By CHRISTIE MARTIN and LEN WEISER-VARON

The IRS on April 11, 2018 released Revenue Procedure 2018-26 (Rev. Proc. 2018-26), which expands remedial action options in connection with certain post-issuance leases to private parties of facilities financed with tax-exempt bonds. Whereas previously the bond issue(s) that financed the leased facility would have to be redeemed or defeased to preserve the tax-exemption of the applicable bonds, the new remedial action permits the bonds to remain outstanding if the present value of the lease payments is applied to other bondable expenses. The new Revenue Procedure also introduces remedial action for certain types of tax credit bonds and direct pay bonds that did not previously have access to remedial action options.

The Internal Revenue Code provides for the issuance of tax exempt bonds under Section 103 (“tax-exempt bonds”), qualified bonds with refundable tax credits payable to issuers under Section 6431 (“direct pay bonds”) and qualified bonds providing tax credits to holders (“tax credit bonds”). Each of these types of bonds has eligibility requirements including the prescribed uses of the proceeds. For example, in the case of tax-exempt bonds issued for the benefit of government entities or 501(c)(3) non-profit borrowers, there are strict limits on private use of bond-financed facilities that are inconsistent with the sale or lease of such facilities to a private party. When proceeds are not used for qualified uses, or cease to be so used, the bonds lose their tax advantage unless an allowable remedial action is taken to cure the nonqualified use. Existing regulations provide for certain remedial actions for tax-exempt bonds and tax credit bonds issued as qualified zone academy bonds.

Rev. Proc. 2018-26 expands the existing remedial action options for tax-exempt bonds to allow an alternative use of “disposition proceeds” to cure nonqualified use resulting from eligible leases (defined below) of financed property. Prior to the new Revenue Procedure, the only remedial action available in the case of such leases was a redemption or defeasance of bonds, often requiring the redemption or defeasance of the entire bond issue that financed the leased facility. Building on the existing alternative use of disposition proceeds remedial action for exclusively cash sales of tax-exempt financed facilities, the new Revenue Procedure treats an “eligible lease” as a disposition made exclusively for cash, and deems the “disposition proceeds” to be an amount equal to the present value of all of the lease payments required to be made under the eligible lease. Instead of redeeming or defeasing the applicable bond issue, tax-exemption of the applicable bonds can be preserved by expending these deemed disposition proceeds on other bondable expenses, provided the issuer expects such expenditure to occur within two years of the date of the lease. This eligible lease remedial action is expected to be helpful to governmental issuers that wish to convert bond-financed public facilities into public-private partnerships using long-term lease arrangements, as well as others who no longer need bond-financed facilities for their original purpose and want the flexibility to lease rather than sell those facilities without retiring the associated tax-exempt debt.

A lease is an “eligible lease” if (a) the consideration for the lease is exclusively cash lease payments (regardless of when paid) that are not themselves financed with tax-advantaged bond proceeds, and (b) the term of the lease (i) is at least equal to the lesser of 20 years or 75% of the weighted average reasonable expected economic life of the leased property, or (ii) runs through the earlier of (x) the end of the reasonably expected economic life of the leased property at bond issuance or (y) the latest maturity date of the bonds.

In contrast to a sale that produces actual disposition proceeds that can be expended during the two-year period, the present value amount required to be expended during the two-year period in the context of a long-term lease is likely to exceed the lease payments actually realized by the issuer or borrower during such two-year period. However, such “out-of-pocket” expenditures may be expenditures that the issuer or borrower already was planning to finance from available cash during such period, and even if that is not the case, expending that amount from sources other than tax-exempt bonds will often be less costly than refinancing on a taxable basis part or all of the tax-exempt bond issue that financed the leased facility. Accordingly, the alternative expenditure option may substantially reduce the costs associated with disposing of a no longer needed facility financed with tax-exempt bonds in situations where a lease is preferable to a sale.

