Transcript SESSION ON THE BASICS OF ARBITRAGE REBATE AND HOW …

POST-ISSUANCE BOND
COMPLIANCE
BY
Arbitrage Compliance Specialists, Inc. (“ACS”)
Robert Goubert, Vice President
800-672-9993 ext. 7536
[email protected]
Stephen H. Broden, Vice President
800-672-9993 ext. 7530
[email protected]
AND
Vicenti, Lloyd & Stutzman LLP
Renée S. Graves, CPA, CGFM, Partner
626-857-7300 ext. 260
[email protected]
New Requirement
The IRS is requiring debt issuers to indicate if written
post-issuance compliance policies and procedures are in
place.
Key characteristics suggested by the IRS:
o
o
o
o
o
o
Due diligence review at regular intervals;
Identifying the official or employee responsible for review;
Training of the responsible official/employee;
Retention of adequate records to substantiate compliance (e.g., records relating to expenditure of
proceeds);
Procedures reasonably expected to timely identify noncompliance; and
Procedures ensuring that the issuer will take steps to timely correct noncompliance.
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New Requirement
3
Bond Compliance
Three golden rules when issuing a bond:
1. Issue the bond when you need the funds
2. Issue just enough bonds that you need for the project –
not more
3. Complete the project with due diligence
4
Bond Compliance
We just closed on a bond issue and received $6,000,000 at closing.
1.
Spend the money immediately
A. Refund an older bond issue (current refunding)
B. Reimburse for prior expenditures
C. Buy an asset – building, software, land, (loans to Government
Units)
D. Cost of issuance to pay:
a) Financial advisor
b) Bond counsel
c) Underwriter
d) Insurance
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Bond Compliance
We just closed on a bond issue and received $6,000,000 at closing.
2. Invest the money until needed for:
A.
B.
C.
D.
Building project
Refunding (advanced refunding)
Interest payments on the bonds
Reserve – set funds aside in case they are need to
make a bond payment
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We just issued a bond – now what?
Are there tax rules that we need to follow?
Arbitrage Rebate
Yield Restriction
Entire Bond
Fund
Are there tax rules that we need to follow?
Yes - Rules are based on three limitations
Interest
Earnings
Interest Earnings
Balance
Balance
Time
Time
Time
We just issued a bond – now what?
Are there tax rules that we need to follow?
Arbitrage Rebate
Yield Restriction
Entire Bond
Fund
Arbitrage Rebate
Investment rate of return > borrowing rate = PROFIT
Interest Earnings
10
Arbitrage Rebate
Borrowing Rate
Interest Earnings
11
Arbitrage Rebate
Are all bonds subject to arbitrage rebate?
EXEMPTIONS
OR
Small Issuer Exemption
Fund Exemption
Entire Bond
Each fund related to bond meets an exemption
Interest Earnings
12
Arbitrage Rebate – Small Issuer Exemption
New Money Bonds - $5,000,000 or less issued in calendar year
Examples:
 $4,999,999 Bond issued in 2011 (No other debt in calendar year) - Exempt
 $4,999,999 Bond A and a $50,000 note issued in 2012

$4,999,999 + $50,000 = $5,049,999 – Subject to arbitrage rebate
* Small Issuer Exception Increase for Public Schools  Public school tax-exempt debt issued from 1/1/98 – 12/31/01 ($10,000,000
limit):

All tax-exempt debt issued in a calendar year cannot exceed $10,000,000. $5,000,000
may be used for any purpose. Any amount over $5,000,000 (up to $5,000,000) must be
used for public school construction as part of the additional $5,000,000 limit.
 Public school tax-exempt debt issued from 1/1/02 – current ($15, 000,000
limit):

All tax-exempt debt issued in a calendar year cannot exceed $15,000,000. $5,000,000
may be used for any purpose. Any amount over $5,000,000 (up to $10,000,000) must be
used for public school construction.
Interest Earnings
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Arbitrage Rebate – Small Issuer Exemption
Refunding Bonds  The debt being refunded (old debt) qualified for the Small Issuer Exception
 The weighted average maturity of the refunding debt (new debt) does not exceed the
weighted average maturity of the refunded debt (old debt)
 The refunding debt (new debt) does not mature more than thirty years after the
issuance of the original refunded debt (old debt)
Note – Historically 1/3 of refunding bonds (new debt) will fail one of the three
rules listed above and become subject to the arbitrage rebate regulations.
Interest Earnings
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Arbitrage Rebate – Small Issuer Exemption
Small Issuer Exception = FAIL (bond is subject to arbitrage rebate)
!
But wait……………….
fund basis
There are also individual exemptions on a fund by
Interest Earnings
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What is Arbitrage Rebate?
Are all bonds subject to arbitrage rebate?
EXEMPTIONS
OR
Small Issuer Exemption
Fund Exemption
Each fund related to bond is exempt
Project
Cost of Issuance
Escrow Refunding
Debt Service
Interest Earnings
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Arbitrage Rebate – Fund Exemptions
There are also individual exemptions on a fund by fund basis for certain funds:
 Project Funds
 Costs of Issuance Funds
 Escrow Refunding Funds
 Debt Service Funds
Interest Earnings
Balance
Time
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Fund Exemption – 6 Month Spending Exception
Expend within 6 months:

Project Funds

Costs of Issuance Funds

Escrow Refunding Funds
Interest Earnings
Balance
Time
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Fund Exemption – 18 Month Spending Exception
Expend within 18 months
• Project Funds
• Cost of Issuance Funds
Spending Timetable
• 15% within 6 months
• 60% within 12 months
• 100% within 18 months
Balance
Time
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Fund Exemption – 24 Month Spending Exception
Expend within 24 months
• Project Funds
Spending Timetable
• 10% within 6 months
• 45% within 12 months
• 75% within 18 months
• 100% within 24 months
Balance
Time
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Arbitrage Rebate – Fund Exemptions
There are also individual exemptions on a fund by fund basis for certain funds:
1. Project Funds
2. Costs of Issuance Funds
3. Escrow Refunding Funds
4. Debt Service Funds
Interest Earnings
Balance
Time
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Fund Exemption – Debt Service
Exemption – if the debt service fund is depleted each year, except for a
reasonable carryover amount defined as an amount up to the greater of:
 the earnings on the fund for the immediate preceding year; or
 1/12 of the principal and interest payments on the issue for the
immediate preceding year
 Example:
 Debt service payments = $1,200,000 for the year
 $1,200,000/12 = $100,000
 Debt Service balance < $100,000 = Exemption
Balance
Time
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Summary of Exemptions
Entire Issuance
Small Issuer Exemption
Bond Structure
Pass all testing criteria (Project + Refunding Criteria)
Funds
Fund Exemption
1. Project
6-Month, 18-Month, 24-Month
2. Cost of Issuance
6-Month, 18-Month
3. Escrow Refunding
6-Month
4. Debt Service
Interest earnings or 1/12 test
Interest Earnings
Balance
Time
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Arbitrage - Time to Review Exceptions
Are all bonds subject to arbitrage rebate?
EXEMPTIONS
OR
Small Issuer Exemption
(entire bond)
Fund Exemption
6-Month
18-Month
24-Month
Debt Service Test
Interest Earnings
Balance
Time
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Arbitrage - Filing Period
IRS filing dates for arbitrage rebate payments
• Every 5 years
• Maturity date of the issue
Interest Earnings
Balance
Time
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We just issued a bond – now what?
Are there tax rules that we need to follow?
Arbitrage Rebate
Yield Restriction
Entire Bond
Fund
Yield Restriction – Fund Restriction
Yield Restriction Limitations on Funds
• Project Funds
• Costs of Issuance Funds
• Escrow Refunding Funds
• Debt Service Funds
Interest Earnings
Balance
Time
Yield Restriction – Project
Project Funds
•
Trigger – funds remain at the end of 3 years
•
Interest earnings on the balance is to be yield restricted to
the bond yield + .125% or provide a yield reduction payment
to the IRS
Interest Earnings
Balance
Time
Yield Restriction – Cost of Issuance
Cost of Issuance
•
Trigger – funds remain at the end of 3 years
•
Interest earnings on the balance is to be yield restricted to
the bond yield + .125% or provide a yield reduction payment
to the IRS
Interest Earnings
Balance
Time
Yield Restriction – Refunding Escrow
Refunding Escrow
•
Trigger – 90 days for a current refunding
•
•
Interest earnings on the balance after 90 days is to be yield
restricted to the bond yield + .001%.
Trigger – 30 days for a advanced refunding
•
Interest earnings on the balance after 30 days is to be yield
restricted to the bond yield + .001%.
Interest Earnings
Balance
Time
Yield Restriction – Debt Service
Balance = Payments
$1,200,000 Balance = $1,200,000 Payments
PERFECT MATCH!
Interest Earnings
Balance
Yield Restriction – Debt Service
What happens if the balance > payments?
Interest Earnings
Balance
Yield Restriction – Debt Service
Balance > Payments
$1,800,000 Balance - $1,200,000 Payments = $600,000 Reserve
Excess debt service funds are treated as a reserve fund . Interest
earnings are to be yield restricted to the bond yield + .001% or provide a yield
reduction payment to the IRS
Interest Earnings
Balance
Yield Restriction – Debt Service
Excess Debt Service Funds
Very High Reserve Balance
> Debt Service Payments
$1,800,000 - $1,200,000 = $600,000 Reserve
Balance
Excess Debt Service Funds
Reserve
> Debt Service Payments
$1,400,000 - $1,200,000 = $200,000 Reserve
Balance
Perfect Match
= Debt Service Payments
$1,200,000 - $1,200,000 = $0 Perfect Match
Balance
Interest Earnings
Balance
Summary of Yield Restriction
Funds
Trigger
Yield Restriction Rate
Project
Balance – after 3 years
Bond Yield + .125%
Cost of Issuance
Balance – after 3 years
Bond Yield + .125%
Current refunding is
defined as a refund that
takes place within 90 days
90 days allowed to invest without regard to yield restriction
Bond Yield + .001%
Advanced refunding is
defined as a refunding
that takes place after 90
days
30 days allowed to invest without regard to yield restriction
Bond Yield + .001%
Debt Service
Very High Reserve Balance
Bond Yield + .001%
Interest Earnings
Balance
Time
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Yield Restriction
IRS Filing Dates for Yield Restriction
 Every 5 years
 Maturity date of the issue
Interest Earnings
Balance
Time
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Record Retention
Section 6001 provides record retention requirements for federal tax
purposes. It is important that sufficient records are retained to
demonstrate the bonds maintain their tax-advantaged status.
*Retention period is the life of the bond plus three years.
**Extended for refunding circumstances as the new retention period
for refunded bonds is the life of the refunding bond plus three years.
(Information provided on flash drive)
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Private Business Use
Private Business Use relates to Section 141 if the Internal Revenue
Code of 1986, as amended and Treasury Regulations §1.141 (the
“Tax Code”).
Leading Question:
What is Private Business Use anyways?
General Questions:
• Is the facility used in a manner that will benefit a for-profit
entity or individual (private business use test)?

