beginnings, middles and ends

Beginnings, Middles and Ends

Beginnings, Middles and Ends

The Tax Compliance Life Story of Your Bond Deal

Daniel P. SmithDPS Legal Counsel

The Tax Compliance Life Story of Your Bond Deal

Daniel P. SmithDPS Legal Counsel

The Life Story of your Bond Deal is a Novel...Not a

Short Story

“Tax-advantaged bonds . . . issued by or on behalf of state and local governments, are subject to applicable federal tax requirements both at the time of issuance and for so long as the bonds remain outstanding.” -- Internal Revenue Service

Prologue

Private Letter Ruling 201114010

• Authority that owns municipal utility system qualifies as a political subdivision for purposes of section 103

• 103 - state or local bonds

• 1.103-1(a)-includes political subdivision

• 1.103-1(b) - municipal corp. or delegated sovereign power (tax, eminent domain, police power)

• Authority had all 3 sovereign powers

• Authority’s eminent domain power not subject to approval or control of the City


• Authority created as public corporation to own piers, terminals and warehouse facilities does not qualify as a political subdivision.

• Authority also does not qualify as an “on behalf of issuer”

• Authority’s eminent domain power was subject to consent of the City Council - not a political subdivision

• Rev. Rul 57-187 - “on behalf of issuer” must be controlled by the political subdivision - The Authority was not controlled because a majority of board members were elected in a general election and none could be removed by the City Council

This is the Double

Whammy!

• Management Agreement on municipal Exhibition and Convention facility does not result in private business use of the facility


• Revenue Procedure 97-13 provides a safe harbor

• Term

• Compensation Methodology

• Relationship b/n service provider and qualified user

• Safe harbor is not met in this ruling, yet the management agreement is “blessed” by the IRS based on a “facts and circumstances” analysis

• Incentive fee (revenue benchmark & net operating surplus/deficit benchmark)

• Term is 2 months longer than permissible 5 year term

Beginnings“Once upon a time, there was a bond

issue . . .”

Introduction of Characters

The Protagonist/Hero

Tax Counsel

The Trusted Sidekick

City/County Attorney

Antagonist/Villain

Setting the Stage for Action in The Tax Compliance

Story of Your Bond Deal

•Your Tax Certificate

•Your Tax Return

•Your Tax Records

Your Tax Certificate

The Tax Certificate is the first significant tax document in your bond deal - sometimes also called the “Arbitrage Certificate” or the “Non-Arbitrage Certificate.”

“The Certificate” is Required . . . Usually • Treasury Regulations Section 1.148-2(b)(i) -

An officer of the issuer responsible for issuing the bonds must, in good faith, certify the issuer’s expectations as of the issue date.

• Treasury Regulations Section 1.148-2(b)(ii) - Exceptions to certification requirement

• No unspent gross proceeds other than BFDSF, or

• Issue price does not exceed $1 million

•The two most important words in the Tax Certificate are . . .

Two Words . ..

NOT “GREAT EXPECTATIONS” BUT . .

.

REASONABLE EXPECTATIONS!

And the “reasonable expectations” are about . . .

Private Use andArbitrage

Private Use

VS.

• Treasury Regulations Section 1.141-2(d)(1) - An issue is an issue of private activity bonds if the issuer reasonably expects, as of the issue date, that the issue will meet either the private business tests or the private loan financing test.

• Treasury Regulations Section 1.141-2(d)(2)(i) - In general, the reasonable expectations test must take into account actions over the entire stated term of an issue.

• Treasury Regulations Section 1.141-2(d)(2)(ii)- An action that is reasonably expected, as of the issue date, to occur after the issue date and to cause either the private business tests or the private loan financing test to be met may be disregarded for purposes of those tests if the following four specific criteria are met.

• The issuer reasonably expects, as of the issue date, that the financed property will be used for a governmental purpose for a substantial period before the action.

• The issuer is required to redeem all nonqualifying bonds (regardless of the amount of disposition proceeds actually received) within 6 months of the date of the action.

• The issuer does not enter into any arrangement with a nongovernmental person, as of the issue date, with respect to that specific action.

• The mandatory redemption of bonds meets all of the conditions for remedial action under Section 1.141-12(a).

And the “reasonable

expectations” are also about . . .

Arbitrage

What is Arbitrage Anyway?

• Section 148 of the Code - For purposes of section 103, the term “arbitrage bond”means any bond issued as part of an issue any portion of the proceeds of which are reasonably expected (at the time of issuance of the bond) to be used directly or indirectly (1) to acquire higher yielding investments, or (2) to replace funds which were used directly or indirectly to acquire higher yielding investments.

