Qualified Small Issue Bonds (I.R.C. § 144(a))

May 24, 2012

General Overview for Manufacturing Facilities

Section 103(a) of the Code provides that gross income does not include interest on a State or local bond.  Under section 103(b)(1), however, section 103(a) does not apply to any “private activity bond,” unless it is a “qualified bond” under section 141.  Section 141(e)(1)(D) provides that a “qualified small issue bond” is a qualified bond.

A “qualified small issue bond” means any bond issued “as part of an issue”:

  1. the aggregate authorized face amount of which is $1,000,000 (or, subject to additional limitations, $10,000,000) or less; and
  2. 95% or more of the net proceeds of which are to be used for the acquisition, construction, reconstruction or improvement of land or property of a character subject to the allowance for depreciation or to redeem part or all of a prior issue which was so used.

See the NABL suggestions for guidance on manufacturing facilities for a good overview of qualified small issue bonds.

Can small issue manufacturing bonds be “program investments”? Some bond counsel believe that bonds under 144(a) may not qualify as program investments.  There is a ruling for a state issuer in which the Internal Revenue Service determined that the loan did qualify, though that loan may have related to exempt facility bonds.

See also this IRS entry with links to ruling relating to small issue manufacturing bonds.

Look-Back and Look-Forward/$20,000,000 Six-Year Test/$40,000,000 Limitation

1.  Look-back required for $1,000,000 issue

In determining whether the bond satisfies the $1,000,000 limit, you must also take into account prior qualified small issue bonds (to the extent outstanding) that financed facilities in the same incorporated municipality or in the same county (but not in any incorporated municipality) a principal user of which is the same person as the principal user of the facility being financed or a related person thereto.  Note the following:

  • A prior bond issue is taken into account only to the extent still outstanding at the time of the later issuance.  Rev. Rul. 76-427.
  • It does not matter that such prior issues may have been issued by different issuers.
  • Only take into account bond issues for facilities located in the same incorporated municipality or located in the same county (but not in any incorporated municipality) as the facilities being financed by the new issue, and only if the principal user of such facilities is or will be the same person or two or more related persons.  Note the contiguous and integrated rules described under a subsequent heading below, including the 1/2-mile rule.

2.  Look-back and Look-Forward for $10,000,000 issue

If the $10,000,000 (previously, this was $5,000,000) limit is elected, you must take into account prior qualified small issue bonds as described above AND you must take into account capital expenditures paid or incurred three years prior to the issue date and actually paid within three years after the issue date – with respect to any such facility.

Therefore, the new bonds plus any prior qualified small issue bonds plus capital expenditures three years before and three years after cannot exceed $10,000,000.  (Note, for bonds issued after December 31, 2006, you may have an additional $10,000,000 of capital expenditures without violating the limit – but the additional $10,000,000 is only for capital expenditures, not an increase in the limit of bonds.  So, for example, if there are no prior bonds, you simply look to whether the new bonds are less than $10,000,000 and the new bonds plus all capital expenditures is less than $20,000,000.)  A capital expenditure for this purpose can include expenditures made by a local government to assist with the facility, but not:

  • Public utility improvements for the facility;
  • Leased personal property, provided it is leased under an operating lease by a person in the trade or business of leasing property or by the manufacturer of the property;
  • Expenditures required by a change in law or due to a casualty;
  • Expenditures up to $1,000,000 that could not be reasonably foreseen when the bonds were issued.

Note that there are difficulties analyzing the capital expenditure and bond tests in leased facility situations.  See Rev. Rul. 85-145, where a landlord incurred capital expenditures in connection with a facility, 75% of which was leased to Corporation X.  These expenditures were not financed with tax-exempt bonds (and benefited only tenants other than Corporation X).  Corporation X proposed to purchase land and build a building at a different location in the same city as the leased building.  After completion of the new building, Corporation X would vacate the leased building.  Corporation X sought to have its new facilities financed with an issuance of small issue bonds.  Landlord’s capital expenditures on the leased building were to be incurred within three years of the proposed issue date of the small issue bonds.  The ruling concludes that the landlord’s expenditures on the leased building are included in the aggregation for purposes of the $10,000,000 capital expenditure rule because (1) Corporation X will be the principal user of the facilities to be acquired and built with the proposed tax-exempt small issue bonds, (2) Corporation X is a principal user of the leased building, (3) the leased building and the new building will be in the same city, and (4) the expenditure with respect to the leased building is a capital expenditure and would be made within three years of the proposed issue date of the small issue bonds.

Regarding the above Rev. Rul. 85-145, see also PLR 8838003, which indicates that a principal user is a user of 10% or more of the facility, and PLR 199909044.  See Notiz 20130123.

The look-forward expenditure test is an actual facts test.  The test does not rely on expectations as of the issue date (except for the special exception for $1,000,000 described above).  If capital expenditures of the borrower, a principal user or a related entity exceed the $10,000,000 limit ($20,000,000 for bonds issued after 12/31/2006), the bonds will become taxable on the date the excess expenditure is made and not retroactively to the date of issue.  See I.R.C. 144(a)(4)(D).  Under certain circumstances, expenditures may be reallocated to avoid the applicable limit.  See PLR 200050034.

Rev. Rul. 77-146, 1977-1 C.B. 24, concludes that the contribution of property to a partnership that does not result in the recognition of gain or loss under section 721 of the Code is not a section 103(b)(6)(D) capital expenditures.

