Bond Lawyers Group Seeks Simplified Rules for Applying Private Activity Bond Restrictions

Ladies and Gentlemen:

The National Association of Bond Lawyers (NABL) respectfully submits the attached comments in response to your request in the Internal Revenue Bulletin on October 30, 2006 (REG-140379-02; REG-142599-02), relating to allocation of and accounting for tax-exempt bond proceeds for purposes of the private activity bond restrictions (Proposed Regulations).

NABL appreciates both the significant effort of the Department of the Treasury and the Internal Revenue Service in the preparation of the Proposed Regulations as well as the request for and consideration of NABL's submission.

Primary drafting responsibilities for these comments were assumed by Perry E. Israel, Orrick, Herrington & Sutcliffe LLP. Substantial contributions were made by other NABL members identified in Exhibit I to this letter.

NABL believes that participating in the guidance process supports clarification of and facilitates compliance with the tax law and regulations. Accordingly, NABL members would welcome the opportunity to discuss these recommendations to achieve clarity, certainty and administrability in this area of the law.

If you have any questions, please contact me at 949/725-4237 or through email at clew@sycr.com or Elizabeth Wagner, Director of Governmental Affairs at 202/682-1498 or through email at ewagner@nabl.org.

Thank you again for the opportunity to submit NABL's comments.

The Proposed Regulations represent a substantial endeavor on the part of the Department of the Treasury (the "Treasury") and the Internal Revenue Service (the "IRS") to structure a set of administrable rules that balance the limitations of the tax law relating to the use of tax-exempt bonds and the growing demand for further private participation in large-scale governmental developments. NABL applauds the willingness of the Treasury and the IRS to devote the resources to develop rules intended to help issuers and bond counsel distinguish between private use of bond-financed facilities and private use of facilities funded from other sources. Moreover, in general, NABL agrees with the underlying principles of the Proposed Regulations: issuers should be able to allocate both bond proceeds and other sources of funds to a particular project and should be able to allocate private use of the project to the sources of funds other than bond proceeds in a reasonable fashion. The allocation rules should also permit State and local governments that issue more than one series of bonds to finance ongoing capital programs to make allocations among their various projects.

NABL believes, however, that the Proposed Regulations could be improved and simplified. NABL also believes that, as drafted, they are highly technical and will prove difficult for issuers and conduit borrowers to comply with and equally difficult for the IRS to enforce. NABL further believes that the concept that private use should be allocated first to contributions that come from sources other than tax-exempt bonds is relatively straightforward and can be set forth with a simple and practical approach that will satisfy the requirements of the Code and other regulations without becoming administratively cumbersome. The basic starting point for this concept is already contained in existing regulations: "[A]llocations generally may be made using any reasonable, consistently applied accounting method." Treas. Reg. § 1.141-6(a). NABL believes that this rule, combined with minor modifications to and clarifications of the "undivided portion allocation method" contained in the Proposed Regulations, results in a relatively easily applied methodology for allocations that will be administrable by the IRS, can be relatively easily applied by issuers (or conduit borrowers) and their advisors, and will ensure that bond proceeds are used for governmental purposes. With that in mind, the following recommendations are respectfully submitted, starting with the most important recommendation.

"Fixed percentage." The Proposed Regulations allow an issuer to elect to use the undivided portion allocation method if the undivided portions "generally" represent fixed percentages of the use of the entire mixed-use project. § 1.141-6(d)(1). NABL reads the "fixed percentage" rule to mean that the percentage of a project financed with equity is fixed, not that the private use percentage is fixed, and NABL recommends that this be made clear in the final regulations.

Flexibility for use with discrete portion method. The Proposed Regulations also allow an undivided portion allocation to be used with respect to a discrete portion after a discrete portion allocation has been made. NABL strongly supports the flexibility that the Proposed Regulations grant to issuers.

