EZ/EC Communities & Taxes

FEDERAL TAX INCENTIVES, STATE TAX INCENTIVES:
STIMULATING EMPOWERMENT ZONE AND ENTERPRISE COMMUNITY DEVELOPMENT

RELEVANT CODE PROVISIONS

PROPOSED REGULATIONS ENTERPRISE ZONE FACILITY BONDS

NABL COMMENTS ON PROPOSED REGULATIONS

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FEDERAL AND STATE TAX INCENTIVES: STIMULATING EZ/EC DEVELOPMENT

I. Objective

A. Stimulation of employment opportunities and tax base within EZ's and EC's

II. Array of Development Tools

A. Tax exempt bonds specific to EZ and EC

B. Employment credit for employers in EZ not EC

C. Expense allowance for qualified zone businesses in EZ not EC

D. Tax exempt qualified small issue bonds for manufacturing facilities

E. Tax exempt qualified 501(c)(3) bonds for 501(c)(3)s

F. Tax exempt facility bonds for exempt facilities such as airports, docks and wharves, solid waste disposal facilities, sewage disposal facilities, facilities for local furnishing of gas and electric, facilities for furnishing water, qualified residential rental property, local district heating and cooling facilities, qualified hazardous waste facilities, high speed intercity rail facilities and environmental enhancements for hydro-electric generating facilities

G. Tax exempt or taxable tax increment bonds

H. Taxable bonds issued by governments for private projects which trigger state incentives, such as relief from property taxes and sales taxes

I. Tax abatement programs

J. Small Business Administration financing

K. State grants, guarantees, job training programs (specific to local law)

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III. General Benefits of Development Tools

A. Tax exempt bonds of any type typically access capital at a cost 1.5% to 2.5% lower than conventional financing (in today's markets) due to the investor's avoidance of federal and, in some cases, state income taxes on the interest paid

B. Tax exempt and taxable conduit bonds issued by government issuers for privately owned projects provide certain federal securities laws and state securities laws exemptions, as well as exemptions in some states from the property taxes and sales taxes on the private owner financing the project

C. The EZ wage credit is a direct credit, i.e., reduction of an EZ business' federal income tax liability - up to $3,000 per EZ business employee living in the EZ

D. The EZ expensing allowance provides an EZ business with as much as a $37,500 a year expense deduction on equipment purchases, which is a $20,000 increase over the 179 $17,500 expense deduction and a more immediate tax benefit than a depreciation deduction.

E.Tax abatement can be a total to partial forgiveness of state or local taxes for businesses located in specially designated distressed areas for various periods of time based on local law

F. TIF is a tax exempt or taxable financing vehicle for projects in designated distressed areas for which the incremental taxes generated in such designated areas after a designated date are dedicated to the debt service on the project financed

G. SBA debt is low rate debt for small businesses meeting the federal government criteria

H. Other state incentives such as grants, guarantee programs and job training programs have self evident benefits.

IV. Practical Considerations

A. Timing - state and federal compliance rules

B. Costs

C. Parties

D. Structure

1. fixed rate, with and without credit enhancement
2. variable, with and without credit enhancement

E. Creditworthiness

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V. EZ and EC Bonds

A. 9 EZ's and 95 EC's were approved and designated on December 21, 1994 for ten year terms with EZ's getting a wider range of benefits

B. EZ's get EZ bonds, EZ wage credit and EZ expense allowance

1(a). EZ wage credit entitles any employer, i.e. employer is not required to meet enterprise zone business tests (other than businesses on the 147 list and farms having assets valued at in excess of $500,000) in EZ to get a federal income tax credit or as much as $3,000 per employee living in EZ if such employee performs 90% of his or her services in EZ, regardless of when hired. Under the rule, an employer gets 20% of each EZ employee's wage up to $15,000 in the first seven years of EZ, declining by 5 % in each of the last three years
(b) Certifications from employees are accepted as long as the employees are told the EZ boundaries, certify that they live in the EZ and are told to report a move out of the EZ and so long as the employer does not know that a certificate is false
(c) Part time employees count, but short time (less than 90 days) do not count
(d) Special rules apply for 1994 based on the same percentages for the wages paid to EZ employees in the 11 day period from December 21 to December 31, 1994
(e) Taxpayer must eliminate the amount of the credit from the wage deduction, i.e., can not double dip, so the credit is reduced by the taxpayer's marginal rate
(f) Wages of owners or relations of owners do not count
(g) Certain training and education expenses paid on behalf of an employee may count as wages if (i) paid to a third person and (ii) the payments are excludable from the employee's gross income under 127 (excluding a maximum of $5,250 of such educational expenses paid by an employer) or paid on behalf of a person under 19 who is in a local youth training program

2(a). EZ expensing allowance entitles a qualifying EZ business to take an expense deduction for up to $37,500 of equipment purchases each year as an exception to taking depreciation deductions to recover the cost of the asset. Such rule is an enhancement of the $17,500 expensing allowance already in 179 which exists independent of EZ status. Both have phase out provisions, 50 per dollar over $200,000 for EZ businesses and $1 per dollar over $200,000 for businesses under 179.

(b)To get expensing allowance for 1994, taxpayer must have placed property in service in the Dec 21 - Dec 31, 1994 window

(c)Provide examples of how it works for (i) EZ property, (ii) both EZ property and 179 property and (iii) both EZ property and 179 property with the respective phase outs taken into account

(d)Property is "qualified zone property" if it is personal property used in taxpayer's business and placed in service in the tax year in question and is subject to the "original use" and "substantial renovation" rules which means (i) acquired after zone designation, either as new property or used property brought in from outside the zone and not previously used by the tax payer in the zone or (ii) if previously used by the taxpayer in the zone before the zone was created, 100% renovation (based on depreciated value). This means you can use the substantial renovation rule even if the property is bought prior to zone designation

(e) In applying the expensing rule, the activities of related persons come into play on dollar limits and phaseout limits whereas they do not in the case of EZ and EC bond rules

(f) Expensing must be elected

3. EZ bonds and EC bonds may be issued at lower tax exempt rates as a form of exempt facility bond financing for the financing of "qualified zone property" for "enterprise zone businesses" which makes it important to know the definitions

(a) $3,000,000 per EZ / $20,000,000 per all EZ's is the dollar limit
(b) (i) "Qualified zone property" means any property to which Section 168 (ACRS) applies or would apply but for Section 179, if (1) such property was acquired after the EZ/EC designation, (2) the "original use" in the EZ/EC commences with the taxpayer (special rule in regulations for property abandoned in EZ or EC for one year or more even before zone designation) and (3) 90% of the use of such property is in an EZ or EC and is used in the active conduct of business by the taxpayer in the zone
(ii) A special rule, however, is that if property is substantially renovated (an amount equal to 100% of the adjusted basis is spent on rehab) during any 24 month period beginning after December 21, 1994, the property can be financed even though acquired before the zone designation
(iii) Special rule on sale-lease back allows a newly built facility to be sold and leased back within 3 months of completion and still be treated as "original use" property

