Par. 4. Sections 1.141-0 through 1.141-16 are added to read as follows:
(a) General rule--(1) In general. The private business use test relates to the use of the proceeds of an issue. The 10 percent private business use test of section 141(b)(1) is met if more than 10 percent of the proceeds of an issue is used in a trade or business carried on by a nongovernmental person. For this purpose, the use of financed property is treated as the use of proceeds. This section also applies to the private business use test under sections 141(b)(3) (unrelated or disproportionate use), 141(b)(4) ($15 million limitation for output facilities), and 141(b)(5) (the coordination with the volume cap where the nonqualified amount exceeds $15 million).
(2) Indirect use. In determining whether an issue meets the private business use test, indirect as well as direct use of the proceeds is taken into account. For example, the issuer's use of the proceeds to engage in a series of financing transactions for property to be used by nongovernmental persons in their trades or businesses may cause the private business use test to be met. In addition, proceeds are treated as used in the trade or business of a nongovernmental person in situations involving other arrangements, whether in a single transaction or in a series of related transactions, whereby a nongovernmental person uses property acquired with the proceeds of an issue in its trade or business.
(3) Ultimate and intermediate use. In determining whether an issue meets the private business use test, both the ultimate and intermediate uses of proceeds are taken into account. For example, a facility is treated as being used for a private business use if it is leased to a governmental person and then subleased to a nongovernmental person or if it is leased to a governmental person and subleased to a governmental person, provided in each case that the nongovernmental person's use is in a trade or business.
(4) Aggregation of private business use. The use of proceeds by all nongovernmental persons is aggregated to determine whether the private business use test is satisfied.
(b) General definition of private business use--(1) In general. Proceeds are used for a private business use if they are used in a trade or business carried on by a nongovernmental person. For this purpose, any activity carried on by a person other than a natural person is treated as a trade or business. See Sec. 1.141-1(e) relating to certain partnerships.
(2) Use of proceeds. As further described in this paragraph (b) and except as otherwise provided in this section, a person uses proceeds, for purposes of the private business use test, if it (i) owns or leases financed property, (ii) is loaned those proceeds, or (iii) has actual or beneficial use of financed property under a management or incentive payment contract, output contract, or other arrangement.
(3) Agents and employees. Use of proceeds by nongovernmental persons in their capacity as agents or employees of a governmental person is not use for purposes of the private business use test.
(4) Ownership. Except as provided in paragraph (b)(3) of this section, ownership of financed property is treated as use of their property for purposes of the private business use test.
(5) Leases. Except as provided in paragraphs (b)(3) or (f) of this section, the lease of a financed facility is treated as a use of that facility for purposes of the private business use test. For this purpose, any arrangement, such as a management contract, that is properly characterized is a lease for federal income tax purposes is treated as a lease.
(6) Management contracts. A management contract (as defined in paragraph (c)(6) of this section) results in use of the financed property if--
(i) The contract is not a qualified management contract (as defined in paragraph (c) of this section); or
(ii) The service provider is treated as the lessee of the financed property for federal income tax purposes.
(7) Output facilities. See Sec. 1.141-7 for special rules under which contracts for purchase of output of output facilities result in use of the financed facility.
(8) Discharge of primary legal obligation--(i) General rule. In general, a nongovernmental person is treated as a user of a financed facility if the financing of that facility discharges a primary and unconditional legal obligation of that nongovernmental person, even if the nongovernmental person has no possession or control of the facility. Further, the use resulting from the discharge of a primary legal obligation is not use as a member of the general public within the meaning of paragraph (e) of this section. A primary legal obligation does not include a law of general application (for example, an ordinance requiring that all businesses properly dispose of hazardous waste). An obligation imposed on the owner of a facility is not the primary obligation of any other user of that facility.
(ii) Example. The following example illustrates the application of this paragraph (b)(8) (see also Example 12 of paragraph (e) of this section):
Example. As a condition to obtaining a permit to construct an industrial development, Developer N unconditionally agrees that it will construct governmentally owned streets and sidewalks in its development. N and several other developers undertake to create District, a political subdivision. District issues its tax assessment bonds, the proceeds of which are used, in part, to construct the street and sidewalk improvements that N is obligated to construct. N's obligation to construct the improvements is unconditional and, therefore, the discharge of that obligation results in private business use of the proceeds used to construct those improvements.
(9) Research agreements. As provided in paragraph (d) of this section, an agreement by a nongovernmental person to sponsor research performed by a governmental person may result in use of the related property for purposes of the private business use test.
(10) Other actual or beneficial use. For purposes of the private business use test, use includes any other actual or beneficial use of a financed facility other than use as a member of the general public (as defined in paragraph (e) of this section).
