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BLX Group LLC 1910 S. Stapley Drive First Floor, Suite 115 Mesa, AZ 85204 ph: 480-539-4084 www.blxgroup.com p. Post Issuance and Arbitrage Compliance Presented by: BLX Group LLC Robin Schlimgen, Managing Director, 480.539.4084 [email protected] Discussion Outline p. 2 • • • • • Post-Issuance Compliance Overview IRS Enforcement Update Arbitrage Overview Record Retention Requirements Additional Resources Post-Issuance Compliance Overview p. 3 “Post-issuance tax compliance begins with the debt issuance process itself and provides for a continuing focus on investments of bond proceeds and use of bondfinanced property.” After the Bonds Are Issued Then What? Advisory Committee on Tax-Exempt and Governmental Entities Post-Issuance Compliance Overview p. 4 • Issuers and conduit borrowers must comply with federal tax rules for the life of the original bonds and any refunding bonds • Easy for borrowers to lack adequate records and detailed information to defend themselves in an IRS audit challenging the tax-exempt status of bonds Post-Issuance Compliance Overview p. 5 Elements of an effective Post-Issuance Compliance Program • • • • • Designation of tax compliance point person(s) Communication with outside tax specialists Continuing education and training Record retention policies and procedures Periodic review of policies and other contracts Post-Issuance Compliance Overview p. 6 Elements of an effective Post-Issuance Compliance Program • • • • • • Investment of bond proceeds Accounting for expenditure of bond proceeds Arbitrage rebate and yield restriction monitoring Monitoring the use of bond financed property Addressing changes in use of bond financed property through self-help remediation and VCAP Written guidelines and procedures Post-Issuance Compliance Overview p. 7 What is the Purpose of a Post-Issuance Tax Compliance Policy? • Demonstrates to the IRS that you are taking your postissuance compliance responsibilities seriously • Assigns responsibility for certain tasks and responsibilities to specific individuals or departments • Provides you with a compliance framework in which to work without burdening you and your staff with too much detail • Memorialized processes and activities to aid in the event of staff turnover • Reduces risk of IRS winning willful neglect case Post-Issuance Compliance Overview p. 8 What should be included in a Post-Issuance Tax Compliance Policy? • Use of tax-exempt bond financing description • Designation of post-issuance tax compliance point person(s) • Tax-exempt bond tax law compliance requirements (including arbitrage and yield restriction) • Record keeping requirements • Annual review and training • Frequency of internal compliance checks IRS Enforcement Update p. 9 Why should you care about the IRS post-issuance compliance initiative? • Defending tax-exempt status of bonds in an IRS audit is expensive and time consuming • Reputation in credit markets • Financial settlement to protect bondholders would be costly IRS Enforcement Update p. 10 IRS Focus on Post-Issuance Compliance Activities • • • • • IRS is looking to ensure that the federal subsidy provided by the interest exclusion on tax-exempt bonds is properly applied Increase in staff – currently around 100 agents Audits – looking at 300 to 400 issues at a time, planned to close up to 1,500 audits in 2013 Random/Targeted/Market Segment Identification Compliance Check Questionnaire Initiative IRS Enforcement Update p. 11 2013 TEB Work Plan • • • • Encourage greater participation in self-correction and voluntary compliance programs (VCAP) Respond promptly and appropriately to abusive arbitrage motivated transactions Enforcement and Compliance Reviews • Market segment examination work • Arbitrage focused exams will cover rebate payment verification • Compliance checks evaluating policies and procedures Guidance, Education and Outreach • Greater understanding of tax responsibilities IRS Enforcement Update p. 12 Market Segment Identification • Identify areas for exam based on financial structure, type of bond or industry/function • Improve focus and efficiency of the exam • Every year: advance refunding, 8038-T(rebate), TRANs, 501(c)(3) bonds, small issue manufacturing and solid waste • Each year will select other areas, e.g. airports, cities • Identify area of greatest likelihood of violation IRS Enforcement Update p. 13 IRS Compliance Check Questionnaire Program • • “Soft contact” approach program (non-audit) Allows the IRS to obtain a lot of information inexpensively Theme of Questionnaires • • • • • • Policies and Procedures Record Keeping Investment and Arbitrage Compliance Expenditures and Assets Private Business Use Training IRS Enforcement Update p. 14 Form 4564 – Information Document Request (“IDR”) • Attached to Notice of Examination Letter • Relates to Examination of one specific bond issue • Examination may end in: - No Change Letter - Issuer and IRS Closing Agreement with settlement - Determination that bonds are taxable and audit and taxation of bondholders IRS Enforcement Update p. 15 TEB Report March 8, 2013 Avoiding Troubled Tax-Advantaged Bonds, A Study of Issuer Compliance Considerations • • • Phase