(c) (i) "Enterprise zone business" means any trade or business of a proprietorship, corporation or partnership which in each year (1) would otherwise qualify if such were separately incorporated, which is significant because it means for purposes of compliance with the 35% employment rule and the 80% gross income rule and 90% use of assets rule (all as discussed below) one can allow a store, division or branch of a chain to qualify separately without worrying about activities, assets or liabilities of the rest of the company outside the EZ or EC, unlike the qualified small issue bond tests for compliance with the ten million dollar capital expenditure limitation and the forty million dollar test period beneficiary test, (2) is in the active conduct of business in an EZ or EC, (3) derives 80% or more of its total gross income from the active conduct of such business in the EZ or EC, (4) uses 90% or more of its tangible personal property and intangible property in, and exclusively related to, the active conduct of such business in the EZ or EC, (5) performs 90% of the services performed by its employees in the EZ or EC, (6) employs at least 35% of its employees from those living in the EZ or EC, (7) attributes less than 5 percent of the average unadjusted bases of its property to collectibles (other than those held primarily for sale to customers in the ordinary course) and, (8) attributes less than 5 percent of the average of the aggregate adjusted bases of its property to non-qualified financial property (debt, stock, partnership interests, options, futures, forwards, warrants, national principal contracts and annuities, with exceptions for working capital held in cash, cash equivalents or debt with an 18 month or less term)

(ii) Rental of real property can be a qualified EZ business only if it is not residential and if at least 50 percent of the gross rental income from the real property is from EZ businesses which meet all the tests

(iii) Businesses which rent equipment qualify if 90 percent of the rentals are to EZ businesses or residents

(iv) Businesses do not qualify if their business is the development or holding of intangibles for sale or license

(v) Businesses on the 147(e) list do not qualify

(vi) Farming businesses do not qualify if the assets used are valued at more than $500,000, based on cost or market whichever is greater

(d) (i) "Continuing compliance" (annual testing) is required and owner must act in good faith to comply, must cure noncompliance within a reasonable period (within one year of discovery) and must certify to issuer at delivery its expectations and later its annual results

(ii) Until any noncompliance is cured, taxpayer's interest deduction is disallowed

(iii) Good faith compliance requires the annual certification process to issuer

(iv) Termination or revocation of EZ or EC designation or bankruptcy of taxpayer does not trigger noncompliance

(e) (i) EZ and EC bonds are subject to certain of the private activity bond rules which require volume cap compliance with carryforward rights,

(ii) inclusion of interest in the AMT calculation,

(iii) cost of carry disallowance under Section 265 (taking most banks out of the market, except in pooled loans-to-lenders programs),

(iv) inducement or "declaration of official intent" to toll reimbursement periods,

(v) TEFRA public approval requirements,

(vi) average maturity of bonds not exceed 120% weighted average useful life of assets to be financed

(f) (i) EZ and EC bonds are not subject to private activity bond rules which require manufacturing to be the only function, (ii) 10 million dollar capital expenditure limitation, (iii) 40 million dollar limitation on bonds outstanding nationally, (iv) no more than 25% of proceeds be spent on land and (v) 15% rehabilitation rule for acquisition of used facilities

(g) EZ and EC bonds financed facilities must use straightline depreciation over 40 year class life of buildings

(h) EZ and EC bonds may be refunded even after zone designation terminates so long as the principal amount and term of refunding bonds does not exceed that of the refunded bonds.

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VI. Qualified Small Issue Bonds (QSIBs") or ("IDBs")

A. IDBs are formally named "qualified small issue bonds" because the Internal Revenue Code exception which allows the interest thereon to be excludable from the bond owner's adjusted gross income is based upon the intent of Congress to favor governmental issuers which are attempting to encourage relatively small operations in the political jurisdiction where the bond financed project is to be located to create jobs and add tax base for that political jurisdiction. There are two small issue exceptions which may be elected by the issuer, one for deals of $1 million or less and one for deals of $10 million or less (but with many more strings attached).

1. Under both exceptions, at least 95% of the "net proceeds" must be used for the acquisition, construction, reconstruction or improvement of land or property of a character subject to the allowance for depreciation ("Substantially All Rule") which is part of a "manufacturing facility" or to redeem part or all of a prior issue which was so used (but including certain IDB financed facilities which were financed prior to 1986 which were not "manufacturing facilities.") This means land, building and structure improvements, machinery, equipment and furnishings and capitalized interest during the construction period may be financed under the Substantially All Rule.

(a) "manufacturing facilities" includes any facility which is used in the manufacture or production of tangible personal property (including processing resulting in a change in the condition of such property). It also includes facilities which are "directly related and ancillary" to a manufacturing facility if (i) they are located on the same site and (ii) not more than 25% of the proceeds are used to provide such facilities (office and warehouse issues).

2. Any bond issue of $1 million or less for the purposes and within the general rules stated above can be a tax exempt QSIB, so long as: (i) there are not other QSIBs outstanding for facilities located in the issuing jurisdiction for the same company or related companies which when aggregated with the current issue do not exceed $1 million ("One Million Dollar Rule") and (ii) there are not other qualified exempt facility bonds ("EFBs") and qualified redevelopment bonds ("QRBs") outstanding for facilities located anywhere in the United States and its territories for the same company and other test period beneficiaries which when aggregated with the current issue do not exceed $40 million ("Forty Million Dollar Rule"). A test period beneficiary generally means an owner or principal user, and related persons thereto, of a facility being financed at any time during the 3-year period beginning on the later of the "in service" date or the bond issue date.

3. Any bond issue of $10 million or less for the purposes and within the general rules stated above can be a tax exempt QSIB, so long as: (i) the aggregate of the following four amounts does not exceed $10 million at any time within the six year counting period which begins three years before the bonds are issued and ends three years after the later of the "in service" date or the issue date ("Six Year Period"): (a) the amount of outstanding QSIBs for facilities located in the issuing jurisdiction (even if issued before the 6-year period) issued for the same company or related persons; (b) the amount of the bonds currently being issued; (c) the amount of capital expenditures made by the company and all related persons for any and all facilities located anywhere in the issuing jurisdiction during the three year period before the bonds are issued; and (d) the amount of the capital expenditures made by the same group in the three year period after the later of the in service date or the date of issue ("Ten Million Dollar Rule"), and (ii) there is compliance with the Forty Million Dollar Rule described above. Because the Ten Million Dollar Rule is a springing test, i.e. there are compliance requirements for the three years after the bonds are issued, the interest on the bonds can remain tax exempt for a time period during the Six Year Period and then become taxable from the point that the Ten Million Dollar Rule is flunked.

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VII. Other Exempt Facility Bonds ("EFBs")

A. See II(F) above for list of types of EFBs which can be financed without any dollar limitations (except to the extent limited by the unavailability of state volume).

B. The Substantially All Rule (95%) applies. Net proceeds means that proceeds of the issue minus amounts used for a debt service reserve fund.

C. Public use is a requirement of EFBs, which means that such facilities must serve or be available on a regular basis for general public use, or be part of a facility so used, with sewage disposal facilities and solid waste disposal facilities being treated as automatically serving the public.

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VIII. General Requirements and Considerations Applicable To EZ and EC Bonds, QSIBs and EFs

A. "Official Intent" to reimburse itself for expenditures with bond proceeds must be declared not later than 60 days after the expenditure to be reimbursed with bond proceeds is paid; and the bonds must be issued not later than 18 months after the later of the date the payment to be reimbursed is made or the date the project financed with such payment is first placed in service (but in no event later than 3 years after the date the payment is made). In certain cases, 3 years may be extended to 5 years based on an architect's or engineer's certificate.

1. The declaration of Official Intent must be made by the governmental issuer rather than the benefitting company, except in the case of 501(c)(3) issuers.

