Tennessee GFOA 2017 Spring Institute

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1 Tennessee GFOA 2017 Spring Institute Post Issuance Compliance: What Do I Need To Know? Mike Steinbrook, Director steinbrookm@pfm.com PFM Asset Management LLC One Keystone Plaza Suite 300 pfm.com Harrisburg, PA PFM 1

2 Old News PFM 2

3 New News Taxation Bond Documents Being Revised for Issue Price Rules March 9, 2017 Taxation Final Issue Price Rules Make Allowances for Competitive Sales December 8, 2016 Taxation IRS Reorganizing Tax Exempt Bond Group in May March 10, 2017 Taxation What's in Treasury's Newly Released Final Arbitrage Rules July 15, 2016 PFM 3

4 Background: Why we have Arbitrage Rebate Tax code limits the permitted uses of tax-exempt bonds to prevent abuses Prevents issuance of more bonds than are necessary Prevents issuance of bonds earlier than is necessary Prevents bonds from remaining outstanding longer than necessary Limitations on advance refunding (only 1 permitted) In other words, borrow what you need, when you need it, for an appropriate duration based on what is being financed. Tax law and Regulations create financial disincentives (i.e., arbitrage rebate) to prevent issuance of tax-exempt debt for profit-driven reasons Yield restriction IRC Section 148(b) Arbitrage rebate IRC Section 148(f) Overlapping requirements Belt & Suspenders Applies to every tax-exempt borrowing and some taxable subsidy obligations PFM 4

5 Tax Considerations Timeline Compliance requirements apply to every tax-exempt borrowing and certain taxable subsidy obligations Compliance begins with pre-issuance planning and continues with postissuance policies and procedures (does it ever end ) Pre-Issuance Timing, Debt Management Project draw schedule, Refunding opportunities Evaluate available exceptions and elections Identify investment options Issuance Make elections in Tax Certificate Establish and document issue price Invest bond proceeds, establish FMV Revise draw schedule Post- Issuance Arbitrage reporting Monitor expenditures Monitor investments Record retention PFM 5

6 Post-Issuance Compliance Post-issuance tax compliance begins with the debt issuance process itself and provides for a continuing focus on investments of bond proceeds and use of bond-financed property. It will require identifying existing policies, the responsible people, the applicable procedures, and the affected population. After the Bonds Are Issued Then What? Advisory Committee on Tax-Exempt and Governmental Entities June 13, 2007 PFM 6

7 Discussion Topics Post issuance compliance program Arbitrage Rebate IRS Regulations update IRS audit examination process Use of proceeds Arbitrage rebate Record Retention Post- Issuance Compliance Disclosure Private business use Record retention Disclosure Private Business Use Use of Proceeds PFM 7

8 Why Implement a Post Issuance Compliance Program? Bond documents include covenants regarding tax law compliance and taxexemption based on such compliance Audits are expensive and time consuming Reputation risk associated with violations Prevent unknown liabilities Be prepared in the event of an audit or receipt of a compliance check evaluation PFM 8

9 Components of a Compliance Program Compliance Program Tax Compliance Continuing Disclosure Arbitrage Rebate Private Business Use Record Retention Team Annual Filing Material Events PFM 9

10 Compliance Program Administration - TEAM Assigning responsibilities/designation of individuals Post Issuance Compliance Officer: Team includes Business Administrator, Accounting Supervisor, Legal, Purchasing/contracting Reporting responsibilities Ongoing review, modification, certification procedures Annual review by staff Review of assigned responsibilities; individuals assigned to monitor and manage post-issuance compliance Training and staff education Who is assigned? What are they assigned to do? When is the Team to take action? Are multiple depts. represented on the Team? PFM 10

11 Steps to Getting Started Continuing to Improve the Program Review current written procedures Document any current unwritten procedures Revise and incorporate unwritten procedures Identify gaps between good internal controls and what exists Create good internal control policies and procedures that are action steps Source materials to use as a guide: Bond documents (primarily tax certificates) Governmental Bond Compliance Check lists IRS Revenue Procedures Industry publications, e.g. GFOA Consult with your legal counsel, rebate consultant, and financial advisor PFM 11

