On December 19, 2011, the Treasury Department released its report to Congress on tax-exempt bonds issued by tribal governments for economic development, a report that was mandated by the American Recovery and Reinvestment Act (the Recovery Act) of 2009 (PL 111-5). The Treasury Department’s recommendations, if enacted into law, would put tribes more on a par with states with respect to issuing tax-exempt bonds. Tribal advocates have been urging this action for many years. The report is captioned Report and Recommendations to Congress regarding Tribal Economic Development Bond provisions under Section 7861 of the Internal Revenue Code (Report) a copy of which is attached. It is also available on the Tribal Policy page of the Treasury Department website at: www.treasury.gov/resource-center/economic-policy/tribal-policy/Pages/Tribal-Policy.aspx.
Background. A basic way that states and local governments finance investments in public infrastructure and other public projects is the issuance of tax-exempt bonds. There are two basic categories of tax-exempt bonds: “governmental” and “private activity.” States and local governments routinely issue both types. Governmental bonds are used to fund governmental functions or are secured or paid from governmental sources, such as tax revenues. Private activity bonds can be used to finance a wide range of projects and activities (listed on page 8 of the Report) which generally have substantial private sector involvement but which also serve public purposes. Governmental bonds are allowed to have some private sector involvement – the basic policy is to limit the extent to which the benefits of tax-exempt financing are transferred to persons other than governments. The Treasury Department uses a two-pronged test to determine if private sector involvement is so great that bonds cross the threshold from governmental to private activity: if both (1) more than ten percent of bond proceeds are used for private business and (2) the debt service on more than ten percent of bond proceeds is paid or secured by payments or property uses for private business. Private activity bonds are more heavily regulated than governmental bonds, and there is a cap on the amount of private activity bonds that can be issued in any year which is allocated among the states.
Tax-exempt bond financing was not available for tribes until the enactment of the Indian Tribal Government Tax Status Act of 1982. (PL 97-473). While that Act provides that tribes are treated as states for certain purposes under the federal tax code, it also imposes a restriction on the use of tribal tax-exempt bonds by specifying that such bonds can only be used to finance “essential governmental functions.” 26 U.S.C. § 7871(c). As amended in 1987, the “essential governmental functions” standard is limited to those functions “customarily” performed by states and local governments with general taxing powers. § 7871(e). As such, tribal “governmental” bonds are subject to a restrictive standard that does not apply to states and local governments, and tribes have been completely barred from issuing tax-exempt private activity bonds. While legislation has been introduced in each Congress since 2002 at tribal request to amend section 7871, those efforts failed until the passage of the Recovery Act. The Recovery Act authorized tribes to issue Tribal Government Economic Development Bonds, subject to the rules applicable to private activity bonds, with a one-time total cap of $2 billion. The Recovery Act also mandated the Report to Congress.
Summary of Recommendations. The Report makes four recommendations, which are explained in the Report in detail with supporting analysis and documentation. The recommendations are:
(1) For tax-exempt governmental bonds, tribal governments should be treated the same as state and local governments. The “essential governmental functions” standard should be repealed. Bonds issued by tribes would be presumed to be for governmental purposes as long as they are not private activity bonds under the two-pronged test.
(2) For private activity bonds, tribes should have permanent authorization to issue such bonds for the types of projects and activities that are allowed for state and local governments, subject to an annual national volume cap tailored to Indian Country. The Report recommends that Congress delegate authority to the Treasury Department to allocate the national cap among tribal governments.
(3) There should be some restrictions on the location of projects financed with tax-exempt bonds issued by tribal governments. The Report recommends flexibility to allow, in addition to projects located within Indian reservations, projects “that both: (i) are contiguous to, within reasonable proximity of, or have a substantial connection to an Indian reservation, and (ii) provide goods or services to resident populations of Indian reservations.”
(4) The existing restrictions against using tax-exempt financing for certain gaming projects should be retained. The Report notes that gaming revenues could be used as a source of payment or security for tax-exempt bonds that finance eligible projects.
The Report is a major step toward making the use of tax-exempt bonds by tribal governments more nearly the same as such financing by state governments. For fair treatment to become a reality, of course, Congress will need to enact legislation along the lines of the Treasury Department’s recommendations. In addition, the Report notes that there are other “significant credit challenges facing Indian tribal governments that impede access to the tax-exempt bond market” and recommends that Congress examine this “difficult issue” and “explore possible ways to improve bond market access.”
If you would like further information regarding the Report, please contact us.