

purpose of transferring the benefits of taxexempt financing to M in a manner

inconsistent with the purposes of section

141.

§1.141–15 Effective dates.

(a) Scope. The effective dates in this

section apply for purposes of §§1.141–

0 through 1.141–14, and 1.145–0

through 1.145–2 (the private activity

bond regulations), and §1.150–1(a)(3)

and the definition of bond documents

contained in §1.150–1(b).

(b) Effective dates. Except as

otherwise provided in this section, the

private activity bond regulations,

§1.150–1(a)(3), and the definition of

bond documents contained in §1.150–

1(b) apply to bonds issued on or after

May 16, 1977 (the effective date) that are

subject to section 1301 of the Tax

Reform Act of 1986.

(c) Refunding bonds. The private

activity bond regulations, §1.150–

1(a)(3), and the definition of bond

documents contained in §1.150–1(b) do

not apply to bonds issued on or after the

effective date to refund a bond to which

the private activity bond regulations do

not apply unless—

(1) The weighted average maturity of

the refunding bonds is longer than—

(i) The weighted average maturity of

the refunded bonds; or

(ii) In the case of a short-term

obligation that the issuer reasonably

expects to refund with a long-term

financing (such as a bond anticipation

note), 120 percent of the weighted

average reasonably expected economic

life of the facilities financed; or

(2) A principal purpose for the

issuance of the refunding bonds is to

make one or more new conduit loans.

(d) Permissive application of

regulations. Except as provided in

paragraph (e) of this section, the private

activity bond regulations, §1.150–

1(a)(3), and the definition of bond

documents contained in §1.150–1(b)

may be applied in whole, but not in

part, to—

(1) Bonds that are outstanding on the

effective date and subject to section 141;

or

(2) Refunding bonds issued on or after

the effective date.

(e) Permissive retroactive application

of certain sections. The following

sections may each be applied to any

bonds issued before the effective date:

(1) Section 1.141–3(b)(4);

(2) Section 1.141–3(b)(6); and

(3) Section 1.141–12.

§1.141–16 Effective dates for qualified

private activity bond provisions.

(a) Scope. The effective dates of this

section apply for purposes of §§1.142–

0 through 1.142–2, 1.144–0 through

1.144–2, 1.147–0 through 1.147–2, and

1.150–4.

(b) Effective dates. Except as

otherwise provided in this section, the

regulations designated in paragraph (a)

of this section apply to bonds issued on

or after May 16, 1997 (the effective

date).

(c) Permissive application. The

regulations designated in paragraph (a)

of this section may be applied in whole,

but not in part, to bonds outstanding on

the effective date.

Par. 7. Sections 1.142–0 and 1.142–3

are added and §§ 1.142–1 and 1.142–2

are revised to read as follows:

§ 1.142–0 Table of Contents.

This section lists the captioned

paragraphs contained in §§ 1.142–1

through 1.142–3.

§ 1.142–1 Exempt facility bonds.

(a) Overview.

(b) Scope.

(c) Effective dates.

§ 1.142–2 Remedial actions.

(a) General rule.

(b) Reasonable expectations requirement.

(c) Redemption or defeasance.

(1) In general.

(2) Notice of defeasance.

(3) Special limitation.

(4) Special rule for dispositions of personal

property.

(5) Definitions.

(d) When a failure to properly use proceeds

occurs.

(1) Proceeds not spent.

(2) Proceeds spent.

(e) Nonqualified bonds.

§ 1.142–3 Refunding issues.

[Reserved]

§ 1.142–1 Exempt facility bonds.

(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.

Under section 141(e)(1)(A), an exempt

facility bond issued under section 142

may be a qualified bond.

Under section 142(a), an exempt

facility bond is any bond issued as a

part of an issue using 95 percent or

more of the proceeds for certain exempt

facilities.

(b) Scope. Sections 1.142–0 through

1.142–3 apply for purposes of the rules

for exempt facility bonds under section

142, except that, with respect to net

proceeds that have been spent, § 1.142–

2 does not apply to bonds issued under

section 142(d) (relating to bonds issued

to provide qualified residential rental

projects) and section 142(f) (2) and (4)

(relating to bonds issued to provide

local furnishing of electric energy or

gas).

