i
The title of this post is taken from an observation that a client once made when the strictures of the notice, hearing, and approval requirements set forth in Internal Revenue Code Section 147(f), which with limited exceptions apply to all issues of tax-exempt private activity bonds, worked to prevent a hoped-for use of proceeds of a qualified private activity bond issue. These notice, hearing, and approval requirements were originally enacted as part of the Tax Equity and Fiscal Responsibility Tax Act of 1982, so the acronym “TEFRA” is commonly used in connection with these requirements. According to urban legend, the coarsest of the four-letter words is also an acronym, the components of which the esteemed etymologists Van Halen detailed in the title to the band’s triple platinum 1991 album.[1]
If the application of the bureaucratic acronym has ever exasperated you to the point that you’ve uttered the vulgar one, take heart – relief is at hand. On September 28, 2017, the Treasury Department issued proposed regulations (“Proposed Regulations”) that make the TEFRA rules much more manageable and that can be used before the Proposed Regulations become final. For a summary of the Proposed Regulations, hit the jump below (or, in keeping with the Van Halen references, go ahead and jump).
Background
Before delving into the Proposed Regulations, an explanation of the TEFRA notice, hearing, and approval regime is necessary for context. As originally enacted, the TEFRA rules applied only to industrial development bonds. The Treasury Department issued temporary regulations in 1983 regarding the TEFRA requirements (the “Existing Regulations”).[2] The Existing Regulations remain in effect, but they have not been amended since their promulgation, even though the Tax Reform Act of 1986 expanded the scope of the TEFRA requirements from industrial development bonds to all qualified private activity bonds (i.e., exempt facility bonds, qualified mortgage bonds, qualified veterans’ mortgage bonds, qualified student loan bonds, qualified redevelopment bonds, and qualified 501(c)(3) bonds).
Under Section 147(f), and subject to limited exceptions, an issue of qualified private activity bonds must be approved on or before its issuance date by the governmental unit that issues the bonds and the governmental unit in which the bond-financed facility will be located (if different than the issuing unit). This latter approval is referred to as “host approval.” Under the Existing Regulations, this approval must be given after a public hearing that is conducted after reasonable public notice of the hearing.
The Existing Regulations provide that both the hearing notice and the approval of the bond issue must set forth: (1) a general, functional description of the type and use of the facility to be financed; (2) the maximum aggregate face amount of obligations to be issued for the facility; (3) the initial owner, operator, or manager of the facility; and (4) the location of the facility by street address.[3] For this purpose, the Existing Regulations define a “facility” as a tract or adjoining tracts of land, including any improvements thereon and any personal property connected with the land and any improvements; non-adjoining tracts of land (and improvements and connected personal property) are part of a single facility only if they are used in an integrated operation.
The Existing Regulations further provide that public notice of the hearing is presumed to be reasonable if it is published in a newspaper of general circulation available to residents of the governmental unit in which the facility will be located (or announced by radio or television broadcast to those residents) no fewer than 14 days before the hearing. Finally, the Existing Regulations provide that a TEFRA approval is valid notwithstanding any insubstantial deviations with respect to: (1) the maximum aggregate face amount of obligations to be issued for the facility under the TEFRA approval; (2) the name of the facility’s initial owner, operator, or manager as set forth in the TEFRA approval; or (3) the type or location of the facility as described in the TEFRA approval. The Existing Regulations do not, however, define what constitutes an “insubstantial deviation.”
The Treasury Department released proposed regulations in 2008 that would have simplified the TEFRA requirements (the “2008 Proposed Regulations”). The 2008 Proposed Regulations were favorably received, but they have not been finalized and cannot be applied to an issue of qualified private activity bonds. The Proposed Regulations withdraw the 2008 Proposed Regulations, but they incorporate and improve upon many of the provisions of the 2008 Proposed Regulations. If finalized, the Proposed Regulations will remove and replace the Existing Regulations; except as modified, however, the Proposed Regulations contain the same substantive provisions as the Existing Regulations.
