The New IRS Strategic Initiative for Tax-Exempt Bonds: Post-Issuance Compliance

Transcription

1 The New IRS Strategic Initiative for Tax-Exempt Bonds: Post-Issuance Compliance 0

2 What is Post-Issuance Compliance? 1

3 Post-Issuance Compliance A process which provides an organization with a record retention and reporting system which enables it to identify actions that could potentially render the interest on the bonds taxable. Cliff Gannett Director, IRS Office of Tax-Exempt Bonds 2

4 Why You Should Care About the IRS Post-Issuance Initiative? IRS is looking to make sure that federal subsidy provided by the interest exclusion on bonds is properly applied. Defending tax-exempt status of bonds in an IRS audit is expensive and time consuming. Reputation in credit markets and beyond. Financial settlement to protect bondholders. 3

5 History of IRS Tax-Exempt Bond Audit Program Audits of tax-exempt bonds rare prior to Focus of early IRS enforcement efforts were on perceived problems on the date of issue of the bonds. Examples, arbitrage driven structures, purchase of investments with bond proceeds ( yield burning ). 4

6 History of IRS Tax-Exempt Bond Audit Program In 1998, a separate IRS division devoted to tax-exempt bonds and governmental entities was created Tax-Exempt and Government Entities Division (TE-GE). 5

7 History of IRS Tax-Exempt Bond Audit Program TE-GE has 40 revenue agents devoted to auditing tax-exempt bonds. Any time during the year, up to 400 bond issues are being audited. In 2007, TE-GE collected $45 million in settlements. 6

8 Maturation of the IRS Bond Audit Program Now that the audit program is more than 10 years old, TE-GE is moving away from solely looking at facts and circumstances as of the date of issue of the bonds. Recent IRS Publication After the Bonds are Issued: Then What? 7

9 New IRS Paradigm - Review of Post-Issuance Matters The average tax-exempt bond issue has a weighted life of 20 years or more. Issuers and conduit borrowers must comply with federal tax rules for the life of the original bonds and any refunding bonds. Easy for foot faults and errors to occur or for borrowers to lack requisite records and detailed information to rebuff IRS in an audit challenging the tax-exempt status of bonds. 8

10 Evidence of IRS Focus on Post-Issuance Compliance IRS Post-Issuance Compliance Questionnaire for 501(c)(3) Organizations - August 2007 New Annual Post-Issuance Reporting requirements for 501(c)(3) organizations (Schedule K to be filed with IRS Form 990) IRS Post-Issuance Compliance Questionnaire for Governmental Bonds - Expected in Fall

11 IRS 501(c)(3) Post-Issuance Questionnaire The Questionnaire was distributed to several hundred 501(c)(3) Organizations in 2007 The Questionnaire is broken into 5 Categories: 1. General Questions 2. Recordkeeping 3. Investments and Arbitrage Compliance 4. Expenditures and Assets 5. Private Business Use 10

12 Example of General Questions Do you have written procedures or guidelines to ensure that qualified 501(c)(3) bond financings remain in compliance with the following federal tax requirements after the bonds are issued? Do you provide training or educational resources to personnel that are responsible for ensuring compliance with the post-issuance private use limitations for bond financed property? 11

13 Example of General Questions Who is primarily responsible for monitoring postissuance compliance of bond financings? Board member Management official Staff person None 12

14 Example of Recordkeeping Questions Do you maintain records pertaining to your tax-exempt bonds? If yes, how long? Less than 1 year; 1-2 years; 3-7 years; 8-15 years; Life of bonds; Life of bonds (including and refunding bonds) plus 3 years 13

15 Example of Recordkeeping Questions Do you maintain documentation of allocations of bond proceeds to expenditures? Do you maintain a list of all bond financed facilities? Do you maintain copies of invoices, bills and cancelled checks? 14

16 Example of Recordkeeping Questions Do you maintain copies of the following agreements - management contracts - research contracts - leases - naming rights contract Do you maintain records of trade or business activities by third parties that use bond financed property? 15

17 What Can We Learn From the IRS Questionnaire? Indicates high expectations of the IRS regarding 501(c)(3) internal controls and policies regarding taxexempt bonds. If you did not receive the questionnaire, it is beneficial to review and prepare a draft response which will reveal areas that need attention. Helpful for state and local governments to review 16

