New planning guidelines and targets for renewable energy in key Australian markets
Victoria and South Australia are tightening their guidelines and planning policies for renewable energy facilities.
On August 22, 2016, the Internal Revenue Service (the “IRS”) released Revenue Procedure 2016-44 (“Rev. Proc. 2016-44”),1 which modifies and supersedes existing management contract guidance under Revenue Procedures 97-13 and 2001-39 and section 3.02 of Notice 2014-67.2 Rev. Proc. 2016-44 provides new safe harbor conditions for management contracts, and provides for a new “eligible expense reimbursement arrangement,” that, if satisfied, will not result in private business use under sections 141 and 145 of the Internal Revenue Code of 1986 (the “Code”).
Rev. Proc. 2016-44 may allow tax-exempt bonds to be issued by a state or political subdivision (a “governmental person”) in so-called “public-private partnership” transactions (“P3s”) to finance governmental facilities subject to long-term contracts whereby such governmental person contracts with a nongovernmental person to design, build, finance, operate and maintain the facilities to be used by governmental persons. As noted below, Rev. Proc. 2016-44 continues to provide that a qualifying management contract not transfer any direct or indirect ownership interest in the facilities to a nongovernmental person. This requirement may be a limiting factor in the context of certain P3 structures.
Under section 103(a) of the Code, interest on bonds of a governmental person generally is excluded from the gross income of the bondholder for regular federal income tax purposes. However, such exclusion is denied under sections 141 and 145 of the Code in the case of bonds that are “private activity bonds” but not “qualified bonds.”3 A private activity bond is a bond of an issue that satisfies both a “private business use” and also a “private security or payment” test. Generally, the private business use test is satisfied if more than a limited amount of the proceeds of the issue are to be “used” by a nongovernmental person in any activity of an entity, or any activity of an individual that is in a trade or business (a “private business use”); and, the private security or payment test is satisfied if either the obligation of the issuer to pay debt service is secured to a substantial extent by property subject to private business use (a “private security”) or the issuer is to receive substantial payments (whether or not made by a nongovernmental user) with respect to a private business use of the proceeds of the issue. In either case, a use of property financed with proceeds of the issue is treated as a use of the proceeds.4 Thus, in determining whether an issue comprises private activity bonds, it is important to identify any private business use of the proceeds of that issue.
A nongovernmental person may enjoy a “use” relationship to bond-financed property if it has special legal entitlements with respect to the bond-financed property such as a direct or indirect (e.g., through a joint venture or partnership) ownership interest; or has a leasehold interest in that property (determined under general federal income tax principles); or will receive a special economic benefit from the property (e.g., by reason of owning nongovernmental property specially benefitted by the proximity of the financed property). In addition, however, a nongovernmental person may enjoy such a “use” relationship to bond-financed property if that nongovernmental person provides services to the governmental owner with respect to any function of the financed property pursuant to a “management contract.”5
Over the previous 34 years,6 the IRS has recognized that not all service arrangements between governmental owner and nongovernmental provider should result in a denial to the governmental owner of the benefits of tax-exempt bond financing. Governmental units and 501(c)(3) organizations frequently enter into arrangements with nongovernmental persons to provide management or other services, with respect to all or a portion of a bond-financed property, that do not create in the service provider sufficient indicia of ownership, possession, or indirect benefit to warrant such denial.
In recent years, issuers have relied on the safe harbor conditions established under Revenue Procedures 97-13 and 2001-39 and Notice 2014-67 (collectively, the “Original Safe Harbors”) satisfaction of which would assure that a management contract would not be treated as establishing in private business use under sections 141 and 145 of the Code. The Original Safe Harbors, however, have been quite narrow, resulting in elaborate efforts to conform the normal commercial practices of the nongovernmental service provider to noncommercial constraints regarding compensation, reimbursement of expenses and, importantly, the term of the service arrangement. Such constraints, for example, have prevented other than the shortest of P3 arrangements, essentially precluding the typical design-build-finance-operate-maintain method of procurement of governmental facilities, all in an effort by the IRS to assure that the nongovernmental service provider derive no benefit as a consequence of the governmental tax-exempt bond financing of the managed facilities.
Under Rev. Proc. 2016-44, the traditional structure of the IRS guidance providing management contract templates that, with careful compliance, afforded safe harbor protection from private business use characterization is abandoned in favor of a broad and generally more inclusive set of principles. The Rev. Proc. 2016-44 safe harbor relief generally includes long- or short-term contracts providing for any type of fixed or variable compensation that is determined to be reasonable for services rendered under management contracts. As under the Original Safe Harbors and applicable regulations, Rev. Proc. 2016-44 does not permit net profits arrangements. Rev. Proc. 2016-44 applies a principles-based approach focusing on (i) the extent of governmental control over the financed property; (ii) the extent to which the service provider does (or does not) bear risk of loss with respect to the financed property; (iii) the term of the arrangement in comparison to the economic life of the financed property; and (iv) consistency of tax positions taken by the service provider. In short, Rev. Proc. 2016-44 adopts criteria closely aligned to the criteria that would be applied in a traditional tax ownership analysis.
