New Market Tax Credits: Meeting IRS Requirements When Structuring - - PowerPoint PPT Presentation

Presenting a live 110‐minute teleconference with interactive Q&A

New Market Tax Credits: Meeting IRS Requirements When Structuring NMTC Deals

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific THURS DAY, APRIL 25, 2013

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

Michael I S anders Partner Blank Rome Washington D C Michael I. S anders, Partner, Blank Rome, Washington, D.C. Annette S tevenson, CP A, Partner, Novogradac & Company, Cleveland Megan A. Christensen, Attorney, Blank Rome, Washington, D.C.

Attendees seeking CPE credit must listen to the audio over the telephone.

Please refer to the instructions emailed to registrants for dial-in information. Attendees can still view the presentation slides online. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 10.

Tips for Optimal Quality

S d Q lit S

• und Quality

For this program, you must listen via the telephone by dialing 1-866-873-1442 and entering your PIN when prompted. There will be no sound over the web connection. If you dialed in and have any difficulties during the call, press *0 for assistance. Y

• u may also send us a chat or e-mail sound@straffordpub.com immediately so

we can address the problem we can address the problem.

Viewing Qualit y

To maximize your screen, press the F11 key on your keyboard. To exit full screen, press the F11 key again.

Continuing Education Credits

FOR LIVE EVENT ONLY

For CLE credits, please let us know how many people are listening online by completing each of the following steps:

• Close the notification box
• In the chat box, type (1) your company name and (2) the number of

attendees at your location

• Click the S

END button beside the box For CPE credits, attendees must listen to the audio over the telephone. Attendees can still view the presentation slides online. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926- 7926 ext. 10.

Program Materials

If you have not printed the conference materials for this program, please complete the following steps:

• Click on the + sign next to “ Conference Materials” in the middle of the left-

hand column on your screen hand column on your screen.

• Click on the tab labeled “ Handouts” that appears, and there you will see a

PDF of the slides for today's program.

• Double click on the PDF and a separate page will open.

Double click on the PDF and a separate page will open.

• Print the slides by clicking on the printer icon.

IRS REQUIREMENTS IRS REQUIREMENTS WHEN STRUCTURING WHEN STRUCTURING WHEN STRUCTURING WHEN STRUCTURING NMTC DEALS NMTC DEALS

Michael I. Sanders, Esq.

Blank Rome LLP 600 New Hampshire Avenue NW Washington, DC 20037 Sanders@BlankRome.com

Excerpted from the forthcoming Joint Ventures Involving Tax-Exempt Organizations, Fourth Edition (available October 2013). Used with permission of John Wiley & Sons, Inc.

NMTC STRUCTURE OVERVIEW 2013 I Introduction:

• I. Introduction:
• Opportunity for nonprofits to
• Opportunity for nonprofits to

subsidize or provide gap financing for developments in a qualified for developments in a qualified census tract (low income, high unemployment) unemployment).

• Financial benefits to developers,

businesses and charities businesses and charities

6

• Major investors such as Goldman,

Bank of America JP Morgan US Bank of America, JP Morgan, US Bank or PNC buy credits for cash infusion to the development which infusion to the development which may not be paid back at the end of the 7-year compliance period the 7-year compliance period.

• Under leverage structure, investor

i i f 9 t 10 may receive in excess of 9 to 10 percent return after tax.

7

New Markets Tax Credit New Markets Tax Credit – – A Government Sponsored Joint A Government Sponsored Joint Venture Vehicle Venture Vehicle

Basics: $33 billion in NMTC allocated through 2012; extended by Congress for 2 more years at $3.5 Billion each year.

Purpose:

The new markets tax credit (NMTC) serves as a way to provide subsidy or gap financing to real estate developments, business activities, or charitable

• perations planned in qualified census tracts (high unemployment or
• perations planned in qualified census tracts (high unemployment or

poverty rate, low median family income).

What does it provide?

39% tax credit on the capital invested in a community development entity (CDE), over 7 years (5% in yrs 1-3; 6% in yrs 4-7).

Who benefits from the credit?

The investor (typically national banks, insurance companies) making an investment in a CDE gets a tax credit of $0.39 for every $1 invested and CRA credit, which under a “leveraged” structure yields in excess of a 10% after-tax return. The CDE directs capital into qualified projects or

• businesses. The investor is not repaid its equity investment.

Eligible Investments:

• Community businesses, including e.g. hospitals, charter schools.
• Commercial or mixed-use real estate projects (at least 20% of gross

income from commercial component).

Examples:

• 105-Unit, The Bradford -- $45M affordable housing and ground floor retail

space in Bedford-Stuyvesant. Innovative structure allowed HDC and HPD financing to be used, with Goldman Sachs as the equity investor; BRP and Bedford-Stuyvesant Restoration Corp were the development partners. y p p p

• $100M charter high school in Mott Haven, Bronx. Robin Hood Foundation

was sponsor; JPMorgan Chase was investor. 8

• II. Unwind Exit Strategies: Put-Call

Options Planning Opportunities to Options, Planning Opportunities to Mitigate Burdens of Tax Consequences at Exit

• At the end of the 7-year compliance

period when the investor has period, when the investor has received all the NMTCs for which it is eligible it along with the CDE is eligible, it, along with the CDE, will likely want to unwind the transaction and exit the structure transaction and exit the structure.

