WASHINGTON - The Treasury Department yesterday issued more restrictive final regulations for bonds backed by payments in lieu of taxes, just three days before a House panel is scheduled to hold a hearing questioning the use of PILOTs to finance the new New York Yankees stadium.

But the rules contain a transitional provision that appears to enable the New York Yankees, Mets, and Nets to continue to issue PILOT bonds as planned without having to comply with the new rules.

The final rules apply to bonds sold on or after Oct. 24. But under one of two transitional provisions, ongoing PILOT-backed projects that were "substantially in progress" on Oct. 19, 2006, when rule changes were proposed, can continue to adhere to the old rules.

Specifically, the provision states that if a governmental person took official action indicating preliminary approval of the project, and significant expenditures were paid or incurred with respect to the project, or a contract was entered into involving significant expenditures, the new regulations do not apply to bonds issued to finance that project.

The New York City Industrial Development Agency sold nearly $1.6 billion of PILOTs in the summer of 2006 to finance new stadiums for the Mets and Yankees. During the same period, the agency began a project for a new New Jersey Nets basketball arena. Plans call for the issuance of more than $700 million of bonds for the project, although no bonds have been issued yet. All three of the projects would be able to continue complying with the 1997 regulations due to the transitional provision.

An additional $300 million of PILOTs could be issued for the Yankees' stadium, and approximately another $80 million may be issued for the Mets' ballpark. The bonds would also be covered by the 1997 rules.

A second transitional provision in the final rules states that refunding bonds issued before Oct. 24, also can adhere to the older regulations, so long as the weighted average maturity of the refunding bonds does not exceed the remaining weighted average maturity of the refunded debt.

Ohio Democrat Rep. Dennis Kucinich, who chairs the House Oversight and Government Reform subcommittee on domestic policy, which is holding the hearing on the new Yankees stadium, could not be reached for comment on the new regulations. But he has opposed the use of PILOT bonds for stadiums, claiming stadiums benefit private parties more than the surrounding localities.

PILOT deals - typically economic development projects - involve payments from private entities that are used to pay debt service on tax-exempt bonds. To meet the tax code's private-payment restrictions, PILOTs must be less than, and commensurate with, the taxes that would have otherwise been collected on the property.

The finalized regulations mostly mirror the regulations proposed back in 2006, which market participants criticized as placing too many restrictions on how PILOTs can be calculated, limiting the flexibility of issuers seeking to use the financing tool.

Despite the criticisms, the Treasury's final rules state that an eligible PILOT payment must represent a fixed percentage of, or reflect a fixed adjustment to, the amount of generally applicable taxes in each year, based on comparable current valuation assessments.

The Treasury also rejected calls for permitting fixed-payment PILOTs, specifically for debt service payments.

"A PILOT is not commensurate with a generally applicable tax if the PILOT is set at a fixed dollar amount ... that cannot vary with changes in the level of the generally applicable tax on which it is based," the Treasury stated in its release of the final rules.

David Caprera

David Caprera, a partner at Kutak Rock LLP in Denver, said the new regulations will require a shift in how many market participants view PILOTs."Prior to these regulations ... I think 'commensurate with' was read by many bond counsel to allow for a lesser but fixed amount to correspond to debt service on the bonds," he said yesterday. "The IRS didn't think that's what commensurate meant ... They took a conservative position."

Since the PILOTs must be tied to taxes, Caprera said the new regulations shift a small amount of risk to the bondholder, who cannot be guaranteed a fixed payment, and unexpectedly low tax revenues could jeopardize a timely payment. As a result, he said bondholders could demand issuers tie their PILOTs to a greater percentage of tax revenues to ensure prompt payments.

Tom Vander Molen, a partner at Dorsey & Whitney LLP in Minneapolis, said that while he appreciates the overall regulations, he is disappointed about the fixed payment restriction.

"While the final regulations generally are an improvement on the proposed regulations, and clarify certain ambiguous provisions, I am disappointed that the government chose to prohibit fixed payment arrangements in situations where the payment is less than the tax would have been," he said.

In the final regulations, the Treasury also clarified and illustrated the scope of the special charge limitation on generally applicable taxes. Under tax code rules, PILOTs cannot be "special charges," imposed on a limited group of people for benefits only to be received by that group, and instead must qualify for treatment as generally applicable taxes, which apply equally to all taxpayers.

The final rules cite, as an example of a special charge, a special assessment to finance infrastructure improvements in a new industrial park that is imposed just on the property owners within the park.

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