NH&RA Summer Institute and NMTC Symposium

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Andra Potter
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1 NH&RA Summer Institute and NMTC Symposium The NMTC Exit Miriam Vock Sheehan: Nolan Sheehan Patten LLP Moderator Mark Einstein: Reznick Group Stephanie Barrett: Bank of America David Trevisani: National Development Council July 25 28, 2012 Harbor View Hotel Martha s Vineyard, MA

Group Stephanie Barrett: Bank of America David Trevisani: National

Structure Before Put Exercise QALICB Affiliate Put/Call of Fund Interest Investor $4,000,000 equity investment in Fund Leverage Lender $8,000,000 Leverage Loan Investment Fund 99.

2 Structure Before Put Exercise QALICB Affiliate Put/Call of Fund Interest Investor $4,000,000 equity investment in Fund Leverage Lender $8,000,000 Leverage Loan Investment Fund 99.99% sub-cde owner $12,000,000 QEI Investor holds Put Option to sell interest in Fund to QALICB Affiliate for $1,000 Allocatee/ Manager 0.01% sub-cde owner Sub-CDE (QLICI Lender) QLICI A Loan: $8,000,000 QLICI B Loan: $4,000,000 QALICB NH&RA Summer Institute & NMTC Symposium

99% sub-cde owner $12,000,000 QEI Investor holds Put Option to sell interest in Fund to QALICB Affiliate for

3 Example 1 Direct Acquisition Structure After Put Exercise QALICB Affiliate Put/Call of Fund Interest 100% Fund Owner Investor Steps 1. Leverage loan repaid Leverage Lender $8,000,000 Leverage Loan Investment Fund 99.99% sub-cde owner 2. Sub CDE distributes B Note to Fund, then liquidates 3. Put exercised Allocatee/Ma nager 0.01% sub-cde owner Sub-CDE (QLICI Lender) QALICB QLICI B Loan: $4,000,000 Result Assuming Put Price of $1,000, then $3,999,000 ordinary income may be recognized by QALICB on date of Put

Sub CDE distributes B Note to Fund, then liquidates 3. Put exercised Allocatee/Ma nager 0.

4 Example 2 Indirect Acquisition Structure After Put Exercise QALICB Affiliate Put/Call of Fund Interest 100% Fund Owner Investor Steps 1. Leverage loan repaid Leverage Lender $8,000,000 Leverage Loan Investment Fund 2. Put exercised 3. Sub CDE continues and holds the B Note Allocatee/Ma nager 0.01% sub-cde owner Sub-CDE (QLICI Lender) QALICB 99.99% sub-cde owner QLICI B Loan: $4,000,000 Result Sub-CDE and QALICB are now related Assuming FMV of B Loan is $1,000,000, then $3,000,000 ordinary income may be recognized by QALICB on date of Put

Sub CDE continues and holds the B Note Allocatee/Ma nager 0.01% sub-cde owner Sub-CDE (QLICI Lender) QALICB 99.

5 Tax Consequences of Put Exercise at End of NMTC Compliance Period Put is for a negotiated price such as $1,000 Investor s goal is to transfer remaining NMTC subsidy to benefit QALICB Put Obligor is typically a QALICB Affiliate The QALICB Affiliate may be a related party for federal income tax purposes If the Put Obligor is a related party and the QLICI is a debt QLICI, exercise of the Put may trigger cancellation of debt income ( COD ) to the QALICB even though the debt is not actually cancelled

Affiliate may be a related party for federal income tax purposes If the Put Obligor is a related party and the QLICI is a

6 Cancellation of Debt Income COD includes both cancelled principal and cancelled accrued, deducted interest For a taxable person, COD is ordinary income For a non-profit entity, no guidance but general consensus that COD is not taxable since Non-profits are only taxed on income from a regularly carried on trade or business, or COD is analogous to a non-taxable receipt of a charitable contribution

general consensus that COD is not taxable since Non-profits are only taxed on income from a

