Is the Pendulum of Bond Pricing Beginning to Swing Back Toward Discount Bonds? If So, We Need to Be Prepared for the Resulting Bond Yield Calculations

Premium bonds have been the choice of investors now for many years but is that preference beginning to shift in favor of discount bonds?  Discount bonds are appearing in bond structures with increasing regularity in recent months.  We lawyers leave that question for the underwriters and financial advisors as interest rates turn upward.  However, we need to be prepared for the shift in bond yield calculations that accompany a re-emergence of discount bonds.

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NABL’s Model Issue Price Certificates – Some Observations

Joel Swearingen reported last week that the National Association of Bond Lawyers (“NABL”) recently released exposure drafts of model issue price certificates that reflect the final Treasury regulations on issue price that take effect for tax-advantaged bonds sold on or after June 7, 2017.  As Joel reported, the model issue price certificates cover the direct sale of tax-advantaged bonds by an issuer to a purchaser, the public offering of tax-advantaged bonds pursuant to a negotiated sale between the issuer and an underwriter(s), and the public offering of tax-advantaged bonds pursuant to a sale of the bonds from the issuer to an underwriter in a competitive bidding process.

Joel also promised that we would have more to come on the model issue price certificates that NABL released.  If I learned anything from my mediocre high school athletic endeavors, it’s that one should never show up, or let down, a teammate.  In accordance with Joel’s promise, herewith are some observations on NABL’s model issue price certificates.

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Model Issue Price Certificates Released

As Alexios wrote about a few weeks ago (here), we are in the middle of a dry spell when it comes to new guidance from the IRS.  Thankfully, the National Association of Bond Lawyers (“NABL”) recently released exposure drafts of several model issue price certificates (see here and here).  The draft certificates are the product of collaboration between NABL and the Securities Industry and Financial Markets Association (“SIFMA”) and are intended to help implement the final issue price regulations (discussed here).  The final regulations take effect on June 7, 2017 and the draft certificates should help facilitate agreement between issuers, financial advisors, underwriters, purchasers, bond counsel, and any other interested parties within a working group.  In order to finalize the drafts in advance of the effective date of the final regulations, NABL has requested comments to be submitted no later than Friday, April 14, 2017.

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Shake-Ups and Changes at the Tax-Exempt Bond Branch

The IRS has announced that it will combine the Tax-Exempt Bonds Branch and the Indian Tribal Government Branch of the IRS Office of Tax Exempt and Government Entities (TE/GE). The new combined entity will be headed by Christie Jacobs, who has long been the Director of the Indian Tribal Government Branch. (Though Ms. Jacobs apparently does not have any experience with tax-exempt bonds, Sunita Lough, the Commissioner of TE/GE, assures us that Ms. Jacobs is a “very smart person” and “very capable.”)  The Tax-Exempt Bonds Branch has been without a permanent Director since Rebecca Caldwell-Harrigal left the post in December 2016 (Imraan Khakoo served as acting Director in the meantime).

Formerly, the IRS Tax-Exempt Bonds Branch was divided into a Field Operations division (focusing on examinations) and a Compliance and Program Management (CPM) division (which, among other things, oversaw the administration of the VCAP program). As part of the reorganization, CPM will cease to exist, and its operations will be spread between a Compliance, Planning and Classification group that will span the full breadth of TE/GE (which includes some areas other than TEB and the Indian Tribal Government Branch), and a smaller, core “technical support” group that will continue to exist within TEB after it is combined with the Indian Tribal Government group. It is unclear whether this reallocation of resources will allow TEB to focus more attention and energy on examinations.

As Alexios noted last week, we are waiting to see how the new administration will change the pace of IRS guidance and enforcement. This reorganization adds to the uncertainty, and it is unclear how the reorganization and the change in administrations will affect the pace and focus of audits of tax-advantaged bonds and guidance regarding tax-advantaged bonds.

The regulatory freeze apparently will not impact the roll-out of the new examination process outlined in two internal guidance memoranda that the IRS released in November (both available at TEGE-04-116-0028), which are intended to increase the “efficiency” of tax-exempt bond audits. Bob described the two memoranda in detail here. As Bob noted, the new guidance attempts to achieve “efficiency” largely through a series of somewhat one-sided measures, which generally impose strict time limitations on issuers and borrowers, and far softer restrictions on the IRS exam team. The new approach also opens the possibility of the IRS contacting issuers early in an audit directly before the issuers can engage counsel, which has generally not been the approach of the IRS in the past.  It remains to be seen how successful the IRS will be in implementing the new guidelines particularly while it undergoes a change in organizational structure at the same time.

In addition, the regulatory freeze apparently will not impact the effective date of the new issue price regulations, which take effect for bonds sold on or after June 7, 2017. As we have discussed before, the new rules mean that issuers can no longer rely on their reasonable expectations regarding the sale price of publicly offered bonds to set the issue price of those bonds. In negotiated deals, they’ll have to rely on the first price at which 10% of each bond with the same credit and payment terms sells. Issuers can use the initial offering price as the issue price if the underwriters agree to “hold the offering price” for five days after the sale date, or if the transaction meets the requirements of a “competitive sale,” laid out in the new regulations. This “hold the offering price” rule sounds easy enough, but it imposes some very real logistical challenges, and threatens to make the sale date of an issue of bonds on or after June 7, 2017 a real chaotic mess. Behind the scenes, various industry groups representing issuers, municipal advisors, and the underwriter community, are hashing out revisions to the various standard forms. We will provide further updates and links as those efforts progress.

 

The Regulatory Freeze: Where do we stand now?