3.  $40,000,000 Limitation

The qualified small issue bonds exemption is NOT available if the aggregate authorized face amount of the issue allocated to any test-period beneficiary (when increased by the outstanding tax-exempt facility-related bonds of such beneficiary) exceeds $40,000,000.  In other words, if the face amount of a qualified small issue bond plus the aggregate face amount of all other small issue bonds, exempt facility bonds (including RZFBs) and qualified redevelopment bonds outstanding at the time of issue in question and attributable to the same “test period beneficiary” (and related persons) exceeds $40,000,000, the qualified small issue exemption is not available.

A “test period beneficiary” is an owner or principal user of a facility at any time during the 3-year period beginning on the later of the date the facility was placed in service and the date of issue.  Depending on the type of user, bonds which are attributed to test period beneficiaries are allocated based upon percentage ownership of a facility, percentage of use based upon fair rental value or percentage of output purchased.  See Prop. Treas. Reg. 1.103-10(i).

Aggregation of Issues, Issuers and Expenditures

Aggregation of issues applies for purposes of determining the $1,000,000 and $10,000,000 limits in I.R.C. § 144(a)(1) and (a)(4)(A).  Aggregation of capital expenditures applies for purposes of determining the $10,000,000 limit in I.R.C. § 144(a)(4)(A)(ii).  There are numerous aggregation rulings, including the ones summarized below, covering possible structures, especially involving “contiguous” or “integrated facilities.”  The concept of “proximity” between facilities is clarified in these rulings.

Rev. Rul. 75-193: In order to determine whether the exempt small issue dollar limitation under section 103(b)(6)(D) of the Code is exceeded with respect to a city’s bonds to finance land acquisition and construction of a manufacturing facility in the city for a corporation, there must be included a related corporation’s capital expenditures for “contiguous” land and a manufacturing facility outside the city boundary even though the facilities are not inter-connected, use dissimilar processes, produce different products, and have different production employees. In the revenue ruling, the related corporation purchased land in the unincorporated portion of a county surrounding the city. This land was “continguous” to the site of the proposed facility.

Rev. Rul. 76-427 (Carpets; Contiguous; Integrated Facilities; 1/2-mile rule):  Issue:  Advice has been requested whether, under the circumstances, certain prior issues and capital expenditures must be taken into account in determining the aggregate face amount of qualified small issue bonds that may be issued.  IDBs separately issued by a county and a city within the county to finance, for use by the same corporation, noncontiguous factories located one-half mile apart with one factory producing carpet yarn (located in the County but not in the City) for the manufacture of carpets in the other (located in the City) so that they are integrated facilities within the meaning of former Treas. Reg. 1.103-10(b)(2)(ii)(e), must be aggregated and considered with capital expenditures to determine whether the $5,000,000 exempt small issue limitation has been exceeded.  The two facilities were located approximately 1/2 mile apart from one another, but the factories did not abut the jurisdictional lines.  Yarn from the County factory was transported by truck to the City factory.  The factories in County and City were each designed to function as an integral unit in the continuous manufacturing process of changing raw materials into finished products (Carpets).  “The involvement of the two facilities in various stages of the same overall continuing manufacturing process is significant.  Another factor to consider is whether or not the facilities are located in the same proximity.”  “Rev. Rul. 76-427 was intended to limit the contiguous or integrated facility rules of sections 1.103–10(b)(2)(ii)(e) and 1.103–10(d)(2) of the regulations to those facilities that are related or dependent upon each other in function and that are no more than one-half mile from each other on opposite sides of a jurisdictional border.  The Revenue Ruling, in effect, restricts the application of those provisions of the regulations to structures located on opposite sides of a jurisdictional border which reasonably can be considered to comprise one facility.” (PLR 7934061)

PLR 8442030 (Facility destroyed):  (1) Whether capital expenditures relating to the subfacilities located outside of County C are taken into account in determining the aggregate face amount of the bond issue, and (2) whether the fair market value of the destroyed facility, determined immediately before destruction, will be excluded capital expenditures for aggregation purposes.  Governmental unit B is issuing bonds within three years of the acquisition and destruction of the facility in order to induce borrower to construct a replacement facility in County C.  Section 103(b)(6)(F)(i) specifically excludes from aggregation capital expenditures made to replace property damaged or destroyed by fire, storm or other casualty – exclusion is limited to the FMV of the destroyed property determined immediately before the casualty.  Determined:  (1) Subfacilities located outside of County C are not deemed integrated; (2) Non-bond amounts used to construct the replacement facility will not be taken into account as capital expenditures in determining the face amount of the bond issue.

PLR 8437027 (Expenditures for Bank; 2.5 miles; “Proximity” Test): Issuer issued bonds for bank building in town.  During the three years prior to issuance, the bank had capital expenditures for a building in city.  Town and city are located 2.5 miles apart.  Issue:  Whether the capital expenditures incurred in the City during the three year period prior to the issuance of the bonds are included in determining capitalized expenditures attributed to bank’s facility located in the town.  Determined:  The facilities are not located within the same proximity and are not integrated.

PLR 8217033 (HMO facility):  An HMO plans to use a newly constructed bond-financed facility in City as the central facility for operations.  There are satellite medical offices in the area.  Additional satellite facilities will be needed in the future.  Three existing satellite facilities are located in City, and each is less than 1/2 mile from the proposed central facility.  Four other satellites are located in four additional incorporated municipalities within the County.  The distances between these facilities and the proposed central facility range from three miles to sixteen miles.  None of the facilities are located on the border of a municipality of the County.  Determined:  In this case, the central facility and the four satellite facilities located outside of the City are at least three miles apart, which is beyond the one-half mile distance described in Rev. Rul. 76-427.  Accordingly, these satellite facilities are not contiguous to or integrated with the central facility or with each other for purposes of the I.R.C. 144(a) rules.

