The ABC’s of PIBC (Post-Issuance Compliance)… keeping you and the IRS happy Karen Huffman, CPA, Controller, City of Tempe Scott W. Ruby, Attorney, Gust Rosenfeld, P.L.C

Issuance of Debt Many of us have issued debt COT issues debt annually GO +Excise money pours in + build streets

Life is Good Citizens are happy pot holes are filled Police facilities are constructed Parks are expanded Local Government is happy Provide great service and amenities in our communities All is well And then…..

Post Issuance Bond Compliance Then comes…. Post Issuance Bond Compliance IRS/tax code mandates these requirements/ “strongly” suggested guidelines One of the main emphasis from these “guidelines” for PIBC written procedures Can be daunting when signing of on bond documents (form 8038) Check box regarding “written procedures” Tempe has procedures just not fully documented

Felt like a monumental task- How do you climb a mountain? One step at a time Looking for the next ledge to anchor to Rock climbing Safety rope- Calling in a “life line”- consultants (experts)

ABC’s of PIBC Legal Expert Practical Aspect What is included in the law What does it mean Practical Aspect What did the City of Tempe do What challenges did we face Approach for Today’s session: 1> legal expert- Scott - what is included in the law - what does it mean 2> practical aspect - what strategies did Tempe use - what challenges did we face Turn it over to our Legal guru….

Post-Closing (What's That?) Tax-advantaged bonds are subject to federal tax requirements BOTH at the time of issuance AND so long as the bonds remain outstanding. IRS is concerned about issuers post-issuance compliance and is “encouraging” adoption of written post-issuance compliance policies. IRS concern has manifested into a post-closing compliance initiative. Governmental issues are now on the radar screen. IRS wants issuers to focus on continued monitoring and better record keeping.

Your Obligation Develop a post-compliance program. Retain certain records. Monitor private business use of financed facilities; and changes in use. Track and Monitor Payments that Result from Financed Facilities. Track Investment of Bond Proceeds and monitor the use of bond proceeds Calculate Arbitrage and Pay Rebate or Yield Reduction. Respond to IRS inquiries.

Specific Focus of a Post-Closing Compliance Program Assign responsibility. Train responsible person and others who work with bonds and bond financed property Develop a system to monitor compliance that is integrated with existing accounting systems and will allow timely discovery and correction of any problems. Record retention must be for LIFE OF BONDS plus 3 years - - who will be around?

Alert! Alert! Tax-advantaged bonds are subject to federal tax requirements BOTH at the time of issuance AND so long as the bonds remain outstanding.

IRS has an initiative We are on the radar screen At City of Tempe- goal Implement such a program that we can just “smile and wave”

IRS Form 14002 Tempe approach: Walk down IRS form 14002- ensuring every area was addressed and documented Defined who was responsible- Document in a policy CFO Policy on “Proper” Use of Bond proceeds What does that mean? CIP funds broken out by function (police, fire) Entire fund reimbursed with bond proceeds Challenge: If not reimbursed, then where is it going to be charged? Capitalizeable items per GAAP “Capitalizeable costs include the cost to purchase/construct an asset including the ancillary charges necessary to place the asset into its intended location and condition for use” Salaries? Admin Spoke with our auditors- Cities are taking the conservative approach and not reimbursing those items with bond proceeds Trip to Japan for Dam? Feasibility study: need pay-go or other source to finance Need to think through this items during the budget process so no surprises Develop system to monitor proper use As accountants, not subject matter experts in what expenditures Are true project costs Developed a “Framework of Allowable Costs” Meet with project managers to discuss Upfront do not charge project costs that are not allowable Method of Department review Training of project managers Understand element of finance (like grant) Need documentation

Retain Certain Records Basic records: Transcript Ordinances Opinion Documentation evidencing expenditure of bond proceeds. Documentation evidencing all sources of payment or security for bonds. Documentation pertaining to any investment of bond proceeds. Remember, the burden of proof is on you to establish the bonds are Tax-Exempt if you are audited – you can only do so through records.

Life of Bonds + 3 Years Biggest Challenge: AP Invoices Burden of Proof: Life of bond+3 years Transcript of Proceedings Bond File Debt Service schedules Cost of issuances Journal entries Electronically filed by bond issuance Schedules Arbitrage support Retaining invoices- CIP Bond File (Challenge) AP staff put invoices in folder weekly Download GL by fund monthly Files the GL with matching invoices in folder Eventually go paperless

Monitor Private Business Use of Financed Facilities What was intended use of facility being financed by the bonds? Who “owns” it? (Use federal tax definition of owner). Who was using it, who is using it, and who may use it? Is there any “bad” use? How much? (10% and 5% Rules). Practical difficulties – your the CFO … who else has control of the building and programming? (Need for formal policy and procedures.)

