[Federal Register Volume 59, Number 250 (Friday, December 30, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-31430]


[[Page Unknown]]

[Federal Register: December 30, 1994]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[FI-72-88]
RIN 1545-AM01

 

Definition of Private Activity Bonds

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document contains proposed regulations on the definition 
of private activity bonds applicable to tax-exempt bonds issued by 
States and local governments. Changes to the applicable law were made 
by the Deficit Reduction Act of 1984 (the 1984 Act), the Tax Reform Act 
of 1986 (the 1986 Act), the Omnibus Budget Reconciliation Act of 1987, 
the Technical and Miscellaneous Revenue Act of 1988, and the Omnibus 
Budget Reconciliation Act of 1993. These regulations affect issuers of 
tax-exempt bonds and provide guidance for applying the private activity 
bond restrictions.

DATES: Written comments must be received by May 1, 1995. Requests to 
speak at the public hearing and outlines of oral comments must be 
received by Thursday, May 18, 1995.

ADDRESSES: Send submissions to: CC:DOM:CORP:T:R (FI-72-88), room 5228, 
Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, 
DC 20044. In the alternative, submissions may be hand delivered between 
the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:T:R (FI-72-88), 
Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue NW, 
Washington, DC.

FOR FURTHER INFORMATION CONTACT:
Concerning the regulations, William P. Cejudo, (202) 622-3980; 
concerning submissions and the hearing, Michael Slaughter, (202) 622-
7190 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collections of information contained in this notice of proposed 
rulemaking have been submitted to the Office of Management and Budget 
for review in accordance with the Paperwork Reduction Act (44 U.S.C. 
3504(h)). Comments on the collections of information should be sent to 
the Office of Management and Budget, Attn: Desk Officer for the 
Department of the Treasury, Office of Information and Regulatory 
Affairs, Washington, DC 20503, with copies to the Internal Revenue 
Service, Attn: IRS Reports Clearance Officer, PC:FP, Washington, DC 
20224.
    The collections of information are in Secs. 1.141-1(b), 1.141-
1(c)(3), 1.141-1(d), 1.141-13(a), and 1.141-13(b)(3). This information 
is required by the IRS to verify compliance with section 141. This 
information will be used to document elections made by an issuer, 
provide evidence of an issuer's expectations, and notify the Service of 
defeasance of bonds. The likely respondents and/or recordkeepers are 
States and political subdivisions that issue bonds and entities that 
issue bonds on behalf of States or political subdivisions.
    Estimated total annual recordkeeping burden: 30,000 hours.
    The estimated annual burden per recordkeeper varies from 1 hour to 
5 hours, depending on individual circumstances, with an estimated 
average of 3 hours.
    Estimated number of recordkeepers: 10,000.
    Estimated total annual reporting burden: 100 hours.
    Estimated average burden per respondent: 1 hour.
    Estimated number of respondents: 100.
    Estimated frequency of respondents: On occasion.

Background

Explanation of provisions

I. Background of regulations

    Section 103 provides generally that interest on certain States or 
local bonds (tax-exempt bonds) is excluded from gross income. Section 
103(b)(1) provides, however, that private activity bonds (other than 
qualified bonds) are not tax-exempt bonds. Section 141 provides that a 
bond is a private activity bond if the issue of which the bond is a 
part satisfies either the private business tests or the private loan 
financing test. The private business tests of section 141(b) are 
satisfied if the issue satisfies both the private business use test, 
which relates to the use of the bond proceeds, and the private security 
or payment test, which relates to the manner in which the issue is 
secured or will be repaid. Section 141(c) provides that the private 
loan financing test is satisfied if the lesser of $5 million or 5 
percent of the proceeds of an issue are to be used to make or finance 
loans to persons other than governmental units.
    Regulations relating to the private business tests under section 
103(b) of the Internal Revenue Code of 1954 (the 1954 Code), the 
predecessor to section 141(b), are contained in Sec. 1.103-7 (the 
industrial development bond regulations.) These regulations have not 
been amended since their finalization shortly after the enactment of 
section 103(b) of the 1954 Code. Since 1972 many changes have occurred 
in the financing practices of State and local governments. In addition, 
the 1984 Act and the 1986 Act made a number of significant changes to 
the private business tests. These changes include reductions in the 
permissible amounts of private business use and private security or 
payments, new limitations for certain types of bonds (for example, 
issues for output facilities), and modifications to the private 
business use and private security or payment tests. Importantly, 
however, the 1986 Act legislative history states that, to the extent 
not amended, principles of prior law continue to apply. The industrial 
development bond regulations have not been amended to reflect the 
changes to the private business tests made in the 1984 Act or the 1986 
Act. Finally, the industrial development bond regulations do not 
provide guidance on the private loan financing test.
    This document proposes to amend the Income Tax Regulations (26 CFR 
part 1) by replacing the industrial development bond regulations under 
Sec. 1.103-7 with comprehensive regulations addressing the private 
business tests and the private loan financing test. This document also 
contains proposed regulations that would replace other guidance found 
in various pronouncements of the Service (for example, Notice 87-69, 
1987-2 C.B. 378, Notice 89-9, 1989-1 C.B. 630, Rev. Proc. 93-17, 1993-1 
C.B. 507, and Rev. Proc. 93-19, 1993-1 C.B. 526). This document also 
proposes certain related rules in the Income Tax Regulations, including 
rules for qualified bonds under section 141(e), qualified 501(c)(3) 
bonds under section 145, arbitrage allocation rules under Sec. 1.148-6, 
definitions in Sec. 1.150-1, changes in use under section 150 (b) and 
(c), and enterprises zone facility bonds under section 1394. In the 
process developing the proposed regulations, the Internal Revenue 
Service and Treasury considered the public comments received with 
respect to the industrial development bond regulations and other 
existing guidance.

II. Description of proposed regulations

A. In general
    The proposed regulations substantially revise the industrial 
development bond regulations to provide more comprehensive guidance, 
including numerous examples. Further, in contrast to the industrial 
development bond regulations, the rules and definitions in the proposed 
regulations, the rules and definitions in the proposed regulations are 
coordinated with the rules in the arbitage regulations under section 
148 and the rules in section 150 that apply generally for tax-exempt 
bond purposes.
B. Section 1.141-1  Definitions and rules of general application
    1. In general. The proposed regulations generally provide a number 
of definitions that apply for all purposes of section 141. Further, for 
many terms, the definitions that apply for arbitrage purposes are made 
applicable for purposes of section 141. Selected definitions are 
discussed below.
    2. Proceeds. The proposed regulations define proceeds as including 
sale proceeds, disposition proceeds, and any replaced amounts. Further, 
proceeds include earnings on nonpurpose investments that accrue during 
the project period but generally exclude sale proceeds used to retire 
the issue.
    3. Replaced amounts. The industrial development bond regulations do 
not specifically address when amounts that are replaced by bond 
proceeds are treated as proceeds under section 141. The proposed 
regulations provide that certain replacement proceeds (as defined for 
arbitrage purposes) are treated as proceeds for purposes of section 
141.
    4. Disposition proceeds. The industrial development bond 
regulations also do not specifically address the application of the 
provisions of section 141 after the issue date. The proposed 
regulations provide that disposition proceeds, defined as amounts 
derived from the sale, exchange, or other disposition of property 
financed with the proceeds of an issue, are treated as proceeds of the 
issue. Under this approach, the property transferred generally ceases 
to be allocable to proceeds of the bonds and is no longer taken into 
account under section 141. Instead, the amounts received from the 
transfer of the property are treated as proceeds of the issue for 
purposes of analyzing continuing compliance with the private activity 
bond limitations. In order to provide administrative simplicity for 
issuers of large, multiproject financings, the proposed regulations 
provide a special exception for property financed with certain general 
obligation issues.
    5. Partnerships. Under the private business tests, use of proceeds 
by any person other than a natural person is treated as trade or 
business use. The proposed regulations provide rules for determining 
under which circumstances use by a partnership is disregarded and, 
instead, treated as use by the partners of that partnership.
C. Section 1.141-2  Private activity bond tests
    1. In general. An issue must satisfy both the private business use 
test and the private security or payment test for the bonds of the 
issue to be private activity bonds under the private business tests of 
section 141(b). Alternatively, bonds are private activity bonds if the 
private loan financing test of section 141(c) is satisfied.
    2. Reasonable expectations and deliberate actions. The industrial 
development bond regulations do not specifically address the effect of 
actions taken after the issue date. The proposed regulations generally 
provide that whether bonds are private activity bonds is determined on 
the basis of the issuer's reasonable expectations on the issue date. An 
issuer's reasonable expectations are determined in the same manner as 
under the arbitrage regulations.
    The proposed regulations also provide that a deliberate action by 
the issuer occurring subsequent to the issue date and resulting in 
satisfaction of the private activity bond tests causes the bonds to be 
private activity bonds. Importantly, many post-issuance transfers will 
not result in private activity bond characterization if the issuer does 
not use the disposition proceeds in an impermissible manner.
D. Section 1.141-3  Definition of private business use
    1. General rules. Under the private business tests, a bond is a 
private activity bond only if the issue of which it is a part satisfies 
the private business use test of section 141(b)(1). The private 
business use test of section 141(b)(1) is met if more than 10 percent 
of the proceeds of the issue is used in a trade or business carried on 
by a nongovernmental person. Any use by a person other than a natural 
person is treated as use in a trade or business. The industrial 
development bond regulations relating to the private business use test 
do not provide specific guidance for many common situations that arise 
in municipal financings.
    2. General definition of private business use. A principal goal of 
the proposed regulations is to provide more complete rules to identify 
whether proceeds, or the facilities financed with those proceeds, are 
used for a private business use. The proposed regulations provide that 
use of proceeds generally results from ownership or leasing of financed 
property, a loan of proceeds, or other actual or beneficial use of 
financed property under a management or incentive payment contract, 
output contract, or other arrangement. As under the industrial 
development bond regulations, private business use can result from 
either direct or indirect use of the proceeds as well as from either 
the ultimate use of the proceeds or an intermediate use of the 
proceeds.
    3. Discharge of primary legal obligation. The proposed regulations 
provide that a bond-financed facility is indirectly used by a 
nongovernmental person if the provision of that facility discharges a 
primary and unconditional obligation of the nongovernmental person.
    4. Management contracts. For management and other incentive payment 
contracts, the proposed regulations implement the directive of section 
1301(e) of the 1986 Act and liberalize the safe harbors contained in 
Rev. Proc. 93-19. The proposed regulations provide that management 
contracts other than qualified management contracts result in private 
business use of the related facility. The proposed regulations expand 
the categories of qualified management contracts to include the 
following: (a) Contracts with terms not exceeding the lesser of 15 
years or 50 percent of the useful life of the property if all the 
compensation is based on a periodic fixed fee; (b) contracts with terms 
not exceeding the lesser of 10 years or 80 percent of the useful life 
of the property if at least 80 percent of the annual compensation is 
based on a periodic fixed fee; (c) contracts with terms not exceeding 5 
years if at least 50 percent of the compensation is based on a periodic 
fixed fee; and (d) contracts with terms not exceeding 3 years if all of 
the compensation is based on a per-unit fee. The proposed regulations 
make a number of other changes in the qualified management contract 
rules in response to comments received with respect to Rev. Proc. 93-
19.
    5. Exception for general public use. The proposed regulations 
provide more complete guidance, including certain bright line tests and 
numerous examples, for purposes of determining whether use is use as a 
member of the general public. These rules include a definition of 
general public use, guidance on the circumstances when general public 
use is insubstantial, special rules for system improvements, and 
guidance for facilities that are integrally related to other 
facilities.
    6. De minimis exceptions. In order to simplify the application of 
the private business use test, the regulations provide that certain de 
minimis uses are disregarded. First, leases and similar arrangements 
that are not renewed or renewable and have terms of less than 1 year 
are generally disregarded. Second, certain temporary use by developers 
of property that will be sold to the general public is also disregarded 
in applying the private business use test. Third, as under Notice 87-
69, both incidental uses of a financed facility and qualified 
improvements of a facility are disregarded. The proposed regulations 
revise the qualified improvement exception to simplify the application 
of these rules.
E. Section 1.141-4  Private security or payment test
    1. General rules. Under the private business tests, a bond is a 
private activity bond only if the issue of which it is a part satisfies 
the private security or payment test of section 141(b)(2). The private 
security or payment test relates to the security for, and the source of 
the amounts used to pay, debt service on the bonds.
    2. Application. The proposed regulations provide that the private 
security or payment test is applied by comparing the present value of 
the private payments and security to the present value of the debt 
service on the issue. Present values are computed using the yield on 
the issue as determined under the arbitrage regulations, with special 
rules provided for variable yield issues. The private security or 
payment test is generally met if more than 10 percent of the principal 
of and interest on the issue in the aggregate is to be secured or 
derived from certain property or payments described below.
    3. Private payments. The private payments taken into account are 
payments, whether to the issuer or any related party, in respect of 
property or borrowed money to be used for a private business use. 
Generally, any payments made by persons that satisfy the private 
business use test are taken into account and the payments taken into 
account cannot exceed the corresponding proportion of proceeds used by 
that person. In addition, payments from persons that are not private 
business users are taken into account if those payments are made in 
respect of a private business use. For example, payments by the general 
public for use of a facility that is managed by a nongovernmental 
person under a management contract that is not a qualified management 
contract are taken into account as private payments.
    4. Private security test. Private security includes any interest in 
property to be used for a private business use or payments in respect 
of property or borrowed money to be used for a private business use 
that secures principal of and interest on the issue. Unlike private 
payments, private security is taken into account if privately used 
property is the security for the bonds even if that property is not 
financed with the proceeds of the issue.
    5. Exception for generally applicable taxes. The proposed 
regulations provide that generally applicable taxes are disregarded 
under the private security or payment test. Generally applicable taxes 
do not include special assessment or payments for a special privilege 
granted or service rendered. Generally applicable taxes must have a 
general manner of determination and collection. The regulations provide 
guidance on whether this requirement is satisfied if the taxpayer makes 
special arrangements with respect to the tax (for example, agreements 
to be personally liable for a tax).
    6. Waste remediation bonds. The proposed regulations incorporate 
the guidance in Notice 89-9, relating to bonds issued to finance 
certain hazardous waste clean-up activities.
F. Section 1.141-5  Private loan financing test
    1. General rules. Under the private loan financing test, a bond is 
a private activity bond if issued as part of an issue more than 5 
percent of the proceeds of which (or $5 million, if less) are used to 
make loans to nongovernmental persons. As with the private business 
tests, both direct and indirect uses of proceeds are taken into 
account.
    2. Definition of loan. Any transaction that is treated as a loan 
for federal tax purposes is a loan of proceeds. Generally, transactions 
that result in an expenditure of proceeds, such as a grant, do not give 
rise to a loan. However, tax increment and similar financings, in which 
proceeds are, in form, granted to a nongovernmental person with the 
debt service on the bonds to be paid from incremental tax revenues may 
be treated as a loan if the recipient of the grant makes special 
agreements regarding payment of the taxes (for example, an agreement 
not to contest the assessment).
    3. Tax assessment bond exception. Section 141(c) provides that 
certain tax assessment loans are not treated as loans in applying the 
private loan financing test. A tax assessment loan is a loan that 
arises from the imposition of a tax or assessment of general 
application for specific, essential governmental functions. The 
proposed regulations generally define essential governmental function 
to have the same meaning as under section 7871. To qualify for this 
special exception, owners of business and nonbusiness property must be 
eligible to make assessment payments on an equal basis. Guidance is 
provided on the types of special arrangements regarding payment of an 
assessment that cause the assessment to fail the equal basis 
requirement (for example, due-on-sale clauses). The proposed 
regulations clarify that loans qualifying under the tax assessment loan 
exception may still result in satisfaction of the private business 
tests.
G. Sections 1.141-3 and 1.141-6  Measurement of use and allocation and 
accounting rules
    1. Measurement of private business use. The proposed regulations 
provide specific rules regarding the measurement of private use. For 
facilities that are simultaneously used for both private business use 
and government use, the regulations generally permit the use of 
reasonable methods of measuring the private business use. Thus, for a 
building with separate portions used for private business use and 
government use, the amount of private business use is based on the 
relative portion of useable space used for a private business use. If 
the private use occurs at different times, the private business use is 
based on a comparison of private business use to total use.
    Except as described below for output facilities, annual periods are 
used to measure the amount of private business use and the private 
business use is equal to the greatest amount of private business use in 
any annual period. As under the industrial development bond 
regulations, the proposed regulations do not provide that private 
business use is measured over the entire term of the issue, except for 
output facilities. For example, a stadium that is used for private 
business use 30 days out of a total use of 200 days in one year 
generally meets the 10 percent private business use test (regardless of 
the use of the facility in other years).
    2. Financing a portion of a mixed use facility. If a facility is 
used for private business use in an amount that would cause the bonds 
to be private activity bonds, in many circumstances the proposed 
regulations permit tax-exempt bonds to be issued for the government use 
portion without causing the bonds to meet the private business use 
test. This special rule applies only if the government use portion of 
the facility is a separate and discrete portion of a facility (such as 
a floor of a building), or an undivided ownership interest in an output 
or similar utility facility. In applying this rule, an allocable 
portion of the cost of common areas may be financed as government use.
    Generally, if the private business use of facility does not occur 
in a separate and discrete portion of the facility or in an output or 
similar utility facility, the proposed regulations do not permit tax-
exempt financing of any portion of that facility. For example, for a 
stadium used 30 percent of the time for private business use, tax-
exempt bonds may not be issued to provide 70 percent of the cost of 
that stadium.
    3. Allocation of proceeds to expenditures. The proposed regulations 
provide that the allocation of proceeds to expenditures for purposes of 
section 141 must be made in the same manner as and consistently with 
allocations of proceeds for arbitrage purposes under Sec. 1.148-6. As 
further described below, the proposed regulations would amend 
Sec. 1.148-6 to provide significant flexibility regarding when these 
allocations are required to be made.
H. Section 1.141-7  Special rules for output facilities
    1. General rule. The proposed regulations adopt the approach of the 
industrial development bond regulations providing special rules for the 
determination of whether the purchase of the output of an output 
facility by a nongovernmental person causes the bonds to be private 
activity bonds. These rules apply the private business use test to 
output contracts by comparing the amount of output purchased by 
nongovernmental persons under take or take or pay contracts to the 
available output of the facility. The proposed regulations provide 
certain additional clarifications. For example, the proposed 
regulations clarify that certain requirements contracts are treated as 
take or take or pay contracts. Transitional rules are provided for 
existing contracts. In modifying the rules for output facilities, the 
Service and Treasury recognize that, as a result of the Energy Policy 
Act of 1992, significant regulatory changes are occurring regarding 
electric generation and transmission facilities. In this regard, the 
proposed regulations attempt to address the changing nature of this 
industry. For example, the proposed regulations provide guidance on 
allocations of use of transmission facilities.
    2. De minimis exceptions. The proposed regulations contain several 
de minimis exceptions under which output contracts are disregarded. 
First, in lieu of the 3 percent de minimis rule in the industrial 
development bond regulations, the proposed regulations adopt a 1 
percent de minimis rule. The proposed regulations also incorporate the 
safe harbors in the 1986 Act legislative history relating to pooling, 
exchange, and spot sale agreements. Special rules are also provided for 
use of transmission facilities. Finally, contracts with terms not 
exceeding 1 year may be disregarded in certain circumstances.
    3. Allocation of output contracts. The proposed regulations provide 
specific guidance on allocations of output sold under a contract among 
particular facilities. Generally, these determinations are made on a 
facts and circumstances basis taking into account certain physical and 
contractual factors.
I. Section 1.141-8   $15 million limitation for output facilities
    1. General rules. Section 141(b)(4) provides a special private 
activity bond limitation for issues used to finance output facilities, 
under which the permissible private business use and private security 
or payments are limited to $15 million. Further, this $15 million 
limitation for an issue is reduced by the amount of private business 
use and private security or payments in other outstanding tax-exempt 
bonds financing the same project.
    2. Definition of project. The proposed regulations define project 
for purposes of the $15 million output limitation. Generating units not 
located at the same site or not placed in service within 3 years are 
not part of the same project. In addition, improvements made more than 
3 years after a generating unit is placed in service are treated as a 
separate project. For transmission facilities, a project includes 
functionally related or contiguous property placed in service during a 
single 24-month period.
J. Section 1.141-9  Unrelated or disproportionate use test
    Under section 141(b)(3), an issue meets the private business tests 
if the amount of private business use and private security or payments 
attributable to any unrelated or disproportionate private business use 
exceeds 5 percent of the proceeds. The proposed regulations provide 
that whether private business use is related to a government use of the 
proceeds of an issue is determined on a case-by-case basis, emphasizing 
the operational relationship of the financed facilities. Generally, 
facilities used for a private business use are related to a government 
use only if the private use occurs in the same facility or an adjacent 
facility. The proposed regulations also provide that a single facility 
that is used for both a government use and a private business use of 
the same type (for example, governmental and private parking) generally 
does not result in unrelated use.
    Disproportionate private business use occurs when the amount of 
proceeds used for a private business use exceeds the amount of proceeds 
used for the related government use. The proposed regulations provide 
allocation rules designed to simplify the application of the 
disproportionate use rules. For example, where a private business use 
relates to more than one government use, in determining the amount of 
disproportionate use the private business use may be allocated either 
entirely to the government use to which it primarily relates or among 
each of the government uses. A number of examples are provided 
illustrating the application of the unrelated and disproportionate use 
rules.
K. Section 1.141-12  Special rules for qualified bonds
    The proposed regulations provide certain limited guidance for 
purposes of applying the provisions of section 141(e), relating to 
qualified private activity bonds (private activity bonds that qualify 
as tax-exempt bonds). Thus, generally, continued compliance throughout 
the term of the issue is required for bonds to be qualified bonds. The 
proposed regulations provide, however, that certain of the remedial 
actions under proposed Sec. 1.141-13 apply for this purpose.
L. Section 1.141-13  Deliberate actions and related remedial actions
    1. Remedial actions. Although a post-issuance deliberate action by 
an issuer may cause bonds to be private activity bonds, the proposed 
regulations provide a number of remedial actions that will prevent 
bonds from ceasing to be tax-exempt bonds. In order to be eligible for 
these remedial actions the issue must satisfy certain conditions. 
First, the issuer must covenant in the bond documents that it will not 
take any action that would cause the bonds to be private activity 
bonds, and must establish reasonable procedures to ensure compliance 
with this covenant. Second, the terms of any agreement that would cause 
the bonds to be private activity bonds must be arm's-length. Third, as 
under the arbitrage regulations, the issuer must certify its 
expectations as of the issue date regarding the amount and use of the 
proceeds. If, however, the possibility that a deliberate action would 
be taken is not remote as of the issue date, remedial actions are 
generally not available unless the bonds provide for redemption within 
6 months of the deliberate action.
    2. Permitted remedial actions. The proposed regulations contain 
several remedial actions that are available in the event of a 
deliberate action. First, the issuer can redeem or defease the 
nonqualifying bonds. Second, the issuer is permitted to use the amounts 
received on the disposition of a facility for a use that would qualify 
for tax-exempt financing as qualified 501(c)(3) bonds. Similarly, in 
certain circumstances, if the transferred facility would itself 
continue to be eligible for tax-exempt bond financing, that use is 
treated as a qualifying remedial actions. For this purpose, in applying 
section 55 through 59, 141 through 147, 149, and 150, the bonds are 
treated as reissued on the date of the deliberate action. Treasury and 
the Service are considering alternative ways in which the requirements 
of section 55 through 59 could be satisfied for this purpose (for 
example, a closing agreement with the issuer similar to the one 
described below). These rules are based on, but are more flexible than, 
the safe harbors in Rev. Porc. 93-17. For example, qualifying 
alternative uses of the financed facility would include uses under 
section 142. Finally, the proposed regulations provide the Commissioner 
with the authority to provide additional remedial actions by 
publication in the Internal Revenue Bulletin.
    3. Consideration of alternative remedial action. Defeasing bonds 
generally results in an issuer foregoing much of the ongoing benefit 
provided by tax-exempt financing. In lieu of providing for defeasing as 
a remedial action, a more direct remedial action is being considered. 
Treasury and the Service are considering the issuance of a revenue 
procedure pursuant to which an issuer may request a closing agreement 
with respect to outstanding bonds. Under the closing agreement, the 
issuer would make a payment to the Service to prevent the interest on 
bonds from being includable in gross income of bondholders as a result 
of a deliberate action that results in satisfaction of the private 
activity bond test. Generally, the closing agreement would be 
conditioned upon satisfying the requirements of Sec. 1.141-13(a) 
(relating to conditions for remedial action). If this procedure is 
adopted, defeasance of bonds would no longer be a permissible remedial 
action.
    The issuer would be required to make the payment within 30 days of 
the execution of the closing agreement. The amount of the payment would 
equal the present value of the interest rate differential (as described 
below) multiplied by the amount of nonqualified bonds that will be 
outstanding for each annual period (or shorter period) subject to the 
closing agreement.
    The interest rate differential would equal an appropriate factor 
multiplied by the difference between the applicable federal rate under 
section 1274(d) (the applicable taxable rate) and the applicable 
federal rate under section 1288(b) (the applicable tax-exempt rate). 
The factor would reflect that the applicable taxable rate is based on 
obligations of the United States. The rates used would be those in 
effect on the date the deliberate action occurs. Each rate (that is, 
the short-term, mid-term, or long-term rate) would be based on the 
remaining weighted average maturity of the nonqualified bonds.
    The amount of the payment would be increased by 20 percent in cases 
where (1) the bond may be redeemed in accordance with its terms or (2) 
the establishment of a defeasance escrow would not satisfy the 
requirements of Sec. 1.141-13(b)(4) (relating to defeasance of 
nonqualified bonds) as proposed.
    Nonqualified bonds would have the same meaning as in Sec. 1.141-
13(g)(1), except that in the case of a transfer for cash as defined in 
Sec. 1.141-13(b)(1), the determination of the nonqualified bonds would 
be based on an amount equal to the disposition proceeds. Nonqualified 
bonds that continue to be treated as tax-exempt because of a 
permissible remedial action under Sec. 1.141-13 (b), (c), or (d) (for 
example, because of a permissible redemption) would not be treated as 
nonqualified bonds for purposes of the closing agreement.
    To enter into the agreement, the issuer also would have to agree to 
(1) redeem the nonqualified bonds on the earliest date on which the 
bonds may be redeemed under their terms, (2) not make any payment under 
the closing agreement from bond proceeds as described in section 103(a) 
of the Code, and (3) comply with Sec. 1.141-14 with respect to any 
refunding of the nonqualified bonds. In limited situations where it is 
foreseeable that the issuer, using its best efforts, will be unable to 
redeem the bonds at the earliest date, the Commissioner may permit the 
bonds to remain outstanding until a later date.
    Finally, for cases in which the conditions of Sec. 1.141-13(a) are 
not satisfied, the amount required to be paid under the closing 
agreement would be based on the highest marginal individual income tax 
rate at the time of the deliberate action and the interest paid or 
accrued on the nonqualified bonds from the issue date. If the 
noncompliance occurred or was expected to occur as of the issue date, 
the nonqualified bonds would include all the bonds of the issue.
M. Section 1.141-14  Refunding Issues
    1. General rules. The industrial development bond regulations 
provide only limited guidance on the application of the private 
activity bond limitations to refunding issues. The proposed regulations 
provide guidance regarding the application of the private activity bond 
test to refunding issues, including guidance regarding whether an issue 
to refund a qualified bond is a qualified bond.
    2. Private activity bond status. The proposed regulations generally 
provide that refunding issues are retested to determine if those bonds 
are private activity bonds. These tests are applied based on the use of 
the proceeds of the refunded issue.
    3. Qualified bond status. The proposed regulations also generally 
provide that refunding issues are retested to determine if those bonds 
are qualified bonds. These tests are applied based on the use of the 
proceeds of the refunded issue.
N. Section 1.141-15  Anti-abuse Rules
    The proposed regulations contain an anti-abuse rule to ensure that 
the regulations are applied consistently with the purposes of section 
141. In the case of a transaction entered into for a principal purpose 
of transferring to a nongovernmental person significant benefits of 
tax-exempt financing in a manner that is inconsistent with the purposes 
of section 141, the Commissioner may take any action to reflect the 
substance of the transaction. The proposed regulations provide several 
examples illustrating the application of the anti-abuse rule.
O. Section 1.145-1  Qualified 501(c)(3) Bonds
    The proposed regulations provide certain limited guidance for 
purposes of applying the provisions of section 145, relating to 
qualified private 501(c)(3) bonds. Thus, generally, as under section 
141, compliance with section 145 is determined based on the issuer's 
reasonable expectations as of the issue date, although deliberate 
actions may cause the bonds to fail to be qualified bonds. The proposed 
regulations also provide that the remedial actions under proposed 
Sec. 1.141-13 apply for this purpose.
P. Section 1.148-6  Arbitrage Allocation and Accounting Rules
    The proposed regulations provide additional guidance regarding when 
expenditures of proceeds must be allocated and accounted for under the 
arbitrage regulations. The proposed regulations provide that if an 
issuer fails to account for the expenditure of bond proceeds, the 
proceeds of the issue are accounted for under a specific tracing 
method. An issuer would be required to account for the allocation of 
proceeds to expenditures not later than 18 months after the later of 
the payment of the expenditure and the date the project financed by the 
issue is placed in service. In no event may the allocation occur after 
the first arbitrage rebate installment payment would be due for the 
issue.
Q. Section 1.150-1  General Definitions for Purposes of All Tax-Exempt 
Bond Rules
    The proposed regulations revise the existing definition of issue 
that applies for all purposes of sections 103 and 141 through 150 to 
clarify the circumstances under which taxable and tax-exempt bonds are 
treated as part of a single issue.
R. Section 1.1394-1  Enterprise Zone Facility Bonds
    1. In general. The proposed regulations provide guidance on certain 
aspects of the provisions of section 1394, relating to enterprise zone 
facility bonds.
    2. Limit on amount of bonds. Guidance is provided on the 
application of section 1394(c), which contains a $3 million and a $20 
million limitation on the amount of outstanding tax-exempt enterprise 
zone facility bonds. These limitations are applied on the basis of the 
issue price of an issue. The proposed regulations also provide that in 
applying these limitations, the lender in a loans-to-lenders program 
may be disregarded.
    3. Good faith compliance. Under the proposed regulations, an issue 
is treated as satisfying certain of the requirements of section 1394 if 
the issuer and each principal user in good faith attempt to meet those 
requirements throughout the term of the issue, and any failure to 
comply with these requirements is corrected within a reasonable period 
after the failure is first discovered. The proposed regulations provide 
guidance on the application of this good faith standard. Generally, 
correction of noncompliance within one year of discovery is reasonable 
if the issuer and principal user are using their best efforts to 
correct the noncompliance.
    4. Other rules. The proposed regulations also provide guidance on 
the definition of qualified zone property, including the original use 
requirement. Finally, the proposed regulations provide special rules 
for purposes of applying the maturity limitation of section 147 to 
these bonds.