Extension beyond use "on the same basis" or "simultaneous use." The usefulness of the undivided portion allocation method as set forth in the Proposed Regulations is significantly impaired, however, by the restriction that only allows that method to be used where private business use and governmental use of a mixed-use project occur (a) at the same time and on the same basis or (b) at different times. NABL's position is that, given reasonable, consistent methods for determining the amount of private business use and governmental use, the undivided portion allocation method should be available when governmental use and private business use occur at the same time, regardless of whether the different uses occur on the same basis.¹ Moreover, in practice, the meaning of the "same basis" requirement is unclear for purposes of simultaneous use. "Same basis" is already defined in Treas. Reg. § 1.141-3(c)(2), and, if the private business use were on "the same basis as the general public," it would not constitute private business use at all. Further, NABL recognizes that Treas. Reg. § 1.141-3(g)(4)(iii) generally provides that any simultaneous private business use of a bond-financed facility that is not on the same basis as that of the governmental use will be treated as private business use for the entire facility. Therefore, both the language in Treas. Reg. § 1.141-3(g)(4)(iii) and the undivided portion allocation method set forth in the Proposed Regulations should be amended to reflect subsequent thinking of the IRS, such as that expressed in private letter ruling ("PLR") 200323006.

In PLR 200323006, the Chief Counsel's office determined that private business use of a facility can arise from "naming rights." In that ruling, the Chief Counsel determined that the amount of private business use arising from the naming rights was less than the lesser of $15 million and 10% of the use of the bond proceeds. However, if the amount of private business use were properly determined² to be more than 10% or $15 million, an issuer should be able to allocate equity to the portion of the facility that is the "naming rights," perhaps, for example, by using the payments for the naming rights to pay for a portion of the facility (or to secure taxable debt for that purpose) and reducing the amount of bond proceeds used to finance the facility.

Bases for determining private use. The Proposed Regulations give examples of bases for allocation under the undivided portion allocation method, including: how many units produced by the facility will be used by various users, what percentage of space will be used on an unreserved basis (e.g., in a parking garage),³ what the fair market value of the respective uses is, what percentage of time will the facility be used by various users, and (where no other measure is reasonably workable) what percentage of revenues is produced by the various uses. § 1.141-6(d)(2). NABL is conscious and appreciative of the fact that, as evidenced by the broad range of alternatives for determining relative amounts of private business use and governmental use set forth in the Proposed Regulations, the Treasury and the IRS have shown a great deal of attention to giving flexibility to issuers to use methods that best reflect the relative uses of the facility while at the same time allowing issuers to chose metrics that are relatively easy to measure. NABL notes, however, that, in the context of facilities, such as laboratories, relative value units (or "RVUs") would appear to be a possible basis for allocation, since RVUs are a method of determining value/cost that, when applied on different pay scales, determine pricing. As long as the same RVU standards apply to both public and private services preformed in the laboratory or facility, this unit of measure should prove to be a fair allocation basis, since it picks up both time and intensity of work. Accordingly, NABL recommends that RVUs be added in the final regulations to the list of examples of permissible bases for allocating private use. Another appropriate measure would be relative amounts of income generated.

Summary. NABL recommends that the undivided portion allocation method be available for use in any mixed-use facility where the relative private business use and governmental use can be reasonably and consistently determined. Within that construct, NABL believes that the method outlined in the Proposed Regulations for allocating private business use -- first to the portion of the facility financed with equity and then to the portion of the facility financed with bonds -- is exactly correct. The possibility of allowing excess unused equity in one year (i.e., where the actual private business use is less than the equity-financed percentage of the facility) to be carried over to another year should also be considered. This would be consistent with Treas. Reg. § 1.141-3(g). NABL would welcome the opportunity to discuss with the Treasury and the IRS how such a rule could be crafted and made administrable.

