Public Finance Provisions included in the American Recovery and Reinvestment Act of 2009: Information for Bond Issuers
Public Finance Update 03/23/09 Elizabeth S. Blutstein, Julianna Ebert, Brian G. Lanser, Ann M. Murphy, Jeff Peelen, Jennifer V. Powers, Michael L. Roshar, Rebecca A. Speckhard, Bridgette DeToro, Allison M. Buchanan
The American Recovery and Reinvestment Act of 2009, enacted on February 17, 2009 ("ARRA"), includes several provisions relating to public finance. We previously provided you with a Public Finance Update regarding changes under ARRA related to the small issuer exception for bank-qualified obligations and the treatment of interest under the Alternative Minimum Tax ("AMT") rules (attached). Below is a more comprehensive summary of ARRA as it relates to some of the most relevant public finance provisions. Please note that interpretive guidance from the U.S. Treasury Department is expected in the near future and will provide additional clarification of certain of these provisions.
I. Marketability of Tax-Exempt Bonds
ARRA made changes to the Internal Revenue Code intended to immediately enhance the marketability of municipal bonds by expanding the ability of financial institutions to deduct interest related to tax-exempt obligations, increasing the bank-qualified limit and liberalizing the AMT treatment of interest on tax-exempt bonds.
A. Financial Institution Deductibility of Interest Related to Tax-Exempt Obligations
Section 265 of the Internal Revenue Code disallows a deduction for a financial institution's interest expense allocable to its investments in certain tax-exempt obligations. However, "bank-qualified" obligations are not taken into account as tax-exempt bond investments for purposes of this interest disallowance. Financial institutions can deduct 80% of the interest allocable to the bank-qualified obligations.
1. Increase in Bank-Qualified Limit
ARRA increases the limit on the amount of bank-qualified bonds from $10 million to $30 million per year. These provisions only apply to tax-exempt obligations issued in 2009 and 2010. Qualified 501(c)(3) borrowers are treated as direct issuers for this purpose. The small issuer exception also applies to a pool or composite issue if all of the individual borrowers in such issue separately qualify for the small issuer exception. Please see the attached Quarles & Brady Public Finance Update for additional information.
2. Temporary 2% Safe Harbor
ARRA also creates a temporary 2% safe harbor that allows financial institutions to purchase certain tax-exempt investments without a 100% interest expense disallowance. To the extent a financial institution's average adjusted basis of tax-exempt obligations is less than 2% of the average adjusted basis of its total assets, the financial institution will be permitted to take an 80% deduction for interest on indebtedness related to all tax-exempt obligations (both governmental and private activity) issued in 2009 and 2010. This 2% safe harbor will only include refunding obligations to the extent the original obligation was issued in 2009 or 2010. Refundings of pre-2009 issues cannot take advantage of the 2% safe harbor. Bank-qualified obligations do not count against the 2% limit.
B. Alternative Minimum Tax
ARRA provides that interest on private activity bonds issued in 2009 and 2010 will not be treated as a specific item of tax preference for purposes of calculating AMT. ARRA also provides that interest on tax-exempt bonds issued in 2009 and 2010 is no longer included in adjusted current earnings of corporations. These provisions apply only to tax-exempt bonds issued in 2009 and 2010 and apply only to refunding bonds to the extent the original non-refunding bonds being refunded were issued after December 31, 2003. Please see the attached Quarles & Brady Public Finance Update for additional information.
II. New Tax Credit and Other Bond Programs
ARRA creates several new categories of bonds with tax credit options and/or direct payment options from the U.S. Treasury Department, namely Build America Bonds, Qualified School Construction Bonds and Recovery Zone Economic Development Bonds and provides issuers of Build America Bonds and Recovery Zone Economic Development Bonds with the option to receive direct payments from the federal government in lieu of a tax credit being provided to the bondholders. ARRA also creates a new category of tax-exempt private activity bonds, namely Recovery Zone Facility Bonds.
A. Build America Bonds
Build America Bonds are a new option for governmental bonds which would otherwise qualify to be issued on a tax-exempt basis. Interest on Build America Bonds is taxable to bondholders. Under ARRA, governmental issuers may irrevocably elect (on or prior to the date of issuance) to treat bonds that would be tax-exempt (and that are not private activity bonds) as taxable Build America Bonds. Build America Bonds can be issued in 2009 after the date of ARRA's enactment and in 2010 without any limitation as to amount and without allocation restrictions.
