COFINA A-2 and B-2 bonds must be exchanged to gain tax exemption

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Holders of $3.6 billion of Puerto Rico Sales Tax Financing Corp. (COFINA) restructured bonds will have to exchange them for new bonds that pay 25 basis point less interest to get a federal tax exemption.

On Thursday COFINA posted an Invitation to Exchange Bonds and Consent to Amendments and a related Question and Answers to the Electronic Municipal Marketplace Access web site on the new exchange offer.

In the offer bondholders have the option to either keep the bonds they have without a federal tax exemption or choose new bonds that will be tax exempt but have interest rates no lower than 25 basis points below those of the current bonds. The current bonds hold interest rates from 4.55% to 5.00% and mature from 2040 to 2058.

The exchange would be for new bonds with equal principal amounts. In order to opt for the new bonds, bondholders need to contact their bank, broker, or financial representative to act on their behalf.

The new exchange of a portion of the COFINA bonds follow the exchange of all the legacy COFINA bonds in February as part of Puerto Rico's bankruptcy restructuring.

Bondholders who wish to accept the deal must have their choice communicated before 5:00 p.m. July 26.

There wasn’t enough time to get an opinion on the tax status of these particular COFINA bonds before the COFINA Plan of Adjustment was confirmed in early February. So COFINA followed a Tax Exemption Implementation Agreement, which included seeking an opinion from the Internal Revenue Service.

COFINA and the IRS entered into a “Closing Agreement” with the IRS on May 15.

“The IRS Closing Agreement does not provide that the Invited Bonds [i.e., existing 2019A-2 and B-2 bonds] are automatically tax exempt,” COFINA explained in the question and answer document. “The IRS Closing Agreement merely permits the corporation [i.e., COFINA] to make certain allocations with respect to the proceeds of its Restructured Sales Tax Bonds as a whole under applicable Treasury Regulations. The corporation must make those allocations and must also take additional actions required under the code and Treasury Regulations in order for interest on the bonds to be tax exempt, including, among other things, adopting tax covenants and amending documents.

“The corporation will not make the same allocations or take the same actions with respect to Invited Bonds that are not exchanged for Converted Bonds,” COFINA continued. “As a result, the interest on Invited Bonds that are not exchanged for Converted Bonds will be fully subject to federal income taxation.”

COFINA goes on to explain that it had told the IRS that the exchange for tax-exempt bonds would result in a 25 basis point reduction in yield on the Invited Bonds exchanged for Converted Bonds. The IRS mentioned this reduction in the IRS Closing Agreement. Legal counsel has told COFINA that the Closing Agreement will not apply unless there is a 25 basis point cut exchange.

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PROMESA Puerto Rico Sales Tax Financing Corp (COFINA) Puerto Rico