It’s Really an Arbitrage Certificate• Treasury Regulations Section 1.148-2(b)(2)(i)

- An officer of the issuer responsible for issuing the bonds must, in good faith, certify the issuer’s expectations as of the issue date. The certification must state the facts and estimates that form the basis for the issuer’s expectations. The certification is evidence of the issuer’s expectations, but does not establish any conclusions of law or any presumptions regarding either the issuer’s actual expectations or their reasonableness.

A Reasonable Municipal Official =A Prudent Municipal

Official

• An issuer’s expectations are reasonable only if a prudent person in the same circumstances as the issuer would have those same expectations or take those same actions, based on all the objective facts and circumstances.

Factors Showing Prudence

• The issuer’s history of conduct concerning stated expectations

• The existence of covenants enforceable by bondholders

• The level of inquiry by the issuer into factual matters

Those Pesky Expectations

Again• Treasury Regulations Section 1.148-2(b)(1) - Except as provided in paragraph (c) of 1.148-2 [i.e., “deliberate actions” - see “Middles” below], the determination of whether an issue consists of arbitrage bonds under section 148(a) is based on the issuer’s reasonable expectations as of the issue date regarding the amount and use of the gross proceeds of the issue.

After Your Tax Certificate comes

. . .

Your Tax Return

Some Famous Returns

A Not-So-Famous Return. . . Hopefully

Your Tax Return!!

IRS Information Returns

• Form 8038-G

• Form 8038-GC

• Form 8038

“Miscellaneous” Tax Issues

•Line 39 - Section 265(b)(3)[BANK QUALIFICATION]

•Qualified Small Issuer

•Not a Private Activity Bond

•Designated by the Issuer

•Line 40 - Penalty in lieu of arbitrage rebate

• Line 43 - Written Procedures regarding non-qualified bonds

• HINT: YOU WANT TO BE ABLE TO CHECK THIS BOX!

•Line 44 - Written procedures regarding Section 148

•DO YOU WANT TO BE ABLE TO CHECK THE BOX?

• YES! DITTO TO LINE 43 ON WRITTEN PROCEDURES FOR

NONQUALIFIED BONDS

“DITTO”

•Line 45 - Reimbursement

• Sec. 1.150-2

• Official Intent

• 60 Days

Read the Return!

• “Under the penalties of perjury, I declare that I have examined this return and accompanying schedules and statements, and to the best of my knowledge and belief, they are true, correct, and complete. . .”

• Bond Counsel signs the Return and sets forth his PTIN.

The 800 Pound Gorilla

• What is his name?

Record Retention!

Existing Guidance?Not So

Much• IRC Section 6001 - Every person liable for any tax imposed by this title, or the collection thereof, shall keep such records, render such statements, make such returns, and comply with such rules or regulations as the Secretary may from time to time prescribe. Whenever in the judgment of the Secretary it is necessary, he may require any person, by notice served upon such person or by regulations, to make such returns, render such statements, or keep such records, as the Secretary deems sufficient to show whether or not such person is liable for tax under this title.

The Heavy Hand• IRC Section 7203 - Any person . . . required by

this title or by any regulations made under the authority thereof to make a return, keep any records, or supply an information, who willfully fails to . . . keep such records, or supply such information, at the time or times required by law or regulations, shall, in addition to other penalties provided by law, be guilty of a misdemeanor and, upon conviction thereof, shall be fined not more than $25,000 ($100,000 in the case of a corporation), or imprisoned not more than 1 year, or both, together with costs of prosecution.

Record Retention - Regulations

• Treasury Regulations Section 1.6001-1(a) - Any person subject to [income] tax..., or any person required to file an information return with respect to income, shall keep such permanent records ... as are sufficient to establish the amount of gross income, deductions, credits, or other matters required to be shown by such person in any return of such tax or information.

• Section 1.6001-1(e) - Books and records required by this section shall be kept at all times available for inspection by authorized internal revenue officers or employees, and shall be retained so long as the contents thereof may become material in administration of any internal revenue law.

• Section 1.148-8(h)(2) - Requires that issuers of tax-exempt bonds retain in their books and records any elections made with respect to application of the 1992 regulations on the calculation methodologies for arbitrage rebate calculations for a period of six (6) years after the computation date.