Thus, NABL recommends that the "consistency requirement" in the Proposed Regulations, requiring consistency between expenditures for private activity bond purposes and arbitrage purposes be deleted. Section 141 of the Code should permit an issuer to allocate bond proceeds to the governmental portion of a mixed-use project⁴ without regard to any particular accounting (or timing) rule.⁵

Once an issuer has used equity to pay for a portion of a facility, the issuer should be allowed to allocate private use to that equity without regard to any election or any allocation of specific discrete space within the facility. Thus, as described above, NABL believes the general rule, rather than that proposed in § 1.141-6(a)(4), should be nearly identical to the undivided portion allocation method set forth in § 1.141-6(d) of the Proposed Regulations, with one important change: if the percentage of private use can be reasonably determined, there should be no requirement that private and governmental use of the facility be either at different times or on the same basis. Thus, in brief, NABL recommends that with respect to any mixed-use facility, the percentage of the project financed with equity should be determined, and then any private use of the facility up to that percentage in each year should be allocated first to the equity contribution and, only thereafter, to the bond-financed contribution, whether or not any private use was expected as of the issue date. This approach is discussed in more depth in Part B above.

Example: Issuer builds new hospital facility for $100X, $80X of which is bond-financed and $20X of which is financed with equity. In any given year, up to 20% of the new hospital can be used for private use without causing any private use of the bond-financed portion of the hospital. Use over 20% will be treated as private use of the bond-financed portion of the hospital.

More on elections. If, despite NABL's recommendation, the requirement of an election is retained, the final regulations should provide that the election can be made at any time, not just at the time the bonds are issued or the beginning of the measurement period. Moreover, in the case of a conduit borrowing, the final regulations should clarify that the election can be made by a 501(c)(3) or other conduit borrower. Please also note that, under the Proposed Regulations, § 1.141-6(a)(4) provides that the time for making the election is on or before the start of the measurement period, while § 1.141-1(c) provides that elections must be made in writing on or before the issue date. If the election concept is retained, these sections should be reconciled.

As a starting point, NABL believes that the statute generally implies that a cost method be used for determining private use, insofar as the statute requires the measurement of the amount of proceeds of the bonds used for private business use. Thus, if the proceeds of a single issue are used to purchase, for example, two adjacent buildings from unrelated parties in arm's-length transactions, with 20% of the proceeds used to purchase building A and 80% used to purchase building B, and if building A were used in the trade or business of a private person, 20% of the proceeds of the bonds should be treated as used for private business use -- based upon the cost of the assets being used by the private persons, with no regard to the fair market value of the two buildings.

NABL applauds the approach in the Proposed Regulations which gives the issuer several alternatives for determining cost or use of proceeds. For example, if 100% of the proceeds of the bonds are used to purchase a 5-story building, each floor having the same square footage, and one floor is used for private business use, an issuer could treat 20% of the proceeds as used for private business use under a per square foot allocation. An issuer would not have to use any method for artificially allocating separate "costs" to each floor that is not based upon any terms of the purchase agreement, negotiations with the seller, or any other hypothetical arrangement.

However, NABL is extremely concerned with the overriding rule (referred to as an "anti-abuse rule" in the preamble of the Proposed Regulations) that states that relative fair market values must be used to allocate private business use if the amount allocated to private business use derived by using relative fair market values is "significantly greater" than would be obtained under an otherwise-permitted allocation methodology. First, as described above, NABL believes the statute actually implies a "cost" override rather than a fair market value override.⁶ Where the proceeds of a bond issue are used to purchase various assets, it is possible that "cost" and "fair market value" are similar measures. However, when bond proceeds are used to construct an asset, such as an office building with commercial units on the ground floor, the proceeds used to construct the various floors (assuming similar build-out or construction costs) will not necessarily have any relationship to the fair rental value, for example, of the different floors. Second, it is not clear how or when fair market value is to be determined: Based upon prices that could be obtained if the building were condominiumized? Based upon fair rental values? Based upon replacement costs? Based upon capitalization of rentals? At the time of the bond closing? At the time the building is placed in service? At some later date, when the relative rental values for commercial office space may be different? Each year, when the relative amounts of private business use and governmental use are determined? Third, it does not seem reasonable to effectively require the issuer in all cases to obtain one or more appraisals with respect to relative fair market values, however determined, just to ensure that there is no "significant" difference. Consequently, NABL does not believe that the fair market value test is an appropriate "anti-abuse" rule, and recommends that the fair market value test be eliminated from the final regulations.

