State and local governments who issue draw-down bonds can breathe a sigh of relief now that the Internal Revenue Service has issued new guidance for their private-activity bond volume cap allocations.
The guidance, which the IRS released on Wednesday, effectively reverses course on a technical issue applied to private-activity volume cap requirements and the PAB issue dates — revising guidance it issued in November for bonds authorized by the American Recovery and Reinvestment Act.
Draw-down bonds are almost always PABs that are privately placed with a bank. They are a popular way for smaller issuers to finance construction projects with bonds without having to make initial interest payments on the entire issue.
The issuer places the bonds with the bank and the bank then lends the bond proceeds to the issuer in several small periodic amounts. The issuer is only obligated to pay interest on the amounts that have been tapped.
Under the new IRS guidance, an issuer can consider the bonds “issued” at the first draw of bond proceeds for purposes of obtaining an allocation of PAB cap. The issuer can carry the cap forward for three years for the bonds, even though some of the bond proceeds may not be drawn down until the second or third year after issuance.
It reasserts conventional IRS requirements for PAB, draw-down bonds, and volume caps that were in place before ARRA, according to bond lawyers.
Under the November guidance, bonds were only considered issued when bond proceeds were drawn down.
For example, if an issuer sold $1 million of draw-down bonds, but only drew $50,000 of the proceeds in the first year, only that $50,000 of bonds would be considered issued in that first year.
The November guidance created a problem for PAB issuers that had to obtain volume-cap allocations for the bonds. For draws of bond proceeds in different years, issuers would need to get additional volume-cap allocations to draw down the bond proceeds.
Securing volume-cap allocation from states or their authorities can be a time-consuming and onerous process. Some states allocate volume cap authorization on a first-come, first-served basis.
The IRS’ November guidance forced issuers to accelerate their draws, but this was impossible for a number of deals, bond lawyers said.
The new guidance “basically puts us back where we thought we were” before the IRS’ November ruling, said Linda Schakel, a partner with Ballard Spahr LLP.
The November ruling could have “potentially jeopardized the tax exemption on many draw-down deals that were already out there,” she said.
“I think the IRS realized the nightmare that would be here” and Wednesday’s update “does the trick, at least for the transactions I’ve been most worried about,” she added.
Most of the problems occurred with multifamily housing deals, according to Schakel. The ruling only applies to the volume cap, carryforward issue, she said.
The ruling does not provide relief for small-issue PAB deals, which are often sold as draw-down bonds for manufacturing projects because volume cap cannot be carried forward for those bonds.
“While they solved the problem for a lot of people, [the IRS] just reconfirmed” that the rule applies to small-issue PAB deals, said Perry Israel, an attorney in Sacramento.