Public Finance Alert
December.12.2018
Overview
In a recently released private letter ruling (Private Letter Ruling 201847001, or the “Ruling”), the IRS approved the use of a “floating equity” allocation method for exempt facility bonds issued to finance renovations to an airport terminal that included certain terminal shops – liquor stores – not permitted to be financed with proceeds of such bonds. Orrick was involved in obtaining the Ruling on behalf of one of its airport clients.
The Ruling represents a significant development regarding the use of floating equity for a project financed with exempt facility bonds. For governmental bonds – bonds subject to the private business use limitations of Section 141 of the Code – regulations issued in 2015 provide that “qualified equity,” such as proceeds of taxable bonds, may be allocated to private business use within a project, and may “float” within that project if the particular locations of the private business use change over the term of the bonds. However, the IRS has not previously provided direction regarding the ability to apply a floating equity allocation method with respect to projects financed with exempt facility bonds. Exempt facility bonds may be issued on a tax-exempt basis to finance certain types of projects, such as airport, dock and wharf and multi-family housing projects, even if such projects are subject to private business use. As further described below, the Ruling generally follows the framework of the floating equity allocation regulations for governmental bonds, but allows equity to float within an airport terminal to certain prohibited facilities that may change location over time within the terminal.
Although exempt facility bonds may generally be issued to finance projects that have private business use, none of the proceeds of exempt facility bonds may be used to finance “prohibited facilities” described in Section 147(e) of the Code. There is no de minimis exception for funding such facilities, and the interest on an issue of exempt facility bonds may be deemed taxable if even a dollar of bond proceeds are used to finance such facilities. The facilities prohibited under Section 147(e) include any “store the principal business of which is the sale of alcoholic beverages for consumption off premises” – essentially, a liquor store.[1]
Facts of the Ruling
The issuer described in the Ruling owns and operates an airport with a terminal complex. A recent trend in airport concessions has been a growth in concession shops or spaces focused primarily on the sale of bottled alcohol. Although duty-free shops have long sold bottled alcohol, those shops generally offer a wide range of other products for sale. This newer trend in airport concessions is towards smaller spaces that primarily or exclusively sell bottled alcohol, particularly in wine-growing regions. These types of spaces, although within an airport terminal, appear to literally fall within the prohibited facility definition in Section 147(e).
The issuer described in the Ruling planned to completely renovate a boarding area within the terminal using proceeds of exempt facility bonds issued under Section 142(a) of the Code, and expected that one or more concession locations within the renovated boarding area would include a store principally focused on selling bottled alcohol (the “Prohibited Shops”). Over the term of the bonds, the issuer reasonably expected that the Prohibited Shops would expand or move within the boarding area. Because the location of the Prohibited Shops was expected to change over time, the issuer requested guidance regarding whether it could allocate proceeds of exempt facility bonds and non-bond funds (“Equity”) on an undivided or floating basis over the term of the bonds, such that the Equity may “float” (i.e. be deemed allocable) to the Prohibited Facilities as they moved within the boarding area.
In the absence of guidance provided by the IRS in the Ruling, the general approach taken in airport financings was that proceeds of exempt facility bonds and Equity may be allocated and, perhaps reallocated, to specific physical or discreet space within a project by no later than the later of 18 months from the date of the expenditure or the placed-in-service date of the project. Under this accounting regime, in the event that Equity was used to finance the cost of a Prohibited Shop and that shop later relocated to another part of the project after the expiration of the above 18-month time frame, it was uncertain whether the discreet space Equity allocation could be disturbed in order to permit such Equity to “float” to the newly located physical location within the project.
What the IRS Concluded
The Ruling concluded that the issuer could allocate proceeds of exempt facility bonds and the Equity on a floating basis to both bond-eligible portions of the boarding area and Prohibited Shops, regardless of their physical location, based on the respective costs of such portions, up to but not exceeding the amount of bond proceeds and Equity allocated to the boarding area project.
For example, in a situation in which the total terminal renovation costs are expected to be $100 million, of which $98 million will be financed with exempt facility bonds and $2 million with Equity, the project may contain Prohibited Shops that have a cost of up to $2 million, regardless of the physical location within such project. In other words, the Ruling provides that Prohibited Shops, and the allocation of Equity to those shops, need not be tied to a specific discreet space or physical location within a terminal project and that such shops may move, expand or relocate within the project provided that the cost of the space used by the Prohibited Shops, determined on an annual basis, does not exceed the amount of Equity contributed to the project.
The approach approved in the Ruling provides significant flexibility for issuers with facilities financed with exempt facility bonds or other tax-exempt bonds that are subject to the prohibitions of Section 147(e). As to be expected in an IRS private letter ruling, the Ruling does not address all of the potential questions that might arise in this context, such as what types of concession shops constitute “a store the principal business of which is the sale of alcoholic beverages for consumption off premises,” and the Ruling does not address whether a floating equity approach can be applied for purposes other than Section 147(e), like the application of floating equity to other nonqualified expenditures, such as commercial space located within a multi-family housing project financed with exempt facility bonds.
[1] Other prohibited facilities described in Section 147(e) include airplanes, a skybox or other private luxury box, health club facilities and a facility primarily used for gambling.