4.6 Governmental Bonds/Private Activity Bonds

4.6 Governmental Bonds/Private Activity Bonds

Public agencies commonly finance facilities owned, operated or used by them through the issuance of governmental bonds. In general, governmental bonds can finance any type of project—roads, schools, administrative buildings, water systems, power plants, and similar—as long as the bonds and the financed project do not satisfy the private activity bond tests described below (the “Private Activity Bond Tests”), either at the time of issuance of the bonds or at any time while the bonds are outstanding. Bonds that meet the Private Activity Bond Tests will be private activity bonds and will be taxable unless they meet the requirements for qualified private activity bonds, such as qualified 501(c)(3) bonds or exempt facility bonds. See Section 4.7, Qualified Private Activity Bonds. The private activity bond tests are intended to limit the situations in which tax exempt bonds may be used to finance projects used in the trade or business of nongovernmental persons, which would result in transferring the benefits of tax exempt financing to a non governmental person. Projects that are directly used by a state or local government (and not by a nongovernmental person), or by the public generally, are referred to as having “governmental use.”

Bonds will NOT meet the Private Activity Bond Tests and therefore will constitute governmental bonds if both of the following are true:

  1. No more than 10% (or $15 million, if less) of the proceeds of the bond issue or the bond financed property are used directly or indirectly in trades or businesses carried on by persons other than a state and local governmental unit (the “Private Business Use Test”).

  2. The amount of revenues derived (directly or indirectly) from the trade or business use and payments or property used in the trade or business that secure the bond issue total no more than 10% (or $15 million, if less) of the debt service on the bond issue (the “Private Security or Payment Security Test”).

Together the two above tests are called the “Private Business Tests.”

The Private Business Use Test threshold is reduced to 5% in the case of a private business use that is (1) unrelated to any governmental use also being financed with the issue, or (2) disproportionate to the related use being financed. Bonds will also be treated as private activity bonds if the lesser of 5% or $5 million of the proceeds of the issue are used to make loans to persons other than state or local governmental units (the “Private Loan Test”).

Generally, the determination of whether an issue of bonds is an issue of private activity bonds is based upon the issuer’s reasonable expectations as of the date the bonds are issued. With certain limited exceptions, it is important that issuers reasonably expect to own and use a bond financed project for the shorter of the following periods:

Notwithstanding an issuer’s reasonable expectations of governmental use, certain deliberate actions taken after issuance by an issuer or independent actions by third parties may cause the Private Business Use Tests or the Private Loan Test to be satisfied with respect to an issue. See Section 8.3.3, Monitoring Use of Bond-Financed Property and Section 8.3.7, Changes in Use of Bond-Financed Property. It is also important for the issuer to track and maintain records with respect to how bond proceeds have been spent or allocated. See Section 8.3.2, Tracking and Allocating Bond Proceeds.