State or local governments have the ability to issue Build America Bonds either as taxable tax credit bonds, where the bondholder receives a tax credit equal to 35% of the interest on the bonds, or as "Qualified Build America Bonds," where the issuer receives payments from the U.S. Treasury Department equal to 35% of the interest payments on the bonds (if all available project proceeds are spent for capital expenditures (as opposed to working capital), excluding amounts in a reasonably required reserve fund). The tax credit may also be "stripped" and sold separately from the bonds to investors.
IRS regulations will provide more guidance as to the technical and procedural aspects of Build America Bonds. Until then, it is not clear how the tax credit payments will be made (i.e., quarterly, semiannually, in accordance with the debt service schedule of each particular issue, etc.), how this election should be indicated on a form similar to an IRS 8038 and so forth. At the moment, it appears that the general tax-exempt bond regulations (including arbitrage, rebate and private activity regulations) will apply to Build America Bonds, but again, expected guidance from the U.S. Treasury Department will provide additional details.
B. Qualified School Construction Bonds
Qualified School Construction Bonds ("QSCBs") are a new category of tax credit bonds, which offer the bondholder a federal tax credit instead of interest. A total of $11 billion in funding is available in each of 2009 and 2010. An additional $400 million ($200 million in 2009 and $200 million in 2010) is allocated to tribal governments for schools funded by the Bureau of Indian Affairs.
Allocation: Sixty percent of the national limitation is allocated to states in proportion to the amount each state was eligible to receive under Section 1124 of the Elementary Education Act of 1965 for the most recent fiscal year. (An allocation to a possession other than Puerto Rico is made on the basis of the respective populations of individuals below the poverty line.) States have the ability to suballocate to political subdivisions. Forty percent is allocated to large local educational agencies (i.e., a local educational agency among the 100 local educational agencies with the largest numbers of children aged 5 through 17 from families living below the poverty level or one of not more than 25 local educational agencies that the Secretary of Education determines are in particular need of assistance) in proportion to the respective amounts each state or local educational agency received for basic grants under the Elementary and Secondary Education Act of 1965 for the most recent fiscal year. Allocations to a state are reduced by the amount received by any of the large local educational agencies located within the state. Allocations not used by a state or tribal government in a given year can be carried forward to subsequent years.
Requirements: All available project proceeds must be used for construction, rehabilitation or repair of a public school facility or for the acquisition of land on which such a facility is to be constructed. The bonds must be issued by a state or local government (including tribal governments) within the jurisdiction where the school is or will be located. The issuer must also designate the bonds as "Qualified School Construction Bonds." QSCBs are subject to the labor standards discussed below.
C. Recovery Zone Economic Development Bonds and
Recovery Zone Facility Bonds
ARRA creates two new classes of bonds for certain projects in newly defined "recovery zones." $10 billion is allocated to Recovery Zone Economic Development Bonds, and $15 billion is allocated to Recovery Zone Facility Bonds. These recovery zone bonds may be issued after the date of ARRA's enactment in 2009 and in 2010.
Recovery Zone Defined: A local government must designate one or more recovery zone areas. To qualify as a recovery zone, an area must have significant poverty, unemployment, rate of home foreclosures, or general distress; be economically distressed by reason of the closure or realignment of a military installation pursuant to the Defense Base Closure and Realignment Act of 1990; or be designated as an empowerment zone or renewal community.
Allocation: Generally, allocations will be made among the states in the proportion each state's 2008 employment decline bears to the aggregate 2008 employment decline in all states. States must then suballocate amounts to counties and large municipalities (a municipality with a population over 100,000) based on their respective proportion of employment decline. Each state is guaranteed 0.9% of the total national issuance authority.
1. Recovery Zone Economic Development Bonds
The interest on Recovery Zone Economic Development Bonds is taxable to bondholders. Issuers will receive a direct payment from the U.S. Treasury Department equal to 45% of the interest payable under the bonds on an interest payment date.
Requirements: All available project proceeds, excluding amounts in a reasonably required reserve fund, must be used for a qualified economic development purpose. The bonds must also be designated as "Recovery Zone Economic Development Bonds."
A qualified economic development purpose is defined as promoting development or other economic activity in a recovery zone, including capital expenditures paid or incurred with respect to property located in such zone, expenditures for public infrastructure and construction of public facilities located in such zone and expenditures for job training and educational programs. Recovery zone economic development bonds are subject to the labor standards discussed below.
2. Recovery Zone Facility Bonds
Recovery Zone Facility Bonds are a new category of "exempt facility" bonds (tax-exempt private activity bonds), which are available after the date of ARRA's enactment in 2009 and in 2010.
Requirements: At least 95% of the net proceeds of an issue must be used for recovery zone property, and the bonds must be designated as "Qualified Recovery Zone Facility Bonds."
