Private activity bonds
A government's ability to form public/private partnerships for infrastructure projects improved in 1997 with the change in Internal Revenue Service (IRS) regulations concerning private activity bonds. Before January 1997, a government contract with a private firm (for example, to operate a water system) was effectively limited to five years. Use of a longer period would result in loss of government tax-exempt bond status. But now tax-exempt debt can be used to finance facilities sold to, or operated on long-term contract by, a private operator.
The new regulations permit management contracts for airports, roads, bridges, buildings, and the like to last for up to 15 years without losing the tax-exempt status of any outstanding debt. They raise the limit to 20 years for public utility operations such as electricity, gas, water and wastewater. But the arrangement must meet certain safe harbor requirements. One condition is that at least 80% of the compensation paid to the private firm must be in the form of a flat fee -- only 20% of the fee can be based on a share of the profits from the facility.
The new rules also address the sale of assets. They permit existing tax-exempt bonds to retain their exempt status under the following three possible circumstances.
- If the bonds are redeemed or defeased within 90 days after the sale.
- If the sale proceeds are all cash, and the government entity uses them for governmental purpose within two years.
- If the private purchaser uses the facility for an exempt purpose, as long as the bonds would meet other applicable requirements. Such requirements could include a state volume cap and required public approval.
The new IRS rules create many new entrepreneurial opportunities for government, especially when combined with state or local legislation facilitating public/private partnerships.
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