(c) Effective dates. For effective dates

of §§ 1.142–0 through 1.142–2, see

§ 1.141–16.

§ 1.142–2 Remedial actions.

(a) General rule. If less than 95

percent of the net proceeds of an exempt

facility bond are actually used to

provide an exempt facility, and for no

other purpose, the issue will be treated

as meeting the use of proceeds

requirement of section 142(a) if the

issue meets the condition of paragraph

(b) of this section and the issuer takes

the remedial action described in

paragraph (c) of this section.

(b) Reasonable expectations

requirement. The issuer must have

reasonably expected on the issue date

that 95 percent of the net proceeds of

the issue would be used to provide an

exempt facility and for no other purpose

for the entire term of the bonds

(disregarding any redemption
Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Rules and Regulations 2303

provisions). To meet this condition the

amount of the issue must have been

based on reasonable estimates about the

cost of the facility.

(c) Redemption or defeasance—(1) In

general. The requirements of this

paragraph (c) are met if all of the

nonqualified bonds of the issue are

redeemed on the earliest call date after

the date on which the failure to properly

use the proceeds occurs under

paragraph (d) of this section. Proceeds

of tax-exempt bonds (other than those

described in paragraph (d)(1) of this

section) must not be used for this

purpose. If the bonds are not redeemed

within 90 days of the date on which the

failure to properly use proceeds occurs,

a defeasance escrow must be established

for those bonds within 90 days of that

date.

(2) Notice of defeasance. The issuer

must provide written notice to the

Commissioner of the establishment of

the defeasance escrow within 90 days of

the date the escrow is established.

(3) Special limitation. The

establishment of a defeasance escrow

does not satisfy the requirements of this

paragraph (c) if the period between the

issue date and the first call date is more

than 101⁄2 years.

(4) Special rule for dispositions of

personal property. For dispositions of

personal property exclusively for cash,

the requirements of this paragraph (c)

are met if the issuer expends the

disposition proceeds within 6 months of

the date of the disposition to acquire

replacement property for the same

qualifying purpose of the issue under

section 142.

(5) Definitions. For purposes of

paragraph (c)(4) of this section,

disposition proceeds means disposition

proceeds as defined in § 1.141–12(c).

(d) When a failure to properly use

proceeds occurs—(1) Proceeds not

spent. For net proceeds that are not

spent, a failure to properly use proceeds

occurs on the earlier of the date on

which the issuer reasonably determines

that the financed facility will not be

completed or the date on which the

financed facility is placed in service.

(2) Proceeds spent. For net proceeds

that are spent, a failure to properly use

proceeds occurs on the date on which

an action is taken that causes the bonds

not to be used for the qualifying purpose

for which the bonds were issued.

(e) Nonqualified bonds. For purposes

of this section, the nonqualified bonds

are a portion of the outstanding bonds

in an amount that, if the remaining

bonds were issued on the date on which

the failure to properly use the proceeds

occurs, at least 95 percent of the net

proceeds of the remaining bonds would

be used to provide an exempt facility. If

no proceeds have been spent to provide

an exempt facility, all of the outstanding

bonds are nonqualified bonds. The

nonqualified bonds must be determined

on a pro rata allocation basis, except

that an issuer may treat bonds with

longer maturities (determined on a

bond-by-bond basis) as the nonqualified

bonds.

§ 1.142–3 Refunding issues.

[Reserved]

Par. 8. Section 1.144–0 is added and

§§ 1.144–1 and 1.144-2 are revised to

read as follows:

§ 1.144–0 Table of Contents.

This section lists the captioned

paragraphs contained in §§1.144–1 and

1.144–2.

§ 1.144–1 Qualified small issue bonds,

qualified student loan bonds, and qualified

redevelopment bonds.

(a) Overview.

(b) Scope.

(c) Effective dates.

§ 1.144–2 Remedial actions.

§ 1.144–1 Qualified small issue bonds,

qualified student loan bonds, and qualified

redevelopment bonds.