Effective Dates

    The regulations are proposed to apply to bonds issued on or after 
the date 60 days after the adoption of final regulations. The 
regulations do not apply to bonds issued on or after the effective date 
to refund a bond that was not subject to these private activity bond 
regulations unless the refunding issue extends the weighted average 
maturity of the financing. Under various transition rules, issuers may 
apply certain of the proposed rules on earlier dates. Before the 
adoption of the regulations, the Service will continue to consider 
requests for rulings in the case of changes of use in which the safe 
harbors provided in Rev. Proc. 93-17 are not satisfied.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in EO 12866. Therefore, 
a regulatory assessment is not required. It also has been determined 
that section 553(b) of the Administrative Procedure Act (5 U.S.C. 
chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do 
not apply to these regulations, and, therefore, a Regulatory 
Flexibility Analysis is not required. Pursuant to section 7805(f) of 
the Internal Revenue Code, this notice of proposed rulemaking will be 
submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on its impact on small business.

Comments and Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written comments that are submitted 
timely (preferably a signed original and eight copies) to the IRS. All 
comments will be available for public inspection and copying.
    A public hearing has been scheduled for Thursday, June 8, 1995, at 
10 a.m. in the Auditorium, Internal Revenue Building, 1111 Constitution 
Avenue NW, Washington, D.C. Because of access restrictions, visitors 
will not be admitted beyond the Internal Revenue Building lobby more 
than 15 minutes before the hearing starts.
    The rules of 26 CFR 601.601(a)(3) apply to the hearing.
    Persons that wish to present oral comments at the hearing must 
submit written comments by May 1, 1995 and submit an outline of the 
topics to be discussed and the time to be devoted to each topic by May 
18, 1995.
    A period of 10 minutes will be allotted to each person for making 
comments.
    An agenda showing the scheduling of the speakers will be prepared 
after the deadline for receiving outlines has passed. Copies of the 
agenda will be available free of charge at the hearing.
    Comment is solicited on all aspects of the proposed regulations. In 
addition, comment is specifically solicited on the following topics:
    (1) the desirability of adopting the closing agreement procedure 
for noncompliance in lieu of providing for defeasance, other situations 
in which the closing agreement procedure, if adopted, should apply, and 
whether other procedures should be available to issuers;
    (2) the condition that, in order to take certain remedial actions, 
certain bonds must contain early redemption provisions;
    (3) additional limitations on the application of the disposition 
proceeds rules to reduce administrative burdens on issuers and whether 
the disposition proceeds rules should apply for purposes of section 
148;
    (4) problems resulting from rules binding an issuer to the form of 
its transaction (see, for example, New York City v. Commissioner, 103 
T.C. No. 27 (1994));
    (5) the application of the private security or payment test to 
variable yield issues;
    (6) other circumstances in which issuers should be permitted to 
finance the government use portion of a mixed use facility;
    (7) the required consistency between arbitrage and private activity 
bond allocations of proceeds;
    (8) the treatment of requirements contracts as output contracts; 
and
    (9) safe harbors for provisions of the regulations requiring 
determinations of reasonableness or fair market value.

Drafting Information

    The principal author of these regulations is William P. Cejudo of 
the Office of Assistant Chief Counsel (Financial Institutions and 
Products). However, other personnel from the Service and Treasury 
Department participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 is amended by adding 
an entry in numerical order to read as follows:

    Authority: 26 U.S.C. 7805 * * *

    Section 1.148-6 also issued under 26 U.S.C. 148(f), (g), and (i).
    Section 1.150-4 also issued under 26 U.S.C. 150(c)(5) * * *
    Section 1.1394-1 also issued under 26 U.S.C. 1397D * * *


Sec. 1.103-7  [Removed]

    Par. 2. Section 1.103-7 is removed.


Sec. 1.141-1  [Redesignated as Sec. 1.141-20]

    Par. 3. Section 1.141-1 is redesignated as Sec. 1.141-20.
    Par. 4. Sections 1.141-0 through 1.141-16 are added to read as 
follows:


Sec. 1.141-0  Table of contents.

    This section lists the captioned paragraphs contained in 
Secs. 1.141-1 through 1.141-16.

Sec. 1.141-1  Definitions and rules of general application.
    (a) In general.
    (b) Definitions.
    (c) Disposition proceeds.
    (1) Definition.
    (2) Amount of disposition proceeds.
    (3) Exception for general obligation programs.
    (4) Below market transfers and authority of Commissioner.
    (d) Elections.
    (e) Treatment of partnerships.
    (1) General rule.
    (2) Certain partnerships disregarded.
    (f) Related parties.
Sec. 1.141-2  Private activity bond tests.
    (a) Overview.
    (b) Scope.
    (c) General definition of private activity bond.
    (d) Reasonable expectations and deliberate actions.
    (1) In general.
    (2) Deliberate actions defined.
    (3) Certain remedial actions.
    (4) Examples.
Sec. 1.141-3  Definition of private business use.
    (a) General rule.
    (1) In general.
    (2) Indirect use.
    (3) Ultimate and intermediate use.
    (4) Aggregation of private business use.
    (b) General definition of private business use.
    (1) In general.
    (2) Use of proceeds.
    (3) Agents and employees.
    (4) Ownership.
    (5) Leases.
    (6) Management contracts.
    (7) Output facilities.
    (8) Discharge of primary legal obligation.
    (9) Research agreements.
    (10) Other actual or beneficial use.
    (c) Qualified management contracts.
    (1) In General.
    (2) General compensation requirements.
    (3) Permissible arrangements.
    (4) No related parties or common control.
    (5) De minimis exception for functionally related use.
    (6) Definitions.
    (d) Research agreements.
    (1) General rule.
    (2) Corporate-sponsored research.
    (3) Cooperative research agreements.
    (4) Basic research.
    (e) Exception for general public use.
    (1) General public use.
    (2) Intended for use by the general public.
    (3) Use on the same basis.
    (4) Special rule for system improvements.
    (5) Examples.
    (f) De minimis exceptions.
    (1) Short-term leases and similar arrangements.
    (2) Temporary use by developers.
    (3) Incidental use.
    (4) Qualified improvements.
    (g) Special rule for tax assessment bonds.
    (h) Examples.
    (i) Measurement of private business use.
    (1) General rule.
    (2) Determining average of use.
    (3) Use of a portion of a facility.
    (4) Allocation of neutral costs.
    (5) Commencement of private business use.
    (6) Examples.
Sec. 1.141-4  Private security or payment test.
    (a) General rule.
    (1) Private security or payment.
    (2) Aggregation of private payments and security.
    (b) Measurement of private payments and security.
    (1) Scope.
    (2) General rule.
    (3) Present value measurement.
    (c) Private payments.
    (1) In general.
    (2) Payments taken into account.
    (3) Allocation of payments.
    (d) Private security.
    (1) In general.
    (2) Security taken into account.
    (3) Pledge of unexpended proceeds.
    (4) Secured by any interest in property or payments.
    (5) Payments in respect of property.
    (6) Allocation of security among issues.
    (e) Generally applicable taxes.
    (1) General rule.
    (2) Definition of generally applicable taxes.
    (3) Special charges.
    (4) Manner of determination and collection.
    (f) Certain waste remediation bonds.
    (1) Scope.
    (2) Persons that are not private users.
    (g) Examples.
Sec. 1.141-5  Private loan financing test.
    (a) In general.
    (1) General rule.
    (2) Direct and indirect us of proceeds determinative.
    (3) Measurement of test.
    (b) Definition of loan.
    (1) General federal tax principles apply.
    (2) Exception if no use of bond proceeds.
    (3) Hazardous waste remediation bonds.
    (4) Prepayments.
    (5) Grants.
    (c) Tax assessment bond exception.
    (1) General rule.
    (2) Tax assessment loan defined.
    (3) Mandatory tax or other assessment.
    (4) Specific essential governmental function.
    (5) Equal basis requirement.
    (6) Coordination with private business tests.
    (d) Nonpurpose investment exception.
    (e) Examples.
Sec. 1.141-6  Allocation and accounting rules.
    (1) Allocation of proceeds to expenditures generally.
    (b) Special rules for mixed use facilities.
    (1) Allocation of expenditures to mixed use facilities.
    (2) Mixed use facility defined.
    (c) Allocation of disposition proceeds.
    (d) Allocation of common areas.
    (e) Allocation of proceeds to bonds.
Sec. 1.141-7  Special rules for output facilities.
    (a) Private business use and private security or payments test.
    (1) General rule.
    (2) Application of benefits and burdens test.
    (3) Special rules and definitions.
    (4) Benefits and burdens test not exclusive.
    (b) Pooling, exchange, spot sales, and wheeling arrangements.
    (1) Swapping and pooling arrangements.
    (2) Certain conduit parties disregarded.
    (3) Spot sales.
    (4) Wheeling.
    (c) Certain short term contracts.
    (d) Allocations of output facilities and systems.
    (1) Facts and circumstances analysis.
    (2) Factors.
    (3) Allocations among users.
    (4) Electric transmission facilities.
    (5) Conservation facilities.
    (e) Examples.
Sec. 1.141-8  $15 million limitation for output facilities.
    (a) In general.
    (1) General rule.
    (2) Reduction in $15 million output limitation for outstanding 
issues.
    (3) Benefits and burdens test applicable.
    (b) Definition of project.
    (1) General rule.
    (2) Separate ownership.
    (3) Generating property.
    (4) Transmission.
    (5) Subsequent improvements.
    (6) Conservation.
    (7) Replacement property.
    (c) Examples.
Sec. 1.141-9  Unrelated or disproportionate use test.
    (a) General rules.
    (1) Description of test.
    (2) Application of unrelated and disproportionate use test--.
    (b) Unrelated use.
    (1) In general.
    (2) Parallel related and unrelated uses.
    (c) Disproportionate use.
    (1) Definition of disproportionate use.
    (2) Aggregation of related uses.
    (3) Allocation rule.
    (d) Maximum use taken into account.
    (e) Examples.
Sec. 1.141-10  Coordination with volume cap.
Sec. 1.141-11  Acquisition of nongovernmental output property.
Sec. 1.141-12  Special rules for qualified bonds.
    (a) Actual compliance required.
    (b) Remedial actions available.
    (1) In general.
    (2) Nonqualified use.
    (c) Limitation on remedial action.
    (1) Failure to spend proceeds.
    (2) Amount of nonqualified bonds.
Sec. 1.141-13  Deliberate actions and related remedial actions.
    (a) Remedial action.
    (1) Required covenants.
    (2) Fair market value consideration.
    (3) Expectations must be certified.
    (4) No abuse.
    (b) Redemption of nonqualified bonds.
    (1) Transfer for cash.
    (2) Other deliberate actions.
    (3) Notice of defeasance.
    (4) Special limitation.
    (5) Defeasance escrow defined.
    (c) Alternative use of facility.
    (d) Alternative use of disposition proceeds.
    (e) Authority of Commissioner to provide for additional remedial 
actions.
    (f) Effect of remedial action on continuing compliance.
    (g) Definition and special rules.
    (1) Definition of nonqualified bonds.
    (2) Section 147.
    (h) Examples.
Sec. 1.141-14  Refunding issues.
    (a) Private activity bond status.
    (1) In general.
    (2) Rules of application.
    (3) Optional treatment as continuation of prior issue.
    (b) Qualified bonds.
    (1) In general.
    (2) Discontinued use in certain qualified bonds.
Sec. 1.141-15  Anti-abuse rules.
    (a) Authority of Commissioner to reflect substance of 
transactions.
    (b) Examples.
Sec. 1.141-16  Effective dates.
    (a) Scope.
    (b) Effective dates.
    (c) Refunding bonds.
    (d) Permissive application of regulations.
    (e) Permissive retroactive application of certain sections.


Sec. 1.141-1  Definitions and rules of general application.

    (a) In general. For purposes of Secs. 1.141-1 through 1.141-16, the 
definitions and rules in this section, the definitions in Sec. 1.150-1, 
and the following definitions under Sec. 1.148-1 apply: bond year, 
commingled fund, higher yielding investment, investment proceeds, 
investments, investment-type property, issue price, nonpurpose 
investment, qualified guarantee, qualified hedge, reasonable 
expectations, reasonably required reserve or replacement fund, rebate 
amount, replacement proceeds, reserve or replacement fund, sale 
proceeds, and yield.
    (b) Definitions.
    Common areas means portions of a facility that are equally 
available to all users of a facility on the same basis for uses that 
are incidental to the primary use of the facility. For example, 
hallways and elevators generally are treated as common areas if they 
are used by the different lessees of a facility in connection with the 
primary use of that facility.
    Consistently applied means applied uniformly to account for 
proceeds and other amounts.
    Essential governmental function is defined in Sec. 1.141-5(c)(4).
    Financed means constructed, reconstructed, or acquired with 
proceeds of an issue.
    Governmental bond means a bond issued as part of an issue no 
portion of which consists of private activity bonds.
    Governmental person means a State or local governmental unit as 
defined in Sec. 1.103-1 or any instrumentality thereof or any entity 
issuing obligations on behalf thereof. It does not include the United 
States or any agency or instrumentality thereof.
    Hazardous waste remediation bonds is defined in Sec. 1.141-4(f).
    Mixed use facility is defined in Sec. 1.141-6.
    Nongovernmental person means a person other than a governmental 
person.
    Nonqualified amount means the lesser of--
    (1) The sale proceeds of an issue used for any private business use 
under Sec. 1.141-3, or
    (2) The sum of the sale proceeds of the issue for which there are 
payments taken into account as private payments under Sec. 1.141-4(c) 
and the sale proceeds of the issue secured by an interest in property 
or payments in respect of property taken into account as private 
security under Sec. 1.141-4(d).
    Output facility, except as otherwise provided in Secs. 1.141-7a), 
includes electric and gas generation, transmission, and related 
facilities, but not (1) sewage or solid waste disposal facilities, or 
(2) water collection, storage, or distribution facilities.
    Private business tests means the private business use test and the 
private security or payment test of section 141(b).
    Proceeds means the sale proceeds, disposition proceeds, and any 
replaced amounts. Proceeds also include any investment proceeds from 
investments that accrue during the project period (net of rebate 
amounts attributable to the project period). Proceeds of an issue do 
not include sale proceeds (other than those deposited in a reasonably 
required reserve or replacement fund) used to retire bonds of the 
issue.
    Project period means the period beginning on the issue date and 
ending on the date that the construction, reconstruction, or 
acquisition of the project financed is substantially complete. In the 
case of a multipurpose issue, the issuer may elect to treat the project 
period for the entire issue as ending on either the expiration of the 
temporary period described in Sec. 1.148-2(e)(2) or the end of the 
fifth bond year after the issue date.
    Replaced amounts means replacement proceeds that are or are 
reasonably expected to be available during the project period other 
than sinking funds, pledged funds, and other replacement proceeds (as 
defined in Sec. 1.148-1(c) (2) through (4), respectively).
    Term of an issue means the period beginning on the issue date and 
ending on the final maturity date of the issue, except that if the term 
of an issue is extended and the primary purpose for that extension is 
not a governmental purpose, the term of the issue is determined as if 
the issue had a final maturity equal to the average maturity date of 
the issue.
    Transfer is defined in paragraph (c)(1) of this section.
    Weighted average economic life is determined under the rules in 
section 147(b). The reasonably expected useful life of a facility may 
be determined by reference to the class life of the property under 
section 168.
    Weighted average maturity is determined under the rules in section 
147(b).
    (c) Disposition proceeds--(1) Definition. Disposition proceeds are 
any amounts (including property) derived from the sale, exchange, or 
other disposition (transfer) of property (other than investments) 
financed with the proceeds of an issue. Except as provided in paragraph 
(c)(4) of this section, if there are disposition proceeds, any proceeds 
of the issue allocable to the transferred property cease to be treated 
as proceeds of the issue.
    (2) Amount of disposition proceeds. Regardless of the amount 
received in connection with the transfer, the amount of disposition 
proceeds is treated as equal to the proceeds of the issue that had been 
allocable to the transferred property immediately prior to the 
transfer. See Sec. 1.141-13(h), Example 1.
    (3) Exception for general obligation programs. Unless the issuer 
elects otherwise, disposition proceeds do not arise on the transfer of 
property financed with the proceeds of a general obligation program if 
the requirements of this paragraph (c)(3) are satisfied. A general 
obligation program is an issue of general obligation bonds issued by a 
general purpose governmental unit that finances more than 75 discrete 
facilities or projects. The requirements of this paragraph (c)(3) are 
satisfied if--
    (i) The transferred property had an original cost not in excess of 
the greater of $3,000,000 and 2.5 percent of the issue price of the 
issue;
    (ii) The transferred property is sold for its fair market value in 
a transaction other than an installment sale;
    (iii) The aggregate amount of the disposition proceeds (determined 
without regard to this paragraph (c)(3)) of the issue to which this 
paragraph (c)(3) applies does not exceed 10 percent of the issue price; 
and
    (iv) The amounts received are deposited in a commingled fund with 
substantial tax or other revenues from governmental operations of the 
transferor and the amounts are reasonably expected to be spent for 
governmental purposes within 6 months from the date of the commingling.
    (4) Below market transfers and authority of Commissioner. The 
Commissioner may treat the proceeds as allocable to either the 
transferred property or the disposition proceeds, whichever allocation 
produces the greater amount of private business use and private 
security or payments, if--
    (i) The financed property is transferred for less than its fair 
market value;
    (ii) The weighted average maturity of the issue to which the 
disposition proceeds are allocable exceeds 120 percent of the 
reasonably expected weighted average economic life of the property 
financed by that issue before the disposition;
    (iii) The issuer does not expend the disposition proceeds or 
deposit those amounts in a defeasance escrow (as defined in Sec. 1.141-
13(b)(5)) within 2 years of the transfer; or
    (iv) The transfer is designed to avoid the provisions of section 
141.
    (d) Elections. Elections must be made in writing on or before the 
issue date and retained as part of the bond documents, and, once made, 
may not be revoked without the permission of the Commissioner.
    (e) Treatment of partnerships--(1) General rule. Except as 
otherwise provided in this paragraph (e), a partnership is treated as a 
separate entity under the private business tests and the private loan 
financing test. Thus, any use of proceeds or other action by a 
partnership is an action of a nongovernmental person.
    (2) Certain partnerships disregarded. A partnership is disregarded 
(that is, treated as an aggregate of its partners) so that the 
partnership's actions are treated as the actions of the partners for 
purposes of the private business tests and private loan financing test 
if--
    (i) The partnership could validly elect under section 761(a)(2) to 
be excluded from the application of Subchapter K of the Code and all 
allocations to partners are consistent with each partner being 
allocated the same distributive share of each item of income, gain, 
loss, deduction, credit, and basis, and this share remains the same 
during the entire period that the person is a partner; or
    (ii) Each of the partners is a governmental person and all of the 
partnership's income is excludable from gross income under section 115.
    (f) Related parties. Except as otherwise provided, all related 
parties are treated as one person and any reference to ``person'' 
includes any related party.