In making this recommendation, NABL refers to Treas. Reg. § 1.141-14. The term "significantly greater" was included in Treas. Reg. § 1.141-14 as an anti-abuse rule that would apply in the rare instance where the portion to be occupied by the government was obviously dramatically different from private business use (government use in the basement, private business on the penthouse floor of an acquired office building). Although the term "substantial" was used in several other rules in the 1997 private activity regulations that included Treas. Reg. § 1.141-14, the term "significantly greater" was used to emphasize that this language pertained to an anti-abuse rule. The intent was not to require a market evaluation every time that private business use arose, as the Treasury and the IRS were very sensitive to imposing an administrative burden and unfunded mandate on State and local governments. Revising the test to quantify this concept would change it from an anti-abuse rule, where a broader set of facts and motivations are analyzed, into a rule requiring unnecessary expenditure by issuers in nearly every case. If the Treasury and the IRS were to attempt to create a percentage test in Treas. Reg. § 1.141-3, every issuer would feel compelled to hire an independent appraiser to come up with the numbers necessary to establish whether the now-quantified fair market value test had been exceeded. This change to existing practice alone would greatly increase the time and expense of doing a transaction, without even contemplating the escalated costs that would arise when the property to be financed is not a standard subject of appraisals (e.g., a bridge), as many government activities are not. In answer to the question raised in the preamble as whether this rule should be quantified, NABL strongly recommends that it be retained solely as an anti-abuse rule without quantification.

NABL recommends, in the alternative, that at the very least "significantly greater" be broadly defined (e.g., a shift in more than 40% of total use of the proceeds) and that the time of the testing be specified to a single testing date, at the time of the issuance of the bonds, based upon expectations. Moreover, the focus should be upon the allocation of the cost of the assets wherever discrete portion allocations are made, rather than fair market value.

NABL is also concerned about when reasonable expectations are to be determined. The general rule under Section 141 of the Code is that private use is determined based upon reasonable expectations at the time the bonds are issued and when deliberate actions after issuance cause a change in use. The Proposed Regulations seem to propose that private business use is determined based upon reasonable expectations at the time the facilities are placed in service. NABL believes this treatment is inconsistent with the statute.

NABL applauds the recognition by the Treasury and the IRS that changes in operations of facilities happen over the term of the bonds, as evidenced in the ability to reallocate discrete portions from time to time set forth in the Proposed Regulations. However, the timing limitation on that ability is difficult to interpret and administer. As written, the Proposed Regulations provide that reallocations may be made only once every five years. First, NABL is uncertain what this means: Can a reallocation be made in year 4, which is the first reallocation? If a reallocation is made in year 4, can another reallocation be made in year 6, which is in a different five-year period (measured from closing) than the reallocation in year 4? Must all allocations be at least 5 years apart, which would mean that if a first reallocation is made in year 4, a second cannot occur before year 9? Second, it is unclear why this restriction should be imposed upon issuers. This treatment appears to be fairly arbitrary and does not seem aimed at either abuses or at simplicity of administration. If this limit is retained, NABL believes that issuers as a regular matter would not use the discrete portion allocation method but would use the undivided portion allocation method, which can give the issuer the same result but without the technical limitations imposed by the discrete portion rules.

A clarification is also needed in the final regulations to state that a "discrete portion" might include equipment located in a mixed-use project.

Finally, if the definition of "project" is retained as proposed, the discrete portion allocation method will need to be clarified to eliminate the requirement that a discrete portion not financed with bonds be owned by the governmental entity. NABL knows of no logical reason that tax-exempt bonds could not be used to finance the governmentally owned portion of a condominium project.

NABL also questions how the definition language of the Proposed Regulations would be applied. Taking a fairly common case, how is the definition of project applied in a financing of capital facilities that are placed in service in stages, like buildings built over time under a schedule? For example, the issuer's plan of financing calls for the construction of a new middle school to be completed in month 10 and to accept students in month 11 prior to the rehabilitation of the old middle school and conversion into a new elementary school to be completed in month 24. If the issuer sells a single issue of bonds for that purpose, are the new middle school and the related renovation of the old middle school and conversion into an elementary school part of the same or separate "project(s)?"