Track and Document Changes in Use Create central repository, clearinghouse process through your office. Review (before it happens) any change in the use of the financed facilities. Changes in use can trigger change in the tax status if not done properly and the changes and tax impact are very fact intensive

Track and Monitor Contracts/Leases that Touch Financed Facilities Types of Relationships that create private use: Leases Management and Services Contracts Research Contracts “Partnerships” with private uses? Sales agreements Take or Pay Contracts Land Use agreements, easements, naming rights, licenses

Track and Monitor Payments that Result from Financed Facilities Review Payments from Users of the Facilities Regardless if Used to Pay Debt Service. Lease Payments. Payments from Management Contracts. Proceeds from Sale of Facilities. Allowed to Reduce Payments by Operating Expenses.

Monitoring Private Use Monitoring Private Business Use Have conversations with Attorney’s office + CD to determine the extent to which have these agreements Review existing Capital Assets Downloaded list of buildings from Capital Asset system removed all items before any outstanding bond issuances reviewed remaining assets to determine items that were reimbursed with bond proceeds Annually review with CD to determine if any of the space is being leased

Investment of Bond Proceeds Allowable Investments: Proceeds may be restricted to tax-exempt (non-AMT) investments depending on use of the proceeds, initial expenditure projections, and/or other bond covenants Investments must comply with ALL of the following: Arizona statute for investment of public funds Issuer's investment policy Authorized investment list included in bond covenants (if applicable)

Investment of Bond Proceeds Investments beyond any qualifying temporary period may have further restrictions – check with bond counsel and/or your bond documents to ensure compliance Initial investment of proceeds: Match investment maturity dates and amounts to the project draw schedule If the issue may qualify for a spending exception to rebate; be sure to structure your portfolio to accommodate the timing of the expenditures No investments should mature beyond the temporary period (if applicable) in the initial portfolio.

Reimbursement With Bond Proceeds Bond proceeds can be treated as spent (no longer need to track the investment of the money) if used to reimburse the issuer for certain qualifying prior expenditures. Expense was paid no earlier than 60 days prior to declaration of official intent to reimburse. Reimbursed not more than 18 months after the facility was placed in service or 3 years after bonds are sold. Exceptions exist for certain preliminary expenditures.

City of Tempe’s Debt Practices Simple + Systematic Typically issue debt each June (unless it is a refunding) GO Issuances Issue a letter of intent (Scott will discuss) August (can go back 60 days on expenditures) Spend for a year- tracking expenditures

Typical Debt Issuance Prior Year Expenditures Up-coming Year’s Anticipated Expenditures Current Year’s Bond Issuance Size bond issuance to cover amounts spent + anticipated expenditures for upcoming year. Balanced approach ½ spent before the issuance ½ spend after the issuance

Reimbursement + Investment Immediate reimbursement of funds spent Remaining investment in LGIP or Trust Account Immediate reimbursement Our approach minimizes the amount of unspent proceeds to track in investments Fairly confident that will be able to spend at within a certain amount of time remaining money into LGIP account- within investment policies challenging to match to draw schedule We don’t utilize the strategy of purchasing maturities (but it is a wise strategy) Advantages- easier to meet 24 month construction exception 3 year Temporary period Disadvantages- cash spent but investment rates are low Arbitrage rebate calculations for 24 month construction spending exception Easy to use LGIP Pool 5 rate Speaking of Arbitrage, fasten your safety belt…… Scott Advantage- meeting 24 month arbitrage spending exception + temporary period Disadvantage- using City’s cash initially

Arbitrage Bonds Bonds become taxable if the Bond is an arbitrage bond. Arbitrage bond exists if the issuer violates either the: Yield restriction requirement; or Rebate requirement. Yield Restriction Requirement: Gross proceeds cannot be invested in a materially higher yield; A materially higher yield is (some exceptions): Governmental Project Bonds: 1/8 of 1% (.125%) greater than the bond yield; Refunding Bonds: 1/1000 of 1%; and Other Types of Bonds: Other limits.

Arbitrage Bonds (cont’d) Exceptions to Yield Restriction Requirement. Investment in tax-exempt bonds (non-AMT). Temporary period for construction fund (3 years) or bona fide debt service fund (13 months). Reserve or replacement fund. Minor portion: lesser of 5% of sales proceeds or $100,000. Bonds must also “pass” the reasonable expectations test. Can lower the yield with yield reduction payments (some exceptions).

