Tax Webinar: Expenditure of Proceeds Timing and Planning Winnie - - PowerPoint PPT Presentation
Tax Webinar: Expenditure of Proceeds Timing and Planning Winnie Tsien, Orrick, Herrington & Sutcliffe LLP Rosa H. Renaud, Financing and Treasury August 24, 2017 ***These materials have been prepared for this internal CSU presentation
Winnie Tsien, Orrick, Herrington & Sutcliffe LLP Rosa H. Renaud, Financing and Treasury August 24, 2017 ***These materials have been prepared for this internal CSU presentation only. Do not distribute as the information largely incorporates current internal procedures, which procedures are periodically changed and updated.***
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II. Tax Parameters and Considerations III. F&T Financing Review IV. Putting It All Together
Tax-exempt bonds established to finance capital projects
for state and local governments
Borrowing cost of tax-exempt bonds “subsidized” by
income tax forgone by U.S. Govt.
CSU has $5 billion tax-exempt bonds currently outstanding Among currently available alternatives, tax-exempt bonds
are the least-expensive and relatively simple to administer
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Proceeds are spent/expended to create Capital Assets Tax rules for Proceeds differ than for Capital Assets Proceeds require tracking, are subject to investment
restrictions, and need to be properly spent
IRS assumes the longer there are unspent proceeds, the
greater likelihood of abuse
Goal: Spend quickly!
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CSU focuses on spending* Proceeds within a 2 year period:
10% by 6 months; 45% by 12 months; 75% by 18 months; 100% by 24 months.
* Expenditures are based on a cash basis, as they are processed and paid through the State Controller’s Office. CSU’s goals:
Timely, safe, orderly and consistently-applied expenditure plan Maximize earnings retention ability Project expectations and assumptions are reasonable based on a
comprehensive review
Project funding sources are prioritized throughout project timeline
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Reserves #1 – Tax-Exempt CP #2 – Tax-Exempt Bonds #3 – Taxable Bonds #4 – Reserves/Donations
Financing
Generally: Early Stages of Project Planning & Working Drawings Construction Period
Do not let your tax-exempt bonds become “Hedge Bonds” –
hedge bonds lose their tax exemption, and there is no available remedy
As written, hedge bonds rule focuses on “reasonable
expectations” of issuer
But, as currently enforced in an audit, IRS position is:
unexpended proceeds 3 years from issuance means issuer’s expectations are not reasonable
Therefore, CSU task to ensure all projects in an issue,
collectively, are on track to meet test, with sufficient time to accelerate spending
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Tax-exemption on bonds is based on the sum of the parts:
Each project impacts all projects and entire bond issue
CSU is measured by its compliance record, which requires
having a good process in place that is followed
Tax Counsel advises CSU to follow 2-year period as
reasonable completion period, for best practices and effective planning, in light of complexity of SRBs
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Are Due Diligence items complete and reasonable?
Project Description and potential risks (ex. permits; site; litigation) Project Budget (CPDC 2-7) Campus Debt Service Coverage Ratio Analysis (only for Self-Support
projects)
Preliminary Allocation of Bonds Proceeds form Site Certification by Land Use Planning and Environmental Review
(LUPER) with clearance and no outstanding issues with easements and liens
Private Use Checklist Reimbursement Summary form
Will the information stand up to future scrutiny by an outside
party over time?
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F&T’s review of Cash Flow projections considers:
How “reasonable” are the expectations? Will the project meet spenddown targets/requirements? Can the projects be grouped to meet the targets? What is the impact if the targets are not met?
Where is the project in its development?
Do we have Commercial Paper capacity? When will the long term bond issuance be?