How the Proposed Regulations Modify the Existing Regulations
The notable modifications of the Existing Regulations by the Proposed Regulations are as follows:
-
Host jurisdiction approval is not required for (i) qualified 501(c)(3) bonds issued to finance working capital expenditures, (ii) qualified mortgage bonds, (iii) qualified veterans’ mortgage bonds, and (iv) certain refundings of bonds that were issued to finance mortgages of owner-occupied residences prior to the enactment of Internal Revenue Code Section 143.[4]
-
Public notice of the TEFRA hearing still must be disseminated at least 14 days before the hearing to be presumed reasonable, but, in addition to newspaper publication and radio or TV broadcast, the Proposed Regulations provide that reasonable public notice of the hearing can be given by (i) postings on the approving governmental unit’s public website or (ii) alternative methods permitted under a general state law regarding public notices for public hearings held by a governmental unit. If notice of the hearing is made by a posting to the approving governmental unit’s public website, the governmental unit must offer to those residents who lack internet access a reasonable, publicly known alternative method for obtaining the information contained in the TEFRA hearing notice. The Proposed Regulations identify telephone recordings as an example of a reasonable, publicly known alternative for such residents. The Proposed Regulations do not clarify whether residents are considered to have internet access if they are served by a publicly available institution that has internet access, such as a public library.
-
The Proposed Regulations use “project,” rather than “facility,” as the item that must be described in the TEFRA hearing notice and approval of the bond issue. The Proposed Regulations define a project as “one or more capital projects or facilities, including land, equipment, and other property, to be financed with an issue, that are located on the same site, or adjacent or proximate sites used for similar purposes” and that are subject to the TEFRA notice, hearing, and approval regime.[5]
The Proposed Regulations do not, however, provide any guidance as to when capital projects or facilities will be considered to be located on “proximate sites” and when such projects or facilities will be treated as “used for similar purposes.” The preamble to the Proposed Regulations notes that the term “facility,” as defined in the Existing Regulations, was ambiguous and in need of replacement because it is difficult to determine whether non-adjacent tracts of land (and improvements thereon and connected personal property) are part of an “integrated operation.” The definition of project does make it clear that a single project can exist on multiple sites, but the definition of project suffers from a not insignificant ambiguity as to whether (i) non-adjacent sites are sufficiently “proximate” and (ii) the purposes carried out at such sites are sufficiently “similar” such that the assets located at different sites can be considered a single “project” for purposes of the TEFRA notice, hearing, and approval requirements.
-
The TEFRA hearing notice and approval still must provide a general, functional description of the type and use of the project to be financed by the bond issue, but the Proposed Regulations make clear that this element will be satisfied if the TEFRA notice and approval identify the category of qualified private activity bonds to be issued and the use of the project to be financed by the bond issue. The Proposed Regulations give as an example of a satisfactory general, functional description “qualified 501(c)(3) bonds as defined in section 145 for a hospital facility and working capital expenditures.” This modification of the Existing Regulations will greatly simplify the project description that must be contained in the TEFRA hearing notice and approval.
-
Under the Proposed Regulations, the TEFRA hearing notice and approval must include the name of the expected initial (i) owner (either the fee titleholder or the person treated for federal tax purposes as the owner) or (ii) principal user of the project. It is not clear whether a “principal user” of the project is the same as a manager or operator, either of whom can be identified under the Existing Regulations.
-
The Proposed Regulations provide special rules for the public approval of (i) qualified 501(c)(3) bonds that are issued for pooled financings, (ii) mortgage revenue bonds, and (iii) qualified student loans.
-
Finally, and perhaps most importantly, the Proposed Regulations provide some clarification as to what constitutes an “insubstantial deviation” from the TEFRA hearing notice and approval, and they also allow for a supplemental public approval to cure certain substantial deviations.
Under the Proposed Regulations, an “insubstantial deviation” arises if: (1) the actual initial owner or principal user of the project differs from, but on the issuance date of the bonds is related to, the person named in the TEFRA hearing notice and approval as the expected initial owner or principal user; or (2) the actual stated principal amount of the bonds that finance the project (i) is no more than 10% greater than the maximum stated principal amount specified in the TEFRA hearing notice and approval or (ii) is any amount less than that specified maximum stated principal amount.[6]
If there is a substantial deviation between the actual use of the bond issue and the use stated in the TEFRA hearing notice and approval, that deviation can be cured under the Proposed Regulations if: (1) the bond issue satisfied the public approval requirements; (2) on the issuance date of the bond issue, the issuer reasonably expected that there would be no substantial deviations between the actual use of the bond issue and the use specified in the TEFRA hearing notice and approval; (3) the proposed substantial deviation in use results from unexpected events or unforeseen changes in circumstances that arise after the issuance date of the bond issue; and (4) before using proceeds of the bond issue in a manner or amount not provided in the TEFRA hearing notice and approval, the issuer obtains a supplemental public approval that complies with the public approval requirements set forth in the Proposed Regulations.