(c) Qualified management contracts--(1) In general. A management contract is a qualified management contract if it meets the requirements of paragraphs (c)(2), (c)(3), and (c)(4) of this section. See also paragraphs (c)(5) and (e) of this section for de minimis exceptions.
(2) General compensation requirements. The contract must provide for reasonable compensation for services rendered with no compensation based, in whole or in part, on a share of net profits from the operation of the facility. Reimbursement of the service provider for actual and direct expenses paid by the service provider to unrelated parties is not by itself treated as compensation.
(i) Compensation based on
(A) a percentage of gross revenues (or adjusted gross revenues) of a facility or a percentage of expenses from a facility, but not both,
(B) a capitation fee, or
(C) a per-unit fee is generally not considered to be based on a share of net profits.
(ii) Similarly, a productivity reward equal to a stated dollar amount based on increases or decreases in gross revenues, reductions in total expenses, but not both, generally does not cause the compensation to be based on a share of net profits.
(3) Permissible arrangements. The management contract must be described in paragraph (c)(3)(i), (ii), (iii), (iv), or (v) of this section.
(i) 100 percent periodic fixed fee arrangements. All of the compensation for services during the term of the contract is based on a period fixed fee and the term of the contract, including all renewal options, does not exceed the lesser of 50 percent of the expected useful life of the related property and 15 years. For purposes of this paragraph (c)(3)(i) and paragraph (c)(3)(ii) of this section, a fee does not fail to qualify as a periodic fixed fee as a result of a single incentive award provision under which compensation automatically increases when a gross revenue or expense target (but not both) is reached if that award is equal to a single, stated dollar amount.
(ii) 80 percent periodic fixed fee arrangements. At least 80 percent of the compensation for services for each annual period during the term of the contract is based on a periodic fixed fee. The term of the contract must not exceed the lesser of 80 percent of the expected useful life of the related property and 10 years.
(iii) 50 percent periodic fixed fee arrangements. Either at least 50 percent of the compensation for services for each annual period during the terms of the contract is based on a periodic fixed fee or all of the compensation for services is based on a capitation fee or a combination of a capitation fee and a periodic fixed fee. The term of the contract must not exceed 5 years, including all renewal options. The contract must be terminable by the governmental persons upon reasonable notice at the end of the third year of the contract term, without penalty or cause.
(iv) Per-unit fee arrangements in certain 3-year contracts. All of the compensation for services is based on a per-unit fee or a combination of a per-unit fee and a periodic fixed fee. The contract has a term, including renewal options, that is not longer than 3 years. The contract must be terminable, by the governmental person on reasonable notice, without penalty or cause, at the end of the second year of the contract term. The amount of the per-unit fee must be specified in the contract or otherwise specifically limited by the government person or an independent third party, such as the administrator of the Medicare program.
(v) Percentage of revenue or expense fee arrangements in certain 2- year contracts. All the compensation for services is based on a percentage of fees charged or a combination of a per-unit fee and a percentage of revenue or expense fee. During the start-up period, however, compensation may be based on a percentage of either gross revenues, adjusted gross revenues, or expenses of a facility. The contract must have a term, including renewal options, that is not longer than 2 years. The contract must be terminable by the governmental person on reasonable notice, without penalty or cause, at the end of the first year of the contract term. This paragraph (c)(3)(v) applies only to contracts under which the service provider primarily provides services to third parties (for example, radiology services), or service contracts involving a facility during an initial start-up period for which there have been insufficient operations to establish a reasonable estimate of the amount of the annual gross revenues and expenses (for example, a contract for general management services for the first year of operations).
(4) No related parties or common control. The service provider must not have any role or relationship with the governmental person that, in effect, substantially limits the governmental person's ability to exercise its rights, including cancellation rights, under the contract. This requirement is satisfied if--
(i) Not more than 20 percent of the voting power of the governing body of the governmental person in the aggregate is vested in the service provider and its directors, officers, shareholders, and employees;
(ii) Except in the case of a contract for physician services to patients or similar contracts, not more than 20 percent of the voting power of the governing body of the service provider in the aggregate is vested in the governmental person and its directors, officers, shareholders, and employees;
(iii) Overlapping board members do not include the chief executive officers of the service provider or its governing body or the governmental person or its governing body; and
(iv) The governmental person and the service provider under the contract are not related parties.
(5) De minimis exception for functionally related use. The use of a financed facility pursuant to a qualified management contract does not result in use of the financed facility for purposes of the private business use test if that use is functionally related and subordinate to that management contract and that use is not, in substance, a separate contractual agreement (for example, a separate lease of a portion of the financed facility). Thus, for example, exclusive use of storage areas by the manager for equipment that is necessary for it to perform its required activities does not give rise to private business use.
(6) Definitions. For purposes of this paragraph (c), the following definitions apply:
(i) Adjusted gross revenues means gross revenues of all or a portion of a facility, less allowances for bad debts and contractual and similar allowances.