PLR 8339087 (Supermarket distribution):  City A and City B are contiguous to one another.  The headquarters, the bakery, the old warehouse and the new warehouse (these are various facilities that are the focus of the ruling) are all located within one-half mile of one another.  Neither the headquarters, the bakery nor the old warehouse, all located in City A, are located on adjoining parcels of land.  The question presented is whether any of these existing facilities will be considered “integrated or contiguous” within the meaning of Treas. Reg. § 1.103-10(b)(2)(ii)(e) with the new warehouse.  Found:  The two warehouses in question will serve a single division.  The functions of the warehouses are the same – storage, etc.  The new warehouse is, in essence, an extension of the old.  Determined:  The two warehouses will be “integrated or contiguous,” but the headquarters and bakery will not.

PLR 7934061 (Chicken breeders):  Requested the following rulings: (1) The facilities to be acquired and constructed from the proceeds of County A’s issue and City’s issue are not integrated facilities with respect to each other or with respect to other facilities owned or leased by Corporation or Subsidiary; (2) the capital expenditures of the independent contractor Breeder Growers and Broiler Growers are not to be added to the capital expenditures of Corporation in determining whether the $10,000,000 limit has been exceeded in connection with the bond issue in which the Corporation is the principal user.

PLR 8051085:  Project site located in the unincorporated portion of the County will not be contiguous to any facility of either Corporation A or Corporation B located anywhere in the County.  Neither will the Project site abut any other county line.  Accordingly, we conclude that the proposed project will not be contiguous to any other facility of Corporation A or Corporation B.  References Rev. Rul. 75-193.

PLR 8115102 (Meat packing and processing company):  Requested the following rulings: (1) That the proposed Facility to be constructed in the City and financed through industrial development revenue bonds issued by the City and the new Plant located in the County not be deemed ‘integrated facilities,’ within the meaning of section 1.103–10(b)(2)(ii)(e) of the Income Tax Regulations; and (2) That the capital expenditures of the Company not be included in the determination of the aggregate face amount of the industrial development revenue bond issued under section 103(b)(6)(D) of the Internal Revenue Code.  The City, an incorporated municipality, is located within the County. The Company is engaged in the business of meat packing and processing. The Facility will be located within the boundary of the City. The Plant is located in the County but outside the boundary of the City. The Plant is six miles from the boundary of the City. It is anticipated that the Facility will utilize approximately forty to fifty percent of its space with meat products from the Plant. The construction of the Facility will be financed through industrial development revenue bonds to be issued by the City. The Company further represents that it will be a principal user of the Facility under section 103(b)(6)(B)(ii) of the Code and that it is the owner of the Plant.  The facts submitted disclose that the Plant and the Facility will be related to each other in function. However, the Plant and the Facility will be located with respect to each other beyond the one-half mile guide line set forth in Rev. Rul. 76–427.  We conclude that, the proposed Facility to be constructed in the City and financed through industrial development revenue bonds issued by the City and the new Plant located in the County not be deemed ‘integrated facilities,’ within the meaning of section 1.103–10(b)(2)(ii)(e) of the regulations.

PLR 8120108 (Egg processing):  In the instant case, although the Company’s bond financed County A facility and its proposed County C facility will be located in adjoining counties, it is represented that they will not be contiguous and that they will be at least 10 miles distant from each other. Furthermore, it is represented that the two facilities will be equipped to operate wholly independently of one another. The fact that the Company’s bueiness headquarters in the State are to be located at the County A facility, which facility will also house a feed mill servicing both facilities does not indicate that the functions of the County A facility and the County C facility will be ‘dependent’ upon each other within the meaning of Rev. Rul. 76–427.  Accordingly, based solely on the facts submitted and representations made, we conclude that the Company’s County A and County C facilities will not be ‘contiguous or integrated facilities’ within the meaning of section 1.103–10(b)(2)(ii)(e) of the regulations.

PLR 8124098 (Paper mill company):  In the instant case, although the W and X mills are located in adjacent counties, it is represented that they are separated by a distance of approximately two miles; have separate manufacturing and supervisory staffs; and are each fully integrated manufacturing and production facilities.  Accordingly, based on the facts submitted and the representations made, we conclude that:  (1) Substantially all the proceeds of each of the W and X issues will be issued for the acquisition, construction or reconstruction of depreciable property. See sections 1.103-10(b)(1)(ii) and 1.103-8(a)(5)(v) of the Regulations; (2) The issue by Y of $C of its industrial development is an issue described in section 103(b)(6)(A) of the Code; (3) The issue by Z of $B of its industrial development bonds is an issue described in section 103(b)(6)(D) of the Code; both rulings 2 and 3 are based on the condition that neither Company nor related persons are beneficiaries of outstanding prior exempt small issues in either county which would cause the dollar limitations of sections 103(b)(6)(A) or 103(b)(6)(D) to be exceeded with regard to the respected issues.  (4) The W and X facilities are not contiguous or integrated facilities with respect to each other for purposes of section 1.103-10(b)(2)(ii)(E) and 1.103-10(d)(2) of the regulations, and the $1,000,000 limitation of section 103(b)(6)(A) of the Code shall be applied separately to W and the $10,000,000 limitation of section 103(b)(6)(D) of the Code shall be applied separately to X.  (5) The capital expenditures of W facility are not to be added to the capital expenditures of the X facility in determining whether the section 103(b)(6)(D) $10,000,000 limit has been exceeded in connection with the X bond issue.

