In final regulations (T.D. 9845) under Section 147(f), the IRS provides issuers of private activity bonds additional flexibility in satisfying the approval requirement for tax exemption. The final regulations update and finalize proposed regulations (REG-128841-07) issued in October 2017 (2017 proposed regulations) that updated and streamlined the rules relating to the public approval requirement. (For details, see Tax Alert 2017-1628.)

Background

Under Section 103, interest received by investors on state and local government bonds is generally tax-exempt. A private activity bond qualifies for this tax-exempt treatment, however, only if it satisfies the requirements for qualified bonds under Section 141. Section 141(e) requires, in part, that qualified bonds meet the public approval requirement of Section 147(f). Under Section 147(f), a private activity bond is not tax exempt unless it is approved by both the governmental unit issuing the bond and the governmental unit in which the financed property will be located.

Final regulations

The final regulations reflect certain changes to the 2017 proposed regulations that commenters suggested during the comment period and the IRS deemed were appropriate. (The IRS received written comments on the 2017 proposed regulations but did not hold a public hearing because none was requested.) Highlights of the changes made in the final regulations follow.

Reasonable public notice (Reg. Section 1.147(f)-1(d))

Under the existing regulations, public notice is presumed reasonable if it is published at least 14 days before the hearing date. Although proposed regulations in 2008 had shortened the public notice period from 14 days to 7 days, the 2017 proposed regulations proposed to retain the 14-day period. In response to public comments noting that substantial increases in the speed at which information spreads warrant a shorter notice period, the IRS has concluded that a 7-day public notice period is sufficient.

The final regulations also reflect commenters' recommendations to: (i) allow issuers that issue bonds on behalf of a governmental unit to post public notice on the public website of either the "on-behalf-of" issuer or the approving governmental unit; (2) eliminate the requirement to provide an alternative notice method (e.g., in a newspaper) in addition to providing notice on the internet; (3) require public notice to be posted on the governmental unit's primary public website in an area used to inform residents about events affecting them; and (4) require public notices given in a way that is permitted under state general law to be reasonably accessible to residents of the approving governmental unit.

Contents of notice and approval (Reg. Section 1.147(f)-1(f))

Maximum stated principal amount of bonds. The 2017 proposed regulations clarified when differences in information constitute insubstantial deviations versus substantial deviations, causing an issue to fail to meet the public approval requirement. Certain specified deviations from the information provided for public approval (i.e., the requisite information that provides a bond's stated use or proceeds, among other items) would be considered insubstantial. These include (i) a stated principal amount of bonds actually issued and used for the project that is no more than 10% greater than the maximum stated principal amount publicly approved for the project, and (ii) a deviation between the initial owner or principal user of the project identified in the public approval information and the actual initial owner or principal user of the project if the parties are related on the issue date. The final regulations offer some flexibility, clarifying that the maximum stated principal amount to finance a project may be determined on any reasonable basis, and may take contingencies into account, without regard to whether the occurrence of a contingency is reasonably expected at the time of the notice.

Initial owner or principal user. Under the 2017 proposed regulations, a project was within the scope of public approval if the public notice and approval included the name of either (i) the expected initial legal owner or principal user of the project or (ii) the true beneficial party of interest for the legal owner or user. Responding to a request for clarification, the IRS and Treasury acknowledge in the Preamble to the final regulations that "limited partnership ownership structures are common among exempt facilities under [Section] 142" and note that the final regulations "include an example clarifying that a public notice and approval may name a general partner of an owner of a project as a true beneficial party of interest."

Special rule for pooled financings with qualified Section 501(c)(3) bonds. The 2017 proposed regulations provided a two-stage public approval process for qualified Section 501(c)(3) bonds issued to finance pooled loan programs described in Section 147(b)(4)(B). Because, at the time bonds are issued, the issuer might only have limited information about the projects to be financed, the 2017 proposed regulations allowed the public notice and approval to include limited general information about the projects, as long as supplemental information was provided in the second stage of public approvals. The final regulations add that, at the first stage pre-issuance public approval, host government approval is not required because the specific project information may be unknown at the time.

Definitions (Reg. Section 1.147(f)-1(g))

Under existing regulations, a "facility" is defined as a tract, or adjoining tracts, of land, the improvements on that land, and any personal property used in connection with the real property; non-adjoining tracts of land may be treated as one facility only if they are used in an "integrated operation." The 2017 proposed regulations replaced the term "facility" with "project" — generally defined as "one or more capital projects or facilities, including land, buildings, equipment, and other property, to be financed with an issue, that are located on the same site, or adjacent or proximate sites used for similar purposes." A commenter pointed out that the 2017 proposed regulations would not treat two financed properties located on non-proximate sites as being part of a single project, although those same properties could be considered part of a single facility under the existing regulations. The Preamble states that the final regulations not only preserve "the more flexible definition of project" in the 2017 proposed regulations — permitting a project to include financed property that is proximate but not adjoining — but "also retain the longstanding 'integrated operations' standard" from the existing regulations so that non-proximate capital projects or facilities may be treated as one project if they are used in an integrated operation.

Effective date/applicability

The final regulations are effective as of December 31, 2018, and apply to bonds issued under public approval that occurs on or after April 1, 2019. An issuer may, however, apply Reg. Section 1.147(f)-1(f)(6) of the final regulations (addressing deviations in public approval information) in whole — not in part — to bonds issued under a public approval that occurs before April 1, 2019.

Implications

In adopting several of the public comments it received on the 2017 proposed regulations, the IRS has taken the already streamlined approach to the public approval requirement and made the process more flexible and less burdensome to the issuer. Bond issuers that are subject to the requirements of Section 147(f) should incorporate the additional flexibility provided by the final regulations into their public notice and public approval processes.

Please contact your Ernst & Young LLP tax professional with any questions

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