I - Pre-Issuance – hiring the right professionals for your bond transaction, checking conflicts, etc. Phase II – Transaction Execution – getting the best price for your bonds Phase III – Post-Issuance – Establishing responsibilities – “institutional knowledge” • Accounting for Proceeds – expectations of use vs. actual • Monitoring Arbitrage • Establishing continued compliance • Arbitrage Overview p. 16 • Arbitrage Rules - Governed by Section 148(a) of the Internal Revenue Code – two different requirements • Yield Restriction - Tax Reform Act of 1969 • Arbitrage Rebate - By 1986 all of tax-exempt debt included • Reason for Regulations: System was abused • Laws and regulations were established to discourage issuers from: • Issuing more bonds than needed • Issuing bonds sooner than needed • Leaving bonds outstanding longer than needed Arbitrage Overview p. 17 Arbitrage Defined • Ability to borrow at tax-exempt rates and invest at higher taxable rates without incurring any additional risk Arbitrage Simplified • The differential between the bond yield and the yield on taxable investments Arbitrage Overview p. 18 • Advance Refunding Bonds – two sets of Bonds outstanding simultaneously – subject to arbitrage rules separately • Upon issuance – Required to be in compliance with yield restriction, rebate, and record retention Arbitrage Overview p. 19 • Two separate requirements though related • Need to comply with both requirements to avoid bonds being declared “Arbitrage Bonds” Arbitrage Rebate Yield Restriction Arbitrage Overview p. 20 Rebate Requirements • • • • • Excess earnings on “non-purpose” investments allocated to gross proceeds Issue by issue determination Positive arbitrage can be offset by negative arbitrage within a particular bond issue Computation Date Credit offset to defray the cost of the calculation (2014 = $1,620) Compliance for the life of the bond issue Arbitrage Overview p. 21 Rebate Requirements • • • Why would you want to owe rebate? Rebate payments are required to be paid no later than 60 days after each 5th “Bond Year” and 60 days after the final redemption date • Bond Year defined as each 1-year period that ends on the day selected by the issuer • First and last bond years may be short periods My bonds have been refunded, do I still need to perform rebate calculations? Arbitrage Overview p. 22 Need to Determine…… • • What is the maximum rate of interest I can earn and retain? (Fixed/Variable Bond Yield) What proceeds are subject to the arbitrage rebate requirements? Arbitrage Overview p. 23 Gross Proceeds Sale Proceeds • Proceeds derived from the sale of the bonds Investment Proceeds • Earnings received from Sale Proceeds and earnings on those earnings Original Proceeds • Includes Sale Proceeds and Investment Proceeds Transferred Proceeds Replacement Proceeds • Sinking & “pledged” funds Arbitrage Overview p. 24 Other Important Considerations Commingled Funds – fund including variety of sources, invested without regard to source • Reimbursement – requires official intent • “Allocate Proceeds to Expenditures” vs “Spend Proceeds” • Arbitrage Overview p. 25 Exceptions to Rebate • All or a portion of the bond proceeds may be excluded from the arbitrage rebate requirements if they meet a spending exception • If you earned positive arbitrage and met a spending exception you are allowed to keep the earnings • Six-Month Spending Exception • 100% spent within six months • Another six months for de minimis amount (less than 5% of proceeds of issue) • Only exception available for refundings Arbitrage Overview p. 26 Exceptions to Rebate • Eighteen-Month Spending Exception • Permitted under 1993 Regulations (not retroactive) • De minimis allowance of lesser of 3% of issue price or $250,000 • Spending requirements 15% in 6 months 60% in 12 months 100% in 18 months Arbitrage Overview p. 27 Exceptions to Rebate • Two-Year Construction Spending Exception • Became available in 1989 Code (not retroactive) • Fairly limiting as only applies to construction issues (75% or more used for construction purposes) • De minimis allowance of lesser of 3% or issue price of $250,000 • Time extension for reasonable retainage • Spending requirements 10% in 6 months 45% in 12 months 75% in 18 months 100% in 24 months Arbitrage Overview p. 28 Exceptions to Rebate • Small Issuer Exception • Permitted under Code since 1986 and finally added to Regulations in 1993 • General taxing authority Bonds issued during a calendar year • $5,000,000 limitation (Subordinate entity debt included) • Private activity bonds - no small issuer allowance • Is NOT an exception for Yield Restriction or Post Issuance Compliance • Public Education limitation • $5,000,000 prior to 1998 • $10,000,000 1998 to 2001 • $15,000,000 2002 to present • No more than $5 million can be used for non-construction Arbitrage Overview p. 29 Exceptions to Rebate • Bona Fide Debt Service Fund Exception • Proper matching of revenues to principal and interest payments within each bond year • Annual depletion requirement to bring account balance below a reasonable carryover amount • Reasonable carryover amount is 1/12th of preceding year’s debt service payments • Private Activity bonds have additional $100,000 