From an analytical view, NABL recommends that the bond-financed project should consist only of the portion of the project financed with bonds. Thus, if an issuer allocates bond proceeds to the first three floors of a building and equity to the fourth floor, there should be no mixed-use project. The bond-financed project is just the first 3 floors (regardless of whether those 3 floors are separately identified as a separate legal estate). However, for simplicity, an issuer may wish to treat the entire building as a mixed-use project, using equity to finance a portion of the facility. Accordingly, NABL's view is that the "project" should consist of whatever the issuer allocates bond proceeds to, i.e., it includes everything that is treated by the issuer as bond-financed and as much of that which is treated as equity-financed as the issuer chooses.⁸ Included within this analysis is an important concept that says "one may look to different legally identifiable interests in real property as separable projects." Accordingly, this rule would be allowed not just for condominiums, but for conservation easements, mineral rights, profits interests, vertical separations, and time-based estates to be financed. See PLR 200501012.

Same plan of financing and subsequent improvements. As mentioned above, the last prong of the proposed test for a single project will be difficult to apply in practice: it is unclear what the "same plan of financing" is or may be. For purposes of giving an unqualified opinion, the language in Treas. Reg. § 1.150-1(c)(1)(ii) is not very helpful in this regard, except for the very specific examples contained in that provision. In addition, the Proposed Regulations treat subsequent improvements as part of the same project under certain circumstances. The definition would appear to cover the following example: a governmental hospital wing is built using tax-exempt bonds. Many years later, 10% of that wing is leased to a radiology group and the governmental issuer uses equity to finance the equipment used by the radiology group. Unless the requirement of an election is eliminated, it would be too late to make an election. Because the equity would be allocated pro rata among the wing, the radiology equipment would be treated as financed in part with the proceeds of the tax-exempt bonds issued years ago, and the radiology group would be treated as using more than 10% of the proceeds of the bonds. This cannot be the right result. NABL notes that, if the general recommendation to eliminate or modify the election requirement in Part D above is followed, and if the definition of "qualified equity" (discussed below) is changed to include costs of subsequent improvements, any private business use by the radiology group would be first allocated to the equity, giving a correct result. However, NABL believes that this issue should also be addressed by making the definition of project more focused.

The subsequent improvements language raises an additional issue: if a facility was financed with equity in the past and today improvements are to be made using proceeds of tax-exempt bonds, would the improvements be treated as part of the same "project" as the original equity-financed construction? If so, even though the improvements that are bond-financed are restricted to governmentally used space, if there is private business use of the entire facility that exceeds 10% of the proceeds of the entire facility, it would appear that the Proposed Regulations would treat the bonds as meeting the private business use test. This result appears wrong: the economic reality is that there is no private business use of the bond proceeds. Again, this problem could be resolved by following NABL's recommendations: eliminate the requirement for an election, and automatically follow an undivided portion allocation method.

In addition, the definition of mixed-use project in § 1.141-6(b)(2) of the Proposed Regulations should be changed to specifically state that it does not, for this purpose, include facilities financed by the proceeds of bonds, or bond-financed property within facilities, if all of the proceeds are expended within a discrete portion of the project which has no private business use or for property not subject to private business use. Such limiting language could be appropriately added to either § 1.141-6(b)(2)(i) or (ii) of the Proposed Regulations. The following example illustrates this comment:

NABL also notes that the Proposed Regulations only apply the entity rule and not the aggregate rule for purposes of Section 145(a)(1) of the Code. § 1.145-2(c)(3). Where there is a "straight-up" allocation of partnership attributes and the 501(c)(3) entity is participating in the partnership in furtherance of its exempt purposes, NABL recommends that the partnership should similarly be disregarded, even for purposes of the Code Section 145(a)(1) ownership rule. In any event, NABL recommends that a partnership solely between 501(c)(3)s and governmental entities should always be disregarded.