18 Governmental Tax Questionnaires Up to 500 to be sent to state and local government issuers of tax-exempt bonds (Fall, 2008) The governmental questionnaires are expected to ask many of the same questions as the 501(c)(3) questionnaires 17

19 Governmental Tax Questionnaires We can expect that the governmental questionnaires will be more refined and require issuers to address the status of post-issuance procedures as of the date of receipt of the questionnaire Issuers should respond to the questionnaires and should be as careful as possible in crafting responses 18

20 Developments - New Schedule K Applies to Not-for-Profit Organizations Only No Similar Annual Reporting requirement for governmental issuers Comprehensive Information Regarding Tax-Exempt Bonds to be filed with IRS Form 990 Must be filed annually The new Schedule K reporting requirement is more rigorous than the arbitrage rebate requirement (generally every 5 years) 19

21 New Schedule K for 501(c)(3) Organizations Effective for 2008 Tax Year Only Part 1 which asks the basic information Effective for 2009 Tax Year All parts must be completed Applies to new money bonds issued in 2003 and after Applies to bonds issued to refund bonds issued in 2003 and thereafter 20

22 New Schedule K Broken into 4 parts Part I Bond Issues Part II Proceeds Part III Private Business Use Part IV Arbitrage 21

23 New Schedule K Part I Identification of Bond Issues Name of Issuer Date Issued Description of Purpose Issue Price Defeased 22

24 New Schedule K Part II Use of Proceeds 1. Total proceeds of Issue 2. Gross Proceeds in Reserve Funds 3. Proceeds in Refunding Escrow *4. Unspent Proceeds 23

25 New Schedule K Part II use of Proceeds 5. Issuance Costs 6. Working Capital Expenditures 7. Capital Expenditures From Proceeds *8. Year of Substantial Completion 24

26 New Schedule K Part II Use of Proceeds 9. Were the Bonds Part of a Current Refunding? 10. Were the Bonds Part of an Advance Refunding? *11. Has the Final Allocation of Proceeds Been Made? *12. Does the Organization Maintain Adequate Books and Records to Support the Final Allocation of Proceeds? 25

27 New Schedule K Part III Private Business Use Are there any lease arrangements with respect to the financed property which may result in private business use? Are there any management or service contracts with respect to the financed property which may result in private business use? 26

28 New Schedule K Part III Private Business Use Does the organization routinely engage bond counsel or other outside counsel to review any management or service contract or research agreements relating to the financed property? 27

29 New Schedule K Part III Private Business Use Enter the percentage of financed property used in private business use by entities other than a 501 (c) (3) organization or a state or local government. Calculation Required: % 28

30 New Schedule K Part III Private Business Use Enter the percentage of financed property used in a private business use as a result of unrelated trade or business activity carried on by your organization or another 501 (c)(3) organization. Calculation Required: % * IRS Instructions calculate percentage to nearest tenth of a percentage point 29

31 New Schedule K Part IV Arbitrage Has the governmental unit identified a hedge with respect to the bond issue? Name of Provider Term of Hedge Were proceeds of the bonds invested in a GIC? Name of Provider Term of GIC Was the resulting safe harbor for establishing the fair market value of GIC satisfied? 30

32 Benefits of an Effective Post-Issuance Program Remove risk of non-compliance and associated hazards. Generate efficient and prompt response to any IRS inquiry. Easy and cost-effective review process at time of a refunding. Identify remaining portion of bond proceeds allowed for private use. Completion of Schedule K 31

33 Private Use Rules 501(c)(3) Bonds Ownership The bond financed property must be owned by a Section 501(c)(3) organization or a governmental unit. 95% Requirement At least 95% of the net proceeds of the bond issue must be used in a manner related to the exempt purposes of the Section 501(c)(3) organization. No more than 5% of the net proceeds of the bond issue can be used for a private use or an unrelated trade or business use. For this purpose, costs of issuance of the bonds paid with bond proceeds are treated as a private use. 32

34 Private Use Rules Governmental Bonds At least 90% of the proceeds of the bond issue must be used for governmental purposes. The 90% requirement is increased to 95% if the proceeds of the bonds are used for any private use that is not related to the governmental use of the issue or such private use is disproportionate to the governmental use. Aggregate private use cannot exceed the lesser of 90%/95% or $15 million. 33

35 Examples of Private Use of Bond-Financed Property Lease of a facility by a for-profit organization. Cafeteria operated by for-profit organization. Parking facility operated by for-profit organization. Long or short term space use arrangements: - Events held in gymnasium or other meeting space - Summer use of dormitories - Use of facilities by outside organizations 34

