PUBLIC FINANCE IN FOCUS

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 .

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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 .

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In certain ( but fairly rare ) instances , the 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 .”

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