Sec. 1.141-2  Private activity bond tests.

    (a) Overview. Interest on a private activity bond is not excludable 
from gross income under section 103(a) unless the bond is a qualified 
bond. The purpose of the private activity bond tests of section 141 is 
to limit the volume of tax-exempt bonds that finance the activities of 
nongovernmental persons, without regard to whether a financing actually 
transfers benefits of tax-exempt financing to a nongovernmental person. 
The private activity bond tests serve to identify arrangements that 
have the potential to transfer the benefits of tax-exempt financing, as 
well as arrangements that actually transfer these benefits. The 
regulations under section 141 may not be applied in a manner that is 
inconsistent with these purposes.
    (b) Scope. Sections 1.141-1 through 1.141-16 apply generally for 
purposes of the private activity bond limitations under section 141. In 
addition, as specifically provided, certain provisions of Secs. 1.141-1 
through 1.141-16 apply for purposes of other limitations on tax-exempt 
bonds under sections 142 through 150.
    (c) General definition of private activity bond. Under section 141, 
bonds are private activity bonds if they meet either (1) the private 
business use and private payment or security tests of section 141(b) or 
(2) the private loan financing test of section 141(c). The private 
business use and private security or payment tests are described in 
Secs. 1.141-3 and 1.141-4. The private loan financing test is described 
in Sec. 1.141-5.
    (d) Reasonable expectations and deliberate actions--(1) In general. 
An issue is an issue of private activity bonds if the issuer reasonably 
expects, as of the issue date, that the issue will meet either (i) the 
private business tests, or (ii) the private loan financing test. An 
issue is also an issue of private activity bonds if the issuer takes a 
deliberate action, subsequent to the issue date, that causes the 
conditions of either the private business tests or the private loan 
financing test to be met.
    (2) Deliberate actions defined. In general, a deliberate action is 
any action taken by the issuer that is within its control. An intent to 
violate the requirements of section 141 is not necessary for an action 
to be deliberate. Except as otherwise provided in the next sentence of 
this paragraph (d)(2), an action that would be treated as involuntary 
under section 1033 is not a deliberate action. Any action is treated as 
a deliberate action if the financed facility was designed differently, 
sized larger, built sooner, or constructed in a more costly manner than 
is reasonably necessary for the governmental purposes of the issuer. A 
deliberate action occurs on the earlier of the date the parties agree 
on the consideration for the new use or the date on which the new use 
occurs.
    (3) Certain remedial actions. See Sec. 1.141-13 for certain 
remedial actions that prevent a deliberate action from causing the 
related bonds to cease to be treated as tax-exempt bonds.
    (4) Examples. The following examples illustrate the application of 
this section:

    Example 1. City B issues bonds to finance the purchase of land. 
On the issue date, B reasonably expects that it will be the sole 
user of the land for the entire term of the bonds. Subsequently, the 
federal government acquires the land in a condemnation action. B 
sets aside the condemnation proceeds to pay debt service on the 
bonds but does not redeem them on their first call date. The bonds 
are not private activity bonds because B has not taken a deliberate 
action after the issue date.
    Example 2. The facts are the same as in Example 1, except that B 
uses all the condemnation proceeds to make a loan to Corporation T, 
a nongovernmental person. The bonds are private activity bonds 
because B has taken a deliberate action after the issue date.


Sec. 1.141-3   Definition of private business use.

    (a) General rule--(1) In general. The private business use test 
relates to the use of the proceeds of an issue. The 10 percent private 
business use test of section 141(b)(1) is met if more than 10 percent 
of the proceeds of an issue is used in a trade or business carried on 
by a nongovernmental person. For this purpose, the use of financed 
property is treated as the use of proceeds. This section also applies 
to the private business use test under sections 141(b)(3) (unrelated or 
disproportionate use), 141(b)(4) ($15 million limitation for output 
facilities), and 141(b)(5) (the coordination with the volume cap where 
the nonqualified amount exceeds $15 million).
    (2) Indirect use. In determining whether an issue meets the private 
business use test, indirect as well as direct use of the proceeds is 
taken into account. For example, the issuer's use of the proceeds to 
engage in a series of financing transactions for property to be used by 
nongovernmental persons in their trades or businesses may cause the 
private business use test to be met. In addition, proceeds are treated 
as used in the trade or business of a nongovernmental person in 
situations involving other arrangements, whether in a single 
transaction or in a series of related transactions, whereby a 
nongovernmental person uses property acquired with the proceeds of an 
issue in its trade or business.
    (3) Ultimate and intermediate use. In determining whether an issue 
meets the private business use test, both the ultimate and intermediate 
uses of proceeds are taken into account. For example, a facility is 
treated as being used for a private business use if it is leased to a 
governmental person and then subleased to a nongovernmental person or 
if it is leased to a governmental person and subleased to a 
governmental person, provided in each case that the nongovernmental 
person's use is in a trade or business.
    (4) Aggregation of private business use. The use of proceeds by all 
nongovernmental persons is aggregated to determine whether the private 
business use test is satisfied.
    (b) General definition of private business use--(1) In general. 
Proceeds are used for a private business use if they are used in a 
trade or business carried on by a nongovernmental person. For this 
purpose, any activity carried on by a person other than a natural 
person is treated as a trade or business. See Sec. 1.141-1(e) relating 
to certain partnerships.
    (2) Use of proceeds. As further described in this paragraph (b) and 
except as otherwise provided in this section, a person uses proceeds, 
for purposes of the private business use test, if it (i) owns or leases 
financed property, (ii) is loaned those proceeds, or (iii) has actual 
or beneficial use of financed property under a management or incentive 
payment contract, output contract, or other arrangement.
    (3) Agents and employees. Use of proceeds by nongovernmental 
persons in their capacity as agents or employees of a governmental 
person is not use for purposes of the private business use test.
    (4) Ownership. Except as provided in paragraph (b)(3) of this 
section, ownership of financed property is treated as use of their 
property for purposes of the private business use test.
    (5) Leases. Except as provided in paragraphs (b)(3) or (f) of this 
section, the lease of a financed facility is treated as a use of that 
facility for purposes of the private business use test. For this 
purpose, any arrangement, such as a management contract, that is 
properly characterized is a lease for federal income tax purposes is 
treated as a lease.
    (6) Management contracts. A management contract (as defined in 
paragraph (c)(6) of this section) results in use of the financed 
property if--
    (i) The contract is not a qualified management contract (as defined 
in paragraph (c) of this section); or
    (ii) The service provider is treated as the lessee of the financed 
property for federal income tax purposes.
    (7) Output facilities. See Sec. 1.141-7 for special rules under 
which contracts for purchase of output of output facilities result in 
use of the financed facility.
    (8) Discharge of primary legal obligation--(i) General rule. In 
general, a nongovernmental person is treated as a user of a financed 
facility if the financing of that facility discharges a primary and 
unconditional legal obligation of that nongovernmental person, even if 
the nongovernmental person has no possession or control of the 
facility. Further, the use resulting from the discharge of a primary 
legal obligation is not use as a member of the general public within 
the meaning of paragraph (e) of this section. A primary legal 
obligation does not include a law of general application (for example, 
an ordinance requiring that all businesses properly dispose of 
hazardous waste). An obligation imposed on the owner of a facility is 
not the primary obligation of any other user of that facility.
    (ii) Example. The following example illustrates the application of 
this paragraph (b)(8) (see also Example 12 of paragraph (e) of this 
section):

    Example. As a condition to obtaining a permit to construct an 
industrial development, Developer N unconditionally agrees that it 
will construct governmentally owned streets and sidewalks in its 
development. N and several other developers undertake to create 
District, a political subdivision. District issues its tax 
assessment bonds, the proceeds of which are used, in part, to 
construct the street and sidewalk improvements that N is obligated 
to construct. N's obligation to construct the improvements is 
unconditional and, therefore, the discharge of that obligation 
results in private business use of the proceeds used to construct 
those improvements.

    (9) Research agreements. As provided in paragraph (d) of this 
section, an agreement by a nongovernmental person to sponsor research 
performed by a governmental person may result in use of the related 
property for purposes of the private business use test.
    (10) Other actual or beneficial use. For purposes of the private 
business use test, use includes any other actual or beneficial use of a 
financed facility other than use as a member of the general public (as 
defined in paragraph (e) of this section).
    (c) Qualified management contracts--(1) In general. A management 
contract is a qualified management contract if it meets the 
requirements of paragraphs (c)(2), (c)(3), and (c)(4) of this section. 
See also paragraphs (c)(5) and (e) of this section for de minimis 
exceptions.
    (2) General compensation requirements. The contract must provide 
for reasonable compensation for services rendered with no compensation 
based, in whole or in part, on a share of net profits from the 
operation of the facility. Reimbursement of the service provider for 
actual and direct expenses paid by the service provider to unrelated 
parties is not by itself treated as compensation.
    (i) Compensation based on
    (A) a percentage of gross revenues (or adjusted gross revenues) of 
a facility or a percentage of expenses from a facility, but not both,
    (B) a capitation fee, or
    (C) a per-unit fee is generally not considered to be based on a 
share of net profits.
    (ii) Similarly, a productivity reward equal to a stated dollar 
amount based on increases or decreases in gross revenues, reductions in 
total expenses, but not both, generally does not cause the compensation 
to be based on a share of net profits.
    (3) Permissible arrangements. The management contract must be 
described in paragraph (c)(3)(i), (ii), (iii), (iv), or (v) of this 
section.
    (i) 100 percent periodic fixed fee arrangements. All of the 
compensation for services during the term of the contract is based on a 
period fixed fee and the term of the contract, including all renewal 
options, does not exceed the lesser of 50 percent of the expected 
useful life of the related property and 15 years. For purposes of this 
paragraph (c)(3)(i) and paragraph (c)(3)(ii) of this section, a fee 
does not fail to qualify as a periodic fixed fee as a result of a 
single incentive award provision under which compensation automatically 
increases when a gross revenue or expense target (but not both) is 
reached if that award is equal to a single, stated dollar amount.
    (ii) 80 percent periodic fixed fee arrangements. At least 80 
percent of the compensation for services for each annual period during 
the term of the contract is based on a periodic fixed fee. The term of 
the contract must not exceed the lesser of 80 percent of the expected 
useful life of the related property and 10 years.
    (iii) 50 percent periodic fixed fee arrangements. Either at least 
50 percent of the compensation for services for each annual period 
during the terms of the contract is based on a periodic fixed fee or 
all of the compensation for services is based on a capitation fee or a 
combination of a capitation fee and a periodic fixed fee. The term of 
the contract must not exceed 5 years, including all renewal options. 
The contract must be terminable by the governmental persons upon 
reasonable notice at the end of the third year of the contract term, 
without penalty or cause.
    (iv) Per-unit fee arrangements in certain 3-year contracts. All of 
the compensation for services is based on a per-unit fee or a 
combination of a per-unit fee and a periodic fixed fee. The contract 
has a term, including renewal options, that is not longer than 3 years. 
The contract must be terminable, by the governmental person on 
reasonable notice, without penalty or cause, at the end of the second 
year of the contract term. The amount of the per-unit fee must be 
specified in the contract or otherwise specifically limited by the 
government person or an independent third party, such as the 
administrator of the Medicare program.
    (v) Percentage of revenue or expense fee arrangements in certain 2-
year contracts. All the compensation for services is based on a 
percentage of fees charged or a combination of a per-unit fee and a 
percentage of revenue or expense fee. During the start-up period, 
however, compensation may be based on a percentage of either gross 
revenues, adjusted gross revenues, or expenses of a facility. The 
contract must have a term, including renewal options, that is not 
longer than 2 years. The contract must be terminable by the 
governmental person on reasonable notice, without penalty or cause, at 
the end of the first year of the contract term. This paragraph 
(c)(3)(v) applies only to contracts under which the service provider 
primarily provides services to third parties (for example, radiology 
services), or service contracts involving a facility during an initial 
start-up period for which there have been insufficient operations to 
establish a reasonable estimate of the amount of the annual gross 
revenues and expenses (for example, a contract for general management 
services for the first year of operations).
    (4) No related parties or common control. The service provider must 
not have any role or relationship with the governmental person that, in 
effect, substantially limits the governmental person's ability to 
exercise its rights, including cancellation rights, under the contract. 
This requirement is satisfied if--
    (i) Not more than 20 percent of the voting power of the governing 
body of the governmental person in the aggregate is vested in the 
service provider and its directors, officers, shareholders, and 
employees;
    (ii) Except in the case of a contract for physician services to 
patients or similar contracts, not more than 20 percent of the voting 
power of the governing body of the service provider in the aggregate is 
vested in the governmental person and its directors, officers, 
shareholders, and employees;
    (iii) Overlapping board members do not include the chief executive 
officers of the service provider or its governing body or the 
governmental person or its governing body; and
    (iv) The governmental person and the service provider under the 
contract are not related parties.
    (5) De minimis exception for functionally related use. The use of a 
financed facility pursuant to a qualified management contract does not 
result in use of the financed facility for purposes of the private 
business use test if that use is functionally related and subordinate 
to that management contract and that use is not, in substance, a 
separate contractual agreement (for example, a separate lease of a 
portion of the financed facility). Thus, for example, exclusive use of 
storage areas by the manager for equipment that is necessary for it to 
perform its required activities does not give rise to private business 
use.
    (6) Definitions. For purposes of this paragraph (c), the following 
definitions apply:
    (i) Adjusted gross revenues means gross revenues of all or a 
portion of a facility, less allowances for bad debts and contractual 
and similar allowances.
    (ii) Capitation fee means a fixed periodic amount for each person 
for whom the service provider or the governmental person assumes the 
responsibility to provide all needed services for a specified period so 
long as the quantity and type of services actually provided to covered 
persons varies substantially. For example, a capitation fee includes a 
fixed dollar amount payable per month to a medical service provider for 
each member of a health maintenance organization plan for whom the 
provider agrees to provide all needed medical services for a specified 
period. A capitation fee may include a variable component of up to 20 
percent of total compensation designed to protect the service provider 
against risks such as catastrophic loss.
    (iii) Periodic fixed fee means a stated dollar amount for services 
rendered for a specified period of time. For example, a stated dollar 
amount per month is a periodic fixed fee. The stated dollar amount may 
automatically increase according to a specified, objective, external 
standard that is not linked to the output or efficiency of a facility. 
For example, the Consumer Price Index and similar external indices that 
track increases in prices in an area or increases in revenues or costs 
in an industry are objective external standards. Capitation fees and 
per-unit fees are not periodic fixed fees.
    (iv) Per-unit fee means a fee based on a unit of service provided. 
For example, a stated dollar amount for each specified medical 
procedure performed, car parked, or passenger mile is a per-unit fee.
    (v) Renewal option means a provision under which the service 
provider has a legally enforceable right to renew the contract. Thus, 
for example, a provision under which a contract is automatically 
renewed for one-year periods absent cancellation by either party is not 
a renewal option (even if it is expected to be renewed).
    (vi) Management contract means a management, service, or incentive 
payment contract between a governmental person and a service provider 
under which the service provider provides services involving all, a 
portion of, or any function of, a facility. For example, a management 
or incentive payment service contract includes a contract for the 
provision of management services for an entire hospital, management 
services for a specific department of a hospital, or an incentive 
payment contract for physician services to patients of a hospital. 
Management contracts do not include a customary contract for janitorial 
or similar services. The mere granting of admitting privileges by a 
hospital to a doctor does not result in a management contract even if 
those privileges are conditioned on the provision of de minimis 
services, if those privileges are available to all qualified physicians 
in the area, consistent with the size and nature of its facilities. A 
contract to provide for the operation of a mixed use facility described 
in Sec. 1.141-6(b)(2)(i)(B) (relating to certain undivided ownership 
interests) is not a management contract if the only compensation is the 
reimbursement of actual and direct expenses paid by the service 
provider.
    (vii) Service provider means any person other than a governmental 
person that provides services under a contract to or for the benefit of 
a governmental person.
    (viii) Penalties for terminating a contract include a limitation on 
the governmental person's right to compete with the service provider; a 
requirement that the governmental person purchase equipment, goods, or 
services from the service provider; and a requirement that the 
governmental person pay liquidated damages for cancellation of the 
contract. In contrast, a requirement effective on cancellation that the 
governmental person reimburse the service provider for ordinary and 
necessary expenses or a restriction on the governmental person against 
hiring key personnel of the service provider is generally not a 
contract termination penalty. The existence of another contract between 
the service provider and the governmental person, such as a loan or 
guarantee by the service provider, constitutes a contract termination 
penalty if that contract contains terms that are not customary or 
arm's-length that could operate to prevent the governmental person from 
terminating the contract (for example, provisions under which the 
contract terminates if the service contract is terminated or that place 
substantial restrictions on the selection of a substitute service 
contract provider).
    (d) Research agreements)--(1) General rule. A research agreement 
described in either paragraph (d)(2) or (d)(3) of this section does not 
result in private business use.
    (2) Corporate-sponsored research. A research agreement relating to 
a facility used for basic research supported or sponsored by a 
nongovernmental person is described in this paragraph (d)(2) if any 
license or other use of resulting technology by the sponsor is 
permitted only on the same terms as the recipient would permit that use 
by any unrelated, nonsponsoring party (that is, the sponsor must pay a 
competitive price for its use), with the price paid for that use 
determined at the time the license or other resulting technology is 
available for use. Although the recipient need not permit persons other 
than the sponsor to use any license or other resulting technology, the 
price paid by the sponsor must be no less than the price that would be 
paid by any non-sponsoring party.
    (3) Cooperative research agreements. A research agreement relating 
to a facility used pursuant to a joint industry-university cooperative 
research arrangement is described in this paragraph (d)(3) if--
    (i) Multiple, unrelated sponsors agree to fund university-performed 
basic research;
    (ii) The research to be performed and the manner in which it is to 
be performed (for example, selection of the personnel to perform the 
research) is determined by the university;
    (iii) Title to any patent or other product incidentally resulting 
from the basic research lies exclusively with the university; and
    (iv) Sponsors are entitled to no more than a nonexclusive, royalty-
free license to use the product of any of that research.
    (4) Basic research. For purposes of this paragraph (d), basic 
research has the same meaning as under section 41(e)(7)(A) (that is, 
any original investigation for the advancement of scientific knowledge 
not having a specific commercial objective, except that this term does 
not include basic research conducted outside the United States or basic 
research in the social sciences, arts, or humanities). Basic research 
does not include applied or practical research, product development, or 
similar activities.
    (e) Exception for general public use--(1) General public use--(i) 
In general. Private business use does not include use as a member of 
the general public (general public use). Use of a financed facility by 
nongovernmental persons in their trades or businesses is treated as 
general public use only if--
    (A) The facility is intended for use by the general public; and
    (B) The use by those nongovernmental persons is reasonably expected 
to be on the same basis as use by other members of the general public.
    (ii) Relation to other use. Use of a financed facility by the 
general public does not prevent the proceeds from being used for a 
private business use because of other use under this section.
    (2) Intended for use by the general public. (i) Number of users. A 
facility is not intended for use by the general public if less than 25 
percent of the reasonably expected direct use of the facility is by 
persons that individually account for no more than 1 percent of the use 
of the facility.
    (ii) Persons constituting the general public. Although the general 
public ordinarily includes natural persons not engaged in trades or 
businesses, the general public may consist entirely of a large number 
of nongovernmental persons engaged in different types of trades or 
businesses. The general public cannot consist predominately of a large 
number of nongovernmental persons engaged in the same type of trade or 
business. For example, an electric transmission line used by a large 
number of electric utilities is not used by the general public. See, 
however, Example 6 of paragraph (h) of this section.
    (3) Use on the same basis--(i) Use related to other facilities--(A) 
General rule. The use of a financed facility by a nongovernmental 
person is not on the same basis as use by the general public if the 
financed facility is functionally and integrally related to another 
facility that is used by that nongovernmental person (the primary 
facility) and significant economic benefits with respect to the primary 
facility arise from the use of the related facility that are not 
available to the general public. If more than 75 percent of the use of 
the related facility is by the general public and not use in connection 
with the primary facility, the benefits to the primary facility are 
treated as insignificant for this purpose.
    (B) Functionally and integrally related. Generally, a facility is 
not functionally and integrally related to a primary facility for this 
purpose if it is not a necessary component of the primary facility. 
Examples of facilities that are typically functionally and integrally 
related to other facilities in a manner that results in significant 
economic benefits are parking lots at airports, stadiums, and shopping 
centers, and utility and other infrastructure improvements for a new 
development, stadium, or airport. On the other hand, a parking lot in a 
large urban business district where there are many separate businesses 
typically does not produce significant benefits to any particular 
person.
    (ii) Priority rights or other preferential benefits. Use under an 
arrangement that conveys priority rights or other preferential benefits 
is not use on the same basis as the general public. Arrangements for a 
term of more than one month generally convey preferential benefits. 
Arrangements providing for use that is available to the general public 
at no charge or on the basis of rates that are generally applicable and 
uniformly applied do not convey priority rights or other preferential 
benefits. For this purpose, rates may be treated as generally 
applicable and uniformly applied even if--
    (A) Different rates apply to different classes of users, such as 
volume purchasers, if the differences in rates are customary and 
reasonable;
    (B) Users are permitted to reserve short-term or incidental use in 
advance;
    (C) Existing users, each using less than 1 percent of a financed 
facility, possess rights of first refusal to renew their use at 
generally applicable, fair market value rates that are in effect at the 
time of renewal; and
    (D) A specially negotiated arrangement is entered into, but only if 
the user is prohibited by federal law from paying the generally 
applicable rates, and the terms of the arrangement are as comparable as 
reasonably possible to the generally applicable rates.
    (4) Special rules for system improvements. For improvements to 
existing public utility or infrastructure systems such as roads or 
sewers, but not discrete structures such as parking facilities (system 
improvements), whether the use of a system improvement is general 
public use may be determined by reference to the system as a whole if 
the system improvement is insubstantial, based either on aggregate cost 
or scope relative to the system as a whole within the jurisdiction of 
the issuer. Except in the case of improvements to roads, a system 
improvement is insubstantial for this purpose if the cost of the system 
improvement is less than 5 percent of the cost of the system as a 
whole. In addition, in determining whether the use of a system 
improvement by the general public is insubstantial, paragraph (e)(3)(i) 
of this section (relating to use related to other facilities) does not 
apply.
    (5) Examples. The following examples illustrate the application of 
this paragraph (e):

