The Economic Stimulus legislation signed into law last week by President Obama, known as the American Recovery and Reinvestment Act of 2009 (the “Act”), provides two new opportunities for Indian tribal governments to finance reservation projects and federally-funded schools on a tax-favored basis. The Act also relaxes an existing limitation on the amount of tax-exempt financing that can be provided by banks for tribal or other qualified projects.
Tribal Economic Development Bonds
The most significant new financing opportunity for tribes is contained in Section 1402 of the Act, which authorizes tribes, for the first time, to issue tax-exempt bonds (called “tribal economic development bonds”) for the same purposes as states and local governments without regard to two existing limitations: the “essential governmental function” test and the prohibition against the issuance of “private activity bonds.”
Tribal economic development bonds are subject to a national volume cap of $2,000,000,000, which will be allocated to tribes by the Secretary of the Treasury, upon consultation with the Secretary of the Interior, using standards and procedures yet to be determined. We understand that Treasury will soon seek the views of the tribes as to the allocation procedures to be adopted. Preliminary indications that we have received from Treasury is that the Department wants to avoid making value judgments on specific projects.
No “Essential Governmental Function “ Test
Tribal economic development bonds are expressly exempted from the “essential governmental function” requirement for tribal projects contained in Internal Revenue Code Section 7871(c). In recent years, Internal Revenue Service (“IRS”) has read the essential governmental function test very narrowly so as to preclude tribal financing of projects the IRS considers to be “commercial” in nature, such as golf courses, hotels, and related dedicated infrastructure. For projects financed by new tribal economic development bonds, there will be no such limitation. The Act does provide, however, that tribal economic development bonds may not be used to finance (1) any portion of a building in which Class II or Class III gaming is conducted, (2) any property used in the conduct of such gaming, or (3) any facility located outside an Indian reservation as defined by Code Section 168(j)(6). Otherwise, an Indian tribe may issue designated tribal economic development bonds up to the amount of bonding authority allocated to the tribe by the Secretary of the Treasury, and the interest paid by the tribe on the borrowing will be exempt from federal income tax.
The ability of tribes to issue tax-exempt bonds for essential governmental functions, under the law as it existed prior to the Act, is unchanged, and no allocation of bonding authority is required for a tribe to do so.
Elimination of “Private Activity Bond” Prohibition
In addition to using tribal economic development bonds to finance golf courses, hotels, and similar tribally-owned and operated projects, tribal economic development bonds may be issued as private activity bonds (“PABs”). PABs are bonds issued by a government (the tribe) with the proceeds being used to benefit a business or private party. Perhaps the most valuable use of this tool will be the ability of tribes to issue single-family mortgage bonds, financing owner-occupied residences for home buyers who meet certain income restrictions. PABs may also be used to finance various capital needs of non-governmental organizations, which would include many tribal business enterprises. The following types of projects may be financed with PABs:
- Manufacturing and production facilities
- Student loans
- Redevelopment in blighted areas
- Docks and wharves
- Mass commuting facilities
- Facilities for the furnishing of water
- Sewage facilities
- Solid waste disposal facilities
- Residential rental projects
- Facilities for the local furnishing of electric energy and gas
- Local district heating or cooling facilities
- Hazardous waste facilities
- High-speed intercity rail facilities
- Environmental enhancements of hydroelectric generating facilities
- Public educational facilities
- Green building and sustainable design projects
- Highway or surface freight transfer facilities
The rules on PABs get complex. If any of these projects sounds like something that you may have an interest in, contact any of us listed to the left and we can work through the specific rules allocable to that project.
Section 1402 requires the Secretary of the Treasury to study the effects of this new tax-exempt financing category and report the results and the Secretary’s recommendations to Congress within one year of its enactment, presumably for the purpose of allowing Congress to consider whether to permanently eliminate the “essential governmental function” requirement for tribal projects.
Qualified School Construction Bonds
The other new tax-favored financing opportunity, available only in 2009 and 2010, is provided in Section 1521 of the Act. Section 1521 authorizes Indian tribal governments to issue “qualified school construction bonds” for purposes of constructing, rehabilitating or repairing schools funded by the BIA. The Secretary of the Interior is authorized to allocate $200 million of bonding authority for each of 2009 and 2010 for these purposes, using standards and procedures yet to be determined. Qualified school construction bonds are “tax credit bonds” which, because they offer a tax credit to the owner of the bonds in lieu of interest payments, are essentially issued at zero percent interest.
Increased Limit for “Bank Qualified” Bonds
Under Section 265(b) of the Code, banks and other financial institutions have a financial disincentive to buy and hold tax-exempt bonds unless they constitute “qualified tax-exempt obligations” (also known as “bank qualified bonds”). Before passage of the Act, bonds issued by a tribal government (or any other issuer of tax-exempt obligations) could not constitute “bank qualified bonds” unless the issuing government reasonably expected to issue no more than $10,000,000 of such bonds during the calendar year. For bonds issued in 2009 and 2010, the Act increases that limit from $10,000,000 to $30,000,000 and applies the limitation to ultimate qualified borrowers of pooled financings (permitting larger pool issues). This means that banks, who otherwise would not have been interested in a tax-exempt borrowing if the tribe intended to issue more than $10,000,000 in bonds in one year, should now be willing to look at tax-exempt financings up to $30,000,000. No change has been made, however, to the rule that most PABs are not eligible to be designated as bank qualified bonds.