i.4.5.2 REQUIREMENT #2 – THE DEBT MUST FINANCE A QUALIFYING PROJECT AND SATISFY ONGOING REQUIREMENTS AND LIMITATIONS REGARDING THE USE OF THE PROJECT
The Tax Code requires the application of complex rules regarding private use. Determining if there is to be any private use of the facility must be completed before issuance and continuously monitored until the bonds are fully paid. “Private use” generally means the use of a financed project in the trade or business of any person other than a state or local government which differs from the use of the project by the general public. Loans of bond proceeds to nongovernmental persons (“private loans”) also will generally prevent debt from qualifying for tax exemption. De minimis amounts of “private use” or “private loans” are permitted but the application of complex rules is required to measure the amount of private use or private loans. Thus, a project that is or will be subject to leases, contracts, or other special arrangements regarding its use must be carefully analyzed to determine whether it is eligible for tax exempt financing. Projects eligible to be financed on a tax exempt basis generally include projects for governmental or general public use (such as government buildings, roads, schools, libraries, and parks). However, some projects the federal government seeks to encourage but that are used by private persons may still be eligible to be financed on a tax exempt basis, such as airports, docks, and wharves, subject to a significant number of special rules applicable to bonds issued for such projects. To analyze whether the project a public agency might finance is a qualifying project, here are the key questions to ask:
- Will any portion of the project be owned by a nongovernmental person?
- Will any portion of the project be leased or licensed to a nongovernmental person?
- Will any portion of the project be subject to a management, service, or other contract relating to the project (such as a food concession or naming rights contract)? Contract arrangements that are purely incidental to the primary governmental function of the project, such as a janitorial contract, generally do not cause private use.
- Will any portion of the project be subject to and used in connection with corporate, nongovernmental, or federally sponsored research?
- Will any portion of the proceeds of bonds be used to make “private loans?”
- Will any portion of the project be used by the federal government?
If the answer to any of the above questions is yes, more analysis is required to determine whether the debt can be issued on a tax exempt basis.
On the date of issuance, the public agency must reasonably expect to not exceed the de minimis limits for private use and private loans for the entire period over which the debt will remain outstanding. Following issuance, the public agency is responsible for ensuring that the limits are in fact not exceeded for the life of the debt. If the limits are exceeded after issuance and before full repayment of the debt, the debt could be determined to fail to qualify for tax exemption, retroactively to the date of issuance. The IRS has been strongly encouraging public agency issuers to adopt formal policies and procedures to ensure that the rules and limits are and remain satisfied for the life of the debt, including compiling and maintaining records of the specific assets financed, identifying persons with primary responsibility for monitoring the use and disposition of the assets, and requiring periodic checks to confirm compliance. See Chapter 8 – Post-Issuance Debt Management Requirements, Including Tax Compliance and Ongoing Disclosure Obligations.