Treasury has provided a valuable yet often overlooked tool in the regulations governing the allocation of bond proceeds to expenditures under IRC §§141 and 148. Using this tool, you can allocate bond proceeds in a way that differs from the flow of funds.
Treas. Reg. 1.148-6(d)(1)(iii) allows an issuer to allocate bond proceeds to expenditures at any time within 18 months after the later of the expenditure date or the placed-in-service date of the financed project. Treas. Reg. 1.141-6(d) provides that the allocations under §141 must be consistent with those under §148.
These rules have a number of potential applications.
For example, if a project is funded with tax-exempt bond proceeds and other sources, the issuer (or conduit borrower) can allocate proceeds away from those portions of the project subject to private business use. The flexibility provided by the timing rules allows the issuer to make this allocation even where the private business use wasn’t foreseen before the project was placed in service or even shortly thereafter. Further, the Service has interpreted these regulations as permitting an issuer to allocate proceeds to one project for tax purposes while allocating the proceeds to an entirely different project for state law purposes (although it may be that the project to which proceeds will be allocated must be financeable under state law with those proceeds). See, e.g., PLR 9706008 (Nov. 12, 1996). In that ruling, the Service noted that the same result would occur where proceeds are allocated to reimburse pre-issuance expenditures and the reimbursement proceeds (which lose their status as proceeds upon the reimbursement allocation) are subsequently spent for, and allocated for state law purposes to, another project.
As flexible as these allocation rules are, however, their limitations must be kept in mind. For example, allocations on a basis other than direct tracing must be made within a five year and 60 day deadline after the bonds are issued. While tax lawyers hope never to find unspent proceeds this long after bond issuance, the real world too often intervenes in an issuer’s best planning, and this is the result. The deadline was undoubtedly intended to accommodate a rebate calculation – any resulting rebate would be due on that day. Stated otherwise, if the IRS let the musical chairs music play beyond that date, there would be no way to calculate rebate because the proceeds expenditure dates would still be uncertain.
This rule makes sense for proceeds that have actually been spent on something within 5 years and 60 days. But what about proceeds not yet spent by that five year 60 day deadline? It seems that those proceeds must be allocated for tax purposes to the expenditures for which they were actually used, i.e., the direct tracing method. While it is understandable that after the five year 60 day deadline has passed, the Service would not want issuers to reallocate pre-deadline expenditures, it isn’t at all apparent why proceeds not actually spent until after that deadline could not be reallocated to another expenditure also occurring after that deadline. In other words, why not permit reallocations from and to expenditures as long as both occur in the second five year (or later) period? This would be consistent with the flexible approach of the accounting regulations without jeopardizing rebate calculations. But note that’s apparently not the rule.
Another timing rule, limiting reallocations to the redemption/maturity date of the issue plus 60 days, impacts primarily bond anticipation notes. In some states, such as Ohio, many long-term financings begin with one or a series of approximately one year or shorter BAN issues. The allocation timing rules literally require any reallocation of BAN proceeds within 60 days after their maturity. This is apparently the rule even though construction of the project may at that point just be getting started. Presumably any unspent BAN proceeds that subsequently become transferred proceeds of the next BAN issue or of the ultimate bond issue are entitled, as transferred proceeds, to a new reallocation period (but again subject to the short deadline if the second issue is also BANs). While this seems like a harsh and unintended consequence of BANs, the regulations provide no apparent relief.
Subject to these and other limitations, the allocation regulations are an important tool for issuers and one that should not be overlooked.