Beginnings,
Middles and Ends
The Tax Compliance Life Story of Your Bond
Deal
Daniel P. Smith
DPS 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
Private Letter Ruling
201104020
• 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!
Private Letter Ruling
201145005
•
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 “NonArbitrage 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
Two Words . ..
• The two most important words
in the Tax Certificate are . . .
NOT “GREAT
EXPECTATIONS” BUT . .
.
REASONABLE
EXPECTATIONS!
And the “reasonable expectations” are
about . . .
Private Use and
Arbitrage
Private Use
VS.
• Treasury Regulations Section 1.1412(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 1.1412(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 1.1412(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 1.1482(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?
IRS Web Site FAQs
(con.)
•
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?
Middles
“And he huffed and he pufffed”
The IRS
Checking Out Your Bond Deal
Deliberate Actions
• Private Use
• Arbitrage
Private Use
•
Treasury Regulations Section 1.1412(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 1.1412(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 1.1412(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 taxadvantaged 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
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/Reissuanc
e - 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.”