(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.

Under section 141(e)(1)(D), a qualified

small issue bond issued under section

144(a) may be a qualified bond. Under

section 144(a), any qualified small issue

bond is any bond issued as a part of an

issue 95 percent or more of the proceeds

of which are to be used to provide

certain manufacturing facilities or

certain depreciable farm property and

which meets other requirements. Under

section 141(e)(1)(F) a qualified

redevelopment bond issued under

section 144(c) is a qualified bond. Under

section 144(c), a qualified

redevelopment bond is any bond issued

as a part of an issue 95 percent or more

of the net proceeds of which are to be

used for one or more redevelopment

purposes and which meets certain other

requirements.

(b) Scope. Sections 1.144–0 through

1.144–2 apply for purposes of the rules

for small issue bonds under section

144(a) and qualified redevelopment

bonds under section 144(c), except that

§1.144–2 does not apply to the

requirements for qualified small issue

bonds under section 144(a)(4) (relating

to the limitation on capital

expenditures) or under section

144(a)(10) (relating to the aggregate limit

of tax-exempt bonds per taxpayer).

(c) Effective dates. For effective dates

of §§1.144–0 through 1.144–2, see

§1.141–16.

§ 1.144–2 Remedial actions.

The remedial action rules of §1.142–

2 apply to qualified small issue bonds

issued under section 144(a) and to

qualified redevelopment bonds issued

under section 144(c), for this purpose

treating those bonds as exempt facility

bonds and the qualifying purposes for

those bonds as exempt facilities.

Par. 9. Sections 1.145–0 through

1.145–2 are added to read as follows:

§ 1.145–0 Table of Contents.

This section lists the captioned

paragraphs contained in §§1.145–1 and

1.145–2.

§ 1.145–1 Qualified 501(c)(3) bonds.

(a) Overview.

(b) Scope.

(c) Effective dates.

§ 1.145–2 Application of private activity

bond regulations.

(a) In general.

(b) Modification of private business tests.

(c) Exceptions.

(1) Certain provisions relating to

governmental programs.

(2) Costs of issuance.

§ 1.145–1 Qualified 501(c)(3) bonds.

(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.

Under section 141(e)(1)(G), a qualified

501(c)(3) bond issued under section 145

is a qualified bond. Under section 145,

a qualified 501(c)(3) bond is any bond

issued as a part of an issue that satisfies

the requirements of sections 145(a)

through (d).

(b) Scope. Sections 1.145–0 through

1.145–2 apply for purposes of section

145(a).

(c) Effective dates. For effective dates

of §§1.145–0 through 1.145–2, see

§1.141–15.

§ 1.145–2 Application of private activity

bond regulations.

(a) In general. Except as provided in

this section, §§1.141–0 through 1.141–

15 apply to section 145(a). For example,

under this section, §1.141–1, and

§1.141–2, an issue ceases to be an issue

of qualified 501(c)(3) bonds if the issuer

or a conduit borrower 501(c)(3)

organization takes a deliberate action,

subsequent to the issue date, that causes

the issue to fail to comply with the

requirements of sections 141(e) and 145

(such as an action that results in

revocation of exempt status of the

501(c)(3) organization).

(b) Modification of private business

tests. In applying §§1.141–0 through

1.141–15 to section 145(a)—
2304 Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Rules and Regulations

(1) References to governmental

persons include 501(c)(3) organizations

with respect to their activities that do

not constitute unrelated trades or

businesses under section 513(a);

(2) References to ‘‘10 percent’’ and

‘‘proceeds’’ in the context of the private

business use test and the private

security or payment test mean ‘‘5

percent’’ and ‘‘net proceeds’’; and

(3) References to the private business

use test in §§1.141–2 and 1.141–12

include the ownership test of section

145(a)(1).

(c) Exceptions—(1) Certain provisions

relating to governmental programs. The

following provisions do not apply to

section 145: §1.141–2(d)(4) (relating to

the special rule for dispositions of

personal property in the ordinary course

of an established governmental

program) and §1.141–2(d)(5) (relating to

the special rule for general obligation

bond programs that finance a large

number of separate purposes).

