What would a Clinton or Trump presidency mean for tax-exempt bonds? Both candidates have declared a desire to change our tax system, but will this mean any changes to the tax-exempt bond rules? Neither candidate has expressed a desire to change how the tax-exempt bond rules work, but their other policy goals may have an indirect impact on the market.
As reported several times in this blog (here, here, and here), Rev. Proc. 2016-44 significantly expands the opportunities for management/service contracts that don’t result in private business use. One such post was Joel Swearingen’s very thoughtful piece on the future of the facts and circumstances test as applied to these contracts (here). Of course, Rev. Proc. 2016-44 retains the prohibition against any portion of the manager’s compensation being based on net profits, as that rule is set forth in the Treasury Regulations (specifically Treas. Reg. 1.141-3(b)(4)(iv)), so the IRS cannot override that rule through a Revenue Procedure. Unfortunately, in restating this prohibition, the IRS has muddied the water as to its boundaries, creating potential need for application of the facts and circumstances test. Please read on for a discussion of the questions that have been created.
Revenue Procedure 2016-44 is laudable because it significantly expands the scope of management contracts that can satisfy the safe harbor from private business use of facilities financed with proceeds of tax-advantaged bonds. It also makes much more feasible the use of tax-advantaged bonds in public-private partnership arrangements. Revenue Procedure 2016-44 does, however, effect one curious change of uncertain implication from its predecessor, Revenue Procedure 97-13.
The management contract safe harbors set forth in Revenue Procedure 97-13 provide that the reimbursement by the “qualified user” of direct expenses paid by the manager to unrelated parties is not treated as compensation of the manager under the management contract. Consequently, such expense reimbursement is not taken into account in determining whether the management contract satisfies a Revenue Procedure 97-13 safe harbor from private business use. The Internal Revenue Service held in Private Letter Ruling 200222006 (Feb. 19, 2002) and Private Letter Ruling 201145005 (Aug. 4, 2011) that the payment of compensation by the manager to its non-executive employees (in the case of the former private letter ruling) and to its employees that do not have an ownership interest in the manager entity (in the case of the latter ruling) was the payment of direct expenses to unrelated parties, the reimbursement of which would not be considered compensation under Revenue Procedure 97-13.
Revenue Procedure 2016-44 changes this result. The reasons for, and implications of, this change are not immediately evident.
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. 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).
In Revenue Procedure 2016-44 (discussed here) the IRS replaced the longstanding safe harbors for management contracts under Rev. Proc. 97-13 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).
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?
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).
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.
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.
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.
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.