Recovery zone property is any depreciable property in which property was constructed, reconstructed, renovated or acquired by the taxpayer after the date the recovery zone was designated; the original use of the property commences with the taxpayer; substantially all of the use of the property is within the recovery zone; and the bond financed property is used in the active conduct of a qualified business.
III. Expansion of Existing Tax Credit Bond Programs
A. Clean Renewable Energy Bonds
ARRA authorizes an additional allocation of $1.6 billion of Clean Renewable Energy Bonds ("CREBs") (which is in addition to the prior $800 million allocation). CREBs are a form of tax credit bond which offer the bondholder a federal tax credit instead of interest.
Allocation: CREBs are allocated by application directly to the U.S. Treasury Department. The total $2.4 billion will be allocated with one-third reserved for qualifying projects of the states, local and tribal governments; one-third reserved for qualifying projects of public power providers; and one-third reserved for qualifying projects of electric cooperatives.
Requirements: CREBs are available to finance qualified renewable energy facilities that generate electricity from the following resources: wind, closed-loop biomass, open-loop biomass, geothermal, small irrigation, landfill gas, trash combustion, qualified hydropower and marine and hydrokinetic renewable energy. Qualifying facilities must be owned by a public power provider, a governmental body (including tribal governments) or a cooperative electric company.
All available project proceeds of the bond issue must be used for capital expenditures for one or more qualified renewable energy facilities incurred by "qualified issuers." Qualified issuers include public power providers, cooperative electric companies, governmental bodies, clean renewable energy bond lenders or not-for-profit electric utilities which have received a loan or loan guarantee under the Rural Electrification Act. The qualified issuer must also designate the bond as a "Clean Renewable Energy Bond." CREBs are subject to the labor standards discussed below.
B. Qualified Energy Conservation Bonds
An additional $2.4 billion has been allocated to Qualified Energy Conservation Bonds ("QECBs") (which is in addition to the prior $800 million allocation). QECBs are another form of tax credit bond which offer the bondholder a federal tax credit instead of interest.
Allocation: Allocations are made to states in proportion to their population with sub-allocations to large local governments (a municipality or county with a population of 100,000 or more). The allocations must be made in a way in which at least 70% of the allocation is used for governmental purposes and not private activity purposes.
Requirements: QECBs must be used to finance state, local and tribal government programs and initiatives designed to reduce greenhouse gas emissions. QECBs can be used for a variety of purposes. Qualifying purposes include capital expenditures to reduce energy consumption in publicly owned buildings by at least 20%; to implement green community programs; for rural development involving the production of electricity from renewable energy sources; and any qualified facility (i.e., any facility that generates electricity from wind, closed-loop biomass, open-loop biomass, geothermal, small irrigation power, landfill gas, trash combustion, qualified hydropower, or marine or hydrokinetic renewable energy). QECB proceeds can also be used for expenditures with respect to research facilities and research grants to support research in certain areas related to the reduction of greenhouse gas emissions. Mass commuting facilities and related facilities that reduce the consumption of energy are another eligible use. Financing is available for a variety of demonstration projects designed to promote commercialization of green building technology, conversion of agricultural waste for use in the production of fuel, advanced battery manufacturing technologies, technologies to reduce peak use of electricity and the capture of and sequestration of carbon dioxide from fossil fuels to produce electricity. Finally, public education campaigns to promote energy efficiency is another qualifying use.
All available project proceeds of the QECB issue must be used for one or more qualified conservation purposes. The bonds must be issued by a state, local or tribal government. The bond must be designated as a "Qualified Energy Conservation Bond." QECBs are subject to the labor standards discussed below.
C. Qualified Zone Academy Bonds
ARRA authorizes the issuance of up to $1.4 billion (an additional $1 billion) of Qualified Zone Academy Bonds ("QZABs") in each of 2009 and 2010. QZABs are another form of tax credit bond which offer the bondholder a federal tax credit instead of interest.
Allocation: Allocations will be made to states based on their comparative percentages of population beneath the poverty line. Allocations will continue to be made by states to school districts per an application process.
Requirements: A "qualified zone academy" is a district or program within a district which offers a specialized academic program in partnership with business and is either located in an empowerment zone or enterprise community, or reasonably expected to serve student populations of which at least 35% qualify for free or reduced-cost lunches. To issue QZABs, school district issuers must also secure written commitments for private, matching contributions equal to 10% of the amount of the QZABs. QZAB bond proceeds can be used to renovate buildings (but not new construction), purchase equipment, develop course material and train teachers and personnel. QZABs are subject to the labor standards discussed below.