NABL recommends consideration by the Treasury and the IRS of a rule that would allow the value of contributed land or other capital asset that was not purchased with bond proceeds to be treated as part of "qualified equity." Where an issuer contributes land to a project, it would appear to be fair to allow that contribution to be treated as equity, assuming a current determination of value. After all, the issuer could have sold the property, obtained cash, and used that cash as qualified equity, merely moving the project to another location. NABL welcomes the opportunity to discuss such a rule further with the Treasury and the IRS .

In addition, if the definition of project contained in the Proposed Regulations is retained so that the project includes any subsequent improvements, then the costs of those subsequent improvements should not be a fortiori treated as financed with bond proceeds even when they are paid for from equity of the issuer.

Please note that a State often grants proceeds of its bonds to a nonprofit or another governmental unit out of the controlled group, which then applies the proceeds to pay for a piece of a project. Frequently, due to the tax rules relating to grants, the grant from the State can be applied by the other governmental unit to cover nonqualifying costs (e.g., costs of a part of a school that has a cafeteria lease with a for-profit organization for after-school care, costs of a new research/medical building with a problematic research agreement) without any problem for the State-level issue. NABL believes that this scenario would be treated as a cash contribution under the language of the Proposed Regulations, but also believes that a clarification is required.

NABL recommends that the definition of "qualified equity" in the Proposed Regulations include the proceeds of tax-exempt private activity bonds. Otherwise, the non-AMT portion of a mixed-use "project" under the Proposed Regulations (e.g., runways and terminal at an airport) will have problems, particularly due to the wording of § 1.141-6(e)(5) of the Proposed Regulations regarding allocations of multiple issues.

In addition, an example is needed in the Proposed Regulations illustrating how the rules work where taxable debt is refinanced in part with tax-exempt bonds and in part with equity because the refinanced project has nonqualified use in excess of the de minimis rule.

§ 1.141-6(a)(4) of the Proposed Regulations provides that an issuer must make preliminary allocations on or before the start of the measurement period, and that the issuer must make final allocations (which cannot be changed) on or before the date required under Treas. Reg. § 1.148-6(d)(1)(iii)(the earlier of 18 months after the project is placed in service and 60 days after the fifth anniversary of the issue).

The Treasury and the IRS have never before required issuers to make formal allocations (before or after bonds are issued) other than for purposes of the arbitrage rebate calculations, which are based on actual facts and require an actual payment. The Treasury and the IRS should not change this approach unless: (1) there is a compelling need to do so, and (2) the requirement will not cause unreasonable administrative burdens for issuers.

First, no apparent reason exists to require issuers formally to allocate bond proceeds to the expenditures for the governmental portion of a mixed-use project. Where else would issuers allocate expenditures of the bond proceeds? The Treasury and the IRS should not impose formal requirements on issuers to perform unnecessary ministerial tasks.

Second, inevitably, issuers will inadvertently fail to perform the ministerial act of formally allocating bond proceeds to the governmental portion of the project. What would the consequence of such a failure be? Certainly, it should not be that the issuer is deemed to allocate the bond proceeds to the private portion of the project, so that the bonds are taxable.

Third, the proposed rule that final allocations must be made after the issue date (and cannot be changed) cannot be reconciled with the general rule that the private activity bond tests are applied based on the issuer's reasonable expectations as of the issue date (and that subsequent deliberate actions are taken into account).

Finally, a formal allocation requirement would impose an unnecessary burden on issuers, because it would require them to engage the services of bond counsel and other experts after the date of issue for no meaningful purpose.