9

• This is typically accomplished

thro gh the se of a “p t/call” through the use of a “put/call” technique that generates a subsidy

• r grant eq i alent to the QALICB
• r grant equivalent to the QALICB.

10

• There is often tension manifested between the

equity investor and the QALICB in equity investor and the QALICB in negotiating the put/call structure. Equity investors are interested in protecting the value p g

• f their cushion while the QALICB is

interested in “assurance” that the investor will i d d i h d indeed exercise the put and may attempt to use techniques that would devalue the call (through the use of a fair market value (through the use of a fair market value formula, annual interest accruals and a significant partial payment in year 7). The g p p y y ) investor, however, wants to be assured that it will be treated as the owner of the equity piece.

11

• Under one version of this technique,

h i h h i h i the investor has the right to require the QALICB, over a specified i d h h i ’ period, to purchase the investor’s interest in the Fund for a specified i ( h “ ”) I h h price (the “put”). In the even the put is not exercised, the QALICB ( ffili t ) h th i ht t (or an affiliate) has the right to purchase the investor’s interest in th F d ifi d i d f the Fund over a specified period for fair market value (the “call”).

12

• The put and call will likely be priced

substantially below the investor’s original substantially below the investor s original investment in the Fund.

• If either the put or the call are exercised, the

If either the put or the call are exercised, the investor would be removed from the

• structure. An affiliate of the QALICB

typically would be substituted in place of the investor, thereby controlling the Fund, and ld t k t t d th i would take steps to redeem the managing member of the CDE. The result here is a net benefit to the project measured by the amount benefit to the project measured by the amount

• f the investor’s original funds less fees,

professional and administrative costs and the p price of the put/call.

13

• After the investor is removed the
• After the investor is removed, the

QALICB may then cause the Fund to liquidate the CDE often using to liquidate the CDE, often using the QLICI “A” Note previously held by the CDE to repay the leverage by the CDE to repay the leverage lender, and subsequently liquidate the Fund leaving the QALICB on the Fund, leaving the QALICB on its own and the leverage lender holding the A Note holding the A Note.

14

• In the event that the leverage lender

is controlled by a §501(c)(3) entity

• r is itself a charity, it may decide to

forgive all or a portion of the leverage loan at the end of the compliance period, but it must not be legally obligated to do so at inception.

15

• Alternatively the QALICB may also

“refinance” the property and use the funds it receives to repay to the CDE the QLICI note that mirrors the leverage loan (but not the QLICI note that mirrors the investor’s equity). The CDE will then use the funds received from the QALICB to replay the leverage lender.

16

• There is additional concern at the

There is additional concern at the QALICB level that there could be a change of administration and change of administration and attitude by the investor at the end of the compliance period as compared the compliance period as compared to its present intent, especially by an institutional investor who may institutional investor, who may decide not to exercise the put.

17

Cancellation of Indebtedness – Cancellation of Indebtedness COD Income

• Discharge of indebtedness: under Section

61(a)(12) a discharge of indebtedness, for l b h d b i i i f i example, by the debtors acquisition of its own debt for less than the principal amount of the debt, constitutes gross income to the debtor. debt, constitutes gross income to the debtor. Under Code Section 108(e)(4)(A) for purposes of determining income of the debtor of the di h f i d b d h i i i f d b discharge of indebtedness the acquisition of debt by a party “related” to the debtor is considered to be the acquisition of indebtedness by the debtor be the acquisition of indebtedness by the debtor.

18

• If the QALICB has operating losses,

Q p g , it may offset COD ordinary income.

• If not the B Note could be payable
• If not, the B Note could be payable

in 25-30 years which would defer the taxability However the the taxability. However, the QALICB would need to pay interest annually during the life of the Note annually during the life of the Note.

• Related party acquisition uses the

attribution and constructive attribution and constructive

• wnership rules under Section

267(b) or 707(b)(1) 267(b) or 707(b)(1).

19

• Exception for qualified real property

p q p p y business indebtedness which would allow income realized pursuant to the related party rule to be excludable from gross income to the extent provided in Section 108(a), whereby gross income does not include discharge from indebtedness income if a taxpayer is not a C-corporation and the discharge indebtedness is “qualified real property business indebtedness.”

20

• Use of equity rather than debt.
• Use of nonprofit as QALICB or

leverage lender: no UBIT realized g if project is substantially related to the exempt function, such as relief p

• f the poor, underprivileged,

relieves the burden of government, g etc.

21

• III. Potential Impact of Atlantic

B d lk and C lid t d Boardwalk and Consolidated Edison cases on NMTC Structure

The Atlantic Boardwalk case involved The Atlantic Boardwalk case involved the rehabilitation of the East Hall building, listed as a National Historic Landmark due to its hosting of the Miss America pageant since 1933. East Hall was owned by NJSEA i li h NJSEA, a state instrumentality that owns and operates certain public venues.