PLR 8149049: Provided that the Service Center is located more than one-half mile from Building A, the Service Center will not be a ‘contiguous or integrated’ facility for purposes of section 1.103-10(b)(2)(ii)(e) of the regulations. See Rev. Rul. 76-427, 1976-2 C.B. 28.

PLR 8313074: [To come]

PLR 8143043: Applies the 1/2-mile rule and concludes that facilities located 10 miles from one another are not contiguous or integrated.

PLR 8228080 (Public utility selling electricity): All of the facilities (which are located in different counties) except the warehouse and headquarters building are part of an interconnected electrical system serving not only the seven county area, but also, the three state area. The seven counties involved are contiguous and located between two metropolitan areas.  While it may be feasible for some purposes to divide an electrical system into component parts such as generating, transmission, and distribution for purposes of the exempt small issue, the transmission lines, substations, and generating facility are all one continuous, integrated electrical facility.  On the other hand, the headquarters building located in County D and the warehouse located in County F are not an integral part of the other facilities.  Based on the above, we conclude that the transmission lines, structures for transmission lines, substations, switching stations and generating facility are an integrated facility within the meaning of section 1.103-10(d)(2)(i) of the regulations. Because the integrated facility is located on both sides of a border between two or more political jurisdictions, the integrated facility will be treated as if it is entirely within each such political jurisdiction for purposes of taking into account prior exempt small issues.  Accordingly, the integrated facility can qualify for an exempt small issue of $1,000,000 in each nonadjacent political jurisdiction.  We also conclude that the warehouse and headquarters building are separate facilities located in different counties, more than one-half mile apart, and, as such, each facility can qualify for a small issue of $1,000,000.

PLR 8503027 (Bonds for POS systems):  The rulings requested are: 1) whether each group of POS Systems will be treated as a separate facility and will not be treated as a single facility that is contiguous to or integrated with any other group of POS Systems or with or to the central communications processor at M for purposes of section 103(b)(6) of the Code; 2) whether, in determining the outstanding face amount of prior issues of bonds required to be aggregated with the face amount of any one of the proposed issues, the Issuer need take into account only those prior issues used to finance facilities located in the same governmental unit as one or more components of the group of POS Systems actually financed by the proceeds of one of the proposed bond issues; 3) whether, in determining the amount of capital expenditures required to be aggregated with the face amount of any one of the proposed bond issues by the Issuer, only those otherwise includible capital expenditures made in the same governmental unit as one or more components of the group of POS Systems actually financed by the proceeds of one of the proposed bond issues need be taken into account; and 4) whether each of the various bond issues will be treated as separate bond issues for purposes of section 103(b)(6) of the Code or will be treated as a single bond issue.

Manufacturing Facility:

Tax exempt small issue private activity bond financing is permitted under sections 103 and 144(a) of the Code for any “manufacturing facility.”  The term manufacturing facility is defined in I.R.C. 144(a)(12)(C) as:

  1. any facility that is used in the manufacturing or production of tangible personal property (including the process resulting in a change in condition of such property);
  2. facilities that are directly related and ancillary to a manufacturing facility if (a) such facilities are located on the same site as the manufacturing facility, and (2) not more than 25 percent of the net proceeds of the issue are used to provide such facilities.  [Ancillary activities are activities that are not integral to the process.  They are activities that, as the statute provides, are directly related to manufacturing, but are, as the dictionary provides, secondary, supplementary or extra.]

No regulations have been promulgated under I.R.C. 144(a)(12)(C).

In its tax-exempt bonds course module for small issue private activity bonds, the Internal Revenue Service states that common characteristics of a manufacturing facility are:

  • Facilities must be of a character subject to allowance for depreciation;
  • The property produced must be tangible personal property;
  • There must be a “change” or “transformation” of the original materials and such “transformation” should be substantial;
  • Manual or machine labor must be expended in the process (as opposed to natural growth); and
  • As a result of the process, a new and different article must be created that has a distinct name, character or use.

Mere assembling is not manufacturing.  Putting a few parts together is not “manufacturing.”  However, major assembly may be manufacturing, such as automobile plants.

The NABL submission referenced above describes shortcomings of the definition of “manufacturing facility.”  One shortcoming is the fact that the legislative history of amendments to I.R.C. 144(a) suggest that there is another category of “manufacturing facilities” consisting of “subordinate and integral” facilities that can be included and that shouldn’t have been subject to the 25% limitation.

There should be three steps to analyzing the manufacturing facility:

  1. Analyze what components make up core manufacturing.
  2. Identify components that are directly related to the manufacturing process but not absolutely necessary.
  3. Analyze the components in this second group to determine what components are spatially or temporally required to be near the manufacturing process, that must be close at hand in space and time to the manufacturing process, for it to operate efficiently.  These components are the ones considered “subordinate and integral” to the manufacturing process and treated as part of core manufacturing.  Those components that do not need to be close at hand to the manufacturing process are treated as ancillary facilities.

Components such as short-term warehousing space for raw materials necessary to support a product cycle would under the test above be treated as “subordinate and integral” to the manufacturing process and not subject to the percentage limitation.  This interpretation (using the subordinate and integral analysis) parallels the exempt facility provisions.