2. The Official Intent must set forth: (a) a general description of the project to be financed, (b) the maximum dollar amount of bonds to be issued, and (c) the company to be benefitted. Reasonable deviations are permitted to the extent the actual project is reasonably related in function to the described project.

3. Exceptions to the Official Intent requirement include (a) a de minimis amount equal to the lesser of (i) $100,000 or (ii) 5% of the proceeds of the issue and (b) "preliminary" expenditures of up to 20% of the issue price, e.g., issuance costs, architectural, engineering, surveying, soil testing and similar early project costs, but not land acquisition, site preparation or actual commencement of construction costs.

B. "State Volume Cap" ($50 per capita per state annually available, but not less than $150,000,000) must be allocated, unless certain facilities are governmentally owned or unless they are refunding bonds. Procedures vary from state to state. Exceptions include 501(c)(3) deals, airports, docks and wharves, environmental enhancements on hydroelectric facilities and 75 % of high speed intercity rail facilities.

C. "Substantial Users" of facilities financed or related persons thereto may not exclude interest from their own adjusted gross income if they become owners of such bonds.

D. "Maturity Limitation" for such bonds provides that the weighted average maturity may not exceed 120% of the weighted average life of the facilities being financed.

E. "Limitation on Land Acquisition" provides that the proceeds of bonds may not be used (1) in excess of 25% thereof for the purchase of land, or (2) for the purchase of farm land, with exceptions for first time farmers, EZ farmers and sound buffer land or wetland preservation for certain exempt facilities.

F. "Acquisition of Existing Property" is limited for QSIBs and EFs (with special and different rules for EZ bonds and EC bonds). The limitation is that bond proceeds may not be used unless the first use of such property is pursuant to acquisition with such bond proceeds (i.e., it has to be new property), unless an amount equal to 15 % of the purchase price is spent on the rehabilitation of the existing (used) building (and equipment if purchased as part of the building purchase) or equal to 100% of the purchase price of structures within the two year period after the later of the date of purchase or the date the bonds are issued. Used equipment can not be bond financed at all, unless purchased as part of the plant which is simultaneously purchased. Some bond counsel will allow purchase of used equipment if 100% rehabilitation is represented.

G. "Certain Prohibited Uses" of such bond proceeds exist, which include any airplanes, sky box, health club, gambling establishment and liquor store and in addition for QSIBs, any commercial golf course, country club, massage parlor, tennis club, skating facility, racquet sport facility, hot tub facility, suntan facility or race track.

H. "Public Approval Requirements" must be met under both state and federal law. This means a notice of public hearing must be published in appropriate newspapers at least fourteen days prior to the date set for a public hearing on the issue, which notice sets forth the name of the issue and company, the project description and location, the dollar amount to be issued and the date, time and place set for the hearing. Such notices must be published in the jurisdiction where the project is to be located which may mean it has to be published in the host jurisdiction as well as in the jurisdiction of the issuer if that is remote. The project description must be more defined than the "Official Intent" description and issuers must be careful to not change the project and use of proceeds once the publication has been made. There are special rules for certain types of issues such as airports which may straddle multiple jurisdictions.

I. "Financing of Issuance Costs" with the proceeds of such bonds is restricted to not more than two percent (2%) of the proceeds of the issue and such 2% is considered to be part of the 5% insubstantial portion of the bond issue that is not required to be aqualifying cost.

J. "Arbitrage Rules and Regulations" apply to all such bonds, the basic thrust of which is to prevent the issuer and the company from keeping any positive arbitrage (the differential between the lower tax exempt yield on the bonds and any higher yield on the investment of the bond proceeds pending the disbursement thereof for costs) except during certain allowed temporary periods.

K. "Bond Registration" is required of all such bonds, i.e., that they be issued inregistered form with the names of the bond owners in the Trustee's bond register (and not in the form of bearer bonds), but certain book-entry forms of registration are allowed.

L. "Federal Guarantees" of such bonds is prohibited with certain exceptions.

M. "Advance Refunding" of such bonds with tax exempt bonds is prohibited. Must use proceeds of refunding bonds within 90 days of issuance for it to be a current refunding, which means an allowed redemption of the old bonds must be available in that time frame. However, defeasance with nonbond proceeds is usually allowed under the documents .

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RELEVANT CODE PROVISIONS

EMPOWERMENT ZONES: ENTERPRISE COMMUNITIES 1393(b)

SECTION 1393. DEFINITIONS AND SPECIAL RULES.

(a) In general. For purposes of this subchapter-

(1) Appropriate secretary.-The term appropriate Secretary means--

(A) the Secretary of Housing and Urban Development in the case of any nominated area which is located in an urban area, and

(B)the Secretary of Agriculture in the case of any nominated area which is located in a rural area.

(2) Rural area. -The term "rural area'' means any area which is--

(A) outside of a metropolitan statistical area (within the meaning of section 143(k)(2)(B)), or

(B) determined by the Secretary of Agriculture, after consultation with the Secretary of Commerce, to be a rural area.

(3) Urban area. -The term "urban area" means an area which is not a rural area.

(4) Special rules for indian reservations.-

(A) In general-.No empowerment zone or enterprise community may include any area within an Indian reservation.

(B) Indian reservation defined.-The term ''Indian reservation'' has the meaning given such term by section 168(j)(6).

(5) Local government. -The term "local government'' means--

(A) any county, city, town, township, parish, village, or other general purpose political subdivision of a State, and

(B) any combination of political subdivisions described in subparagraph (A) recognized by the appropriate Secretary.

(6) Nominated area. --The term "nominated area" means an area which is nominated by 1 or more local governments and the State or States in which it is located for designation under section 1391.

(7) Governments. --If more than 1 State or local government seeks to nominate an area under this part, any reference to, or requirement of, this subchapter shall apply to all such governments.

(8) Special rule. --An area shall be treated as nominated by a State and a local government if it is nominated by an economic development corporation chartered by the State.

(9) Use of census data. --Population and poverty rate shall be determined by the most recent decennial census data available.

(b) Empowerment zone: enterprise community. --For purposes of this title, the terms "empowerment zone'' and ''enterprise community" mean areas designated as such under section 1391.

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PART II - TAX EXEMPT FACILITY BONDS FOR EMPOWERMENT ZONES AND ENTERPRISE COMMUNITIES SECTION 1394. TAX-EXEMPT ENTERPRISE ZONE FACILITY BONDS.

(a) In general.-For purposes of part IV of subchapter B of this chapter (relating to tax exemption requirements for State and local bonds) the term "exempt facility bond' ' includes any bond issued as part of an issue 95 percent or more of the net proceeds (as defined in section 150(a)(3)) of which are to be used to provide any enterprise zone facility.

(b) Enterprise zone facility.-For purposes of this section-

(1) In general.-The term "enterprise zone facility'' means any qualified zone property the principal user of which is an enterprise zone business, and any land which is functionally related and subordinate to such property.

(2) Qualified zone property.-The term ''qualified zone property'' has the meaning given such term by section 1397C; except that the references to empowerment zones shall be treated as including references to enterprise communities.

(3) Enterprise zone business.-The term ''enterprise zone business'' has the meaning given to such term by section 1397B, except that---

(A) references to empowerment zones shall be treated as including references to enterprise communities, and
(B) such term includes any trades or businesses which would qualify as an enterprise zone business (determined after the modification of subparagraph ( A)) if such trades or businesses were separately incorporated.

