Municipal Bond Financing: Post-Issuance Tax Compliance Policies and Procedures
Municipal borrowers such as New Hampshire towns, cities, counties and village districts can borrow money at tax exempt rates which are lower than rates offered to most commercial borrowers since they are "favored borrowers" under the Internal Revenue Code of 1986, as amended (the "Code"). Such municipalities can borrow at these low rates for both capital purposes (bonds) and operating purposes (tax anticipation notes). The tax exempt status of these bonds or notes means that the purchasers of the same can exclude the receipt of the interest payments on the bonds or notes from their taxable income. However, in order to prevent a municipality from taking unfair advantage of this ability to borrow at low rates, the Code imposes a number of requirements on the municipality's use, expenditure and investment of the proceeds of the bonds or notes.
The decision of whether a borrowing is tax exempt is made at the time of issuance of the bonds or notes (known as the "closing"), based on the situation that exists at such time. At the closing, the governing board of the municipality will sign a No Arbitrage and Tax Certificate which provides the municipality's bond counsel with the information necessary to make a determination that the bond or note is tax exempt. Bond counsel can then issue its opinion regarding tax exemption to the issuer of the bond or note and to the purchaser of such bond or note.
However, there are a number of things that can occur "post-issuance" that could adversely affect the tax-exempt status of the bonds or notes, such as (1) the direct or indirect use of the proceeds by a non-governmental person that might cause the bonds or notes to be taxable private activity bonds; or (2) the municipality's potential liability for rebate payments to the federal government due to the failure to expend funds quickly enough to qualify for one of the spending exceptions to the rebate rules.
Over the past year or so, the Internal Revenue Service (the "IRS") has focused on the post-issuance tax compliance of municipal bond issuers. During that time, we have seen an increased number of IRS examinations of bonds and tax notes to determine compliance with the requirements of the Code. One of the questions posed by the IRS in such examinations is whether the issuer has adopted written procedures to ensure post-issuance compliance with the Code provisions applicable to tax-exempt bonds and notes.
Although, at present, the adoption of post-issuance compliance procedures is not required by statute or regulation, the IRS includes guidance on its website that makes it evident that written procedures are an important part of an issuer's tax-exempt bond program. Moreover, in the fall of 2011, the IRS updated its Form 8038-G to add questions about whether the issuer has established written procedures to address private activity concerns and to monitor the requirements of section 148 related to arbitrage rebate. The IRS also now requests more detail about an issuer's reimbursement for pre-issuance expenditures on this form.
In order to address this increased level of review by the IRS, we have prepared a form of Post-Issuance Tax Compliance Policies and Procedures. This form of policy names a "Coordinator" who has the responsibility to monitor compliance with the policy. It also addresses, among other things, record keeping requirements, the proper use of proceeds of the bond or note, arbitrage/rebate compliance and timely expenditure of proceeds, the proper use of bond or note financed assets, bank qualification and due diligence and remedial actions. The policy follows the requirements of the Code and closely tracks the information included in the No Arbitrage and Tax Certificate that is signed at closing.
If your municipality is planning to finance a project with tax exempt bonds, or may need to issue tax anticipation notes or may be considering a lease-purchase arrangement in the near future, it is important to implement these policies as soon as possible. The governing board of a municipality should have the authority to adopt these policies without the need for a vote of the legislative body.
As a result of the adoption of these policies, the municipality would be able to answer "yes" to the questions on the Form 8038-G, thereby showing the IRS that it is aware of its post-issuance obligations under the Code and that it intends to meet those obligations. An additional reason for the timely adoption is the IRS's indication that an issuer who discloses a compliance issue that is discovered as a result of its own internal review will be looked upon favorably by the IRS in determining a resolution to the problem.
In addition to preparing the form of policies, we have prepared a form of resolution that the governing board could use to adopt the policies. If you are interested in discussing this topic or would like more information, please contact Dave Barnes at 603.695.8500 or Renelle L'Huillier at 603.410.1709.
David Barnes is an attorney and shareholder with Devine, Millimet & Branch, Professional Association.