An office is usually not considered “functionally related and subordinate” to manufacturing facility, and therefore a manufacturing facility does not include an office unless: (1) the office is located on the premises of a “manufacturing facility”; and (2) not more than a de minimis amount of the functions to be performed at such office is not directly related to the day-to-day operations at such facility.  See I.R.C. 144(a)(12)(C)(i) and I.R.C. 142(b)(2).  NABL suggests that there is a concern that the IRS is thinking of this test as a “de minimis amount of space” standard, rather than a “directly related activities” standard.  NABL believes that an office is subject to the “ancillary” standard with the 25% limitation.  There may be circumstances when a portion of the office space may be integral to the manufacturing process and would not be taken into account in application of the 25% limitation.

Note: In ARRA, Congress revised the definition of “manufacturing” for qualified small issue bonds issued in 2009 and 2010 to eliminate the concept of “ancillary and related” and to provide that the net proceeds of an issue are used to provide a manufacturing facility if such proceeds are used to provide a facility which is “functionally related and subordinate” to a manufacturing facility (determined without regard to this subclause) if the facility is located on the same site as the manufacturing facility.  I.R.C. 144(a)(12)(iii).  Refundings:  When you refund a 2009 or 2010 small issue bond that was non-AMT and non-ACE, you can continue to have non-AMT and non-ACE refunding bonds (I.R.C. 57(a)(5)(vi) and 56(g)(4)(B)(iv)).  However, you would need to satisfy the old manufacturing facility definition again – a reallocation of bond proceeds may be needed to avoid refunding bonds for purposes that would have been allowed under the expanded manufacturing facility definition.

Note the various standards: “Directly related and ancillary,” “subordinate and integral,” and “functionally related and subordinate.”  Functionally related and subordinate is also the standard used for exempt facility bonds.

Generators, solar panel:  Part that is needed for core manufacturing is treated as core manufacturing.

In the context of publicly traded partnerships and qualifying income from activities with respect to minerals or natural resources, the Treasury Department in May 2015 proposed regulations distinguishes between “good” production” and “bad” manufacturing.  “In addition, except as specifically provided otherwise, processing or refining does not include activities that cause a substantial physical or chemical change in a mineral or natural resource, or that transform the extracted mineral or natural resource into new or different mineral products, including manufactured products”

The following are IRS rulings regarding the status of facilities as manufacturing facilities:

Rock Crusher PLR:  TAM 199904034: Whether the proceeds of the Bonds were used to provide a ‘manufacturing facility’ within the meaning of section 144(a)(12)(C) of the code.  The bonds financed the acquisition of equipment, including a loader, two bulldozers and a rock crusher.  The Company used proceeds of bonds to purchase equipment used by Company to mine and crush limestone.  In excess of 25% of the net proceeds of the bonds were allocated to bulldozers used to prepare a site for the extraction of limestone and to reclaim the site once extracting is completed.  Bulldozers must be part of a core manufacturing facility for the bonds to be qualified small issue bonds.  The IRS ruled that based on the statute and legislative history, core manufacturing should be narrowly defined.  Company’s mining and rock crushing process is not a single core manufacturing facility.  Additionally, even if it were a core manufacturing process, the bulldozers would not be part of either process.  Bonds are not qualified small issue bonds.

Art PLR:  PLR 200234012: Request for a ruling that the facility financed with the proceeds of the bonds would be a “manufacturing facility” under section 144(a)(12)(C) of the code.  This PLR addresses the distinction between core manufacturing and ancillary manufacturing.  Processing and transformation of data and intellectual, literary and artistic ideas is not considered core manufacturing.

Cheese Curing PLR:  TAM 200025004: Whether the facility, used for the purpose of curing cheese, is a manufacturing facility under section 144(a)(12)(C) of the code.  The IRS determines that the curing of cheese is a key component of manufacturing cheese.  Therefore, the curing is part of the core manufacturing of cheese.

Scallops PLR:  PLR 9014014: Whether certain operations of the corporation constitute a “manufacturing facility.”  The corporation proposes to utilize proceeds of the bonds to finance modifications to a steel hull vessel for use in the Corporation’s scallop harvesting and processing business.  The vessel will facilitate the processing of raw scallops while at sea and significantly increase payloads per trip. The IRS determines that the operations to be financed will transform ocean harvested scallops into a processed product ready for commercial consumption and use.  Therefore, such operations constitute a “manufacturing facility” within the meaning of section 144(a)(12)(C) of the code.

Bag Maker PLR:  PLR 8815033: Whether the facility is a manufacturing facility.  The company intending to use the bond proceeds is engaged in a variety of businesses, including the production of kraft paper, multi-wall bags and other paper products. The financed facility would consist of a new multi-wall kraft bag plant. Because the facility will be engaged in the transformation of rolls of paper, tangible personal property, into paper bags, a new product, and because the offices in the production facilities are directly related to the manufacturing operations (as are the storage facilities, which are located on the same site and are integrally related), the facility constitutes a “manufacturing facility.”  In its training module linked above, the IRS includes the following summary of this ruling: “Facility engaged in the transformation of rolls of paper into paper bags is a manufacturing facility.  Mere cutting of timber into boards might not be enough.”