22

To pay for rehabilitation, NJSEA p y , attracted Pitney Bowes (“Pitney”) as an equity investor to defray costs q y y to the state, in consideration for 99.9 percent of HBH. NJSEA p would manage and hold 0.1 percent

• f HBH. Profits, losses and tax

, credits were allocated in accordance with the ownership interests. p

23

Pursuant to the HBH operating p g agreement, if at any time Pitney wanted to exit the transaction, NJSEA would be obligated both to redeem Pitney’s interest and give Pitney all allocable tax credits. The IRS asserted that HBH was a The IRS asserted that HBH was a sham, created only for the purpose

• f passing along tax benefits to
• pass g a o g ta be e ts to

Pitney and that the transaction lacked economic substance. c ed eco o c subs ce.

24

In September, 2012, the Third Circuit Court of Appeals reversed Circuit Court of Appeals reversed the Tax Court (Historic Boardwalk Hall v Comm’r 136 T C 1 (2011)) Hall v. Comm r, 136 T.C.1 (2011)) and concluded that Pitney Bowes was not a partner because it had no was not a partner because it had no real prospect of an upside and was fully protected from any downside fully protected from any downside risks.

25

The Court was concerned that significant investor pay-ins were timed to begin only after investor pay ins were timed to begin only after construction expenditures had generated enough credits to be equal to the amount of the g q intended tax credit equity investment. In addition, entities related to the State of New id d i Jersey provided guarantees against cost

• verruns, recapture, operating deficits,

disallowance and nonpayment of priority disallowance and nonpayment of priority returns and the put. (Although guarantees are standard in most HTC transactions the investor also funded a reserve for priority of returns in the form of a guaranteed investment contract from its own equity pay-in.)

26

The Third Circuit essentially asked the questions: did the investor have “any meaningful stake in the success or failure” of the venture? It paid particular attention to features that appeared to fl t l lik t E ti ll th reflect a loan-like return. Essentially the Court concluded that the investor did not have enough of a stake in the venture’s have enough of a stake in the venture s success or failure.

27

In Consolidated Edison Company p y

• f New York, Inc. and subsidiaries v

U.S. (No. 06-CV-305), the US ( ), Court of Appeals for the Federal Circuit, ruled that a tax shelter , transaction (LILO) did not have substance due to the “reasonable likelihood” that a purchase option would be exercised.

28

Although the Con Edison decision g has not been applied to tax credit transactions to date, the ruling is relevant to put options which are typical in NMTC structure. The use

• f a put may be modified or indeed
• dropped. The issue as to

“reasonable likelihood” standard is whether the party was economically compelled to exercise the put.

29

There are significant differences in NMTC transactions as compared to the Con Edison tax shelter structure. In i i i l any event it is unwise to use language that specifically states or suggests that th t ti ld b i d A the put option would be exercised. A more conservative approach would be t li i t th f t lt th to eliminate the use of a put altogether and include only a call option equal to current fair market value without current fair market value without direction to the appraiser.

30

In the LILO case, which is a tax shelter, there are only 2 parties as compared to at least 3 parties involved in a new market structure. Moreover the new markets structure is congressionally sanctioned with a third party developer unrelated to the investor. Finally, the 7-year statutory period does not nullify the validity of the QLICI loans. Indeed, both sides have risks.

31

Moreover, in the new market structure, after the 7-year compliance period there is a the 7-year compliance period, there is a reasonable likelihood that the equity investor may not exercise the “put” for any of the following reasons, including the turnover in key personnel; a change in the bank’s policy; regulatory pressures; there could be an audit regulatory pressures; there could be an audit (compliance) pending or defaults that preclude the exercise. In such a case the QALICB or its affiliate could exercise the call, but in that case it would be based on fair market value which could see an increase in value in view of the could see an increase in value in view of the gentrification of the neighborhood, especially as to equity QLICI’s. q y Q

32

If the borrower exercises the call, it ld COD i hi h could generate COD income which may be a deterrent. As to the new market guarantee or indemnification there is less guarantee or indemnification, there is less concern relative to the guarantee argument because there is a 100 percent g p risk of recapture throughout the 7-year

• period. Finally, the congressional intent

is to revitalize low-income communities

• r assist businesses located therein, and

in exchange Congress has provided a in exchange, Congress has provided a significant tax benefit through the new markets tax credit to the investor. markets tax credit to the investor.

33

The IRS is auditing more tax credit i h “ f h transactions, even the “run of the mill” structures and has developed a i hi h f matrix which focuses on guarantees. In view of the Atlantic Boardwalk, h IRS i i i h h the IRS is examining whether or not the investor is a “partner.” The j ti l b i i d projections are also being examined. The IRS is unlikely to provide any i di t id t th i d t immediate guidance to the industry with regard to the recent decisions di d b discussed above.

34

• IV. Work-Outs of Old Deals-

Substantial Loan Modification

• Subordination-Reset issues –

including updated tax opinion g p p relating to continued qualification

• f QALICB/QLICIs

Q Q

• Review of Tax Credit

Indemnifications Indemnifications

• Attract new equity

35

• At QALICB level (in the event of

the incorporation of new QALICB); representations and warranties that there are no existing recapture defaults

• Impact of potential COD income on

note modification

• Reexamination of NQFP tests

Q

36

• V. Qualified Active Low-

Income Community Business: Income Community Business: Non Qualified Financial P t C t ti S f Property: Construction Safe- Harbor

In general, a qualified active low-income community business (QALICB) includes any corporation (including a nonprofit corporation (including a nonprofit corporation), partnership, or LLC if with respect to any taxable year less than 5 percent

• f the average of the aggregate unadjusted

basis of the property of such entity is attributable to nonqualified financial property attributable to nonqualified financial property.