(c) Limitation on amount of bonds.-

(1) In general. -Subsection (a) shall not apply to any issue if the aggregate amount of outstanding enterprise zone facility bonds allocable to any person (taking into account such issue) exceeds-

(a) $3,000,000 with respect to any 1 empowerment zone or enterprise community, or
(b) $20,000,000 with respect to all empowerment zones and enterprise communities.

(2) Aggregate enterprise zone facility bond benefit.- For purposes of subparagraph (A), the aggregate amount of outstanding enterprise zone facility bonds allocable to any person shall be determined under rules similar to the rules of section 144(a)( 10), taking into account only bonds to which subsection (a) applies.

(d) Acquisition of land and existing property permitted.- The requirements of sections 147(c)(1)(A) and 147(d) shall not apply to any bond described in subsection (a).

(e) Penalty for ceasing to meet requirements.-

(1) Failures corrected.-An issue which fails to meet 1 or more of the requirements of subsections (a) and (b) shall be treated as meeting such requirements if-

(A) the issuer and any principal user in good faith attempted to meet such requirements, and

(B) any failure to meet such requirements is corrected within a reasonable period after such failure is first discovered.

(2) Loss of deductions where facility ceases to be qualified--No deduction shall be allowed under this chapter for interest on any financing provided from any bond to which subsection (a) applies with respect to any facility to the extent such interest accrues during the period beginning on the first day of the calendar year which includes the date on which-

(i) substantially all of the facility with respect to which the financing was provided ceases to be used in an empowerment zone or enterprise community, or
(ii) the principal user of such facility ceases to be an enterprise zone business (as defined in subsection (b)).

(3) Exception if zone ceases.-Paragraphs (1) and (2) shall not apply solely by reason of the termination or revocation of a designation as an empowerment zone or an enterprise community.

(4) Exception for bankruptcy.-Paragraphs (1) and (2) shall not apply to any cessation resulting from bankruptcy.

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SUBPART C -- GENERAL PROVISIONS
SECTION 1397B. ENTERPRISE ZONE BUSINESS DEFINED.

(a) In general. --For purposes of this part, the term "enterprise zone business" means-

(1) any qualified business entity, and
(2) any qualified proprietorship.

(b) Qualified business entity.-For purposes of this section, the term "qualified business entity'' means, with respect to any taxable year, any corporation or partnership if for such year-

(1) every trade or business of such entity is the active conduct of a qualified business within an empowerment zone,
(2) at least 80 percent of the total gross income of such entity is derived from the active conduct of such business,
(3) substantially all of the use of the tangible property of such entity (whether owned or leased) is within an empowerment zone,
(4) substantially all of the intangible property of such entity is used in, and exclusively related to, the active conduct of any such business,
(5) substantially all of the services performed for such entity by its employees are performed in an empowerment zone,
(6) at least 35 percent of its employees are residents of an empowerment zone,
(7) less than 5 percent of the average of the aggregate unadjusted bases of the property of such entity is attributable to collectibles (as defined in section 408(m)(2)) other than collectibles that are held primarily for sale to customers in the ordinary course of such business, and
(8) less than 5 percent of the average of the aggregate unadjusted bases of the property of such entity is attributable to nonqualified financial property.

(c) Qualified proprietorship.-For purposes of this section, the term "qualified proprietorship" means, with respect to any taxable year, any qualified business carried on by an individual as a proprietorship if for such year-

(1) at least 80 percent of the total gross income of such individual from such business is derived from the active conduct of such business in an empowerment zone.
(2) substantially all of the use of the tangible property of such individual in such business (whether owned or leased) is within an empowerment zone.
(3) substantially all of the intangible property of such business is used in, and exclusively related to, the active conduct of such business,
(4) substantially all of the services performed for such individual in such business by employees of such business are performed in an empowerment zone.
(5) at least 35 percent of such employees are residents of an empowerment zone,
(6) less than 5 percent of the average of the aggregate unadjusted bases of the property of such individual which is used in such business is attributable to collectibles (as defined in section 408(m)(2)) other than collectibles that are held primarily for sale to customers in the ordinary course of such business, and
(7) less than 5 percent of the average of the aggregate unadjusted bases of the property of such individual which is used in such business is attributable to nonqualified financial property.

For purposes of this subsection, the term ''employee" includes the proprietor.

(d) Qualified business.-For purposes of this section-

(1) In general.-Except as otherwise provided in this subsection, the term "qualified business'' means any trade or business.
(2) Rental of real property.-The rental to others of real property located in an empowerment zone shall be treated as a qualified business if and only if-
(A) the property is not residential rental property (as defined in section 168(e)(2)), and
(B) at least 50 percent of the gross rental income from the real property is from enterprise zone businesses.
(3) Rental of tangible personal property. -The rental to others of tangible person property shall be treated as a qualified business if and only if substantially all of the rental of such property is by enterprise zone businesses or by residents of an empowerment zone.
(4) Treatment of business holding intangibles. -The term ''qualified business" shall not include any trade or business consisting predominantly of the development or holding of intangibles for sale or license.
(5) Certain businesses excluded. -The term "qualified business'' shall not include-
(A) any trade or business consisting of the operation of any facility described in section 144(c)(6)(B), and
(B) any trade or business the principal activity of which is farming (within the meaning of subparagraphs (A) or (B) of section 2032A(e)(5)), but only if, as of the close of the preceding taxable year, the sum of-
(i) the aggregate unadjusted bases (or, if greater, the fair market value) of the assets owned by the taxpayer which are used in such a trade or business, and
(ii) the aggregate value of assets leased by the taxpayer which are used in such a trade or business exceeds $500,000.

For purpose of subparagraph (B), rules similar to the rules of section 1397(b) shall apply.

(e) Nonqualified financial property. -For purposes of this section, the term "nonqualified financial property" means debt, stock partnership interests, options, futures contracts,. forward contracts, warrants, notional principal contracts, annuities, and other similar property specified in regulations; except that such term shall not include-

(1) reasonable amounts of working capital held in cash, cash equivalents,. or debt instruments with a term of 18 months or less, or
(2) debt instruments described in section 1221(4).

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SECTION 1397C. QUALIFIED ZONE PROPERTY DEFINED.

(a) General rule.-For purposes of this part-

(1) In general. -The term ''qualified zone property" means any property to which section 168 applies (or would apply but for section 179) if-

(A) such property was acquired by the taxpayer by purchase (as defined in section 179(d)(2)) after the date on which the designation of the empowerment zone took effect.

(B) the original use of which in an empowerment zone commences with the taxpayer, and

(C) substantially all of the use of which is in an empowerment zone and is in the active conduct of a qualified business by the taxpayer in such zone.

(2) Special rule for substantial renovations.-In the case of any property which is substantially renovated by the taxpayer, the requirements of subparagraphs (A) and (B) of paragraph (1) shall be treated as satisfied. For purposes of the preceding sentence, property shall be treated as substantially renovated by the taxpayer if, during any 24-month period beginning after the date on which the designation of the empowerment zone took effect, additions to basis with respect to such property in the hands of the taxpayer exceed the greater of (i) an amount equal to the adjusted basis at the beginning of such 24-month period in the hands of the taxpayer, or (ii) $5,000.

(b) Special rules for sale-leasebacks.- For purposes of subsection (a)(1)(B), if property is sold and leased back by the taxpayer within 3 months after the date such property was originally placed in service, such property shall be treated as originally placed in service not earlier than the date on which such property is used under the leaseback.