(2) Costs of issuance. Section 1.141–

3(g)(6) does not apply to section

145(a)(2) to the extent that it provides

that costs of issuance are allocated

ratably among the other purposes for

which the proceeds are used. For

purposes of section 145(a)(2), costs of

issuance are treated as private business

use.

Par. 10. Sections 1.147–0 through

1.147–2 are added to read as follows:

§ 1.147–0 Table of Contents.

This section lists the captioned

paragraphs contained in §§1.147–1 and

1.147–2.

§1.147–1 Other requirements applicable

to certain private activity bonds.

(a) Overview.

(b) Scope.

(c) Effective dates.

§1.147–2 Remedial actions.

§ 1.147–1 Other requirements applicable to

certain private activity bonds.

(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.

Under section 147, certain requirements

must be met for a private activity bond

to qualify as a qualified bond.

(b) Scope. Sections 1.147–0 through

1.147–2 apply for purposes of the rules

in section 147 for qualified private

activity bonds that permit use of

proceeds to acquire land for

environmental purposes (section

147(c)(3)), permit use of proceeds for

certain rehabilitations (section 147(d)

(2) and (3)), prohibit use of proceeds to

finance skyboxes, airplanes, gambling

establishments and similar facilities

(section 147(e)), and require public

approval (section 147(f)), but not for the

rules limiting use of proceeds to acquire

land or existing property under sections

147(c) (1) and (2), and (d)(1).

(c) Effective dates. For effective dates

of §§ 1.147–0 through 1.147–2, see

§ 1.141–16.

§ 1.147–2 Remedial actions.

The remedial action rules of § 1.142–

2 apply to the rules in section 147 for

qualified private activity bonds that

permit use of proceeds to acquire land

for environmental purposes (section

147(c)(3)), permit use of proceeds for

certain rehabilitations (section 147(d)

(2) and (3)), prohibit use of proceeds to

finance skyboxes, airplanes, gambling

establishments and similar facilities

(section 147(e)), and require public

approval (section 147(f)), for this

purpose treating those private activity

bonds subject to the rules under section

147 as exempt facility bonds and the

qualifying purposes for those bonds as

exempt facilities.

Par. 11. Section 1.148–6 is amended

by adding new paragraphs (a)(3) and

(d)(1)(iii) to read as follows:

§ 1.148–6 General allocation and

accounting rules.

(a) * * *

(3) Absence of allocation and

accounting methods. If an issuer fails to

maintain books and records sufficient to

establish the accounting method for an

issue and the allocation of the proceeds

of that issue, the rules of this section are

applied using the specific tracing

method. This paragraph (a)(3) applies to

bonds issued on or after May 16, 1997.

* * * * *

(d) * * *

(1) * * *

(iii) Timing. An issuer must account

for the allocation of proceeds to

expenditures not later than 18 months

after the later of the date the

expenditure is paid or the date the

project, if any, that is financed by the

issue is placed in service. This

allocation must be made in any event by

the date 60 days after the fifth

anniversary of the issue date or the date

60 days after the retirement of the issue,

if earlier. This paragraph (d)(1)(iii)

applies to bonds issued on or after May

16, 1997.

* * * * *

Par. 12. Section 1.150–1 is amended

as follows:

1. Paragraph (a)(3) is added.

2. Paragraph (b) is amended by adding

a new definition in alphabetical order.

The additions read as follows:

§ 1.150–1 Definitions.

(a) * * *

(3) Exception to general effective date.

See § 1.141–15 for the effective date of

the definition of bond documents

contained in paragraph (b) of this

section.

* * * * *

(b) * * *

Bond documents means the bond

indenture or resolution, transcript of

proceedings, and any related

documents.* * *

* * * * *

Par. 13. Section 1.150–4 is added to

read as follows:

§ 1.150–4 Change in use of facilities

financed with tax-exempt private activity

bonds.