Arbitrage Bonds (cont’d) Rebate Requirement. Certain earnings must be rebated (e.g. earnings on the construction, reserve and debt service funds). Exceptions to Rebate. Small Issuer: governmental issuer who issues less than $5 million of tax-exempt obligations in the year. Spending: (1) 6 months – spending 100%; (2) 18 months, spend certain percentages by 6, 12 and 18 months; (3) 24 months (construction bonds), spend certain percentages by 6, 12, 18 and 24 months. (Still rebate on reserve and debt service funds). Bona Fide Debt Service Fund: If $100,000 or less.

Arbitrage Rebate and Yield Reduction Calculations Issuer is responsible for rebate and yield reduction calculations: Calculations must be completed every 5 years (IRS) and payment remitted if required Calculations are typically done more frequently (annually, monthly..) to monitor and track liabilities and spending exceptions if applicable A rebate fund must be established if a liability exists to set aside funds for payment If calculations show no payments are due, no reporting is required to the IRS

Arbitrage Rebate and Yield Reduction Calculations (cont’d) Choose accounting method with respect to bond proceeds and interest earnings, investment, and expenditures. Obtain computation of “yield” of bonds and establish procedure to track investment returns. Establish procedure for allocation of bond proceeds and interest earnings to expenditures, including reimbursement of pre-issuance expenditures.

Tips to Avoid Becoming an Arbitrage Bond (cont’d) Monitor compliance with “temporary period” expectations for expenditure of bond proceeds, typically 3 years for new money bonds, and provide for yield restriction of investment or “yield reduction payments” if expectations are not satisfied. Establish procedures to ensure investments acquired with bond proceeds are purchased at fair market value. These can include use of bidding procedures under regulatory safe harbor.

Tips to Avoid Becoming an Arbitrage Bond (cont’d) Avoid formal or informal creation of funds reasonably expected to be used to pay debt service on bonds without determining in advance whether such funds must be invested at restricted yield. Consult with bond counsel before engaging in post-issuance credit enhancement transactions (e.g., bond insurance, letter of credit) or hedging transactions (e.g., interest rate swap, cap). Identify situations in which compliance with applicable yield restrictions depends upon later investments, (e.g., purchase of 0% SLGS from U.S. Treasury), and monitor implementation.

Tips to Avoid Becoming an Arbitrage Bond (cont’d) Monitor compliance with 6-month, 18-month, or 2-year spending exceptions to rebate requirement. Arrange for timely computation of rebate liability and, if rebate is payable, for timely filing of Form 8038-T and payment of rebate. Rebate is ordinarily due at 5-year intervals. Arrange for timely computation and payment of “yield reduction payments,” if applicable. Issuers/borrowers frequently engage outside arbitrage/rebate consultants to do such computations.

Tracking Expenditures Issuer is responsible for rebate and yield reduction calculation!! Tempe example of how we monitor the spending exceptions and allocate interest. Track expenditures on Arbitrage Support schedule Monthly download + review exp Monitor 6-month, 18-month, 24 month exceptions Interest allocation Quarterly charged to fund (per IRS no less than quarterly) Move total earning to DS fund to avoid approp issue Arbitrage Need to track taxable series (BAB, QECB) WIFA  

Debt Service Fund Debt Service Fund If one is established through bond documents- (DS Reserve Fund) If required in the bond doc’s Fund holding secondary property tax Must clear out 11/12th annually to be “Bona Fide” Tempe’s method lend us NOT to having a Bona Fide DS Fund Non-Bona Fide Fund analysis We will “yield restrict” or make a “yield reduction payment” Compare arbitrage yield to annual portfolio yield Consult with your Arbitrage consultant IRS may forgive penalty but will not forgive interest It compounds! Look at a 5 year period Could own but then later it may be able to request a refund Key: have the calculation done timely and remitted to the IRS Two past issuances owing a rebate on the Debt Service Fund (property tax) 1995 GO Issuance $14k in arbitrage rebate payment $12k in interest 1998 GO Issuance $7.4k in rebate payment $4.6k in interest “Innocent Failure” letter Importance of working with your arbitrage consultant Speaking of the IRS….

IRS City on it 3rd Desk Review BAB Excise issuance- 2009 Refunding- 2003 TCA Excise- 2006 Answered a 15 page questionnaire Send closing documents Follow up Had to supply invoices

Summary The tax-issues do not go away once you close the bonds. Continuing obligations are important. Uses of your buildings that were financed with bond proceeds will probably change over 20 plus years. IRS is becoming much more active in policing post-issuance compliance matters Consequences of non-compliance: Bonds could forfeit their tax-exempt status.