On August 18, 2011, the Internal Revenue Service (IRS) issued long-awaited final regulations (the final regulations) regarding the types of facilities that qualify as “solid waste disposal facilities” under section 142(a)(6) of the Internal Revenue Code (the Code).
The final regulations (TD 9546) adopt proposed regulations (the proposed regulations) published on September 16, 2009 (74 FR 47500) with certain modifications and improvements. The final regulations apply to bonds sold on or after October 18, 2011, but can be applied retroactively to outstanding bonds if an issuer so elects. The final regulations do not need to be applied to bonds that currently refund bonds that were not originally subject to the final regulations as long as the weighted average maturity of the refunding bonds does not exceed the remaining weighted average maturity of the refunded bonds.
Section 142 of the Code provides that certain exempt facilities can be financed with tax-exempt private activity bonds, including solid waste disposal facilities. Existing regulations (the existing regulations) adopted in the 1970s, define a solid waste disposal facility as property used for the collection, storage, treatment, utilization, processing or final disposal of solid waste. Solid waste is defined as garbage, refuse and other discarded solid materials, including solid waste materials resulting from industrial, commercial, agricultural operations and community activities, but only if the material has no market or other value on the date of issue of the bonds (the “novalue test”).
For a number of years, the IRS took audit positions that challenged the status of material as waste on the basis of the no-value test in a number of significant waste and recycling scenarios, including waste paper, and many practitioners questioned the legal basis for such challenges. In 2004, the IRS issued its first set of proposed regulations on solid waste disposal facilities that made a number of changes to the existing regulations, including the elimination of the no-value test. These were withdrawn by the IRS in 2009 in conjunction with the issuance of the proposed regulations. The proposed regulations issued in 2009 were an improvement over the prior proposed regulations, but still contained a number of technical interpretive issues, most of which have been addressed in the final regulations released last week.
The final regulations add new Treasury Regulation §1.142(a)(6)-1 that replaces the existing regulations (Treasury Regulation §1.103-8(f)(2)(ii) and Temporary Treasury Regulation §17.1) and provides modified rules which, among other things, eliminate the “no-value test” in determining whether material is solid waste and implement a policy in favor of recycling. Many of the concepts in the final regulations, other than the conceptual basis of the definition of “solid waste,” reflect long-standing ruling positions of the IRS based on the contents of the existing regulations. The final regulations maintain and strengthen the existing rules and provide a workable definition of solid waste.
Solid Waste Disposal Facility
The final regulations define a “solid waste disposal facility” as a facility that processes solid waste in a qualified solid waste disposal process, performs a function preliminary to such process, or is functionally related and subordinate to such a facility.
Definition of Solid Waste
The final regulations eliminate the no-value test and provide a definition that takes into account both the material itself as well as the process by which the material is to be disposed of or recycled. The final regulations define “solid waste” as garbage, refuse and other solid material derived from any agricultural, commercial, consumer, governmental or industrial operation or activity if the material is reasonably expected to be introduced within a reasonable time into a qualified solid waste disposal process and is either:
- used material, meaning material that is a product of any agricultural, commercial, consumer, governmental or industrial operation or activity, including animal waste produced by animals from a biological process; or
- residual material, meaning a residual byproduct or excess raw material that results from or remains after the completion of any agricultural, commercial, consumer, governmental or industrial production process or activity or from the provision of any service, provided that as of the issue date of the bonds, the material is reasonably expected to have a fair market value that is lower than the value of all of the products made in the production process, or is lower than the value of the service that produces such residual material.
The final regulations eliminate a troublesome 5% test contained in the proposed regulations which would have required that residual material constitute less than 5% of the total material introduced into the original production process. The final regulations provide a helpful clarification that material is “solid” if it is solid at ambient temperature and pressure. The final regulations also expand the definition of solid waste to include waste resulting from governmental operations or activities, and waste that is animal waste.
Exclusions from Solid Waste
Like the proposed regulations, the final regulations contain a list of materials that do not constitute solid waste, including:
- virgin material, except to the extent that it constitutes input to a final disposal process or residual material; virgin material means material that has not been processed into an agricultural, commercial, consumer, governmental or industrial product, or a component of any such product;
- solids within liquids and liquid waste, defined as any solid or dissolved material in domestic sewage or other significant pollutant in water resources, such as silt, dissolved or suspended solids in industrial waste water effluents, dissolved materials in irrigation return flows or other common water pollutants, and liquid or gaseous waste;
- precious metals, except to the extent that a precious metal constitutes an input to a final disposal process and/or an unrecoverable trace of the particular precious metal, including, for this purpose, gold, silver, ruthenium, rhodium, palladium, osmium, iridium, platinum, gallium, rhenium and any other precious metals identified by the IRS in future guidance;
- hazardous material, defined as hazardous material that must be disposed of at a facility that is subject to final permit requirements under subtitle C of title II of the Solid Waste Disposal Act as in effect on the date of enactment of the Tax Reform Act of 1986 (October 22, 1986); and
- radioactive material, defined as radioactive material subject to regulation under the Nuclear Regulatory Act (10 CFR §1.1 et seq.) as in effect on the issue date of the bonds.
