Industrial Revenue Bonds—IRBs Definiton

What Are Industrial Revenue Bonds—IRBs?

Industrial revenue bonds (IRB) are municipal debt securities issued by a government agency on behalf of a private sector company and intended to build or acquire factories or other heavy equipment and tools.

IRBs were formerly called Industrial Development Bonds (IDB).

Understanding Industrial Revenue Bonds—IRBs

Municipal bonds (aka munis) are tax-exempt debt obligations issued by a state, city, or county to raise money for major capital projects, such as infrastructure or new schools. Investors expect a timely and periodic stream of interest income on these bonds and, upon maturity, repayment of their principal. The source of funds used for interest payments and principal depends on whether the muni bond is a general obligation bond or a revenue bond.

• A general obligation bond makes its repayments from the general funds of the municipal issuer; they’re backed by the full faith and credit of the issuer, which may increase taxes in order to meet its payment obligations.
• A revenue bond is a municipal bond that is backed by the revenues generated from a specific project or related revenue source (like the tolls collected from a new highway).

One type of revenue bond is the private activity bond (PAB), which is issued by the municipality on behalf of private organizations (either for-profit or non-profit) to finance particular projects. Although a private entity is doing the work, the project is one that will benefit the community in some way: a hospital, airport, or sports stadium.

An industrial revenue bond (IRB) is a variety of PAB—one issued by the state or local government on behalf of a for-profit company. The municipality’s aim is to improve the economic and employment conditions of its region, and, via the IRB, is willing to help fund a project and issue to tax breaks to the entity undertaking it.

How Industrial Revenue Bonds—IRBs Work

Municipalities issue IRBs to assist a company that might otherwise be unable to obtain financing for its industrial venture or unwilling to undertake the project on its own. The proceeds from the bond are used to fund the acquisition, construction/reconstruction, expansion, or improvement of property that qualifies as a manufacturing facility or equipment. As with PABs in general, the IRB’s underlying borrower—the for-profit company—agrees to reimburse the issuer, which pays the interest and principal on the securities solely from the revenue stream of the borrowers’ projects.

A private company’s project qualifies for an IRB if it involves manufacturing, waste disposal/recovery, or wastewater treatment. Also, to qualify, total capital expenditures at the project site for the three years prior and subsequent to the issuance of the bonds must be $20 million or less.

Other IRB provisions include:

• the maximum amount of bonds that may be issued or outstanding is $10 million
• at least 95% of the bond proceeds must be spent on qualifying costs
• not more than 2% of the proceeds may be used for costs of issuance
• total IRBs outstanding at the company may not exceed $40 million
• the weighted average maturity of the bonds cannot exceed 120% of the average economic life of the facilities to be financed
• bond proceeds cannot be used to acquire used equipment, except as part of the acquisition of an entire facility
• no more than 25% of the proceeds can be used to acquire land

As these provisions suggest, IRBs tend to be small-issue manufacturing bonds.

Tax Treatment of Industrial Revenue Bonds—IRBs

As with other munis, the interest IRBs pay is exempt from both federal and state income taxes. As a result, these bonds carry lower nominal interest rates than comparable conventional debt obligations.

IRBs are subject to IRS statutes. Since the project is legally owned by a governmental entity, however, the company developing the project obtains the status of a state or local government (for this project). The property being developed thus becomes exempt from many taxes, especially property taxesuntil the bonds mature. If the company defaults on the lease payments, the bond trustee forecloses and sells the company’s assets to repay bondholders.