Certain state or local bonds can qualify for tax-exemption under Section 103 of the Internal Revenue Code of 1986, as amended (Code) despite the fact that the proceeds are to be used in a private trade or business or are otherwise loaned to non-governmental persons. However, such bonds qualify for tax-exemption only if all of the requirements for a qualified private activity bond are met. One of these requirements is the public approval requirement under Section 147(f) of the Code. This provision generally requires that an issuance of any private activity bond be approved by the governmental unit issuing the bonds and, if the facility being financed is located in a different jurisdiction than the issuer, by the governmental unit having jurisdiction over the area where the facility is located. Approval by a governmental unit generally consists of either (i) voter referendum, or (ii) approval by the applicable elected representative of the governmental unit after a public hearing following reasonable public notice. For this purpose, the applicable elected representative generally means an elected legislative body, the chief elected executive officer, the chief elected state legal officer of the executive branch, or any other elected official designated by the chief elected executive officer or by state law. Generally, no approval is required for refunding issues that do not extend weighted average maturity.
Temporary Regulations were issued in 1983 under the 1954 Code predecessor to Section 147(f) (Existing Regulations). When Section 147(f) was enacted as part of the Tax Reform Act of 1986, the legislative history indicated that, to the extent not amended by changes to the statute, the principles in the Existing Regulations would continue to apply under the new Section 147(f).
The Proposed Regulations.
On September 9, 2008, the IRS issued new proposed regulations dealing with the public approval requirement under Section 147(f) of the Code (Proposed Regulations). The Proposed Regulations do not provide comprehensive guidance on all aspects of the public approval requirement, but rather update, clarify, and simplify discrete aspects of the public approval requirement. For example, the Proposed Regulations generally do not update the portions of the Existing Regulations dealing with the determination of the applicable governmental units that are required to approve an issue or the determination of the applicable elected representatives of those governmental units. The Proposed Regulations provide that, to the extent they are not inconsistent with the final version of the Proposed Regulations or subsequent changes in law, the Existing Regulations will continue to apply for purposes of Section 147(f).
Content of Public Approval.
The Proposed Regulations update and modify the information required to be included in a reasonable public notice and public approval. While the Existing Regulations require a functional description of the type and use of the facility to be financed by the bonds, the Proposed Regulations allow issuers to instead include only a general reference to the type of exempt facility bond being issued (e.g., an exempt facility bond for an airport) or, for other types of private activity bonds, a reference to the type of qualified bond and a general description of the type and use of the facility to be financed (e.g., a qualified 501(c)(3) bond to finance a hospital). The Proposed Regulations continue the requirement that the maximum stated principal amount of the bonds expected to be issued be included. The Proposed Regulations modify the requirement in the Existing Regulations that the notice and approval include the name of the expected initial legal owner, operator, or manager of the facility. Under the Proposed Regulations, the name provided may be either the name of the legal owner or principal user of the facility or, alternatively, the name of the true beneficial party of interest, such as the name of a 501(c)(3) organization that is the sole member of an LLC that owns the facility. This change is significant in light of the increasingly common use of single member LLCs by 501(c)(3) organizations.
The required description of the location of the facility under the Existing Regulations (generally, the street address) contemplates that a bond issue would finance only a single capital project. The Proposed Regulations provide that, for a facility involving multiple capital projects on the same site, or on adjacent or reasonably proximate sites, the issuer may instead use a consolidated description of the geographic boundaries of all such capital projects. The Proposed Regulations also expand the definition of the term "facility" to include the possibility of multiple capital projects.
Special Rules for Mortgage Revenue Bonds, Qualified Student Loan Bonds, and 501(c)(3) Pooled Financings.
The Proposed Regulations acknowledge that there has been uncertainty over how to apply certain aspects of the public approval requirements to certain categories of private activity bonds which were not subject to the public approval requirement at the time the Existing Regulations were promulgated. These include mortgage revenue bonds and 501(c)(3) pooled financings (under which the locations of the facilities to be financed are widespread or unknown), and qualified student loan bonds (under which there are no financed facilities). Accordingly, the Proposed Regulations provide that issuers of these types of bonds that made a good faith effort to comply with the public approval requirement, taking into account Congressional intent and the special characteristics of these types of financings, will not be subject to audit by the IRS simply because the issuer did not include all of the information required by the Existing Regulations.