    Example 1. Governmentally owned and operated hotel. State C 
issues its bonds to purchase land and construct a hotel for use by 
the general public (that is, tourists, visitors, business travelers, 
etc.). The bond documents provide that C will own and operate the 
project for the period required to redeem the bonds. Use of the 
hotel by hotel guests who are travelling in connection with trades 
or businesses of nongovernmental persons is not a private business 
use of the hotel by these persons because it is general public use.
    Example 2. Toll road. State D issues its bonds to finance the 
construction of a toll road and the cost of erecting related 
facilities such as gasoline service stations and restaurants. These 
related facilities represent less than 10 percent of the total cost 
of the project and are to be leased or sold to nongovernmental 
persons. The road is to be owned and operated by D. The bonds do not 
satisfy the private business use test since less than 10 percent of 
the proceeds is to be used, directly or indirectly, in the trades or 
businesses of nongovernmental persons. The fact that vehicles owned 
by nongovernmental persons engaged in their trades or businesses may 
use the road in common with, or as a part of, the general public, is 
not material.
    Example 3. Contract with United States. G, a sewage collection 
and treatment district, operates facilities that were financed with 
its bonds. F, an agency of the United States, has a base located 
within G. Approximately 20 percent of G's facilities are used to 
treat sewage produced by F under a contract under which G uses its 
best efforts to charge F as closely as possible the same amount for 
its use of G's services as its other customers pay for the same 
amount of services, although those other customers pay for services 
based on standard district charges and tax levies. The use of G's 
facilities by F is general public use.
    Example 4. Parking garage. Authority P uses all the proceeds of 
its bond issue to construct a parking garage containing more than 
100 spaces located in the central business district of a large urban 
area. At least 90 percent of the spaces in the garage will be 
available to the general public on an hourly, daily, or monthly 
first-come, first-served basis and the Authority reasonably expects 
that at least 25 of the spaces will be leased by unrelated 
individuals. Individual lessees of monthly parking spaces may renew 
their spaces at then current fair market value rates. The bonds do 
not satisfy the private business use test because at least 90 
percent of the use of the parking garage is general public use.
    Example 5. Road improvements for stadium. H, a political 
subdivision, issues its bonds to finance construction of a new exit 
and entrance ramp from an existing highway onto an adjacent street 
that will front a newly constructed stadium. The existing highway 
and street are part of systems that are used on the same basis by 
members of the general public. The stadium is owned by 
nongovernmental persons. Although the improvements to the highway 
and the local street are available to the general public and not 
limited to persons going to the stadium, more than 75 percent of the 
use of the ramp will be used in connection with the stadium (that 
is, employees, spectators, and other users of the stadium). Thus, 
these improvements are functionally and integrally related to the 
stadium. Under these facts, however, the ramp qualifies as an 
insubstantial system improvement and, therefore, the proceeds of H's 
bonds are not used for a private business use.
    Example 6. Airport runway. Airport Authority I, a political 
subdivision, issues its bonds and uses all of the proceeds to 
finance construction of a runway at a new city-owned airport. The 
runway will be available for take-off and landing by any operator of 
an aircraft desiring to use the airport. It is reasonably expected 
that more than 25 percent of the use of the runway (that is, direct 
use of the runway) will be by private air carriers (both charter 
airlines and commercial airlines) in connection with their use of 
the airport terminals leased by those carriers. Use of the runways 
by the private carriers is not on the same basis as the general 
public because their lease of property that is functionally and 
integrally related to the runways (the terminals) results in 
significant economic benefits from runway use that are not available 
to other users. The use by these private air carriers is not general 
public use, and the proceeds of I's bonds are used for a private 
business use.
    Example 7. Airport parking lot. The facts are the same as in 
Example 6, except that several months after the issuance of the 
bonds to finance the construction of the runway, I issues bonds all 
of the proceeds of which are used to construct a parking lot at the 
airport. The parking lot will be used entirely by employees of the 
airport, employees of the airlines and other businesses that are 
private business users of the airport terminal, and persons 
traveling by airplane that depart from the airport. The use of the 
parking lot by the airlines and other private business users of the 
airport terminal is not treated as general public use for the same 
reasons as in Example 6.
    Example 8. Federal use of prisons. Authority P uses all of the 
proceeds of its bonds to construct a prison. P contracts with a 
federal agency F to house federal prisoners on a space-available, 
first-come, first-served basis, pursuant to which the federal agency 
will be charged approximately the same amount for each prisoner as 
other governmental persons that enter into similar transfer 
agreements. It is reasonably expected that other governmental units 
will enter into similar agreements. P may terminate the contract on 
90 days notice. it is reasonably expected that during the term of 
the contract, federal prisoners will constitute more than 10 percent 
of the prisoners at the prison. The bonds satisfy the private 
business use test because F and any governmental persons using the 
prison under similar agreements are not members of the general 
public.
    Example 9. Business insurance fund. Authority deposits all of 
the proceeds of its bonds in its hazardous business insurance fund 
and invests all of those proceeds in tax-exempt bonds. The hazardous 
business insurance fund provides liability insurance to more than 
100 operators of different types of hazardous businesses within the 
meaning of State law. Each of the insured persons is required under 
State law to obtain this type of insurance as a condition to their 
trade or business operations. Each participant receives insurance 
for a term of one year, and it is expected that the fund will be 
available for renewals. The participants are not treated as members 
of the general public because the term of the insurance conveys 
preferential benefits.
    Example 10. Port road. Highway Authority W uses all $200 million 
of the proceeds of its bonds to construct a 25-mile road to connect 
an industrial port owned by Corporation C with existing roads owned 
and operated by W that are all located within City T. Other than the 
port, the nearest residential or commercial development to the new 
road is 12 miles away. Although there may be additional development 
in the area surrounding the new road, there is no reasonable 
expectation that the development will occur within the 3-year period 
following the issuance of the bonds. W does not reasonably expect 
that more than 25 percent of the use of the new road will be by 
persons other than employees and other persons doing business with 
C. The bonds satisfy the private business use test because the road, 
although available for use by the general public, will have 
insubstantial general public use and will not qualify as an 
insubstantial system improvement because the cost of the project is 
not insubstantial.
    Example 11. Connecting road. The facts are the same as in 
Example 10, except that the road extends beyond the port to a new 
residential development. Persons residing in this development will 
account for more than 25 percent of the use of both segments of the 
road. The bonds do not satisfy the private business use test because 
the use of the road is general public use.
    Example 12. Fish ladder. J, a political subdivision, owns and 
operates a hydro-electric generation plant and related facilities. 
Pursuant to a take or pay contract having a term equal to the useful 
life of the facility, J sells 15 percent of the output of the plant 
to Corporation K, an investor-owned utility. Under the license 
issued to J for operation of the plant, J is required by federal 
regulations to construct various facilities for the preservation of 
fish and for public recreation. J issues its obligations to finance 
the fish preservation and public recreation facilities. The financed 
facilities provide no direct benefits to J or the purchasers of the 
electricity produced by the plant. Because K has no primary legal or 
contractual obligation to provide the financed facilities, the 
facilities are not used for a private business use by K under 
paragraph (b)(8) of this section. Under this paragraph (e), however, 
the fish preservation facilities, but not the public recreation 
facilities, are treated as used by K because they are functionally 
and integrally related to the generation plant.

    (f) De minimis exceptions--(1) Short-term leases and similar 
arrangements. Use by a nongovernmental person pursuant to a lease, 
management contract, or similar arrangement does not result in private 
business use if--
    (i) The agreement may not be renewed or extended beyond the period 
described in this paragraph (f)(1);
    (ii) Following the expiration of that agreement the facility 
subject to the agreement is not used for a private business use 
(determined without regard to this paragraph (f)(1));
    (iii) The term (or in the case of an agreement entered into prior 
to, and not in connection with, the issuance of the bonds, the 
remaining term) of the agreement does not exceed the least of (A) 1 
year, (B) 10 percent of the remaining economic life of the financed 
facility (determined at the time the arrangement is entered into), and 
(C) 10 percent of the remaining term of the bonds; and
    (iv) Except in the case of a lease, management contract, or similar 
agreement entered into prior to the issue date (or contemplated 
issuance) of bonds financing the acquisition of the property, the 
agreement must be an arm's-length, fair market value agreement.
    (2) Temporary use by developers. Use by a developer of an 
improvement that carries out an essential governmental function during 
an initial development period does not result in private business use 
if--
    (i) The issuer and the developer reasonably expect on the issue 
date to proceed with all reasonable speed to develop and sell the 
related property to members of the general public and covenant in the 
bond documents to do so with due diligence;
    (ii) The issuer and the developer reasonably expect on the issue 
date that the related property will be sold to members of the general 
public within 3 years of the issue date; and
    (iii) Bonds of the issue are not required to be retired in 
connection with the developer's sale of property to members of the 
general public.
    (3) Incidental use--(i) General rule. Incidental use of a financed 
facility is disregarded to the extent that that use doe not exceed 2.5 
percent of the proceeds of the entire issue. A use of a facility by a 
person is incidental if--
    (A) The use does not involve the transfer to the person of 
possession and control over space that is separated from other areas of 
the facility by walls, partitions, or other physical barriers, such as 
a night gate affixed to a structural component of a building (a 
nonpossessory use);
    (B) The nonpossessory use is not functionally related to any other 
use of the facility by the same person (other than a different 
nonpossessory use); and
    (C) All nonpossessory uses of the facility do not, in the 
aggregate, involve the use of more than 2.5 percent of the facility.
    (ii) Illustrations. Incidental uses may include pay telephones, 
vending machines, advertising, use for television cameras, etc., but 
not output purchases.
    (4) Qualified improvements. Proceeds that provide a governmentally 
owned improvement to a governmentally owned building (including its 
structural components and land functionally related and subordinate to 
the building) are not used for a private business use if:
    (i) The building was placed in service more than one year before 
the construction or acquisition of the improvement is begun;
    (ii) The improvement is not an enlargement of the building or an 
improvement of interior space occupied exclusively for any private 
business use;
    (iii) No portion of the improved building or any payments in 
respect of the improved building are taken into account under section 
141(b)(2)(A) (the private security test);
    (iv) No more than 15 percent of the improved building is used for a 
private business use; and
    (v) The improvement (and any related improvements) does not 
increase the fair market value of the building by more than 5 percent. 
This requirement is treated as satisfied if the improvement is to 
common areas (such as the roof, heating, ventilation, and air 
conditioning system, or elevators), and the improvement is not made as 
part of a substantial rehabilitation of the building.
    (g) Special rule for tax assessment bonds. In the case of a tax 
assessment bond that satisfies the requirements of Sec. 1.142-5(c), the 
loan (or deemed loan) of the proceeds to the borrower paying the 
assessment is disregarded in determining whether the private business 
use test is satisfied. Thus, the private business use of those proceeds 
is determined on the basis of the use of the property improved with the 
tax assessment loan and any other use of the proceeds used for that 
assessment.
    (h) Examples. The following examples illustrate the application of 
paragraphs (b) through (g) of this section:

    Example 1. Long-term lease with nongovernmental person. State A 
and Corporation X enter into an arrangement under which A is to 
provide a factory that X will lease for 20 years. The arrangement 
provides that A will issue $10 million of bonds, the proceeds of the 
bond issue will be used to purchase land and to construct and equip 
a factory in accordance with X's specifications, X will rent the 
facility (land, factory, and equipment) for 20 years at an annual 
rental equal to the amount necessary to amortize the principal of 
and pay the interest on the outstanding bonds, and the payments by X 
and the facility itself will be the security for the bonds. The 
bonds are private activity bonds under section 141(b)(1) and (2) 
since they are part of an issue (1) all of the proceeds of which are 
to be used (by purchasing land and constructing and equipping the 
factory) in a trade or business by a nongovernmental person, and (2) 
the payment of the principal of and interest on which is secured by 
the facility and payments to be made with respect to the facility. 
See Sec. 1.141-5 (relating to the private loan financing test) and 
Sec. 1.141-4 (relating to the private security or payment test).
    Example 2. Sale to nongovernmental person. The facts are the 
same as in Example 1 except that X will purchase the facility, and 
annual payments equal to the amount necessary to amortize the 
principal of and pay the interest on the outstanding bonds will be 
made by X. The bonds are private activity bonds under section 141(b) 
(1) and (2) for the reasons set forth in Example 1. See Sec. 1.141-5 
(relating to the private loan financing test) and Sec. 1.141-4 
(relating to the private security or payment test).
    Example 3. Private payments not based on debt service. The facts 
are the same as in Example 1 except that the annual payments 
required to be made by Corporation X are equal to the fair rental 
value of the facility and exceed the amount necessary to amortize 
the principal of and pay the interest on the outstanding bonds. The 
bonds are private activity bonds for the reasons set forth in 
Example 1. The requirement that Corporation X pay an amount equal to 
fair market value, which is in excess of the amount necessary to pay 
the principal of and interest on the bonds, does not affect the 
status of the bonds as private activity bonds. Similarly, if the 
present value of the annual payments required to be made by X 
exceeded 10 percent of the present value of the debt service on the 
outstanding bonds, the bonds would be private activity bonds under 
section 141(b) (1) and (2) for the reasons set forth in Example 1. 
See Sec. 1.141-2(a) and Sec. 1.141-4.
    Example 4. Private lease of portion of building. (i) State D and 
Corporation Y enter into an agreement under which Y will lease for 
20 years one floor of a 10-story office building to be constructed 
by D on land that it will acquire. D will occupy the street level 
floor and the remaining eight floors of the building. The portion of 
the costs of acquiring the land and constructing the building that 
are allocated to the space to be leased by Y is not in excess of 10 
percent of the total costs of acquiring the land and constructing 
the building. These costs, whether attributable to the acquisition 
of land or the construction of the building, were allocated to 
leased space in the same proportion that the reasonable rental value 
of that leased space bears to the reasonable rental value of the 
entire building. From the facts and circumstances presented, it is 
determined that that allocation was reasonable. D issues $10 million 
of bonds, the proceeds of which will be used to purchase land and 
construct the office building. The arrangement does not, by itself, 
cause the private business use test to be met because not more than 
10 percent of the proceeds is to be used, directly or indirectly, in 
the trade or business of a nongovernmental person. See Sec. 1.141.6.
    (ii) If Corporation Y instead leases 2 floors, and the costs 
allocated to these floors are in excess of 10 percent of D's 
investment in the land and building, the arrangement causes the 
private business use test to be met because more than 10 percent of 
the building is to be used in the trade or business of a 
nongovernmental person.
    Example 5. Numerous private leases. The facts are the same as in 
Example 4 except that, instead of leasing any space to Corporation 
Y, State D leases the two floors to numerous unrelated private 
businesses to be used in their trades or businesses. No lease will 
have a term in excess of 2 years. The bonds meet the private 
business use test for the reasons set forth in Example 4.
    Example 6. Municipal auditorium. City G issues its obligations 
to finance the construction of a municipal auditorium that it will 
own and operate. The use of the auditorium will be open to anyone 
who wishes to use it for a short period of time on a rate-scale 
basis. The rights of such a user are only those of a transient 
occupant, rather than the full legal possessory interest of a 
lessee. It is anticipated that the auditorium will be used by 
schools, church groups, fraternities, and numerous commercial 
organizations. The revenues from the rentals of the auditorium and 
the auditorium itself will be the security for the bonds. The bonds 
are not private activity bonds because none of the uses constitute 
use in the trade or business of a nongovernmental person.
    Example 7. Long-term lease of municipal auditorium. The facts 
are the same as in Example 6 except that one nongovernmental person 
engaged in a trade or business will have a 10-year rental agreement 
providing for exclusive use of the entire auditorium for 6 weeks of 
each year at a rental comparable to that charged short-term users. 
The bonds satisfy the private business use test since use of the 
auditorium for 6 weeks each year is more than 10 percent of the use 
of the auditorium and the agreement is not disregarded as a de 
minimis use under paragraph (f) of this section. Thus, more than 10 
percent of the proceeds of the issue will be used in a trade or 
business of a nongovernmental person. See also paragraph (i) of this 
section.
    Example 8. Management contract in substance a lease. City L 
issues bonds to finance the construction of a city hospital. L 
enters into a 5-year contract with M, a nongovernmental person that 
operates a health maintenance organization relating to the treatment 
of M's members at L's hospital. The contract meets the conditions 
for qualified management contracts under paragraph (c) of this 
section. However, the contract also provides that L will guarantee M 
that 20 percent of the capacity of the hospital will be exclusively 
available to members of M's health maintenance organizations at 
special rates so that the contract is properly characterized as a 
lease for federal income tax purposes. Therefore, the issue meets 
the private business use test.

    (i) Measurement of private business use--(1) General rule. The 
private business use of proceeds allocated to a facility under 
Sec. 1.141-6 is determined according to the use of that financed 
facility during each one-year period beginning from the later of the 
issue date or the date the facility is placed in service. The private 
business use of a facility is equal to the greatest percentage of 
private business use for any one year period. The private business use 
of a facility for any one year period is equal to the average private 
business use during that year.
    (2) Determining average of use. The average of the private business 
use of a facility is determined by comparing the amount of private 
business use of that facility during a year to the total amount of 
private business use and government use during that year. In 
determining the total amount of use, periods during which the facility 
is not in use are disregarded. In determining the average amount of 
private business use, the following rules apply:
    (i) Uses at different times. For a facility in which the government 
use and private business use occur at different times (for example, on 
different days), the average amount of private business use is based on 
the amount of time that the facility is used for private business use 
as a percentage of total time for all use. If, however, the use of a 
facility during different times has significantly different value, this 
determination must take into account those different values.
    (ii) Simultaneous use. For a facility in which government use and 
private business use occur simultaneously, the entire facility is 
treated as having private business use. If, however, the private 
business use and government use is on the same basis, the average 
amount of private business use may be determined on a reasonable basis 
(for example, relative value of use, relative amount of time used). For 
example, a governmentally owned facility that is leased or managed by a 
nongovernmental person in a manner that results in private business use 
is treated as entirely used for a private business use. On the other 
hand, a garage with unassigned spaces that is used for government use 
and private business use is only partially used for a private business 
use.
    (iii) Combined use. If a facility has private business use that is 
described in both paragraphs (i)(2)(i) and (1)(2)(ii) of this section, 
the amount of private business use is determined according to whichever 
method produces the greatest amount of private business use. See, 
however, Sec. 1.141-6 for special rules for common areas of a discrete 
portion of a mixed use facility.
    (3) Use of a portion of a facility--(i) Discrete portion. For 
purposes of this paragraph (i), measurement of the use of proceeds 
allocated to a discrete portion of a mixed use facility is determined 
by treating the discrete portion as a separate facility.
    (ii) Common areas. The amount of private business use of common 
areas within a mixed use facility is based on the average amount of 
private business use of the remainder of the entire facility.
    (4) Allocation of neutral costs. Proceeds that are used to pay 
costs of issuance, invested in a reserve or replacement fund, or paid 
as fees for a qualified guarantee or a qualified hedge must be 
allocated ratably among the other purposes for which the proceeds are 
used.
    (5) Commencement of private business use. Generally, private 
business use commences on the first date on which there is actual use 
by the nongovernmental person. If, however, the issuer and a 
nongovernmental person enter into an arrangement to transfer a financed 
facility, private business use commences on the date of that 
arrangement if that arrangement was entered into substantially in 
advance of the transfer and the transfer will occur during the final 
year of the term of the issue or after the retirement of the issue.
    (6) Examples. The following examples illustrate the application of 
this paragraph (i):

    Example 1. Research facility. University U is a state owned and 
operated university. As part of its activities, U owns and operates 
a bond-financed research facility. U enters into sponsored research 
agreements with nongovernmental persons that result in private 
business use. The research otherwise conducted by U (government use) 
and the private research will take place simultaneously in all 
laboratories within the research facility. All laboratory equipment 
will be available continuously for use by workers who will perform 
both types of research. A researcher will often use a single 
laboratory to perform identical research that may meet the 
objectives of U's research and the obligations under the research 
contracts. Under this section, the nongovernmental persons are using 
the facility for a private business use. The private business use 
results from a use of the facility, the research, that is on the 
same basis as government use of the facility. Therefore, the portion 
of the facility that is used for a private business use may be 
determined on a reasonable basis. If more than 10 percent of the use 
of the facility is private business use, no portion of the facility 
can be financed with tax-exempt bonds.
    Example 2. Stadium. City L issues its obligations and uses all 
of the proceeds to construct a stadium. L enters into a long-term 
contract with a professional sports team T under which T will use 
the stadium 20 times during each year. These uses will occur on 
weeknights and weekends. L reasonably expects that the stadium will 
be used more than 180 other times each year, none of which will give 
rise to private business use. This expectation is based on a 
feasibility study and historical use of the old stadium that is 
being replaced by the new stadium. There is no significant 
difference in the value of T's uses when compared to the other uses 
of the stadium. Assuming no other private business use, the 
obligations do not satisfy the private business use test of section 
141(b)(1) on the issue date since not more than 10 percent of the 
use of the facility is for a private business use.
    Example 3. Stadium with significant private business use. The 
facts are the same as in Example 2, except that L reasonably expects 
that more than 10 percent of the use of the stadium will be for a 
private business use. The obligations satisfy the private business 
use test. Further, since the stadium is not a mixed use facility 
under Sec. 1.141-6, any obligations issued to finance any portion of 
the stadium are treated as having private business use in excess of 
10 percent. Therefore, no portion of the stadium can be financed 
with tax-exempt bonds.


Sec. 1.141-4  Private security or payment test.

