The Issue Spot: Identifying Private Business Use

Identifying Private Business Use As discussed in Bracewell’s Issue Spot on “ Governmental Bonds: Private Benefit Limitations ,” interest on state and local government bonds generally will be taxable if the bond proceeds provide a special benefit to private entities in excess of certain limits, unless the bonds fit within one of the special subcategories of “qualified private activity bonds.” As a result, an issuer of “governmental bonds” must monitor the amount of private business use associated with the bond-financed property to protect the bonds’ tax-exempt status. Federal tax law allows for a limited amount of private business use before obligations lose their status as governmental bonds, and there are exceptions for some arrangements that might otherwise result in private business use. Remember that private business use is one part of a two-part test – the other part is the “private payment or security test” – and that bonds will be taxable private activity bonds only if both parts of the test are met. In other words, if the issue of bonds meets the private business use test, but fails the private payment or security test (or vice versa), then the bonds will not lose their tax-exempt status. Private Business Use Test (aka the “10 percent Test”) Subject to certain exceptions, an issue of bonds meets the private business use test if more than 10 percent of the proceeds of the issue are to be used for any private business use. In certain (but fairly rare) instances, the 10 percent percent threshold is reduced to 5 percent if the private business use is “unrelated and disproportionate” to the governmental use of the bond-financed property. Moreover, for bond issues in excess of $150 million, if the amount of private business use stays beneath the threshold percentage but nonetheless exceeds $15 million, the bonds will be private activity bonds unless the issuer receives an allocation of the “state volume cap” for private activity bonds for the amount that exceeds the $15 million threshold. In certain (but fairly rare) instances, the 10% percent threshold is reduced to 5 percent% if the private business use is “unrelated and disproportionate” to the governmental use of the bond-financed property. Identifying Private Users Generally, private business use occurs when the proceeds of the bonds or the property financed by the bonds is used, directly or indirectly, by any private person in that person’s trade or business. A “private person” is any person or organization other than a state or local government or an instrumentality thereof. Any activity carried on by a private person who is not a natural person is considered to be a “trade or business.” For purposes of the private business use test, both the federal government and nonprofit organizations are considered to be private persons.

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