(ii) Capitation fee means a fixed periodic amount for each person for whom the service provider or the governmental person assumes the responsibility to provide all needed services for a specified period so long as the quantity and type of services actually provided to covered persons varies substantially. For example, a capitation fee includes a fixed dollar amount payable per month to a medical service provider for each member of a health maintenance organization plan for whom the provider agrees to provide all needed medical services for a specified period. A capitation fee may include a variable component of up to 20 percent of total compensation designed to protect the service provider against risks such as catastrophic loss.
(iii) Periodic fixed fee means a stated dollar amount for services rendered for a specified period of time. For example, a stated dollar amount per month is a periodic fixed fee. The stated dollar amount may automatically increase according to a specified, objective, external standard that is not linked to the output or efficiency of a facility. For example, the Consumer Price Index and similar external indices that track increases in prices in an area or increases in revenues or costs in an industry are objective external standards. Capitation fees and per-unit fees are not periodic fixed fees.
(iv) Per-unit fee means a fee based on a unit of service provided. For example, a stated dollar amount for each specified medical procedure performed, car parked, or passenger mile is a per-unit fee.
(v) Renewal option means a provision under which the service provider has a legally enforceable right to renew the contract. Thus, for example, a provision under which a contract is automatically renewed for one-year periods absent cancellation by either party is not a renewal option (even if it is expected to be renewed).
(vi) Management contract means a management, service, or incentive payment contract between a governmental person and a service provider under which the service provider provides services involving all, a portion of, or any function of, a facility. For example, a management or incentive payment service contract includes a contract for the provision of management services for an entire hospital, management services for a specific department of a hospital, or an incentive payment contract for physician services to patients of a hospital. Management contracts do not include a customary contract for janitorial or similar services. The mere granting of admitting privileges by a hospital to a doctor does not result in a management contract even if those privileges are conditioned on the provision of de minimis services, if those privileges are available to all qualified physicians in the area, consistent with the size and nature of its facilities. A contract to provide for the operation of a mixed use facility described in Sec. 1.141-6(b)(2)(i)(B) (relating to certain undivided ownership interests) is not a management contract if the only compensation is the reimbursement of actual and direct expenses paid by the service provider.
(vii) Service provider means any person other than a governmental person that provides services under a contract to or for the benefit of a governmental person.
(viii) Penalties for terminating a contract include a limitation on the governmental person's right to compete with the service provider; a requirement that the governmental person purchase equipment, goods, or services from the service provider; and a requirement that the governmental person pay liquidated damages for cancellation of the contract. In contrast, a requirement effective on cancellation that the governmental person reimburse the service provider for ordinary and necessary expenses or a restriction on the governmental person against hiring key personnel of the service provider is generally not a contract termination penalty. The existence of another contract between the service provider and the governmental person, such as a loan or guarantee by the service provider, constitutes a contract termination penalty if that contract contains terms that are not customary or arm's-length that could operate to prevent the governmental person from terminating the contract (for example, provisions under which the contract terminates if the service contract is terminated or that place substantial restrictions on the selection of a substitute service contract provider).
(d) Research agreements)--(1) General rule. A research agreement described in either paragraph (d)(2) or (d)(3) of this section does not result in private business use.
(2) Corporate-sponsored research. A research agreement relating to a facility used for basic research supported or sponsored by a nongovernmental person is described in this paragraph (d)(2) if any license or other use of resulting technology by the sponsor is permitted only on the same terms as the recipient would permit that use by any unrelated, nonsponsoring party (that is, the sponsor must pay a competitive price for its use), with the price paid for that use determined at the time the license or other resulting technology is available for use. Although the recipient need not permit persons other than the sponsor to use any license or other resulting technology, the price paid by the sponsor must be no less than the price that would be paid by any non-sponsoring party.
(3) Cooperative research agreements. A research agreement relating to a facility used pursuant to a joint industry-university cooperative research arrangement is described in this paragraph (d)(3) if--
(i) Multiple, unrelated sponsors agree to fund university-performed basic research;
(ii) The research to be performed and the manner in which it is to be performed (for example, selection of the personnel to perform the research) is determined by the university;
(iii) Title to any patent or other product incidentally resulting from the basic research lies exclusively with the university; and
(iv) Sponsors are entitled to no more than a nonexclusive, royalty- free license to use the product of any of that research.
(4) Basic research. For purposes of this paragraph (d), basic research has the same meaning as under section 41(e)(7)(A) (that is, any original investigation for the advancement of scientific knowledge not having a specific commercial objective, except that this term does not include basic research conducted outside the United States or basic research in the social sciences, arts, or humanities). Basic research does not include applied or practical research, product development, or similar activities.
