4/4/2019 Tax-Exempt Bonds – Issues for Governmental and 501(c)(3) Healthcare Institutions April 11, 2019 D. Michael Moyers W. Taylor Marshall 501-370-1492 501-370-3388 mmoyers@fridayfirm.com tmarshall@fridayfirm.com Discussion Topics • Bond Options • Tax-Exempt Bonds versus Taxable Bonds • Can your institution take advantage of tax-exempt bonds? • What are the strings attached to tax-exempt bonds? • Hot Topics in the Bond World • Audit Risk – Costs of issuance in 501(c)(3) bond issues • SEC Rule 15c2-12 Amendments • No tax-exempt advance refundings • GASB/FASB lease changes implications for bond financial covenants • LIBOR phase-out 1
4/4/2019 Bond Options • Discussion encompasses “bond issues” and tax-exempt bank loan transactions – not typical commercial bank loans. • Capital project financings – not working capital • Bond options applicable to a particular healthcare institution will depend on the ownership and management structure of an institution. • Government owned/managed? • Government owned and leased to 501(c)(3)? • Government owned and managed by 501(c)(3)? • Government owned and managed by for-profit? • 501(c)(3) owned and managed? • For-profit owned and managed? • Important to consult legal counsel to determine what options are available based on individual circumstances. Bond Options – Based on Purchaser • Public Issue • Underwriter sells bonds to investors (individuals, banks, institutions) • Official Statement (prospectus) is used to market bonds • Market drives the rates and the deal provisions • Private Placement • Bank buys the obligation • Bank may book the obligation as a loan or an investment • Negotiate terms with bank/purchaser 2
4/4/2019 Bond Options – Based on Purchaser, continued USDA – Rural Development • Rural areas of up to 20,000 in population • Must be unable to finance proposed project from own resources or through commercial credit at reasonable rates/terms • Feasibility study necessary • Public entity or non-profit • Non-profits must demonstrate significant ties to the local community (board makeup) and local support ($ contributions towards the project) • Financing parameters: • New construction, renovations, equipment • Refinancing under certain circumstances • Maximum term 40 years • No maximum amount • Interim financing “bridge loan” typically required for construction period • USDA is not responsible for obtaining interim financing – reach out to banks or retain a placement agent • Bond Counsel is needed • “Take-Out Letter” • USDA-RD provides permanent financing once construction completed or close to completion. • Grants may also be available. Bond Options – Based on Security Common types of bond issues based on security: • Hospital revenues bonds • Pledge of revenues of entity operating hospital (owner and/or lessee) • Mortgage/Guaranty may be necessary • Real estate/lease payment security • RE holding company serves as “borrower” and owns building, then leases to affiliated operating entities • Secured by lease payments to RE holding company and mortgage • Sales and use tax bonds • Must be government owned, but lease to 501(c)(3) is okay • Requires an election • Government owned and operated institutions may also pursue a supporting sales tax (without debt) for operation, maintenance, improvement, renovation, expansion, equipping • Government owned and leased institutions may also pursue a supporting sales tax (without debt) for maintenance, improvement, renovation, expansion, equipping (not payroll or operation) 3
4/4/2019 Access to Tax-Exempt Bond Market • Tax-Exempt Bonds - Investors demand a lower return on their investment if they do not have to pay income tax on the interest income, and this lowers borrowing costs. • Governmental entities have the authority to issue tax-exempt bonds. • Government owned institutions • Also government owned institutions that are leased to 501(c)(3)s • For 501(c)(3) owned facilities - 501(c)(3)s can access the tax- exempt bond market through a governmental “conduit issuer” • Arkansas Development Finance Authority • City or county public facilities board Strings Attached to Tax-Exempt Bonds In effect, tax-exempt bonds are a federal subsidy, and there are strings attached. • Private business use limitations (PBU is a special legal entitlement for use of a bond-financed property to a nongovernmental entity or the federal government) • In 501(c)(3) context, must look at unrelated use, use by non-affiliated 501(c)(3)s and for-profits. • The federal government is a “bad user” for this purpose. • Arbitrage limitations and investment restrictions • Spend money within reasonable time (generally 3 years) • Adverse findings at audit? • IRS taxes bondholders • IRS settles • Formula rate percentage of interest for the past three years (2018 was 27.8%). 4
