Since the final allocation and accounting regulations (“Allocation Regs”) were published on October 27, 2015, they have been a recurring topic of this blog (see here, here, here, and here). One question yet to be addressed is what, if anything, is the continuing importance of a “final allocation” of tax-favored bond proceeds in the wake of the Allocation Regs? In its broadest sense, a final allocation of proceeds is the latest action that causes bond proceeds to be allocated to particular expenditures, whether that action is based on a direct tracing of proceeds to expenditures or an allocation statement adopted by an issuer within the time period permitted by Treas. Reg. §1.148-6(d). The precise question to be addressed here is whether a final allocation, beyond the allocation mandated by the Allocation Regs, is permitted and if so is ever needed.
The Allocation Regs begin with this general statement in Reg. §1.141-6(a): “The allocations of proceeds and other sources of funds to expenditures under §1.148-6(d) apply for purposes of §§1.141-1 through 1.141-15.”
Reg. §1.148-6(d) provides a generous time limit for the allocation of proceeds: “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” (subject to certain further limits). The cross-reference to this permitted time period for the Code §141 allocation, which extends well beyond the expenditure date of the bond proceeds, would seem to indicate that a method of allocation other than direct tracing remains available under the Allocation Regs.
But this leaves the questions of what allocation beyond that provided by the Allocation Regs is permitted and when, if ever, would such an alternative allocation be desirable? The first question arises because the Allocation Regs mandate that, for an eligible mixed-use project, governmental use bond proceeds (or qualified 501(c)(3) bond proceeds) are allocated to governmental use (or qualifying 501(c)(3) use) to the extent of such use, and only the remaining proceeds are allocated to private business use. The second question arises because this mandatory allocation is generally the ideal allocation from an issuer’s perspective, and is thus an allocation from which an issuer may never choose to deviate.
For example, it is not clear under the Allocation Regs whether a final allocation of proceeds within an eligible mixed-use project to a discrete portion of the project can be made. And of course this question is generally moot because the Allocation Regs will allocate the proceeds in what is seemingly the ideal manner –to the governmental use portions of the project. Moreover, even if the issuer strongly expects to use the facility portion to which it would allocate proceeds only for governmental use, it would still seem undesirable to attempt to override the effect of the Allocation Regs because the use of the facility could change over time. Under the Allocation Regs, the allocation of proceeds within the facility will automatically shift, at least on an annual basis, to follow the shifting governmental use.
One point of uncertainty under the Allocation Regs, however, exists where some proceeds must be allocated to private business use (because the private business use percentage exceeds the percentage of qualified equity) and there are different types of private business use, some of which involve significant private payments or security and some of which do not. For example, consider a professional sports stadium 80% of which is financed with tax-exempt bond proceeds and 20% with qualified equity. Assume further that 100% of the stadium is subject to private business use, including a naming rights contract that represents 3% of the use of the stadium (based on the formula set forth by the IRS in Letter Ruling 200323006). Finally, assume that the private payment percentage is 9% if all of the bond proceeds are allocated to portions of the stadium other than the naming rights portion of the stadium but is more than 10% if 3% of the bond proceeds are allocated to the portion of the stadium representing the naming rights.
The Allocation Regs do not state how bond proceeds will be allocated to different sources of private business use. It is clear, however, that the thrust of the regulations is to relieve issuers of the burden of specifically and continually allocating bond proceeds to portions of an eligible mixed-use project in order to minimize private business use. Thus the regulations reflect a policy of allowing issuers to use tax-exempt financing for a project to the maximum extent that, as a mathematical matter, the project qualifies for such financing. This policy suggests the further, “sub-allocation” of proceeds to the source(s) of private business use that minimize the private payment/security percentage. Does silence on this point in the Allocation Regs suggest that the approach described here was not intended? I believe the answer is no and that the drafters did not consider this question, being one of those many questions that would not be considered until it actually arose in practice.
In further support of this interpretation of the Allocation Regs is the fact that the allocation of proceeds away from the naming rights portion through an explicit, final allocation may not be permitted under the Allocation Regs. If no such final allocation is permitted, and if the Allocation Regs do not allocate proceeds away from the naming rights, an issuer has no ability to avoid an allocation of proceeds to naming rights. This would be a worse result than prior to the Allocation Regs and would seem to be entirely inconsistent with the policy of these new Regs. Accordingly, the rule governing allocations of proceeds to private business use should be interpreted to permit the distinction among sources of private business use and to allocate proceeds among those sources to minimize the private payment/security percentage.
One final point on the question of whether a final allocation is permitted and may be desirable arises upon considering the allocation of proceeds beyond the eligible mixed-use project (as determined based on direct tracing of the bond proceeds). “Eligible mixed-use project” is defined as “a project (as defined in paragraph (a)(3) of this section) that is financed with proceeds of bonds that, when issued, purported to be governmental bonds (as defined in §1.150-1(b)) (the applicable bonds) and with qualified equity pursuant to the same plan of financing (within the meaning of §1.150-1(c)(1)(ii)).” Reg. §1.141-6(b)(2). “Project” is defined as “one or more facilities or capital projects, including land, buildings, equipment, or other property, financed in whole or in part with proceeds of the issue.” Reg. §1.141-6(a)(3)(i). Thus, while the Allocation Regs may preclude an allocation within an eligible mixed-use project, they do not preclude allocating proceeds to expenditures outside the eligible mixed-use project (determined based on direct tracing), with the effect of broadening the scope of the eligible mixed-use project with respect to the issue. Thus a final allocation could expand or change the scope of the eligible mixed-use project for the purpose of reducing the current or future private business use percentage of the bond issue. This type of final allocation is not foreclosed by the Allocation Regs and could have very desirable effects.
In conclusion, the need for a final allocation of bond proceeds is greatly reduced under the Allocation Regs. However, there remain limited situations where such an allocation will be helpful.