A private activity bond for an airport facility issued as an exempt facility bond is a “qualified bond” that is eligible for tax-exempt treatment. I.R.C. §§ 141(e)(1), 142(a)(1).
Certain general matters relating to exempt facility bonds, including such bonds for airports, are described in this post.
An airline’s right to net revenues from an airport may be considered an ownership-like interest that must be treated as private business use just as outright ownership would.
Treas. Reg. 1.141-13(d) provides that, for I.R.C. § 141 purposes, the multipurpose issue allocation rules of Treas. Reg. 1.148-9(h) apply, including allocations involving refunding purposes of the issue. An allocation under that subsection may be made at any time but once made may not be changed. An allocation, however, is not reasonable if it achieves more favorable results under I.R.C. § 141 than could be achieved with actual separate issues. The issue to be allocated and each of the separate issues under the allocation must consist of one or more tax-exempt bonds. Allocations made under this paragraph (d) and Treas. Reg. § 1.148-9(h) (arbitrage rules for refundings) must be consistent for purposes of I.R.C. § 141 and I.R.C. § 148.
In connection with the proposed Accounting and Allocation regulations of September/October 2006 (the 2006 Proposed Regulations), NABL raised the concern that Treas. Reg. 1.141-13(d) suggests that a single issue with governmental and, e.g., exempt facility airport bonds will not be eligible for tax-exemption. The single issue, if analyzed as a whole against I.R.C. § 141, would not “consist of one or more tax-exempt bonds” even though the two components, analyzed separately, would qualify.
The 2006 Proposed Regulations revised Treas. Reg. 1.141-13(d) and permitted retroactive application. The relevant revision changes the bold sentence above to “[e]ach of the separate issues under the allocation must consist of one or more tax-exempt bonds,” thereby removing the requirement that the issue as a whole consist of tax-exempt bonds. The 2006 Proposed Regulations also added an Example 5 to provide further guidance.
NABL stated the following in its comments to the 2006 Proposed Regulations:
NABL greatly appreciates the step taken in the Proposed Regulations to fix the inadvertent error introduced into Treas. Reg. §1.141-13(d). Correction of this error will mean that issuers will not be forced to separate issues by more than 15 days when issuance of them as a single issue will still result in tax-exempt debt if the two parts of the issue are analyzed separately.
Example 5 of the 2006 Proposed Regulations states:
(i) In 2006, State D issues bonds to finance the construction of two office buildings, Building 1 and Building 2. D expends an equal amount of the proceeds on each building. D enters into arrangements that result in private business use of 8 percent of Building 1 and 12 percent of Building 2 during the measurement period under § 1.141-3(g). In addition, D enters into arrangements that result in private payments in percentages equal to that private business use. These arrangements result in a total of 10 percent of the proceeds of the 2006 bonds being used for a private business use and for private payments. In 2007, D purports to make a multipurpose issue allocation under paragraph (d) of this section of the outstanding 2006 bonds, allocating the issue into two separate issues of equal amounts with one issue allocable to Building 1 and the second allocable to Building 2. An allocation is unreasonable under paragraph (d) of this section if it achieves more favorable results under section 141 than could be achieved with actual separate issues. D’s allocation is unreasonable because, if permitted, it would allow more favorable results under section 141 for the 2006 bonds (for example, private business use and private payments which exceeds the aggregate 10 percent permitted de minimis amounts for the 2006 bonds allocable to Building 2) than could be achieved with actual separate issues. In addition, if D’s purported allocation was intended to result in two separate issues of tax-exempt governmental bonds (versus tax-exempt private activity bonds), the allocation would violate paragraph (d) of this section in the first instance because the allocation to the separate issue for Building 2 would fail to qualify separately as an issue of tax-exempt governmental bonds as a result of its 12 percent of private business use and private payments, which exceed the 10 percent permitted de minimis amounts.
(ii) The facts are the same as in paragraph (i) of this Example 5, except that D enters into arrangements that result in 8 percent private business use for Building 1, and it expects no private business use of Building 2. In 2007, D allocates an equal amount of the outstanding 2006 bonds to Building 1 and Building 2. D selects particular bonds for each separate issue such that the allocation does not achieve a more favorable result than could have been achieved by issuing actual separate issues. D uses the same allocation for purposes of both section 141 and 148. D’s allocation is reasonable.
(iii) The facts are the same as in paragraph (ii) of this Example 5, except that as part of the same issue, D issues bonds for a privately used airport. The airport bonds if issued as a separate issue would be qualified private activity bonds. The remaining bonds if issued separately from the airport bonds would be governmental bonds. Treated as one issue, however, the bonds are taxable private activity bonds. Therefore, D makes its allocation of the bonds under §§ 1.141-13(d) and 1.150-1(c)(3) into 3 separate issues on or before the issue date. Assuming all other applicable requirements are met, the bonds of the respective issues will be tax-exempt qualified private activity bonds or governmental bonds.
Note that the rule in Treas. Reg. § 1.141-13(d) applies for I.R.C. § 141 purposes only. It does not, for example, cause a multipurpose allocation for I.R.C. § 148 purposes.
Assume proceeds are on deposit in a construction fund for the governmental portion of airport bonds (the “Governmental Fund”) and in a construction fund for the exempt facility portion of airport bonds (the “Exempt Facility Fund”). For I.R.C. § 141 purposes, moneys in the Exempt Facility Fund could be used for the governmental portion of the project, but care would need to be taken to ensure that moneys in the Governmental Fund don’t end up paying for the exempt facility portion of the project. Interest earnings on the Governmental Fund during the project period should be captured and directed to the governmental project portion as long as the project is underway.