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Post Issuance and Arbitrage Compliance Presented by: BLX Group LLC

BLX Group LLC 1910 S. Stapley Drive First Floor, Suite 115 Mesa, AZ 85204 ph: 480-539-4084 www.blxgroup.com. Post Issuance and Arbitrage Compliance Presented by: BLX Group LLC Robin Schlimgen, Managing Director, 480.539.4084

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Post Issuance and Arbitrage Compliance Presented by: BLX Group LLC

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  1. BLX Group LLC 1910 S. Stapley Drive First Floor, Suite 115 Mesa, AZ 85204 ph: 480-539-4084 www.blxgroup.com Post Issuance and Arbitrage Compliance Presented by: BLX Group LLC Robin Schlimgen, Managing Director, 480.539.4084 rschlimgen@blxgroup.com

  2. Discussion Outline • Post-Issuance Compliance Overview • IRS Enforcement Update • Arbitrage Overview • Record Retention Requirements • Additional Resources

  3. Post-Issuance Compliance Overview “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 bond-financed property.” After the Bonds Are Issued Then What? Advisory Committee on Tax-Exempt and Governmental Entities

  4. Post-Issuance Compliance Overview • 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

  5. Post-Issuance Compliance Overview 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

  6. Post-Issuance Compliance Overview 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

  7. Post-Issuance Compliance Overview What is the Purpose of a Post-Issuance Tax Compliance Policy? • Demonstrates to the IRS that you are taking your post-issuance 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

  8. Post-Issuance Compliance Overview 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

  9. IRS Enforcement Update 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

  10. IRS Enforcement Update 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

  11. IRS Enforcement Update 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

  12. IRS Enforcement Update 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

  13. IRS Enforcement Update 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

  14. IRS Enforcement Update 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

  15. IRS Enforcement Update 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

  16. Arbitrage Overview • 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

  17. Arbitrage Overview 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

  18. Arbitrage Overview • 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

  19. Arbitrage Overview • Two separate requirements though related • Need to comply with both requirements to avoid bonds being declared “Arbitrage Bonds” ArbitrageRebate Yield Restriction

  20. Arbitrage Overview 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

  21. Arbitrage Overview 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?

  22. Arbitrage Overview 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?

  23. Arbitrage Overview 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

  24. Arbitrage Overview 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”

  25. Arbitrage Overview 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

  26. Arbitrage Overview 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

  27. Arbitrage Overview 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

  28. Arbitrage Overview 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

  29. Arbitrage Overview 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

  30. Arbitrage Overview 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

  31. Arbitrage Overview 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

  32. Arbitrage Overview 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

  33. Arbitrage Overview 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

  34. Arbitrage Overview

  35. Arbitrage Overview 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)

  36. Arbitrage Overview 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

  37. Arbitrage Overview 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

  38. Record Retention Requirements 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

  39. Record Retention Requirements 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

  40. Record Retention Requirements 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 (TEBVCAP) - 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-FAQs-Regarding-Record-Retention-Requirements

  41. Additional Resources 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-and-Publications

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