37

There is a specific rule that provides an exception to the definition of nonqualified financial property relating t th t ti f l t to the construction of real property, provided that the proceeds of a capital

• r equity investment or loan by a CDE
• r equity investment or loan by a CDE

is expended for construction of real property within 12 months after the date property within 12 months after the date the investment or loan is made; in such a case, the expenditure will be treated as a case, the expenditure will be treated as a “reasonable amount of working capital.” p

38

Many commentators believe that the f id i i “ f h b ” aforesaid exception is a “safe harbor” rule, although others conclude that the above described language sets forth a above-described language sets forth a “bright line.” Because the construction

• f real property often extends well
• f real property often extends well

beyond 12 months to perhaps 18 to 24 months – the regulatory language g y g g presently is a disincentive to CDEs to make qualified low-income community investments to fund many legitimate projects because the construction period t d b d th li it extends beyond the limits.

39

If a CDE intends to make a loan to a QALICB involved in the construction of real estate and anticipates that the construction period will exceed 12 months, it generally has two options:

40

• 1. The CDE can receive the QEI from

their investor, but defer up to 12 months to advance the money to the

• QALICB. If the cash is retained by

the CDE, then the CDE may incur negative interest rate arbitrage by holding the funds at the CDE level and then lending the money to the QLICI over the next 12 months. Furthermore the CDE will incur transaction costs as it makes each disbursement.

41

• 2. The investor may make multiple QEIs
• ver a span of 12 to 24 months If the
• ver a span of 12 to 24 months. If the

CDE accepts multiple QEIs, then the CDE may avoid negative interest rate arbitrage may avoid negative interest rate arbitrage by holding the funds at the CDE level, but will incur additional transaction costs with each QEI it receives, in addition to the actual transaction costs as it disburses the f d t th CDE (H h th funds to the CDE. (However, when the dollars are held in escrow at the QALICB level they provide added assurance to level, they provide added assurance to

• ther lenders and potentially reduce

borrowing costs.) g )

42

Pursuant to Treas. Reg. §1.45(D)- g § ( ) 1(d)(4)(iv), a QALICB has 3 years to generate revenue after the g investment is made. Such a rule contemplates newly formed p y businesses and implicitly recognizes that some QALICBs have longer Q g start-up periods, including the real estate construction period with p multi-year construction periods.

43

• VI. Opportunities for
• VI. Opportunities for

Nonprofits

Consistent with its charitable purpose, a Section 501(c)(3) p p , ( )( )

• rganization may play various roles

in NMTC transactions:

• As CDE
• As QALICB
• As QALICB
• As Leverage Lender

44

N M k t T C dit M ti New Markets Tax Credits: Meeting IRS Requirements When Structuring NMTC Deals

Annette Stevenson, CPA Novogradac & Company LLP

annette.stevenson@novoco.com Phone: (216) 298-9000 x104 www.novoco.com

NMTC Recapture Issues

• 1. “Substantially-All” Test
• 2. Redemption Test

46

≥85% Substantially All Test Year 1 ≥85% ≥85% ≥85% Year 1 Year 2 Year 3 ≥85% ≥85% ≥85% Year 3 Year 4 Y 5 ≥85% ≥85% Year 5 Year 6 ≥75% Year 7

CDE QALICB

Low-Income Community

QALICB

47

QEIs & Substantially All

QEIs QEIs

“Substantially ALL” “Substantially ALL”

• Safe Harbor Test

– At least 85% of the CDE’s aggregate gross assets (not gg g g ( per investment) on a cost basis are invested in eligible activities (i.e., QLICIs). U d thi t t th CDE d t d t t th – Under this test, the CDE does not need to trace the use

• f QEIs to eligible activities.

48

QEIs & Substantially All

QEIs QEIs

“Substantially ALL” “Substantially ALL”

• Direct Tracing Test

– At least 85% of the proceeds of the specific QEI can be At least 85% of the proceeds of the specific QEI can be traced to eligible investments (i.e., QLICIs). – Under this test, the CDE is free to engage in other non- g g NMTC related activities without impairing the substantially-all test.