Implement the Program Include people knowledgeable about the accounting systems, asset records, tax exempt / BABs bond rules, and development of

Create a Compliance Manual with sufficiently detailed action steps, personnel or positions responsible Create a checklist that can be completed at

12 Implement the Program Include people knowledgeable about the accounting systems, asset records, tax exempt / BABs bond rules, and development of internal controls Multi-specialty team review to identify needed changes, duplications, etc. Create a Compliance Manual with sufficiently detailed action steps, personnel or positions responsible Create a checklist that can be completed at least annually that forces a senior level review and certification of compliance Schedule ongoing (annual) training for the Compliance Team Issuer Name Post-Issuance Compliance Procedures Manual Adopted on 3/30/2017 PFM 12

13 Carrot and Stick Standard IDR question is now: do you have written policies and procedures? 2015 and before: Potential VCAP relief if you have written procedures and discover a failure (penalties to date of discovery, not failure date) 2016 and beyond IRS not encouraged by issuer compliance Statement that procedures don t have to be written (just need to be effective) Removed VCAP relief for written procedures no issuer had availed themselves PFM 13

14 IRS TEB FY 2017 Work Plan Education Outreach Publications and webinars/webcasts Direct pay bond refund process Interactive Form 8038-CP Efficiency Transparency Effectiveness Priority Examinations Evidence of noncompliance (referrals) History indicates future risk of noncompliance VCAP Voluntary Compliance Agreement Program Reduction in number of VCAP requests Streamlining the process to minimize IRS and issuer resources Possible streamlined VCAP process for arbitrage violations PFM 14

15 Final IRS Regulations Effective date: 10/16/2016 Intended to finalize proposed regs from 2007 and 2013 Working Capital Computation Date Credits Premium Callable Bonds Joint Bond Yield Authority Integration of Hedges Recovery of Overpayments (Refunds) Valuation of Investments Yield Reduction Payments FMV of U.S. Treasury Obligations External Commingled Investment Funds Small Issuer Exception Pooled Bonds FMV of Guaranteed Investment Contracts (GIC) PFM 15

business days after the sale date (or, if earlier, until 10% of the bonds have been sold at no greater than the IOP) C.

16 Final IRS Regulations Issue Price A. General rule: First price at which 10% of the bonds are sold to the public B. Special rule for use of initial public offering price (IOP): Issue price is the IOP, subject to a modified hold-the-price anti-abuse rule Underwriters agree to hold the price for five business days after the sale date (or, if earlier, until 10% of the bonds have been sold at no greater than the IOP) C. Special rule for competitive sales: Issue price is the reasonably expected IOP, subject to a three-bid requirement (with no hold-theprice rule) If three bids not received, revert to A or B A, B and C can be measured maturity by maturity Private placement with no underwriter: Issue price is the price paid by the buyer PFM 16

17 IRS Audits Priority Examination Areas Referrals, whistleblower, refunds Refund claims for arbitrage overpayments and direct-pay bonds 80% of refund claims paid History indicates future noncompliance Specifically identified small issuer bonds and prison financings Data analytics to identify trends and noncompliance indicators Market segmentation Variable rate advance refunding issues Advance refundings with open market security escrows Solid waste financings that include manufacturing processes PFM 17

IRS agent sends IDR (Information Document Request) 3. Issuer will generally have 30 days to respond 4.

18 IRS Audit Process Moving to standard 30-day response time Extension requests almost always honored when filed timely New process effective by April 2017: 1. IRS agent makes initial contact to discuss scope (new) 2. IRS agent sends IDR (Information Document Request) 3. Issuer will generally have 30 days to respond 4. Two extension requests permitted Goal: Reduce the burden on issuers and IRS agents, leading to reduced cycle time and quicker resolution PFM 18

