Facilities for the Local Furnishing of Electric Energy or Gas (I.R.C. 142(f))

April 13, 2015

General Overview

As described in section 142(e), the local furnishing of electric energy or gas from a facility includes only furnishing within the area consisting of either (1) a city and one contiguous county, or (2) two contiguous counties.  There are special rules for treatment of electric energy that is transmitted outside of a local area, when required pursuant to an order of the FERC.

Local furnishing bonds may no longer be issued unless:

  1. the facility will (a) be used by a person who is engaged in the local furnishing of that energy source on January 1, 1997 and (b) be used to provide service within the area served by that person on January 1, 1997 (or within a county or city any portion of which is within such area); or
  2. the facility will be used by a successor in interest to such person for the same use and within the same service area as described in 1 above.

Rulings

PLR 9635010 (May 22, 1996): Holds that the “two-county rule” of Internal Revenue Code section 142(f)(1) is not violated by reason of a gas company’s emergency transfers of gas outside of the permitted city and contiguous county service area or by reason of gas brokerage arrangements outside of the service area.  The ruling notes that no tax-exempt bond proceeds have been spent for distribution or storage facilities relating to gas supplied outside of the service area.

PLR 20034007 (June 27, 2003):  Ruling that a reorganized company is the successor in interest to an historic local furnisher of electricity under I.R.C. 142(f)(3)(B) and that its facilities would serve or be available on a regular basis for general public use.

PLR 200942002 (dated July 7, 2009, released October 16, 2009): Describes facts and special accommodations and rules for a utility that generates more than it needs for its two serviced counties.

Facilities for the Furnishing of Water (I.R.C. 142(e))

February 17, 2015

General Matters:

PLR 201507002 (October 28, 2014):  Private business use of proceeds to be used for 1st water supply improvements, services allocable to improvements, and equipment allocable to 1st water supply doesn’t exceed 10 percent; and 2nd water supply improvements, including services allocable to improvements, and equipment allocable to 2nd water supply constitute facilities for furnishing of water under Code Sec. 142(a)(4) and 142(e).  The ruling illustrates how to determine whether output sold pursuant to an output contract is treated as output from a bond-financed facility.  The ruling also describes what a facility for the furnishing of water is.  Most water facilities are financed with normal governmental bonds.


Exempt Facility Bonds for Airports (I.R.C. § 142)

June 10, 2014

General Matters

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.

Multipurpose Issue

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.

 

 


Qualified Highway or Surface Freight Transfer Facilities (142(m))

July 24, 2013

General Discussion:

Examples of qualified highway or surface freight transfer facilities are facilities such as cranes, loading docks and computer controlled equipment for the transfer of freight from truck to rail or rail to truck.  Facilities that do not qualify include lodging, retail, industrial or manufacturing facilities.

Passage of SAFETEA-LU and the private activity bond provision reflects the government’s “desire to increase private sector investment in U.S. transportation infrastructure.” (http://www.fhwa.dot.gov)

Volume Cap Matters:

The total volume cap made available for private activity bonds for qualified highway or surface freight transfer facilities is $15 billion, under I.R.C. 142(m)(2) and SAFETEA-LU, Pub. L. 109-59.  Volume cap is allocated to qualifying projects by the Secretary of Transportation.  A notice regarding availability of volume cap was published in January 2006.

As of July 2013, the Department of Transportation has approved approximately $4 billion in bonds that support a total of eight projects.  Over $3.8 billion of this allocated cap has actually been issued through July 2013 for the following projects:

  • Capital Beltway HOT Lanes
  • North Tarrant Expressway in Texas
  • IH 635 (LBJ Freeway) in Texas
  • Denver RTD Eagle Project (East Corridor and Gold Line)
  • CenterPoint Intermodal Center, Joliet Illinois (two projects)
  • Downtown Tunnel/Midtown Tunnel in Norfolk, Virginia
  • I-95 HOT/HOV Project
  • East End Crossing, Ohio River Bridges.

Approximately $11 billion in volume cap remains unallocated.

Any project that receives Title 23 assistance is qualified to benefit from private activity bonds under I.R.C. 142(m).

Applications for projects may be made at any time.  There is no fixed format for bond applications.


Convention and Trade Show Facilities

February 6, 2013

General Discussion:

Prior to the Tax Reform Act of 1986, convention and trade show facilities were considered one type of “exempt facility,” together with sports facilities, parking facilities and pollution control facilities.  The authority to issue tax-exempt bonds for such facilities were repealed by the Tax Reform Act of 1986.

“Convention or trade show facilities” means special-purpose buildings or structures, such as meeting halls and display areas that are generally used to house a convention or trade show, including facilities functionally related and subordinate to such facilities such as parking lots or railroad sidings.  A hotel or motel that is available to the general public, whether or not it is intended primarily to house persons attending or participating in a convention or trade show, is neither a convention or trade show facility nor functionally related and subordinate thereto.  See Treas. Reg. 1.103-8(d).


Solid Waste

May 24, 2012

General:

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.

References:

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.