49

QEIs & Substantially All

QEIs QEIs

“Substantially ALL” “Substantially ALL”

• Reinvestment

– Repayments to a CDE of capital, equity or principal from lifi d i t t t b i t d i th qualified investments must be reinvested in another QLICI within 12 months

• Special rule for loans

p – Scheduled periodic payments of principal must be reinvested by the end of the following year

• Repayments received in year 7 are not

required to be reinvested

50

Distributions vs. Redemptions

Treasury Regulation 1.45D-1(e)(2)(iii): An event of recapture occurs if an equity investment is redeemed or equity investment is redeemed or cashed out by CDE

51

Cash Distribution Cash Distribution

Partnerships a t e s ps

• No definition of Redemption
• Safe Harbor for Cash Distributions

– If a pro rata distribution does not exceed the CDE’s If a pro rata distribution does not exceed the CDE s

• perating income, it is not treated as a redemption,

and N t d i i h di t ib ti t – Non-pro rata de minimus cash distributions are not treated as a redemption

• May not exceed lessor of 5% of CDE’s operating income or

y p g 10% of the partners capital interest

52

Cash Distribution Cash Distribution

Partnerships

• Operating Income is calculated as:

a t e s ps

– Current Year Taxable Income – Plus

• Amortization
• Depreciation
• QLICI Loan Losses

QLICI Loan Losses

– Equals Current Year Operating Income

53

Cash Distribution Cash Distribution

Partnerships

• Distributions must be made during the tax year
• Operating Income is current year operating

a t e s ps

• Operating Income is current year operating

income (not cumulative) Di t ib ti t id f h b t

• Distributions outside safe harbor are not

automatically redemptions

54

Leveraged Tax Credit Investment Fund

$9m

Leveraged Lender Investor

$22.5m $9m

Qualified Equity Investment Qualified Equity Investment

$31.5m CDE

Community D l t E tit

CDE Fees $1.5m $22.5m QLICI A $7 5m QLICI B

Development Entity

(“Substantially ALL”) (“Substantially ALL”)

Qualified Low-Income Community Investment Qualified Low-Income Community Investment

$7.5m QLICI B $30m

Qualified Active Low-Income Community Business

Low-Income Community

55

Leveraged Tax Credit Investment Fund

$9m

Leveraged Lender Investor

$22.5m $9m

Qualified Equity Investment Qualified Equity Investment

$31.5m CDE

Community D l t E tit

CDE Fees $1.5m $22.5m QLICI A $7.5m QLICI B $30m

Development Entity

$30m $1m Accrued Interest $31m

Low-Income Community

56

Alt ti O Alternative One $4 million Payment & C l R i d Cancel Remainder f D bt

• f Debt

57

Leveraged Tax Credit Investment Fund

$9m

Leveraged Lender Investor

$22.5m $9m

Qualified Equity Investment Qualified Equity Investment

$31.5m CDE

Community D l t E tit

CDE Fees $1.5m

Development Entity

Low-Income Community

58

Substantially-All Calculation

QEI = $31.5m Sub-All % 85% Req ired QLICIs $26 775 000 Required QLICIs = $26,775,000 QALICB Debt Total QLICI A- Principal $22 5m $22 5m QLICI A- Principal $22.5m $22.5m QLICI B- Principal $ 7.5m $ 7.5m Accrued Interest $1m $ 1m $ $ $ $30m $1m $31m Payment <$3m> <$1m> <$4m> Discharged Debt <$27m> <0> <$27m> Sub-All: “Worthless” QLICI $27m Worthless QLICI $27m QEI $31.5m = Sub-All % = 85.7

59

Alt ti T Alternative Two Modify Notes – Current Pay Tranche & Cash Flow Pay Tranche

60

Leveraged Tax Credit Investment Fund

$9m

Leveraged Lender Investor

$22.5m $9m

Qualified Equity Investment Qualified Equity Investment

$31.5m CDE

Community D l t E tit

CDE Fees $1.5m

NEW QLICI A NEW QLICI B

Development Entity

NEW QLICI B

Low-Income Community

61

Substantial Modification of a debt Substantial Modification of a debt instrument

 Issue: Does the modification constitute an “exchange” for tax purposes?  New debt instrument (QLICIs) issued in exchange of old debt instruments (QLICIs) exchange of old debt instruments (QLICIs)  In order for a modification to be an exchange, th difi ti d t b “ b t ti l the modification needs to be a “substantial modification”

62

Modification

• Means any “alteration, including any deletion or

addition, in whole or part, of a legal right or

• bligation of the issuer or a holder of a debt

instrument, whether the alteration is evidenced b t ( l itt ) by an express agreement (oral or written), conduct of the parties, or otherwise.” (Treasury Regulation Sec 1 1001-3(c)(1)) Regulation Sec 1.1001-3(c)(1))

63

Significant Modification

 General Rule-

 “If and only if based on all facts and circumstances  If and only if, based on all facts and circumstances, the legal rights or obligations that are altered and the degree to which they are altered are economically g y y significant.” (Treas. Reg. 1.1001-3(e)(1))  All modifications are considered collectively  All modifications are considered collectively

64

S ifi R l

Significant Modification

 Specific Rule-

1) Change in yield (does not apply to contingent payment notes)

• If change in yield varies from annual yield on old note by

th th GREATER f more than the GREATER of:

 ¼ of one percent (25 basis pts); or 5% of the ann al ield of old note (ie 05 times ann al  5% of the annual yield of old note (ie. .05 times annual yield/rate)

65

S ifi R l ( t )

Significant Modification

• Specific Rule- (cont.)

2) Change in timing of payments that is a material deferral of scheduled payments deferral of scheduled payments

• Applies to extension of maturity date
• Applies to deferral of payments prior to maturity

y y

• Facts and circumstances test
• Safe-harbor test:

 Deferral of one or more scheduled payments is not material if deferred payments are within the safe harbor period  Safe harbor period – begins original due date of first deferred payment through a period equal to the lessor of 5 yrs or 50% of the original term through a period equal to the lessor of 5 yrs or 50% of the original term

• f the note

66

Significant Modification

• Specific Rule- (cont.)

