All of the property financed by spaceport bonds must be owned by a state or local governmental unit. “Owned” refers not to state law title ownership, but instead to economic/tax ownership. In other words, a state or local governmental entity must have a beneficial interest in all of the property financed with spaceport private activity bonds (PABs) that is significant enough to conclude that even if a private company is the title owner of the assets, a state or local government will ultimately obtain possession of the property with sufficient remaining useful life to conclude that the governmental entity, and not the private company, is the economic owner of the property.
Parties typically comply with this requirement by using a safe harbor described below (which requires, among other things, that the state/local government receive the property back at the end of the lease with at least 20% of its economic life remaining and that the private company forego federal tax benefits such as depreciation). This requirement imposes unique challenges and creates one of the biggest tax hurdles to structuring and completing a spaceport bond deal. In effect, the governmental ownership requirement forces space companies to weigh the benefit of tax-exempt financing against giving up the benefits of being the economic owner of the property (including depreciation, any available federal tax credits, and a permanent stake in the profits produced by the property).
Legislative History: How the 1986 Tax Reform Act Shaped Spaceport Bond Ownership Rules
Congress enacted the governmental ownership requirement in the Tax Reform Act of 1986. It applies only to certain categories of private activity bonds, including airports, spaceports, and dock/wharf facilities. Before the 1986 Act, the governmental ownership concept first appeared as an exception to the volume cap requirement for certain types of PABs. This requirement was mechanical: If you agreed to forego depreciation and federal investment tax credits for the property, you were deemed to have relinquished tax ownership of it. In the 1986 Act, Congress turned this into a prerequisite for tax-exempt financing for certain types of PABs. The Committee Reports for the precursor to the 1986 Act say that Congress created this requirement for two reasons.
The first reason was that “certain governmental facilities…require continuing governmental participation.” If you look at the list of PAB projects that were subject to the governmental ownership requirement in 1986 (airports, dock/wharf facilities, and mass commuting facilities), this makes some sense. These facilities are all transportation facilities used by the general public and by common carriers of people and goods, where public safety and other considerations make significant continuing governmental participation (rising to the level of tax ownership) a good idea. In this respect, it is interesting that Congress chose to make spaceports subject to this requirement.
Perhaps this was viewed as a trade-off for folding the spaceport bond provisions into the deeply rooted body of law governing airport PABs, which was a good idea that likely will help the market embrace these deals. However, although the hazards of space flight are obvious to anyone with internet access or who has ever been to the movies, we are not yet living like the world of “The Jetsons,” in which spaceports are public transportation facilities where we can show up with our luggage for a weekend trip to Mars. The governmental ownership requirement will be better suited for spaceports once we reach that golden age. In the meantime, it will create challenges.
The second rationale for the governmental ownership requirement was that “other tax benefits arising from ownership of property should not accrue to nongovernmental persons also receiving the Federal subsidy provided by bond financing.” This makes a little less sense because it would be just as true for other types of PABs where private ownership is permitted. In other words, private conduit borrowers of multifamily housing PABs, for example, are allowed to keep these “other tax benefits arising from ownership” despite the fact that they receive the “Federal subsidy provided by bond financing.”
In addition, Congress strengthened the governmental ownership requirement in the 1986 Act and made it so it could not be satisfied merely by agreeing to forego depreciation and federal tax credits. You now had to show that a state/local government was the owner for tax purposes under general federal tax principles. Perhaps recognizing that this question — “Who is the tax owner?” — has ruined the weekends of countless law firm associates over the decades, destroyed entire forests worth of paper, and swamped the digital records of any law firm attempting to answer it, Congress created a safe harbor that allows an issuer to satisfy the governmental ownership requirement.
The Safe Harbor Rule for Satisfying the Governmental Ownership Requirement
Under the safe harbor, “property leased by a governmental unit shall be treated as owned by such governmental unit” if (i) the lessee makes an irrevocable election (binding on the lessee and all successors in interest under the lease) not to claim depreciation or an investment credit with respect to such property, (ii) the lease term is not more than 80 percent of the reasonably expected economic life of the property, and (iii) the lessee has no option to purchase the property other than at fair market value (as of the time such option is exercised). There is not much further guidance from the IRS about how to apply the safe harbor, but transaction participants have generally found it mechanical enough to apply to complete transactions.
One private letter ruling (PLR 201918008) describes an interesting fact pattern that could allow for leases to be extended after bonds are issued and could even allow the parties to take post-issuance improvements to the facilities in general into account, even if they were not bond-financed. In addition, although this is not entirely clear, most bond counsel take the position that the 80% requirement is measured in the aggregate; that is, the bonds can finance some short-lived assets whose useful lives are entirely consumed during the term of the lease while they are in the hands of the private lessee, and as long as a sufficiently large amount of bond proceeds also finances long-lived assets that bring the average up so, in the aggregate, the local government gets back at least a 20% residual interest in the economic life of the assets, then everything works.
Applying the Requirement: Lessons from Airport and P3 Financings
In a typical airport PAB financing, the governmental ownership requirement is easy to satisfy. The local government airport authority is the title owner of all of the bond-financed property, and any leases of space in terminal facilities by airlines or other tenants are structured (often for business reasons more than to comply with the governmental ownership safe harbor) so that tax ownership also clearly resides with the airport authority.
In P3 airport financings, this becomes a bit more challenging because of the long-term lease that the P3 concessionaire enters into with the airport authority. In these cases, the P3 concessionaire often arranges for the construction work for a new facility and then contributes the improvements to the airport authority. The airport authority then leases the improvements back to the P3 concessionaire for a term that is short enough to allow the bonds to satisfy the 80% economic life element of the safe harbor. It is likely that spaceport financings will follow some variation of this latter approach.
Practical Challenges for Space Companies: Bonus Depreciation vs. Tax-Exempt Financing
Many of the companies that are likely to be the conduit borrowers on the initial spaceport deals are probably going to be young companies that, understandably, are not familiar with the municipal market, because they did not have access to it until last year. Reports are that the initial conversations have been difficult — “You mean I have to let the government own my rocket manufacturing plant?” Further complicating these conversations is the fact that in the same legislation that created spaceport PABs last year, Congress created an extraordinarily generous bonus depreciation provision (Code Section 168(n)) that allows taxpayers to fully write off the cost of a “qualified production property” in the first year that the property is placed in service.
The definition of “qualified production property” is staggeringly broad and likely to include many of the assets that would otherwise be eligible for spaceport PAB financing. This further forces companies to choose, for each asset, between writing off the entire cost of the asset and financing it with tax-exempt bonds, because the bonus depreciation specifically does not apply to tax-exempt bond-financed property, and even if it did, spaceport bonds require the borrower to forego any depreciation deduction.
Given the cost, size, and scale of the future of space exploration in the United States, and the comparably expansive breadth of the spaceport bond statute, it is likely that spaceport bonds will have a role to play in financing the capital improvements that will help this burgeoning industry grow and thrive. But the tradeoffs between low-cost financing through tax-exempt bonds and the benefits of ownership are real, and spaceport companies will have to grapple with them in developing their capital plans.