IV. Industrial Development Bonds
For purposes of qualified small issue manufacturing private activity bonds, the definition and scope of a "manufacturing facility" is expanded for bonds issued after the date of ARRA's enactment in 2009 and in 2010. The definition during this time period now includes facilities used in the production of intangible property, including any patent, copyright, formula, process, design, pattern, knowhow, format or other similar item. Legislative history indicates computer software and intellectual property associated with biotech and pharmaceuticals would be allowed. The 25% limit on financing directly related and ancillary property is not required for bonds issued after the date of ARRA's enactment in 2009 and in 2010 so long as the property is "functionally related and subordinate" to the manufacturing facility and is located on the same site as the manufacturing facility.
V. High-Speed Rail Grants, State Revolving Fund, Brownfields Projects, USDA Rural Development Loans and Grants, New Markets Tax Credits and Tribal Economic Development Bonds
A. High Speed Rail Grants
An $8 billion appropriation was made under ARRA for High Speed Rail Grants. For purposes of these grants, the definition of "high-speed train" has been modified to include trains that are reasonably expected to attain a top speed of 150 mph. The Secretary of Transportation will make grants for capital costs. Preference will be given to projects that support development of intercity high-speed rail service. Grants will be available through September 30, 2012. The Secretary of Transportation will issue guidance within 120 days of ARRA's enactment to cover the terms, conditions and procedures for High Speed Rail Grants until final regulations are in place.
B. Clean Water/Safe Drinking Water
ARRA makes an additional $4 billion available for capitalization grants under Clean Water State Revolving Funds and an additional $2 billion available for capitalization grants under the Safe Drinking Water Act.
Allocation: Priority for allocations will be given to projects on a state priority list, that are ready to proceed to construction within 12 months of ARRA's enactment.
Requirements: Each state must use not less than 50% of the amount of its capitalization grants to subsidize eligible recipients in the form of forgiveness of principal, negative interest loans or grants or any combination of these. If there are sufficient eligible applications, not less than 20% of the funds under ARRA for Revolving Funds shall be for projects to address green infrastructure, water or energy efficiency improvements or other environmentally innovative activities. Up to 1.50% of the funds under ARRA for the Clean Water State Revolving Funds may be made available for tribal governments. None of the funds may be used for the purchase of land or easements or for certain other set asides under the Safe Drinking Water Act. Funds may be used to buy, refinance or restructure debt only if the debt was incurred on or after October 1, 2008.
C. Brownfields Projects
$100 million has been made available under ARRA to carry out Brownfields projects. Funds are not subject to cost-sharing requirements of the Comprehensive Environmental Response, Compensation and Liability Act of 1980.
D. USDA Rural Development Loans and Grants
USDA Rural Development is a program within the U.S. Department of Agriculture funded with federal tax dollars. The program provides financial and technical assistance to rural individuals, municipalities and businesses. Programs for municipalities include the Rural Utility Program through which Rural Development provides loans, grants and loan guarantees to municipal water and waste disposal programs in rural areas and communities with populations of up to 10,000 and the Community Facility Program through which Rural Development provides loans, grants and loan guarantee to develop essential community facilities in rural areas and communities with populations of up to 20,000.
ARRA provides additional funding of $1.5 billion for the Rural Utility Program, for a total program level of $3.836 billion. ARRA provides additional funding of $200 million for the Rural Facilities Program, for a total program level of $1.239 billion.
E. New Markets Tax Credits
ARRA increases the total amount of New Market Tax Credits ("NMTCs") available in 2008 and 2009 to $5 billion for each year. The additional NMTCs for 2008 will be allocated to community development entities that submitted an allocation application with respect to the 2008 calendar year and either did not receive an allocation or received an amount for less than the amount applied for in 2008.
F. Tribal Economic Development Bonds
Tribal Economic Development Bonds are a new category of tax-exempt bonds that may be issued by a tribal government. Tribal Economic Development Bonds and other programs available for tribal governments under ARRA are discussed in the attached Quarles & Brady Indian Law Update.
VI. Labor Standards
Prior to the passage of ARRA, there were no requirements that labor standards apply to projects financed by tax credit bonds or tax-exempt bonds. However, the Act applies the prevailing wages standards under 40 U.S.C. 3141 (known as the "Davis-Bacon Act") to any projects financed with "tax-favored bonds" authorized under ARRA. "Tax-favored bonds" are CREBs, QECBs, QZABs, QSCBs and Recovery Zone Economic Development Bonds.
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If you have questions about the Public Finance provisions of the American Recovery and Reinvestment Act of 2009, please contact any of the Quarles & Brady public finance attorneys.