3) Ch i bli it 3) Change in obligor or security

• New obligor
• Change in security or credit enhancement
• Change in priority
• Change in priority
• Change in payment expectation

67

Significant Modification

• Specific Rule- (cont.)

4) Ch i t f d bt i t t 4) Change in nature of debt instrument

• Property not debt
• Change in recourse nature

Accounting or financial covenant changes—are not significant modifications

68

Alt ti Th Alternative Three Foreclosure/Deed in Lieu Foreclosure/Deed in Lieu

69

Leveraged Tax Credit Investment Fund

$9m

Leveraged Lender Investor

$22.5m $9m

Qualified Equity Investment Qualified Equity Investment

$31.5m CDE

Community D l t E tit

CDE Fees $1.5m

Development Entity

Low-Income Community

70

Leveraged Tax Credit Investment Fund

$9m

Leveraged Lender Investor

$22.5m $9m

Qualified Equity Investment Qualified Equity Investment

$31.5m CDE

Community D l t E tit

CDE Fees $1.5m

Development Entity

Equity

Low-Income Community

71

Alt ti F Alternative Four Do Nothing Do Nothing

72

Leveraged Tax Credit Investment Fund

$9m

Leveraged Lender Investor

$22.5m $9m

Qualified Equity Investment Qualified Equity Investment

$31.5m CDE

Community D l t E tit

CDE Fees $1.5m $22.5m QLICI A $7.5m QLICI B $30m

Development Entity

$30m $1m Accrued Interest $31m

Low-Income Community

73

OID considerations in NMTC structuring Original Issue Discount- IRC Section 1273(a)(1)- OID is the “excess (if any) of a 1273(a)(1) OID is the excess (if any) of a debt instrument’s stated redemption price at maturity” is over its “issue price” maturity is over its issue price

74

Typical A/B leveraged NMTC structure

Leveraged Lender Tax Credit Investor Investment Fund

$22.5m $9m

Qualified Equity Investment Qualified Equity Investment Investment Investment

$31.5m CDE Fees $1 5m

Community Development Entity

$1.5m

Qualified Low-Income Community Investment Qualified Low-Income Community Investment

$22.5m QLICI A $7.5m QLICI B $30m

(“Substantially ALL”) (“Substantially ALL”)

Community Investment Community Investment

Qualified Active Low-Income Comm nit B siness Community Business

Low-Income Community

75

OID Issues 1)“S b t ti ll All” d All ti 1)“Substantially-All” and Allocation agreement compliance – deemed principal payments versus interest payments

76

OID Issues 2) Redemption – Recapture risk! 2) Redemption – Recapture risk!

a.Safe harbor test – distributions cannot exceed

• perating income
• perating income
• i. Operating income – taxable income plus certain

add-backs (amortization, depreciation, Sec 165 add backs (amortization, depreciation, Sec 165 losses, etc.) ii.If payments are deemed to be principal payments

• vs. interest payments, they are not included in
• perating income test

iii Cash may not be able to be distributed to pay iii.Cash may not be able to be distributed to pay leveraged loan

77

OID Considerations in NMTC Structuring

• B loan – Parties prefer to keep interest rate as low

as possible with generally longer terms (ie. 30 yrs) A l T b d d l i l d

• A loan- Terms are based on underlying leveraged

debt Issue debt instruments issued in connection with

• Issue—debt instruments issued in connection with

the same transaction (or related transactions) are treated as a single debt instrument for purposes of IRC and related regulations

– Thus—differing interest rates with different terms and/or payment schedules can trigger OID payment schedules can trigger OID

78

Issues

OID Considerations in NMTC Structuring

Issues- Multiple sources of Leveraged Loans

• Multiple sources of Leveraged Loans

D d E h f QLICI i d bt

• Deemed Exchange of QLICIs in debt

restructuring

79

Issues -

OID Considerations in NMTC Structuring

Issues

• Upfront loan fees paid to Sub CDE

1)Can be deemed to reduce issue price which impacts yield to maturity calculation and may cause OID issue

• Ongoing CDE asset management or other fees

1)Often fees are tied to allocation size and are paid

• utside of interest

2)If such fees are “re-characterized” as loan payments d i l d d i t t d d ti i t t it and included in stated redemption price at maturity calculation, OID may be triggered

80

New Markets Tax Credits: New Markets Tax Credits: New Markets Tax Credits: New Markets Tax Credits: Meeting IRS Requirements Meeting IRS Requirements When Structuring NMTC Deals When Structuring NMTC Deals When Structuring NMTC Deals When Structuring NMTC Deals

QALICB/QLICI Tax Opinion Issues

Megan Christensen Megan Christensen Blank Rome LLP April 25, 2013 Strafford Teleconference Strafford Teleconference

81

Basic Structure Basic Structure Basic Structure Basic Structure

Leveraged Lender

Fund

Investor

2 8

QEI

CDE

Treasury

Allocation

10 3.9 NMTCs Community Development Entity (CDE)

CDFI Fund

Allocation Authority

Community Development Entity (CDE) 10 Equity or

QALICB

Equity or Loan

QLICI

Qualified Active Low-Income Community Business

82

Tax Opinion re QALICB/QLICI Tax Opinion re QALICB/QLICI Tax Opinion re QALICB/QLICI Tax Opinion re QALICB/QLICI

• Typically, attorney representing the

yp y, y p g project/developer is asked to provide a tax opinion regarding the status of the entity as a QALICB and the qualification of the investment as a QLICI the qualification of the investment as a QLICI.