19 Use of Proceeds Financed project What is an expenditure? (outlay vs. earmarking/encumbering funds) Capital expenditures and working capital expenditures Allocation methodology options Capital expenditure allocation options Working capital limitations and exceptions - beyond today s scope Timing of allocations Reimbursements & reimbursement resolutions Project completion; documentation/certification of project completion (occupancy certificate?) Costs of issuance PFM 19

20 Use of Proceeds & Accounting Procedures Category Financed Projects Reimburse with bond proceeds Project Completion Spend-down Requirements Expenditure Allocations Pooled Inv. Approach (Commingled Fund) Procedure Verify use of proceeds for approved projects Adoption of Reimbursement Resolution Require Occupancy Certificate, Completion Certificate Monitor 6-mo spending benchmarks Consistent method to allocate bond proceeds no later than 18-months after expenditure date Ratable allocation of investment earnings on periodic basis (no less than quarterly) PFM 20

21 Investment of Proceeds Investments, investment earnings FMV rules Open-market securities GICs CDs Escrows Valuation requirements Allocation of investment earnings Commingled Funds PFM 21

22 Investment of Proceeds Open-Market Securities (Treasuries, Agencies) Non-Negotiable Certificates of Deposit Investment Agreements & Refunding Escrows -Request at least 3 bids to establish fair market value -If 3 bids is not achievable, document prices/yields of comparable securities -For securities purchased on primary market, document trade date, issue date, purchase price, yield, etc. Safe Harbor to establish Fair Market Value: -CD yield is reasonably comparable to yield of similar maturity U.S. Treasury -CD yield is the same or higher than yield offered to the public Safe Harbor to establish Fair Market Value: -Bid specs -At least 3 bidders, noninterested parties -No last look -Highest yield wins -For escrows, open market escrow yield exceeds yield of SLGS only escrow PFM 22

23 Accounting For Bond Proceeds Significant factor in determining arbitrage rebate and yield restriction liabilities Permitted to use any reasonable, consistently applied accounting method to account for gross proceeds, investments, and expenditures of an issue Examples: FIFO, direct tracing, ratable allocation, gross proceeds spent first Proceeds are allocated to an issue until they are spent (actual cash outlay) Expenditure reallocations are permitted, however there are time limits Expenditure allocations must be made no later than 18-months after the later of the expenditure date or the date the project is placed in service Must be made no later than 60 days after five-year anniversary/final maturity date Proceeds of working capital financings (e.g., TANS, TRANs) subject to proceeds-spent-last requirement PFM 23

24 Arbitrage Rebate Requirements Arbitrage Rebate Requirements Yield Restriction Requirements Difference between Arbitrage Rebate and Yield Restriction Calculation and reporting requirements Exceptions to rebate Small issuer exception Spending exceptions BFDS exception Penalty-in-lieu of rebate Exceptions to yield restriction Temporary periods Minor portion Reasonably required reserve funds Commercial Paper - rules specific to commercial paper PFM 24

Arbitrage Rebate Monitoring Procedures Determine the yield for arbitrage purposes Compile and maintain a list of bonds in need of rebate and yield restriction calculations Monitor compliance with

25 Arbitrage Rebate Monitoring Procedures Determine the yield for arbitrage purposes Compile and maintain a list of bonds in need of rebate and yield restriction calculations Monitor compliance with exceptions Identify temporary periods Monitor compliance with yield restriction requirements Perform calculations no later than 5-year anniversary dates and final maturity dates or final bond redemption dates (may be earlier than 5-years) Make payments no later than 60 days after computation date Initiate corrective steps if payments are not made timely, or if other violations are identified If 501(c)(3) filing IRS Form 990 Schedule K, report date that required rebate calculations were completed PFM 25

Spending Exceptions Can Be Internally Monitored Reward for spending bond proceeds quickly Allowed to keep positive arbitrage Simple way to establish compliance (no FV, no yields) Must meet each

26 Spending Exceptions Can Be Internally Monitored Reward for spending bond proceeds quickly Allowed to keep positive arbitrage Simple way to establish compliance (no FV, no yields) Must meet each benchmark, no catch-up allowed * De minimis exceptions generally apply for the last benchmark ** De minimis and reasonable retainage exceptions may apply for last benchmark Application of spending exceptions is optional 6-Month 18-Month 2-Year (ACP) All gross proceeds All new money Construction issues 6 months 100% * 6 months 15% 6 months 10% 12 months 60% 12 months 45% 18 months 100% * 18 months 75% 24 months 100% ** PFM 26

