WASHINGTON - Municipal bonds could get caught up in corporate tax reform, particularly if infrastructure financing is involved, a former Treasury Department official said.
"The good news is, if we're only talking corporate tax reform this year, if that's truly what happens, then there's less likely to be radical change in the treatment of tax-exempt bonds," Vicky Tsilas, who recently left Treasury's Office of Tax Policy to return to private practice.
However, "if the past is any indicator of the future, there have been a lot of discussions of whether this is an effective mechanism to finance infrastructure. So I don't think the debate ever goes away," she said in a wide-ranging interview with The Bond Buyer.
Also, a debate on corporate tax reform could spill over into discussions about individual tax reform and which tax expenditures, such as the tax exemption for municipal bonds, are good and bad, she said.
Tsilas was the tax policy office's expert on tax-exempt and tax-credit bonds. During her two years at Treasury, she advised the Obama administration and others about policy for tax-advantaged bonds and worked with the Internal Revenue Service on muni-related guidance.
Earlier this month, Tsilas joined Ballard Spahr LLP as a partner in Washington, returning to the firm after two earlier stints there. She also worked in the chief counsel's office at the IRS before working at Treasury.
Tsilas said about 2015: "I think it should be an exciting year in terms of guidance, so I think there's going to be some good things coming out . It will be interesting to see what happens with tax reform."
While comprehensive tax reform would be challenging to do this year, people are predicting that if any tax reform gets done in 2015, it will be corporate tax reform, she said.
Several key lawmakers and President Obama have said they either want, or are open to the idea of, corporate tax reform. Obama wants the one-time revenues generated from corporate tax reform to be used for infrastructure. And discussions about infrastructure are likely to look at the best ways to finance projects, Tsilas said.
"Is it tax-exempt bonds as it's been in the past? Is it these direct pay bonds, like Build America Bonds? Or is it some other mechanism like a bank? Naturally, any discussion opens up the effectiveness of financing something with bonds," she said.
Congress will need to pass some type of highway bill this year, because the current legislation that authorizes surface transportation programs and keeps the Highway Trust Fund solvent expires May 31.
It remains to be seen how a highway bill will be paid for and how highway projects will be financed, Tsilas said. Some members of Congress have called for increasing the federal gas tax and others have not ruled it out, but any discussion of a tax increase is a difficult issue politically. Sen. Ron Wyden, D-Ore., several years ago proposed using tax-credit bonds to finance infrastructure. Obama's fiscal 2015 budget proposes creating a national infrastructure bank.
"I think everybody agrees on the problem, but [agreeing] on the solution is a whole other question," Tsilas said.
As a supplement to his legislative proposals on infrastructure spending, President Obama issued an executive action over the summer that established a working group headed by the Treasury and Transportation Secretaries that was tasked with submitting recommendations on how to increase public and private collaboration on infrastructure development. Those recommendations have reportedly been sent to the President, but have not been made public.
Guidance Projects
Tsilas also talked about the guidance projects she worked on while at Treasury. She was proud of the fact that Treasury and the IRS have been able to release significant guidance during that time.
She is particularly pleased that Treasury and the IRS were able to release interim guidance on how management contracts and accountable care organizations can be structured to avoid giving rise to private business use. This is important because there were concerns that these arrangements, which are encouraged by the Affordable Care Act, could cause bonds to become taxable private-activity bonds.
There was particular concern that ACOs could give rise to private business use. ACOs are health care organizations where doctors, hospitals and other providers join together to coordinate care. They can include both taxable and tax-exempt participants, including hospitals and other organizations that are issuers or borrowers of tax-exempt bond financings.
If projects financed by governmental and 501(c)(3) bonds have excessive private business use, the bonds can become taxable. Management contracts can give rise to private business use. The IRS in 1997 provided some safe harbors under which contracts won't cause there to be private business use. But since then, governments and nonprofits have been entering into new types of arrangements that don't neatly fit into the safe harbors created in 1997.
"I think the Affordable Care Act has certainly changed the way contracts are entered into, changed the dynamics," she said. It was good that Treasury and the IRS "at least provided some guidance on the new changes.," she said.
The guidance, released in October, represented the first time since 1997 that there was a significant change to management contract rules. The notice included a new safe harbor for when management contracts won't give rise to private business use. The safe harbor is broadly applicable and does not just have to be used in the health care context.
Tsilas called the new safe harbor "flexible" and pointed out that the notice solicits comments about further guidance on management contracts.
"There is a recognition that things have changed. The industry has changed. And with it, the guidance needs to be updated," she said.