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SECTION 1397D. REGULATIONS.

The Secretary shall prescribe such regulations as may be necessary or appropriate to carry out the purposes of parts II and III, including-

(1) regulations limiting the benefit of parts II and III in circumstances where such benefits, in combination with benefits provided under other Federal programs, would result in an activity being 100 percent or more subsidized by the Federal Government.

(2) regulations preventing abuse of the provisions of parts II and III, and

(3) regulations dealing with inadvertent failures of entities to be enterprise zone businesses.

(b) Clerical amendment.-The table of subchapters for chapter 1 is amended by inserting after the item relating to subchapter T the following new item: Subchapter U. Designation and treatment of empowerment zones, enterprise communities, and rural development investment areas.

STATUTORY HISTORY

1993-P.L. 103-66 1391-1394, 1397B-1397D. Section 13301 amended the Code to add these sections

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PROPOSED REGULATIONS

Par. 9. Section 1.1394-l is added under the heading "DEFINlTIONS; SPECIAL RULES" to read as follows:

1.1394-1 Enterprise zone facility bonds.

(a) Scope. This section contains rules relating to section 1394, relating to tax-exempt bonds for enterprise zone facilities (enterprise zone facility bonds). See sections 1394, 1397B, and 1397C for other rules and definitions.

(b) Continuing compliances --

(1) In general. Except as provided in paragraph (b)(2) of this section, compliance with the requirements applicable to enterprise zone facility bonds apply throughout the term of the bonds.

(2) Start-up period. For a qualified business that is first established in connection with the isssuance of enterprise zone facility bonds (as opposed to a continuing qualified business to which financing is provided), the requirements relating to qualification as an enterprise zone business and satisfaction of the rules for qualified zone property do not apply prior to the date that is one year after the later of the issue date of the bonds and the date the financed facility is placed in service (the testing date).

(3) Manner of continuing compliance. An issue is treated as continuing to comply with the requirements of section 1394(a) and (b) if-

(i) The issuer and each principal user in good faith attempts to meet these requirements throughout the term of the bonds; and
(ii) Any failure to meet these requirements is corrected within a reasonable period after the failure is first discovered.

(4) Good faith. In order to satisfy the good faith requirement of paragraph (b)(3) (i) of this section, the issuer and each principal user must satisfy the requirements of 1.141-13(a) (relating to conditions to taking remedial actions). For this purpose, reasonable procedures to ensure compliance with the requirements of section 1394(a) and (b) include a requirement that, at least annually, each principal user submit to the issuer information demonstrating its monitoring of compliance with these requirements.

(5) Reasonable period to correct noncompliance. Noncompliance that is corrected within one year of discovery satisfies the requirement of paragraph (b)(3)(ii) of this section if, during the period in which the noncompliance exists, the issuer and the principal user use their best efforts to correct the noncompliance.

(6) Application to employee requirements. For purposes of the requirement of section 1397B(b)(6) and (c)(5) that at least 35 percent of the employees are residents of the empowerment zone or enterprise community, the issuer and each principal user may rely on an employee certification, signed under the penalty of perjury in connection with the hiring of that employee, regarding the residence of the employee provided-

(i) The employee is made aware of the geographic boundaries of that zone or community;
(ii) The employee is required to notify the employer of a change of residence; and
(iii) Neither the issuer nor the relevant principal user has actual knowledge to the contrary.

(7) Application to gross income requirements. For purposes of paragraph (b)(3)(i) of this section, the requirement of section 1397B(b)(2) or (c)(l) continues to be treated as satisfied for each 5-year period during which, on the average, at least 85 percent of the total gross income of the enterprise zone business is derived from the active conduct of that business if-

(i) The requirements of paragraph (b)(3)(i) of this section are satisfied; and
(ii) The requirement of section 1397B(b)(2) or (c)(1) is satisfied during each of the first 3 years after the testing date.

(c) Limitation on amount of bonds-

(1) Determination of outstanding amount. Whether an issue satisfies the requirements of section 1394(c) (relating to the $3 million and $20 million aggregate limitations on the amount of outstanding enterprise zone facility bonds) is determined as of the issue date of that issue based on the issue price of that issue and the adjusted issue price of outstanding bonds.

(2) Loans-to-lenders programs. Whether an issue satisfies thc requirements of section 1394(c) may be determined without regard to the amount of bonds allocable to lenders in a loans-to-lenders program. This paragraph (c)(2) applies only if the proceeds of those bonds are loaned to an enterprise zone business within 42 months of the issue date of the bonds or, to the extent not so used, are used to redeem bonds of the issue within that 42 month period. A loans-to-lenders program is a program in which the issuer of enterprise zone facility bonds, in order to provide loans to enterprise zone businesses, lends the proceeds of the bonds to a bank or similar intermediary which must then relend the proceeds to enterprise zone businesses.

(d) Qualified zone property. For purposes of applying the term qualified zone property, the following rules apply:

(1) Original use requirement. In general, for purposes of section 1397C(a)(1)(B), original use means the first use to which the property is put within the empowerment zone, whether or not that use corresponds to the use of that property by the taxpayer. However, for purposes of section 1394, property that has been abandoned for a period in excess of one year is treated as satisfying the requirement of section 1397C(a)(1)(B), notwithstanding that the date of abandonment occurred before the date on which the designation of the empowerment zone took effect. See, however, 1.103-8(a)(5).

(2) Substantially all. For purposes of sections 1397B and 1397C(a), substantially all means 90 percent.

(e) Land. The determination of whether land is functionally related and subordinate to qualified zone property is made in a manner consistent with 1.103-8(a)(3).

(f) Application of sections 141 through 150-

(1) In general. Enterprise zone facility bonds are treated as exempt facility bonds that are described in section 142(a). Paragraphs (f)(2) through (f)(4) of this section provide special rules for applying sections 141 through 150 to enterprise zone facility bonds. See also paragraph (g)(3) of this section.

(2) Maturity limitation-(i) Requirements treated as satisfied. The requirements of section 147(b) are treated as satisfied for an issue of enterprise zone facility bonds the proceeds of which are to be used as part of a loan recycling program if-

(A) Each loan satisfies the requirements of section 147(b) (determined by treating each separate loan as a separate issue); and
(B) The term of the issue does not exceed 30 years.
(ii) Loan recycling program defined. A loan recycling program is a program in which-

(A) The issuer reasonably expects as of the issue date of the bonds that loan repayments from principal users will be used to make additional loans during the portion of the 10-year period following the issue date of the bonds during which the enterprise community or empowerment zone designation is in effect; and

(B) Repayments of principal on loans (including prepayments) that are received during the period described in paragraph (f)(2)(i)(A) of this section that are not reasonably expected to be used to make new loans to enterprise zone businesses and repayments of principal on loans (including prepayments) that are received after that period are used within 6 months of receipt to redeem bonds that are part of the issue.

(3) Volume cap. For purposes of applying section 146(f)(5) (relating to elective carryforward of unused volume limitation), issuing enterprise zone facility bonds is a carryforward purpose.

(4) Other regulations applicable. Regulations under sections 103 and 141 through 150 apply to enterprise zone facility bonds.