    (a) General rule. (1) Private security or payment. The private 
security or payment test relates to the nature of the security for, and 
the source of, the payment of debt service on an issue. The private 
payment portion of the test takes into account the payment of the debt 
service on the issue that is directly or indirectly to be derived from 
payments (whether to the issuer or any related party) in respect of 
property, or borrowed money, used or to be used for a private business 
use. The private security portion of the test takes into account the 
payment of the debt service of the issue that is directly or indirectly 
secured by any interest in (i) property used or to be used for a 
private business use, or (ii) payments in respect of property used or 
to be used for a private business use.
    (2) Aggregation of private payments and security. For purposes of 
the private security or payment test, payments taken into account as 
private payments and payments or property taken into account as private 
security are aggregated. However, the same payments are not taken into 
account as both private security and private payments. For example, the 
10 percent private security or payment test is met if, in the 
aggregate, the payments taken into account as private payments and the 
property or payments taken into account as private security exceed 10 
percent of the debt service on the bonds, provided no payment is taken 
into account under both portions of the test.
    (b) Measurement of private payments and security--(1) Scope. This 
paragraph (b) contains rules that apply to both private security and 
private payment.
    (2) General rule. The security for, and payment of debt service on 
an issue is determined from the terms of the bond documents and on the 
basis of any underlying arrangement. An underlying arrangement may 
result from separate agreements between the parties or may be 
determined on the basis of all the facts and circumstances surrounding 
the issuance of the bonds. If the payment of debt service on an issue 
is secured by both a pledge of the full faith and credit of a State or 
local governmental unit and any interest in property used or to be used 
in a private business use, the issue satisfies the private security or 
payment test. For special rules for output facilities, see Sec. 1.141-
7.
    (3) Present value measurement--(i) Use of present value. In 
determining whether an issue meets the private security or payment 
test, the present value of the payments or property taken into account 
is compared to the present value of the debt service to be paid over 
the term of the issue.
    (ii) Debt service--(A) Debt service paid from proceeds. Debt 
service does not include any amount paid or to be paid from sale 
proceeds or investment proceeds. For example, debt service does not 
include payments of capitalized interest funded with bond proceeds.
    (B) Adjustments to debt service. Debt service is adjusted to take 
into account payments and receipts that adjust the yield on an issue 
for purposes of section 148(f). For example, debt service includes fees 
paid for qualified guarantees under Sec. 1.148-4(f) and is adjusted to 
take into account payments and receipts on qualified hedges under 
Sec. 1.148-4(h).
    (iii) Computation of present value--(A) In general. Present values 
are determined by using the yield on the issue as the discount rate and 
by discounting all amounts to the issue date. For a fixed yield issue, 
yield is determined on the issue date and is not adjusted to take into 
account subsequent events.
    (B) Variable yield issues. The yield on a variable yield issue is 
determined over the term of the issue. To determine the reasonably 
expected yield as of any date, the issuer may assume that the future 
interest rate on a variable yield bond will be the then-current 
interest rate on the bonds determined under the formula prescribed in 
the bond documents. Unless a change in interest rate results in a new 
issuance, changes in interest rates do not constitute deliberate 
actions.
    (iv) Application to private security. For purposes of determining 
the present value of debt service that is secured by property, property 
is valued at fair market value as of the first date on which the 
property secures bonds of the issue.
    (c) Private payments--(1) In general. This paragraph (c) contains 
rules that apply to private payments.
    (2) Payments taken into account--(i) Payments for use--(A) In 
general. Both direct and indirect payments made by any nongovernmental 
person that is treated as using proceeds of the issue are taken into 
account as private payments to the extent allocable to the proceeds 
used by that person. Payments for a use of proceeds include payments 
(whether or not to the issuer) in respect of property financed 
(directly or indirectly) with those proceeds, even if not made by a 
private business user. Payments are not made in respect of property 
financed with proceeds if those payments are directly allocable to 
other property being directly used by the person making the payment, 
but only to the extent that those payments are reasonable compensation 
for that other use. See Example 4 and Example 5 in paragraph (g) of 
this section.
    (B) Payments not to exceed use. Payments by a person for a use of 
proceeds are allocable to the payment of the debt service on the 
proceeds used by that person (or with respect to property used by that 
person) to the extent that the present value of those payments does not 
exceed the present value of the debt service on those proceeds. Thus, 
if 7 percent of the proceeds of an issue is used by a person, payments 
by that person are taken into account as private payments only to the 
extent that the present value of those payments does not exceed the 
present value of 7 percent of the debt service on the issue.
    (C) Payments for operating expenses. Payments by a person for a use 
of proceeds do not include the portion of any payment that is properly 
allocable to the payment of ordinary and necessary expenses (as defined 
under section 162) directly attributable to the operation and 
maintenance of the financed property used by that person. For this 
purpose, general overhead and administrative expenses are not directly 
attributable to those operations and maintenance. For example, if an 
issuer receives $5,000 rent during the year for use of space in a 
financed facility and pays $500 during the year for ordinary and 
necessary expenses properly allocable to the operation and maintenance 
of that space, $500 of the $5,000 received would not be considered a 
payment for the use of the proceeds allocable to that space (regardless 
of the manner in which that $500 is actually used).
    (ii) Refinanced debt service. (A) Payments of debt service on an 
issue to be made from proceeds of a refunding issue are taken into 
account as private payments in the same proportion that--
    (1) the present value of the payments taken into account as private 
payments for the refunding issue, bears to
    (2) the present value of the debt service to be paid on the 
refunding issue.
    (B) For example, if all the debt service on a note is paid with 
proceeds of a refunding issue, the note meets the private security or 
payment test if (and to the same extent that) the refunding issue meets 
the private security or payment test. This paragraph (c)(2)(ii) does 
not apply to deliberate actions that occur more than 3 years after the 
retirement of the prior issue that are not reasonably expected on the 
issue date of the refunding issue. For purposes of this paragraph 
(c)(2)(ii), whether an issue is a refunding issue is determined without 
regard to Sec. 1.150-1(d)(2)(i) (relating to certain payments of 
interest).
    (iii) Use. For purposes of determining the amount of private 
payments, all related uses of proceeds of an issue by one person are 
treated as one use. For example, proceeds used to make a grant and a 
loan to the same person to be used to construct a facility are 
aggregated in determining the portion of the loan repayments taken into 
account as private payments.
    (3) Allocation of payments--(i) Allocations among issues. If a 
payment is made for a facility financed with two or more issues, that 
payment must be allocated among those issues according to the relative 
amounts of proceeds of each of those issues that are allocated to that 
property.
    (ii) Repayments of equity. A payment from a private business user 
of property may be allocated first to repay the issuer for any equity 
investment of the issuer in that property (that is, amounts invested by 
the issuer that do not, directly or indirectly, involve an expenditure 
of amounts borrowed).
    (d) Private security--(1) In general. This paragraph (d) contains 
rules that relate to private security.
    (2) Security taken into account. The property that is the security 
for, or the source of, the payment of debt service on a bond need not 
be property financed with proceeds. For example, unimproved land or 
investment securities used, directly or indirectly, in a private 
business use that secures a bond provides private security.
    (3) Pledge of unexpended proceeds. Proceeds qualifying for an 
initial temporary period under Sec. 1.148-2(e) (2) or (3) or on deposit 
in a reasonably required reserve or replacement fund (as defined in 
Sec. 1.148-2(f)(2)(i)) are not taken into account under this paragraph 
(d) before the date on which those amounts are either expended or 
loaned by the issuer to an unrelated party.
    (4) Secured by any interest in property or payments. Property used 
or to be used for a private business use and payments in respect of 
that property are treated as private security if any interest in that 
property or payments secures the payment of debt service on the bonds. 
For this purpose, the phrase any interest in is to be interpreted 
broadly and includes, for example, any right, claim, title, or legal 
share in property or payments. However, in order for an interest in 
property or payments to be taken into account as private security, that 
interest must secure the payment of debt service on the bonds.
    (5) Payments in respect of property. The payments taken into 
account as private security are payments in respect of property used or 
to be used for a private business use. Thus, to be taken into account 
as private security, payments need not be made by the private business 
user. Therefore, payments made by members of the general public for use 
of a facility used for a private business use may be taken into account 
as private security (for example, payments by persons using a facility 
that is the subject of a management contract that results in private 
business use). Except as otherwise provided in this paragraph (d)(5) 
and paragraph (d)(6) of this section, the rules in paragraph (c) of 
this section apply to determine the amount of payments treated as 
payments in respect of property used or to be used for a private 
business use.
    (6) Allocation of security among issues. If any property or 
payments are taken into account as private security for two or more 
issues that are equally and ratably secured (parity bonds), the 
property or payments securing those issues must be allocated among 
those issues on a reasonable basis that takes into account the relative 
amounts of debt service on each of the issues. For this purpose, any of 
the ratable allocation methods specified in Sec. 1.148-6(e)(6) 
(relating to allocations of commingled reserve or sinking funds for 
arbitrage purposes) are treated as reasonable. For bonds other than 
parity bonds, property or payments that are taken into account as 
private security (but not as private payments) are fully allocated to 
each issue secured by the property or payments.
    (e) Generally applicable taxes--(1) General rule. For purposes of 
the private security or payment test, generally applicable taxes are 
not taken into account (that is, are not payments from a 
nongovernmental person and are not payments in respect of property used 
for a private business use).
    (2) Definition of generally applicable taxes. A generally 
applicable tax is an enforced contribution exacted pursuant to 
legislative authority in the exercise of the taxing power that is 
imposed and collected for the purpose of raising revenue to be used for 
governmental purposes. A generally applicable tax must have a uniform 
tax rate that is applied to all persons of the same classification in 
the appropriate jurisdiction, and a generally applicable manner of 
determination and collection.
    (3) Special charges. A payment for a special privilege granted or 
service rendered is not a generally applicable tax. Special assessments 
paid by property owners benefiting from financed improvements are not 
generally applicable taxes. For example, a tax that is limited to the 
property or persons benefitted by an improvement is not a generally 
applicable tax.
    (4)  Manner of determination and collection--(i) In general. A tax 
does not have a generally applicable manner of determination and 
collection if one or more taxpayers make any special agreements 
relating to payment of those taxes. A special agreement relating to the 
payment of a tax is taken into account whether or not it is reasonably 
expected to result in any payments that would not otherwise have been 
made. On the other hand, if an issuer uses proceeds to make a grant to 
a taxpayer to improve property, agreements that impose reasonable 
conditions on the use of the grant do not cause a tax on that property 
to fail to be a generally applicable tax. If an agreement by a taxpayer 
causes a tax to fail to have a generally applicable manner of 
determination and collection, the entire tax paid by that taxpayer is 
treated as a special charge, unless the agreement is limited to a 
specific portion of the tax.
    (ii) Impermissible agreements. The following are examples of 
agreements that cause a tax to fail to have a generally applicable 
manner of determination and collection: an agreement to be personally 
liable, to provide additional credit support such as a third party 
guarantee, or to pay unanticipated shortfalls; an agreement regarding 
the minimum market value of property subject to property tax; and an 
agreement not to challenge or seek deferral of the tax.
    (iii) Permissible agreements. The following are examples of 
agreements that do not cause a tax to fail to have a generally 
applicable manner of determination and collection: an agreement to use 
a grant for specified purposes (whether or not that agreement is 
secured); a representation regarding the expected value of the property 
following the improvement, an agreement to insure the property and, if 
damaged, to restore the property; and a right of a grantor to rescind 
the grant if property taxes are not paid.
    (iv) Payments in lieu of taxes. A tax equivalency payment and any 
other payment in lieu of a tax is treated as a generally applicable tax 
if--
    (A) The payment is measured by and equal to the amounts imposed by 
a regular statute for a tax of general application;
    (B) The payment is imposed by a specific statute (even if another 
agreement, such as a lease, is used as the vehicle for collection); and
    (C) The payment is designated for a public purpose rather than for 
a privilege, service or regulatory function, or for any other local 
benefit tending to increase the value of the property with respect to 
which the payments are made.
    (f) Certain waste remediation bonds--(1) Scope. This paragraph (f) 
applies to bonds issued to finance hazardous waste clean-up activities 
on privately owned land (hazardous waste remediation bonds).
    (2) Persons that are not private users. Payments from 
nongovernmental persons who are not (other than coincidentally) either 
users of the site being remediated or persons potentially responsible 
for disposing of hazardous waste on that site are not taken into 
account as private security. This paragraph (f)(2) applies to payments 
that secure the payment of principal of, or interest on, the bonds 
(directly or indirectly) under the terms of the bonds. This paragraph 
(f)(2) applies only if the payments are made pursuant to either (i) a 
generally applicable state or local taxing statute, or (ii) a state or 
local statute that regulates or restrains activities on an industry-
wide basis of persons who are engaged in generating or handling 
hazardous waste, or in refining, producing, or transporting petroleum, 
provided that those payments do not represent, in substance, payment 
for the use of proceeds. For this purpose, a state or local statute 
that imposes payments that have substantially the same character as 
those described in Chapter 38 of the Code are treated as generally 
applicable taxes.
    (3) Persons that are private users. If payments from 
nongovernmental persons who are either users of the site being 
remediated or persons potentially responsible for disposing of 
hazardous waste on that site do not secure the payment of principal of, 
or interest on, the bonds (directly or indirectly) under the terms of 
the bond, the payments are not taken into account as private payments. 
This paragraph (f)(3) applies only if at the time the bonds are issued 
the payments from those nongovernmental persons are not material to the 
security for the bonds. For this purpose, payments are not material to 
the security for the bonds if--
    (i) The payments are not required for the payment of debt service 
on the bonds;
    (ii) The amount and timing of the payments are not structured or 
designed to reflect the payment of debt service on the bonds;
    (iii) The receipt or the amount of the payment is uncertain (for 
example, as of the issue date, no final judgment has been entered into 
against the nongovernmental person);
    (iv) The payments from those nongovernmental persons, when and if 
received, are used either to redeem bonds of the issuer or to pay for 
costs of any hazardous waste remediation project; and
    (v) If a judgment (but not a final judgment) has been entered 
against a nongovernmental person by the issue date, there are, as of 
the issue date, costs of hazardous waste remediation other than those 
financed with the bonds that may be financed with the payments.
    (g) Examples. The following examples illustrate the application of 
this section:

    Example 1. Aggregation of payments. State B issues bonds with 
proceeds of $10 million. B uses $9.7 million of the proceeds to 
construct a 10-story office building. B uses the remaining $300,000 
of proceeds to make a loan to Corporation Y to finance unrelated 
privately owned facilities. In addition, X leases 1 floor of the 
building for a significant period that is less than the term of the 
bonds. As a percentage of the present value of the debt service on 
the bonds, the present value of Y's loan repayments is 3 percent and 
the present value of X's lease payments is 8 percent. The bonds 
satisfy the private security or payment test because the private 
payments taken into account are more than 10 percent of the present 
value of the debt service on the bonds.
    Example 2. Indirect private payments. J, a political subdivision 
of a state, will issue several series of bonds from time to time and 
will use the proceeds to rehabilitate urban areas. More than 10 
percent of the proceeds of each issue will be used for the 
rehabilitation and construction of buildings that will be leased or 
sold to nongovernmental persons for use in their trades or business. 
Nongovernmental persons will make payments for these sales and 
leases that have an aggregate present value that is more than the 
present value of debt service on 10 percent of each issue. There is 
no limitation either on the number of issues or the aggregate amount 
of bonds that may be outstanding. No group of bondholders has any 
legal claim prior to any other bondholders or creditors with respect 
to specific revenues of J, and there is no arrangement whereby 
revenues from a particular project are paid into a trust or 
constructive trust, or sinking fund, or are otherwise segregated or 
restricted for the benefit of any group of bondholders. There is, 
however, an unconditional obligation by J to pay the principal of 
and interest on each issue. The bonds meet the private security or 
payment test because all of the private payments are counted.
    Example 3. Allocations of payments. City Z purchases property 
for $1,250,000 using $1,000,000 of proceeds of its tax increment 
bonds and $250,000 of other revenues that are in its redevelopment 
fund. The bonds are secured only by the incremental property taxes 
on the property attributable to the increase in value of the 
property from the planned redevelopment of the property. Z will 
reimburse the redevelopment fund from amounts paid from the resale 
of the property. After clearing the property, Z sells it to 
Developer M for $250,000, an amount not in excess of the fair market 
value of the land, which Z uses to reimburse the redevelopment fund. 
Although M uses the property financed with the proceeds of the 
bonds, it also directly uses property that was not financed with 
those proceeds. The payments by M are properly allocable to the 
property financed with the amounts in Z's redevelopment fund. 
Accordingly, the issue does not meet the private security or payment 
test because of M's $250,000 payment. See paragraph (c)(3)(ii) of 
this section.
    Example 4. Payments in respect of bond financed property. In 
order to further public safety, City Y issues $5,000,000 of its tax 
assessment bonds the proceeds of which are used to move existing 
electric utility lines underground. Although the utility lines are 
owned by a nongovernmental utility company, that company is under no 
obligation to move the lines. The debt service on the bonds will be 
paid using assessments levied by City Y on the customers of the 
utility. Although the utility lines are privately owned and the 
utility customers make payments to the utility company for the use 
of those lines, the assessments are payments in respect of the cost 
of relocating the utility line. Thus, the assessment payments are 
not made in respect of property used for a private business use. Any 
direct or indirect payments to Y by the utility are, however, taken 
into account as private payments.
    Example 5. Management contract. City P issues general obligation 
bonds to finance the renovation of a hospital that it owns. The 
hospital is operated for P by D, a nongovernmental person, under a 
management contract that results in private business use under 
Sec. 1.141-3. P will use the revenues from the hospital (after the 
required payments to D) to pay the debt service on the bonds. The 
bonds satisfy the private security or payment test because the 
revenues from the hospital are payments in respect of property used 
for a private business use.
    Example 6. Lease financing. (i) County W issues certificates of 
participation in a lease of a building that W owns and covenants to 
appropriate annual payments for the lease. A portion of each payment 
is specified as interest. More than 10 percent of the building is 
used for private business use. None of the proceeds of the 
obligations are used with respect to the building. W uses more than 
10 percent of the proceeds of the obligations to construct a stadium 
that is to be used for a private business use. If W defaults under 
the lease, the trustee for the holders of the certificates of 
participation has a limited right of repossession under which the 
trustee may not foreclose but may lease the property to a new tenant 
at fair market value. The obligations are secured by an interest in 
property used for a private business use and, therefore, the 
obligations satisfy the private security for payment test.
    (ii) The facts are the same as in part (i) of this Example 6 
except that, under the terms of the lease, in the event of a default 
by W, the trustee's only rights are to sue W for any failure to make 
payments pursuant to the lease. Thus, the trustee has no rights to 
the building and no limited right of repossession. The right to 
receive lease payments is not an interest in the leased property 
and, therefore, this right does not provide private security.
    Example 7. Limitation of payments to use not determined 
annually. City Q issues bonds with a term of 15 years and uses the 
proceeds to construct an office building. The debt service on the 
bonds is level throughout the 15-year term. O enters into a 5-year 
lease of 11 percent of the building with Corporation R under which R 
will make lease payments equal to 20 percent of the annual debt 
service on the bonds for each year of the lease. The present value 
of R's lease payments is equal to 12 percent of the present value of 
the debt service over the entire 15-year term of the bonds. If, 
however, the lease payments taken into account as private payments 
were limited to 11 percent of debt service paid in each year of the 
lease, the present value of these payments would be only 8 percent 
of the debt service on the bonds over the entire term of the bonds. 
The bonds satisfy the private security or payment test, because R's 
lease payments are taken into account as private payments in an 
amount not to exceed 11 percent of the debt service on the bonds 
over the term of the bonds (rather than 11 percent per year).
    Example 8. Parity bonds. University L, a political subdivision, 
issued three separate series of revenue bonds during 1989, 1991, and 
1993 under the same bond resolution. L used the proceeds to 
construct facilities exclusively for its own use. Bonds issued under 
the resolution are equally and ratably secured and payable solely 
from the income derived by L from rates, fees, and charges imposed 
by L for the use of the facilities. The bonds issued in 1989, 1991, 
and 1993 are not private activity bonds. In 1995, L issues another 
series of bonds under the resolution to finance additional 
facilities. L enters into 10-year leases for 20 percent of the new 
facilities with nongovernmental persons who will use the facilities 
in their trades or businesses. The present value of the lease 
payments from the nongovernmental users will equal 15 percent of the 
present value of the debt service on the 1995 bonds. L will 
commingle all of the revenues from all its bond-financed facilities 
in its revenue fund. The portion of the lease payments from 
nongovernmental lessees of the new facilities allocable to the 1995 
bonds under Sec. 1.148-6(e)(6) is less than 10 percent of the 
present value of the debt service on the 1995 bonds. The 1995 bonds 
will meet the private security or payment test because the private 
lease payments for the new facility are properly allocated to those 
bonds (that is, because none of the proceeds of the prior issues 
were used for the new facilities).
    Example 9. Variable yield issues. (i) City M issues general 
obligation bonds with proceeds of $10 million to finance a 5-story 
office building. The bonds bear interest at a variable rate that is 
recomputed monthly according to an index that reflects current 
market yields. They yield that the interest index would produce on 
the issue date is 6 percent. M leases one floor of the office 
building to Corporation T, a nongovernmental person, for the term of 
the bonds. Using the 6 percent yield as the discount rate, M 
reasonably expects on the issue date that the present value of lease 
payments to be made by T will be 8 percent of the present value of 
the total debt service on the bonds. After the issue date of the 
bonds, interest rates decline significantly, so that the yield on 
the bonds over their entire term is 4 percent. Using this actual 4 
percent yield as the discount rate, the present value of lease 
payments made by T is 12 percent of the present value of the actual 
total debt service on the bonds. The bonds are not private activity 
bonds because M reasonably expected on the issue date that the bonds 
would not meet the private security or payment test and because M 
did not take any subsequent deliberate action to meet the private 
security or payment test.
    (ii) The facts are the same as part (i) of this Example 9, 
except that 5 years after the issue date M leases a second floor to 
Corporation S, a nongovernmental person, under a long-term lease. On 
the date this lease is entered into M reasonably expects that the 
yield on the bonds over their entire term will be 5.5 percent, based 
on actual interest rates to date and the then-current rate on the 
variable yield bonds. Using this 5.5 percent yield as the discount 
rate, as a percentage of the present value of the debt service on 
the bonds, the present value of lease payments made by T is 9 
percent and the present value of the lease payments made by S is 2 
percent. The bonds are private activity bonds because M has taken a 
subsequent deliberate action that causes the bonds to meet the 
private security or payment test.
    Example 10. Stadium ticket tax. (i) Authority issues its bonds 
to finance the construction of a stadium. Under a long-term lease, 
Corporation X, a professional sports team, will use more than 10 
percent of the stadium. Corporation X will not, however, make any 
payments for this private business use. The security for the bonds 
will be a ticket tax imposed on each person purchasing a ticket for 
an event at the stadium. The portion of the ticket tax attributable 
to tickets purchased by persons attending X's events will, on a 
present value basis, exceed 10 percent of the present value of 
Authority's bonds. The bonds satisfy the private security or payment 
test. The ticket tax is not a tax of general application and, to the 
extent that the tax receipts relate to X's events, the taxes 
constitute payments in respect of property used for a private 
business use.
    (ii) The facts are the same as in part (i) of this Example 10, 
except that the ticket tax is imposed by Authority on tickets 
purchased for events at a number of large entertainment facilities 
within the jurisdiction of Authority (for example, other stadiums, 
arenas, concert halls, etc.), some of which were not financed with 
tax-exempt bonds. The ticket tax is a tax of general application and 
therefore the revenue from this tax are not payments in respect of 
property used for a private business use. Therefore, the bonds do 
not satisfy the private security or payment test.


Sec. 1.141-5  Private loan financing test.

    (a) In general--(1) General rule. Bonds of an issue are private 
activity bonds if more than the lesser of 5 percent of the proceeds or 
$5 million of the sale proceeds of the issue is to be used (directly or 
indirectly) to make or finance loans to persons other than governmental 
units. Section 1.141-2(d) applies in determining whether the private 
loan financing test is met.
    (2) Direct and indirect use of proceeds determinative. In 
determining whether the proceeds of an issue are used to make or 
finance loans, indirect, as well as direct, use of the proceeds is 
taken into account. Any use of proceeds by a governmental person that 
results in the expenditure of those proceeds (rather than the 
acquisition of investment property), such as a grant, is treated as the 
ultimate use of those proceeds. For purposes of this paragraph (a)(2), 
investment property has the meaning in Sec. 1.148-1, except that tax-
exempt bonds may be treated as investment property. See Sec. 1.148-6 
for rules to determine when proceeds are expended.
    (3) Measurement of test. In determining whether the private loan 
financing test is met, the amount actually loaned to a nongovernmental 
person is not discounted to reflect the present value of the loan 
repayments.
    (b) Definition of loan--(1) General federal tax principles apply. 
Any transaction that, for federal income tax purposes generally, is 
characterized as a loan is a loan for purposes of this section. Thus, 
the determination of whether a loan is made depends on the substance of 
a transaction. For example, a lease or other contractual arrangement 
(for example, a management contract) may in substance constitute a loan 
if the arrangement transfers tax ownership of the facility to a 
nongovernmental person. Similarly, an output contract with respect to a 
financed facility generally is not treated as a loan of proceeds unless 
the agreement in substance shifts significant burdens and benefits of 
ownership to the nongovernmental purchaser or manager of the facility.
    (2) Exception if no use of bonds proceeds. Any use of proceeds that 
does not, treating the user as a nongovernmental person that is not a 
natural person, give rise to private business use, is not a loan of 
proceeds. See Sec. 1.141-3.
    (3) Hazardous waste remediation bonds. In the case of an issue of 
hazardous waste remediation bonds, payments from nongovernmental 
persons that are either users of the site being remediated or persons 
potentially responsible for disposing of hazardous waste on that site 
do not indicate a loan for purposes of this section. This paragraph 
(b)(3) applies only if those payments do not secure the payment of 
principal of, or interest on, the bonds (directly or indirectly), under 
the terms of the bonds and those payments are not taken into account 
under the private payment test pursuant to Sec. 1.141-4(f)(3).
    (4) Prepayments. A prepayment does not result in a loan of proceeds 
if the prepayment is not investment-type property. In applying the 
definition of investment-type property under Sec. 1.148-1, providing 
the benefits of tax-exempt financing to the seller of the property or 
service is treated as an investment return to the issuer.
    (5) Grants--(i) In general. A grant of proceeds is not a loan. 
Whether a transaction is a grant or a loan depends on all the facts and 
circumstances.
    (ii) Tax increment financing--(A) In general. Generally, a loan 
does not result from the making of a grant using proceeds of an issue 
that is secured by generally applicable taxes attributable to the 
improvements to be made with the grant unless the grantee makes any 
special agreements relating to the payment that results in those taxes 
failing to be generally applicable under Sec. 1.141-4(e).
    (B) Amount of loan. If a grant is treated as a loan under this 
paragraph (b)(5), the entire grant is treated as a loan unless the 
special agreement is limited to a specific portion of the related tax.
    (c) Tax assessment bond exception--(1) General rule. For purposes 
of this section, a tax assessment loan that meets the requirements of 
this paragraph (c) is not a loan.
    (2) Tax assessment loan defined--(i) In general. A tax assessment 
loan is a loan that arises for federal tax purposes when a governmental 
unit permits or requires its residents to pay a tax or assessment over 
a period of years. The tax assessment loan exception may apply if the 
assessed property is used by a nongovernmental person in its trade or 
business (whether or not private business use) or for nonbusiness 
purposes. In addition, a tax assessment loan must satisfy the following 
requirements:
    (A) Mandatory tax or assessment. The loan must arise from the 
imposition of a mandatory tax or other assessment of general 
application.
    (B) Essential governmental function. The mandatory tax or 
assessment (collectively, assessments) must be imposed for one or more 
specific, essential governmental functions (as opposed to installment 
payments of property taxes or other taxes);
    (C) Equal basis requirement. If the property that is subject to the 
tax or assessment is used by a nongovernmental person, owners of both 
business and nonbusiness property benefiting from the financed 
improvements are eligible or required to make deferred payments of the 
assessment on an equal basis (the equal basis requirement).
    (ii) [Reserved]
    (3) Mandatory tax or other assessment. An assessment is an enforced 
contribution that is imposed and collected for the purpose of raising 
revenue to be used for a specific purpose (that is, to defray the 
capital cost of an improvement). Assessments must be levied on a 
property frontage basis, an ad valorem basis, or any other comparable 
method that results in equivalent mandatory assessment to all residents 
benefiting from the improvements in an amount proportionate to the 
benefit to the assessed property. Assessments do not include fees for 
services.
    (4) Specific essential governmental function. For this purpose, in 
general, the term essential governmental function has the same meaning 
as under section 7871. An essential governmental function does not 
include any function to the extent that it is not customarily performed 
(and financed with governmental bonds) by governments with general 
taxing powers. In determining whether an activity is customarily 
performed by a governmental unit, isolated instances of bond financing 
are disregarded. Examples of specific essential governmental functions 
for purposes of this section include street paving and street-light 
installation, sewage treatment and disposal, and municipal water 
facilities, but not commercial or industrial ventures. A specific 
essential governmental function does not include permitting installment 
payments of property taxes or other taxes or any improvement to 
property owned by a nongovernmental person.
    (5) Equal basis requirement--(i) In general. An assessment does not 
satisfy the equal basis requirement if the terms for payment of the 
assessment are not the same for all assessed persons (for example, if 
certain residents are permitted to pay the assessment over a period of 
years while others must pay the entire assessment immediately or if the 
assessment is required to be prepaid when the property is sold). In 
addition, the amounts payable and the rates used to determine those 
amounts must be determined on the basis of non-discriminatory criteria. 
Thus, for example, an assessment does not satisfy the equal basis 
requirement if imposed on a different basis for business and non-
business beneficiaries. The equal basis requirement is not, however, 
violated solely because an assessment varies on the basis of the 
relative benefit conferred.
    (ii) Additional security. The equal basis requirement is not 
violated as a result of one benefitted party acquiring a guaranty of a 
third party to pay debt service on bonds if it is not reasonably 
expected that payments will be made because of the additional 
assurances that otherwise not have been made and the guarantor's 
recourse is limited to the assessments and the benefitted property.
    (6) Coordination with private business tests. See Secs. 1.141-3 and 
1.141-4 for rules for determining whether tax assessment loans cause 
the bonds financing those loans to be private activity bonds under the 
private business use and the private security or payment tests.
    (d) Nonpurpose investment exception. Any loan that is a nonpurpose 
investment is not treated as a loan for purposes of this section. Thus, 
for example, proceeds invested in loans such as obligations of the 
United States during any available temporary period, as part of a 
reasonably required reserve or replacement fund, as part of a refunding 
escrow, or as part of a minor portion (as each of those terms is 
defined under Sec. 1.148-1(b)) are not loans for purposes of this 
section. This paragraph (d) does not apply to any nonpurpose investment 
acquired pursuant to a plan to avoid the limitations of section 141(c) 
and this section.
    (e) Examples. The following examples illustrate the application of 
this section:

    Example 1. State agency Z and federal agency H will each 
contribute to rehabilitate a project owned by Z. H can only provide 
its funds through a contribution to Z to be used to acquire the 
rehabilitated project on a turnkey basis from an approved developer. 
Under H's turnkey program, the developer must own the project while 
it is rehabilitated. Z issues its notes to provide funds for 
construction. A portion of the notes will be retired using the H 
contribution, and the balance of the notes will be retired through 
the issuance by Z of long-term bonds. Z lends the proceeds of its 
note to Developer B as construction financing and transfers title to 
B for a nominal amount. The conveyance is made on condition that B 
rehabilitate the property and reconvey it upon completion, with Z 
retaining the right to force reconveyance if these conditions are 
not satisfied. B must name Z as an additional insured on all 
insurance. Upon completion, B must transfer title to the project 
back to Z at a set price, which price reflects B's costs and profit, 
not fair market value. Further, this price is adjusted downward to 
reflect any cost-underruns. For purposes of section 141(c), this 
transaction does not involve a private loan.
    Example 2. Assessment district U issues bonds the proceeds of 
which are used to construct water and sewer improvements in the 
district. At the time that the bonds are issued, all of the property 
in the district is owned by several developers, each of which is in 
the trade or business of developing the property in the district for 
residential use. In accordance with the procedures required by 
applicable State law, U imposes assessments on each parcel in the 
district. U requires that, at the time that a developer sells a 
residential parcel, the developer must prepay the remaining amount 
of the assessment. The assessments do not satisfy the equal basis 
requirement, because the payment terms are not the same for all 
assessed persons.


