Yale University Suggests Changes to Proposed Private Activity Bond Regs

From: postoffice@www.irs.gov [mailto:postoffice@www.irs.gov]

I am writing on behalf of Yale University with respect to the notice of proposed rulemaking concerning general allocation and accounting regulations under Section 141 (71 FR 56072). Thank you for the opportunity to comment on this important issue in the administration of tax-exempt bonds.

We are pleased that the Internal Revenue Service intends to issue additional regulatory guidance providing rules for allocating uses in mixed-use facilities funded with both tax exempt bond proceeds and other sources. The current rules leave many questions unanswered and bond issuers need clarity to ensure that they are in full compliance. We welcome the Service's efforts to refine and rationalize the rules.

Allocation Methods. We commend the Service for proposing a choice of three allocation methodologies. We expect that the default, pro rata method would be impractical for most research universities that intend to use a blend of tax-exempt bonds proceeds and other sources to fund research and health care facilities. The default method would limit private uses to a de minimis level throughout an entire facility regardless of the level of equity financing. This would pose serious compliance issues for institutions that conduct industry-sponsored research or that include commercial or retail space in facilities for the convenience of users or to enrich the quality of life in the local community.

The two alternative allocation methods the discrete physical portion and the undivided portion method would be helpful. Both methods would allow more than incidental private uses in the portions of a facility financed with equity. This is a reasonable proposal that reflects the current practice of many institutions. We recommend that the undivided portion method be made the default rule, in order to eliminate the necessity for making an affirmative election in almost all mixed-financing situations.

Proposed Section 6(b)(2) would allow issuers to use the alternative methods only for facilities that are expected to have more than de minimis private business uses at the time the bonds are issued. The alternative allocation methods would appear to be a moot point for projects that are not expected to have private uses. However, over the life of tax exempt bonds, needs for the facilities will involve, and for many facilities, significant private uses may eventually become advantageous. Under the proposed regulations, bond issuers would be required to include significant private uses in their facilities at the time of issuance in order to preserve flexibility later. It may also result in unnecessary refinancings in later years in order to create the reasonable expectation at time of issuance. These seem to be misdirected incentives. It is therefore imperative that the eligibility criteria be relaxed at the front end so that issuers have the option of changing allocation methods as the circumstances for use of a particular facility (or part of a facility) change. The rule currently does not provide that degree of flexibility.

We also recommend that the Service relax a significant restriction on the undivided portion method. Proposed Section 6(d)(4)(ii) states that for any one-year measuring period, the allocation of private business uses to the portion of the project financed with equity may not (as a percentage of total private business use) exceed the proportion of total project expenditures represented by equity financing. Under some interpretations of this requirement, the undivided portion method would fail to provide any significant allowance for private business use, effectively conflating the undivided portion method with the pro rata method. Moreover, the restrictions tied to single-year measuring periods are inconsistent with the life-of-the-bond approach of Section 1.141-3(g)(3). This limitation is counter-intuitive. The purpose of introducing equity financing in a project is to be able allocate private business primarily to that financing, and the rule should reflect that expectation.

Reallocations. The proposed rules would permit issuers which have elected to use the discrete physical portion allocation method to reallocate bond proceeds and equity financing under certain conditions. (Proposed Section 6(c)(5)). We believe the conditions are too restrictive and do not recognize the degree to which uses of buildings may evolve over time. For example, the proposed rule would require that the benefits under the original allocation and the reallocation be comparable. We do not see the reason to link the two because the use of the facility may have changed considerably during the intervening period.

In general, we believe an issuer should be allowed, through reallocation, to establish any arrangement that would have been allowable initially. We do not object to the proposed limitation on the frequency of reallocations (no more than once every five years) but we believe the proposed rule sets unreasonable limits on the scope of reallocations.

In addition, because the proposed regulations would permit the combined use of the discrete physical portion and the undivided portion allocation methods for one facility (Proposed Section 6(d)(1)), issuers should have the option of reallocating bond proceeds and equity across portions of facilities to which the issuer has applied different allocation methods.

Finally, the rule would use a fair market value test in determining whether a reallocation is allowable. In many older facilities, it will be very difficult to develop reliable fair market values. It would entail burdensome documentation and may lead to potentially irresolvable disputes between issuers and the Service.

Anticipatory Refunding. We commend the Service for addressing how institutions may redeem bonds in anticipation of actions that would otherwise result in non-compliance. (Proposed Section 6(f)) This would be an improvement upon current regulations, which appear to limit the ability of issuers to take remedial actions in advance of a change in use that would result in noncompliance.

However, the refunding option would be available only for projects that were at the outset not expected to have mixed uses; the projects must also have had no significant private business uses for the first five years of the measurement period. Issuers would be permitted to refund bonds during a limited window no earlier than one year before and no later than 91 days before the deliberate act that would trigger noncompliance. These restrictions on timing, as well as the exclusion of projects that were expected to have mixed uses, would significantly limit the usefulness of the refunding option.

Transition Rule. We recommend that the Service provide issuers sufficient time to make necessary elections and to compile required documentation to ensure that existing arrangements do not default to the pro rata rule and render hundreds of millions of dollars of bonds nationwide taxable.

Definition of Project. Proposed Section 6(b)(2)(ii)(A)(2) requires portions of capital projects placed into service more than 12 months apart to be treated as separate projects for purposes of the allocation rules. This time restriction fails to capture the realities and complexities of large project construction. Major research and health care institutions must often implement such projects in phases involving successive demolitions, construction, and relocations, especially where ongoing operations must be preserved. The functional relationship, proximate siting, and unitary financing requirements of proposed sections 6(b)(2)(ii)(A)(1)&(3) better reflect the realities of large complex construction projects. We therefore recommend either eliminating the 12-month restriction, or increasing it to 30 months.

Thank you for providing the opportunity to comment on this proposal.