(g) Continuing compliance and change of use penalties -

(l) Termination of designation and cessation due to bankruptcy. An enterprise zone facility bond does not cease to be treated as a tax-exempt bond and the penalties described in section 1394(e) (2) do not apply solely by reason of the termination or revocation of a designation as an empowerment zone or enterprise community or any cessation resulting from bankruptcy.

(2) Coordination with good faith compliance provisions. Section 1394(e)(2) does not apply during any period in which, under the good faith compliance provisions of paragraph (b)(3) of this section, the issue is treated as continuing to comply with the requirements of section 1394.

(3) Section 150(b)(4) inapplicable, Section 150(b)(4) does not apply to enterprise zone facility bonds.

(h) Refunding bonds. Bonds issued after the termination or revocation of a designation as an empowerment zone or enterprise community to refund tax-exempt bonds that are enterprise zone facility bonds (other than in an advance refunding) are treated as tax-exempt bonds if -

(1) The weighted average maturity of the refunding bonds does not exceed the remaining weighted average maturity of the refunded bonds; and

(2) The amount of the refunding bonds does not exceed the outstanding amount of the refunded bonds.

(i) Effective date. For effective dates of this section. see 1.141-16.

/s/Margaret Milner Richardson Commissioner of Internal Revenue 1994 DTR 248 d62

END OF DOCUMENT

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NABL COMMENTS ON PROPOSED REGULATIONS

Specific Comments on the Application of the Proposed Regulations to Enterprise Zone Facility Bonds

Proposed Treasury Regulations 1.1394-1: Enterprise Zone Facility Bonds

Introduction

Proposed Treasury Regulation section 1.1394-1, regarding Enterprise Zone Facility Bonds (the "Proposed Regulations"), provides some guidance and clarity with respect to Sections 1394, 1397B and 1397C of the Code (the "EZFB Provisions"), which EZFB Provisions impose numerous difficult tests in order to meet the requirements of the definitions of enterprise zone facility, qualified zone property and enterprise zone business. Notwithstanding the guidance and clarity provided by the Proposed Regulations, it is respectfully submitted that the final enterprise zone regulations (the "Final Regulations") should further enhance implementation of the EZBF Provisions if the Congressional aspirations for enterprise communities are going to be even modestly achieved. We believe that the suggestions and clarifications set forth below would follow the legislative intent of Congress and are within the language of the Code. As currently drafted, the EZBF Provisions and the Proposed Regulations make tax-exempt enterprise zone facility bonds ("Enterprise Bonds") unlikely to provide much help to many otherwise valid business opportunities for enterprise communities.

The Internal Revenue Service may wish to consider the comments outlined below in the broader context of how such comments would also enhance the empowerment zone employment credit program and the empowerment zone expensing allowance authorized under Code Sections 1396 and 1397A, respectively. Failure to address the definitional problems to be discussed herein will also limit the viability of the employment credit and expensing allowance programs.

Unless otherwise indicated, section references beginning with 1.1394-1 are to the Proposed Regulations and section references beginning with 1391 through 1397C are to the Code.

Proposed Treasury Regulation Section 1.1394-l(b)(l): Good Faith Period Alternative to Continuous Compliance

Under Prop. Treas. Reg. 1.1394-l(b)(1), continuing compliance with the requirements applicable to enterprise zone facility bonds generally is required throughout the term of the bonds: various exceptions are provided. We suggest an alternative, and more feasible, approach that would depart from the requirement that there be continuous compliance with all of the requirements applicable to Enterprise Bonds throughout the term of the bonds. Under the alternative approach, only a five-year "good faith period" would be required (following an appropriate start-up period discussed below) in lieu of continuous compliance. Compliance with the numerous requirements of the Code throughout the term of the bonds, tested annually as proposed by the Proposed Regulations, will significantly diminish the possibility of achieving the presumed Congressional intent of encouraging growth and expansion of business and employment of persons living within enterprise communities.

For example, section 1397(b)(2), which requires 80 percent of the total gross income of an enterprise zone business to be derived from the active conduct of business in an enterprise community, will become a major obstacle to a business that becomes successful and seeks to develop a larger business base outside of the enterprise community. Development of such "outside" business could cause the successful business enterprise to exceed the 80 percent limitation, thereby losing its qualification as a qualified enterprise zone business. If the Internal Revenue Service considers a five-year "good faith" period to be too short, we propose that the "good faith period" be set at ten years, that would make it coterminous with the initial enterprise community designation. If the Service rejects the "good faith period" approach, adoption of the specific implementing changes set forth below becomes even more critical if Enterprise Bonds are going to be a viable financing vehicle.

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Proposed Treasury Regulation Section 1.1394-1(b)(2): Start-up Period for Compliance

It is respectfully suggested that a start-up period for compliance with the various requirements be extended to 1 and 1/2 years and not be limited solely to startup businesses. Limiting the start-up compliance period to start-up businesses appears to serve little purpose because the extensive EZBF Provisions and regulatory requirements will be as onerous for an established business as they will be for a startup business. Creation of a reasonable start-up compliance period for established businesses would help avoid unintended results such as the replacement of current employees who are non-residents of the enterprise community with employees who are residents in order to comply with the rule. Furthermore, existing businesses wi11 be the more viable candidates for enterprise zone financing. Thus, unnecessary barriers such as unworkable compliance periods should be removed if the Congressional intent of encouraging economic growth within enterprise communities is going to be achieved.

Proposed TreasuryRegulation Sections l.1394-1(b)(3), (4), (5): Continuous Compliance Rules Applicable Only During Good Faith Period

It is proposed that the Final Regulations clarify that such provisions apply only during the "good faith period" described above.

Proposed Treasury Regulation Section 1.1394-l(b)(3)(i): Appropriate Definition of "Principal User"

Is the term "principal user" intended to have the same definition as such term is given in the regulations applicable to small issue bonds? If so, a requirement that all principal users make a good faith effort to meet the requirements may be too onerous, given the fact that "principal user" in the small issue context has been interpreted to include principal customers. Such a result probably was not intended by Congress, because it affects a business's qualification as a qualified enterprise zone business if one (or more) of its larger customers fails to satisfy the EZBF Provisions. Assuming Congress did not intend these provisions to apply to an enterprise zone business's customers, a clarification that a more limited definition for "principal user" in this context was intended, would be helpful.

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Proposed Treasury Regulation Section 1.1394-l (b)(6): Changes Implementing Compliance with the 35 Percent Employment Rule

We commend the Service for the clarity it brings to the mechanics for documenting compliance with the requirements of Code Sections 1397B(b)(6) and (c)(5) that at least 35 percent of the employees of an enterprise zone business be residents of the enterprise community. However, if enterprise zone financing is going to have any chance of achieving the Congressional objectives, further implementing changes must be made. The 35 percent employment requirement is extremely onerous, considering the demographic requirements that areas must meet in order to qualify as enterprise communities. Because of the geographical size limitations and poverty level requirements, enterprise communities will not be fertile employment pools. It will be very difficult for a well-intentioned enterprise zone business to achieve initially and maintain thereafter, the 35 percent employment level. Thus, implementing changes within the word and spirit of Code Sections 1397B(b)(6) and (c)(5) are critical if Enterprise Bond financing is going to be a viable financing vehicle.