Rev. Proc. 2018-26 also provides for curing a nonqualified use of direct pay bond proceeds by simply reducing the amount of the refundable tax credit to eliminate the amount allocable to the nonqualified bonds. This is a common sense and simple way to remediate nonqualified use of otherwise taxable bonds. To effect this remedial action, the issuer must exclude the portion of the interest allocable to the nonqualified bonds that accrues on or after the date of the nonqualified use on the first Form 8038-CP filed after the nonqualified use occurs.

Finally, Rev. Proc. 2018-26 extends the availability of certain existing remedial actions to direct pay bonds and tax credit bonds. In addition to the reduction in subsidy available to direct pay bonds as described in the previous paragraph, an issuer may cure a nonqualified use by redeeming or defeasing nonqualified bonds or applying disposition proceeds to an alternative qualified use.

Rev. Proc. 2018-26 applies to a nonqualified use that occurs on or after April 11, 2018 and may be applied to a nonqualified use that occurs prior to April 11, 2018.

 

 

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By MAXWELL D. SOLET and CHRISTIE MARTIN

In August, 2016, the IRS issued Revenue Procedure 2016-44, the first comprehensive revision of its management contract safe harbors since Revenue Procedure 97-13.  Rev. Proc. 2016-44 (see our description here) built upon and amplified principles laid out in private letter rulings issued over many years and in Notice 2014-67.  Now, less than six months later, the IRS has published Revenue Procedure 2017-13, which clarifies and supersedes Rev. Proc. 2016-44 but does not materially change the safe harbors described therein.  The clarifications are in response to questions received with respect to certain types of compensation protected under earlier safe harbors, incentive compensation, timing of payments, treatment of land when determining useful life, and approval of rates.

 

 

By MAXWELL SOLET and CHRISTIE MARTIN

Treasury and IRS today announced a decision to withdraw the much-criticized portion of the notice of proposed rulemaking published in the Federal Register on September 16, 2013 (the “2013 Proposed Regulations”) related to the definition of issue price for tax-advantaged obligations and to propose a revised definition of issue price in its place. A determination by the IRS that the “issue price” has been erroneously calculated can have ramifications, including for the calculation of arbitrage yield, that could ultimately cause loss of tax-exempt status in the case of tax-exempt bonds and loss of federal subsidy in the case of Build America Bonds (BABs), hence the importance to the tax-exempt bond community of a clear and predictable definition.

The new proposed regulations (the “2015 Proposed Regulations”) are scheduled to be published in the Federal Register on June 24, 2015 and can be found here. A 90-day comment period will be followed by a hearing on October 28, 2015.

The 2015 Proposed Regulations eliminate most of the troublesome features of the 2013 Proposed Regulations, including maintaining a 10% standard rather than the 2013 Proposed Regulations 25% standard for what constitutes a “substantial amount” of obligations sold to the public. However, the 2015 Proposed Regulations do not maintain the long-established “reasonable expectations” standard for establishing issue price. Instead, the 2015 Proposed Regulations look to actual facts as the general rule.

In recognition of the need in the tax-advantaged debt world for certainty as of the sale date (particularly in the case of advance refundings), the 2015 Proposed Regulations helpfully provide an alternative method in the event a substantial amount of bonds have not been sold to the public as of the sale date. The alternative method allows reliance on the initial offering price if certain conditions are satisfied.

Procedures for satisfying the conditions for use of this alternative method will have to be developed, and underwriters may conclude that compliance will be difficult. In particular, a preclusion of sales at prices above the initial offering price unless it can be demonstrated that the differential is based on market changes could be problematic.

The 2015 Proposed Regulations will be effective for obligations that are sold on or after 90 days after final regulations are published in the Federal Register. However, issuers may rely upon the 2015 Proposed Regulations with respect to obligations that are sold on or after June 24, 2015, the date the 2015 Proposed Regulations will be published in the Federal Register.