Subject: Private Business Use
Contained in this attachment is a brief discussion of various arrangements that can give rise to ‘private business use’ as defined in Attachment A.
The following types of arrangements can give rise to private use:
- Leases of UMS property to Non-Exempt Persons, including a parking area lease *
- Management or service contracts * (e.g., food service and parking contracts)
- Research contracts *
- Naming rights agreements involving a bond financed facility *
- Output Facilities *
- Privatization/change in use – sales or dispositions of bond financed property
* Described in more detail in remainder of this attachment.
B. LEASES AND PERIODIC SPACE RENTALS
A bond financed facility is treated as leased to a Non-Exempt Person:
- Whether leased by the Non-Exempt Person, then subleased to a governmental organization, or
- Leased to a governmental organization and then subleased to a Non-Exempt Person
Factors that bear on the lease analysis;
- Degree of control that the Non-Exempt Person has in the facility,
- Risk of loss borne by the Non-Exempt Person
A lease or rental of bond-financed property by a private user constitutes private use unless an exception is satisfied.
- A lease or rental of property to a state or local governmental unit should not give rise to private business use.
- Use of facilities intended for general public use is not considered “use” by nongovernmental persons in a trade or business if such persons use the facilities in their trade or business on the same basis as other members of the public. Use of the financed facilities by organizations such as school groups, church groups, and fraternal organizations and numerous commercial organizations for a short period of time on a rate scale basis will not be considered use by nongovernmental persons in a trade or business if the rights of such a user are only those of a transient occupant rather than the full legal possessory interests of a lessee. Any arrangement that conveys priority rights to the use or capacity of the financed property will be treated a private business use.
- Rental of property should not give rise to private business use if the term of the use under the arrangement, including all renewal options is not longer than 200 days, and the use of the financed property under the same or similar arrangements is predominantly by natural persons who are not engaged in a trade or business.
- Rental of property that is made generally available to third parties (though not necessarily individuals) should not give rise to private business use if:a. the term of the use under the arrangement, including all renewal options, is not longer than 100 days,b. the property is not financed for a principal purpose of providing it to an outside user, and
c. to the extent the property is not generally available to individuals, the reason is because “generally applicable and uniformly applied rates are not reasonably available to natural persons not engaged in a trade or business.”
Example 1: Authority E uses all of the proceeds of its bonds to construct a prison. E contracts with Federal Agency F to house federal prisoners on a space available, first-come, first-served basis, pursuant to which F will be charged approximately the same amount for each prisoner as other persons that enter into similar transfer agreements. It is reasonably expected that other persons will enter into similar agreements. The term of the use under the contract is not longer than 100 days, and F has no right to renew, although E reasonably expects to renew the contract indefinitely. The prison is not financed for a principal purpose of providing the prison for use by F. It is reasonably expected that during the term of the bonds, more than 10 percent of the prisoners at the prison will be federal prisoners. F’s use of the facility is not general public use because this type of use (leasing space for prisoners) is not available for use on the same basis by natural persons not engaged in a trade or business. The issue does not meet the private business use test, however, because the lease is not longer than 100 days.
- Rental of property should not give rise to private business use ifa. the arrangement is a negotiated arm’s-length arrangement and compensation under the arrangement is at “fair market value”;b. the term of the use under the arrangement, including all renewal options, is not longer than 50 days; and
c. the property is not financed for a principal purpose of providing it to a user other than the University.
- Incidental use of a facility by an external party (whether or not described as a “rental”) should not give rise to private business use to the extent that all such uses do not exceed 2.5% of the proceeds of the bonds and ifa. the user does not have possession and control of space that is physically separated from other parts of the facility (e.g., by walls) except in the case of vending machines, pay phones, kiosks and the like,b. the non-possessory use is not functionally related to any other use of the facility by the same party, and
c. all non-possessory uses of the facility do not, in the aggregate, involve the use of more than 2.5% of the facility.
Example: This exception may cover an ATM which is located in a bond financed facility for the convenience of those who use the facility but not a rental of roof space for a mobile telecommunications tower which provides service over a wide area.
