WASHINGTON — The Council of Development Finance Agencies will unveil a draft legislative proposal Friday that would ease tax-law restrictions for  small industrial development bonds, which are used to finance manufacturing facilities.

CDFA, which is seeking congressional sponsors, contends the tax-law provisions governing qualified small-issue bonds haven’t been changed in 30 years and need to be updated in order to expand their capacity and usability.

The draft legislation, among other things, would expand the permitted size of small-issue IDBs and allow the bonds to be used to finance intangible property, such as software.

The draft also calls for raising the limits for bank deductibility to $30 million so that banks could deduct 80% of the cost of buying and carrying tax-exempt bonds sold by issuers that have issued $30 million of bonds or less in a year — a tax law change pushed for by all of the muni market groups.

Under current tax law, small-issue IDBs can be up to $10 million in size. CDFA’s draft legislation would increase that size limit to $30 million. The $10 million limit has not been raised since 1979 and has never been adjusted for inflation. Many companies cannot complete a project that would otherwise fit into this category for less than $30 million, CDFA said in a release.

Small-issue IDBs are sold through conduit transactions, with issuers lending the proceed to corporate borrowers. But under existing tax-law provisions, the borrowers can only have up to $20 million of pending capital expenditures over a six-year period — three years before and three years after issuance of the bonds. The limit includes not only the capital expenditures to be financed with the small-issue IDB bonds, but other capital expenditures as well. The purpose of the limit was to ensure only small issuers sell the bonds, according to lawyers. CDFA wants to raise the capital expenditure limit to $40 million.

“This bedrock tool is the single most actively used bond tool for financing the small to mid-sized manufacturing sector and are a key economic development tool for many state and local economic development agencies,” the group said.

Toby Rittner, CDFA’s president and chief executive officer, said the group has been laying the groundwork for this proposal for about 10 months. There is support from senior leadership from both parties on the Senate Finance Committee and the House Ways and Means Committee, he said. Rittner said he expects lawmakers will introduce the legislation in the next few months before the November elections.

“If Congress wants to create jobs, this is the right tool,” he said.

As a result of the arcane regulations and the weak economy, there has been a declining trend for using this finance tool, Rittner said. While over $3.1 billion of manufacturing bonds were issued in 2007, only $666 million were issued in 2010, according to CDFA. It appears that even less than that — only $400 million — were issued in 2011, although that estimate is not final, the group said.

The group highlighted seven of what it sees as the most problematic areas of current law that need changing. The reforms would expand access to capital for manufacturers and boost productivity in the industry, according to the group.

“In a perfect world we would have rewritten the whole code but we know that isn’t realistic,” Rittner said.

The number one problem with current IDB regulations for small to mid-sized manufacturers is the level of difficulty to access low-cost, affordable, and efficient capital, CDFA said.

In part, the challenges of accessing capital in this environment has driven many manufacturers overseas because small banks aren’t willing to take risks with manufacturing projects anymore, Rittner said. If IDB regulations were reformed, banks’ risk would be mitigated and instead passed onto borrowers and bondholders.

Three tax law changes sought by CDFA were included in the American Recovery and Reinvestment Act: expanding the definition of manufacturing to include intangible property, eliminating curbs on what constitutes as integral elements to the manufacturing operation, and allowing financial firms to buy bonds in an amount that does not exceed 2% of their assets. The changes took effect in early 2009, but the act expired at the end of 2010.

“Manufacturing processes, production and technology have changed significantly since this definition was introduced in the 1970s,” CDFA wrote in its  release. “Today’s manufacturers encompass more modern, high-tech, and intangible manufacturing practices.”

The group proposed eliminating the current restriction that only “functionally related and subordinate facilities” can be used to finance a manufacturing facility. Currently, IDBs are limited to core manufacturing operations such as raw material warehousing. Elements restricted from being financed with IDBs are largely considered part of the manufacturing process, such as locker rooms in a cafeteria for employees, Rittner said.

Current law states that only non-financial institutions can deduct up to 80% of their interest for tax-exempt bonds as long as their share of bonds does not exceed 2% of their assets. CDFA would like to see this provision expanded to include financial institutions so that small, local banks  can purchase IDBs and directly support manufacturing investments.

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