(e) Exception for general public use--(1) General public use--(i) In general. Private business use does not include use as a member of the general public (general public use). Use of a financed facility by nongovernmental persons in their trades or businesses is treated as general public use only if--
(A) The facility is intended for use by the general public; and
(B) The use by those nongovernmental persons is reasonably expected to be on the same basis as use by other members of the general public.
(ii) Relation to other use. Use of a financed facility by the general public does not prevent the proceeds from being used for a private business use because of other use under this section.
(2) Intended for use by the general public. (i) Number of users. A facility is not intended for use by the general public if less than 25 percent of the reasonably expected direct use of the facility is by persons that individually account for no more than 1 percent of the use of the facility.
(ii) Persons constituting the general public. Although the general public ordinarily includes natural persons not engaged in trades or businesses, the general public may consist entirely of a large number of nongovernmental persons engaged in different types of trades or businesses. The general public cannot consist predominately of a large number of nongovernmental persons engaged in the same type of trade or business. For example, an electric transmission line used by a large number of electric utilities is not used by the general public. See, however, Example 6 of paragraph (h) of this section.
(3) Use on the same basis--(i) Use related to other facilities--(A) General rule. The use of a financed facility by a nongovernmental person is not on the same basis as use by the general public if the financed facility is functionally and integrally related to another facility that is used by that nongovernmental person (the primary facility) and significant economic benefits with respect to the primary facility arise from the use of the related facility that are not available to the general public. If more than 75 percent of the use of the related facility is by the general public and not use in connection with the primary facility, the benefits to the primary facility are treated as insignificant for this purpose.
(B) Functionally and integrally related. Generally, a facility is not functionally and integrally related to a primary facility for this purpose if it is not a necessary component of the primary facility. Examples of facilities that are typically functionally and integrally related to other facilities in a manner that results in significant economic benefits are parking lots at airports, stadiums, and shopping centers, and utility and other infrastructure improvements for a new development, stadium, or airport. On the other hand, a parking lot in a large urban business district where there are many separate businesses typically does not produce significant benefits to any particular person.
(ii) Priority rights or other preferential benefits. Use under an arrangement that conveys priority rights or other preferential benefits is not use on the same basis as the general public. Arrangements for a term of more than one month generally convey preferential benefits. Arrangements providing for use that is available to the general public at no charge or on the basis of rates that are generally applicable and uniformly applied do not convey priority rights or other preferential benefits. For this purpose, rates may be treated as generally applicable and uniformly applied even if--
(A) Different rates apply to different classes of users, such as volume purchasers, if the differences in rates are customary and reasonable;
(B) Users are permitted to reserve short-term or incidental use in advance;
(C) Existing users, each using less than 1 percent of a financed facility, possess rights of first refusal to renew their use at generally applicable, fair market value rates that are in effect at the time of renewal; and
(D) A specially negotiated arrangement is entered into, but only if the user is prohibited by federal law from paying the generally applicable rates, and the terms of the arrangement are as comparable as reasonably possible to the generally applicable rates.
(4) Special rules for system improvements. For improvements to existing public utility or infrastructure systems such as roads or sewers, but not discrete structures such as parking facilities (system improvements), whether the use of a system improvement is general public use may be determined by reference to the system as a whole if the system improvement is insubstantial, based either on aggregate cost or scope relative to the system as a whole within the jurisdiction of the issuer. Except in the case of improvements to roads, a system improvement is insubstantial for this purpose if the cost of the system improvement is less than 5 percent of the cost of the system as a whole. In addition, in determining whether the use of a system improvement by the general public is insubstantial, paragraph (e)(3)(i) of this section (relating to use related to other facilities) does not apply.
(5) Examples. The following examples illustrate the application of this paragraph (e):
Example 1. Governmentally owned and operated hotel. State C issues its bonds to purchase land and construct a hotel for use by the general public (that is, tourists, visitors, business travelers, etc.). The bond documents provide that C will own and operate the project for the period required to redeem the bonds. Use of the hotel by hotel guests who are travelling in connection with trades or businesses of nongovernmental persons is not a private business use of the hotel by these persons because it is general public use.
Example 2. Toll road. State D issues its bonds to finance the construction of a toll road and the cost of erecting related facilities such as gasoline service stations and restaurants. These related facilities represent less than 10 percent of the total cost of the project and are to be leased or sold to nongovernmental persons. The road is to be owned and operated by D. The bonds do not satisfy the private business use test since less than 10 percent of the proceeds is to be used, directly or indirectly, in the trades or businesses of nongovernmental persons. The fact that vehicles owned by nongovernmental persons engaged in their trades or businesses may use the road in common with, or as a part of, the general public, is not material.