Sec. 1.141-6  Allocation and accounting rules.

    (a) Allocation of proceeds to expenditures generally. For purposes 
of Secs. 1.141-1 through 1.141-16, the provisions of Sec. 1.148-6(d) 
apply for purposes of allocating proceeds to expenditures, except that 
Sec. 1.148-6(d)(6) does not apply. Thus, allocations generally may be 
made using any reasonable, consistently applied accounting method, and 
allocations under section 141 and section 148 must be consistent with 
each other.
    (b) Special rules for mixed use facilities--(1) Allocation of 
expenditures to mixed use facilities. Proceeds may be specifically 
allocated to the expenditures comprising a discrete portion of a mixed 
use facility. To approximate the actual expenditures, a percentage of 
actual costs based on rental values or usable space may be used if 
reasonable based on all the facts and circumstances.
    (2) Mixed use facility defined--(i) Discrete portions. A mixed use 
facility is a facility containing two or more discrete portions. A 
discrete portion of a mixed use facility is a portion of a facility 
that consists of--
    (A) Any separate and discrete portion of a facility (for example, a 
floor of a building, a portion of a building separated by walls, 
partitions, or other physical barriers) to which use is limited (other 
than common area use); or
    (B) An undivided ownership interest in an output facility, sewage 
facility, water collection, storage, or distribution facilities, or any 
similar utility system (for example, railroads or fiber optic networks, 
but not airports or stadiums) or a portion of such a facility that, if 
owned by a person other than the actual owner, would constitute an 
undivided ownership interest.
    (ii) Special rule for certain facilities. To the extent that a 
mixed use facility consists of discrete portions that are used for a 
government use in the same manner as for a private business use, 
proceeds allocated to expenditures comprising one discrete portion may 
be subsequently reallocated to expenditures comprising another discrete 
portion in that facility.
    (iii) Examples. The following examples illustrate the application 
of this paragraph (b)(2).

    Example 1. State S and Corporation C enter into an agreement 
under which C will lease for 20 years the third and fourth floors of 
an 11-story office building to be constructed on land that S will 
acquire. S will occupy the grade floor and the remaining eight 
floors of the building. S will issue $10 million of bonds the 
proceeds of which will be used to finance 10/11ths of the cost of 
the purchase of the land and construction of the building. S will 
use other funds for the remaining costs of the land and building. 
From the facts and circumstances presented, it is determined that an 
allocation of the costs of the acquisition of land and the 
construction of the building to the leased space based on the ratio 
of area leased to the entire building is reasonable. Thus, no 
proceeds are allocated to 1 of the 2 floors used by C.
    Example 2. The facts are the same as in Example 1 except that 
some years after the building is placed in service, C and S agree 
that, in order to consolidate certain uses, S will begin to occupy 
the third and fourth floors and C will begin to occupy the seventh 
and eighth floors, each of which has an equal rental value. The 
result is the same as in Example 1.

    (c) Allocation of disposition proceeds. Except as otherwise 
provided in this paragraph (c) and Sec. 1.141-1(c), disposition 
proceeds are allocated under the rules of this section. If a transfer 
that produces disposition proceeds is made pursuant to an installment 
sale or the property otherwise continues to have a nexus to the bonds, 
however, the disposition proceeds are allocated to the transferred 
property.
    (d) Allocation of common areas. The allocation of proceeds to 
common areas may be made according to any reasonable method that 
properly reflects the proportionate benefit to be derived directly or 
indirectly by the users of the facility.
    (e) Allocation of proceeds to bonds. Proceeds are allocated to 
bonds in a manner consistent with the allocation rules of Sec. 1.148-
9(h).


Sec. 1.141-7  Special rules for output facilities.

    (a) Private business use and private security or payments test--(1) 
General rule. The purchase by one or more nongovernmental persons of 
more than 10 percent of the available output of an output facility 
(including water facilities) financed with the proceeds of an issue may 
satisfy the private business use test and the private security or 
payment test under section 141(b)(1) and (2). These tests are satisfied 
if that use has the effect of transferring to those nongovernmental 
persons substantial benefits of owning the facilities and substantial 
burdens of paying the debt service on bonds used (directly or 
indirectly) to finance the facilities (the benefits and burdens test), 
so as to constitute the indirect use by those persons of (and the 
indirect payment by those persons of debt service of) more than 10 
percent of those proceeds.
    (2) Application of benefits and burdens test. The benefits and 
burdens test is satisfied (and the bonds are private activity bonds 
under section 141(b)(1) and (2)) if each of the following conditions is 
satisfied:
    (i) Either--
    (A) A nongovernmental person agrees pursuant to a contract to take, 
or take or pay for, more than 10 percent of the available output of a 
facility; or
    (B) Two or more nongovernmental persons, each of whom pays an 
average annual demand charge or other guaranteed minimum payment during 
the contract term exceeding 1 percent of the average annual debt 
service with respect to the issue agree to take or take or pay for more 
than 10 percent of the available output of a facility. For purposes of 
this section, contractual conditions related to the production of 
output are disregarded;
    (ii) Payments made or to be made with respect to contracts 
described in paragraph (a)(2)(i) of this section by nongovernmental 
persons (or by other persons under those contracts) exceed 10 percent 
of the debt service with respect to that issue over the contract term, 
determined under the rules provided in Sec. 1.141-4 (that is, on a 
present value basis).
    (3) Special rules and definitions. For purposes of this paragraph 
(a) the following special rules and definitions apply:
    (i) Available output. The available output of a facility is 
determined by multiplying the number of units produced or to be 
produced by the facility in one year by the number of years in the 
contract term of the issue issued to finance that facility. The number 
of units produced or to be produced by a generating facility in one 
year is determined by reference to its nameplate capacity or the 
equivalent (or where there is no nameplate capacity or the equivalent, 
its maximum capacity) and is reduced to account for scheduled 
maintenance but not for reserves or other unutilized capacity. If 
nameplate capacity or the equivalent is greater than 150 percent of the 
average expected output during the contract term, average expected 
output is used in lieu of nameplate capacity. For transmission 
facilities and cogeneration facilities, available output must be 
measured in a reasonable manner. For example, for short, radial 
transmission lines, thermal capacity may be reasonable. Similarly, for 
a transmission network, the use of load share ratios, in a manner 
consistent with the requirements of the Federal Energy Regulatory 
Commission, may be reasonable.
    (ii) Contract term. The contract term of an issue begins on the 
date the output facility is placed in service (but not earlier than the 
issue date of the bonds), and ends on the final maturity date of the 
issue (determined without regard to any optional redemption dates.) If 
a contract may be extended by the owner of the facility, the term of 
the contract includes the period for which that contract may be so 
extended.
    (iii) Refundings and extensions of maturity. In determining the 
contract term and debt service on an issue under paragraphs (a)(2)(ii) 
and (a)(3)(ii) of this section if, on or before the issue date of an 
issue to finance a facility, the issuer makes a commitment (for 
example, in the bond documents) to refund that issue with a refunding 
issue, the contract term and debt service are based on the final 
maturity date of any bond of the refunding issue (determined without 
regard to any optional redemption dates).
    (iv) Take or take or pay contracts. A take or pay contract is a 
contract under which the purchaser agrees to pay for the output under 
the contract, whether or not that output is received by the purchaser. 
A take contract is a contract under which the purchaser agrees to pay 
for the output under the contract if the output facility is capable of 
providing the service. In the case of a transmission facility, both 
agreements to provide firm transmission services and agreements to 
provide transmission service comparable to the owner's own use are 
treated as a take or take or pay contracts.
    (v) Certain requirements contracts treated as take or take or pay 
contracts--(A) In general. An agreement by a nongovernmental person to 
purchase all of its output requirements (a requirements contract) is 
not a take or take or pay contract unless the purchaser agrees to pay a 
guaranteed minimum payment or if the purchaser has no substantial 
ability to purchase its output requirements from other sources.
    (B) Requirements for certain contracts. A requirements contract 
entered into on or after the date that is 60 days after publication of 
final regulations is a take or take or pay contract if the purchaser 
has priority rights to the output (or rights to control the allocation 
of the available output), if it is reasonably expected that the 
purchaser will purchase at least 10 percent of the available output of 
the facility, or if the purchaser under the contract is a regulated 
utility that is in the business of reselling output of the type 
purchased. For these purposes, to the extent that the amount of output 
under the contract does not increase, a contract is treated as entered 
into before the date that is 60 days after publication of final 
regulations notwithstanding an extension of the contract term or 
changes to other terms of the contract, provided that there is no 
change, directly or indirectly, in the parties to the contract and the 
weighted average maturity of the bonds financing the facility is not 
extended.
    (vi) Reasonable expectations determinations. The provisions of this 
paragraph (a) regarding renewals of output contracts and the issuer's 
requirements for output from the facility are applied on the basis of 
the issuer's reasonable expectations as of the issue date.
    (4) Benefits and burdens test not exclusive. The benefits and 
burdens test of this section is not the exclusive means by which bonds 
financing output facilities may satisfy the private business use or 
private security or payment tests. Thus, for example, an output 
facility that is leased to a nongovernmental person may satisfy the 
private business use test.
    (b) Pooling, exchange, spot sales, and wheeling arrangements--(1) 
Swapping and pooling arrangements. An agreement that provides for 
swapping or pooling of power by one or more governmental persons and 
one or more nongovernmental persons does not result in private business 
use of the output facility owned by the governmental person if--
    (i) Net importers. (A) Under the agreement, on an annual basis and 
without regard to emergency consumption, the governmental person is a 
net importer of power (for example, output produced at a particular 
facility that is owned by a governmental person is provided to a 
nongovernmental person in exchange for output with a greater value to 
be delivered by the nongovernmental person at a different location); 
and
    (B) The facilities are not designed differently, sized larger, 
built sooner, or constructed in a more costly manner than is reasonably 
necessary for the ordinary customers of the owner of the facilities; or
    (ii) Temporary outages, etc. (A) The swapped power is approximately 
equal in value determined over periods of one year or less;
    (B) The agreement is not a take or take or pay contract; and
    (C) The purpose of the agreement is to enable each of the parties 
to satisfy different peak load demands or to accommodate temporary 
outages.
    (2) Certain conduit parties disregarded. The presence of a 
nongovernmental person acting solely as a conduit for the exchange of 
output among governmentally owned and operated utilities is disregarded 
in determining whether the private business tests are satisfied with 
respect to financed facilities other than those of the nongovernmental 
person.
    (3) Spot sales. Spot sales of excess power capacity for temporary 
periods, other than pursuant to take or take or pay contracts, do not 
result in private business use. For this purpose, a spot sale is a sale 
pursuant to a single agreement that is limited to no more than 30 days' 
duration including renewal periods.
    (4) Wheeling--(i) General rule. Use of transmission facilities 
financed by an issue is not treated as private business use to the 
extent that it results from an order or actions taken in response to 
(or to prevent) an anticipated order by the United States that those 
facilities be used to provide transmission services to a particular 
nongovernmental person (including a requirement that the owner or 
operator either purchase the output of a facility or provide 
transmission services). This paragraph (b)(4) applies only if--
    (A) The transmission facilities were financed based on the issuer's 
reasonable expectations regarding the amount of wheeling anticipated;
    (B) The terms of the transmission agreement are bona fide and 
arm's-length, and the new user pays consideration equal to the fair 
market value for the use of the financed property (for example, as 
determined by the Federal Energy Regulatory Commission); and
    (C) No circumstances are present that indicate an attempt to avoid 
directly or indirectly the requirements of section 141.
    (ii) Exceptions. This paragraph (b)(4) does not, however, apply to 
any transmission facilities (or portion thereof) that are--
    (A) Made necessary by the agreement to provide transmission 
service, including improvements needed due to increased loads;
    (B) Designed differently, sized larger, built sooner, or 
constructed in a more costly manner than is reasonably necessary for 
the ordinary customers of the owner of the transmission facilities; or
    (C) In excess of the services that are reasonably necessary to the 
purchaser of the output being transmitted.
    (iii) Special limitation. If the transmission services provided 
under this paragraph (b)(4) involve more than 20 percent of the 
facility financed with proceeds of the issue, paragraph (b)(4)(i) of 
this section applies only if the issuer takes a remedial action 
described in Sec. 1.141-13 regarding the bonds allocable to that use. 
Paragraph (b)(4) of Sec. 1.141-13 does not apply for this purpose. This 
paragraph (b)(4)(iii) does not apply if substantially all of the 
consideration for providing the transmission services is the provision 
of other output property (for example, transmission).
    (c) Certain short term contracts. The purchase of the output of an 
output facility by a nongovernmental person pursuant to an output 
contract is not treated as private business use if:
    (1) As of the later of the issue date or the date the contract is 
entered into, the issuer reasonably expects that at the expiration of 
that agreement the related output will not be used for a private 
business use (determined without regard to this paragraph (c)) and no 
subsequent deliberate actions are taken that are inconsistent with this 
reasonable expectation;
    (2) The contract has a term not in excess of 1 year and cannot be 
renewed or extended beyond this 1-year term; and
    (3) The facilities are not designed differently, sized larger, 
built sooner, or constructed in a more costly manner than is reasonably 
necessary for the ordinary customers of the owner of the facilities.
    (d) Allocations of output facilities and systems--(1) Facts and 
circumstances analysis. Whether output sold under a contract is 
allocated to a particular facility (for example, a generating unit), to 
the entire system of the seller of that output (net of any uses of that 
system output allocated to a particular facility), or to a portion of a 
facility is based on all the facts and circumstances, including whether 
the transaction is inconsistent with the purpose of section 141. In 
general, output is allocated to a facility or system only to the extent 
that it is physically possible. For example, output from a generating 
unit that is fed directly into a lower voltage distribution system of 
the owner of that unit generally cannot leave that distribution system 
and, therefore, must be allocated to those receiving electricity 
through that distribution system. Output may be allocated without 
regard to physical limitations, however, if exchange agreements, or 
similar agreements, provide output to a purchaser where, but for the 
exchange agreements, it would not be possible for the seller to provide 
output to that purchaser.
    (2) Factors. Except as provided in paragraph (d)(1) of this 
section, contractual terms relating to the delivery of the output (such 
as delivery limitations and options or obligations to deliver power 
from additional sources) are the most significant factor in allocating 
output to a facility or system. For example, a contract to provide a 
specified amount of electricity from a system, but only when at least 
that amount of electricity is being generated by a particular unit, 
generally is allocated to that unit. Similarly, a contract to buy 20 Mw 
of system power with a right to take up to 40 percent of the actual 
output of a specific 50 Mw facility whenever total system output is 
insufficient to meet all of the seller's obligations generally is 
allocated to the specific facility rather than the system. The method 
of pricing output under the contract and the consistency of the 
contract with commercially reasonable terms are also significant 
factors. For example, output sold under a contract to provide peaking 
capacity from a combustion turbine generally is allocated to that 
turbine if the contract provides for pricing that is typical of peaking 
unit pricing, this pricing is based on the capital and generating costs 
of that turbine, or no power need be delivered if that turbine is 
inoperable.
    (3) Allocations among users. A facility or system (or portion 
thereof) that, under this paragraph (d), is allocable to two or more 
users generally is allocated among those users on a ratable basis. 
Payments for output provided by an output facility financed with two or 
more issues of bonds generally are allocated ratably among the issues 
according to the relative amounts of proceeds of each issue used to 
finance that facility.
    (4) Electric transmission facilities. If a contract for use of a 
transmission facility provides for payments for transmission services 
using a more accurate method of measuring the transmission facilities 
used than the contract path specified by the parties (for example, a 
method that accounts for loop flow or a method based on load share 
ratios of a network), that method must be used to determine use under 
this paragraph. In other cases, the determination of use of an electric 
transmission facility may be based on the contract path specified by 
the parties to the contract, if reasonable.
    (5) Conservation facilities. In general, the financing of an output 
conservation improvement is treated as the acquisition of an output 
facility by the utility sponsoring the improvement. The use of a 
conservation improvement is allocated under the rules in this paragraph 
(d). Thus, generally, the output attributable to a conservation 
improvement is allocable to the beneficiary of that output.
    (e) Examples. The following examples illustrate the application of 
this section.

    Example 1. Joint ownership. Z, a privately owned electric 
utility, and City H agree to construct an electric generating 
facility of a size sufficient to take advantage of the economies of 
scale. H will issue $50 million of its 25-year bonds and Z will use 
$100 million of its funds for construction of a facility they will 
jointly own as tenants in common. Each of the participants will 
share in the ownership, output, and operating expenses of the 
facility in proportion to its contribution to the cost of the 
facility, that is, one-third by H and two-thirds by Z. H's bonds 
will be secured by H's ownership in the facility and by revenues to 
be derived from its share of the annual output of the facility. 
Because H will need only 50 percent of its share of the annual 
output of the facility during the first 20 years of operations, it 
agrees to sell Z 10 percent of its share of that annual output for a 
period of 20 years pursuant to a contract under which Z agrees to 
take that power if available. The facility will begin operation and 
Z will begin to receive power 4 years after the H bonds are issued 
and, therefore, the contract term of the issue will be 21 years. H 
also agrees to sell the remaining excess portion of its share of the 
annual output (40 percent) to numerous other private utilities under 
a prevailing rate schedule, including demand charges. No contracts 
will be executed obligating any person other than Z to purchase any 
specified amount of the power for any specified period of time and 
no person (other than Z) will pay a demand charge or other minimum 
payment under conditions which, under paragraph (a) of this section, 
result in a transfer of substantial benefits of ownership and 
substantial burdens of paying the debt service on bonds used 
directly or indirectly to provide those facilities. The bonds are 
not private activity bonds because H's one-third interest in the 
facility (financed with proceeds) is treated as a discrete portion 
of a mixed use facility and, although 10 percent of H's interest in 
the annual output of the facility will be used, directly or 
indirectly, in the trade or business of Z, a non-governmental 
person, under the rule in paragraph (a) of this section, that 
portion constitutes not more than 10 percent of the available output 
of the facility. If more than 10 percent of the available output of 
the facility were to be sold to Z pursuant to a take or pay contract 
and more than 10 percent of the debt service on the bonds were to be 
paid or secured by Z, the bonds would be private activity bonds 
under paragraph (a) of this section.
    Example 2. Power Authority K, a political subdivision created by 
the legislature in State X to own and operate certain power 
generating facilities, sells all of the power from its existing 
facilities to four private utility systems under contracts executed 
in 1990, under which the four systems are required to take or pay 
for specified portions of the total power output until the year 
2020. Currently, existing facilities supply all of the present needs 
of the four utility systems but their future power requirements are 
expected to increase substantially. K issues 20-year bonds to 
construct a large generating facility. A fifth private utility 
system contracts with K to take or pay for 15 percent of the 
available output of the new facility. The balance of the output of 
the new facility will be available for sale as required, but 
initially it is not anticipated there will be any need for that 
power. The revenues from the contract with the fifth private utility 
system will be sufficient to pay less than 10 percent of the debt 
service on the bonds (determined on a percent value basis). The 
balance, which will exceed 10 percent of the debt service on the 
bonds, will be paid from revenues from the contracts with the four 
systems from sale of power produced by the old facilities. The bonds 
meet the private business use test because more than 10 percent of 
the proceeds will be used in the trade or business of a 
nongovernmental person. In addition, the bonds meet the private 
payment or security test because payment of more than 10 percent of 
the debt service, pursuant to an underlying arrangement, will be 
derived from payments in respect of property used for a private 
business use. Therefore, the bonds are private activity bonds.
    Example 3. Municipal utility U, a political subdivision, 
purchases all of the electricity required to meet the needs of its 
customers (1,000 Mw) from B, an investor-owned utility that operates 
its own electric generating facilities, under a 50-year take or pay 
contract. Although U does not anticipate that it will require 
additional electric resources and any new resources would produce 
electricity at a higher cost to U than its cost under its contract 
with B, B encourages U to construct new resources sufficient to meet 
the requirements of U's customers. U issues obligations to construct 
facilities that will produce 1,000 Mw of electricity. B, U, and I, 
another investor-owned utility, enter into an agreement under which 
U assigns to I its rights under U's take or pay contract with B. 
Under this arrangement, I will make payments to U and U will 
continue to make payments to B for the 1,000 Mw it is entitled to 
under the original take or pay contract. The payments made by I to U 
will be equal to or greater than the amounts required to pay the 
debt service on U's bonds. Under paragraph (d) of this section, U's 
obligations are financing a facility in a manner that is 
inconsistent with the purposes of section 141 and, therefore, the 
take or pay contract under which I purchases electricity is 
allocable to U's new facilities. Because I is a nongovernmental 
person, U's bonds are private activity bonds.
    Example 4. Transmission network. In response to an order by the 
Federal Energy Regulatory Commission (FERC), municipal utility V and 
investor-owned utility W enter into an agreement for the shared use 
of W's transmission facilities and transmission facilities that V is 
to construct (collectively, the network). Both V and W require 
shared use of the entire network, rather than point-to-point 
service. Pursuant to the agreement, V issues its bonds to construct 
new transmission facilities. The FERC order provides for sharing of 
costs of the network using relative load share ratios. Under this 
methodology, V will be responsible for 40 percent of the load share 
of the network. Under all the facts and circumstances, relative load 
share ratios is a reasonable method of measuring the capacity and 
use of the network. V and W reasonably expect that, on an annual 
basis, more than 90 percent of the amounts owed to V for use of its 
facilities will be paid for in kind (that is, through the provision 
of transmission services on W's facilities). The agreement provides 
that V and W will be entitled to transmission services that are 
comparable to the owner's own use. V reasonably expects that, due to 
the isolated location of the network, no other parties will seek to 
use V's transmission facilities. Under these circumstances, W will 
use more than 10 percent of the available output of the facilities 
financed with V's bonds and more than 10 percent of the debt service 
on V's bonds will be paid by W. Under paragraph (b)(4) of this 
section, however, W's use of the financed facilities will not be 
treated as private business use if those facilities are financed 
based on V's reasonable expectations regarding the amount of 
wheeling anticipated and the requirements of paragraph (b)(4)(i) and 
(iii) are satisfied. Although W's use of the financed facilities 
involves more than 20 percent of the property financed with the 
proceeds of the issue, because substantially all of the 
consideration for this use is the provision of other transmission 
services, the limitation in paragraph (b)(4)(iii) of this section 
does not apply. Assuming that the financed facilities are not 
necessitated by the need to provide transmission to W and that the 
other conditions of paragraph (b)(4)(i) of this section are 
satisfied, W's use of the financed facilities will not cause V's 
bonds to be private activity bonds.


