This is the seventh post in the FCRA Non-Federal Series
FCRA is not the only federal law that needs to make a distinction between federal and non-federal debt repayment sources. Federal tax law has this at IRC § 149 (b):
(b) Federally guaranteed bond is not tax exempt
(1) In general Section 103(a) shall not apply to any State or local bond if such bond is federally guaranteed.
(2) Federally guaranteed defined. For purposes of paragraph (1), a bond is federally guaranteed if:
(A) the payment of principal or interest with respect to such bond is guaranteed (in whole or in part) by the United States (or any agency or instrumentality thereof) …..
(C) the payment of principal or interest on such bond is otherwise indirectly guaranteed (in whole or in part) by the United States (or an agency or instrumentality thereof).
The primary purpose of this prohibition is to prevent the creation of a class of ‘tax-exempt Treasury bonds’ that would compete with Treasury’s taxable issues. It is another example of a rule that determines federal boundaries for certain debt-related activities. Federal debt isn’t eligible for tax-exempt status (which would interfere with Treasury’s management of the nation’s debt) or for FCRA treatment (which would undermine the accuracy of the nation’s budget).
The same issue arises in both cases – short of explicit federal guarantees or repayment obligations, when is the debt ‘federal’ or ‘non-federal’? Just as in the FCRA non-federal issue, it can be complicated for the application of IRC 149 (b) (emphasis added):
The prohibition under section 149 applies not only to direct guarantees, but also in circumstances where an underlying arrangement may result in the federal government indirectly guaranteeing debt service on an obligation. Congress intended that the determination of whether a federal guarantee exists be based on the underlying economic substance of a transaction, taking into account all facts and circumstances. See H.R. Rep. No. 99-426, at 1013 (1985),1986-3 (Vol. 2) C.B. 538.
For both IRC 149 (b) and FCRA, the underlying economic substance of the transaction must be examined with respect to federal involvement, not the nominal forms. This is because the substance of the transaction is what matters for the rule’s objective — for the former, to avoid the creation of securities that the market would view as effectively tax-exempt Treasuries, and for the latter, to ensure that a FCRA loan’s repayment obligation is subject to external, non-federal discipline.
In 2003, the IRS released a Private Letter Ruling concerning a facility’s ability to issue tax-exempt bonds despite significant federal contractual involvement in various activities at the facility, some of which directly or indirectly created revenues which could be used for bond debt service. The question was whether such federal involvement was a de facto guarantee of the bonds. The decision focused on the facts related to the transfer of risk in the bonds’ repayment obligations (emphasis added):
Based on the facts and circumstances, the payments to the Organization under the Contracts will not cause the Bonds to be federally guaranteed within the meaning of section 149(b). Although the revenues from the Facility will consist primarily of amounts received from the Agencies, the mere fact that federal funds may be available to pay debt service on the Bonds does not result in an indirect federal guarantee. Rather, the question is whether the substance of the transaction (i.e., the contractual relationships between the Organization and the Agencies) results in a transfer of risk to the federal government to pay debt service on the Bonds.
Despite the federal revenues and other activities (which presumably enhanced the overall creditworthiness of the facility’s bonds), the IRS didn’t find that the federal government was at risk for the bonds’ repayment:
In the instant case, there has been no transfer of risk to the federal government to pay debt service on the Bonds. There is no guaranteed stream of revenues from the Agencies that is available to pay debt service on the Bonds. Unlike a guarantee, the Agencies have no obligation to make payments of debt service upon a default on the Bonds. Rather, any payments from the Agencies are subject to the Organization’s fulfillment of its obligations under the Contracts. Moreover, payments under the Contracts are subject to the Agencies’ receipt of funds pursuant to annual appropriations. Thus, there is no transfer of risk to the federal government to pay debt service on the Bonds in the event of a default and the Bonds will not be federally guaranteed within the meaning of section 149(b).
Although this is a federal tax ruling, the ‘risk transfer’ principle here is completely consistent with the federal budget’s external discipline principle described in the 1967 Report. If the federal participant in a project is, or could be, substantively obligated to repay the project’s debt, the project’s lenders won’t be looking to the project for repayment, but to the federal government. The debt effectively becomes subject only to internal federal discipline. This outcome is prohibited by IRS and Treasury (because their internal decision is to avoid creating tax-exempt Treasury bonds) and examined by infrastructure loan programs with respect to FCRA treatment (because FCRA requires external, non-federal discipline on repayment cash flows).
Because IRC 149 (b) and FCRA decisions for federally involved projects will involve looking at the same facts in basically the same way, I think that a decision in one can serve as an analogous precedent for, or at least provide guidance to, the other. An infrastructure loan program faced with an application from a federally involved project should ask whether the project intends to issue tax-exempt bonds with the same repayment sources as the proposed program loan (in a prior post, I noted this idea in the explanation of Criterion F and in the guidance for WIFIA’s question 11).
There’s no evidence I’ve found that that Treasury pointed out the possible relevance of IRC 149 (b) in developing the WIFIA ‘criteria’. I think this suggests that, despite the Congressional directive and their ultimate sign-off on the published criteria, Treasury wasn’t very involved in the criteria’s development.
IRC 149 (b) and FCRA at Amtrak and Fargo-Moorhead
There are at least two recent cases where federally involved entities issued tax-exempt debt and applied to a federal infrastructure loan program.
The first is Amtrak. As an independent federal agency, Amtrak doesn’t issue tax-exempt debt, presumably because their direct debt would be perceived to carry an implied federal guarantee. But in the agency’s 2021 financial statement, there’s a note describing an Amtrak maintenance facility, subject to a lease-leaseback with a local development authority, that did issue about $100 million of tax-exempt revenue bonds. Presumably, despite Amtrak’s substantial involvement in the facility, the tax opinion was based on factors similar to those in the 2003 PLR described above. Apparently, there wasn’t a risk of an Amtrak obligation to repay the bonds, so the IRC 149 (b) prohibition didn’t apply.
Later in that statement, there’s a note describing a $2.45 billion loan from the RRIF federal program in 2016. RRIF’s analysis of this loan for FCRA treatment was also mentioned in the GAO Report. Per the GAO, the program said that they “ensured the 2016 …loan provided to Amtrak was fully repayable by Northeast Corridor revenues. DOT officials assessed Amtrak’s available revenues and did not consider any federal assistance as a repayment source for the loan.”
It appears that for both IRC 149 (b) and FCRA tests applied here with consistent outcomes, the non-federal source of repayment was the key factor, whereas Amtrak’s overall status as an independent federal agency was not.
The second case is the Fargo-Moorhead project, which received a $569 million WIFIA loan in 2021. The loan received FCRA treatment prior to the implementation of current WIFIA ‘criteria’, but “EPA officials told [the GAO] that if the criteria had been in place during the letter of interest review of the Fargo-Moorhead project, the project would have been deemed ineligible to receive the special budgetary treatment under FCRA.”
Yet later in 2021, the same project issued $280 million of tax-exempt private activity bonds through a state development authority. There isn’t much publicly available information about the details, but it seems that the bonds were part of the $2.75 billion P3 financing that included the WIFIA loan, so some basic terms (e.g., security, repayment sources, etc.) would presumably be similar. I think PABs get even more scrutiny regarding tax-exempt status than typical bonds, so it would appear that the project’s federal involvement was not an issue for IRC 149 (b).
If the project’s WIFIA loan and PABs were in fact essentially equivalent with respect to a non-federal source of repayment, how can the loan’s retrospective ineligibility for FCRA treatment under the new ‘criteria’ be consistent with the tax-exempt status of the PABs? I find it difficult to see how both can be a correct assessment of the project’s debt.