Example 3. Contract with United States. G, a sewage collection and treatment district, operates facilities that were financed with its bonds. F, an agency of the United States, has a base located within G. Approximately 20 percent of G's facilities are used to treat sewage produced by F under a contract under which G uses its best efforts to charge F as closely as possible the same amount for its use of G's services as its other customers pay for the same amount of services, although those other customers pay for services based on standard district charges and tax levies. The use of G's facilities by F is general public use.
Example 4. Parking garage. Authority P uses all the proceeds of its bond issue to construct a parking garage containing more than 100 spaces located in the central business district of a large urban area. At least 90 percent of the spaces in the garage will be available to the general public on an hourly, daily, or monthly first-come, first-served basis and the Authority reasonably expects that at least 25 of the spaces will be leased by unrelated individuals. Individual lessees of monthly parking spaces may renew their spaces at then current fair market value rates. The bonds do not satisfy the private business use test because at least 90 percent of the use of the parking garage is general public use.
Example 5. Road improvements for stadium. H, a political subdivision, issues its bonds to finance construction of a new exit and entrance ramp from an existing highway onto an adjacent street that will front a newly constructed stadium. The existing highway and street are part of systems that are used on the same basis by members of the general public. The stadium is owned by nongovernmental persons. Although the improvements to the highway and the local street are available to the general public and not limited to persons going to the stadium, more than 75 percent of the use of the ramp will be used in connection with the stadium (that is, employees, spectators, and other users of the stadium). Thus, these improvements are functionally and integrally related to the stadium. Under these facts, however, the ramp qualifies as an insubstantial system improvement and, therefore, the proceeds of H's bonds are not used for a private business use.
Example 6. Airport runway. Airport Authority I, a political subdivision, issues its bonds and uses all of the proceeds to finance construction of a runway at a new city-owned airport. The runway will be available for take-off and landing by any operator of an aircraft desiring to use the airport. It is reasonably expected that more than 25 percent of the use of the runway (that is, direct use of the runway) will be by private air carriers (both charter airlines and commercial airlines) in connection with their use of the airport terminals leased by those carriers. Use of the runways by the private carriers is not on the same basis as the general public because their lease of property that is functionally and integrally related to the runways (the terminals) results in significant economic benefits from runway use that are not available to other users. The use by these private air carriers is not general public use, and the proceeds of I's bonds are used for a private business use.
Example 7. Airport parking lot. The facts are the same as in Example 6, except that several months after the issuance of the bonds to finance the construction of the runway, I issues bonds all of the proceeds of which are used to construct a parking lot at the airport. The parking lot will be used entirely by employees of the airport, employees of the airlines and other businesses that are private business users of the airport terminal, and persons traveling by airplane that depart from the airport. The use of the parking lot by the airlines and other private business users of the airport terminal is not treated as general public use for the same reasons as in Example 6.
Example 8. Federal use of prisons. Authority P uses all of the proceeds of its bonds to construct a prison. P contracts with a federal agency F to house federal prisoners on a space-available, first-come, first-served basis, pursuant to which the federal agency will be charged approximately the same amount for each prisoner as other governmental persons that enter into similar transfer agreements. It is reasonably expected that other governmental units will enter into similar agreements. P may terminate the contract on 90 days notice. it is reasonably expected that during the term of the contract, federal prisoners will constitute more than 10 percent of the prisoners at the prison. The bonds satisfy the private business use test because F and any governmental persons using the prison under similar agreements are not members of the general public.
Example 9. Business insurance fund. Authority deposits all of the proceeds of its bonds in its hazardous business insurance fund and invests all of those proceeds in tax-exempt bonds. The hazardous business insurance fund provides liability insurance to more than 100 operators of different types of hazardous businesses within the meaning of State law. Each of the insured persons is required under State law to obtain this type of insurance as a condition to their trade or business operations. Each participant receives insurance for a term of one year, and it is expected that the fund will be available for renewals. The participants are not treated as members of the general public because the term of the insurance conveys preferential benefits.
Example 10. Port road. Highway Authority W uses all $200 million of the proceeds of its bonds to construct a 25-mile road to connect an industrial port owned by Corporation C with existing roads owned and operated by W that are all located within City T. Other than the port, the nearest residential or commercial development to the new road is 12 miles away. Although there may be additional development in the area surrounding the new road, there is no reasonable expectation that the development will occur within the 3-year period following the issuance of the bonds. W does not reasonably expect that more than 25 percent of the use of the new road will be by persons other than employees and other persons doing business with C. The bonds satisfy the private business use test because the road, although available for use by the general public, will have insubstantial general public use and will not qualify as an insubstantial system improvement because the cost of the project is not insubstantial.
Example 11. Connecting road. The facts are the same as in Example 10, except that the road extends beyond the port to a new residential development. Persons residing in this development will account for more than 25 percent of the use of both segments of the road. The bonds do not satisfy the private business use test because the use of the road is general public use.