4/4/2019 Private Business Use Most common types of Private Business Use (PBU) for healthcare institutions • Management and other service agreements (discussed on the next slide); • Leases/Subleases; • Research contracts; • Shared-use arrangements; • Sale or disposition of tax-exempt bond financed property; and • Any other agreement or arrangement that grants a special entitlement for the use of bond-financed property to a nongovernmental entity. Always ask if a facility is financed with tax-exempt bonds. Management and Service Agreements • Facilities operated or services provided by an outside entity • Management of entire facility by healthcare company • Management by doctor groups (ER, radiology, anesthesiology, etc.) • Food service/cafeteria • Pharmacy • Any other outsourcing 5
4/4/2019 Revenue Procedure 2017-13 Revenue Procedure 2017-13 provides a safe-harbor. If a management/service agreement meets the safe- harbor provisions, it does not constitute PBU. • No net profits arrangements • Contract must not, in substance, impose upon the service provider the burden of bearing any share of net losses from the operation of the managed property. • Limited term, depending on economic life of property. • Governmental/501(c)(3) must exercise a significant degree of control over the use of the managed property. • Budget approval • Governmental/501(c)(3) must bear the risk of loss upon damage or destruction of the managed property. Revenue Procedure 2017-13, continued • Service provider must agree that it is not entitled to and will not take any tax position that is inconsistent with being a service provider to the governmental/501(c)(3) with respect to the managed property. • Language needs to be added to the management agreement. • Service provider will not claim any depreciation or amortization deduction, investment tax credit, or deduction for any payment as rent with respect to the managed property. • Service provider must not have any role or relationship with the governmental/501(c)(3) that, if effect, substantially limits the governmental/501(c)(3)’s ability to exercise its rights under the contract. • Governing body 6
4/4/2019 Structuring a Financing • Financing transactions can be structured so that actual or anticipated PBU of a particular facility will not be a problem. • Combine tax-exempt bonds with other funding sources • Taxable bonds/debt • Reserves • Grants • A taxable component can provide flexibility • Spread between tax-exempt and taxable might not be much • Market-driven • Discuss plans and ideas with financing team on the front end. Remedial Actions • The tax regulations provide mechanisms to cure a deliberate action (the use of proceeds that causes the PBU test to be met). • For instance, a governmental hospital deciding to lease to a 501(c)(3) or a hospital selling or leasing to a for-profit. • Regs have differing mechanisms, depending on the facts and circumstances: • Redeem or defease bonds • “Reissue” bonds as qualified 501(c)(3) bonds • There are limitations on eligibility for remedial actions • For instance, deliberate action should be bona fide, arm’s length, for FMV. • Did not reasonably expect to take deliberate action on closing date • Voluntary Compliance Agreement Program 7
4/4/2019 IRS Form 990 Schedule K – Audit Concerns • The IRS tax-exempt bond group has implemented a data driven audit focus (as opposed to a random focus) • Soft-Contact Compliance Checks • Letter 4408 and Form 14002 • Concern with IRS Form 990 Schedule K in this environment • “Cross-selling” between IRS groups Form 990 Schedule K, continued • Part III • 1 – Was the organization a partner in a partnership, or a member of an LLC, which owned property financed by tax-exempt bonds? • 2 – Are there any lease arrangements that may result in PBU of bond financed property? • 3a – Are there any management or service contracts that may result in PBU of bond-financed property? • 3c – Are there any research agreements that may result in private business use of bond-financed property? Are any of these answers “Yes”? 8
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