Fish Hatchery PLR (Not manufacturing): PLR 8819026:  A ruling that the project constitutes a “manufacturing facility.”  The bond proceeds will be used for breeding, growing, harvesting and later limited processing of fish.  The Company will acquire breeding stock and produce offspring fry and fingerlings in a hatchery and nursery.  The fingerlings will then be placed into circular above ground concrete tanks.  There is significant labor involved.  At some point, fish will be harvested by the employees, graded, sized and packaged in cardboard boxes with refrigeration sufficient to chill but not freeze the fish.  “We believe that, for purposes of I.R.C. 144(a)(12)(C)(i), the terms ‘manufacturing’ and ‘production’ do not include activities such as feeding, growing and harvesting live animals, including fish.  Facilities for these activities are more in the nature of agricultural facilities which if appropriate for financing by an issue described in I.R.C. 144(a) would more appropriately be limited by the constraints imposed by I.R.C. 144(a)(12)(C)(ii), pertaining to the use of an exempt small issue to finance certain facilities for first time farmers.  Therefore, based on the facts of this case we conclude that the project is not a ‘manufacturing facility’ within the meaning of I.R.C. 144(a)(12)(C).”  The IRS states in its training module referenced above that “an entire operation of processing, cleaning and canning food is manufacturing.  For example, meatpacking is manufacturing, but a butcher shop is not.”

Recycling PLR (Not manufacturing):  PLR 8829048:  Facility (a “reverse vending machine”) used to crush and flatten aluminum, glass or plastic is not a manufacturing facility because this does not create tangible personal property.  The machines were to be placed in supermarkets in a state whose law required beverage distributors to redeem empty containers.  There was no formation of any intermediate product.

Printing Company PLR:  PLR 8934063:  Facilities used in a printing company, printing presses and other similar equipment used in the printing company are considered manufacturing facilities.  However, photocopying with finishing may not be manufacturing.

Snowmaking PLR (Not manufacturing):  GCM 39379:  Snowmaking at a ski resport is not manufacturing.  Although air and water are used to make snow, snow-making is not the primary activity but is incidental to the recreational activity.

TV Studio PLR (Not manufacturing):  PLR 8839049:  A television broadcasting studio consisting of sales, accounting and personnel offices, news and commercials production facilities and a network signal receiving facility was not a manufacturing facility.

See also the discussion in Bing, Small Issue Bonds for Manufacturing Facilities, Tax Notes, December 26, 1988, regarding processes that qualify as “manufacturing” for purposes of certain investment tax credit rules.  Examples include processing junk cars and scrap metal for resale, grain handling, blending petroleum products, chicken processing, maturation of bourbon whiskey, fruit ripening, snowmaking in Vail, egg farms, coal gasification.

Facility that provides coating to other products – does it qualify as a manufacturing facility?  If part of the process of manufacturing the product or part of the manufacturing change, perhaps the facility is a manufacturing facility.


A bond can be a qualified small issue bond if 95 percent or more of the net proceeds are used to “redeem part or all of a prior issue which is issued for purposes described in subparagraph (A) o[f] this subparagraph.”  Subparagraph (A) sets forth the purposes of acquiring, constructing, reconstructing or improving land or property of a character subject to allowance for depreciation.  It is not clear what a “prior issue” consists of.  Does a prior issue include a corporate obligation? Does a prior issue include a taxable governmental obligation?

Assume for instance that a manufacturing company entered into a bank loan several years ago to finance a manufacturing facility.  It now intends to refinance the bank loan with proceeds of a tax-exempt qualified small issue bond.  If the bank loan is considered a “prior issue,” the refunding paragraph applies.  If the bank loan is not considered a “prior issue,” the bonds must satisfy subparagraph (A), and an argument based on reimbursement for valid purposes must be made.  The Bond Attorneys’ Workshop outlines from the 2010 conference describe that the use of qualified small issue bonds to reimburse expenditures that were paid before the issue date is governed by the usual reimbursement regulations of Treas. Reg. 1.150-2 (rather than the prior “official action” rules in Treas. Reg. 1.103-8(a)(5)), as suggested by Treas. Reg. 1.142-4.  (It is important to note that the declaration of official intent must be adopted by the governmental issuer, not the conduit borrower!)  The refunding exceptions (once financed, not reimbursed) in Treas. Reg. 1.150-2(g) do not apply, by analogy to Treas. Reg. 1.142-4(b), to proceeds of bonds that are used to refinance debt that is not a governmental obligation.  In other words, even though the manufacturing facility was financed with obligations, and the bonds will be used to pay principal of and, probably, accrued interest on the bank loan, the use of bond proceeds for this purpose is not prohibited under the “once financed, not reimbursed” rule.

Consider, however, whether a reimbursement is still proper if the financed facilities were placed in service several years ago.  Can the use of proceeds to refinance the bank loan still be viewed as a reimbursement for this purpose?

There are other special rules regarding refundings of small issue bonds:

  • No increased bond size:  The amount of the refunding bond cannot exceed the outstanding amount of the refunded bonds.  I.R.C. 144(a)(12)(A)(ii)(I).
  • TEFRA: As long as the weighted average maturity of the refunding bonds is not later than the remaining weighted average maturity of the refunded bonds, no public approval is needed.  I.R.C. 147(f)(4)(D).
  • Volume cap:  If the amount of the refunding bond does not exceed the outstanding amount of the refunded bonds, no volume cap allocation is needed.  I.R.C. 146(i).

General Overview for First-Time Farmers

A private activity bond is not a qualified bond if more than 25 percent of the net proceeds of the issue are to be used (directly or indirectly) to acquire land or an interest therein, or if any portion of the proceeds is to be used (directly or indirectly) for the acquisition of land or an interest therein to be used for farming purposes.