Specific examples of possible private business use according the Tax Code.
• Is the facility owned or leased to a for-profit entity or individual
(security or payment tests)?
• Are proceeds used to make or finance loans (financing test)?
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Private Business Use
Private Business Use relates to Section 141 if the Internal Revenue
Code of 1986, as amended and Treasury Regulations §1.141.
Leading Question:
What is Private Business Use anyways?
Private Business Use relates to the identification of proceeds or bond
financed property that are to be used for any private business use.
The general rule (private business use test) is that if 10% or more of
the proceeds of the issue/or bond financed property are used for
private business use than the issue is not a private activity bond (in
other words it is taxable).
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Private Business Use
General Question:
Is the facility used in a manner that will benefit a for-profit entity or
individual?
Ways to validate proper use:
• Identify clearly what building or project site is involved in each
financing.
• Establish a uniform and rational system, for example:




Calculate the total square footage of useable space of the facility.
Calculate the square footage of the area used for private use purposes.
Determine if the private use area has general access from all of the common areas of the facility
or if there is a limited area of general access devoted to the entrance to the private use area.
The other areas of general access may then be added to the other public purpose use areas.
Divide the private use area by the total area of the facility. This is the percentage of private use
and must not exceed the private use allocation based upon the proceeds percentage.
• If 100% of the building is used by a qualified 501(c)(3)
corporation or a governmental entity compliance is achieved.
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Private Business Use
General Question:
Is the facility used in a manner that will benefit a for-profit entity or
individual?
Measuring for the private business use test is based upon the
average percentage of use during the measurement period:
• The measurement period of property financed by an issue
begins on the later of:


the issue date of that issue, OR
the date the property is placed in service.
• The measurement period ends on the earlier of:


the last date of the reasonably expected economic life of the property, OR
the latest maturity date of any bond of the issue financing the property (determined without regard
to any optional redemption dates).
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Private Business Use
Specific examples of possible private business use according the Tax
Code include:
•
•
•
•
•
Sale of facilities
Leases
Special legal entitlements such as naming rights
Management contracts
Research agreements
See handout for specifics.
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Private Business Use
General Question:
Is the facility owned or leased to a for-profit entity or individual?
Ways to validate proper use:
• If less than 10%, of the proceeds/property are directly or
indirectly secured by an interest in:



