WASHINGTON -- Small-issue industrial development bonds used to finance two manufacturing plants will not automatically become taxable even though the owner closed the facilities, the Internal Revenue Service has ruled.
Several lawyers said the private letter ruling made public last week appears to clear up a murky area of bond regulation, even though the IRS offered its usual cautionary statement that its conclusions should not be viewed as precedent-setting.
Another helpful aspect of the letter ruling was that it deals with a change-in-use situation, giving lawyers further evidence that the IRS is living up to its promise to grant relief in certain cases when bond issues do not meet the safe harbors set up under a revenue procedure published last year, lawyers said.
At issue in letter ruling number 9440016 are two sets of tax-exempt bonds, the issuer of which was not identified by the IRS. The first set was sold in 1986 to finance the acquisition of a structure used as an office building and for research and development activities. The second set was sold in 1988 to finance purchase of a manufacturing facility.
In 1990, the ownership of both the 1986 and 1990 facilities changed hands. The new owner later decided to streamline the company's operations, resulting in the closure of both buildings in March 1993.
The 1986 facility has never reopened, but the owner finally sold the 1988 facility and part of its equipment to another company that resumed using that plant for manufacturing. The equipment that was not sold was moved by the owner to a facility in another state.
In its ruling, the IRS said that because the facilities were used in the manner in which they were intended, their closure does not render the bonds taxable.
Several lawyers said the bond community has long been unclear on that point. The question often comes up in the manufacturing area in cases where a bond-financed facility in a particular industrial sector falls on hard times and the plant must be closed until economic conditions improve and orders pick up.
"It's nice to know that if you stop using your facility temporarily, at least mothballing it might be all right," said William M. Loafman, a lawyer with Whitman Breed Abbott & Morgan in New York.
The ruling indicates that, if a factory is idled, the key to keeping the bonds tax-exempt is to make sure not to change over to a non-qualified use, even temporarily, lawyers said.
"If you're holding it out to use it as a manufacturing facility, that will get you the proper use," said Brian G. Belisle, a lawyer with Briggs & Morgan in Minneapolis. "It's' when you change it to some other use, such as warehousing, that you're going to run into some problems" with the IRS, Belisle said.
The ruling also dealt with a change-in-use question raised by the sale of the 1988 facility. Although the plant and some of the equipment was purchased by a qualified owner, a change in use of the bonds was deemed to have occurred because the equipment retained by the previous owner was moved to another state. Moving the equipment runs afoul of the requirements of small-issue IDB regulations, which state that a bond-financed facility must remain within the issuer's jurisdiction.
The issuer of the 1988 bonds sought the ruling because the bonds are not covered by Revenue Procedure 93-17, issued in February 1993, under which issuers and borrowers who meet certain criteria may Change the use of their bond-financed facilities without undermining the tax-exempt status of the bonds.
One of the key criteria in the 1993 revenue procedure was that the bond issue must be outstanding, and the facility properly used, for at least five years. According to last week's letter ruling, the equipment in question was moved after 4.9 years of use, causing the issuer to fail to meet the safe harbor standard.
But the IRS deemed that the bonds would not become taxable because the issuer agreed to redeem the 1988 bonds. Thus the owner "is taking practical, good-faith action to prevent bond proceeds from being used in a manner that fails to meet requirements for tax exemption," the IRS said.
The service's favorable decision involving the change-in-use situation was in itself not startling because the issuer was so close to meeting the safe harbor requirements, lawyers said.
But it was still significant because it is proof of the IRS's continuing effort to provide guidance on change-in-use situations. Shortly after it issued the revenue procedure, IRS officials conceded that the safe harbor guidelines did not cover all situations, and they urged lawyers and issuers to seek letter rulings that 93-17 did not address.
Last week's ruling shows "the continuing willingness of the IRS to grant rulings in a reasonable manner interpreting this revenue procedure, 93-17," said Michael Lehr, a partner with Ballard, Spahr, Andrews & Ingersoll in Philadelphia.
"This gives the IRS lots of credibility," Lehr said. "It gives practitioners out there confidence that the people in the IRS live up to their word."
Belisle agreed, saying the ruling "is indicative of what the IRS has promised: 'Come talk to us and we'll grant you relief'" in cases where the service deems relief is appropriate.