Final accounting safe harbor. Issuers often pay bills from the most convenient and available resource at the time of the expenditure. Construction project managers are often not attuned to the nuances of Sections 103, 141 and 148 of the Code. However, following completion of the facility, it should be possible for a final accounting of the expenditures and a determination of the total cost be made. NABL recommends that the final regulations require issuers to keep track of expenditures on a particular project and to use a reasonable, consistently applied (for a particular bond issue) method for allocating proceeds to a particular project or capital program. For example, an issuer might state in the tax certificate that it will allocate all expenditures of the bond proceeds to a particular project or to its capital program. That allocation should be adequate unless the issuer later determines to spend some or all of the bond proceeds on a separate project or to the first paid expenditures of its capital program. NABL recommends that the final regulations include a safe harbor that provides that an issuer may, within some reasonable time after the bonds are issued and the proceeds are allocated to expenditures for arbitrage purposes, allocate the bond proceeds to different projects. This allocation should be in writing. However, in the event that an issuer fails to make this subsequent allocation, the issuer should be able to establish by contemporaneous materials the particular projects on which the bond proceeds were spent.

The Proposed Regulations permit anticipatory remedial action in anticipation of future private use, but only in very limited circumstances. Among other things:

• Anticipatory remedial action is limited to "retirement" of bonds.

• Bonds must be retired at least 5 years before their otherwise-scheduled maturity date or mandatory sinking fund redemption date.

• Bonds must be retired within a period that starts one year before the deliberate act occurs and ends 91 days before the deliberate act occurs.

• The issuer must not reasonably expect at the start of the measurement period that the project would be a mixed-use project.

• For the first 5 years of the measurement period, the project must not be used in a manner that would cause the private business use limit to be exceeded.

Indeed, the greater restrictiveness of the rules applicable to anticipatory remedial actions in the Proposed Regulations may have adverse results both for issuers and the federal government. An issuer that expects to have a future deliberate action but cannot meet the requirements for an "anticipatory remedial action" in the Proposed Regulations (e.g., because its bonds are noncallable) may be left with no other option than to keep the bonds outstanding and non-defeased until no more than 90 days prior to the date of the deliberate action (at which time it becomes eligible for a Treas. Reg. § 1.141-12 remedial action). This approach may be detrimental to both the issuer (because it has to determine exactly when the deliberate action occurs, which may be impossible, (e.g., a financed research facility with an expected increasing number of "bad" research agreements but without an exact determination when the 5% threshold will be crossed)), as well as for the federal government (because tax-exempt bonds would be outstanding for longer than would otherwise be the case).

NABL understands that one motivation behind the restrictiveness of the Proposed Regulations may have been to prevent issuers from treating ordinary bond amortization payments as "anticipatory remedial actions." However, NABL believes the restrictions applicable to Treas. Reg. § 1.141-12 remedial actions, if applied to anticipatory remedial actions, should largely address this concern. Specifically, the requirement in Treas. Reg. § 1.141-12(j)(2) that allocations of nonqualified bonds be made on a pro rata basis or by selecting bonds with longer maturities (or, under Treas. Reg. § 1.141-12(j)(2) that, in general, allocations be made in a manner such that the remaining weighted average maturity of the bond issue is not increased as a result of the nonqualified bond allocation), would, if applied to anticipatory remedial actions, substantially eliminate the potential for treating an ordinary bond amortization as an anticipatory remedial action. An issuer could not simply designate, at any given time, the next-occurring bond amortization payment as a redemption qualifying as an anticipatory remedial action, because if it did, it would have treated the bond with the earliest maturity as the nonqualified bonds in contravention of the rule of Treas. Reg. § 1.141-12(j)(2).¹¹

NABL believes that there is no good reason why defeasance should not be an acceptable alternative when redemption is not possible. There are times when an issuer wants to be free to use bond-financed property for nonqualifying purposes prior to the bonds' call date. In the case of small or privately placed bond issues, bonds may be simply unavailable for purchase if not yet callable. Accordingly, NABL respectfully recommends that a far simpler way to address anticipatory remedial action which satisfies legitimate policy concerns is by adding language such as the following to Treas. Reg § 1.141-12(d):

2. Subsection Title. In the Proposed Regulations, the § 1.141-0 Table of Contents as well as the subsection itself use the word "property" for the title of § 1.141-6(a)(2), when the context and language of the subsection indicate the word should instead be "project".