Last month, Treasury and the IRS released final regulations that pertain to new requirements for nonprofit hospitals that were created by the Affordable Care Act. The regulations were a project of the exempt organizations division of the IRS, but Tsilas worked on the part of them that specifically pertained to bonds.
The regulations had been proposed in 2012 and 2013. "It was wonderful that the IRS and Treasury were able to finalize that so fast," she said. It can be challenging to get guidance projects out quickly, since there are a lot of offices within Treasury and the IRS that have to sign off on the projects, she added.
Tsilas also helped push out final regulations on the process for recovering overpayments of arbitrage rebate on tax-exempt and tax-advantaged bonds.
But one section of other proposed arbitrage regulations released in September 2013 that Tsilas worked on was poorly received by market participants. Market groups said the definition of issue price in the proposed rules would be unworkable.
Under the current rules, the issue price for each maturity of bonds publicly offered is the first price at which a substantial amount of the bonds is reasonably expected to be sold to the public, with substantial defined as 10%.
But the proposed rules would eliminate the reasonable expectations standard and instead base the determination of issue price on actual sales of the bonds. They include a safe harbor under which the issue price would be the price at which the first 25% of the bonds is actually sold to the public. Market groups it is almost impossible to track the first 25% of bonds sold to the public.
Tsilas said she wasn't surprised by the market's reaction to the proposed issue price rules.
"There was certainly a recognition that this is not something that is necessarily going to be favorably received," she said. "It was a change in direction, a complete change in direction, and different from what the industry had asked for. So any time something is a change in direction and radically different, I'd be remiss to say that you expect an overwhelming applause. I think the industry was surprised the direction it took."
Tsilas couldn't say if the Treasury and IRS might go back to using the "reasonable expectations" standard in future guidance on issue price, but she said the agencies recognize that commenters had problems with the proposed rules.
"IRS and Treasury heard loud and clear, 'Hey, what went out had issues,'" she said.
Allocation and Accounting Rules
Tsilas wishes final allocation and accounting regulations had been released before she left. The proposed regulations were issued in 2006.
The project is important because it will help issuers and borrowers to finance projects using both bond proceeds and equity, Tsilas said.
"It sets the stage for different forms of financing, different sources of funds going into financing," she said. "And it gives some security to clients, to people doing the financing. And that's a long time coming."
Treasury and the IRS have said that in 2014-2015 they also want to work on guidance on the definition of a political subdivision, final regulations on public approval requirements for private-activity bonds, and allocating unused volume cap for new clean renewable energy bonds.
Tsilas was succeeded at Treasury by John Cross, who preceded her at the department before moving over to the Securities and Exchange Commission to head up its Office of Municipal Securities. With Cross once again at Treasury, Tsilas said she's hopeful that guidance projects will move forward in the way that they should.
"I'm thrilled that John Cross came back," Tsilas said. "He is intimately familiar with all of the details of all the projects."
Cross has been able to get out guidance projects in the past, she said.
Tsilas also discussed two recent bond-related documents released by the IRS on which she did not work.
One was a chief counsel advice memorandum that concluded that an issuer's BABs were essentially reissued when they were defeased after refunding bonds were issued. While many bond lawyers criticized the ruling, Tsilas said she wasn't surprised by it because it followed existing regulations.
The other was a standardized voluntary closing agreement program for issuers of 501(c)(3) bonds that met certain criteria. "It's always very good to see something like that and see streamlining of certain procedures," she said.
While Tsilas enjoyed writing regulations, she missed advising clients and working on deals.
"It's wonderful to do the policy, it's wonderful to actually work on the regulations and see how they're made, but it's quite another thing to actually apply that in real-life settings," she said.
At Ballard, Tsilas will be advising on tax matters for bond deals. She has liked the clients when she's worked at the firm in the past and returning to Ballard is "sort-of like going back home," she said.
"I know the players, I know the people and I know the clients," she said. In the past, a lot of her clients were hospital systems and universities, and she also worked on governmental and sold-waste bond deals. Ballard is one of the bond counsel firms for the District of Columbia Revenue Bond Program, so she's worked on many financings that are local to her.
Having worked at Treasury and the IRS has given her an idea of the thought process behind regulations, which Tsilas said will help her as she advises clients.
At "IRS you get a sense for the sort-of the questions [that go into a rule]. Treasury gives you a broader perspective of the overall policy questions that come up in the tax-exempt bond area," she said. "How will that affect my practice? I think I'm infinitely more qualified as a tax practitioner advising a client, because I know what goes into drafting a reg, the challenges in drafting a reg, and also the broader policy questions that are involved in doing that."
