Rev. Proc. 2016-44 Greatly Expands Rev. Proc. 97-13 Safe Harbor for Management Contracts, Opening the Door for Long-Term Management Contracts

The IRS has released new management contract safe harbors that profoundly change the prior rules under Rev. Proc. 97-13. The new revenue procedure, Rev. Proc. 2016-44, which was released August 22 by the IRS, appears on first glance to have brought many favorable changes to the safe harbor rules. Unlike the prior guidance under Rev. Proc. 97-13, Rev. Proc. 2001-39, and Notice 2014-67, the new safe harbor under Rev. Proc. 2016-44 applies more principles-based tests rather than mechanical tests based on the length of the contract.

The new safe harbor takes effect immediately, but during an initial transition period running until February 18, 2017, issuers and borrowers can apply either the prior safe harbors or the new safe harbor. More specifically, the new safe harbor of Rev. Proc. 2016-44 applies to management contracts entered into on or after August 22, 2016. In addition, issuers and borrowers may elect to apply the new safe harbor to management contracts entered into earlier. The prior safe harbors may continue to be applied to any contract entered into before February 18, 2017, that is not materially amended or modified on or after February 18, 2017, except pursuant to certain renewal options.

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Final Arbitrage Regulations – The Good and the Not-So-Good Changes to the Working Capital Rules

The 2013 proposed arbitrage regulations included significant changes to the working capital financing rules, including the first rules for long-term working capital financings.  The proposed rules have been finalized in the recently issued final arbitrage regulations (discussed here) (“Final Regulations”), with some changes but without one very significant suggested change.  This post summarizes the important changes that were made to the proposed working capital regulations (“Proposed Regulations”) and commiserates with our readers over the significant change that Treasury rejected.

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Ignore the rules (if they don’t apply)

We are rather fond (because you are rather fond) of discussing Rev. Proc. 97-13 and related authorities that address private business use from management contracts. Back in 2014, when the IRS amplified Rev. Proc. 97-13 in Notice 2014-67 (collectively, “97-13”), we even made a holiday present of it. Now more than ever, 97-13 is an essential tool that allows issuers and borrowers to use managers in their facilities and still stay within the private business use limitations. But 97-13 is not a panacea, nor do you always need it to avoid private business use. So, to mix things up, we’ll now discuss when you can ignore 97-13, either because you don’t need it, or because it can’t help you anyway. Many people fall into the habit of thinking that the 97-13 rules apply to any arrangement in bond-financed facilities. However, that’s not the case.

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Final Arbitrage Regulations Require “Look Through” to a Grantee’s Use of Bond Proceeds: A Big “So What?”

From time to time, issuers will use bond proceeds to make grants to accomplish a governmental purpose. For example, a State bond issuer may make grants to various counties and cities to help with the cost of local transportation improvements. Under the arbitrage regulations (Reg. 1.148-6(d)(4)), the bond proceeds are treated as spent once an issuer makes a grant of bond proceeds to an unrelated party, so long as it is truly a grant (and not an advance that must be repaid). This means that the issuer can stop monitoring the investment yield that it receives from those proceeds once it makes the grant.`

Contrast this with the case in which an issuer transfers bond proceeds to a recipient in the form of a loan. In that case, the loan will be treated as an investment of bond proceeds. This means that the issuer must continue to monitor the investment yield that it receives on the loan, in the form of debt service payments from the recipient. In addition, in the case of a loan, it is clear under other provisions that apply to tax-exempt bonds that the issuer must look through to examine what the loan recipient does with the proceeds that it receives. For example, the issuer must look through to the status of the loan recipient as a governmental person or a private person for purposes of the private business use rules. However, once the loan recipient then spends the bond proceeds on something that counts as an expenditure under the arbitrage rules (for example, by paying them to a construction company in exchange for the company’s services in building capital assets of the bond-financed project), at that point the bond proceeds are treated as spent for the purpose to which the loan recipient applied them. In other words, neither the issuer nor the loan recipient would need to look through to examine how the construction company invested and spent the proceeds that were transferred.

Prior to 2013 proposed arbitrage regulations covering the point, the Code and Treasury Regulations were silent on how to treat bond proceeds that are used to make a grant for purposes other than when to treat the proceeds as spent for arbitrage purposes. Faced with this silence, issuers or conduit borrowers that made a grant of bond proceeds had basically two choices: (1) treat the arbitrage rule as applying for all tax-exempt bond purposes, so that once the issuer or conduit borrower made the grant, the grant recipient would be treated like the construction company in the above example (for example, its identity as a private person would not affect the private business use analysis, and its further investment and use of the proceeds could not affect the tax status of the bonds that financed the grant), or (2) treat the arbitrage rule as applying for arbitrage purposes relating to the timing of the expenditure of bond proceeds (and any purposes that explicitly tie to that arbitrage treatment, such as the “hedge bond” rules (see Reg. 1.149(g)-1(b)), but look through to the grantee’s use for other purposes, such as private business use. (One supposes that a particularly cheeky issuer might have cherrypicked Choice (1) or (2) depending on the tax issue in question, but we will rule that out in the interest of good manners.)

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A Chart Summarizing the Changes in the New Non-Issue Price Arbitrage Regulations

In case you missed it, we prepared a chart comparing the differences between the old arbitrage regulations and the new arbitrage regulations that were released recently. We published it as part of Joel’s comprehensive summary of the new regulations, but here is the chart by itself. The chart shows you the old language and the new language, side by side. The footnote numbers in the left column tie back to Joel’s summary post, which you can find here. (Completists will note a few minor provisions missing, but this is most of them.)