27 Yield Restriction Impact Unspent Proceeds Yield restriction liability calculation Cannot blend negative arbitrage on unrestricted proceeds with positive arbitrage on restricted proceeds (can blend for rebate liability calculation) PFM 27

28 Refunding Bonds and Impacts of Refundings May accelerate final redemption of the issue Need for final arbitrage rebate report Possible loss of temporary period on the bonds being refunded Identify unspent proceeds of the old issue May create Transferred Proceeds when proceeds of the prior issue or issues become proceeds of the Refunding Bonds Escrow Management Escrow yield cannot exceed the bond yield by more than 1/1000th of 1% 0% SLGS reinvestments (rolls) Procedures for SLGS window closure (currently) Advance refunding issues have long been a target of IRS audit initiatives PFM 28

29 Arbitrage Rebate Common Omissions REPLACEMENT PROCEEDS Reserve funds funded with non sale proceeds Insurance, sale of asset proceeds Debt Service Funds (always replacement proceeds but may be excluded if they meet bona fide income and depletion tests) IRS audits now asking about how bona fide exclusion was tested more than an assumption PFM 29

30 Follow the Money! There may not be any anticipated liability You must complete and keep even if the liability is $0 Bond covenants and IRS regulations are not predicated on completion only when you anticipate a liability REALLY IMPORTANT: the arbitrage rebate computation is the financial roadmap that an IRS agent uses to trace the expenditure of proceeds and by extension, the facilities financed. IRS Consistency Requirement for Sections of the Code PFM 30

Private Business Use Tax law limits private use of TE financed facilities to 5% for unrelated use, 10% for related use Example: Lease space to Starbucks For 501(c)(3), limit 5% related use; costs of

31 Private Business Use Tax law limits private use of TE financed facilities to 5% for unrelated use, 10% for related use Example: Lease space to Starbucks For 501(c)(3), limit 5% related use; costs of issuance count against 5% Maintain records of business activities and measure private business use periodically Require legal counsel review of all management & service agreements, leases, sub-leases, naming rights contracts, etc. Coordinate use of tax-exempt-bond financed facilities with administrative team to ensure compliance PFM 31

32 Private Business Use Make sure you know the tax theory of the financing on or before bond closing (e.g.. what did the tax exempt dollars really finance) Final allocation needs to support private use case and arbitrage rebate (required consistency)! For private business use within debt financed property: Measured on issue by issue basis Procedures to flag it Process to measure it Non Profits must report annual private use by issue on IRS Form 990 Schedule K Tax restrictions are on private use over life of issue PFM 32

33 Measuring Private Business Use PBU = Average % of private business use during the 1-year periods during the measurement period Measurement Period = Beginning later of the issue date of the bonds or the date the project is placed in service Ending earlier of end of economic life of project or final maturity date of the bonds * separate rule for private ownership: PBU = greatest % of 1-year period PBU PFM 33

34 Private Business Use Change in use may require remedial action Declare official intent Identify and allocate property and non-qualified bonds Redeem or defease bonds Disclosure Management service contracts Rev Proc replaced by New safe harbors apply to management contracts entered in to on or after 8/22/2016 PFM 34

Record Retention Current requirements are burdensome and may not be consistent with document destruction policies Life of the Bonds + 3 years If the Bonds are refunded, life of refunding bonds + 3

35 Record Retention Current requirements are burdensome and may not be consistent with document destruction policies Life of the Bonds + 3 years If the Bonds are refunded, life of refunding bonds + 3 years Consider creating separate document storage and/or retention methodologies, and destruction policies for bond-related records Banks and other third parties may destroy records after 7 years Bond Proceeds Records DO NOT DESTROY! PFM 35