Example 12. Fish ladder. J, a political subdivision, owns and operates a hydro-electric generation plant and related facilities. Pursuant to a take or pay contract having a term equal to the useful life of the facility, J sells 15 percent of the output of the plant to Corporation K, an investor-owned utility. Under the license issued to J for operation of the plant, J is required by federal regulations to construct various facilities for the preservation of fish and for public recreation. J issues its obligations to finance the fish preservation and public recreation facilities. The financed facilities provide no direct benefits to J or the purchasers of the electricity produced by the plant. Because K has no primary legal or contractual obligation to provide the financed facilities, the facilities are not used for a private business use by K under paragraph (b)(8) of this section. Under this paragraph (e), however, the fish preservation facilities, but not the public recreation facilities, are treated as used by K because they are functionally and integrally related to the generation plant.
(f) De minimis exceptions--(1) Short-term leases and similar arrangements. Use by a nongovernmental person pursuant to a lease, management contract, or similar arrangement does not result in private business use if--
(i) The agreement may not be renewed or extended beyond the period described in this paragraph (f)(1);
(ii) Following the expiration of that agreement the facility subject to the agreement is not used for a private business use (determined without regard to this paragraph (f)(1));
(iii) The term (or in the case of an agreement entered into prior to, and not in connection with, the issuance of the bonds, the remaining term) of the agreement does not exceed the least of (A) 1 year, (B) 10 percent of the remaining economic life of the financed facility (determined at the time the arrangement is entered into), and (C) 10 percent of the remaining term of the bonds; and
(iv) Except in the case of a lease, management contract, or similar agreement entered into prior to the issue date (or contemplated issuance) of bonds financing the acquisition of the property, the agreement must be an arm's-length, fair market value agreement.
(2) Temporary use by developers. Use by a developer of an improvement that carries out an essential governmental function during an initial development period does not result in private business use if--
(i) The issuer and the developer reasonably expect on the issue date to proceed with all reasonable speed to develop and sell the related property to members of the general public and covenant in the bond documents to do so with due diligence;
(ii) The issuer and the developer reasonably expect on the issue date that the related property will be sold to members of the general public within 3 years of the issue date; and
(iii) Bonds of the issue are not required to be retired in connection with the developer's sale of property to members of the general public.
(3) Incidental use--(i) General rule. Incidental use of a financed facility is disregarded to the extent that that use doe not exceed 2.5 percent of the proceeds of the entire issue. A use of a facility by a person is incidental if--
(A) The use does not involve the transfer to the person of possession and control over space that is separated from other areas of the facility by walls, partitions, or other physical barriers, such as a night gate affixed to a structural component of a building (a nonpossessory use);
(B) The nonpossessory use is not functionally related to any other use of the facility by the same person (other than a different nonpossessory use); and
(C) All nonpossessory uses of the facility do not, in the aggregate, involve the use of more than 2.5 percent of the facility.
(ii) Illustrations. Incidental uses may include pay telephones, vending machines, advertising, use for television cameras, etc., but not output purchases.
(4) Qualified improvements. Proceeds that provide a governmentally owned improvement to a governmentally owned building (including its structural components and land functionally related and subordinate to the building) are not used for a private business use if:
(i) The building was placed in service more than one year before the construction or acquisition of the improvement is begun;
(ii) The improvement is not an enlargement of the building or an improvement of interior space occupied exclusively for any private business use;
(iii) No portion of the improved building or any payments in respect of the improved building are taken into account under section 141(b)(2)(A) (the private security test);
(iv) No more than 15 percent of the improved building is used for a private business use; and
(v) The improvement (and any related improvements) does not increase the fair market value of the building by more than 5 percent. This requirement is treated as satisfied if the improvement is to common areas (such as the roof, heating, ventilation, and air conditioning system, or elevators), and the improvement is not made as part of a substantial rehabilitation of the building.
(g) Special rule for tax assessment bonds. In the case of a tax assessment bond that satisfies the requirements of Sec. 1.142-5(c), the loan (or deemed loan) of the proceeds to the borrower paying the assessment is disregarded in determining whether the private business use test is satisfied. Thus, the private business use of those proceeds is determined on the basis of the use of the property improved with the tax assessment loan and any other use of the proceeds used for that assessment.