Exempt Facility Bonds (I.R.C. § 142)

July 14, 2011

General Matters:

Exempt facility bond means any bond issued as part of an issue 95 percent or more of the net proceeds of which are to be used to provide one of the following:

  1. Airports;
  2. Docks and wharves;
  3. Mass commuting facilities;
  4. Facilities for the furnishing of water;
  5. Sewage facilities;
  6. Solid waste disposal facilities;
  7. Qualified residential rental projects;
  8. Facilities for the local furnishing of electric energy or gas;
  9. Local district heating or cooling facilities;
  10. Qualified hazardous waste facilities;
  11. High-speed intercity rail facilities;
  12. Environmental enhancements of hydro-electric generating facilities;
  13. Qualified public educational facilities;
  14. Qualified green building and sustainable design projects; or
  15. Qualified highway or surface freight transfer facilities.

Note that, with certain exceptions, the basic rules applicable to all private activity bonds apply to exempt facility bonds.  These rules include:

  1. Volume cap rules under Section 146 (not applicable to airport exempt facilities);
  2. Substantial user requirement under Section 147(a);
  3. Limitation on maturity under Section 147(b);
  4. Limitation on use of proceeds to acquire land under Section 147(c);
  5. Prohibition for acquiring existing property under Section 147(d);
  6. Prohibition of certain “bad” uses under Section 147(e);
  7. TEFRA approval requirement under Section 147(f);
  8. Restrictions on costs of issuance under Section 147(g) (2% of sale proceeds);
  9. Official action requirements (adoption of an inducement resolution, for example);
  10. Arbitrage limitations; and
  11. Special change in use penalties under Sections 150(b) and (c).

Governmental Ownership Requirement (Sec. 142(b)):

(1) Certain facilities must be governmentally owned; and

(2) Limitation on office space.

There are special exempt facility bond rules set forth in Section 142(b) of the Code.  First, for several types of exempt facility bonds, the facilities must be “governmentally owned.”  The Code states that “a facility shall be treated as described in paragraph (1) (airports), (2) (docks and wharves), (3) (mass commuting facilities) or (12)(environmental enhancements of hydro-electric generating facilities) only if all of the property to be financed by the net proceeds of the issue is to be owned by a governmental unit.”

In paragraph (b)(1)(B), the Code provides for a safe harbor for leases and management contracts.  Under this safe harbor, if the facilities are leased to a non-governmental person, the bonds can still be exempt facility bonds if certain conditions are met:

  1. the non-governmental lessee makes an irrevocable election (binding on the lessee and all successors in interest under the lease) not to claim depreciation or an investment tax credit with respect to such property;
  2. the lease term (as defined in 168(i)(3)) is not more than 80% of the reasonably expected economic life of the property (as determined under section 147(b)); and
  3. the lessee has no option to purchase the property other than at fair market value (as of the time such option was exercised).

(Note that the 80% requirement is more conservative than under I.R.C. 467(b)(4)(A), which states that a disqualified leaseback or long-term agreement means any section 467 rental agreement if such agreement is part of a leaseback transaction or such agreement is for a term in excess of 75 percent of the statutory recovery period for the property.  A “section 467 rental agreement” is a rental agreement that has increasing or decreasing rents or deferred or prepaid rents.  Treas. Reg. 1.467-1.  If an agreement is a section 467 rental agreement, the lessor and the lessee must each take into account for any taxable year the sum of (1) the section 467 rent for the taxable year and (2) the section 467 interest for the taxable year.  Section 467, in other words, may be viewed as imputing a loan in certain non-level rent payment structures.  This mismatch in timing of payments and the receipts of any benefits relates to private loan analyses.)

In applying these rules, use by a non-governmental person includes use pursuant to any arrangement that allows use on a basis different from that available to the general public, such as leases, management contracts, service contracts and preferential-use agreements.

It should be noted that “ownership” and the status of an activity as a “lease” is determined under federal tax law, not state law.  Under federal tax law, ownership is determined based on substance over form. In other words, it does not matter what the intent of the parties is or what the documents are called – what matters is whether there is evidence that an activity should be considered ownership.  This substance over form approach determines whether a lessor really has sufficient property ownership of the asset involved or whether the lessor is really just a conditional seller, an option holder or a lender.

The Internal Revenue Code does not define what a real lease is.  Instead, case law provides the relevant rules.  The bottom line, as determined in Frank Lyon Company v. United States, 435 U.S. 561 (1978), is that, in considering tax ownership, and therefor true lease status, is to determine whether the lessor, rather than the lessee, is the equipment’s/property’s tax owner, having “significant and genuine attributes of the traditional lessor status.  What those attributes are in any particular case will necessarily depend upon its facts.”  See Richard M. Contino, Esq., “Understanding Tax Leases,” available online at http://www.continopartners.com/UnderstandingTaxLeases.pdf

What this means is that a lease transaction between a bank and a city, for municipal trucks, should not necessarily be treated as a lease within the meaning of Section 142(b).  If the city actually operates the trucks and maintains them, for instance, the facts strongly suggest that federal tax law should treat this lease arrangement as actual ownership by the city.  This means, in turn, that the special rule in paragraph (b)(1) is met without the need to satisfy the safe harbor in subparagraph (b)(1)(B).