• Section 1.148-5(d)(6)(ii) - Provides a safe harbor that provides in order to demonstrate that investments in yield restricted escrows or guaranteed investment contracts are at a fair market value, issuers must maintain certain investment documentation (including trade confirmations) until three years after the final maturity of the bond issue.

Other “Record Retention” Lore

• IRS Notice 2006-63

• NABL/GFOA Form Tax Compliance Checklists

• 2007 Tax-Exempt Bond Financings Compliance Questionnaire

• 2009 Governmental Bond Financings Compliance Questionnaire

• 9/11/08 IRS Interim Report on Charitable Financings

• Form 990 (Schedule K)

• Advisory Committee on Tax Exempt and Governmental Entities (ACT)’s Proposed Record Retention Revenue Procedure, 6/10/09

• IRS Web Site FAQs

IRS Web Site FAQs

• Why keep records with respect to tax-exempt bonds?

• Who may maintain records?

• What are the basic records that should be retained?

• Are these the only records that need maintaining?

• In what format must the records be kept?

• How long should records be kept?

• How does this general rule apply to refundings?

• What happens if records aren’t maintained?

• Can a failure to maintain records be corrected?

• Are there exceptions to the general rule regarding record retention?

IRS Web Site FAQs (con.)

Middles“And he huffed and he pufffed”

The IRSChecking Out Your Bond Deal

Deliberate Actions

•Private Use

•Arbitrage

Private Use

• Treasury Regulations Section 1.141-2(d)(1) - An issue is also an issue of private activity bonds if the issuer takes a deliberate action, subsequent to the issue date, that causes the conditions of either the private business tests or the private loan financing test to be met.

• Treasury Regulations Section 1.141-2(d)(3)(i) - A deliberate action is any action taken by the issuer that is within its control. An intent to violate the requirements of Section 141 is not necessary for an action to be deliberate.

• Treasury Regulations Section 1.141-2(d)(3)(ii) - An action is not treated as a deliberate action if (A) it would be treated as an involuntary or compulsory conversion under Section 1033; or (B) it is taken in response to a regulatory directive made by the federal government. See Section 1.141-7(g)(4).

• Treasury Regulations Section 1.141-2(d)(4) - Dispositions of personal property in the ordinary course of an established governmental program are not treated as deliberate actions if (A) the weighted average maturity of the bonds is not greater than 120 percent of the reasonably expected actual use of that property; (B) the issuer reasonably expects on the issue date that the fair market value of that property on the date of disposition will be not greater than 25 percent of its cost; and (C) the property is no longer suitable for its governmental purposes on the date of disposition.

• Treasury Regulations Section 1.141-2(e) - A deliberate action occurs on the date the issuer enters into a binding contract with a nongovernmental person for use of the financed property that is not subject to any material contingencies.

Arbitrage• Section 148(a) of the Code - A bond

shall be treated as an arbitrage bond if the issuer intentionally uses any portion of the proceeds of the issue of which such bond is a part in a manner described in paragraph (1) or (2) of Section 148(a) [i.e., to acquire higher yielding investments, or to replace funds which were used directly or indirectly to acquire higher yielding investments].

• Treasury Regulations Section 1.148-2(c) - The taking of any deliberate, intentional action by the issuer or person acting on its behalf after the issue date in order to earn arbitrage causes the bonds of the issue to be arbitrage bonds if that action, had it been expected on the issue date, would have caused the bonds to be arbitrage bonds. An intent to violate the requirements of section 148 is not necessary for an action to be intentional.

Monitoring Compliance - Private Use

• Written Procedures for Nonqualified Bonds

• Remedial Actions Under Treasury Regulations Section 1.141-12

• Voluntary Compliance Agreement Program (VCAP)

Written Procedures for Nonqualified

Bonds• “The on-going nature of post-issuance compliance requirements applicable to tax-advantaged bonds requires issuers to actively monitor compliance throughout the entire period their bonds remain outstanding. This due diligence will significantly improve the issuer’s ability to identify noncompliance and prevent violations from occurring, or timely correct identified violations (when prevention is not possible), to ensure the continued tax-advantaged status of the bonds.... Issuers should adopt written procedures, applicable to all bond issues, which go beyond reliance on tax certificates included in bond documents provided at closing. Sole reliance on the closing bond documents may result in procedures insufficiently detailed or not incorporated into an issuer’s operations.”

