Following Revenue Procedure 2016-44, is there still a ‘facts and circumstances’ test for private business use?

As we have discussed in previous posts (here), most practitioners treat a management contract for services at bond-financed property that does not fit within a safe harbor from private business use as giving rise to private business use of the bonds for tax purposes.  However, the Treasury Regulations provide that whether or not a management contract gives rise to private business use is based on all the facts and circumstances surrounding the contract.[1] A number of IRS private letter rulings, though they technically cannot be relied on as precedent, rule that various management contracts that don’t fit within a safe harbor do not give rise to private business use (discussed here).[2]

In Revenue Procedure 2016-44 (discussed here) the IRS replaced the longstanding safe harbors for management contracts under Rev. Proc. 97-13[3] with a “one-size-fits-all” type safe harbor for all management contracts. This post will discuss the evolution of the policy behind the private business use rules and show that the relevance of the “facts and circumstances” analysis following Rev. Proc. 2016-44 may be diminished.  The cause of the diminished value is attributable to the fact that Rev. Proc. 2016-44 has, in effect, imported many of the considerations that previously existed in the facts and circumstances test in the Treasury Regulations into the new safe harbor.  As a result, many agreements that fail to qualify for the new safe harbor will no longer be eligible for the facts and circumstances test because the agreements convey a leasehold or ownership interest in bond-financed property (and are therefore not management contracts).

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Try These WEIRD TRICKS to Split a Bond Issue Into Separate Portions

Many of the tax-exempt bond rules apply to an “issue” of bonds. With a few exceptions, an issue of bonds includes all bonds sold by an issuer less than 15 days apart under the same plan of financing, if the debt service on those bonds is reasonably expected to be paid from the same source of funds. If an issuer wants to keep two sets of bonds separate, the usual technique is to sell them 15 days apart. But this can expose the bonds to market movements. Where an issuer does not want to take these risks, if bonds are treated as part of the same issue under this rule, what can be done to separate them?

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GFOA, NABL Release Post-Issuance Compliance Guidance

Just in time for the weekend, the Government Finance Officers Association (GFOA) and the National Association of Bond Lawyers (NABL) have each issued guidance for the development of post-issuance compliance procedures.  These procedures, which have long been encouraged by the IRS, are intended to facilitate compliance with the tax requirements applicable to tax-advantaged bonds after their issuance.  The organizations cooperated in the drafting of the two documents, although they published separate documents for their different audiences – the GFOA document is designed primarily for issuers and the NABL document is designed for lawyers.  You can access the GFOA document here (link, pdf), and you can access the NABL document here (link, pdf).

Update to Revenue Procedure 2016-44

A little over a week after the IRS released Revenue Procedure 2016-44 (the “Revenue Procedure”), it has been updated!  The IRS recently (and covertly) updated Section 7 (“Date of Applicability”) of the Revenue Procedure. Following the update, the prior safe harbors established in Revenue Procedure 97-13, as modified by Notice 2014-67, can be applied to any management contract entered into before (and not materially modified after) August 18, 2017 (as opposed to February 18, 2017).

Here is a link to a prior blog post discussing the Revenue Procedure in detail.

Treasury Department Releases 2016-17 Priority Guidance Plan for Tax-Exempt Bonds – And It’s Already About One-Third Complete!

On August 15, 2016, the Treasury Department released its 2016 – 2017 Priority Guidance Plan (the “Plan”).  Tax-exempt bonds are the last category in the Plan, but the Plan lists the priority guidance categories in alphabetical order.  Had these categories been listed in order of esteem, we know that tax-exempt bonds would have been [INSERT ESTEEM-BASED POSITION HERE].

Any respectable “to-do” list includes items that already have been, or soon will be, completed.  This balances against the difficult items that have languished so that the person who created the list (or had it thrust upon him or her) has some sense of accomplishment.  Otherwise, the creation or review of the to-do list would be the soul crushing experience that it’s intended to be.  By this standard, the Plan’s priority guidance for tax-exempt bonds is an exceptionally well crafted to-do list.  Sure, the seven items on the list include projects that have been there (and will very likely continue to be there) for years, but it also includes two items that are complete – one of which was completed before the Plan was released!  So, what’s the Plan for tax-exempt bonds?  Read on.
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Rev. Proc. 2016-44 Greatly Expands Rev. Proc. 97-13 Safe Harbor for Management Contracts, Opening the Door for Long-Term Management Contracts

UPDATE: The IRS has updated Section 7 (“Date of Applicability”) of Revenue Procedure 2016-44.  Following the update, the prior safe harbors can be applied to any management contract entered into before (and not materially modified after) August 18, 2017 (as opposed to February 18, 2017). The original post is below.

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 glan ce 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 August 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 August 18, 2017, that is not materially amended or modified on or after February 18, 2017 August 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