H.R. 1 - The American Recovery and Reinvestment Act of 2009 - contains numerous provisions that affect bonds issued by states and political subdivisions. One beneficiary of the amendments made to existing law is manufacturing companies. The Act liberalizes the rules governing the use of tax-exempt bonds to benefit manufacturing. Consequently, the use of tax-exempt bonds as a source of funding for capital projects undertaken in 2009 and 2010 has become more attractive.
The Internal Revenue Code permits a state or political subdivision to issue so-called "small issue bonds" in an amount not greater than $10 million to finance manufacturing facilities, defined to mean a facility engaging in a process resulting in the change in condition of tangible personal property. Facilities ancillary to the manufacturing process could be financed under prior law if located on the same site as the "core manufacturing" and if not more than 25 percent of the proceeds of the bonds were devoted to such ancillary activities. With small issue bonds, the private company is responsible for making payments on the bonds, however, the tax-exempt rate on such bonds has traditionally been lower than taxable, commercial borrowing rates.
The Act relaxes the rules in two significant ways. First, facilities engaged in the creation of intangible property are now considered to be manufacturing facilities. Intangible property includes patents, copyrights, formulae, processes, designs, know how, or other similar items. Examples of intangible property include computer software and pharmaceuticals. With this change, a large category of activities become eligible for tax-exempt bond financing.
Second, the somewhat restrictive "ancillary facilities" rule is being replaced with the concept of "functionally related and subordinate", a concept which has long been in use for other tax-exempt financed facilities. Land, buildings and facilities commensurate with the manufacturing operation fit within the definition of "functionally related and subordinate." Various site improvements, for example, warehouse facilities, have now become easier to finance. Additionally, the 25% of proceeds limitation no longer applies, making it possible to use tax-exempt bonds to finance a project consisting entirely of functionally related and subordinate improvements without any expenditures for "core" manufacturing.
Small issue bonds are still subject to numerous rules and requirements and anyone considering their use should seek the advice of bond counsel early on in the process to assess the usefulness of this financing option.