Rev. Proc. 2016-44 generally applies to any management contract that is entered into on or after August 22, 2016, provided that an issuer may continue to rely upon the Original Safe Harbors in evaluating any agreement entered into prior to February 18, 2017, that is not materially modified or extended after that date (other than pursuant to a renewal option). In addition, an issuer may apply the new Rev. Proc. 2016-44 safe harbor conditions to any management contract that was entered into before August 22, 2016.
A management contract satisfying all of the conditions below does not result in private business use under sections 141 or 145 of the Code:7
Furthermore, a service provider’s use of a project that is functionally related and subordinate to its performance under a management contract meeting all of the conditions above does not result in private business use.
If a management contract is an “eligible expense reimbursement arrangement,” such management contract does not result in private business use under sections 141 and 145 of the Code. An “eligible expense reimbursement arrangement” is a management contract under which the only compensation consists of reimbursements of actual and direct expenses paid by the service provider to unrelated parties and reasonable related administrative overhead expenses of the service provider.
1 2016-36 I.R.B. 1.
2 All other sections of Notice 2014-67, 2014-46 I.R.B. 822, remain in effect with respect to contracts entered into prior to February 18, 2016 and not materially modified thereafter. Revenue Procedure 97-13, 1997-1 C.B. 632, as originally issued, specifies various permitted terms of contracts that depend on the extent to which the compensation is a periodic fixed fee. The greater the percentage of fixed compensation, the longer the permitted term of the management contract. Revenue Procedure 2001-39, 2001-2 C.B. 38, only made a minor amendment to Revenue Procedure 97-13. Notice 2014-67 expanded the Revenue Procedure 97-13 safe harbors to address certain developments involving accountable care organizations after the enactment of the Patient Protection and Affordable Care Act, Pub. L. 111-148, 124 Stat. 119, and also to allow a broader range of variable compensation arrangements for shorter-term management contracts of up to five years.
3 “Qualified bonds” are listed in section 141(e) of the Code and include “exempt facility bonds” issued under section 142 of the Code and “qualified 501(c)(3) bonds” issued under section 145 of the Code.
4 Section 145(a) of the Code provides generally that a “qualified 501(c)(3) bond” means any private activity bond issued as part of an issue if all property that is to be provided by the net proceeds of the issue is to be owned by a 501(c)(3) organization or a governmental unit, and if there is to be only insubstantial private business use of the property by any nongovernmental person (other than by a 501(c)(3) organization in an activity that, as to its exempt purposes, is not an unrelated trade or business under section 513(a) of the Code).
5 Treas. Regs. § 1.141-3(b)(4)(i). This concept of “use” of property is a deviation from general federal income tax provisions in the converse situation, in which such certain federal income tax benefits, including investment credits and accelerated depreciation, are denied to a nongovernmental owner by reason of a governmental entity’s “use” of nongovernmental property. Under those provisions, “use” is limited to situations of governmental ownership or possession of the nongovernmental property, and does not include situations where the governmental involvement is through the provision or receipt of services involving the nongovernmental property. For that reason, Code provisions such as section 7701(e) and legal authority under Code provisions such as sections 49 or 168(i) are of limited value in identifying where a service arrangement should give rise to private business use of a governmental facility.
6 See, e.g., Rev. Procs. 82-14, 82-15, 92-17, etc.
7 For purposes of Rev. Proc. 2016-44, a “management contract” means a management, service or incentive payment contract between a qualified user and a service provider under which the service provider provides services for a “managed property.” In the case of a contract that covers both pre-operating services (e.g., construction management) and operating services, only that portion of the contract covering the latter is the “management contract”. A “service provider” means any person (other than another qualified user) that provides services to, or for the benefit of, a qualified user under a management contract. The term “qualified user” means, for projects financed with governmental bonds, any government person or, for projects financed with qualified 501(c)(3) bonds, any governmental person or 501(c)(3) organization with respect to its activities that do not constitute an unrelated trade or business, determined by applying section 513(a) of the Code.
8 For purposes of Rev. Proc. 2016-44, the term “service provider” means any person other than a qualified user that provides services to, or for the benefit of, a qualified user under a management contract. A “qualified user” means, for projects financed with government bonds, any government person or, for projects financed with qualified 501(c)(3) bonds, any governmental person or 501(c)(3) organization with respect to its activities that do not constitute an unrelated trade or business, determined by applying section 513(a) of the Code.
9 For purposes of Rev. Proc. 2016-44, the term “unrelated party” means a person other than a related party (as defined in Treas. Regs. § 1.150-1(b)) or a service provider’s employee. Thus, for example, an arrangement under which the amount of reimbursement of a vendor for its employee expenses (or those of a related party) is contingent on both the revenues and expenses of operation of the managed property would fail this second condition.
10 See, Rev. Proc. 83-35, 1983-1 CB 745. For buildings, the asset guideline lives under Rev. Proc. 62-21 may be used. As an alternative, economic life may be established under section 147(b) through the expert opinion of a licensed engineer or other professional, and usually is based upon industry experience with the particular type of property and familiarity with the maintenance practices of the governmental owner of the property.
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