The Proposed Regulations provide special rules allowing less specific information to be provided for public approvals of mortgage revenue bonds, qualified student loan bonds, and 501(c)(3) pooled financings. For mortgage revenue bonds, no information is required on specific names of mortgage loan borrowers or specific locations of individual residences. Instead, issuers are only required to provide the maximum stated principal amount of qualified mortgage bonds to be issued and a general description of the geographic jurisdiction in which the financed residences will be located. Similarly, for qualified student loan bonds, the Proposed Regulations generally require that the issuer provide the maximum stated principal amount of the bonds and a general description of the type of student loan program under which the loans will be made.
For 501(c)(3) pooled financings, the Proposed Regulations provide for a two-stage public approval process. First, prior to the issuance of the bonds, public approval must be obtained based on the stated maximum principal amount of the bonds to be issued and a general description of the types of facilities to be financed with loans to be made from the proceeds (e.g., loans for hospital facilities). No information is required with respect to the locations or initial users of the facilities if the information is not known at that time. Second, before a loan is made from the proceeds of the issue (but potentially after the bonds have been issued) a supplemental public approval must be obtained based on particular information about the borrower and the financed facility, including the location of the financed facility. This helpful rule resolves longstanding uncertainty about how to comply with the public approval requirements in the case of so-called "blind pools." The IRS has requested comments on whether this type of procedure should also be adopted for other types of pooled bond issues.
Under the Existing Regulations, an issuer is treated as not failing the public approval requirement as a result of "insubstantial deviations" from the information provided in the public notice and public approval. There has been significant uncertainty over what kinds of changes can fall within the term "insubstantial deviation" and therefore not invalidate a prior public approval. The Proposed Regulations provide two safe harbors under which certain changes will be treated as insubstantial deviations. First, a difference in the amount of proceeds used for a facility from the amount set forth in the public approval will be considered an insubstantial deviation if the difference does not exceed 5 percent of the net proceeds of the issue. Second, a change in the initial owner or principal user of a project will be considered an insubstantial deviation if the new owner or principal user is a related party (as defined in Treas. Reg. § 1.150-1) to the owner or principal user named in the public approval.
The Proposed Regulations also provide a new process to deal with situations where unanticipated events or unforeseen changed circumstances result in substantial deviations from the information contained in the public approval. Under the Proposed Regulations, provided that the issuer reasonably expected on the issue date of the bonds that the proceeds would be used in accordance with the public approval, and provided that the issuer encountered unexpected events or unforeseen circumstances after the issue date causing such use of the proceeds to be no longer feasible or viable, the issuer may obtain a supplemental public approval for the bonds affected by the substantial deviation. The supplemental public approval will generally require the issuer to take the same steps that it would be required to take for a new approval.
Reasonable Public Notice and Public Hearing.
The Proposed Regulations also update and simplify the rules in the Existing Regulations on reasonable public notice and public hearings. While the Existing Regulations generally allowed for newspaper, television, and radio as permitted means of providing reasonable public notice, the Proposed Regulations also allow for reasonable public notice by posting notice on the issuer's website, provided that the issuer regularly uses that website to inform its residents about events affecting the residents and provided that the issuer offers a reasonable alternative method for obtaining the information for residents without access to computers. The Proposed Regulations also (i) allow the governmental unit to receive comments from the public in electronic form, (ii) reduce the time required between the public notice and the public hearing from fourteen days to seven business days, and (iii) allow a governmental unit to cancel a public hearing if it provided reasonable public notice of the hearing and received no requests to participate in the hearing.
In summary, the Proposed Regulations should provide issuers with significantly more flexibility in complying the public approval requirements of Section 147(f).
The Proposed Regulations will generally apply to bonds that are sold on or after the date that final regulations are published in the Federal Register.