• Primary Focus

Primary Focus

– Real estate development project – QLICI investments made as loans

• Disclaimer: No discussion of Circular 230

83

QALICB/QLICI Tax Opinion QALICB/QLICI Tax Opinion QALICB/QLICI Tax Opinion QALICB/QLICI Tax Opinion

• Part I: Qualification of Borrower as QALICB

– Statutory/Regulatory Requirements – “Borrower should constitute a QALICB within the meaning of Section 45D(d)(2) as of the date hereof [and it should be id d bl f th CDE t t th t th QALICB ill considered reasonable for the CDE to expect that the QALICB will satisfy the requirements for the entire term of the Loan.”

• Part II: Qualification of the Loans as Bona Fide Indebtedness
• f the Borrower
• f the Borrower

– Case Law; IRS Guidance – “The Loans should be treated as debt of the Borrower for federal income tax purposes in the face amount of each note ” income tax purposes in the face amount of each note.

• Part III: Qualification of the Loans as QLICIs

– Statutory/Regulator Requirements “The Loans should be treated as “qualified low income community – The Loans should be treated as qualified low-income community investments” for purposes of Section 45D(d)(1).”

84

I: QALICB Opinion I: QALICB Opinion – Tax Status Tax Status I: QALICB Opinion I: QALICB Opinion Tax Status Tax Status

• § 45D(d)(2)(A); Treas. Reg. § 1.45D-

§ 45D(d)(2)(A); Treas. Reg. § 1.45D 1(d)(4)(i)

• Corporation or Partnership

Corporation or Partnership

– Treas. Reg. § 301.7701-2

• Some investors/CDEs want this specifically

Some investors/CDEs want this specifically stated.

• Nonprofit – furthering nonprofit purpose

Nonprofit furthering nonprofit purpose

85

I: QALICB Opinion I: QALICB Opinion – LIC LIC I: QALICB Opinion I: QALICB Opinion LIC LIC

• § 45D(e)(1)

§ 45D(e)(1)

– Poverty Rate at least 20% – Median family income ≤ 80% applicable area Median family income 80% applicable area median family income

• Include census tract data in opinion.

p

• Transition from 2000 Census.
• Attach Geocoder report.

Attach Geocoder report.

86

I: QALICB Opinion I: QALICB Opinion – Gross Income Gross Income I: QALICB Opinion I: QALICB Opinion Gross Income Gross Income

• § 45D(d)(2)(A)(i); Treas. Reg. § 1.45D-1(d)(4)(i)(A)
• 50% from active conduct of qualified business in LIC

– Active Conduct – 3 years or activity to further nonprofit purpose – Qualified (Treas. Reg. § 1.45D-1(d)(5)(iii)) ( g § ( )( )( ))

• No farming
• no developing/holding intangibles for sale (Operating Business

transaction may need to more specifically address (e.g. telecommunications company) telecommunications company)

• no sin uses
• Rental of Real Property: Improvements, Not Residential Rental, no rent

to businesses engaged in sin uses (§ 45D(d)(3); Treas. Reg. § 1.45D- 1(d)(5)(ii) & (iii)(B) 1(d)(5)(ii) & (iii)(B)

• Satisfied by Employee Test or Tangible Property Test ≥ 50%
• Reliance on borrower’s operating agreement, leases, projections,

appraisal financial statements client certification appraisal, financial statements, client certification

87

I: QALICB Opinion I: QALICB Opinion – Tangible Property Tangible Property I: QALICB Opinion I: QALICB Opinion Tangible Property Tangible Property

• § 45D(d)(2)(A)(ii); Treas. Reg. § 1.45D-

§ 45D(d)(2)(A)(ii); Treas. Reg. § 1.45D 1(d)(4)(i)(B)

• Must be at least 40%; Often 100%

Must be at least 40%; Often 100%

– Mobile property – Hotel Shuttle – Example in Regulations - Trucks p g

• If at least 50%, Gross Income Requirement

is satisfied.

• Reliance on client representations,

projections p j

88

I: QALICB Opinion I: QALICB Opinion – Employee Services Employee Services I: QALICB Opinion I: QALICB Opinion Employee Services Employee Services

• § 45D(d)(2)(A)(iii); Treas. Reg. § 1.45D-

§ 45D(d)(2)(A)(iii); Treas. Reg. § 1.45D 1(d)(4)(i)(C)

• Must be at least 40%

Must be at least 40%

• If no employees, Tangible Property at least

85%. %

• What if hire employees later?
• Reliance on client certificate
• Reliance on client certificate.