(a) Scope. This section applies for

purposes of the rules for change of use

of facilities financed with private

activity bonds under sections 150(b)(3)

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

150(b)(4) (relating to certain exempt

facility bonds and small issue bonds),

150(b)(5) (relating to facilities required

to be owned by governmental units or

501(c)(3) organizations), and 150(c).

(b) Effect of remedial actions—(1) In

general. Except as provided in this

section, the change of use provisions of

sections 150(b) (3) through (5), and

150(c) apply even if the issuer takes a

remedial action described in §§ 1.142–2,

1.144–2, or 1.145–2.

(2) Exceptions—(i) Redemption. If

nonqualified bonds are redeemed

within 90 days of a deliberate action

under § 1.145–2(a) or within 90 days of

the date on which a failure to properly

use proceeds occurs under § 1.142–2 or

§ 1.144–2, sections 150(b) (3) through (5)

do not apply during the period between

that date and the date on which the

nonqualified bonds are redeemed.

(ii) Alternative qualifying use of

facility. If a bond-financed facility is

used for an alternative qualifying use

under §§ 1.145–2 and 1.141–12(f),

sections 150(b) (3) and (5) do not apply

because of the alternative use.

(iii) Alternative use of disposition

proceeds. If disposition proceeds are

used for a qualifying purpose under

§§ 1.145–2 and 1.141–12(e), 1.142–

2(c)(4), or 1.144–2, sections 150(b) (3)

through (5) do not apply because of the

deliberate action that gave rise to the

disposition proceeds after the date on

which all of the disposition proceeds

have been expended on the qualifying

purpose. If all of the disposition

proceeds are so expended within 90

days of the date of the deliberate action,

however, sections 150(b) (3) through (5)

do not apply because of the deliberate

action.

(c) Allocation rules—(1) In general. If

a change in use of a portion of the

property financed with an issue of

qualified private activity bonds causes
Federal Register / Vol. 62, No. 11 / Thursday, January 16, 1997 / Rules and Regulations 2305

1The Clean Air Act is codified, as amended, in

the U.S. Code at 42 U.S.C. 7401 et seq.

2Mandatory class I Federal areas include

international parks, national wilderness areas, and

national memorial parks greater than five thousand

acres in size, and national parks greater than six

thousand acres in size, as described in section

162(a) (42 U.S.C. 7472(a)). Each mandatory Class I

Federal area is the responsibility of a ‘‘Federal land

manager’’ (FLM), the Secretary of the department

with authority over such lands. See section 302(i)

of the Act, 42 U.S.C. 7602(i).

section 150 (b)(3), (b)(4), or (b)(5) to

apply to an issue, the bonds of the issue

allocable to that portion under section

150(c)(3) are the same as the

nonqualified bonds determined for

purposes of §§ 1.142–1, 1.144–1, and

1.145–1, except that bonds allocable to

all common areas are also allocated to

that portion.

(2) Special rule when remedial action

is taken. If an issuer takes a remedial

action with respect to an issue of private

activity bonds under §§ 1.142–2, 1.144–

2, or 1.145–2, the bonds of the issue

allocable to a portion of property are the

same as the nonqualified bonds

determined for purposes of those

sections.

(d) Effective dates. For effective dates

of this section, see § 1.141–16.

PART 602—OMB CONTROL NUMBERS

UNDER THE PAPERWORK

REDUCTION ACT

Par. 14. The authority citation for part

602 continues to read as follows:

Authority: 26 U.S.C. 7805.

Par. 15. In § 602.101, paragraph (c) is

amended by adding entries in numerical

order to the table to read as follows:

§ 602.101 OMB Control numbers.

* * * * *

(c) * * *

CFR part or section where

identified and described

Current OMB

control No.

* * * * *

1.141–1 ................................. 1545–1451

1.141–12 ............................... 1545–1451

1.142–2 ................................. 1545–1451

* * * * *

1.148–6 ................................. 1545–1451

* * * * *

Margaret Milner Richardson,

Commissioner of Internal Revenue.

Approved: December 30, 1996.

Donald C. Lubick,

Acting Assistant Secretary of the Treasury.