The supplemental public approval requirement applies by treating the bonds as if they are reissued for purposes of Internal Revenue Code Section 147(f) and, thus, necessitates a new notice of public hearing, a new public hearing, and a new approval by an applicable elected representative of the issuer (and, if different than the issuer, the host governmental unit). It is not clear that this cure for substantial deviations extends to such deviations that involve (i) a different location for the project than the one specified in the TEFRA hearing notice and approval or (ii) the issuance of bonds in a principal amount that exceeds by more than 10% the maximum principal amount set forth for the project in the hearing notice and approval. There is no discernable reason why this cure cannot extend to these situations. Perhaps the Proposed Regulations when finalized will clarify more definitively the scope of this cure for substantial deviations.
The ability to ameliorate certain substantial deviations is, however, a significant improvement over the Existing Regulations. The Existing Regulations provide no method by which an issuer can remediate a substantial deviation. Consequently, under the Existing Regulations, if there is a substantial deviation from the specifications contained in the TEFRA hearing notice and approval, the issuer can ameliorate this deviation only by entering into the IRS’s Voluntary Closing Agreement Program. Unlike the Proposed Regulations’ remedial action for substantial deviations, the use of VCAP entails uncertainty as to the resolution and can result in significant expense.
Going Forward
A taxpayer normally cannot avail itself of proposed Treasury regulations, but the Proposed Regulations expressly allow issuers to apply them (in whole but not in part) to bonds that are issued pursuant to a public approval that is given on or after September 28, 2017. Notwithstanding the items noted above that need clarification, the Proposed Regulations are a significant improvement over the Existing Regulations. It is difficult to conceive of a circumstance in which the Proposed Regulations would not be applied to an eligible issue of qualified private activity bonds. As for the uncertainties described above (and those that I’ve overlooked), comments on the Proposed Regulations can be submitted to the Treasury Department by December 27, 2017.
[1] To my knowledge, these are the only two acronyms that can act as a noun, verb, and adjective.
[2] The Treasury Department also issued proposed regulations along with the Existing Regulations, but these proposed regulations have never taken effect and are withdrawn by the Proposed Regulations described below.
[3] If no street address is available, a general description designed to inform readers of the facility’s location must be given.
[4] The Proposed Regulations collectively define items (ii), (iii), and (iv) as “mortgage revenue bonds.”
[5] The Proposed Regulations make clear that, in the case of mortgage revenue bonds and qualified student loan bonds, a “project” is the mortgage loans or qualified student loans to be financed by the bond issue, and the Proposed Regulations also provide that, in the case of qualified 501(c)(3) bonds, a “project” also includes working capital expenditures financed by the bond issue.
[6] This is a significant, and beneficial, change from the 2008 Proposed Regulations. The 2008 Proposed Regulations required that the TEFRA hearing notice and approval set forth “the maximum stated principal amount of the issue of private activity bonds to be issued to finance the facility.” The 2008 Proposed Regulations also provided that only an insubstantial deviation results if the difference between “the amount of proceeds of the issue that the [TEFRA hearing notice and approval] stated would be used for a facility and the amount of proceeds actually used for that facility . . . does not exceed an amount equal to five percent (5%) of the net proceeds . . . of the issue.” There were several problems with this proposal. First, the 2008 Proposed Regulations mandated that the TEFRA hearing notice and approval state the maximum principal amount, rather than the proceeds, of the bond issue that would finance the facility. An insubstantial deviation that was defined with reference to proceeds of the issue set forth in the TEFRA hearing notice and approval was unworkable, given that proceeds of the issue would not be set forth in the hearing notice and approval. Second, in the absence of any guidance in the Existing Regulations as to what constitutes an insubstantial deviation in the maximum principal amount specified in the TEFRA hearing notice and approval, bond counsel had routinely defaulted to a 10% excess amount by reference to the 10% “substantial amount” test set forth in the Section 148 regulations for purposes of determining whether a substantial amount of a maturity had been sold to the public such that the issue price of that maturity could be established based on actual sales to the public. Accordingly, a 5% collar above and below the maximum stated amount came as quite a surprise to practitioners. Finally, any reduction in the actual amount of qualified private activity bonds issued as compared to the amount stated in the TEFRA hearing notice and approval should be an insubstantial deviation, because it results in a lower (i.e., less burdensome) implicit subsidy paid by the federal treasury and a smaller project that is less disruptive to the affected residents. A cap on insubstantial deviation is necessary if an excess amount of bonds will be issued, but if the amount of bonds to be issued will be reduced, the sky should be the limit (yes, you read that correctly).