(h) Examples. The following examples illustrate the application of paragraphs (b) through (g) of this section:
Example 1. Long-term lease with nongovernmental person. State A and Corporation X enter into an arrangement under which A is to provide a factory that X will lease for 20 years. The arrangement provides that A will issue $10 million of bonds, the proceeds of the bond issue will be used to purchase land and to construct and equip a factory in accordance with X's specifications, X will rent the facility (land, factory, and equipment) for 20 years at an annual rental equal to the amount necessary to amortize the principal of and pay the interest on the outstanding bonds, and the payments by X and the facility itself will be the security for the bonds. The bonds are private activity bonds under section 141(b)(1) and (2) since they are part of an issue (1) all of the proceeds of which are to be used (by purchasing land and constructing and equipping the factory) in a trade or business by a nongovernmental person, and (2) the payment of the principal of and interest on which is secured by the facility and payments to be made with respect to the facility. See Sec. 1.141-5 (relating to the private loan financing test) and Sec. 1.141-4 (relating to the private security or payment test).
Example 2. Sale to nongovernmental person. The facts are the same as in Example 1 except that X will purchase the facility, and annual payments equal to the amount necessary to amortize the principal of and pay the interest on the outstanding bonds will be made by X. The bonds are private activity bonds under section 141(b) (1) and (2) for the reasons set forth in Example 1. See Sec. 1.141-5 (relating to the private loan financing test) and Sec. 1.141-4 (relating to the private security or payment test).
Example 3. Private payments not based on debt service. The facts are the same as in Example 1 except that the annual payments required to be made by Corporation X are equal to the fair rental value of the facility and exceed the amount necessary to amortize the principal of and pay the interest on the outstanding bonds. The bonds are private activity bonds for the reasons set forth in Example 1. The requirement that Corporation X pay an amount equal to fair market value, which is in excess of the amount necessary to pay the principal of and interest on the bonds, does not affect the status of the bonds as private activity bonds. Similarly, if the present value of the annual payments required to be made by X exceeded 10 percent of the present value of the debt service on the outstanding bonds, the bonds would be private activity bonds under section 141(b) (1) and (2) for the reasons set forth in Example 1. See Sec. 1.141-2(a) and Sec. 1.141-4.
Example 4. Private lease of portion of building. (i) State D and Corporation Y enter into an agreement under which Y will lease for 20 years one floor of a 10-story office building to be constructed by D on land that it will acquire. D will occupy the street level floor and the remaining eight floors of the building. The portion of the costs of acquiring the land and constructing the building that are allocated to the space to be leased by Y is not in excess of 10 percent of the total costs of acquiring the land and constructing the building. These costs, whether attributable to the acquisition of land or the construction of the building, were allocated to leased space in the same proportion that the reasonable rental value of that leased space bears to the reasonable rental value of the entire building. From the facts and circumstances presented, it is determined that that allocation was reasonable. D issues $10 million of bonds, the proceeds of which will be used to purchase land and construct the office building. The arrangement does not, by itself, cause the private business use test to be met because not more than 10 percent of the proceeds is to be used, directly or indirectly, in the trade or business of a nongovernmental person. See Sec. 1.141.6.
(ii) If Corporation Y instead leases 2 floors, and the costs allocated to these floors are in excess of 10 percent of D's investment in the land and building, the arrangement causes the private business use test to be met because more than 10 percent of the building is to be used in the trade or business of a nongovernmental person.
Example 5. Numerous private leases. The facts are the same as in Example 4 except that, instead of leasing any space to Corporation Y, State D leases the two floors to numerous unrelated private businesses to be used in their trades or businesses. No lease will have a term in excess of 2 years. The bonds meet the private business use test for the reasons set forth in Example 4.
Example 6. Municipal auditorium. City G issues its obligations to finance the construction of a municipal auditorium that it will own and operate. The use of the auditorium will be open to anyone who wishes to use it for a short period of time on a rate-scale basis. The rights of such a user are only those of a transient occupant, rather than the full legal possessory interest of a lessee. It is anticipated that the auditorium will be used by schools, church groups, fraternities, and numerous commercial organizations. The revenues from the rentals of the auditorium and the auditorium itself will be the security for the bonds. The bonds are not private activity bonds because none of the uses constitute use in the trade or business of a nongovernmental person.
Example 7. Long-term lease of municipal auditorium. The facts are the same as in Example 6 except that one nongovernmental person engaged in a trade or business will have a 10-year rental agreement providing for exclusive use of the entire auditorium for 6 weeks of each year at a rental comparable to that charged short-term users. The bonds satisfy the private business use test since use of the auditorium for 6 weeks each year is more than 10 percent of the use of the auditorium and the agreement is not disregarded as a de minimis use under paragraph (f) of this section. Thus, more than 10 percent of the proceeds of the issue will be used in a trade or business of a nongovernmental person. See also paragraph (i) of this section.
Example 8. Management contract in substance a lease. City L issues bonds to finance the construction of a city hospital. L enters into a 5-year contract with M, a nongovernmental person that operates a health maintenance organization relating to the treatment of M's members at L's hospital. The contract meets the conditions for qualified management contracts under paragraph (c) of this section. However, the contract also provides that L will guarantee M that 20 percent of the capacity of the hospital will be exclusively available to members of M's health maintenance organizations at special rates so that the contract is properly characterized as a lease for federal income tax purposes. Therefore, the issue meets the private business use test.