C. MANAGEMENT CONTRACTS
1. General Rule
private business use of that property if the contract provides for compensation for services rendered with compensation based, in whole or in part, on a share of net profits from the operation of the facility.
Generally, compensation under a management contract is not based on net profits if it is based on –
a. A percentage of gross revenues (or adjusted gross revenues) of a facility or
b. A percentage of expenses from a facility, but not both;
c. A capitation fee; or
d. A per-unit fee.
Example 1: County uses proceeds of tax-exempt bonds to finance a courthouse. County enters into a contract with Corporation pursuant to which Corporation is to manage the cafeteria located in the courthouse. The contract provides that Corporation’s compensation will equal 5 percent of the net profits of the cafeteria. The management contract results in private use because compensation is based on net profits.
Example 2: County uses proceeds of tax-exempt bonds to finance a courthouse. County enters into a contract with Corporation pursuant to which Corporation is to manage the cafeteria located in the courthouse. The contract provides that Corporation will receive 10 percent of the gross receipts of the cafeteria. This aspect of the management contract does not result in private use because the compensation is based only on gross receipts not gross receipts and expenses from the facility. However, the contract must be further reviewed to determine whether it meets one of the safe harbor provisions outlined in the following paragraph.
2. Safe Harbors
In addition to the compensation requirements outlined above, the management contract must meet one of the following safe harbors to avoid being classified as private business use:
a. Safe Harbor 1:
(1) At least 95% of the fee is a fixed amount and
(2) the contract term, including renewal options, is the lesser of 80% of useful life of the property or 15 years.
b. Safe Harbor 2:
(1) At least 80% of the fee is fixed and
(2) the contract term, including renewal options, is the lesser of 80% of useful life of the property or 10 years.
c. Safe Harbor 3:
(1) At least 50% of the fee is fixed or capitated,
(2) the contract term, including renewal options, is not more than 5 years, and
(3) the contract must be cancellable by the University after the third year.
d. Safe Harbor 4:
(1) All of the compensation is based on a per-unit fee or a combination of a per-unit fee and a periodic fixed fee,
(2) the contract term, including renewal options, is not more than 3 years, and
(3) the contract must be cancellable by the University after the second year.
e. Safe Harbor 5:
(1) If compensation is all based on a percentage of gross revenue, the contract term, including renewal options, cannot exceed 2 years and
(2) the contract must be cancellable by the University after the first year.
Example: County uses proceeds of tax-exempt bonds to finance a courthouse. County enters into a contract with Corporation pursuant to which Corporation is to manage the cafeteria located in the courthouse. The contract provides that the contract will be a term of 15 years (including renewal options) and Corporation’s compensation will be (i) $X per month and (ii) 1 percent of gross receipts of the cafeteria during such month. The contract provides that in no event will the amount received by Corporation under clause (ii) be more than 5 percent of Corporation total compensation each month.
The management contract meets the safe harbor described in ‘a’ above: 95 percent of the compensation is based on a period fixed fee and the contract term including renewal options is 15 years or less. Please note also that the variable portion of the compensation is based on gross receipts and not net profits.
3. Contracts Deemed to be Leases
A management contract with respect to bond financed property results in private business use of that property if the service provider is treated as the lessee or owner of financed property for federal tax purposes.
Example: City uses proceeds of bonds to finance an office building. The office building includes a cafeteria that is open to the general public. City enters into a contract with Corporation to manage the cafeteria for a term of 10 years. Corporation receives all the receipts of the cafeteria and in turn gives $X per month to City. Corporation has complete discretion to manage the cafeteria without any input from City. The contract is labeled “management contract.” Notwithstanding its title, the contract seems to be a lease and should not be analyzed under IRS rules pertaining to management contracts.
See SECTION 3 and SECTION 5 of Rev. Proc. 97-13 in Attachment C of this APL for more information.
D. RESEARCH AGREEMENTS
Research performed in bond-financed facilities may constitute private business use if a Non-Exempt Person funds the research and receives particular benefits from the results of the research. If a research agreement meets the requirements of the applicable safe harbor provided in Revenue Procedure 2007-47, use of the research facility or equipment subject to the research agreement is considered not to result in private business use.
