Internal Revenue Service Proposes to Streamline the TEFRA Public Hearing and Approval Requirements for Tax-Exempt Private Activity Bonds

September 11, 2008

Background

Private activity bonds (including qualified 501(c)(3) bonds issued for the benefit of health care or educational organizations) will not qualify for tax-exempt status unless the bonds have satisfied the public approval requirement of Section 147(f) of the Internal Revenue Code. In general, the public approval requirement is satisfied if (i) a public hearing is held after reasonable public notice and (ii) the applicable State and local governmental units have provided proper and timely public approval (the so-called "issuer approval" and "host approval" requirements).

Congress first imposed the public approval requirement on certain types of facility-specific tax exempt bonds in the Tax Equity and Fiscal Responsibility Act of 1982 or "TEFRA." In 1983, the Internal Revenue Service published temporary regulations regarding the public approval requirements (the "Existing Regulations"). The Existing Regulations have not been updated since their original publication, not even to recognize the extension of the public approval requirements to all tax-exempt private activity bonds in the Tax Reform Act of 1986.

On September 9, 2008, the IRS promulgated proposed regulations (the "Proposed Regulations") to amend the Existing Regulations. The Proposed Regulations focus generally on the scope, content, process, and timing for reasonable public notices, public hearings, and public approvals. The Proposed Regulations also provide guidance to simplify compliance and reduce administrative burdens on State and local governments associated with the public approval requirements, including guidance to recognize the advances in technology and electronic communications since 1982.

The Proposed Regulations do not alter the general rules for obtaining issuer and host approvals.

Scope, Content, Process and Timing

Contents of Public Hearing Notice and Approval. An often-noted shortcoming of the Existing Regulations is that they focus on one-shot financings for a single capital project. They are difficult to apply when drafting notices of public hearings and public approvals for financings of multiple capital projects and system improvements. The Proposed Regulations address this shortcoming in several ways.

The Existing Regulations require a highly specific description of a proposed bond-financed facility (for example, "a l0,000 square foot machine shop and hardware manufacturing plant"). Changes in the size and the function of the facility are inevitable, even between the public hearing and the issuance of the bonds. The Proposed Regulations streamline this requirement to allow a general reference to the type of exempt facility bond being issued or, for other types of private activity bonds, a reference to the type of qualified bond and a general description of the type and use of the facility to be financed (for example, "an exempt facility bond for an airport under section 142(a)(1)," or "a qualified 501(c)(3) bond to finance a hospital"). The Proposed Regulations modify and expand the existing definition of a "facility" to embrace the principle that a facility may include multiple capital projects.

The Existing Regulations require the name of the expected initial legal owner, operator, or manager of the facility. The Proposed Regulations permit the name provided to be either the name of the legal owner or principal user or, alternatively, the name of the true beneficial party of interest (for example, the name of a 501(c)(3) organization, which is the sole member of a limited liability company owner).

The Proposed Regulations continue the requirement to state the maximum principal amount of bonds expected to be issued to finance each facility, but the expanded definition of "facility" as described above and the liberalized location description provision described below should make this requirement much easier to satisfy.

The single-capital-project focus of the Existing Regulations is most evident in its requirement that the public hearing notice and the public approval must contain a general description of the prospective location of the facility by street address, or, if none, a general description that is reasonably designed to inform the public about the location of the project. The Proposed Regulations provide that, for a facility composed of multiple capital projects on the same site, or adjacent or reasonably proximate sites used for similar purposes, a consolidated description of the geographic boundaries of all such capital projects may be a sufficient description of the location. The Proposed Regulations include as an example a facility for a 501(c)(3) educational entity involving multiple buildings on the entity’s main urban college campus. In the example, the public hearing notice and the public approval may describe the location of the facility by reference to the outside street boundaries of that campus with a reference to any noncontiguous features of that campus.