There is an exception to this land acquisition prescription that applies for first-time farmers.  If the land is to be used for farming purposes and the land is acquired by someone who is a first-time farmer, who will be the principal user of the land and who will materially and substantially participate on the farm of which the land is a part in the operation of the farm, then the land may be financed so long as the expenditures financed by the issue are not in excess of $450,000.  The expenditure limit is subject to adjustment for inflation for calendar years after 2008.  The following maximum amounts applied in the following calendar years:

  • 2009: $469,200
  • 2010: 470,100
  • 2011: 477,000
  • 2012: 488,600
  • 2013: 501,100
  • 2014: 509,600
  • 2015: 517,700 (Rev. Proc. 2014-61)

Other References

GCM 37906 (March 30, 1979): Whether interest on industrial development bond proceeds allocable to the construction of a factory is a qualified cost under section 103(b)(6)(A) if it accrues before construction began.

Solid Waste Disposal Facilities (Treas. Reg. 1.142(a)(6)-1)

May 24, 2012


The IRS issued final regulations regarding solid waste disposal facilities that are eligible for financing with tax-exempt private activity bonds.  See the reference below for a summary of the regulations prepared by Nixon Peabody LLP.

What is a Solid Waste Disposal Facility:

Under the final regulations, a “solid waste disposal facility” means any facility to the extent that the facility:

  • processes “solid waste” in a “qualified solid waste disposal process”;
  • performs a “preliminary function”; or
  • is functionally related and subordinate to a facility that performs either a qualified solid waste disposal process or a preliminary function.

What is a Preliminary Function:

A preliminary function is a function to collect, separate, sort, store, treat, disassemble or handle solid waste.  The function must be “preliminary” to and “directly related” to the qualified solid waste disposal process.  There is no longer a requirement that the input to the preliminary function facility consist of at least 50% solid waste.  I.e., there is no need to consider the input to determine whether the facility is a preliminary function facility.

What is Functionally Related and Subordinate:

Consider PLR 8618008 in which the IRS determined that a port road was not functionally related or subordinate to the exempt facility.

Mixed-Use Facilities

See Westrock Virginia Corp., U.S. Claims Court, (Feb. 16, 2018) for a discussion of allocating cost basis of a facility between electricity generation and process steam generation, in the context of the Section 1603 Grant. (United States Court of Federal Claims. No. 15-355C)


IRS issues final regulations on solid waste facilities,” August 22, 2011, Nixon Peabody LLP.

Exempt Facility Bonds,” February 14, 2012, McGuireWoods LLP.

PLR 9143036 (Jul. 29, 1991):  Taxpayer operates a polyester manufacturing business.  The plant includes sludge disposal facilities consisting of dewatering, incineration and emission control equipment.

PLR 9252011 (Sept. 24, 1992):  Whether solid waste treatment facilities to be located at a plant qualify as a solid waste disposal facility for purposes of section 142(a)(6) of the code.  The facility recovers waste in gases.  Refers to water as a transportation medium.  Identifies specific components of the facility that qualify.

Article X, Section 20 of the Colorado Constitution (“TABOR”) Matters

May 17, 2012

Relevant Case Law:

Bickel v. City of Boulder, 885 P.2d 215 (Colo. S. Ct. 1994):  Appeal by plaintiff seeking declaratory and injunctive relief and the invalidation of several ballot issues proposed by the defendants. At issue are ballot titles and matters concerning approval of consolidated debt and tax increases, approval of unlimited general obligation bonds, exemption from future voter approval of tax rate increases, failure to include the text of the ballot issue in the election notice and failure to include in the election notice a proper estimate of the district’s first full fiscal year spending.  Quote: “Unlike the federal constitution which grants powers, state constitutions, including Colorado’s, are documents of limitation.”

Boulder v. Dougherty, 890 P.2d 199 (Colo. App. 1994):  Defendant claimed that equipment lease-purchase agreement and related instruments violated TABOR.  The court of appeals affirms the district court’s decision that the agreement does not violate TABOR.  Issue: Does the agreement create a multiple fiscal year direct or indirect district debt or other financial obligation whatsoever?  The defendant had agreed to purchase Certificates of Participation evidencing proportionate rights in the agreement, but then backed out, claiming that the agreement violated TABOR because (1) TABOR is worded as broadly as possible to include all multiple-fiscal year financial obligations, (2) the agreement is a multiple-fiscal year financial obligation, (3) TABOR supersedes prior case law to the contrary, (4) TABOR should be given the interpretation that most restrains growth in government, and (5) the promoters  of TABOR intended it to apply to lease-purchase transactions.  Case summarizes the pre-TABOR Gude v. City of Lakewood (636 P.2d 691 (Colo. 1981)) case (stating “to constitute debt in the constitutional sense, one legislature, in effect, must obligate a future legislature to appropriate funds to discharge the debt created by the first legislature’).  The Dougherty case is a case of first impression relating to lease purchase agreements in the post-TABOR era.  Quote: “Doughty also argues that any interest earned on the certificates of participation are being represented as tax free pursuant to the Internal Revenue Code which is true only if the Agreement constitutes an obligation of a state or political subdivision thereof.  This argument, even if correct, is of no assistance.  The Internal Revenue Code does not control the interpretation of the Constitution of the State of Colorado.  In addition, whether or not the interest income derived from the Agreement is tax free is a risk assumed by Dougherty, or any investor concerning which we express no opinion.  Whether the interest on this, or any similar, transaction is tax free will affect the financial benefit contemplated by all parties, but it has no impact upon our interpretation of the Colorado Constitution.”

Leases and Installment Purchase Agreements (e.g., I.R.C. 167)

May 8, 2012

Typical Lease Financing Structure

The lease purchase agreement (LPA) is entered into between the municipality, as lessee, and a lender or other lessor.  Under the LPA, the lessor leases the equipment to the lessee, and the lessee rents, leases and hires the equipment from the lessor.  The term of the LPA is for one year and is subject to renewal and appropriation by the lessee.  In some jurisdictions, a built-in evergreen provision might be added to provide for automatic renewals of the IPA unless the lessee takes action to “not” appropriate.

