Industrial Revenue Bond or IRB is one of the methods in which a state or local government can help provide subsidy or financing to a private company. In this, the state or local government issues bonds, but its proceed goes to the private company. This financing method is pretty common due to its low cost.
A government entity primarily issues IRBs to help a private business, who otherwise would not be able to get the funding for their project, or they would not be willing to take up the project on their own. And such projects may be needed to boost the larger social, economic, infrastructural, or industrial welfare or interest of the state and its people.
Generally, an IRB helps to support a specific project, including a new manufacturing area. A govt. can use it to finance 100% of a project. Previously, IRBs were called IDB (Industrial Development Bonds).
In an IRB, the state or local government issues the bonds on behalf of the private business. But, the bond issue is managed by the government, and the proceeds go to the private business.
The private business is responsible for repaying the proceeds at maturity. Until the repayment is complete, the govt. holds the title to the underlying collateral. Since the sponsoring government is not liable for repayment, the issue has no effect on the government’s credit rating.
Benefits of Industrial Revenue Bond
Following are the benefits of Industrial Revenue Bond (IRBs):
- Along with being cost-effective, such bonds may get federal tax-exempt status. Also, sometimes the collateral qualifies for a property tax exemption.
- Another benefit for private businesses is that they get funds at a lower interest rate. Apart from this, they may qualify for a property tax exemption and get a long-term, fixed-rate financing package.
- The private business may use the proceeds from the issue of bonds for many purposes. These could be buying land, machinery, and equipment, construction work, covering the cost of the bond issue, and real estate development fees.
- Such a source of financing encourages a business to take on a project that they otherwise won’t take up. Also, it helps companies get funding, which otherwise won’t be available to them.
Industrial Revenue Bond – How it Works?
Companies can issue bonds themselves in the financial market. In such a case, they would have to offer the investors the current interest rate. On the other hand, if a government entity issues the bond on behalf of the business, the bonds get tax-exempt and also carry a lower interest rate.
This means the investors who buy these bonds will not have to pay federal tax on the interest income they get. Owing to this benefit, such bonds usually carry a lower interest rate. One can consider this difference in the interest rate as a subsidy from the government to the private business.
IRBs are part of the securities called private-activity bonds. These bonds are different from the ones that the government issues to fund its own projects, such as developing schools, hospitals, and more.
One of the objectives of the government in issuing private-activity bonds is to lower unemployment and boost economic growth. The direct benefit of the issue, however, goes to the private business. IRBs are the most popular type of private-activity bonds.
IRBs got popular after World War II. Southern states used them at the time to attract the Northern manufacturing businesses. These bonds got so common by the 1960s that the authorities started worrying about the loss in revenue because of their tax-exempt feature. Thus, the government started putting limits on the use of the bond proceeds. Also, restrictions were placed on the volume of bonds.
Presently, the US government allows the issue of two types of tax-exempt IRBs:
Small Issue IRBs
A business can use these IRBs for expansion, construction, or manufacturing facilities. Usually, they are about $1 million but can extend up to $10 million in specific scenarios.
Exempt Facility IRBs
These IRBs have no size limit, but a business can use the proceeds for specific types of projects only. These projects could be for water, electricity, rental housing, sewer facilities, etc.
There is a limit on the total outstanding IRBs for a business. Also, there is a restriction on the private-activity bonds that a state can come up with. Usually, half of the limit is for the state agencies and the other 50% for the local government entities.
Some states or entities are able to bypass or overcome this limit by issuing non-tax-exempt IRBs. For example, New Mexico had issued such bonds worth billions for Intel Corporation. Taxable IRBs are not a low-cost financing option. Instead, they work as a tool to allow a business to avoid the standard property taxes. For this, the business needs to transfer property ownership to the public entity.
In this, the business buys the bond that the government entity issues. The business then makes the lease payment to repay the bonds. In a way, it means that the business is borrowing money from itself.
Apart from IRBs, 501(c)(3) bonds are another type of tax-exempt private-activity bonds. The government issues these bonds to assist non-profit organizations. Moreover, there are no volume caps on such bonds.
Approval Process for Issuance of Exempt IRBs
The approval of both Federal and State law is needed to issue the tax-exempt IRB’s. In the case of tax-exempt IRB’s, the state law decides whether or not the public entity has the authority to issue the bonds for that purpose. Also, state law lays down the procedural requirements for the issue. The federal law will decide whether or not to grant tax-exempt status to the bond issue.
Provision for IRBs in the US
IRS statute governs the IRBs in the US. Following are the features (or limitations) of IRBs:
- $10 million is the maximum limit for the bond issue.
- The total Capex of the project should not be more than $20 million.
- Total outstanding IRBs for one private business must not be more than $40 million.
- A minimum of 95% of proceeds should go towards the qualifying costs.
- The cost of issuance must not be more than 2% of proceeds.
- The weighted average maturity of the bonds must not be more than 120% of the average economic life of the facility in question.
- A business must not use the proceeds to buy second-hand equipment. But, if such equipment is part of the acquisition of an entire facility, then it is allowed.
- A business can use a maximum of 25% proceeds to buy the land.
Read about other Different Types of Bonds.