[FR Doc. 97–710 Filed 1–10–97; 8:45 am]

BILLING CODE 4830–01–U

ENVIRONMENTAL PROTECTION

AGENCY

40 CFR Part 52

[CO–001–0007; FRL–5669–5]

Clean Air Act Approval and

Promulgation of Air Quality

Implementation Plan Revision for

Colorado; Long-Term Strategy of State

Implementation Plan for Class I

Visibility Protection, Part I: Hayden

Station Requirements

AGENCY: Environmental Protection

Agency (EPA).

ACTION: Final rule.

SUMMARY: EPA is approving a revision to

the long-term strategy portion of

Colorado’s State Implementation Plan

(SIP) for Class I Visibility Protection,

contained in Section VI of the document

entitled ‘‘Long-Term Strategy Review

and Revision of Colorado’s State

Implementation Plan for Class I

Visibility Protection, Part I: Hayden

Station Requirements,’’ as submitted by

the Governor with a letter dated August

23, 1996. The revision incorporates into

the SIP, among other things, emissions

reduction requirements for the Hayden

Station (a coal-fired steam generating

plant located near the town of Hayden,

Colorado) that are based on a consent

decree addressing numerous air

pollution violations at the plant. The

SIP revision is expected to remedy

Hayden Station’s contribution to

visibility impairment in the Mt. Zirkel

Wilderness Area and, therefore, make

reasonable progress toward the Clean

Air Act National visibility goal with

respect to such contribution. On

October 3, 1996, EPA published a notice

of proposed rulemaking that proposed

to approve this SIP revision and

provided a thirty-day period for public

comment. EPA received one set of

generally supportive comments

regarding the proposed revision, and is

therefore finalizing the proposal without

modification.

EFFECTIVE DATE: This action is effective

February 18, 1997.

ADDRESSES: Copies of the State’s

submittal and other information are

available for inspection during normal

business hours at the following

locations: Air Program, Environmental

Protection Agency, Region VIII, 999

18th Street, Suite 500, Denver, Colorado

80202–2405; Colorado Department of

Public Health and Environment, Air

Pollution Control Division, 4300 Cherry

Creek Drive South, Denver, Colorado

80222–1530; and The Air and Radiation

Docket and Information Center, 401 M

Street, SW, Washington, D.C. 20460.

FOR FURTHER INFORMATION CONTACT:

Vicki Stamper at (303) 312–6445.

SUPPLEMENTARY INFORMATION:

I. Background

Section 169A of the Clean Air Act

(CAA or Act),1 42 U.S.C. section 7491,

establishes as a National goal the

prevention of any future, and the

remedying of any existing,

anthropogenic visibility impairment in

mandatory Class I Federal areas 2

(referred to herein as the ‘‘National

goal’’ or ‘‘National visibility goal’’).

Section 169A calls for EPA to, among

other things, issue regulations to assure

reasonable progress toward meeting the

National visibility goal, including

requiring each State with a mandatory

Class I Federal area to revise its State

Implementation Plan (SIP) to contain

such emission limits, schedules of

compliance and other measures as may

be necessary to make reasonable

progress toward meeting the National

goal. CAA section 169A(b)(2). Section

110(a)(2)(J) of the CAA, 42 U.S.C.

section 7410(a)(2)(J), similarly requires

SIPs to meet the visibility protection

requirements of the CAA.

EPA promulgated regulations that

require affected States to, among other

things, (1) coordinate development of

SIPs with appropriate Federal Land

Managers (FLMs); (2) develop a program

to assess and remedy visibility

impairment from new and existing

sources; and (3) develop a long-term

(10–15 years) strategy to assure

reasonable progress toward the National

visibility goal. See 45 FR 80084,

December 2, 1980 (codified at 40 CFR

51.300–307). The regulations provide

for the remedying of visibility

impairment that is reasonably

attributable to a single existing

stationary facility or small group of

existing stationary facilities. These

regulations require that the SIPs provide

for periodic review, and revision as

appropriate, of the long-term strategy

not less frequently than every three

years, that the review process include

consultation with the appropriate FLMs,

and that the State provide a report to the

public and EPA that includes an

assessment of the State’s progress