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Post Issuance Compliance Annual Meeting July 16, 2012 PowerPoint Presentation
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Post Issuance Compliance Annual Meeting July 16, 2012. Post Issuance Compliance – Agenda Room X, 16 th Floor, MSB, Monday, July 16 th , 2-4 PM. Welcome and Introductions – Nancy Winkler, City Treasurer Post-Issuance Compliance Team Bond Arbitrage 101 – Joan DiMarco, PFM Asset Management

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Presentation Transcript
Post Issuance Compliance
  • Annual Meeting
  • July 16, 2012
post issuance compliance agenda room x 16 th floor msb monday july 16 th 2 4 pm
Post Issuance Compliance – AgendaRoom X, 16th Floor, MSB, Monday, July 16th, 2-4 PM
  • Welcome and Introductions – Nancy Winkler, City Treasurer
  • Post-Issuance Compliance Team
  • Bond Arbitrage 101 – Joan DiMarco, PFM Asset Management
  • Private Use 101 – Valarie Allen, Ballard Spahr
  • IRS Audit and Compliance Initiatives – Kim Betterton, Ballard Spahr
  • Policies and Procedures – Charlie Jones, Sinking Fund
  • Investments – Nancy Winkler
  • Adjournment
post issuance compliance team members
Post Issuance Compliance Team Members
  • Not only does Uncle Sam want you, but the City of Philadelphia needs you to be an active member of the team. Because of the wide-ranging nature of bond proceeds, including issuance, spending, investing and tracking, no one person or department can handle all the tasks that are necessary to adequately and successfully perform post issuance compliance. The Treasurers Office takes the lead in this activity but will recruit, enlist and, if necessary, draft individuals to assist in this process. We appreciate the time and effort that you will contribute to this process.
dear irs
“Dear IRS”
  • Maybe it works for Snoopy, but it doesn’t work for the rest of us. Even though we are a tax-exempt bond issuer, the City of Philadelphia is still subject to many IRS rules and regulations. No matter how many times we tell them not to, they still keep sending us audits and examinations.

Before, During and Immediately After Issuance

timeline continued
Timeline (continued)

