The new Federal Stimulus bill has changed the eligibility requirements for certain types of tax-exempt industrial development bonds. This opens up opportunities for funding new facilities using tax-exempt financing for companies that develop intellectual property. Unlike prior funding restrictions, the new rules permit more than just manufacturing equipment for the creation of tangible property, e.g., physical products, to be funded by such tax-exempt industrial development funds. With the stimulus package, certain industrial bonds issued prior to 2011 may fund the creation or production of intangible property. There is a funding limit of $10 million, as well as other restrictions. Thus, new testing labs and engineering facilities may be able to secure funding through a local government issuing tax-exempt industrial development bonds to fund the acquisition of the building and equipment needed for a company locating new product development facilities in Indiana.

Industrial Development Bonds

It is not uncommon for a county, city, or town to be asked what incentives may be available to companies locating in a certain area. One of the most overlooked incentives that can be facilitated by the political subdivision is to assist the company by issuing industrial development bonds (or industrial revenue bonds) (IDBs). In order to encourage small manufacturing in the United States, Congress has permitted manufacturers to borrow money on a tax-exempt basis in order to provide manufacturing facilities. However, because only political subdivisions can issue tax-exempt bonds, the bonds must be issued by the political subdivision for the benefit of the manufacturing company.

By issuing the industrial development bonds, the political subdivision acts merely as a “conduit” for the issuance of the bonds. The political subdivision has absolutely no liability with regard to the bonds. The bond proceeds “pass through” the political subdivision and are loaned directly to the company. In turn, the company is responsible for making payments of debt service on the bonds. In order to market the bonds, a bank will frequently issue a letter of credit that promises payment on the bonds to the bondholders. In the event of nonpayment by the company, the bank would have recourse against the company.

Companies that are in the manufacturing business reap great benefits from the issuance of tax-exempt bonds. On some types of bonds, interest rates can be 4 percent to 5 percent lower than conventional financing. However, Congress, through the federal tax code, has placed various restrictions on the issuance of IDBs. First, there is a limit to how many IDBs can be issued in any state based upon its population. This allocation of “volume cap” is regulated in the State of Indiana by the Indiana Finance Authority (IFA). Before IDBs can be issued as tax-exempt debt, the proposed financing must first be awarded a portion of the volume cap by the IFA. To receive such an award, a company must submit an application to the IFA that is scored based upon how many new jobs will be created, the location of the facility, the wage rate being paid, and other factors. Once a month, the IFA awards volume cap to the top scorers until the volume cap allocated under the federal tax code is consumed for the State.

Another prior restriction is that the bonds must be used for a “manufacturing facility.” The definition of manufacturing facility is quite broad, and is defined to include any facility that is used in the manufacture or production of tangible personal property (including the processing resulting in a change in the condition of such property). Generally, the “acid test” is whether one type of property goes into the facility and another type of property emerges. In addition, the proceeds of IDBs may also be used for facilities that are “directly related and ancillary to a manufacturing facility,” if such facilities are located on the same site as the manufacturing facility, and not more than 25 percent of the net proceeds of the bond issue are to be used to provide for such facilities. Therefore, warehouse and office space may qualify for the use of bond proceeds as long as such amount does not exceed 25 percent of the amount of the bond issue. In addition, only 25 percent of the proceeds of the bond issue may be used for the purchase of land. In 2009 and 2010, the definition of manufacturing facility includes facilities for the creation or production of intangible property.

Congress has limited the use of IDBs to “small” manufacturing facilities. In order to meet the requirement of being “small,” Congress provided that the bond issue may not exceed $10 million, nor may all capital expenditures (including the bonds) exceed $10 million for a period of three years before the issuance of bonds and a period of three years after the issuance of bonds. In other words, at the date of the issuance of the bonds, the company must look three years back and add up all of its capital expenditures in the jurisdiction and determine that they do not exceed $10 million. In addition, after the bond issue closes, the company must make sure that it does not exceed the capital expenditure requirement in the three years going forward, when combined with the three years before the bonds were issued. For example, if the company found that two years after the closing on the bonds it was going to exceed the $10 million capital expenditure rule, it would have to refinance with taxable debt. Additionally, the legislation provides that no company can exceed $40 million in total bonds outstanding, no matter what jurisdictions in which the company has facilities that are bond financed.

The final major qualification for IDBs is a requirement that tax-exempt bond proceeds be used for new manufacturing facilities or new equipment. The exception to this rule is that in the event a used building is purchased, the company can still qualify for tax-exempt financing if it spends 15 percent of the proceeds of the bond for rehabilitation of the building.

The mechanics of issuing an IDB involve the use of a local economic development commission (EDC). The EDC will adopt an “inducement resolution” proposing to finance the project with tax-exempt bonds. This inducement resolution will be forwarded to the fiscal body for its approval and, after obtaining volume cap, the EDC will hold a public hearing in connection with the proposed IDB after proper notice is given. Finally, the EDC will approve the financing documents and forward such approval to the fiscal body for its adoption of a bond ordinance and the approval of all the financing documents.

For additional information on the entire stimulus package, visit B&D Consulting's economic stimulus resource center here.