The lessee, on behalf of the lessor, orders the equipment and installs the equipment, and only then leases the equipment.

Under the IPA, the lessee promises to make rental payments only to the extent appropriated therefore.  In the event of a nonappropriation, the IPA is deemed terminated, and the lessee is required to deliver the equipment to the lessor.

Upon acceptance of the equipment by the lessee, title to the equipment and any and all additions, repairs, replacements or modifications will vest in the lessor, subject to the lessee’s rights under the IPA.  The lessee has no right, title or interest in the equipment except its leasehold interest therein.

The lessee commonly has a purchase option under which it may be allowed to purchase the equipment from the lessor.

Typical Installment Purchase Agreement Structure

The installment purchase agreement (IPA) is entered into between the municipality, as borrower, and the lender.  Under the IPA, the lender makes a loan to the municipality.  Usually, the loan proceeds are deposited to an escrow fund.  The municipality, with the consent of the lender, may make a draw from the escrow fund from time to time to use the loan proceeds to purchase the equipment (or energy conservation measures).  The lender does not operate, control or have “possession” of such equipment or measures.  The municipality is responsible for selecting the equipment and using, maintaining, operating and storing the equipment.

In the IPA, the municipality promises to make loan payments to the lender during the loan term, usually based on a payment schedule attached to the IPA.  A portion of the loan payment is separately identified as the interest component, which is eligible for tax-exempt treatment.  The lender may assign the loan payments to another person.

During the loan term, legal title to and “ownership” (vs. possession) of all equipment and any and all repairs, replacements, substitutions and modifications thereto is in the lender, and the municipality must take all actions necessary to vest such title and ownership in the lender.  For instance, the municipality may need to mark or otherwise label the equipment to identify the lender as the owner.  Upon termination of the loan by prepayment in full by the municipality or through payment by the municipality of all loan payments and other amounts relating thereto, the lender must convey its ownership interest in the equipment thereby terminating the lender’s ownership of the equipment.

The municipality may permit the lender to file financing statements and amendments thereto describing the equipment in order to evidence the lender’s ownership interests in the equipment.  Such financing statements should reflect the lender’s legal title to the equipment and be designated as “filed for notice purposes only.”

Upon failure by the municipality to pay, the lender may declare the outstanding balance immediately due and payable and may be able to enter the municipality’s premises to disable the equipment or retrieve the equipment.

In certain states, depending on state law and other pertinent circumstances, it may not be possible to structure an IPA as an annually appropriated financing that would not be considered a multiple fiscal year debt of the municipality.

What’s the Difference Between an LPA and IPA?

There isn’t really a difference.  The LPA may be more acceptable in certain jurisdictions in which there is an express prohibition of multiple fiscal year obligations.  The lease, as such, is more easily understood as a structure that provides for annual renewals.  Unlike the IPA structure where the municipality is considered the borrower of the loan, the LPA refers to the municipality merely as lessee, and there is no “loan” – instead, the lessee purchases the equipment on behalf of the lessor, and then leases the equipment.  In some jurisdictions, these distinctions may not matter. In others, they are significant reasons for why the lease structure is preferred.

Other Matters

It is questionable whether a “true lease” can be structured as a tax-exempt obligation given the federal tax law requirement that the lessee build up equity in the leased property. See Rev. Rul. 55-540 and PLRs 8235056 and 8347058.  See discussion in Bond Attorneys Workshop materials from 2008.

True lease vs. financing lease?  See “When Is a Lease Not a Lease? Seventh Circuit Adopts ‘Substance Over’ Form Test for True Lease Determination,” David A. Hatch and Mark G. Douglas, Jones Day, available online.

A basic source of rules regarding distinguishing between a true lease and a financing lease is Rev. Proc. 2001-28.  In public finance transactions, the objective is typically to treat the arrangement as an installment sale transaction such that the lessee is considered the owner of the property.  This requires an inverse reading of the revenue procedure.  A basic requirement for this treatment is that the lease extend at least 125% beyond the useful life of the property on which the bond-financed property is constructed.  This ensures that the lessee has beneficial use of the bond-financed property for a period of time that is nearly guaranteed to cover all of the life of the financed property.


Partnership Matters

May 3, 2012

Contributions of Property with BIG or BIL; Reverse § 704(c) Allocations:

See the IRS Audit Technique Guide for a good overview of contribution matters relating to property with BIG or BIL.


Orrisch v. Commissioner, 55 T.C. 395 (Dec. 2, 1970) (Download): Whether an amendment to a partnership agreement allocating to petitioners the entire amount of the depreciation deduction allowable on two buildings owned by the partnership was made for the principal purpose of avoidance of tax within the meaning of section 704(b).  The court holds that avoidance of tax was the principal purpose and that the amounts of each of the partners’ deductions for the depreciation of partnership property must be determined in accordance with the ratio used generally in computing their distributive shares of the partnership’s profits and losses.  See also section 704(a) and (b).

Generating Client Relationships

May 3, 2012

Question 1: “I’m curious: What are your current business priorities?”

Question 2: “I’m interested in knowing: Where is the pain in your business? What keeps you up at night?”

Question 3: “I would be interested in knowing where the areas of growth are in your business.  Where are the opportunities for gain?”

Last Question: “How can my firm and I support you?”

See David King Keller, 100 Ways to Grow a Thriving Law Practice.