89

I: QALICB Opinion I: QALICB Opinion – Collectibles Collectibles I: QALICB Opinion I: QALICB Opinion Collectibles Collectibles

• § 45D(d)(2)(A)(iv); Treas. Reg. § 1.45D-

§ 45D(d)(2)(A)(iv); Treas. Reg. § 1.45D 1(d)(4)(i)(D)

• Less than 5% average of aggregate

unadjusted bases of property j p p y

• Not typically an issue – client certifies
• Not typically an issue – client certifies

90

I: QALICB Opinion I: QALICB Opinion – NQFP NQFP I: QALICB Opinion I: QALICB Opinion NQFP NQFP

• § 45D(d)(2)(A)(v); Treas. Reg. § 1.45D-1(d)(4)(i)(E)
• <5% of the average of the aggregate unadjusted bases of property

attributable to nonqualified financial property.

• NQFP = debt, stock, partnership interests, options, futures contracts,

forward contracts, warrants, notional principal contracts, annuities.

– Interest rate swaps, caps, etc. – Reliance on accountants’ projections, client certification.

NQFP ≠ bl t f ki it l h ld i h h

• NQFP ≠ reasonable amounts of working capital held in cash, cash

equivalents, or debt instruments w/term of ≤18 months.

– How to determine? – “reasonable needs of the business: authorities under Section 531 re – reasonable needs of the business: authorities under Section 531 re accumulated earnings; Bardahl Manufacturing Corp., T.C. Memo. 1965- 200; Central Motor Co. v. U.S., 583 F.2d 470 (10th Cir. 1978).

• Construction of real property

– Proceeds of QLICI, expended w/in 12 months.

91

I: QALICB Opinion I: QALICB Opinion – – Portions of Business Portions of Business Q C Op

• Q

C Op

• t o s o

us ess

• t o s o

us ess

• § 45D(d)(2)(C); Treas. Reg. § 1.45D-

§ 45D(d)(2)(C); Treas. Reg. § 1.45D 1(d)(4)(iii)

• Trades or businesses which would qualify

Trades or businesses which would qualify as a QALICB if separately incorporated.

• Must keep separate books and records.

p p

• QLICI funds must be used for the separate

trade or business.

92

I: QALICB Opinion I: QALICB Opinion – – Reasonable Expectation Reasonable Expectation Q p Q p p

• Active Conduct

– Treas. Reg. § 1.45D-1(d)(4)(iv) – Will be treated as engaged in active conduct of T/B, if CDE reasonably expects (at time of QLICI) entity to generate revenues w/in 3 years.

• QALICB

– Treas. Reg. § 1.45D-1(d)(6) – Will be treated as QALICB for duration of QLICI investment if CDE reasonably expects (at time of QLICI) that entity will satisfy requirements throughout entire investment/loan.

• If CDE controls or obtains control during credit period, reasonable

expectation is unavailable.

• Control = >50% value or voting/management rights, direct or indirect.
• Reliance on projections; client certification

Reliance on projections; client certification.

93

II: Bona Fide Indebtedness II: Bona Fide Indebtedness II: Bona Fide Indebtedness II: Bona Fide Indebtedness

• Why is true debt important?

– bona fide debt – Chief Counsel Memorandum (11/9/07); must be debt or equity (no grants) – Ramifications to Borrower – Ramifications to CDE

• Redemption issues
• Related party
• Proposed & withdrawn Section 385 regulations.
• John Kelley Co. v. Comm’r, 326 U.S. 521 (1946); In re: Lane,

742 F.2d 1311 (11th Cir. 1984); Bauer v. Comm’r, 748 F.2d ( ); , 1365 (9th Cir. 1984); Fin Hay Realty co. v. U.S., 398 F.2d 694 (3rd Cir. 1968); Farley Realty Corp. v. Comm’r, 279 F.2d 701 (2d Cir. 1960)

• Notice 94-47, 1994-1 C.B. 357

94

II: True Debt Factors II: True Debt Factors II: True Debt Factors II: True Debt Factors

• Fixed maturity date in reasonably foreseeable future; repay in all events
• Presence of interest or interest payments; not dependent on profit
• Right to enforce of payment of principal & interest; adequate remedies in

event of default

• Subordination of payment of obligation to claims of other creditors
• Subordination of payment of obligation to claims of other creditors
• Lender participation in management
• State law characterization of the instrument; Intent of parties
• Adequacy of security

dequacy o secu ty

• Existence of guarantees
• Borrower’s ability to obtain outside credit
• Identity of interest between borrower and lender
• Source of loan payments
• Thin capitalization
• Intended use of funds
• Bona fide business purpose for incurring debt

95

III: QLICI Opinion III: QLICI Opinion III: QLICI Opinion III: QLICI Opinion

• § 45D(d)(1); Treas. Reg. § 1.45D-1(d)(1)(i)

§ 45D(d)(1); Treas. Reg. § 1.45D 1(d)(1)(i)

• “Any capital or equity investment in, or loan

to, any qualified active low-income to, any qualified active low income community business … .”

• Pieces discussed above get tied together:

g g

– Investment – equity or loan – Borrower is a QALICB

• Meets requirements
• Active conduct of qualified business (e.g., rental

f l t hibit d ti it )

• f real property; no prohibited activity)

96