Chart – comparison of old and new arbitrage provisions

 

 

Bondholders of the Lost Ark

When most bond advisors think of the types of projects that bond proceeds may be used for, they think of roads, bridges, hospital or university buildings, etc.  I think it is safe to say that very few bond advisors visualize an ark, let alone a replica of Noah’s Ark.  However, the City Council of Williamstown, Kentucky did just that.  I guess that makes them visionary. Continue Reading

A Summary of the Final Regulations on Non-Issue Price Arbitrage Restrictions

On July 18, 2016, the Treasury Department published final regulations on non-issue price arbitrage restrictions (the “Final Regulations”) in the Federal Register. The Final Regulations finalize regulations proposed in 2007 and 2013 (collectively, the “Proposed Regulations”).  Click here for a copy of the Final Regulations, and read below for a high-level summary of them.  We will in subsequent posts be publishing more detailed analysis of specific provisions in the Final Regulations.

As discussed in a prior post, the Final Regulations apply to bonds sold on or after October 17, 2016 (the “Effective Date”).  References in this blog post to “Prior Regulations” are references to the Treasury Regulations in effect prior to the Effective Date of the Final Regulations.

The Final Regulations make changes to a number of rules scattered throughout the arbitrage regulations. Below, we take them in order, progressing through the Final Regulations.  To facilitate your review, at the end of this post is a comparison table showing certain provisions of the Final Regulations next to the parallel provisions in the Prior Regulations.

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Breaking News: IRS Releases Final Arbitrage Regulations (Unrelated to Issue Price)

The IRS has released final regulations that make a variety of changes to the arbitrage rules for tax-advantaged bonds. These regulations finalize proposed regulations from 2007 and portions of the infamous 2013 proposed regulations that are unrelated to issue price. To say it again, these final regulations do not change the current issue price rules. To recap the timeline:

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Topics Covered: The final regulations change some rules that apply to:

  • Working capital financings (including long-term working capital financings)
  • The rebate computation credit
  • Procedures for recovering rebate overpayments
  • Certain rules for computing the yield on an issue of bonds (including, for our underwriter friends, the rules for yield-to-call high-premium bonds)
  • Integration of hedges (swaps, etc.) with a bond issue
  • Accounting for modifying and terminating hedges
  • Yield reduction payments (expanding the circumstances under which you can make them)
  • Valuing investments of bond proceeds
  • The small issuer exception to rebate
  • The arbitrage anti-abuse rules
  • The definitions of “tax-advantaged bonds” and “issue”
  • The definition and treatement of bond-financed grants
  • (Rather randomly) Noting that Rev. Proc. 97-15 (dealing with closing agreements requests) is subsumed by Notice 2008-31 (which announced the Voluntary Closing Agreement Program, or VCAP, for tax-exempt bonds), and providing that Rev. Proc. 97-15 is now obsolete

Effective Dates: The final regulations generally apply to bonds sold on or after 90 days after Treasury publishes the final regulations in the Federal Register. The regulations are scheduled to be officially published on Monday (July 18), and 90 days after that date is October 16, 2016, which is a Sunday, so the regulations will generally apply to bonds sold on or after October 17, 2016. You can elect to apply certain provisions of the final regulations to bonds sold before that date. The rules for hedges apply to hedges that are entered into or modified on or after October 17, 2016, and there are specific effective dates for some of the provisions.

We will have much, much more to say about these in the coming days. (Please note that, out of our commitment to you, our readers, we are canceling the Squire Patton Boggs Public Finance Tax Group Pokémon Go event that was originally scheduled for this weekend, to study these new regulations.)

Recent IRS Private Letter Ruling Provides Helpful Guidance on Management Contracts

On May 27, 2016, the National Office of the Internal Revenue Service (“IRS”) released Private Letter Ruling (“PLR”) 201622003.  PLR 201622003 continues the trend of favorable PLRs issued by the IRS on the question of whether, under a facts-and-circumstances analysis, a management contract that fails to satisfy a Rev. Proc. 97-13 safe harbor from private business use results in private business use of a tax-exempt bond issue.  PLR 201622003 also provides helpful guidance in interpreting the scope of the safe harbor from private business use set forth in Rev. Proc. 97-13 §5.03(7) in the case of a management contract that provides for incentive compensation based on the attainment of a threshold for an increase in gross revenue of the managed facility or a decrease in the expenses of operating the managed facility (but not both an increase in revenue and decrease in expenses).[1]    Continue Reading

Lawmakers target the tax-exemption for municipal bonds……..again

On Friday, June 24th, House Republicans released a blueprint for tax reform that suggests ways to increase federal tax revenue. Among other things, the blueprint may signal lawmakers’ willingness to curb or eliminate certain tax expenditures. A “tax expenditure” is a tax subsidy (including deductions, exclusions, and other tax preferences) in the Internal Revenue Code and corresponding Treasury Regulations.  The federal government frequently utilizes tax expenditures to encourage taxpayers to participate in various activities.[1]   For example, there is a strong federal policy in favor of employer-provided health insurance.  To accomplish this, employer contributions to pay for employee health insurance plans are not taxed as income to the employee, but the employer is still permitted to deduct the expense as an ordinary and necessary business expense.  Likewise, there is a strong federal policy in favor of permitting low-cost financing options for certain borrowers (e.g., municipalities, tax-exempt organizations) and for certain projects (e.g., airports, docks and wharves, etc.).  In furtherance of this policy, interest on certain types of debt is exempt from federal income taxes.

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