Note also that the AGL&F 50 State Survey has a good discussion of leases vs. ownership.  The publication explains that a “lease-purchase arrangement, conditional sale or purchase agreement […] is generally treated as a lease under state law, but as an installment sale and loan for federal tax purposes. […] For federal tax purposes, the city is both the buyer and new owner of the property and the borrower of a loan.”

Public Use Requirements of the Regulations:

The Code does not impose a public use requirement to qualify bonds as exempt facility bonds for airports.  However, the Regulations (Treas. Reg. 1.103-8(e)(1)) require that the facility must be available on a regular basis for general public use, or be part of a facility so used, as contrasted with similar types of facilities that are constructed for the exclusive use of a limited number of non-governmental persons in their trades or businesses.  A facility at a municipal airport, such as a terminal gate, baggage or cargo handling facility, qualifies as an exempt facility even if it is leased to or preferentially used by a non-governmental person; provided that the non-governmental person directly serves the general public as a common passenger carrier or freight carrier.  In addition, any other airport owned or operated for general public use is considered to be a facility for public use.

Airports, Docks and Wharves, Mass Commuting Facilities and High-Speed Intercity Rail Facilities (Sec. 142(c)):

Section 142(c) provides certain additional rules for airports, docks and wharves, mass  commuting facilities and high-speed intercity rail facilities.

Treas. Reg. 1.103-8(e)(2)(iv) provides that a mass commuting facility includes realty, improvements and personalty used to serve the general public commuting on a day-to-date basis by bus, subway, rail, ferry or other vehicles with prescribed routes.  Machinery, equipment, furniture and terminals are specifically mentioned in the regulations as “mass commuting facilities.”  In addition, a facility will qualify even if used by noncommuters and commuters.  Thus, a bus terminal used by a common carrier serving commuters and long-distance travelers qualifies as a mass commuting facility.

Treas. Reg. 1.103-8(e)(1) provides that the facility must be available for use by members of the general public or for use by common carriers or charter carriers who serve members of the general public.

Change in Use or Ownership:

Section 1.142-2 of the Regulations states that a change in use of a qualified facility from a qualifying to a non-qualified use will generally require that outstanding airport bonds be redeemed or defeased.

Section 150(b) of the Code states that a change in the use of a qualified facility from a qualifying to a non-qualifying use will also result in the denial of certain deductions to the users for any time the airport bonds remain outstanding until they are actually redeemed (e.g., in a defeasance situation).  For example, legislative history states that if a governmentally owned airport facility is converted to a private office building, each non-governmental tenant would be denied any rent deduction to the extent of bond interest payments allocable to that portion of the facility used by the tenant.

Section 150(c) of the Code states that change in the ownership of a facility in whole or part after issuance of the bonds will act to deny the new owner any deduction for interest paid by the new owner in connection with the facility for any time the airport bonds remain outstanding until actually redeemed.  Therefore, if the new owner assumes the bond debt, interest paid is not deductible.  In addition, if the bond debt is not assumed but remains outstanding and the owner incurs new debt in connection with the facility, deductions on the new debt may be denied to the extent of interest on the airport bonds accruing after acquisition.

Demolition is not change in use.  PLR 200928018: Bond-financed pollution control facilities sold to a new owner became subject to a consent degree and were demolished because the new owner determined the conditions imposed by the consent decree were not economical and as a result the property would not be used for anything other than scrap materials for recycling and the demolition contract provided there was no net scrap value.  PLR 201110007:  Demolition of the project facilities will not cause interest on the bonds to fail to be excludable from gross income and will not preclude the borrower from deducting interest where the facility was demolished due to an environmental law decree and uncertainty regarding the plant’s future fuel contracts and the salvage value net of decommissioning costs was negative.

Other Rules:

  1. Deep discount obligations:  The proceeds of any issue of exempt facility bonds includes any imputed proceeds of the issue.  The imputed proceeds of the issue equal the sum of the amounts of imputed proceeds for each annual period over the term of the issue.  But, there are no imputed proceeds if the obligation does not have a stated interest rate (determined on the date of issuance) that increases over the term of the obligation, and the purchase price of the obligation is at least 95% of its face amount.  See Treas. Reg. § 1.103-8(a)(6) and (a)(7).

Sewage Facilities:

PLR 8814017 (Jan. 4, 1988):  Ruling requested as to whether certain facilities proposed to be built by the company are “sewage facilities.”  Request was made under the provisions of Rev. Proc. 84-49, which provides procedures for the issuance of rulings under I.R.C. 103 when the requestor of the ruling is not the issuer of the prospective obligations.  The facilities consist of a pump station, an equalization tank and an anaerobic reactor that consists of a distribution system on the bottom of the reactor for the income effluent, a settling device to remove solids from the effluent and a methane gas collection system.  The facilities also include office space in a laboratory.  The sewage consists of process waters from rinsing and cleaning production equipment that is discharged into the sewer system and that is contaminated with soluble biochemical oxygen demand (“BOD”).