AHLA. C. Tax-Exempt Financing Basics for Section 501(c)(3) Organizations. L. Todd Gibson Squire Sanders (US) LLP Cleveland, OH

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1 AHLA C. Tax-Exempt Financing Basics for Section 501(c)(3) Organizations L. Todd Gibson Squire Sanders (US) LLP Cleveland, OH Julie K. Seymour Ungaretti & Harris LLP Chicago, IL Tax Issues for Health Care Organizations October 20-22, 2013

2 American Health Lawyers Association Tax Issues for Healthcare Organizations October 21 & 22, 2013 Tax Exempt Financing Basics for Section 501(c)(3) Organizations Todd Gibson Squire Sanders (US) LLP Julie Seymour Ungaretti & Harris LLP Healthcare is big business Significant percentage of national GDP Largest employer in many communities Capital intensive business 2 1

3 What are tax exempt revenue bonds? Revenue Bonds A bond issued by a governmental agency (the Issuer ), but payable solely from loan or lease payments received by the Issuer from the borrower (the Borrower ). The Issuer normally has no liability for debt service on the bonds except to the extent of payments received from the Borrower. Purpose Revenue bonds are usually issued for economic development, housing, and cultural, health and educational facilities. Source of Payment Payments from the Borrower are typically assigned directly to the bond trustee with those payments held in trust for distribution to the bondholders. Payments can be secured by a mortgage of the Borrower s real property and/or gross revenues. Payments may also be secured by letters of credit, bond insurance and/or reserves. Interest Interest on tax exempt revenue bonds is excluded from the gross income of the bondholder for federal income tax purposes (and state income tax purposes in many states). 3 Diagram of revenue bond structure Issuer Loan Agreement Bond Indenture 501(c)(3) Borrower loan repayments Bond principal and interest Bond Trustee Holders Master Trust Indenture Master Trustee 4 2

4 Documentation Bond Indenture and Loan Agreement Tax Agreement Bond Purchase Agreement Official Statement, including Appendix A Continuing Disclosure Agreement Master Trust Indenture 501(c)(3) opinion Bond counsel opinion 5 Timeline and Players Time Prior to Issue Date Event / Action Project T 3 18 months identified; declaration of intent signed T 10 weeks Appendix A initiated; bond documents initiated; diligence questionnaires mailed to Borrower T 7 weeks Plan of finance settled; Corporate resolutions adopted; Issuer application due; Issuer preliminary resolution adopted. T 6 weeks Bond documents, POS s and Appendix A sent to rating agencies for review T 5 weeks TEFRA notice published T 4 weeks On site due diligence visits T 3 weeks Receive ratings; TEFRA hearing and Issuer authorizing resolution adopted; substantially final form of bond documents put on file with Issuer; diligence interviews with executive officers; finalize and mail fixed rate Preliminary Official Statement T 2 weeks Investors call; price fixed rate bonds; sign fixed rate Bond Purchase Agreement; auditors deliver Agreed Upon Procedure Letter T 1 week Finalize and mail fixed rate Official Statement; finalize and mail variable rate Preliminary Official Statement T 2 days Price variable rate Bonds; finalize variable rate Official Statement; sign variable rate Bond Purchase Agreement; auditors deliver Agreed Upon Procedure Letter T 1 day Pre Closing meeting; all bond documents and opinions signed and delivered into escrow; mail variable rate Official Statement; auditors deliver bring down letter T Close on Issue of Bonds (i.e., Underwriter delivers sale price and Trustee delivers Bonds; DTC intermediates the exchange; documents released from escrow; leases recorded) Players Governmental issuer* 501c3 borrower* Underwriter* Bond trustee* Bond counsel Letter of Credit Bank or Bank Purchaser* Accountants Financial Advisor Bond Insurer * Represented by counsel (some roles may be combined) Applicable Laws State law Federal tax law Securities laws 6 3

5 What can be financed? Theory of exempt purpose, which is the basis for allowing a 501c3 oranization to borrow like a governmental entity, necessarily limits how the borrower can spend the bond proceeds. 7 What can be financed? Ownership Requirement All property financed by proceeds of a qualified 501c3 bond issue must be owned by a 501c3 organization or a state or local government throughout the term of the bonds. 8 4

6 What can be financed? Use Requirement At least 95% of the net proceeds of a qualified 501c3 bond issue must be used for a good use. Use of property = use of proceeds net net of Debt Service Reserve Fund 9 What can be financed? Use Requirement Types of Use: Ownership Leases Management or service contracts (safe harbors available) Research contracts (safe harbors available) Other actual or beneficial use 10 5

7 What can be financed? Use Requirement Use by the 501c3 in an unrelated trade or business not good use of bond financed facility unrelated trade or business is: Any trade or business Regularly carried on No substantial causal relationship to furthering the exempt purpose 11 Certain structural limitations Weighted average maturity of 501c3 bonds cannot exceed 120% of average reasonably expected economic life of the financed asset This limits the ability or attractiveness of bondfinancing electronic medical records / IT because of short useful life of software and hardware Skyboxes, airplanes, gambling facilities and liquor stores are prohibited Public hearing by issuer and approval of applicable elected representative 2% limit on costs of issuance 12 6

8 Management Contracts Generally, a management contract will not result in private use if it meets certain term and termination limits, based on the form of compensation chosen A management contract will result in private use if compensation is based, in whole or in part, on a share of net profits from the operation of a facility 13 Management Contracts Compensation must be reasonable and not based on a percentage of net profit Length of contract will depend on type of compensation (longer terms allowed where the relative portion of fixed compensation is increased) Renewal options solely in the hands of the exempt user are not counted in determining the term of the contract For some safe harbors, exempt person must have rights to terminate after a set period without penalty and without cause Appropriate treatment of management s employee expenses 14 7

9 Research Agreements Rev. Proc (formerly 97 14) provides safe harbors for research agreements Issue is whether the business entity providing the funding for (or sponsors) the research gets particular benefits from the research. This is an issue primarily for universities and specialty healthcare facilities such as cancer centers. 15 Research Agreements A research agreement with a corporate or government sponsor to sponsor research performed by a 501(c)(3) charitable organization or a state or local government unit conducted with property financed by qualified 501(c)(3) bonds may create private business use 16 8

10 Research Agreements Safe Harbors exist for corporate/industry sponsors and the federal government In general, the sponsor is allowed a non exclusive license or use of the research product after paying a competitive fair market value price Allow research governed by Bayh Dole Act procedures so long as safe harbor is met 17 Change in Use of Bond Financed Property Bonds can retroactively taxable as a result of excessive bad use or a deliberate action by the borrower that causes the use of bondfinanced property to change from a good use to a bad use 18 9

11 Issues Raised by Health Reform Does the creation or establishment of an ACO constitute a special legal entitlement that results in private business use? Service has solicited comments concerning whether guidance is needed regarding participation by tax exempt entities in ACOs Guidance has been requested by NABL Section 501(r) requirements Market Forces 19 10

TAX EXEMPT FINANCING BASICS FOR SECTION 501(C)(3) ORGANIZATIONS

American Health Lawyers Association Tax Issues for Healthcare Organizations October 21 & 22, 2013 TAX EXEMPT FINANCING BASICS FOR SECTION 501(C)(3) ORGANIZATIONS TODD GIBSON SQUIRE SANDERS (US) LLP JULIE