The IRS tax exempt bond group (“TEB”) continues to work on completing its 2016-‘17 Guidance Plan, as Bob Eidnier wrote last week. However, it might be some time before we see that guidance because of executive branch actions intended to reduce regulations and regulatory costs.  The restrictions on new guidance are very broad, and appear to apply to more than just regulations. Tax Notes reported on February 14 that it will be “a while” before new guidance is released by the IRS. For those of you who have lost track, see below for links to and a summary of President Trump’s executive orders and related executive branch guidance concerning the regulatory freeze and regulatory reform.

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Report from TSLI – What Can We Expect in the Near Term from the IRS?

Last week I attended the NABL Tax and Securities Law Institute, which always provides valuable insights from representatives of Treasury and the IRS.  Vicky Tsilas, Chief, Branch 5, Financial Institutions and Products, was a panelist for Tax Hot Topics and gave a very interesting status report on the 2016-2017 Guidance Plan (first reported on here by Mike Cullers), which was issued on August 15, 2016.  In addition to noting those projects that have been completed, she also discussed the remaining items, indicating her priorities and possibly the order in which they will be completed, recognizing of course that TEB does not have control over the timing of the necessary approvals within Treasury.  (I’d also like to thank Ms. Tsilas for our subsequent discussion clarifying several points for this report.)

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How Poker Reminded Me that the Rev. Proc. 97-13 Safe Harbors for Management Contracts Live On

Poker has a well-established hierarchy of winning hands.  If you’re holding a full house, you’ve got a right fine hand, but if you reach for the pot when the last bets are called and another player has four deuces, you will at best be the object of ridicule and at worst the subject of grievous bodily harm or death (it all depends on with whom you are playing).  Legal authorities also have a strict order of priority.  The most extreme adverse consequences that can befall one who forgets the priority of winning poker hands are unlikely to meet one who forgets which legal authorities take precedence over others, but it’s good practice to be mindful of the hierarchy of legal authorities.

The recent issuance of Rev. Proc. 2017-13 is a case in point.  As Bob Eidnier discussed in his recent post on this Revenue Procedure, the Internal Revenue Service issued it in response to requests from the National Association of Bond Lawyers and others for clarification of Rev. Proc. 2016-44 (which superseded Rev. Proc. 97-13)[1] that a management contract does not result in the manager receiving net profits from the managed facility (and, thus, in private business use of the tax-exempt bond proceeds that financed that facility) if the qualified user of the facility pays the manager a form of compensation permitted under Rev. Proc. 97-13 (percentage of gross revenue or expense (but not both), per-unit fees, capitation fees, periodic fixed fees, and certain types of incentive compensation) and the manager also bears some amount of the cost of operating the managed facility.  Stated another way, NABL requested that the IRS make clear that the various management contract compensation arrangements permitted under the Rev. Prov. 97-13 safe harbors from private business use not be treated as the sharing of net profits of the managed facility under Rev. Proc. 2016-44.

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Potential Changes for Churches and Charities Regarding Political Campaigning

A few weeks ago, President Trump announced that he would advocate for the repeal of the prohibition against certain religious organizations (i.e., those exempt from paying federal income taxes under Section 501(c)(3)) from engaging in political campaigning.  His statement was made at the National Prayer Breakfast to a group of religious leaders.  However, since the prohibition applies to all Section 501(c)(3) entities (e.g., 501(c)(3) universities and hospitals), it seems likely that any such repeal would also apply to all Section 501(c)(3) entities.

To be clear, the prohibition on political campaigning does not apply to religious organizations or other charities per se. Rather, the ban only applies to those entities that have obtained Section 501(c)(3) status.  A 501(c)(3) organization is exempt from federal income tax on what would otherwise be its taxable income (aside from taxable income derived from a trade or business that is unrelated to the organization’s tax-exempt purpose), and donors to a 501(c)(3) organization may, subject to certain limits, claim a federal income tax deduction for contributions made to the 501(c)(3) organization.  In other words, under current law, a Section 501(c)(3) organization has chosen to give up its right to engage in political campaigning in exchange for generous federal income tax benefits.  The practical impact of the ban (also known as the Johnson Amendment) is that Congress has decided for the past 60 years that the federal government will not subsidize political campaigning by 501(c)(3) organizations.

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The Countdown to August 18, 2017 – Something You Should Know.

The IRS has over the past three years issued significant guidance on the safe harbors from private business use for management contracts, and we’ve been dutifully reporting on this guidance (here, here, here, and here).  This guidance has generally been well received, but some issues remain.  In addition to questions raised by Bob Eidnier in his post a few weeks ago (link above), the recent spate of IRS guidance raises a concern that is the subject of this post. By correlating the permitted length of management contracts with the economic lives of the managed property, some management contracts that are materially modified after August 18, 2017 might not fit within the New Safe Harbors (defined below) even if the term of the modified contract is unchanged from the prior iteration!! (Tax lawyers use exclamation points to try and keep people awake).

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New Proposed Legislation: PABs for Social Infrastructure and a Ban on Stadium Bonds

The new Congressional session is heating up, and we’ll cover two new pieces of proposed legislation below. For the first time in several years, we can avoid giving the usual disclaimer that any new piece of legislation is “likely going nowhere.” Tax reform appears to be a real possibility for the first time in many years, and it will probably involve expansions of some areas of the tax-exempt bond world and contractions of others. The two bills discussed below are an example of each.

The first bill would allow tax-exempt private activity bond financing for public buildings that have too much private involvement. The second bill goes in the other direction, and would forbid governmental bond financing for stadiums, which, as we’ll see, would have the effect of preventing tax-exempt financing of any kind for stadiums.

We are continuing to work with our industry-leading public policy group to study the many new legislative developments that are sure to arise, and we will use the blog to provide resources and reactions to them.

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