3. Recommended Change to Arbitrage Regulations. NABL's consideration of the "consistency rule" has lead to a proposed change to the portion of Treas. Reg. § 1.148-6 relating to arbitrage. While the rule in Treas. Reg. § 1.148-6(d)(1)(iii) generally works, it creates a problem for the allocation of bond proceeds that are actually spent or allocated to expenditures that take place after 60 days following the fifth anniversary date of the issue. Treas. Reg. § 1.148-6(d)(1)(iii) should be clarified to provide that allocations of any amounts that are to be made to expenditures prior to the end of the first rebate computation period must be made no later than 5 years after the date the bonds are issued. In addition, NABL believes Treas. Reg. § 1.148-6 should address the situations where proceeds are not all spent within 5 years, e.g., a transaction where a bond-funded reserve is allowed to reduce over time or is replaced by a surety, or where a small amount of proceeds remains in the project fund after 5 years. Treas. Reg. § 1.148-6 should be clarified that, for amounts that are not spent within the 5-year period, the issuer may apply the same methods of allocation that were available prior to the end of the 5-year period.

² As an aside, NABL notes that the percentage of private business use in PLR 200323006 was determined by comparing the present value of the payments for the naming rights in each year to the debt service on the bonds in each year. NABL believes that, in many cases, a more appropriate denominator for using a revenue-based measure of private business use would be the present value in each year of all revenues generated by the facility. Issuers should be given the flexibility of using either method. Of course, for determining the amount of private payments, the present value of the revenues from private business use would be compared to the present value of debt service.

³ Interestingly, the Proposed Regulations also give the example of the percentage of square feet of usable leased office space. That approach raises the question of why an issuer would ever make an allocation under the discrete portion test when it is limited to reallocating once every 5 years. If an issuer does its allocation under the undivided portion allocation method, it could reallocate without any time constraints.

⁴ In these comments, NABL follows the language of the Proposed Regulations and refers to "mixed-use projects." However, as described in more depth in Part G below, NABL believes that the Proposed Regulations, in effect, actually only apply to projects (including portions of projects) that are treated as financed both with bond proceeds and other sources. Accordingly, it may be more appropriate to refer to these as "mixed-financed" projects.

⁵ NABL does believe, however, that it is appropriate for the Treasury and the IRS to require an issuer to use the same accounting method used for purposes of Section 148 of the Code solely for purposes of determining the amount of investment proceeds under Section 141 of the Code. NABL does not believe that the amount of investment proceeds should be different for arbitrage and private activity bond purposes.

⁶ NABL recognizes that Treas. Reg. § 1.141-3(g)(4)(v) similarly refers to fair market value and intends that these Proposed Regulations comments regarding "fair market value" versus "cost" treatment also apply to Treas. Reg. § 1.141-3 relating to measurement of private business use.

⁷ It could be argued that the proceeds of the bonds and the equity are not being expended on the facilities pursuant to the "same plan of financing." However, as discussed below, to give an unqualified opinion, it is often difficult to be certain about what is the "same plan of financing,"

⁸ This determination by the issuer would be made either at closing or, in the case of a financing where some elements changed, at the time the project is complete.

⁹ NABL believes the reference should instead be to taxable debt, since there is often confusion about whether "bonds" have been issued.

¹⁰ NABL also notes that if the above-recommended general rule relating to the undivided portion allocation method is adopted, the issuer will not be required to make final allocations as contemplated by the Proposed Regulations.

¹¹ Similarly, if the rules of Treas. Reg. § 1.141-12 applied in the case of anticipatory remedial action by way of a defeasance of bonds, bond amortization could not be treated as an anticipatory remedial action if the bonds are callable prior to maturity (as is typically the case), because of the requirement under Treas. Reg. § 1.141-12(d) that bonds be defeased to their first call date (thus, the issuer could not simply defease bonds to the next principal payment date). In the case of noncallable bonds, anticipatory remedial action could be taken by defeasing bonds to their scheduled principal payment date. This approach seems reasonable considering that the bonds must still be selected on a pro rata basis or by choosing the longer maturities first, and considering that this is already the rule for Treas. Reg. § 1.141-12 remedial actions.