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Friday January 24, 1997
Treasury Department Rule Eases Private-Public Partnerships
The U.S. Department of Treasury issued new Internal Revenue Service (IRS) private activity bond regulations on January 16 which will greatly expand a municipalities options to enter into public/private partnerships for the operation and maintenance of public utilities, including publicly owned treatment works (POTWs), with outstanding tax exempt bonds (see Federal Register Vol. 62, No. 11, page 2275). The new regulations greatly expand the maximum permissible term for management contracts (up to 20 years) and expand the number of projects able to access the "change in use" rules in the event of an asset sale (provided certain requirements are met). These changes will simplify the structuring process for many public/private partnerships and will make tax exempt financing available to a greater number of projects.
According to an article prepared by the law firm of McDermott, Will & Emery, the basic legal principal, which remains unchanged by the new rules, is that if arrangements between a governmental and a private entity constitute a "private business use" of 10% or more of a facility financed with tax exempt government obligations, interest on the debt may become taxable retroactive to the date of its issuance. Prior to the issuance of the new rules there was no guidance available to proscribe when private business use existed and management contract deemed not private business use were limited in duration and payment structures. Under the old rules the longest contract term available to keep tax exempt status was five years. By allowing for up to 20 year management contracts, the new rules encourage private activity by providing contractors with added assurance that they could recoup the large front-end investments involved in privatization transactions for concession fees, facility improvements and start-up costs, and made such transactions unattractive. In the event of an asset sale, the new rules provide opportunities to retain the tax exempt status of outstanding bonds if, 1) the outstanding bonds are redeemed within 90 days following the sale of the facility or a defeasance escrow is established if the bonds cannot be redeemed within that time frame; 2) the consideration for the sale of the facility is exclusively cash, the issuer may expend the sale proceeds for a governmental purpose (any purpose -- for example, money generated from the sale of a POTW could be used fix roads) within two years of the sale; or, 3) after the sale, the facility is used for a purpose which would permit the bonds to be considered qualified 501(c)3 bonds or exempt facility private activity bonds if the requirements applicable to the new bond classification, such as volume cap and public approval, are satisfied.
The new rules address several issues raised by the U.S. Conference of Mayors (USCM) in a letter to Treasury Secretary Rubin last summer. The USCM, which has been advocating the removal of federal impediments to private operation and capitalization of public water and wastewater systems, asserts that private investment in POTWs is "critical" because municipalities will have to invest about $140 billion in capital improvements during the next decade to comply with federal water quality requirements. A complete summary of the new rules will be forwarded to the membership soon via Member Update.