(i) Measurement of private business use--(1) General rule. The private business use of proceeds allocated to a facility under Sec. 1.141-6 is determined according to the use of that financed facility during each one-year period beginning from the later of the issue date or the date the facility is placed in service. The private business use of a facility is equal to the greatest percentage of private business use for any one year period. The private business use of a facility for any one year period is equal to the average private business use during that year.
(2) Determining average of use. The average of the private business use of a facility is determined by comparing the amount of private business use of that facility during a year to the total amount of private business use and government use during that year. In determining the total amount of use, periods during which the facility is not in use are disregarded. In determining the average amount of private business use, the following rules apply:
(i) Uses at different times. For a facility in which the government use and private business use occur at different times (for example, on different days), the average amount of private business use is based on the amount of time that the facility is used for private business use as a percentage of total time for all use. If, however, the use of a facility during different times has significantly different value, this determination must take into account those different values.
(ii) Simultaneous use. For a facility in which government use and private business use occur simultaneously, the entire facility is treated as having private business use. If, however, the private business use and government use is on the same basis, the average amount of private business use may be determined on a reasonable basis (for example, relative value of use, relative amount of time used). For example, a governmentally owned facility that is leased or managed by a nongovernmental person in a manner that results in private business use is treated as entirely used for a private business use. On the other hand, a garage with unassigned spaces that is used for government use and private business use is only partially used for a private business use.
(iii) Combined use. If a facility has private business use that is described in both paragraphs (i)(2)(i) and (1)(2)(ii) of this section, the amount of private business use is determined according to whichever method produces the greatest amount of private business use. See, however, Sec. 1.141-6 for special rules for common areas of a discrete portion of a mixed use facility.
(3) Use of a portion of a facility--(i) Discrete portion. For purposes of this paragraph (i), measurement of the use of proceeds allocated to a discrete portion of a mixed use facility is determined by treating the discrete portion as a separate facility.
(ii) Common areas. The amount of private business use of common areas within a mixed use facility is based on the average amount of private business use of the remainder of the entire facility.
(4) Allocation of neutral costs. Proceeds that are used to pay costs of issuance, invested in a reserve or replacement fund, or paid as fees for a qualified guarantee or a qualified hedge must be allocated ratably among the other purposes for which the proceeds are used.
(5) Commencement of private business use. Generally, private business use commences on the first date on which there is actual use by the nongovernmental person. If, however, the issuer and a nongovernmental person enter into an arrangement to transfer a financed facility, private business use commences on the date of that arrangement if that arrangement was entered into substantially in advance of the transfer and the transfer will occur during the final year of the term of the issue or after the retirement of the issue.
(6) Examples. The following examples illustrate the application of this paragraph (i):
Example 1. Research facility. University U is a state owned and operated university. As part of its activities, U owns and operates a bond-financed research facility. U enters into sponsored research agreements with nongovernmental persons that result in private business use. The research otherwise conducted by U (government use) and the private research will take place simultaneously in all laboratories within the research facility. All laboratory equipment will be available continuously for use by workers who will perform both types of research. A researcher will often use a single laboratory to perform identical research that may meet the objectives of U's research and the obligations under the research contracts. Under this section, the nongovernmental persons are using the facility for a private business use. The private business use results from a use of the facility, the research, that is on the same basis as government use of the facility. Therefore, the portion of the facility that is used for a private business use may be determined on a reasonable basis. If more than 10 percent of the use of the facility is private business use, no portion of the facility can be financed with tax-exempt bonds.
Example 2. Stadium. City L issues its obligations and uses all of the proceeds to construct a stadium. L enters into a long-term contract with a professional sports team T under which T will use the stadium 20 times during each year. These uses will occur on weeknights and weekends. L reasonably expects that the stadium will be used more than 180 other times each year, none of which will give rise to private business use. This expectation is based on a feasibility study and historical use of the old stadium that is being replaced by the new stadium. There is no significant difference in the value of T's uses when compared to the other uses of the stadium. Assuming no other private business use, the obligations do not satisfy the private business use test of section 141(b)(1) on the issue date since not more than 10 percent of the use of the facility is for a private business use.
Example 3. Stadium with significant private business use. The facts are the same as in Example 2, except that L reasonably expects that more than 10 percent of the use of the stadium will be for a private business use. The obligations satisfy the private business use test. Further, since the stadium is not a mixed use facility under Sec. 1.141-6, any obligations issued to finance any portion of the stadium are treated as having private business use in excess of 10 percent. Therefore, no portion of the stadium can be financed with tax-exempt bonds.