36 Examples of Private Use of Bond-Financed Property Management contracts with non-employee individuals or outside entities Research contracts/licenses granting preferred treatment/royalty Certain naming rights for buildings, athletic facilities Use by Federal government 35

37 Evaluating Management and Research Contracts For IRS Safe-Harbor Compliance Management contract safe harbor Revenue Procedure Considers term and fee structure Six specified contractual arrangements 36

38 Evaluating Management and Research Contracts For IRS Safe-Harbor Compliance Research contract safe harbor Revenue Procedure Considers terms of license agreement Basic research Corporation sponsor licensee pays market price Federally-sponsored research controlled by Section 501(c)(3) organization 37

39 Applicable Private Use Exceptions Short Term Use Exceptions In certain circumstances, if < 100 days of use In certain circumstances, if < 50 days of use Depends on user profile and terms of contract Short term use exceptions do not apply to unrelated activities of Section 501(c)(3) organization 38

40 Applicable Private Use Exceptions Incidental Contracts or Arrangements Small physical use of space ATM, kiosks, vending machines, laundry facilities Cannot exceed 2.5% of proceeds or space of facility Contract for services supporting organization activities Janitorial services Equipment repair Billing activities or similar services 39

41 How to Measure Private Use Square footage Time of use Time/space analysis Expense/revenue 40

42 Managing and Monitoring Private Use Private Use Identified at the Time of Issuance of the Bonds Step 1: Quantify the Expected Private Use Option A: Contribute equity or other amounts to projects to cover private use Option B: Allocate private use to bad money portion of the bond issue if possible. 41

43 Managing and Monitoring Private Use Monitoring Private Use After the Bonds are Issued Step 1: Review use of bond-financed projects and applicable third party agreements annually Step 2: Calculate private use per bond issue Establish that less than 10%-5% of bond proceeds are privately used - For entire period that bonds are outstanding 42

44 What if You Discover a Private Use Problem? Reallocate bond proceeds and other funds if the allocation time frame is still open. Change use, modify contract terms, avoid future private or unrelated use. IRS Voluntary Compliance Program. 43

45 Other Post-Issuance Responsibilities Continuing Disclosure Responsibilities. Provide to nationally recognized municipal securities information repository certain financial and operating information annually. Provide immediate notice of the occurrence of 11 specific events listed in the continuing disclosure certificate. FASB 133 and GASB Technical Bulletin No provides for a number of specific accounting and disclosure requirements for swaps and other hedging instruments. Material Event Notices. 44

46 Other Post-Issuance Responsibilities Various Bond Document Responsibilities. Provide audited financial statements by a certain date. Provide other specified information periodically or upon the occurrence of certain events to bondholders, rating agencies, bond insurers, other credit enhancement, liquidity providers and swap providers. 45

47 Other Post-Issuance Responsibilities Compliance with rate covenants. Compliance with other financial tests. Periodically renewing UCC or other filings. Maintenance and periodic certification of insurance. 46

48 How BLX and Orrick Can Assist with Post-Issuance Compliance BLX is a consulting and SEC registered investment advisory firm. BLX employs over 59 finance professionals in 7 offices. Since 1989, BLX has provided pre and post-issuance services for over 15,000 transactions issued by approximately 1,500 State and local governments. 47

49 Range of BLX Post-Issuance Services Private use monitoring Assist in completing Schedule K Arbitrage rebate, yield restriction and other federal tax compliance services Investment advisory services Swap advisory and monitoring services Evaluation of proposed financing strategies Continuing disclosure services 48

50 Overview of BLX Private Use Monitoring Services Provide summary of assets and property financed with each issue of tax-exempt bonds (the catalogue ). Review all management, service and research contracts relating to the use of bond-financed property. Provide strategic advice regarding the allocation of non-bond proceeds to maximize private use in any mixed-use facilities Periodic snapshot of assets and private use levels per bond issue. Annual private use report will serve as tax compliance document for retention with other permanent bond and tax records. 49

51 Other Private Use Services Provided by BLX Review of record retention policies and internal controls to improve post-issuance tax compliance. Full day or half day educational seminars tailored to your specific needs regarding postissuance tax law compliance. Review and provide historic analysis of postissuance compliance for all or a portion of your outstanding bonds. Important analysis in cases of staff turnover, absence of institutional memory and being better prepared for IRS inquiry. 50