Sec. 1.141-8  $15 million limitation for output facilities.

    (a) In general--(1) General rule. Section 141(b)(4) provides a 
special private activity bond limitation (the $15 million output 
limitation) for issues 5 percent or more of the proceeds of which are 
to be used to finance output facilities. Under this rule, a bond is a 
private activity bond under the private business tests of section 
141(b) (1) and (2) if the nonqualified amount with respect to output 
facilities financed by the proceeds of the issue exceeds $15 million. 
The $15 million output limitation applies in addition to the private 
business tests of section 141(b) (1) and (2). In addition, under 
section 141(b)(4) and paragraph (a)(2) of this section, the $15 million 
limitation is reduced in certain cases. Specifically, under the $15 
million output limitation, the private business use test and the 
private security or payment test apply as follows:
    (i) Private business use test. An issue to which the $15 million 
limitation applies meets the private business use test if more than $15 
million of the sale proceeds of the issue to be used with respect to an 
output facility are to be used for a private business use.
    (ii) Private security or payment test. An issue to which the $15 
million limitation applies meets the private security or payment test 
if the payment of the principal of, or the interest on, more than $15 
million of the sale proceeds of the portion of the issue used with 
respect to an output facility is (under the terms of the issue or any 
underlying arrangement) directly or indirectly--
    (A) Secured by any interest in an output facility used or to be 
used for a private business use (or payments in respect of such an 
output facility); or
    (B) To be derived from payments (whether or not to the issuer) in 
respect of an output facility used or to be used for a private business 
use.
    (2) Reduction in $15 million output limitation for outstanding 
issues--(i) General rule. In determining whether an issue more than 5 
percent of the proceeds of which are to be used with respect to an 
output facility consists of private activity bonds under the $15 
million output limitation, the $15 million limitation on private 
business use and the $15 million limitation on the private security or 
payment test are each applied by taking into account any outstanding 
issues of tax-exempt bonds with respect to that output facility or any 
other output facility that is part of the same project. Thus, the $15 
million limitation on private business use for an issue is reduced by 
the amount of private business use for that same project financed by 
any other outstanding tax-exempt bonds. Similarly, the $15 million 
limitation on the private security or payment test is reduced by the 
amount of private security or payments for that same project for any 
other outstanding tax-exempt bonds.
    (ii) Bonds taken into account. For purposes of this paragraph 
(a)(2), in applying the $15 million output limitation to an issue (the 
later issue), a tax-exempt bond of another issue (the earlier issue) is 
taken into account if--
    (A) The earlier issue is outstanding on the issue date of the later 
issue;
    (B) The earlier issue will not be redeemed within 90 days of the 
issue date of the later issue in connection with the refunding of the 
earlier issue by the later issue; and
    (C) More than 5 percent of the sale proceeds of the earlier issue 
financed an output facility that is part of the same project as the 
output facility that is financed by more than 5 percent of the sale 
proceeds of the later issue.
    (3) Benefits and burdens test applicable--(i) In general. In 
applying the $15 million output limitation, the benefits and burdens 
test of Sec. 1.141-7 applies, except that ``$15 million'' is 
substituted for ``10 percent''. For this purpose, the amount of private 
business use with respect to an output facility financed by an issue is 
determined by multiplying the percentage of private business use over 
the contract term of the issue by the issue price of the issue.
    (ii) Earlier issues for the project. If an earlier issue is 
outstanding that must be taken into account under paragraph (a)(2) of 
this section, the amount of private business use and private security 
or payments for that issue (as determined under paragraph (a)(3)(i) of 
this section) is multiplied by a fraction, the numerator of which is 
the greater of the outstanding principal amount or present value of the 
outstanding bonds of the earlier issue as of the issue date of the 
later issue, and the denominator of which is the issue price of the 
earlier issue as of the issue date of that issue.
    (b) Definition of project--(1) General rule. For purposes of 
paragraph (a)(2) of this section, project has the meaning provided in 
this paragraph. Facilities having different purposes or serving 
different customer bases are not ordinarily part of the same project. 
For example, the following are generally not part of the same project:
    (i) generation and transmission facilities;
    (ii) separate facilities designed to serve wholesale customers and 
retail customers; and
    (iii) a peaking unit and a baseload unit.
    (2) Separate ownership. Facilities that are not owned by the same 
person are not part of the same project. All participants in a joint 
powers authority that issues bonds to finance a project are treated as 
related parties for purposes of applying the $15 million limitation to 
bonds financing the same project. In the case of undivided ownership 
interests in a single output facility, property that is not owned by 
the same person is treated as separate projects only if the separate 
interests are not financed--
    (i) With bonds of a single issuer; and
    (ii) With a principal purpose of avoiding the limitation in this 
section.
    (3) Generating property--(i) Property on same site. In the case of 
property for the generation of output and related facilities 
(generating property), project means property located at the same site.
    (ii) Special rule for generating units. Separate generating units 
(and related facilities) are not a part of the same project if one is 
placed in service (determined under Sec. 1.150-2(c)) more than 3 years 
before the other. Common facilities or property that will be 
functionally related to more than one generating unit must be allocated 
on a reasonable basis. If a generating unit already is constructed or 
is under construction (the first unit) and bonds are to be issued to 
finance an additional generating unit (the second unit), all costs for 
any common facilities paid or incurred before the earlier of the issue 
date of bonds to finance the second unit or the commencement of 
construction of the second unit are allocated to the first unit. At the 
time that bonds are issued to finance the second unit (or, if earlier, 
upon commencement of construction of that unit), any remaining costs of 
the common facilities may be allocated among the first and second units 
so that in the aggregate the allocation is reasonable.
    (4) Transmission. In the case of property for the transmission of 
output and related facilities, project means functionally related or 
contiguous property used for transmission of output but only to the 
extent that the property is placed in service during a single 2-year 
period. Separate property is not part of a single project, however, 
unless it is intended to provide transmission between two significant 
output facilities (for example, a line to connect two substations).
    (5) Subsequent improvements. An improvement to generating or 
transmission property that is not part of the original design of that 
property (the initial project) is not part of the same project as the 
initial project if the construction, reconstruction, or acquisition of 
that improvement commences more than three years after the initial 
project is placed in service and the bonds issued to finance that 
improvement are issued more than three years after the initial project 
is placed in service.
    (6) Conservation. In the case of property to provide energy 
conservation, project means functionally related property that is 
located at a single site.
    (7) Replacement property. For purposes of this section, output 
property that replaces existing output property is treated as part of 
the same project as the replaced output property unless--
    (i) The need to replace the property was unexpected or occurred 
more than 3 years in advance of the expected need to replace the 
property; and
    (ii) The bonds that financed (and refinanced) the replaced output 
property have a weighted average maturity that is not greater than the 
reasonably expected economic life of the replaced output property.
    (c) Examples. The application of the provisions of this section is 
illustrated by the following examples:

    Example 1. Power authority K, a political subdivision, intends 
to issue a single issue of tax-exempt bonds to finance the 
construction of an electric generating facility under a turnkey 
construction contract providing for a single payment of $500 million 
at the completion of construction. No portion of the facility will 
be used for a private business use except that L, an investor-owned 
utility, will purchase 10 percent of the output of the facility 
under a take contract and will pay 10 percent of the debt service on 
the bonds. The maximum amount of tax-exempt bonds that may be issued 
for the acquisition of the facility is $465 million (that is, $450 
million for the 90 percent of the facility that is governmentally 
owned and used, and a maximum of $15 million for the privately used 
portion).
    Example 2. The facts are the same as in Example 1 except that 
the construction contract calls for milestone payments every 6 
months beginning July 1, 1995. K intends to finance the facility 
with 4 separate issues of tax-exempt bonds. On July 1, 1995, K 
issues the first issue for $100 million and makes the first 
milestone payment. On January 1, 1996, K intends to issue the second 
issue for the facility for $150 million and use the proceeds of that 
issue to make the second milestone payment. As of January 1, 1996, 
no other amounts have been paid under the construction contract for 
the facility and none of the bonds issued on July 1, 1995, have been 
retired. The January 1, 1996, issue will consist of private activity 
bonds since the issue will have $15 million of private business use 
and private payments or security (10 percent of $150 million) and 
the maximum permitted private use portion for the second issue is 
only $5 million ($15 million less than $10 million private use 
portion of the first issue). For each subsequent issue for the 
facility and assuming that the January 1, 1996, issue consisted of 
tax-exempt bonds, K could not issue tax-exempt bonds to finance the 
portion of the facility used by L.


Sec. 1.141-9  Unrelated or disproportionate use test.

    (a) General rules--(1) Description of test. Under section 141(b)(3) 
(the unrelated or disproportionate use test), an issue meets the 
private business tests if the amount of private business use and 
private security or payments attributable to unrelated or 
disproportionate private business use exceeds 5 percent of the proceeds 
of the issue. For this purpose, the private business use test is 
applied by taking into account only use that is not related to any 
government use of proceeds of the issue (unrelated use) and use that is 
related but disproportionate to any government use of those proceeds 
(disproportionate use). The private security or payment test is applied 
by taking into account the payments of the principal of, or the 
interest on, the proceeds of the issue that are (under the terms of the 
issue or any underlying arrangement) directly or indirectly--
    (i) Secured by any interest in (A) property used or to be used for 
a private business use that is either unrelated use or disproportionate 
use, or (B) payments in respect of this property; or
    (ii) To be derived from payments (whether or not to the issuer) in 
respect of property, or borrowed money, used or to be used for a 
private business use that is either unrelated use or disproportionate 
use.
    (2) Application of unrelated and disproportionate use test--(i) 
Order of application. The unrelated and disproportionate use test is 
applied by first determining whether a private business use is related 
to a government use. Next, private business use that relates to a 
goverment use is examined to determine whether it is disproportionate 
to that govenment use.
    (ii) Aggregation of unrelated and disproportionate use. All 
unrelated use and disproportionate use financed with the proceeds of an 
issue are aggregated to determine compliance with the unrelated or 
disproportionate use test. The amount of permissible unrelated and 
disproportionate private business use is not reduced by the amount of 
private business use financed with the proceeds of an issue that is 
neither unrelated use nor disproportionate use.
    (iii) Deliberate actions. A deliberate action that occurs after the 
issue date does not result in unrelated or disproportionate use if the 
issue meets the conditions of Sec. 1.141-13(a).
    (b) Unrelated use--(1) In general. Whether a private business use 
is related to a government use financed with the proceeds of an issue 
is determined on a case-by-case basis, emphasizing the operational 
relationship between the government uses and the private business uses. 
In general, a facility that is used for a related private business use 
must be located within, or adjacent to, the governmentally used 
facility.
    (2) Parallel related and unrelated uses. Use of a facility by a 
nongovernmental person for the same purpose as use by a governmental 
person is not treated as unrelated use if the government use is not 
insignificant. Similarly, a use of a facility in the same manner both 
for private business use that is related use and private business use 
that is unrelated use does not result in unrelated use if the related 
use is not insignificant. For example, a privately owned pharmacy in a 
governmentally owned hospital does not ordinarily result in unrelated 
use solely because the pharmacy also serves individuals not using the 
hospital. In addition, use of parking spaces in a garage by a 
nongovernmental person is not treated as unrelated use if more than an 
insignificant portion of the parking spaces are used for a government 
use (or a private business use that is related to a government use), 
even though the use by the nongovernmental person is not directly 
related to that other use.
    (c) Disproportionate use--(1) Definition of disproportionate use. A 
private business use is disproportionate to a related government use 
only to the extent that the amount of proceeds used for that private 
business use exceeds the amount of proceeds used for the related 
government use. For example, a private use of $100 of proceeds that is 
related to a government use of $70 of proceeds results in $30 of 
disproportionate use.
    (2) Aggregation of related uses. If two or more private business 
uses of the proceeds of an issue relate to a single government use of 
those proceeds, those private business uses are aggregated to apply the 
disproportionate use test.
    (3) Allocation rule. If a private business use relates to more than 
a single use of the proceeds of the issue (for example, two or more 
government uses of the proceeds of the issue or a government use and a 
private use), the amount of any disproportionate use may be determined 
by:
    (i) reasonably allocating the proceeds used for the private 
business use among the related uses,
    (ii) aggregating government uses that are directly related to each 
other, or
    (iii) allocating the private business use to the government use to 
which it is primarily related.
    (d) Maximum use taken into account. The determination of the amount 
of unrelated use or disproportionate use of a facility is based on the 
maximum amount of reasonably expected government use of a facility 
during the term of the issue. Thus, no unrelated use or 
disproportionate use arises solely because a facility initially has 
excess capacity that is to be used by a nongovernmental person if the 
facility will be completely used by the issuer during the term of the 
issue for more than an insignificant period.
    (e) Examples. The following examples illustrate the application of 
this section:

    Example 1. School and remote cafeteria. County X issues bonds 
with proceeds of $20 million and uses $18.1 million of the proceeds 
for construction of a new school building and $1.9 million of the 
proceeds for construction of a privately operated cafeteria in its 
administrative office building, which is located at a remote site. 
The bonds are secured, in part, by the cafeteria. The $1.9 million 
of proceeds is unrelated to the government use (that is, school 
construction) financed with the bonds and exceeds 5 percent of $20 
million. Thus, the issue meets the private business tests.
    Example 2. Public safety building and courthouse. City Y issues 
bonds with proceeds of $50 million for construction of a new public 
safety building ($32 million) and for improvements to an existing 
courthouse ($15 million). Y uses $3 million of the bond proceeds for 
renovations to an existing privately operated cafeteria located in 
the courthouse. The bonds are secured, in part, by the cafeteria. 
Y's use of the $3 million for the privately operated cafeteria does 
not meet the unrelated or disproportionate use test since these 
expenditures are neither unrelated use nor disproportionate use.
    Example 3. Unrelated garage. City Y issues bonds with proceeds 
of $50 million for construction of a new public safety building 
($30.5 million) and for improvements to an existing courthouse ($15 
million). Y uses $3 million of the bond proceeds for renovations to 
an existing privately operated cafeteria located in the courthouse. 
The bonds are secured, in part, by the cafeteria. Y also uses $1.5 
million of the proceeds to construct a privately operated parking 
garage adjacent to a private office building. The private business 
use of the parking garage is unrelated to any government use of 
proceeds of the issue. Since the proceeds used for unrelated uses 
and disproportionate uses do not exceed 5 percent of the proceeds, 
the unrelated or disproportionate use test is not met.
    Example 4. Disproportionate use of garage. County Z issues bonds 
with proceeds of $20 million for construction of a hospital with no 
private business use ($17 million); renovation of an office building 
with no private business use ($1 million); and construction of a 
garage that is entirely used for a private business use ($2 
million). The use of the garage is related to the use of the office 
building but not to the use of the hospital. The private business 
use of the garage results in $1 million of disproportionate use 
because the proceeds used for the garage ($2 million) exceed the 
proceeds used for the related government use ($1 million). The bonds 
are not private activity bonds, however, because the 
disproportionate use does not exceed 5 percent of the proceeds of 
the issue.
    Example 5. Bonds for multiple projects. (i) County X issues 
bonds with proceeds of $80 million for the following purposes: (1) 
$72 million to construct a County owned and operated waste 
incinerator; (2) $1 million for a County owned and operated facility 
for the temporary storage of hazardous waste prior to final 
disposal; (3) $1 million to construct a privately owned recycling 
facility; and (4) $6 million to build a garage adjacent to the 
County owned incinerator that will be leased to Company Y to store 
and repair trucks that it owns and uses to haul County X refuse. 
Company Y uses 75 percent of its trucks to haul materials to the 
incinerator and the remaining 25 percent of its trucks to haul 
materials to the temporary storage facility.
    (ii) The $1 million of proceeds used for the recycling facility 
is used for an unrelated use. The garage is related use. In 
addition, 75 percent of the use of the $6 million of proceeds used 
for the garage is allocable to the government use of proceeds at the 
incinerator. The remaining 25 percent of the garage ($1.5 million) 
relates to the government use of proceeds at the temporary storage 
facility. Thus, this portion of the proceeds used for the garage 
exceeds the proceeds used for the temporary storage facility by $.5 
million and this excess is disproportionate use (but not unrelated 
use). Thus, the aggregate amount of unrelated use and 
disproportionate use financed with the proceeds of the issue is $1.5 
million. Alternatively, under paragraph (c)(3)(iii) of this section, 
the entire garage may be treated as related to the government use of 
the incinerator and, under that allocation, the garage is not 
disproportionate use. In either event, section 141(b)(3) limits the 
aggregate unrelated use and disproportionate use to $4 million. 
Therefore, the bonds are not private activity bonds under this 
section.


Sec. 1.141-10  Coordination with volume cap.

    Section 141(b)(5) provides a special definition of private activity 
bond for bonds having a nonqualified amount of more than $15 million. 
The provisions of Secs. 1.141-1 through 1.141-16 (except Sec. 1.141-12) 
apply to section 141(b)(5).


Sec. 1.141-11  Acquisition of nongovernmental output property.

    Section 141(d) provides a special definition of private activity 
bond for bonds the proceeds of which are used to acquire 
nongovernmental output property. The provisions of Secs. 1.141-1 
through 1.141-16 (except Sec. 1.141-12) apply to section 141(d).


Sec. 1.141-12  Special rules for qualified bonds.

    (a) Actual compliance required. Except as provided in Sec. 1.145-1 
and this section, a private activity bond is a qualified bond only if 
the issue of which it is a part satisfies all of the applicable 
requirements under section 141(e) throughout the term of the issue.
    (b) Remedial actions available--(1) In general. Except as otherwise 
provided in paragraph (c) of this section, if an action results in 
nonqualified use, the remedial actions in Sec. 1.141-13 (other than the 
actions permitted under Sec. 1.141-13(d)) may be applied to prevent the 
bonds from ceasing to be treated as tax-exempt bonds (but not to 
failures existing as of the issue date).
    (2) Nonqualified use. For purposes of this section, nonqualified 
use means failures to satisfy the applicable requirements of section 
142 (except paragraph (d)), 144 (except paragraphs (a)(4) and (a)(10)), 
147(c), 147(d), 147(e), or 147(f).
    (c) Limitation on remedial action--(1) Failure to spend proceeds. 
In the case of a failure to spend on qualifying costs the percentage of 
net proceeds required under sections 142(a), 144(a)(1), 144(b), or 
144(c)(1), paragraph (b) of this section applies only if the amount of 
the issue was based on reasonable estimates of the cost of facilities 
(or other property) to be provided by the issue and the failure to 
expend the net proceeds on qualifying costs was due to circumstances 
that were not reasonably foreseeable as of the issue date.
    (2) Amount of nonqualified bonds. For failures described in 
paragraph (c)(1) of this section, the nonqualified bonds for purposes 
of paragraph (b) of this section are those bonds having an amount that, 
if treated as redeemed, would result in the net proceeds of the 
remaining bonds of the issue satisfying the requirement for the 
percentage of the net proceeds to be used for qualifying costs.


Sec. 1.141-13  Deliberate actions and related remedial actions.

    (a) Remedial action. An action that causes the private business 
tests or the private loan financing test to be met is not treated as a 
deliberate action if the issuer takes a remedial action described in 
paragraph (b), (c), (d), or (e) of this section with respect to the 
nonqualified bonds and all of the following requirements are met:
    (1) Required covenants. The issuer covenants on the issue date in 
the bond documents for the issue that it will take no action that would 
cause the bonds to be private activity bonds and that it will not fail 
to take any action that would prevent the bonds from being private 
activity bonds, and the issuer established reasonable procedures to 
ensure compliance with this covenant.
    (2) Fair market value consideration. The terms of any agreements 
that result in satisfaction of either the private business tests or the 
private loan financing test are bona fide and arm's-length, and the new 
user pays consideration equal to the fair market value for the use of 
the financed property.
    (3) Expectations must be certified. An officer of the issuer 
responsible for issuing the bonds, in good faith, certifies as part of 
the bond documents the issuer's expectations as of the issue date, 
including the facts and estimates that form the basis for the issuer's 
expectations regarding the use of proceeds of the issue. The 
certification is evidence of the issuer's expectations, but does not 
establish any conclusions or presumptions of law or fact. A 
certification under this paragraph (a)(3) is not required if the issue 
price of the issue does not exceed $1,000,000.
    (4) No abuse. No circumstances are present that indicate an attempt 
to avoid directly or indirectly the requirements of section 141.
    (b) Redemption of nonqualified bonds--(1) Transfer for cash. If the 
financed facility is transferred exclusively for cash (a transfer for 
cash), the requirements of this paragraph (b) are satisfied if an 
amount equal to the disposition proceeds are used to redeem a pro rata 
portion of the nonqualified bonds at the earliest call date after the 
deliberate action. If the bonds are not redeemed within 90 days of the 
date of the transfer, the disposition proceeds must be used to 
establish a defeasance escrow for those bonds within 90 days of that 
date.
    (2) Other deliberate actions. If the deliberate action does not 
exclusively involve a transfer for cash, funds other than proceeds of a 
tax-exempt bond must be used to redeem all the nonqualified bonds. If 
the bonds are not redeemed within 90 days of the date of the deliberate 
act, a defeasance escrow must be established for those bonds within 90 
days of that date.
    (3) Notice of defeasance. The issuer must provide written notice to 
the Commissioner of the establishment of the defeasance escrow within 
180 days of the date of the transfer.
    (4) Special limitation. The establishment of a defeasance escrow 
does not satisfy the requirements of this paragraph (b) if--
    (i) The terms of the nonqualified bonds do not provide for a 
redemption of those bonds within 6 months of the date of the deliberate 
action; and
    (ii) As of the issue date of the nonqualified bonds, there was more 
than a remote possibility that the financed property would be 
transferred to a nongovernmental person during the period beginning on 
the issue date and ending on the date the bonds can first be redeemed 
by the issuer. For this purpose, the possibility of transfer to a 
nongovernmental person is treated as remote if the facility is of a 
type that is not customarily owned and operated by nongovernmental 
persons.
    (5) Defeasance escrow defined. A defeasance escrow is an 
irrevocable escrow established to redeem bonds at their earliest call 
date in an amount that, together with investment earnings, is 
sufficient to pay all the principal of the interest and call premium on 
the related bonds from the date the escrow is established to the 
earliest call date. If the amount of the nonqualified bonds is limited 
to the amount of the disposition proceeds, the amount required to be 
deposited in the defeasance escrow is limited to that amount. The 
escrow may not be invested in higher yielding investments or in any 
investment under which the obligor is a user of the proceeds of the 
related bonds.
    (c) Alternative use of facility. The requirements of this paragraph 
(c) are satisfied if--
    (1) The facility with respect to which the deliberate action occurs 
is used in an alternative manner (for example, used for a different 
purpose or used by a different person);
    (2) The nonqualified bonds are treated as reissued, as of the date 
of the deliberate action, for purposes of sections 55 through 59 and 
141 through 147, 149 and 150, and under this treatment, the 
nonqualified bonds satisfy all the applicable requirements for 
qualified bonds throughout the remaining term of the nonqualified bonds 
(except as provided in paragraph (g) of this section); and
    (3) The deliberate action does not involve a transfer to a 
purchaser that finances the acquisition with proceeds of another issue 
of tax-exempt bonds.
    (d) Alternative use of disposition proceeds. The requirements of 
this paragraph (d) are satisfied if--
    (1) The deliberate action involves a transfer for cash of a 
facility financed by an issue or a repayment of a loan of proceeds;
    (2) The nonqualified bonds are treated as reissued, as of the date 
of the deliberate action, for purposes of sections 141 through 147, 149 
and 150, and under this treatment, the nonqualified bonds satisfy all 
the applicable requirements for qualified 510(c)(3) bonds throughout 
the remaining term of the nonqualified bonds; and
    (3) A remedial action that satisfies paragraph (b), (c), or (e) of 
this section is taken for any disposition proceeds not used for an 
alternative use described in paragraphs (d) (1) and (2) of this 
section.
    (e) Authority of Commissioner to provide for additional remedial 
actions. The Commissioner may, by publication in the Internal Revenue 
Bulletin, provide additional remedial actions under which a subsequent 
action will not be treated as a deliberate action for purposes of 
Sec. 1.141-2.
    (f) Effect of remedial action on continuing compliance. If a 
remedial action is taken under paragraph (b), (c), (d), or (e) of this 
section, the private business use, private security or payments, or 
private loans resulting from the deliberate action are not taken into 
account for purposes of determining whether the bonds are private 
activity bonds.
    (g) Definition and special rules--(1) Definition of nonqualified 
bonds. The nonqualified bonds are the outstanding bonds allocable to 
the proceeds with respect to which the deliberate action was taken. The 
nonqualified bonds must be in an amount such that, if redeemed with 
sale proceeds of the issue, the proceeds of the remaining bonds of the 
issue are used in a manner that does not cause the bonds to be private 
activity bonds. Allocations to nonqualified bonds must be made in 
accordance with Sec. 1.141-6, except that allocations (i) must be made 
on a pro rata basis (adjusted to reflect allocations permitted under 
Sec. 1.141-6); and (ii) may be made without regard to whether property 
qualifies as a discrete portion of a mixed use facility.
    (2) Section 147. For purposes of paragraph (c) of this section, 
section 147(d) (relating to the acquisition of existing property) is 
applied as of the issue date (not the date of the deliberate action).
    (h) Examples. The following examples illustrate the application of 
this section:

    Example 1. Disposition proceeds less than outstanding bonds used 
to retire bonds. On June 1, 1995, City C issues bonds with an issue 
price of $10 million to finance the construction of a building. The 
bonds have a weighted average maturity that does not exceed 120 
percent of the weighted average economic life of the building. On 
the issue date, C reasonably expects with a high degree of certainty 
that it will be the only user of the building for the entire term of 
the bonds. Six years after the issue date, C sells the building to 
Corporation P for $5 million. The sale price is the fair market 
value of the building, as verified by an independent appraiser. C 
uses all of the disposition proceeds to immediately retire a pro 
rata portion of the bonds. The bonds are not private activity bonds 
because of the sale because P is not a user of process (that is, the 
disposition proceeds were used to redeem the bonds). See Sec. 1.141-
1(c).
    Example 2. Lease to nongovernmental persons. The fact are the 
same as in Example 1, except that instead of selling the building, 
C, six years after the issue date, leases the building to P for 7 
years and uses other funds to redeem all of the bonds within 90 days 
of the deliberate act. The bonds are not treated as private activity 
bonds because C has taken remedial action described in paragraph (b) 
of this section.
    Example 3. Sale for less than fair market value. The facts are 
the same as in Example 1, except that the fair market value of the 
building at the time of the sale to P is $6 million. Under these 
facts and Sec. 1.141-1(c), the proceeds of the bonds remain 
allocated to the office building. Therefore, the proceeds of the 
bonds are used by P. In addition, because the transfer was for less 
than fair market value, the bonds are ineligible for the remedial 
actions under this section.
    Example 4. Redemption of bonds. In 1995, City D issues bonds 
with proceeds of $10 million to finance a courthouse. The bonds have 
a weighted average maturity that does not exceed 120 percent of the 
weighted average economic life of the courthouse. D uses $1 million 
of the proceeds for a private business use and more than 10 percent 
of the debt service on the issue is secured by private security or 
payments. D later sells one-half of the courthouse property to a 
nongovernmental person for cash. D immediately redeems 50 percent of 
the outstanding bonds. For purposes of subsequently applying section 
141 to the issue, D may continue to use all of the proceeds of the 
outstanding bonds in the same manner (that is, for both the 
courthouse and the existing private business use) without causing 
the issue to meet the private business tests. The result would be 
the same if D, instead of redeeming the bonds, established a 
defeasance escrow for those bonds, provided that the requirement of 
paragraph (b)(4) of this section was met as of the issue date.


