WASHINGTON — The Internal Revenue Service has published remedial actions that state and local issuers can take to preserve the tax-advantaged status of bonds when they become jeopardized because bond-financed facilities are used for private or other nonqualified purposes.
The remedial actions were set forth in Revenue Procedure 2018-26, which was published Wednesday night. They are immediately effective.
The IRS has existing remedial action rules for tax-exempt governmental bonds that date back to the 1990s, but that do not cover long-term leases, Build America Bonds and other direct-pay bonds, or most tax credit bonds. This revenue procedure remedies that.
The change-of-use remedial action for long-term leases provided in the guidance “is notable because it aims to be responsive to interests of the public-private partnership community and the infrastructure initiatives from the White House,” said John Cross, associate tax legislative counsel at the Treasury Department.
Bond lawyers were pleased with the guidance.
“The Revenue Procedure provides common sense remedial action methods for direct pay bonds, and we welcome the additional flexibility the Revenue Procedure provides with respect to a long-term lease arrangement,” said Sandy MacLennan, president of the National Association of Bond Lawyers. “We are assessing the extent to which this Revenue Procedure can be used for reasons other than a change in use.”
Existing rules provide remedial actions when issuers of tax-exempt governmental bonds violate private use or private loan restrictions. Under these rules, Issuers can either defease their outstanding bonds; sell a bond-financed facility to a private business and recycle the sale proceeds into another good governmental use within two years; or find an alternative use for the bond-financed facility that would still qualify for tax-exempt bonds.
The existing rules also provide remedial actions for tax-exempt private activity bonds when the bond-financed facility is longer used for its qualified purpose. Under these rules, issuers can redeem or defease the bonds.
Issuers of qualified zone academy bonds also have existing rules for remedial actions they can take if the violate QZAB requirements. They can redeem or defease the bonds or sell the facility and use the sales proceeds to cure the violations.
However, market participants generally haven't liked the remedial action option of defeasance for the last 10 years or so because it is cumbersome and expensive. Investment rates have been so low that issuers doing advance refundings to defease their bonds haven't been able to earn anything on the securities in the refunding escrow, sources said.
Section 5 of the revenue procedure provides a remedial action for long-term, private leases of public roads or facilities, such as the ones in P3s. It allows the issuer to take the present value of the lease payments and recycle that amount into “good” governmental use within two years. This is similar to the already permitted remedial action of recycling proceeds from selling projects for tax-exempt governmental bonds.
Section 6 also is notable, Cross said, because it allows issuers of Build America Bonds and other direct-pay bonds to take “a very simple change-of-use remedy” by turning off the subsidy payment they get from the Treasury Department. Direct-pay bonds are taxable but issuers get subsidy payments from Treasury equal to a percentage of their interest costs.
The revenue procedure has been in the works for some time, predating a recent discussion at the National Association of Bond Lawyers’ Tax and Securities Institute meeting in Phoenix in February about whether BABs can be advance refunded with tax-exempt bonds if the BAB’s federal subsidy payments are turned off so two sets of tax-advantaged bonds are not outstanding at the same time.
While this revenue procedure makes no mention of advance refundings and is not designed to address them, it nevertheless gives issuers the steps they would have to take to turn off the subsidy.
Section 7 extends some of the remedial actions provided by the existing rules to other direct-pay bonds and tax credit bonds that aren’t currently covered, such as qualified school construction bonds or new clean renewable energy bonds.