We propose that compliance with the 35 percent employment rule be established by permitting an enterprise zone business to meet the 35 percent test on an average basis for rolling 5-year periods. Thus, the test would be met if, during each 5-year period, an average of 35 percent of a business's employees live within the enterprise community. This averaging concept would follow the approach used in Prop. Treas. Reg. 1.1394-1(b)(7) with respect to the 80% gross income requirement in sections 1397B(b)(2) and (c)(1). If such averaging approach is rejected, we believe that the specific implementing changes proposed below would be necessary as alternative means to achieve compliance with the rule.

In amplification of the 1 l/2 year start-up period discussed above, it is suggested that an enterprise zone business be given at least 11/2 years to come into initial compliance with the 35 percent employment test. After an enterprise zone business has initially complied with the 35 percent employment requirement, it is proposed that the enterprise zone business be considered to be in compliance when employees who initially live within the enterprise community move from the enterprise community, so long as such employees continue to be employed by the enterprise zone business at its business location in the enterprise community. It is further suggested that if employees who were initially part of the 35 percent qualifying pool leave the employment of the enterprise zone business, the enterprise zone business be deemed to be in compliance so long as the positions that have been vacated are held open and made available for at least 6 months to persons living within the enterprise community. The model for this approach can be found in section 143(h) of the Code, which deals with compliance with the low and moderate income multi-family housing project requirements. An alternative approach would be to treat a business as in compliance with this rule so long as the next employees it hires live within the enterprise community. The model for this approach can be found in section 142(d)(3) of the Code (compliance with tenant income limitations for low and moderate income multi-family housing, project financing) and section 42(g)(2) of the Code (low income housing credit).

The House Committee report with respect to Section 1397B provides that the Treasury Secretary will prescribe regulations to determine appropriate treatment for part-time employees for purposes of calculating the 35 percent employment rule. The Proposed Regulations do not address such question. It is proposed that the Final Regulations provide that part-time employees who live in the enterprise community and who work at least 50 percent of what is certified to be a normal work week for employees in their job classification be counted towards compliance with the 35 percent employment test.

Proposed Treasury Regulation Section 1.1394-l(b)(7): Changes Implementing Compliance with the 80 Percent Gross Income Rule

We commend the Internal Revenue Service for its recognition of the need to enhance the taxpayers' ability to comply with the very demanding 80 percent rule by proposing a five-year averaging approach. It is respectfully proposed, however, that the five-year average requirement of 85 percent be reduced to 80 percent. Because the 80-percent provision will be very difficult to comply with as a result of the inherent economic negatives of an enterprise community, a more realistic implementation would be to set the five-year averaging percentage at 80 percent. The fact that the Code sets the percentage at 80 percent makes this change reasonable.

A more fundamental issue with respect to the 80 percent gross revenue requirements of sections 1397B(b)(1) and (c)(1) arises in the construction of the language requiring that at least 80 percent of the total gross income of the business entity or proprietorship be derived from the "active conduct" of such business in an enterprise community. It will be extremely difficult for any business entity or proprietorship to comply with this requirement unless the Final Regulations provide an implementing construction of the term "active conduct". Although it is understandable why Congress might have felt that a provision limiting the availability of such bonds to businesses conducted primarily within an enterprise community might be desirable, the ensuing restriction on growth caused by such provision should be obvious. If a business that is started within an enterprise community becomes successful and continues to expand, will its growth have to be stunted at the boundaries of the enterprise community in order to comply with such provision? For example, if a business (e.g., a messenger or courier service) is contained within an enterprise community, but the growth of the business requires deliveries to customers outside of the enterprise community, should the designation as a "qualified business" require the rejection of business that would be conducted elsewhere? Such a rule seems to create an illogical obstacle to the natural growth and profitability of a business enterprise.

Furthermore, there are certain businesses that, while located physically within an enterprise community, may, by their very nature, engage in business that takes them outside of the enterprise community. Some examples of these types of businesses are trucking and/or moving companies, livery services and courier services. Similarly, if an architectural or construction firm locates within an enterprise community, should that business be penalized if some of its customers desire work to be done outside the enterprise community? Can Congress really have intended to put such shackles on small businesses located within an enterprise community?

It is recommended that the Final Regulations define the "active conduct" of business in such a way as to allow an enterprise zone business to conduct business and derive revenues outside of the enterprise community, so long as the business entity or proprietorship is physically located within the enterprise community and satisfies the 35 percent employee-residence requirement. Although conducting an enterprise zone business in an enterprise community may not be difficult for supermarkets or other retail establishments, many businesses will be significantly constrained if they have to derive 80 percent of their revenues from business physically conducted in an enterprise community that is inherently a small geographic area and a poor market. Any regulation permitting enhanced implementation of the requirements of the rule would be extremely helpful.

The Final Regulations should provide that the "active conduct" of business includes such business that occurs and generates revenue from outside of the enterprise community so long as the business originates within the enterprise community (e.g., couriers, services businesses, such as furnace sales and installation businesses and the like).

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Proposed Treasury Regulation Section 1.1394-l(b)(3): Continuous Compliance and "Cure" of 80% Test Violation

Correction of any failure to meet the Enterprise Bond requirements of sections 1394(a) and (b) is required within a reasonable period after the failure is discovered. One of such requirements (incorporated by cross-reference to section 1397B) is the 80 percent gross income rule discussed above.

Regardless of whether the modification suggested in that discussion above is adopted, it is requested that the Final Regulations clarify how a failure to satisfy the 80 percent gross income rule can be corrected. If an enterprise zone business makes a good faith effort to meet this test, but, after the applicable 5-year averaging period the percentage has been slightly exceeded, what is the result? Does the business lose its qualification as an enterprise zone business? Must the business disgorge itself of enough of its non-zone income to get itself to the 80 percent level? Guidance on this point would be extremely helpful.

Proposed TreasuryRegulation Section 1.1394-l(c)(2): Clarification of Public Approval Compliance for Loans-to-Lenders Programs

It is proposed that the Final Regulations expressly set forth the method for compliance with the public approval requirement in the loans-to-lenders program. The broad cross-reference to sections 141 to 150 of the Code, and the regulations therefore, in Prop. Treas. Reg. 1.1394-l(f)(1) and (f)(4) do not provide the clarity needed for achieving compliance with the public approval requirement in a loans-to-lenders program. It is proposed that the Final Regulations clearly state that in a loans-to-lenders pool bond program the public approval requirement may be complied with in one of two ways. First, where none of the potential borrowers are known at the time of publication and hearing, a general description of the program and the expected borrower criteria could be published. The model for this approach may be found in the public hearing requirements for student loan bond financings and mortgage revenue bond financings. Because the loans-to-lenders provisions contain a 42-month rule similar to the one contained in Code Section 143(a)(2)(D) (applicable to loans made with proceeds of mortgage revenue bonds), reference to the public approval requirements applicable to mortgage revenue bonds seems reasonable. Second, where some of the potential borrowers are known at the time of publication and hearing, the "known" borrowers and projects could be published initially, and subsequent publications of notice and public hearings may occur as additional borrowers and projects become known and before the subsequent loans are made. In the General Explanation of the Tax Reform Act of 1986 (the "1986 Blue Book"), the Staff of the Joint Committee on Taxation recognized that identification of borrowers prior to bond issuance is not possible and therefore, should not be necessary in all cases. In fact, the 1986 Blue Book indicated that Congress intended regulations to be amended to reflect those types of issues (e.g., student loan bonds, mortgage revenue bonds and 501(c)(3) bonds) where such pre-issuance identification should not be required. The same reasoning applies to the loans-to-lenders program for Enterprise Bonds.