Definition of Public Hearing. The Proposed Regulations define the term "public hearing" to mean a forum providing a reasonable opportunity for interested individuals to express their views, both orally and in writing, on the proposed issue of bonds and the location and nature of the proposed facility to be financed. In general, a governmental unit may select its own procedure for a public hearing, provided that interested individuals have a reasonable opportunity to express their views. Thus, a governmental unit may impose reasonable requirements on persons who wish to participate in the hearing, such as a requirement that persons desiring to speak at the hearing make a written request to speak at least 24 hours before the hearing or that they limit their oral remarks to a prescribed time.[*]

Many have observed that bond public hearings are not hearings at all—the public rarely shows up. The Proposed Regulations permit a governmental unit to cancel a public hearing if it has provided reasonable public notice and has received no timely requests to participate in the hearing. In this circumstance, the public hearing requirement will be deemed satisfied.

The Proposed Regulations provide that the notice of public hearing must state the time and place for the public hearing and contain the above-described requirement information. Notice is presumed reasonable if given in one of the following ways: (i) newspaper publication; (ii) radio or television broadcast; (iii) governmental unit website posting; and (iv) alternative State law public notice procedures.

Public notice may be given by electronic posting on the approving governmental unit’s web site for its residents, provided that the governmental unit regularly uses that web site to inform its residents about events affecting the residents (including notice of public meetings of the governmental unit) and the governmental unit offers a reasonable, publicly known alternative method for obtaining this information for residents without access to computers (such as phone recordings).

The Existing Regulations require the public hearing notice to appear no fewer than fourteen (14) days before the hearing date. The Proposed Regulations shorten the notice period to seven (7) business days.

Substantial and Insubstantial Deviations and Remedial Actions

Substantial Deviation. The Proposed Regulations provide that, in general, a substantial deviation between the information required to be provided in the public hearing notice and the public approval and the actual facts causes the bonds to fail the public approval requirement. The determination of whether a deviation is material is based on the facts and circumstances. However, a change in the fundamental nature or type of a project is a substantial deviation.

Insubstantial Deviation: Objective Standards. The Proposed Regulations provide two objective standards for a determination that a particular deviation in public approval information is insubstantial. First, a deviation between the amount of the bond proceeds to be used for a facility stated in the public approval documents and the amount of proceeds actually used for that facility is insubstantial if the difference does not exceed five percent (5%) of the net proceeds of the issue. Second, a deviation between the initial owner or principal user of the facility named in public approval documents and the actual initial owner or principal user is treated as insubstantial if such parties are related parties on the issue date of the bonds.

Remedial Action. The Proposed Regulations allow an issuer to remediate a substantial deviation by meeting each of the following requirements:

(i) Original public approval and reasonable expectations. The issuer obtained a timely public approval for the issue in accordance with section 147(f) and, on the issue date of the issue, the issuer reasonably expected there would be no substantial deviations between the required public approval information and the actual facts.

(ii) Unexpected events or unforeseen changes in circumstances. As a result of unexpected events or unforeseen changes in circumstances that arise after the issue date of the issue, the issuer determines that it cannot use some or all of the proceeds in the manner provided in the public approval either because such use is no longer feasible or viable, or because the cost of the facility was less than expected so the issuer did not need all of the proceeds specified in the public approval for the facility.

(iii) Supplemental public approval. Before using the proceeds of the bonds that are affected by the substantial deviation for a different use, the issuer obtains a supplemental public approval for those bonds, and that supplemental public approval meets all the requirements of section 147(f) applied by treating those bonds as if they were reissued for purpose of section 147(f).

Proposed Effective Date and Miscellaneous

The Proposed Regulations would become effective for bonds issued on and after the date they are published in final form in the Federal Register. There are no provisions for elective retroactive relief for bonds issued before the effective date.

There are special rules proposed for qualified mortgage bonds, qualified student loan bonds and qualified 501(c)(3) bonds issued to finance working capital and pooled loans.

Written or electronic comments on the Proposed Regulations must be received by the IRS by December 8, 2008. The IRS will hold a public hearing on January 26, 2009, in Washington, D.C. The IRS must receive outlines of topics to be discussed at the public hearing by December 29, 2008.


NOTE

* Changes in state law may be necessary to give full effect to the beneficial changes in the Proposed Regulations. For example, see Va. Code § 15.2-4906.

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