Key Points in Written

Procedures• Due diligence review at regular intervals

• Identifying the responsible official or employee

• Training of the responsible official/employee

• Retention of adequate records

• Procedures to timely identify noncompliance

• Procedures to ensure timely correction

Remedial Actions• Treasury Regulations Section 1.141-12

• Reasonable Expectations Test Met

• Maturity Not Unreasonably Long

• Fair Market Value Consideration

• Disposition Proceeds Treated as Gross Proceeds

• Proceeds Expended on Governmental Purpose, OR . . .

Mandatory Redemption

• All the other requirements are met (except for use of proceeds on a governmental purpose)

• Redemption or defeasance of nonqualified bonds

• Within 90 days of deliberate action

• With cash, pro rata redemption is OK

• Notice to IRS within 90 days

• Not more than 10.5 years b/n issue and 1st call

Alternative Use of Proceeds

• Consideration is exclusively cash

• Reasonable expectation to spend proceeds w/i 2 yrs.

• Private business/private loan financing tests of Section 141 are met & no deliberate action

• Redemption/defeasance of nonqualified portion of bonds

Alternative Use of Facility

• Alternative use by nongovernmental person or 501(c)(3) organization

• Nonqualified bonds treated as reissued

• No financing of acquisition with tax-exempt bonds

• Proceeds used to pay debt service or deposited in yield restricted escrow

VCAP

• IRS Notice 2008-31

• Closing Agreement for violations that cannot be remediated by a remedial action and the bonds are not under audit, “in court,” or IRS appeals [also violation not due to “willful neglect”]

• IRM Section 7.2.3

• Anonymous Request/Full Disclosure

Written Procedures for Arbitrage Rebate

• Yield Reduction Payments - Treasury Regulations Section 1.148-5(c) - An intentional act that results in a violation of the arbitrage requirements cannot be remediated. However, in certain instances, an issuer may be allowed to file Form 8038-T, “Arbitrage Rebate, Yield Reduction and Penalty in Lieu of Arbitrage Rebate,” to pay a yield reduction payment to resolve the noncompliance.

Written Procedures for Arbitrage Rebate

(con.)• VCAP - Yield reduction payments are

not permissible in all cases (see Treasury Regulations Section 1.148-5(c)(3)). If an issuer is not permitted to pay a yield reduction payment under the Regulations, the issuer can submit a request under VCAP to resolve the matter.

IRS Help - Monitoring Compliance

• IRS Publication 4079, “Tax-Exempt Government Bonds Compliance Guide” [www.irs.gov]

• IRS Compliance Questionnaires

• 2007 Questionnaire - 501(c)(3) organizations

• 2009 Questionnaire - Governmental issuers

• 2011Questionnaire - Advance Refunding Bonds

http://www.irs.gov/

Governmental Bond Financings

Questionnaire• Post-Issuance Compliance

• General Recordkeeping

• Investments and Arbitrage Compliance

• Expenditure and Assets

• Private Business Use

Advance Refunding

Questionnaire• Current Debt Management Policies and Procedures

• Current Procedures to Assure Compliance with Federal Requirements Related to Advance Refundings

• Current Arbitrage Yield Restriction and Rebate Procedures

• Current Procedures Related to Determining Issue Price

• Current Record Retention Procedures

• Post-Issuance Compliance Procedures and Educational Resources

• Current Awareness of Voluntary Compliance Options

• Where did you become familiar with your options?

Rebate Returns

• Form 8038-T

Ends“And they lived happily ever after. . .”

“Or not.”

Maturity of Bonds

•Woo Hoo! No more rules!!

IRS Audits and Closing

Agreements

Anatomy of an IRS Audit

• Opening Audit Letter - Targeted or Random Audit?

• Selection of Tax/Audit Counsel

• Bond Counsel? - Conflict Waiver

• Independent Tax/Audit Counsel?

• Co-Counsel?

• Information Document Requests

• Advocate for You - Tell the Story of Your Bond Deal in a Persuasive Way

Refundings/Reissuance - The “Never-Ending

Story”

Epilogue

• Beginnings

• Read (Tax Certificate and Tax Return)

• Retain (Tax Records)

• Ramp Up Written Procedures

Epilogue (con.)• Middles

• Be Deliberate - watch your deliberate actions/engage counsel to review proposed agreements

• Be Compliant - monitor your compliance (private use, arbitrage, record retention)

• Be Diligent - consider a periodic independent tax counsel review of your existing agreements, record retention policies, and written procedures

Epilogue (con.)

• Ends - IRS Audits

• Be prepared

• Be proactive

• Be cooperative

The End

“I laughed, I cried, my municipal bond deal

became a part of me.”

beginnings, middles and ends

Documents