earnings test -- If bona fide debt service fund earns less than $100,000 in a given bond year it shall not be taken into account for rebate purposes Arbitrage Overview p. 30 Build America Bonds (BABs) • • • • • • Governmental bonds eligible for certain tax advantages New money capital expenditures only Issuer elects to issue bonds as taxable Tax Credit Bonds • Purchaser receives tax credit of 35% of interest • Accepts lower yield on bonds Direct Pay Bonds • Issuer receives tax credit of 35% of interest payment • Form 8038-CP filed to retrieve tax credit • Still subject to rebate Program ended December 2010 Arbitrage Overview p. 31 Yield Restriction • • Issue by issue determination Restricts investment earnings relating to Yield Restricted Proceeds Temporary Period - 3 Years (Project Fund) – certify at closing that reasonably expect to spend more than 85% in 3 years • Advance refunding and defeasance escrows • Transferred proceeds • Amounts in excess of reasonably required reserve funds • Arbitrage Overview p. 32 Yield Reduction Payments • • • • • • Apply to bonds issued on or after July 1, 1993, or bonds retro-actively applying the 1993 Regulations Similar to rebate payments - pay positive arbitrage on yield restricted proceeds Pay 90% of yield restriction liability at every fifth bond year, and 100% at the final maturity Can owe a yield reduction payment without owing a rebate payment Made in the same time and manner as rebate payments Does not result in “double” payments Arbitrage Overview p. 33 Exceptions to Yield Restriction • • • Temporary period Materially higher yield allowance - Unexpended Construction 1/8th of 1% - Refunding Escrow – 1/1000th of 1% Minor portion – lesser of 5% of issue price or $100,000 Arbitrage Overview p. 34 Yield Restriction Arbitrage Rebate Tax Reform Act of 1969 Tax Reform Act of 1986 Purpose and Non-purpose Investments Non-purpose Investments Materially Higher Yield Bond Yield Temporary Periods Issue Date Minor Portion Exception Certain Exceptions (Spending, BFDSF, Small Issuer) Yield Reduction Payments Rebate Payment Computation Credits Arbitrage Overview p. 35 Documents Required for Arbitrage • • • • • • • • Final Official Statement Tax Certificate IRS Form 8038-G/8038 Trust Indenture Verification Report (if applicable) Other Special Documents (Investment Agreement, Swap Agreement, etc.) Copy of 8038-T/Check (if applicable) All Investment Data (entire calculation period) Arbitrage Overview p. 36 Does Reporting Ever Stop? • • • Calculations are required every five years and at the final maturity date of the issue. A refunding may accelerate the final computation date Arbitrage requirements may cease for outstanding bonds if all the following criteria is met: • All bond proceeds have been spent • No Reserve Fund has been funded • Debt Service Funds are 100% bona fide (Bona Fide Debt Service Fund Exception) and non-governmentals earn less than $100k in a bond year • No other proceeds arise: • Replacement • Transferred Proceeds Arbitrage Overview p. 37 Failure to Comply • Loss of tax-exempt status • 50% (100% for private activity bond) penalty and late interest on underpayment • Waiver of 50% penalty under certain circumstances • Not willful neglect Record Retention Requirements p. 38 How long must records and source documents be maintained? • • • Minimum 3 years after bonds are retired Extended to 3 years after refunding bonds are retired, if the bonds were refunded Older requirement in most tax documents require a 6 year retention policy Determine the Storage Medium • • Paper – must be kept for the long term Electronic – must meet requirements of Revenue Procedure 97-22 and keep technology up to date Record Retention Requirements p. 39 What records must be maintained? • • Documents related to the bond transaction (entire transcript) Documents related to post-closing elections • Bond Year Selection • Retro-Active or Selective Application of Regulations • Documents evidencing any investment of bond proceeds • Trust Bank Statements • Internal Records • • • • Documents evidencing expenditure of bond proceeds Use of bond financed property by public and private sources Sources of payment or security for the bonds Arbitrage Reporting – Rebate and Yield Restriction Record Retention Requirements p. 40 What if records not maintained? • • Loss of tax exemption Additional rebate could be due (based upon IRS conclusions) • Failure can be corrected through - Voluntary Closing Agreement Program (TEB VCAP) - Must be filed prior to Audit • VCAP team --- about 20 agents Where to find assistance: • • Access NABL/GFOA websites to use as a starting point or for additional support Visit IRS Website • http://www.irs.gov/Tax-Exempt-Bonds/Tax-Exempt-Bond-FAQsRegarding-Record-Retention-Requirements Additional Resources p. 41 IRS Website – Access to Forms and Information • Form 13907 - 501(c)3 Questionnaire http://www.irs.gov/pub/irs-tege/f13907.pdf • Form 14002 – Governmental Bonds Questionnaire http://www.irs.gov/pub/irs-tege/f14002.pdf • Form 14127 – Build America Bonds Questionnaire http://www.irs.gov/pub/irs-tege/form_14127.pdf • Tax Exempt Bond Forms and Publications http://www.irs.gov/Tax-Exempt-Bonds/Tax-Exempt-Bonds-Forms-andPublications