36 Examples Records to Retain Board minutes, resolutions Appraisals Bond transcripts Newspaper ads, misc. correspondence Investment records Expenditure histories Invoices IRS Filings Records related to acquisition of investment agreements and interest rate swaps Payments for credit facilities Arbitrage rebate and yield restriction compliance reports Issue price certifications PFM 36

37 Continuing Disclosure Annual filing requirements Mandatory filings Voluntary filings Material Events EMMA System Recent MCDC Initiative shows failings by many PFM 37

reasonably expected to timely identify noncompliance; and Procedures ensuring that the issuer will take steps to timely

38 Wrap-Up Best Practices Due diligence review at regular intervals; Identifying the official or employee responsible for review; Training of the responsible official/employee; Retention of adequate records to substantiate compliance; Procedures reasonably expected to timely identify noncompliance; and Procedures ensuring that the issuer will take steps to timely correct noncompliance. PFM Golden Rule: Processes, procedures and internal controls to assure timely compliance and avoid problems PFM 38

39 Additional Resources IRS website IRS Gov t. Compliance Check Form (from 2008 but still useful) GFOA/NABL Post Issuance Compliance Checklist GFOA/NABL Post-Issuance Compliance Guidance See Appendix for sample IRS audit questions PFM 39

40 Today s Take Aways IRS has strongly encouraged the adoption and implementation of written post-issuance compliance procedures Now - emphasis on effective procedures Not a federal tax law requirement Periodic training is encouraged (today counts!) Arbitrage rebate and yield restriction compliance is an integral part of post-issuance compliance Keeping good records, making timely allocations, and proactively monitoring arbitrage rebate and yield restriction liabilities will mitigate audit risk Arbitrage reporting creates a good tax stamp PFM 40

41 THANK YOU! PFM 41

42 Appendix Sample IRS Audit Questions PFM 42

43 Easy: Generic and straightforward Please provide a description of the current status of the Bonds. (i.e., outstanding, retired, refunded, defeased, etc.). Please provide a complete copy of the bond transcript. Please provide a schedule of the total interest expense paid on the Bonds from the issue date to the most recent interest payment date. Please describe the specific project(s) financed with the Bonds. PFM 43

44 Moderate: More intriguing, requires some digging Provide copies of all bank trustee or other statements for all accounts containing gross proceeds of the Bonds. Please describe the accounting method used to account for gross proceeds, investments, and expenditures of this bond issue and how this accounting method is reflected in the issuer's books and records. (Note: If an issuer fails to maintain books and records sufficient to establish the accounting method used for an issue and the allocation of the proceeds of that issue, the specific tracing method is to be used.) Were there any changes to the expected use of proceeds since the date of issuance? If so, please describe. Please provide a copy of the most recent arbitrage rebate and yield restriction computation prepared for the Bonds. PFM 44

45 Difficult: Requires research and your time For each project identified above, please provide a listing of the facilities or assets acquired or financed with bond proceeds including the date acquired or placed in service and the total cost of each asset. For any office space, training facilities, or storage space included in the bond financed property, please provide a description of the size, location, user, or use of any such space. Please provide a statement of assets, or other documentation, showing the value of each nonpurpose investment held in each account purchased with gross proceeds of the Bonds for any date the investments must be valued (e.g., a computation date). PFM 45

46 Question on written procedures Are there written procedures, other than bond documents provided at closing, which contain the following key characteristics to ensure that violations are timely identified and corrected so that the Bonds remain in compliance with federal tax requirements from the time they are issued until they are no longer outstanding? Due diligence review at regular intervals? Identification and training of the officer or employee responsible for review? Retention of adequate records to substantiate compliance (e.g., records relating to the allocation of proceeds, etc.). Procedures reasonably expected to timely identify noncompliance? Procedures to ensure that steps will be taken to timely correct noncompliance? PFM 46

Post Issuance Compliance

Post Issuance Compliance Joan M. DiMarco, Managing Director PFM Asset Management LLC Arbitrage Rebate and Post Issuance Compliance Group Two Logan Square Suite 1600 Philadelphia, PA 19103 Phone: 215-667-6100