With respect to the exclusion for hazardous and radioactive material, the preamble to the final regulations indicates that the exclusion is limited to the extent that the waste is required to be disposed of or contained at a regulated hazardous waste or radioactive waste disposal facility. The IRS did not accept public comments that hazardous and radioactive material should be considered solid waste for purposes of these rules, reflecting its belief that Congress generally intended to exclude these materials from the definition of solid waste.
Qualified Solid Waste Disposal Process
A “qualified solid waste disposal process” includes three eligible types of solid waste disposal processes -- a final disposal process, an energy conversion process and a recycling process. To provide flexibility for future innovation, the final regulations provide that absent an express restriction to the contrary, a qualified solid waste disposal process may employ any biological, engineering, industrial or technological method.
- A “final disposal process” means the placement of material in a landfill (including the spreading of solid waste over land in an environmentally compliant and safe manner with no intent to remove such solid waste), the incineration of solid waste without capturing any useful energy, or the containment of solid waste with a reasonable expectation that the containment will continue indefinitely and that the solid waste has no current or future beneficial use.
- An “energy conversion process” mean a thermal, chemical, or other process that is applied to solid waste to create and capture synthesis gas, heat, hot water, steam, or other useful energy. The energy conversion process begins at the point of first application of such a process and ends at the point in which the useful energy is first created, captured or incorporated and before any transfer or distribution of such synthesis gas, heat, hot water or other useful energy, regardless of whether such energy constitutes a “first useful product” as described below.
- A “recycling process” means reconstituting, transforming, or otherwise processing solid waste into a useful product. The recycling process begins at the point of the first application of a process to reconstitute or transform the solid waste into a useful product, such as decontamination, melting, re-pulping, shredding, or other processing of the solid waste to accomplish this purpose. The recycling process ends at the point of completion of production of the “first useful product” from the solid waste. The term “recycling process” does not include refurbishment, repair or similar activities.
First Useful Product
The final regulations provide guidance on determining the first useful product for purposes of determining the end of a solid waste disposal process. Generally, the first useful product means the first product produced from the processing of solid waste that is useful for consumption in agricultural, consumer, commercial, governmental or industrial operation or activity and that could be sold for such use, whether or not actually sold. A useful product includes both a product useful to an individual consumer as an ultimate end-use consumer product, as well as a product useful to an industrial user as a material or input for processing in some stage of a manufacturing or production process to produce a different end-use consumer product. The determination of whether a useful product has been produced may take into account operational constraints that affect the point in production when a useful product reasonably can be extracted or isolated and sold independently. The costs of extracting, isolating, storing and transporting the product to a market may only be taken into account as operational constraints if the product is not to be used as part of an integrated manufacturing or industrial process in the same location as that in which the product is produced.
In addition to a qualified solid waste disposal process, a solid waste disposal facility can include a facility that performs a “preliminary function.” A preliminary function is a function to collect, separate, sort, store, treat, process, disassemble or handle solid waste that is preliminary to and directly related to a qualified solid waste disposal process. The final regulations removed a limitation that would have required that more than 50% of the total materials resulting from the function be solid waste in each year that the bond issue is outstanding.
If a facility performs both a solid waste disposal or preliminary function and another nonqualified function, then the costs of the facility allocable to the solid waste function are determined using any reasonable method, based on all the facts and circumstances. Facilities that are functionally related and subordinate qualify only to the extent that they are functionally related and subordinate to the portion of the mixed-use facility that is used for a solid waste function.
Similar to existing regulations, the final regulations provide rules for mixed-input facilities, which are facilities that process both material that qualifies as solid waste and material that does not. Generally, the qualifying costs of such a facility cannot exceed the average annual percentage of solid waste processed while the bond issue is outstanding. However, if the annual percentage of solid waste processed at a facility is at least 65% of the materials processed in the facility for each year that the bond issue is outstanding, then all of the costs of the property used for such process are treated as allocable to a qualified solid waste disposal process. The annual percentage of solid waste processed in a qualified solid waste disposal process or a preliminary function for any year is the percentage, by weight or volume, of the total materials processed in that qualified solid waste disposal process or preliminary function that constitute solid waste for that year. In response to public comments, the final regulations provide a three-year curative period to address the impact of extraordinary events outside the control of the operator of the solid waste facility (such as natural disasters, strikes, major utility disruptions, or governmental interventions) that caused a facility to fail to meet the 65% test in the first year of the period. In addition, the final regulations provide that for purposes of complying with the 65% test, the annual testing does not begin until the facility is placed in service within the meaning of the special placedin- service definition in Treasury Regulation §1.150-2(c), which generally begins on the date a facility is operational at substantially its design level.
The final regulations provide a number of examples illustrating the application of these rules in the context of waste coal, logs, landfills, tire recycling, energy conversion, paper recycling and mixed-input facilities.
The final regulations apply to bonds to which section 142 applies that are sold on or after October 18, 2011. Issuers are permitted to apply the final regulations in whole, but not in part, to outstanding bonds that have been sold before that date. The final regulations do not need to be applied to bonds that currently refund bonds that were not originally subject to the final regulations as long as the weighted average maturity of the refunding bonds does not exceed the remaining weighted average maturity of the refunded bonds.
The final regulations eliminate the “no-value test” which has been a source of contention for recycling financings. The broad application of this test on audit made the financing of many recycling facilities questionable. The final regulations now clearly anticipate and support the financing of recycling facilities, and are a welcome development in the area of solid waste disposal financings.