property used or to be used for a private business use, or
payments in respect of such property, or.
to be derived from payments (whether or not to the issuer) in respect of property, or borrowed
money, used or to be used for a private business use.
General measurement of private payment and security test:
• The present value of the payments or property is compared to
the present value of debt service to be paid over the term of
the issue.
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Private Business Use
Are proceeds used to make or finance loans?
Ways to validate proper use:
• If less than 5% or $5 million of the proceeds are directly or
indirectly used to make/finance loans to non governmental
persons.
General measurement of private loan financing test:
• The actual amount loaned is not discounted to reflect present
value but instead relies testing based on the “face amount.”
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Private Business Use
The Tax Code identifies a private activity bond as a bond which
meets the following criteria:
• the private business use test, and
• the private security or payment test, or
• the private loan financing test.
Both the reasonable expectations of the issuer on the issuance date
and subsequent deliberate actions of the issuer are considered when
determining if the private activity bond tests are met.
There are three basic remedial action options as generally described
below:
• Redemption or defeasance of nonqualified bonds within 90
days
• Alternative use of disposition proceeds
• Alternative use of facility
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Continuing Disclosure
The Official Statement will state the following regarding Continuing
Disclosure:
The District will enter into a “Continuing Disclosure Undertaking”
In the last 5 years, the District has complied in all material
respects with its previous undertakings under the Rule to provide
annual reports and notices of Listed Events
Important Acronyms:
SEC
Securities and Exchange Commission
MSRB
Municipal Securities Rulemaking Board
EMMA
Electronic Municipal Market Access
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Continuing Disclosure
SEC 15c2-12(b) Requirements:
15c2-12(b)(5)(i) An underwriter shall not purchase or sell municipal
securities unless they have reasonably determined that the issuer
(District) has undertaken to provide the following to the MSRB:
A. Annual Financial Information or operating data presented in the
final official statement
B. If not submitted as part of the Annual Financial Information,
audited financial statements
C. Notice of any of the following events in a timely manner, not to
exceed 10 business days:
1. Principal and interest payment delinquencies
2. Material non-payment related defaults
3. Unscheduled draws on debt service reserves for financial
difficulties
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Continuing Disclosure
C. Notice of any of the following events in a timely manner, not to
exceed 10 business days: (continued)
4. Unscheduled draws on credit enhancements for financial
difficulties
5. Substitution of credit or liquidity providers, or their failure to
perform
6. Adverse tax opinions affecting the tax status of the security
7. Material modifications to rights of security holders
8. Material bond calls or tender offers
9. Defeasances
10. Release, substitution or sale of property securing
repayment of the securities
11. Rating changes
12. Bankruptcy, insolvency, receivership or similar event
13. Consummation of a merger, consolidation or acquisition
14. Appointment of a successor, additional trustee or change of
a trustee
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Continuing Disclosure
Form of Continuing Disclosure Undertaking
Usually an appendix to the Official Statement that is signed by District
Administration
• Describes the content for the Annual Financial Information
• Financial information in the Annual Report may be unaudited
• Audited financial information must be provided to the MSRB as
soon as practical after it has been made available to the District
Include Operating Data in the Annual Financial Information to the extent
it's not included in audited financial statements:
1. Outstanding debt and lease obligations
2. General fund budget and actual results
3. Enrollment, or equivalent information, as is reasonably
available
4. Assessed valuations
5. Largest local secured taxpayers
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Continuing Disclosure
Form of Continuing Disclosure Undertaking
District agrees to provide to MSRB Notice of Listed Events (Material
Events) with respect to the Bonds no later than 10 business days
after the occurrence
• Provided in electronic format
• Accompanied by identifying information as prescribed by the
MSRB
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Continuing Disclosure
If the District includes any information in addition to what is
specifically required:
• There is no obligation to update the information or include it in
any future disclosure
The sole remedy for failure to comply with the Continuing Disclosure
Undertaking:
• Is an action to compel performance
• Don't risk management's credibility by not complying!
The Continuing Disclosure Undertaking terminates:
• When the District is no longer obligated with respect to the
Bonds
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Post Issuance Policy and Procedure Manual
=
(Information provided on flash drive)
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Delegation of Compliance Matters
Arbitrage and Yield Restriction
Appointed Party
Retention of Adequate Records
Appointed Party
Borrower Spending's Report – Construction
Progress
Appointed Party
Qualified Use of Proceeds, Financed Property and
Private Activity
Appointed Party
Issuance Price and Volume Cap Allocation
Appointed Party
Fair Market Value of Investments
Appointed Party
Continuing Disclosure
Appointed Party
Compliance Training
Compliance Officer
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This presentation provides brief and general information . IRS rules are complex
and detailed, so it is important to review the specific guidance provided by the
arbitrage rebate and related requirements of IRC Section 148.