Post Issuance Compliance – Potential Issues

Arbitrage Rebate 101
  • Joan DiMarco
  • PFM Asset Management
background why we have arbitrage rebate
Background – Why we have Arbitrage Rebate
  • To prevent abuses, the tax code limits the permitted uses of tax-exempt bonds
    • Prevents issuance of more bonds than are necessary
    • Prevents issuance of bonds earlier than is necessary
    • Prevents bonds from remaining outstanding longer than is necessary
    • Limitations on advance refunding
    • In other words, borrow what you need, when you need it, for an appropriate duration based on what is being financed.
  • Tax law and Regulations create financial disincentives (i.e., arbitrage rebate) to prevent issuance of tax-exempt debt for profit-driven reasons
    • Yield restriction – IRC Section 148(b)
    • Arbitrage rebate – IRC Section 148(f)
    • Overlapping requirements – “Belt & Suspenders”
  • Applies to every tax-exempt borrowing
how is arbitrage measured
How is Arbitrage Measured?
  • Arbitrage % = Actual investment earnings yield (–) average borrowing rate (aka, the Arbitrage Yield)
  • Arbitrage rebate liability =
    • Earnings of bond proceeds invested in taxable securities less (-)
    • Earnings of bond proceeds invested at the Arbitrage Yield
      • “Positive Arbitrage” = Actual Earnings > Earnings @ arbitrage yield (positive earnings yield spread)
      • “Negative Arbitrage” = Actual Earnings < Earnings @ arbitrage yield (negative earnings yield spread)
  • Future value methodology
  • Measured on an issue-by-issue basis
    • Within an issue, aggregated among funds
funds subject to rebate
Funds Subject to Rebate
  • Proceeds Category
  • Sale Proceeds / Investment
  • Proceeds
  • (“Proceeds”)
  • Transferred Proceeds (“Proceeds”)
  • Cash / Revenue Funded
  • (“Replacement Proceeds”)
  • Proceeds + Replacement Proceeds = Gross Proceeds
  • Proceeds Category Funds
  • Funds
  • Project / Construction Funds
  • Capitalized Interest Funds
  • Debt Service Reserve Funds
  • Escrow Funds
  • Costs of Issuance Funds
  • Any of the above
  • Debt Service Funds
  • Debt Service Reserve Funds
  • Any “Pledged” Fund
exceptions to arbitrage rebate
Exceptions to Arbitrage Rebate
  • The Small Issuer Exception
  • The Spending Exceptions
    • 6-month spending exception
    • 18-month spending exception
    • 2-year spending exception
  • “Bona Fide” Debt Service Fund exception
  • Electing to pay the 1.5% penalty in lieu of rebate
  • Investing in tax-exempt obligations
bona fide debt service fund exception
“Bona Fide” Debt Service Fund Exception
  • Depleted at least annually except for greater of:
    • Previous year’s earnings in the fund, or
    • 1/12th of previous year’s principal and interest payments
  • Private Activity Bonds, Variable rate governmental bonds, < 5 years governmental bonds
    • Fund has annual earnings of less than $100,000, or
    • Average annual debt service does not exceed $2.5 million
what is yield restriction
What is Yield Restriction?
  • Like rebate, restriction against investing above the arbitrage yield
  • Only applies to proceeds that are subject to yield restriction
  • Exceptions apply
    • Temporary periods
    • Exception for “Reasonably Required” Reserve Fund
    • Minor Portion
temporary periods
Temporary Periods
  • Fund Type
  • Construction fund
  • Bona fide Debt Service Funds
  • Advance Refunding Proceeds
  • Current Refunding Proceeds
  • Investment Proceeds
  • Temporary Period
  • Typically 3 years, with 5 year cert.
  • 13 months
  • 30 days
  • 90 days
  • 1 year from date of receipt
yield restriction impact unspent proceeds
Yield Restriction Impact - Unspent Proceeds
  • Yield restriction liability calculation
    • cannot blend negative arbitrage on unrestricted proceeds with positive arbitrage on restricted proceeds (can blend for rebate liability calculation)
yield restriction compliance methods
Yield Restriction Compliance Methods
  • Active Yield Restriction
    • Investments must be purchased at fair market value
  • Yield Reduction Payments
    • Rebate like payments
    • Limited availability for advance refunding issues
  • Other Options
    • Longer construction fund temporary period (5-years vs. 3-years)
    • Waiver of temporary period at issuance
accounting for bond proceeds
Accounting for Bond Proceeds
  • Significant factor in determining arbitrage rebate and yield restriction liabilities
  • Permitted to use any reasonable, consistently applied accounting method to account for gross proceeds, investments, and expenditures of an issue
    • Examples: FIFO, direct tracing, ratable allocation, gross proceeds spent first
    • Proceeds are allocated to an issue until they are spent (actual cash outlay)
  • Expenditure reallocations are permitted, however there are time limits
    • Expenditure allocations must be made no later than 18-months after the later of the expenditure date or the date the project is placed in service
    • Must be made no later than 60 days after five-year anniversary/final maturity date
  • Proceeds of working capital financings (e.g., TANS, TRANs) subject to “proceeds-spent-last” requirement
Private Use 101
  • Valarie Allen
  • Ballard Spahr
tax exemption subsidy
Tax Exemption = Subsidy

Congress promoting public purposes of, and investment by, state and local governments by lowering cost of capital

Issuers must ensure that uses of bond financed facilities are for the public good for federal tax purposes

the holy grail governmental bonds
The Holy Grail: Governmental Bonds

Federal tax code allows for tax-exempt interest on:

Governmental Bonds

“Qualified” Private Activity Bonds

the holy grail governmental bonds1
The Holy Grail: Governmental Bonds

Governmental Bonds means

Bonds that are not Private Activity Bonds

Governmental issuer is not enough

For federal tax purposes “governmental” refers to the ownership and use of the facilities being financed

pab tests don t want no satisfaction
PAB Tests: Don’t Want No Satisfaction

A Bond is a Private Activity Bond (PAB) if it meets either:

BOTH the Private Business Use andPrivate Security and Payment Tests


Private Loan Financing Test

pab tests don t want no satisfaction1
PAB Tests: Don’t Want No Satisfaction

Private Business Use Test: No more than 10% of the proceeds of the issue can be used in private business

Private Security or Payment Test: No more than 10% of the debt service on the bonds may be secured by private security or payment (capped at $15,000,000)

pab tests don t want no satisfaction2
PAB Tests: Don’t Want No Satisfaction

Private Loan Financing Test: No more than the lesser of 5% and $5,000,000 of the proceeds of the bonds can be used to finance private loans