Proposed TreasuryRegulation Section 1.1394-l(c): Clarification of Bond Amount Limitations

Two points of clarification are proposed. First, in section 1394(c)(2), it seems clear that Congress intended a specific cross-reference to subsection (C) of section 144(a)( 10) of the Code, which deals with the rules regarding the allocation of the face amount of bond issues for facilities used by multiple users, rather than all facets of section 144(a)(10) of the Code. Clarification of the intent of that cross reference would be helpful.

Second, clarification is requested as to whether the approach to be used for purposes of section 1394(c)(1)(A) in counting the aggregate amount of outstanding Enterprise Bonds would be appropriate for purposes of complying with the $20 million limitation of section 1394(c)(1)(B), notwithstanding the fact that section 1394(c)(2) only states that such approach should be used for purposes of the $3 million limitation.

With regard to Prop. Treas. Reg. 1.1394-1(c)(1), an example of the "adjusted issue price" of outstanding bonds would be helpful. We commend the Internal Revenue Service for clarifying that the test is based on the issue price of the issue, but there is uncertainty as to what is intended by the term "adjusted issue price." If the definition is intended to be the same as that contained in the "original issue discount" regulations, such clarification would be welcomed.

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Proposed Treasury Regulation Section 1.1394-l (d)(1): Changes Clarifying and Implementing Compliance With Original Use Requirement

An example of the original use requirement in the qualified zone property definition would be helpful. It would appear from the language in the Proposed Regulations that the financing of used machinery and equipment that is later moved into an enterprise community is permitted, so long as such machinery and equipment was acquired after the creation of the enterprise community and after passage of an inducement resolution, regardless of taxpayers previous use of the machinery and equipment. A simple example would clarify that understanding.

Another point deals with the abandoned property exception. The term "abandoned" implies cessation of private ownership, as distinguished from being merely "out of use." Also, the exception fails to address the most common distressed property scenario in economically failing areas, i.e., retail shopping facilities and malls, that are only vestigially in use. Furthermore, it is submitted that the requirement that property must have been abandoned for a full year is an unnecessarily tough test for under-utilized property to qualify for the exception to the original use requirement. Therefore, it is respectfully suggested that a defined term "substantially out of use" be used and that the definition mean "at least 80 percent unoccupied for a period of six-months, or longer." In the alternative, it would be helpful to obtain clarification that the occupied portion of a largely unused facility could be allocated as a non-qualifying portion of the facility so that the portion of the facility that has not been in use for over six months could qualify as qualified zone property, so long as it meets the other tests. Lastly, a clarification of what the cross reference in Prop. Treas. Reg. 1.1394-l(d)(1) to "section 1.103-8(a)(5)" is intended to incorporate, would be helpful.

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Proposed Treasury Regulation Section 1.1394-l (d)(2): Changes Implementing Compliance With Qualified Zone Property and Enterprise Zone Business Definitions

It is respectfully suggested that use of "90 percent" as the definition for "substantially all" in this context is inappropriate and unduly burdensome. The percentage appears to be borrowed from the "substantially all" rule with respect to the use of the proceeds of bonds issued under the Internal Revenue Code of 1954, as illustrated in the regulations applicable thereto. In the context of the amount of bond proceeds to be used for specifically permitted projects, 90 percent has some logic and does not effectively inhibit the legislative intent of Congress. In the context of the definitions of qualified zone property and an enterprise zone business, application of a "90 percent" threshold will effectively preclude the financing of many of the types of businesses that could succeed in enterprise communities. Section 1397B(b), subsections (3), (4) and (5) and section 1397B(c), subsections (2), (3) and (4), as expanded by the Proposed Regulations, would require that 90 percent of the use of the tangible and intangible personal property be within the enterprise community and that 90 percent of the services be performed within the enterprise community. This requirement would essentially preclude the financing of many businesses that rely upon mobile equipment, businesses involved in local deliveries and businesses involved in service (whether it be furnace installations, appliance repairs, courier services, architectural services, etc.). In order to succeed and expand, such types of businesses will have to operate and derive revenue outside of the relatively small geographic area of an enterprise community and from markets that have the means to pay for the services and/or products offered by the enterprise zone business. Enterprise communities are statutorily required to be areas that are geographically small and economically poor.

Requiring enterprise zone businesses to use 90 percent of their tangible and intangible personal property and to deliver 90 percent of their services within the enterprise community will essentially limit enterprise zone businesses to retail operations and some manufacturing businesses. Moreover, even such retail operations will find it difficult to succeed given the level of poverty an area must possess in order to quaiify as an enterprise community. Presumably, the purpose of Enterprise Bonds is to create job opportunities and add to the tax base by causing businesses to locate in, and eventually grow within, those enterprise communities. The 90 percent rules will work at cross-purposes to the creation of many potentially successful enterprise zone businesses.

The same observations apply equally with respect to the use of a 90 percent definition for "substantially all" as it appears in section 1397C(a)(l)(C). That section requires that "substantially all" of the use of qualified zone property be in an enterprise community and in the active conduct of a qualified business by the taxpayer in such community.

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Proposed Treasury Regulation Sections 1.1394-169(1) and 69(4): Clarification of Code Section and Regulations Incorporated by Reference

It is helpful that the IRS has attempted to limit the number of new definitions and regulations applicable to Enterprise Bonds by incorporating existing and relatively well understood rules and regulations. However, it is respectfully suggested that the incorporation by reference of sections 141-l50 of the Code and the regulations applicable thereto is too all inclusive and creates some confusion. Thus, it would be helpful if the Final Regulations establish specifically which sections are applicable (or, in the alternative, which are not). For example, sections 143, 144 and 145 seem to be entirely inapplicable except for the one incorporation by reference of section 144(a)(10)"(C)" (see discussion, above).

Proposed Treasury Regulation Section 1.1394-1(f)(2)(ii)(B) (Technical Correction)

The cross-reference to paragraph (f)(2)(i)(A) should, in fact, be to paragraph (f)(2)(ii)(A).

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Proposed Treasury Regulation Section 1.1394-l(f)(l): Clarification of Applicability of Office Space Limitation

It is helpful that clarification has been provided that Enterprise Bonds are treated as exempt facility bonds that are described in section 142(a) of the Code. However, Prop. Treas. Reg. 1.1394-l(f)(l) and (f)(4) incorporate by reference, sections 141-150 of the Code and the regulations thereto in their entirety, creating ambiguity as to whether the limitations on financing office space as set forth in section 142(d) of the Code would apply to Enterprise Bond facilities. The office space limitation should not apply, because it is clear Congress did not intend to limit enterprise zone businesses in the same way that exempt facilities and qualified small issue facilities are limited. This point further illustrates the ambiguity and confusion that is created by the overly inclusive cross-references to sections 141 through 150 of the Code and the regulations thereunder.

Section 1397B(d)(5)(B): Necessary Clarification of Small Farm Business Exception

The Final Regulations should not require compliance with the $500,000 limitation on farm business size on a year-by-year basis because a mere rise in market value of a taxpayer's assets could jeopardize the tax exemption for interest on any outstanding Enterprise Bonds. It is proposed that compliance be determined at the time of issue or in the alternative, that compliance be required for a minimum finite period, such as five years, beginning on the date of issue. Annual testing would unduly jeopardize the tax-exemption of the interest on the Enterprise Bonds and unduly constrain a small farm operation from succeeding and becoming a larger farm operation.

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