Indian tribes will have a harder time issuing tax-exempt bonds under proposed regulations the IRS issued in August.

Tribes are treated like sovereign governments. The Internal Revenue Code treats them like states for purposes of issuing tax-exempt debt. State and local governments can borrow at reduced rates to finance schools, roads, hospitals and other public facilities; anyone lending to them for such a purpose does not have to pay federal income taxes on the interest the lender receives.

However, tribes can only issue bonds to raise financing for “essential governmental functions.” The IRS is concerned that some tribes are stretching this term beyond what was intended. New proposed IRS regulations say that an undertaking will not be considered an “essential governmental function” unless the tribe can show that “numerous” state and local governments have engaged in the same activity and financed it with tax-exempt debt“ for many years.”The tribe must also show that the project is not a commercial or industry activity. Examples of projects that qualify for tax-exempt financing under this standard are construction of an office building to house tribal offices or the type of lodge customarily owned and operated by a state park or recreation agency.

Tribes have limited authority to issue so- called “private activity bonds,” or bonds for projects in which there will be more than 10% private business use. An example of private business use is where a facility is leased to a private company. However, such projects must be owned and operated by the tribe. They must be on Indian lands. The face amount of the bond issue cannot exceed 20 times the annual wages paid to tribe members and their spouses for working at the facility.