WASHINGTON — The Internal Revenue Service has granted a school district that experienced "financial distress" a roughly 16-month extension to spend the proceeds of its qualified school construction bonds.
The IRS made this conclusion in a private-letter ruling that was dated Dec. 8 but not released until Friday. The PLR did not name the issuer. It was signed by James Polfer, chief of the tax-exempt bond branch of the IRS chief counsel's office.
Under federal tax law, 100% of available project proceeds for QSCBs and other tax-credit bonds must be spent within three years of issuance and any proceeds unspent in that time period must be used to redeem the bonds. Issuers can request additional time to spend the proceeds. Polfer previously said that the IRS has been liberal in granting extensions.
The IRS will give issuers more time to spend the proceeds if it sees that there were unforeseen circumstances that made it difficult or impossible to spend the proceeds within three years and there's a commitment to spending the proceeds with due diligence, he said.
The issuer that the PLR applies to is a public-school district and agency of a state. At the time that it issued its QSCBs, the school district expected to spend the proceeds within three years. The bond proceeds were to be used for certain projects in the district's capital needs plan.
But after the bonds were issued, the district encountered "financial distress" that was mainly caused by reductions in state funding, according to the ruling. As a result, the district's operations were impeded and there were layoffs of teaching, support and administrative staff.
To address its financial condition, the district reviewed its facilities and building uses. During the review, the district suspended the implementation of its plan and did not make any additional commitment of funds to bond-financed projects.
When it finished its review, the district decided that a certain number of schools should be closed, and as part of the school-closure plan, the district changed its building uses. Projects in the capital plan, including those that were to be financed with the QSCB proceeds, needed to be reprioritized and the school district needed to determine which projects would be substituted for those previously earmarked for the closed schools, the IRS said.
"As a result of this substitution and reprioritization, [the] district was required to undertake additional planning and preparation of specifications and bidding, which was necessary to comply with applicable law," the ruling said. Therefore, there was a significant delay in committing and spending bond proceeds and the district will be unable to spend all available project proceeds within three years of issuance. The district now plans to spend all of the proceeds by a date that is about 16 months after the three-year period expires.
The school district requested an extension prior to the expiration of the three-year period.
Under federal tax law, issuers can submit requests for extensions of expenditure periods before the three-year period expires. The extensions can be granted if the issuer establishes that there's a reasonable reason why the proceeds won't be spent within the original time period and that "the expenditures for qualified purposes will continue to proceed with due diligence."
The IRS chief counsel's office concluded in the ruling that the district met the criteria for an extension, and it granted the district a longer expenditure period.
"The expected failure to spend all available project proceeds of the bonds by the expiration of the original expenditure period was caused by events that were not reasonably expected at the time the Bonds were issued, that were beyond the control of [the] district, and that caused a significant delay in committing and spending the bond proceeds," Polfer wrote. "The expected failure to spend all available project proceeds was due to reasonable cause."
Bond lawyers said the IRS ruling was fair.
"I think it is a reasonable holding and is consistent with the previous rulings issued for extending the three-year expenditure period," said Matthias Edrich, an attorney at Kutak Rock in Denver.
"It's a helpful ruling and an appropriate result," said Ed Oswald, a partner at Orrick, Herrington and Sutcliffe in Washington.
There are different rules for tax-exempt bonds on the spending of proceeds.
Under federal tax law, bonds generally are hedge bonds unless the issuer reasonably expects to spend 85% of the proceeds in three years. For hedge bonds to be tax exempt, the issuer has to reasonably expect to spend proceeds in a manner that meets certain benchmarks, including that 85% of the proceeds be spent within five years of issuance.
The IRS cautions market participants that PLRs only apply to the issuers that request them. But bond lawyers still take note of them in areas of the tax law where there is not a lot of guidance.
Carol Lew, a shareholder at Stradling Yocca Carlson & Rauth in Newport Beach, Calif. , and Oswald said there may be differences between the case underlying the PLR and audits in which the IRS has found issuers delayed spending proceeds. During audits, issuers of governmental, tax-exempt bonds with similar fact patterns as the issuer in the PLR might have their initial expectations to quickly spend their proceeds challenged by the IRS, said Lew.
Oswald pointed out that there is no requirement that issuers of tax-exempt bonds request an extension to spend proceeds or redeem bonds. In fact, there is no option to request an extension for tax-exempt bonds, Lew said.
The PLR came from the IRS chief counsel's office, while audits are conducted by the IRS tax-exempt bond office. Also, the issuer voluntarily asked for the ruling and historically issuers get more favorable treatment from the IRS when they are proactive, Lew said.
