The flexibility to reallocate proceeds to expenditures using an accounting method other than direct tracing has been a well-recognized and much-appreciated opportunity under the allocation and accounting rules of IRC section 141. The former proposed section 141 regulations (REG-140379-02, Sept. 26, 2006) (“Proposed Regulations”), now replaced by the final section 141 regulations issued October 27, 2015 (“Final Regulations”) on which we reported here, here, here, and here and cross-referenced the arbitrage allocation rules in 1.148-6 in allowing the reallocation of proceeds away from the expenditures for which the proceeds were actually spent to different expenditures producing more favorable tax results. If the expenditures to which the proceeds were reallocated were paid later than the proceeds were actually spent, the reallocation raised the question of whether the proceeds had to be treated as spent later for arbitrage purposes, resulting in additional, “phantom” (because they were never actually earned) investment proceeds that were deemed to arise during the time between the date when the issuer originally spent the proceeds, and the date of the expenditure to which it later reallocated proceeds. Fortunately, the Proposed Regulations included an explicit exception from the otherwise applicable consistency rule between the section 141 and section 148 allocation and accounting rules, thereby avoiding phantom investment proceeds. The Final Regulations do not include this rule. So where are we now? Might we have phantom investment proceeds?
With the recent issuance of the proposed regulations that would redefine the term “political subdivision” for purposes of determining which entities can issue tax-exempt bonds under Section 103 of the Internal Revenue Code, as amended (the “Code”), the answer to this seemingly rhetorical question is “yes,” at least according to the Treasury Department. This is a significant, and startling, departure from the current Treasury regulations that define “political subdivision” for purposes of Code Section 103.
Current Treasury regulation § 1.103-1(a) provides that interest on an obligation issued by a political subdivision of a State is, except as otherwise provided, excluded from gross income of the holder of the obligation under Section 103(a) of the Code. Current Treasury regulation § 1.103-1(b) further provides that “the term ‘political subdivision’ . . . denotes any division of any State or local governmental unit which is a municipal corporation . . . .” A municipal corporation is therefore by definition treated as a political subdivision for purposes of Code Section 103. Although the term “municipal corporation” is not defined for this purpose, it has been interpreted, as illustrated by Revenue Ruling 80-136, 1980-1 C.B. 25, with deference to the laws of the applicable State to mean a city, village, town, or borough that is treated under the constitution or laws of the applicable State as a municipal corporation and imbued under such constitution or laws with the powers of self-government.
As we have discussed here before, we may be coming to the point where there are no new ideas in public finance tax law. Yet another example: The recent proposed political subdivision regulations hearken back to a similar regulation project on a related topic many years ago, which suffered from many of the same drawbacks found in the proposed political subdivision regulations.
That is, according to certain U.S. lawmakers, who believe that private colleges and universities with 501(c)(3) status that have at least a $1 billion endowment should be subject to some extra rules and regulations. If these well-endowed private colleges and universities fail to abide by such extra rules and regulations, under the proposed legislation (which is still being drafted), they will be subject to penalties and may even lose their 501(c)(3) status. A private college or university that does not have 501(c)(3) status cannot be the beneficiary of qualified 501(c)(3) bonds issued by a state or local governmental unit. In addition, a private college or university that loses its 501(c)(3) status will be required to start paying federal income tax on its taxable income, and donors to such institutions of higher learning will no longer be able to receive a charitable deduction for their generosity.
The federal government has brought the first ever criminal securities fraud charges in connection with a municipal bond financing, following an investigation by U.S. Attorney for the Southern District of New York Preet Bharara, according to recent news reports. (NYT, Reuters.)
So what lessons are there to be learned from this?
Rep. Steve Russell, R-Okla., recently introduced a bill (H.R. 4838) in the House to prohibit tax-exempt financing of professional sports stadiums and for-profit entertainment facilities. This is only the most recent in a string of similar proposals, including by President Obama and former Senator Tom Coburn. In this case, tax-exempt financing would be prohibited for any “stadium or arena for professional sports exhibitions, games, or training” and for any “venue for any entertainment event (i) the live audience for which exceeds 100 individuals, and (ii) any net earnings from which inure to the benefit of an individual or any entity other than [the United States or any State or local governmental entity or certain tax-exempt organizations, including but not limited to 501(c)(3) organizations],” in each case if the facility is used for such purpose at least five days during any calendar year. (This post won’t address the over-breadth of “entertainment facilities” included in this prohibition other than to note that, for example, many if not most public and private college arenas, theaters, etc. would be precluded from tax-exempt financing as a result of hosting performances, lectures, concerts, etc. provided by groups or individuals who are paid for their services.) The question considered in this post is not so much the propriety of permitting tax-advantaged financing of these sports and entertainment facilities but whether it is good policy to create targeted rules for certain facilities that may currently be out of favor rather than to rely on the fundamental principles of industrial development bond/private activity bond status that have limited the availability of tax-exempt financing for facilities with private involvement for almost 50 years.