Sec. 1.141-14   Refunding issues.

    (a) Private activity bond status--(1) In general. Whether a 
refunding issue satisfies the private business tests or the private 
loan financing tests is determined exclusively on the use of the 
proceeds of the refunding issue and the private security or payments 
with respect to that issue (that is, without regard to whether the 
prior issue satisfied those tests).
    (2) Rules of application--(i) Private business use and private loan 
financing tests. In applying section 141 to a refunding issue, except 
as otherwise provided in this paragraph (a)(2), the proceeds of the 
refunding issue are treated as used for the same purposes as the 
proceeds of the prior issue except that the use of the property 
financed with the proceeds of the prior issue before the issue date of 
the refunding issue is not taken into account.
    (ii) Special rule. If, as of the issue date of the refunding issue, 
the weighted average maturity of the refunding issue is greater than 
120 percent of the remaining average economic life of the property 
financed with the proceeds of the prior issue, the proceeds of the 
refunding issue are treated as being used for the same purposes as the 
proceeds of the prior issue and use of the property financed with the 
proceeds of the prior issue before the issue date of the refunding 
issue is taken into account.
    (3) Optional treatment as continuation of prior issue. In applying 
the private business use test and the private security or payment test 
(including under Sec. 1.141-7) to a refunding issue, the issuer may 
treat the entire refunding issue as a continuation of the prior issue. 
For this purpose, under the private security or payment test (including 
under Sec. 1.141-7), the issuer may use the yield on the refunded issue 
to present value payments and security from arrangements that were not 
entered into in contemplation of the refunding issue.
    (b) Qualified bonds--(1) In general. Generally, whether bonds 
issued as part of a refunding issue are qualified bonds (other than 
bonds issued under sections 144(a) or 1394) is determined exclusively 
on the basis of the use of the proceeds of the refunding issue, 
determined in the same manner as under paragraph (a)(2) of this 
section. In addition, section 147(d) is applied as of the issue date of 
the prior issue. A refunding issue meets the requirements of section 
147(b) if the refunded issue met these requirements and the weighted 
average maturity of the refunding bonds is not greater than the 
remaining weighted average maturity of the refunded bonds. See also 
Sec. 1.103-8.
    (2) Discontinued use in certain qualified bonds. If, as of the 
issue date of the refunding bonds, the property that was financed by 
the proceeds of the refunded bond is not used (or is not reasonably 
expected to continue to be used), and the refunded bond was a qualified 
bond under sections 142, 144(a), 144(c), or 1394, the refunding bond is 
a qualified bond only if--
    (i) The refunding issue does not have a weighted average maturity 
that exceeds the remaining weighted average maturity of the refunded 
bonds; and
    (ii) The refunded bonds were qualified bonds.


Sec. 1.141-15  Anti-abuse rules.

    (a) Authority of Commissioner to reflect substance of transactions. 
If an issuer enters into a transaction or series of transactions with 
respect to one or more issues with a principal purpose of transferring 
to nongovernmental persons (other than as members of the general 
public) significant benefits of tax-exempt financing in a manner that 
is inconsistent with the purposes of section 141, the Commissioner may 
take any action to reflect the substance of the transaction or series 
of transactions, including--
    (1) Treating separate issues as a single issue for purposes of the 
private activity bond test;
    (2) Reallocating proceeds to expenditures, use, or bonds; and
    (3) Reallocating payments to use or proceeds.
    (b) Examples. The provisions of this section are illustrated by the 
following examples:

    Example 1. City D enters into a development agreement with 
Corporation T to induce T to locate its headquarters within the D 
city limits. Pursuant to the development agreement, in 1995 D will 
issue $20 million of its general obligation bonds (the 1995 bonds) 
to purchase land that it will grant to T. The development agreement 
also provides that, in 1996, D will issue $20 million of its tax 
increment bonds (the 1996 bonds), secured solely by the increase in 
property taxes in a special taxing district made under the 
improvements resulting from the development agreement. Substantially 
all of the property within the special taxing district is owned by T 
or D. T will separately enter into an agreement to guarantee the 
payment of tax increment to D in an amount sufficient to retire the 
1996 bonds. The proceeds of the 1996 bonds will be used to finance 
governmentally owned and operated improvements within the special 
taxing district that will not give rise to private business use. 
Treated separately, the 1995 issue meets the private business use 
test, but not the private security or payment test; the 1996 issue 
meets the private security or payment test, but not the private 
business use test. Because the two issues are a part of a plan to 
provide the benefits of tax-exempt financing to T for its 
headquarters, however, the 1995 issue and the 1996 issue may be 
treated by the Commissioner as a single issue for purposes of 
applying the private activity bond tests. Accordingly, the bonds of 
both the 1995 issue and the 1996 issue may be treated as private 
activity bonds.
    Example 2. City E acquires an electric generating facility with 
a useful economic life of more than 35 years and enters into a 25-
year take or pay contract to sell 30 percent of the available output 
to investor-owned utility M. E plans to use the remaining 70 percent 
of available output for its own governmental purposes. To finance 
the entire cost of the facility, E issues $30 million of its series 
A taxable bonds at taxable interest rates and $70 million series B 
bonds, which purport to be tax-exempt bonds, at tax-exempt interest 
rates. E allocates all of M's private business use to the proceeds 
of the series A bonds and all of its own government use to the 
proceeds of the series B bonds. The series A bonds have a weighted 
average maturity of 15 years, while the series B bonds have a 
weighted average maturity of 26 years. M's payments under the take 
or pay contract are equal to 30 percent of M's total costs (that is, 
the sum of the debt service required to be paid on both the series A 
and the series B bonds and all other operating costs). The 
allocation of all of M's private business use to the series A bonds 
does not reflect economic substance because the series of 
transactions transfers to M significant benefits of the tax-exempt 
interest rates paid on the series B bonds. Because of this actual 
transfer of benefits, M's private business use must be allocated on 
a pro rata basis to both the series B bonds as well as the series A 
bonds. Accordingly, both the series A bonds and the series B bonds 
are private activity bonds.
    Example 3. The facts are the same as in Example 2, except that 
the debt service component of M's payments under the take or pay 
contract is based exclusively on the amounts necessary to pay the 
debt service on the series A bonds. E's allocation of all of M's 
private business use to the series A bonds is respected because the 
series of transactions does not actually transfer benefits of tax-
exempt interest rates to M. Accordingly, the series B bonds are not 
private activity bonds. The result would be the same if the series A 
bonds and the series B bonds had substantially equivalent weighted 
average maturities and E and M had entered into a customary contract 
providing for payments based on a ratable share of total debt 
service.


Sec. 1.141-16  Effective dates.

    (a) Scope. The effective dates in this section apply for purposes 
of Secs. 1.141-1, through 1.141-16, 1.145-1, 1.150-1(a)(3), and 1.1394-
1 (the private activity bond regulations).
    (b) Effective dates. Except as otherwise provided in this section, 
the private activity bond regulations apply to bonds issued on or after 
the date that is 60 days after publication of final regulations in the 
Federal Register (the effective date) that are subject to section 1301 
of the Tax Reform Act of 1986.
    (c) Refunding bonds. The private activity bond regulations do not 
apply to bonds issued on or after the effective date to refund a bond 
to which the private activity bond regulations do not apply unless--
    (1) The weighted average maturity of the refunding bonds is greater 
than the remaining weighted average maturity of the refunded bonds; or
    (2) A principal purpose for the issuance of the refunding bonds is 
to make one or more new conduit loans.
    (d) Permissive application of regulations. Except as otherwise 
provided, the private activity bond regulations may be applied in 
whole, but not in part, to--
    (1) Bonds issued after December 30, 1994 and before the effective 
date; or
    (2) Refunding bonds issued on or after the effective date.
    (e) Permissive retroactive application of certain sections. The 
following sections may each be applied to any bonds issued before the 
effective date:
    (1) Section 1.141-6;
    (2) Section 1.141-13; and
    (3) Section 1.141-14.
    Par. 5. Section 1.145-1 is added to read as follows:


Sec. 1.145-1  Qualified 501(c)(3) bonds.

    (a) In general. In applying the requirements of section 145(a)(2), 
Secs. 1.141-1 through 1.141-16 apply to determine whether use of the 
proceeds of an issue (or private payments or security with respect 
thereto) by a person (other than a section 501(c)(3) organization using 
the proceeds in an activity that does not constitute an unrelated trade 
or business) gives rise to private business use, private security or 
payments, or private loans.
    (b) Reasonable expectations and deliberate actions--(1) In general. 
Except as otherwise provided in this paragraph (b), an issue is an 
issue of qualified 501(c)(3) bonds if the issuer and the 501(c)(3) 
organization reasonably expect, as of the issue date, that the issue 
will meet the requirements applicable to those bonds under section 
141(e) and section 145. An issue ceases to be an issue of qualified 
501(c)(3) bonds if the issuer or 501(c)(3) organization takes a 
deliberate action, subsequent to the issue date, that causes the bonds 
to fail to comply with the applicable requirements under section 141(e) 
and 145 (for example, revocation of exempt status as a result of 
private inurement). For this purpose, deliberate actions are defined 
under Sec. 1.141-2. In lieu of this paragraph (b), Sec. 1.141-12 
applies for purposes of section 145(d)(2)(B) (related to certain 
residential rental projects).
    (2) Remedial actions. The remedial actions of Sec. 1.141-13 may be 
applied to prevent a deliberate action from causing an issue to cease 
to be treated as tax-exempt bonds under section 145.
    (c) Effective dates. For effective dates of this section, see 
Sec. 1.141-16.
    Par. 6. Section 1.148-6 is amended by adding new paragraphs (a)(3) 
and (d)(1)(iii) to read as follows:


Sec. 1.148-6  General allocation and accounting rules.

    (a) * * *
    (3) Absence of allocation and accounting methods. If an issuer 
fails to maintain books and records sufficient to establish the 
accounting method for an issue and the allocation of the proceeds of 
that issue, the rules of this section are applied using the specific 
tracing method. This paragraph (a)(3) applies to bonds issued on or 
after the date that is 60 days after publication of final regulations 
in the Federal Register.
* * * * *
    (d) * * *
    (1) * * *
    (iii) Timing. An issuer must account for the allocation of proceeds 
to expenditures not later than 18 months after the later of the date 
the expenditure is paid or the date the project, if any, that is 
financed by the issue is placed in service. This allocation must be 
made in any event by the date 60 days after the fifth anniversary of 
the issue date or the date 60 days after the retirement of the issue, 
if earlier. This paragraph (d)(1)(iii) applies to bonds issued on or 
after the date that is 60 days after publication of final regulations 
in the Federal Register.
* * * * *
    Par. 7. Section 1.150-1 is amended as follows:
    1. Paragraph (a)(3) is added.
    2. In the list of definitions in paragraph (b), a definition is 
added to appear in alphabetical order.
    3. Paragraph (c)(2) is revised.
    4. Paragraph (c)(3)(ii) is revised.


Sec. 1.150-1  Definitions.

    (a) * * *
    (3) Exception to general effective date. See Sec. 1.141-16 for the 
effective date of the definition of bond documents contained in 
paragraph (b) of this section, the provisions contained in paragraph 
(c)(2) of this section, and the provisions contained in paragraph 
(c)(3)(ii) of this section.
* * * * *
    (b) * * *
    Bond documents means the bond indenture or resolution, transcript 
of proceedings, and any related documents.
* * * * *
    (c) * * *
    (2) Exception for taxable bonds--(i) In general. Taxable and tax-
exempt bonds are not part of the same issue under this paragraph (c).
    (ii) Exceptions. The issuance of tax-exempt bonds in a transaction 
(or series of related transactions) that includes taxable bonds, 
however, may constitute an abusive arbitrage device under Sec. 1.148-
10(a), an abuse under Sec. 1.141-15(a), or otherwise violate the 
requirements of sections 103 and 141 through 150, for example, 
structures involving windows or unreasonable allocations of bonds. This 
paragraph (c)(2)(ii) does not apply to a taxable issue with an issue 
price that is less than 5 percent of the issue price of the related 
tax-exempt issue.
    (3) * * *
    (ii) Exceptions. This paragraph (c)(3) does not apply for purposes 
of sections 144(a), 148, 149(d), and 149(g).
* * * * *
    Par. 8. Section 1.150-4 under the heading ``Standard deduction for 
individuals'' is added to read as follows:


Sec. 1.150-4  Change in use of facilities financed with tax-exempt 
private activity bonds.

    (a) In general. The change of use provisions of sections 150(b) and 
(c) apply even if the issuer takes the actions described in Sec. 1.141-
13(b), (c), (d), or (e).
    (b) Allocation rules. If section 150(b) or (c) applies to a portion 
of an issue and the issuer has not taken a permitted remedial action 
under Sec. 1.141-13 to maintain the status of the bonds as tax-exempt 
bonds, the portion of the issue to which section 150(b) applies is that 
portion that is the nonqualified bonds, within the meaning of 
Sec. 1.141-13(g)(1), except that any common areas (as defined in 
Sec. 1.141-1) are entirely allocated to the nonqualified bonds.
    (c) Effective dates. For effective dates of this section, see 
Sec. 1.141-16.
    Par. 9. Section 1.1394-1 is added under the heading ``Definitions; 
special rule'' to read as follows:


Sec. 1.1394-1  Enterprise zone facility bonds.

    (a) Scope. This section contains rules relating to section 1394, 
relating to tax-exempt bonds for enterprise zone facilities (enterprise 
zone facility bonds). See sections 1394, 1397B, and 1397C for other 
rules and definitions.
    (b) Continuing compliance--(1) In general. Except as provided in 
paragraph (b)(2) of this section, compliance with the requirements 
applicable to enterprise zone facility bonds apply throughout the term 
of the bonds.
    (2) Start-up period. For a qualified business that is first 
established in connection with the issuance of enterprise zone facility 
bonds (as opposed to a continuing qualified business to which financing 
is provided), the requirements relating to qualification as an 
enterprise zone business and satisfaction of the rules for qualified 
zone property do not apply prior to the date that is one year after the 
later of the issue date of the bonds and the date the financed facility 
is placed in service (the testing date).
    (3) Manner of continuing compliance. An issue is treated as 
continuing to comply with the requirements of section 1394 (a) and (b) 
if--
    (i) The issuer and each principal user in good faith attempts to 
meet these requirements throughout the term of the bonds; and
    (ii) Any failure to meet these requirements is corrected within a 
reasonable period after the failure is first discovered.
    (4) Good faith. In order to satisfy the good faith requirement of 
paragraph (b)(3)(i) of this section, the issuer and each principal user 
must satisfy the requirements of Sec. 1.141-13(a) (relating to 
conditions to taking remedial actions). For this purpose, reasonable 
procedures to ensure compliance with the requirements of section 1394 
(a) and (b) include a requirement that, at least annually, each 
principal user submit to the issuer information demonstrating its 
monitoring of compliance with these requirements.
    (5) Reasonable period to correct noncompliance. Noncompliance that 
is corrected within one year of discovery satisfies the requirement of 
paragraph (b)(3)(ii) of this section if, during the period in which the 
noncompliance exists, the issuer and the principal user use their best 
efforts to correct the noncompliance.
    (6) Application to employee requirements. For purposes of the 
requirement of section 1397 (b)(6) and (c)(5) that at least 35 percent 
of the employees are residents of the empowerment zone or enterprise 
community, the issuer and each principal user may rely on an employee 
certification, signed under penalty of perjury in connection with the 
hiring of that employee, regarding the residence of the employee 
provided--
    (i) The employee is made aware of the geographic boundaries of that 
zone or community;
    (ii) The employee is required to notify the employer of a change of 
residence; and
    (iii) Neither the issuer nor the relevant principal user has actual 
knowledge to the contrary.
    (7) Application to gross income requirements. For purposes of 
paragraph (b)(3)(i) of this section, the requirement of section 1397B 
(b)(2) or (c)(1) continues to be treated as satisfied for each 5-year 
period during which, on the average, at least 85 percent of the total 
gross income of the enterprise zone business is derived from the active 
conduct of that business if--
    (i) The requirements of paragraph (b)(3)(i) of this section are 
satisfied; and
    (ii) The requirement of section 1397B (b)(2) or (c)(1) is satisfied 
during each of the first 3 years after the testing date.
    (c) Limitation on amount of bonds--(1) Determination of outstanding 
amount. Whether an issue satisfies the requirements of section 1394(c) 
(relating to the $3 million and $20 million aggregate limitations on 
the amount of outstanding enterprise zone facility bonds) is determined 
as of the issue date of that issue based on the issue price of that 
issue and the adjusted issue price of outstanding bonds.
    (2) Loans-to-lenders programs. Whether an issue satisfies the 
requirements of section 1394(c) may be determined without regard to the 
amount of bonds allocable to lenders in a loans-to-lenders program. 
This paragraph (c)(2) applies only if the proceeds of those bonds are 
loaned to an enterprise zone business within 42 months of the issue 
date of the bonds or, to the extent not so used, are used to redeem 
bonds of the issue within that 42 month period. A loans-to-lenders 
program is a program in which the issuer of enterprise zone facility 
bonds, in order to provide loans to enterprise zone businesses, lends 
the proceeds of the bonds to a bank or similar intermediary which must 
then relend the proceeds to enterprise zone businesses.
    (d) Qualified zone property. For purposes of applying the term 
qualified zone property, the following rules apply:
    (1) Original use requirement. In general, for purposes of section 
1397C(a)(1)(B), original use means the first use to which the property 
is put within the empowerment zone, whether or not that use corresponds 
to the use of that property by the taxpayer. However, for purposes of 
section 1394, property that has been abandoned for a period in excess 
of one year is treated as satisfying the requirement of section 
1397C(a)(1)(B), notwithstanding that the date of abandonment occurred 
before the date on which the designation of the empowerment zone took 
effect. See, however, Sec. 1.103-8(a)(5).
    (2) Substantially all. For purposes of sections 1397B and 1397C(a), 
substantially all means 90 percent.
    (e) Land. The determination of whether land is functionally related 
and subordinate to qualified zone property is made in a manner 
consistent with Sec. 1.103-8(a)(3).
    (f) Application of sections 141 through 150--(1) In general. 
Enterprise zone facility bonds are treated as exempt facility bonds 
that are described in section 142(a). Paragraphs (f)(2) through (f)(4) 
of this section provide special rules for applying sections 141 through 
150 to enterprise zone facility bonds. See also paragraph (g)(3) of 
this section.
    (2) Maturity limitation--(i) Requirements treated as satisfied. The 
requirements of section 147(b) are treated as satisfied for an issue of 
enterprise zone facility bonds the proceeds of which are to be used as 
part of a loan recycling program if--
    (A) Each loan satisfies the requirements of section 147(b) 
(determined by treating each separate loan as a separate issue); and
    (B) The term of the issue does not exceed 30 years.
    (ii) Loan recycling program defined. A loan recycling program is a 
program in which--
    (A) The issuer reasonably expects as of the issue date of the bonds 
that loan repayments from principal users will be used to make 
additional loans during the portion of the 10-year period following the 
issue date of the bonds during which the enterprise community or 
empowerment zone designation is in effect; and
    (B) Repayments of principal on loans (including prepayments) that 
are received during the period described in paragraph (f)(2)(i)(A) of 
this section that are not reasonably expected to be used to make new 
loans to enterprise zone businesses and repayments of principal on 
loans (including prepayments) that are received after that period are 
used within 6 months of receipt to redeem bonds that are part of the 
issue.
    (3) Volume cap. For purposes of applying section 146(f)(5) 
(relating to elective carryforward of unused volume limitation), 
issuing enterprise zone facility bonds is a carryforward purpose.
    (4) Other regulations applicable. Regulations under sections 103 
and 141 through 150 apply to enterprise zone facility bonds.
    (g) Continuing compliance and change of use penalties--(1) 
Termination of designation and cessation due to bankruptcy. An 
enterprise zone facility bond does not cease to be treated as a tax-
exempt bond and the penalties described in section 1394(e)(2) do not 
apply solely by reason of the termination or revocation of a 
designation as an empowerment zone or enterprise community or any 
cessation resulting from bankruptcy.
    (2) Coordination with good faith compliance provisions. Section 
1394(e)(2) does not apply during any period in which, under the good 
faith compliance provisions of paragraph (b)(3) of this section, the 
issue is treated as continuing to comply with the requirements of 
section 1394.
    (3) Section 150(b)(4) inapplicable. Section 150(b0(4) does not 
apply to enterprise zone facility bonds.
    (h) Refunding bonds. Bonds issued after the termination or 
revocation of a designation as an empowerment zone or enterprise 
community to refund tax-exempt bonds that are enterprise zone facility 
bonds (other than in an advance refunding) are treated as tax-exempt 
bonds if--
    (1) The weighted average maturity of the refunding bonds does not 
exceed the remaining weighted average maturity of the refunded bonds; 
and
    (2) The amount of the refunding bonds does not exceed the 
outstanding amount of the refunded bonds.
    (i) Effective date. For effective dates of this section, see 
Sec. 1.141-16.
Margaret Milner Richardson,
Commissioner of Internal Revenue.
[FR Doc. 94-31430 Filed 12-29-94; 8:45 am]
BILLING CODE 4830-01-M