Grants, unlike loans, are not private use

IRS Initiatives and Audit Compliance
  • Kim Betterton
  • Ballard Spahr
time line
Time Line
  • Early 1990s – IRS basically has no tax-exempt bond audit program. Issuers are operating under the assumption that if they had reasonable expectations of compliance at the time of issuance, everything will be fine.
  • Mid 1990s – IRS begins targeted audits. Audit program is still very small and very few agents are dedicated to tax-exempt bonds.
  • Early 2000s – Audit program begins to ramp up.
  • Mid 2000s - IRS publishes an FAQ stating that issuers have responsibility to PROVE that their bonds are tax-exempt by keeping records for the life of the bonds (including any refunding bonds) plus three years.
time line cont d
Time Line (cont’d)
  • Late 2000s – IRS has as many as 60 field agents dedicated to auditing tax-exempt bonds in both targeted and random audits.
  • Additionally, IRS begins sending out post-issuance compliance questionnaires requesting “voluntary” disclosure of information concerning bonds. So far these questionnaires have covered:
          • 501(c)(3) Bonds
          • Governmental Bonds
          • Build America Bonds
          • Advance Refundings
          • Tax Anticipation Notes
          • Small Issuers
time line cont d1
Time Line (cont’d)
  • Current – IRS is increasingly adding questions about WRITTEN post-issuance compliance procedures to its Forms 8038-G, 8038, post-issuance compliance questionnaires, audit information requests, and, for 501(c)(3) organizations, Schedule K to the Form 990 (the annual tax filing).
  • IRS is considering requiring a filing similar to the Schedule K from governmental entities (which would include the City of Philadelphia).
  • IRS has added provisions to its Voluntary Closing Agreement Program (“VCAP”) that give special benefits to issuers who have written procedures in place.
  • Tax-exempt (and tax-favored financing, such as build America bonds or tax credit bonds) are a form of federal subsidy. Just as there are strings attached to most federal grants, similar strings are attached to the ability to borrow at a low rate of interest.
  • Issuers have control over whether their bonds are in compliance with the tax rules.
  • IRS believes that if the proper procedures are put in place that issuers will be able to keep their bond issues in compliance.
  • If you put procedures in place that you can actually follow, the IRS is probably correct in that belief.
  • Cost of audit, regardless of outcome, is most likely far greater than a good faith effort toward compliance.
  • The policies and procedures apply to all tax-exempt governmental and qualified private activity bonds issued by the following entities:
  • City of Philadelphia General Fund (including TRANs)
  • Philadelphia Gas Works
  • Philadelphia Water Department
  • Philadelphia Airport
  • Philadelphia Authority for Industrial Development (PAID)
  • Philadelphia Municipal Authority (PMA)
  • Philadelphia Redevelopment Authority
expenditure of proceeds for qualified costs
Expenditure of Proceeds for Qualified Costs
  • Records must be kept of date, amount and purpose of each capital expenditure
  • Requisitions must identify the property in conformity with the Tax Certificate
  • Reimbursements of previously expended costs must be for expenditures made subsequent to or within 60 days prior to the declaration to reimburse such costs
  • Initial funding of debt service reserve funds must be made according to certain limitations
  • Timing of expenditures will be according to documentation at the time of issuance. If the expected schedule is not met, reasons will be documented and retained
use of bond financed property after completion and in service
Use of Bond-Financed Property (after completion and in service)
  • After a property that has been financed with bond proceeds is put into use, the use of that property must be monitored
  • If the property is leased or sold to a for-profit entity (private use), the status of the tax-exempt bonds may change
  • If the private use of property exceeds 10% of the proceeds the status of the tax-exempt bonds may change
  • Prior to the switch of a bond-financed property to private use, a remedial action must be determined per Treasury regulations
refunding bonds
Refunding Bonds
  • Refunding (new) bonds are treated as if they were the refunded (old) bonds
  • Use of the property financed by old bonds is continued to monitored in the same manner during the life of the new bonds
  • Advance refunding bonds, proceeds of which are used to refund bonds more than 90 days after the new bonds are issued, have additional compliance requirements regarding the investments and escrows
record keeping
Record Keeping
  • Requirements are burdensome and may not be consistent with document destruction policies
    • Life of the Bonds + 3 years
    • If the Bonds are refunded, life of refunding bonds + 3 years
  • Consider separate document collection, storage and destruction policies for bond related records
  • Consider electronic storage systems
examples of records to maintain
Examples of Records to Maintain
  • Board minutes, resolutions
  • Appraisals
  • Bond transcripts
  • Newspaper ads, misc. correspondence
  • Investment records
  • Expenditure histories
  • Invoices
  • IRS Filings
  • Records related to acquisition of investment agreements and interest rate swaps
  • Payments for credit facilities
  • Arbitrage rebate and yield restriction compliance reports
  • Private use
  • Change in use/Dispositions
  • Final allocation of new money
  • Secondary market pricing
  • Cost of issuance (2% limit on PABs and BABs)
  • DAC
  • IRS
  • See IRS Publication 4079 Tax-Exempt Governmental Bonds Compliance Guide
  • and IRS Publication 4078 Tax-Exempt Private Activity Bonds
benjamin franklin

We must all hang together,

or assuredly we’ll all hang separately.”

Benjamin Franklin