Suppose you, or a friend, issued build America bonds or another form of direct payment subsidy bonds in 2009 or 2010, as permitted by the American Recovery and Reinvestment Act, to do your bit to stimulate aggregate demand during the depths of the Great Recession. You, or your friend, as applicable, did not, however, include an extraordinary optional call feature in the BABs that would allow for the immediate redemption of the BABs if the direct payment subsidy was reduced. Consequently, you’ve been suffering with the reductions to the direct payment subsidy mandated by sequestration (and that will continue through fiscal year 2024), which have increased the net cost of your BABs.
You would like to advance refund your BABs to replace them with (historically) low-coupon tax-exempt bonds, but you know that the Internal Revenue Service has taken the position that a legal defeasance of tax-advantaged bonds, such as BABs, results in the reissuance for federal tax purposes of those bonds as taxable bonds that are no longer entitled to a direct payment subsidy (even one reduced by sequestration). Under this position, the BABs would lose their direct pay subsidy long before they are called in an advance refunding, a result that’s best avoided. Is there anything that can be done in this seemingly hopeless situation?
Treasury recently issued proposed regulations that tell us whether an entity is a “political subdivision” that can issue tax-exempt bonds on its own behalf. One requirement is that an entity must serve a “governmental purpose” to be a political subdivision. The proposed regulations say that an entity is only organized for a governmental purpose if the entity operates “in a manner that provides a significant public benefit with no more than incidental benefit to private persons.” As support for this statement, the proposed regulations contain this citation: “Cf., Rev. Rul. 90–74 (1990–2 CB 34).”
This year marks the 90th anniversary of The Bluebook: A Uniform System of Citation, and last year, the 20th edition of the text was published. The Bluebook is written by law review editors at several top-tier law schools. Depending on your perspective, it is either what it purports to be (a uniform system of citation) or a loathsome testament to the “reflex desire of every profession to convince the laity of the inscrutable rigor of its methods.” (Or both.) There have been several pretenders to the throne, including the Maroonbook, created at the University of Chicago law school years ago, which has faded away, and the ALWD Citation Manual, created by teachers of legal writing in law school as a more user-friendly alternative. The ALWD manual has been adopted by a few jurisdictions, but the Bluebook still reigns. Each text provides for the usage of “citation signals” that introduce the citation and explain its relevance to the point that the author is making; the “Cf.” signal in the proposed political subdivision regulations is an example.
The signal “cf.” is an abbreviation for the Latin word “confer,” which translates to “compare.” It depends on which edition of The Bluebook you’re reading, but the 18th Edition (we work on a shoestring budget here at The Public Finance Tax Blog), like most modern editions, says this about the “cf.” signal: “Cited authority supports a proposition different from the main proposition but sufficiently analogous to lend support. . . The citation’s relevance will usually be clear to the reader only if it is explained.” Among the signals that an author can use to show that the cited authority supports the position the author asserts, “cf.” is the weakest.
But because the proposed political subdivision regulations offer no other support for the position that an entity cannot provide more than incidental private benefits and remain a political subdivision, one can only believe that Treasury must have meant something entirely different and that, at long last, the lowly “cf.” signal might be taking on new prominence.
And now, members of the legal citation community are scrambling to react to what could be a revolution in citation signal usage.
Every year, the National Association of Bond Lawyers (“NABL”) hosts the Tax and Securities Law Institute (“TSLI”), which is an advanced conference with various workshops related to pressing issues confronting tax and securities lawyers in the public finance arena. Essentially, the annual TSLI is like Chrismukkah for tax and securities lawyers. This year’s meeting was held on March 11th and 12th and was sure to be a barn burner in light of the meaningful guidance released by the IRS over the last year including the proposed issue price regulations, the allocation and accounting regulations (the “Allocation Regulations”) and, most recently, the proposed political subdivision regulations (the “Proposed Political Subdivision Regulations”). This year’s meeting did not disappoint as one tax practitioner loudly interrupted a panel consisting in part of IRS and Treasury agents to proclaim that the proposed political subdivision regulations were the worst piece of guidance to come out of the Treasury in recent history.
Below is a list of tax items discussed at TSLI that this blogger thought were particularly noteworthy. When reading the information below, please keep in mind that statements made by personnel from the IRS or Treasury reflect the individual’s personal beliefs and are not necessarily reflective of an official position taken by the IRS or the Treasury.
When an issuer of tax-advantaged bonds discovers a problem with the bonds, the issuer can resolve the problem by requesting a closing agreement through the IRS Voluntary Closing Agreement Program (VCAP). Similarly, where the IRS discovers a problem in the course of an audit of a tax-advantaged bond issue, and the issuer agrees that there is a problem, the issuer can resolve the problem by entering into a closing agreement with the IRS.
In the closing agreement, the IRS agrees not to attempt to tax bondholders or reclaim direct payments from the issuer, and in exchange the issuer agrees to cut a check and redeem the “nonqualified” bonds.
As part of its campaign for greater consistency and standardization, the IRS has released “standard form” closing agreements for each of these situations. In VCAP, issuers or borrowers must submit a draft of the closing agreement based on this new model agreement when they submit the VCAP request (in addition to new Form 14429 and the descriptive information it requires).