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** Goal is to reflect anticipated payments of expenditures processed through the State Controller’s Office
Appears Unlikely Good representation
84 Project Cash Flow Projections
(a) Pay-Off Commercial Paper (b) New Construction: 12 Self Support & 72 Academic (c) Refunding of 3 Bond Series (w/7 projects)
2017A, B, and C Bond Issuances
Analysis*
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* By F&T, CSU Financial Advisor, and Tax Counsel
CO CPDC Analysis F&T Analysis Financial Advisor & Tax Analysis Tax- Exempt Bond Proceeds #1 Campus Projections
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Bond Sale and Closing:
Formal Due Diligence Review for overall bond issuance with
Underwriters
Extensive Tax Review for new projects and proposed refunding of
bonds (and related prior projects)
Posting Preliminary Official Statement (POS) locks in
representations to investors
Sale of bonds via (Bond Purchase Agreement/Contract) BPA locks in
cost and terms of borrowing
Bond Opinion and Tax Opinion delivered as CSU confirms
representations and covenants
Chancellor, CFO, and Management certify compliance on behalf of
CSU Trustees
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Post Bond Issuance:
During Construction – periodic review of projects to see if on track Near Completion – review progress and identify potential problems Completion of Projects –accounting and allocation of proceeds
documentation; final chance to try to fix any expenditure problem (but not everything can be fixed)
Uniform process of cash flow and project reviews are
necessary for systemwide bonds to meet tax compliance
Ongoing F&T
, CPDC, and Campus effort: time and resources to continue monitoring and adjusting
Best Proof of Expectations is Actual Facts and
Performance
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CSU’s representations are only as good as underlying information
and compliance efforts by campuses
Executives signing tax certificate, bond indenture and other
documents certify as to representations and covenants for all campuses and underlying units
Tax documents require that CSU has institutional knowledge of all
matters represented, and has system for compliance
Active tax compliance starts on campus level – complete and robust
monitoring and reporting
F&T level of compliance largely depends on active tax compliance by
campus
IRS expects issuers to have adequate procedures to comply with
expenditure of proceeds rules
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Develop realistic cash flow projections given a project’s
particular circumstances
Consider how best to position a project to meet expectations
Identify risks and bottlenecks Move towards being “shovel ready” prior to financing
Document and retain information tracking financing proceeds,
expenditures, and use of completed facility
Monitor and advise CPDC and F&T as you identify potential
problems
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One project can affect all projects
CP lesson learned: failure of 1 project in spenddown resulted in all
projects not meeting spenddown
Therefore payment owed on all projects due to positive earnings Future CP issuances then only allowed 1 project each, spaced out
by 15 days, to assure separate spend-down requirements and “wall
Separating projects is not practical in SRBs.
Taxable SRBs provide buffer on spend-down, but more
expensive, so due diligence focuses on not issuing earlier or more than necessary
Changes to a project, or a change in projects, requires
additional due diligence, staff time and other costs
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CSU has paid the IRS approximately $2.4 million in rebate
in recent years:
SRBs: 27 projects paid out $1,952,364 Commercial Paper (CP): 17 projects paid out $422,570
Each issue not meeting rebate exception incurs costs
for reports, legal fees, and staff and campus time
As long as there are proceeds, ongoing costs for
monitoring and reports will incur fees.
Lost earnings not used for more projects
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Certain self-correction rules available if internal system
properly - and timely - identifies problem
Voluntary Closing Agreement Program (VCAP) with IRS considers
issuer’s system of compliance monitoring
Ultimate fear – IRS audit
Audited bond issue is completely re-analyzed, with hindsight but
possible missing records or memory; incurs time and costs even if resolved favorably
No issuer can challenge IRS finding in court; issuer may need to
pay even if they are “right”
Adverse effects include expansion of audit, other financings,
increased costs and downgrades, negative publicity, costs and payment to IRS
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Among current alternatives, tax-exempt financing is the most
cost-effective way to finance capital projects
Track record and compliance process enable use of bonds to
maximize number of projects
CSU Executives who sign bond and tax documents certify
compliance on behalf of campuses, auxiliaries, and Trustees
Therefore CSU’s representations are only as good as
underlying information and compliance efforts by campuses
Compliance with rules and requirements ensure continuing
success in using tax-exempt bonds
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Arbitrage - Can you earn it?
“Arbitrage” means the applicable yield restriction when investing bond proceeds. In general, bond proceeds may not be invested at a yield higher than the yield on the issue of bonds, subject to exceptions.
Arbitrage Rebate – Can you keep it?
If bond proceeds are eligible to be invested at a yield higher than the yield on the issue, the issuer must usually remit (rebate) the excess back to the U.S. Government, unless one or more rebate (spending) exceptions are met.
Arbitrage Bonds
An “arbitrage bond” means a bond where proceeds are invested at a materially higher yield than usually the yield on the applicable issue of bonds. Arbitrage bonds are not tax-exempt. CSU makes covenants representing that their tax-exempt CP and SRBs are not arbitrage bonds in their offering/ marketing document and issuance documents.
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Rebate Exceptions
Excess earnings need not be rebated to the U.S. Government if the
expenditure of proceeds meet the 6-month, 18-month, or the 2-year construction spending exceptions. Rebate exceptions apply to an entire issue
, excluding the refunding portions.
Spend-down Requirements
Both the 18-month and 2-year rebate exceptions have several interim 6-
month benchmarks. CSU must meet each benchmark to qualify. Failing one benchmark will disqualify the entire exception. Reference Slide 3 for the 2- year construction exception benchmarks, which CSU adopts for its internal expenditure model.