Safe Harbor 1 –Corporate Sponsored Research
a. The research agreement provides for basic research,
b. any license to or other use by the sponsor of any technology, product or other application resulting from the basic research is permitted only on the same terms as the University would permit that use by any non-sponsoring unrelated party (that is, the sponsor must pay a competitive price for its use) and
c. the price is determined at the time the license or other resulting technology, product or other application is available for use (and such price is no less than the price that would be paid by any non-sponsoring party for those same rights).
Safe Harbor 2 – Industry Sponsored Research
a. A single sponsor agrees, or multiple sponsors agree to fund University-performed basic research;
b. the University determines the research to be performed and the manner in which it will be performed (e.g., selection of personnel to perform the research);
c. title to any patent or other product incidentally resulting from the basic research lies exclusively with the University; and
d. the sponsor or sponsors are entitled to no more than a nonexclusive, royalty-free license to use the product of any such research.
Safe Harbor 3 –Federally-Sponsored Research
a. The sponsor agrees to fund University-performed basic research,
b. the University determines the research to be performed and the manner in which it will be performed (e.g., selection of personnel to perform the research),
c. title to any patent or other product incidentally resulting from the basic research lies exclusively with the University, and
d. the nature of any license granted the federal government or the sponsoring federal agency or any third-party Non-Exempt Person to use the product of the research is no more than a nonexclusive, royalty-free license.
If a research agreement with a federal sponsor (or a grantee of a federal sponsor) meets all of the elements of Safe Harbor 3 above, the rights of the federal government and its agencies mandated by the Bayh-Dole Act will not cause a research agreement to fail the safe harbor requirements and will not constitute private use. For information about the Bayh-Dole Act, see Attachment D, sections 2.02 and 6.04.
E. NAMING RIGHTS AND SPONSORSHIP PAYMENTS
Private business use is generally not created when a building, or a room, or an area within a building, is named for an individual or individuals when the name is not that of a company or a commercial name, e.g., the John and Mary Doe Building. Private business use could result when a naming situation involves a company or commercial name such as the XYZ Bank Building.
Agreements which permit a private company or organization to make payments for the right to have its name or logo used in connection with property financed with tax-exempt debt may result in private business use. The rules in this area continue to evolve but “qualified sponsorship payments” should not give rise to a private business use. A qualified sponsorship payment means any payment made by any person engaged in a trade or business with respect to which there is no arrangement or expectation that such person will receive any substantial return benefit other than the use or acknowledgement of the sponsor’s name or logo in connection with the activities of the University. Such use or acknowledgement may not include advertising such person’s products or services. The qualified sponsorship payment would not include any payment that -
- is contingent upon attendance at events or
- entitles the payor to the use or acknowledgement of the payor’s name or logo in regularly scheduled and printed material published by or on behalf of the University. This would allow donations in exchange for the usual “brass plaque” but call into question arrangements such as the right to name a University facility and control how that facility is referred to in publications and press releases.
F. OUTPUT FACILITIES
Occasionally an Exempt Person (e.g., the University) will acquire facilities such as co-generation facilities. The sale of output (as distinguished from consumption of the output by the Exempt Person) from an output type facility can result in a private business use.
A sale or transfer of ownership (as determined under federal income tax principles) or other disposition of bond financed property to a Non-Exempt Person will result in private business use unless remedial action is planned in advance.
H. QUALIFIED IMPROVEMENTS
Proceeds of tax-exempt bonds that provide a University owned improvement to an existing University owned building (including its structural components and land functionally related and subordinate to the building) are not used for a private business use if
- The building was placed in service more than 1 year before the construction or acquisition of the improvement is begun;
- The improvement is not an enlargement of the building or an improvement of interior space occupied exclusively for any private business use;
- No portion of the improved building or any payments in respect of the improved building secures payment of the tax-exempt bonds; and
- No more than 15 percent of the improved building is used for a private business use.