WASHINGTON - An issuer's fare revenues for bus service along privately-operated highway lanes would not cause bonds to be used to finance the lanes to be private-activity bonds, the Internal Revenue Service ruled.
The IRS reached its conclusion in a private-letter ruling that was dated Feb. 3 but not publicly released until Friday. The PLR did not identify the issuer or the state in which it is located. It was signed by James Polfer in the IRS chief counsel's office.
The facts of the case are not completely clear, but the ruling relates to a project that appears to be some type of public-private partnership. The bonds in the ruling appear to be Build America Bonds. But the IRS does not explicitly state the ruling involves a P3 or BABs. The ruling could have implications for P3s, some lawyers suggested, but the IRS always cautions against applying letter-rulings to other situations.
Several bond lawyers said that the IRS reached the right conclusion.
The issuer in the ruling is a political subdivision of a state that provides bus transportation services to the public. Some of the issuer's bus routes involve a U.S. highway.
Members of the general public pay the issuer fares to ride on the buses. Some riders pay per ride, while others purchase monthly or annual passes. The price of each ride or pass depends on whether the rider travels on local, express or regional routes, according to the ruling.
The state's transportation department and one of its divisions have started a project that will include the segregation and construction of one managed lane in each direction of the highway. A private concessionaire will operate the managed lanes pursuant to a management contract.
The issuer will contribute money to the construction of the managed lanes and will finance equipment along the lanes that will be owned by the issuer and used in its bus operations. It plans to use the proceeds of bonds to finance a portion of these expenses. On some of the issuer's regional and express bus routes, the buses will use the managed lanes. The buses' travel on the managed lanes may be only part of the total distance they travel. The fares for passengers who travel on regional and express routes that use the managed lanes will be the same as the fares for regional and express use passengers who don't use those lanes, the ruling stated.
Build America Bonds are taxable bonds that could be issued in 2009 and 2010. BAB issuers receive federal subsidy payments equal to a portion of their interest costs. Under federal tax law, BABs cannot be PABs.
Bonds are PABs if more than 10% of the proceeds are used for private business use and more than 10% of the debt service for the bonds is derived from, or secured by, private payments. Under Section 141(b)( 2) of the Internal Revenue Code, a bond issue meets the private security or payment test if more than 10% of the payment of principal and interest is derived from payments "in respect of property, or borrowed money, used or to be used for a private business use," the IRS noted.
The issuer already acknowledged that there would be private business use from the management contract with the concessionaire, and it wants to know that the bus fare revenues that are collected for service along the managed lanes would not be private payments as well.
The IRS ruled these fare revenues would not be payments that count toward the private payment test.
"The fare revenues will have little connection to the managed lanes," the IRS said.
A number of bond lawyers said the ruling had the correct result.
"I think the ruling is a helpful ruling," said Ed Oswald, a partner at Orrick, Herrington and Sutcliffe in Washington. Any nexus between the fare revenues and the managed lanes is "too weak" for the IRS to conclude that the revenues were payments with respect to a bond-financed project, he said.
It's good that the IRS recognizes that there should be a "clear relationship" between payments and the use that gives rise to private business use, said Matthias Edrich, of counsel at Kutak Rock in Denver.
Todd Cooper, a partner at Squire Patton Boggs in Cincinnati, said that the IRS likely could have also come to the conclusion that the fare revenues weren't private payments on the debt service by taking a different approach.
"A rider of a public bus rarely pays enough in fares to cover the full cost of the ride. The remainder is typically subsidized by other tax revenues and federal subsidies," Cooper said. "Thus, it is very likely the fares would not even cover the operating expenses of the bus and none of the fare revenue would be available for debt service on the BABs."
The ruling is an example of how tax-advantaged bonds can be used for P3 arrangements, but does not address all the tax issues relating to incorporating bond financing in P3 transactions, said Carol Lew, a shareholder at Stradling Yocca Carlson & Rauth in Newport Beach, Calif. Lew and others are working on a comment project about P3s for the tax-exempt financing committee of the American Bar Association's taxation section.
Over the years, the IRS has released rulings on the private payments test that pertain to a number of different circumstances, Lew said.
"We have these kinds of issues in a lot of different contexts," Lew said.
Oswald said that in the future, there are likely to be more rulings along these lines that ask similar questions.
"There's a lot of pressure to promote P3s," he said.
The bond community hopes that the Treasury Department will provide guidance that clearly explains how P3s can be structured to avoid private business use and private payments, Edrich said.
Bond lawyers, including Perry Israel, who has his own law firm in Sacramento, Calif., said that the ruling does not include many of the facts of the case.
Build America Bonds can no longer be issued. Cooper said it is unclear why the ruling was requested several years after the ability to issue BABs expired, while Oswald said the issuer probably had some unspent BAB proceeds.