7 Deemed COD Event to QALICB on Investor Put If the QLICI is debt and the Put Obligor is a Related Party COD will result on a direct acquisition COD will result on an indirect acquisition but only if the Sub CDE acquired the QLICI note in anticipation of becoming related facts and circumstances test possible Return disclosure requirement Amount of COD is excess of Cancelled Debt Amount (i) over Put Price in a Direct Acquisition and (ii) over Fair Market Value of the Cancelled Debt in an Indirect Acquisition Because of low interest rate, long term and other characteristics, QLICI FMV probably less than face amount

possible Return disclosure requirement Amount of COD is excess of Cancelled Debt Amount (i) over Put Price in a Direct Acquisition and (ii) over Fair

8 Example 1 Direct Acquisition 1. Sub CDE distributes $4,000,000 B Note to the Fund after Leverage Loans have been repaid 2. Investor puts its 100% interest in the Fund to the QALICB Affiliate for $1, Transaction is treated as a direct acquisition of the B Note by the QALICB Affiliate COD Income Results B Note Principal = $4,000,000 Put Price = $ 1,000 COD Income = $3,999,000

Investor puts its 100% interest in the Fund to the QALICB Affiliate for $1,000 3.

9 Example 2 Indirect Acquisition 1. Leverage Loan is repaid 2. Investor puts its 100% interest in Fund to QALICB Affiliate 3. Sub CDE continues as a partnership and holds the B Note 4. As Sub CDE is now more than 50% owned by a party related to the QALICB, the Sub CDE as holder of the B note has become related to the debtor An Indirect Acquisition that triggers COD income has occurred if based on the facts and circumstances the holder (the Sub CDE) acquired the indebtedness (the B Note) in anticipation of becoming related to the debtor. Treasury Regulation (c) Relevant facts: (i) intent at time of acquisition, (ii) nature of contacts before acquisition, (iii) period of time debt held, (iv) size of debt as proportion of holder group assets

income has occurred if based on the facts and circumstances the holder (the Sub CDE) acquired the indebtedness (the B Note) in anticipation of becoming related to the debtor.

10 Possible Exclusion of COD Income if: Qualified real property business indebtedness exclusion Only available if QLICI debt was used to acquire or improve real property used in a trade or business and is secured by such real property Limited to lesser of excess of qualified debt over net FMV of such real property (FMV of such real property reduced by other qualified debt) prior adjusted basis in all of Taxpayer s depreciable real property Basis write-down by amount of COD required Not available to C corporations; measured at the partner level for a partnership Insolvency exclusion If the debtor is insolvent, then exclusion to the extent of the insolvency Insolvency measured at the partner level for a partnership

qualified debt) prior adjusted basis in all of Taxpayer s depreciable real property Basis write-down by amount of COD required Not available to C corporations; measured at the

11 Can COD Income be Avoided or Income Deferred? No Deemed COD income if the Put is to an Unrelated Party Who is a related party: Individual related to parents, spouse, children and spouses, grandchildren and spouses Corporations related if more than 50% common ownership Partnerships related if same persons own more than 50% of capital or profits Detailed rules under 267(b) and 707(b), constructive ownership rules apply If possible, set up an unrelated put obligor from the beginning No COD income if original loan was from a Related Party Reasonable Expectations again an issue

grandchildren and spouses Corporations related if more than 50% common ownership Partnerships related if same persons own more than 50% of

12 Can COD Income be Avoided or Income Deferred? No COD income if the QLICI is Equity at time of put exercise Structure the QLICI initially as an equity QLICI. Challenge is the reasonable expectations test which is unavailable if the Sub CDE has a more than 50% interest by value or vote in the QALICB Structure the QLICI in part as equity so that the Sub CDE is a related party lender. Reasonable expectations issue again Convert a debt QLICI to equity prior to the put exercise. November 2011 partnership debt-for-equity regulations are an obstacle COD if debt exceeds FMV of partnership interest Liquidation value safe harbor not available if related party acquires the interest as part of a plan with a principal purpose of avoiding COD

that the Sub CDE is a related party lender. Reasonable expectations issue again Convert a debt QLICI to equity prior to the put exercise.

USDA Guarantee + NMTC Equity = Facility Financing for a Start Up Charter School

USDA Guarantee + NMTC Equity = Facility Financing for a Start Up Charter School Berkshire Arts & Technology Public Charter School Adams, MA The BArT Charter School opened its doors in the fall of 2004