Tax Exempt Bonds (TEB) focuses on providing participants in the municipal bond industry with quality service to assist issuers and conduit borrowers in understanding their tax responsibilities. As part of that service, TEB provides the following basic information for issuers of tax-advantaged bonds with respect to their post-issuance compliance requirements. Issuers may use this information to establish practices to monitor tax compliance throughout the period that their bonds are outstanding. However, issuers may not cite this information as an authoritative source. TEB recommends that issuers review this information in consultation with their counsel.
Tax-advantaged bonds (tax-exempt, tax credit and direct pay) are bonds that receive preferential tax treatment. These bonds, issued by or on behalf of state and local governments, are subject to federal tax requirements both at the time of issuance and for so long as the bonds remain outstanding. An issuer or other party’s failure to comply with any federal tax requirement with respect to tax-advantaged bonds jeopardizes the preferential tax status of those bonds.
Compliance with certain federal tax requirements normally occurs at the closing of the bond transaction, while other federal tax requirements apply after the issuance of the bonds. Issuance related requirements include filing a Form 8038 series information return (8038 (PDF), 8038-G (PDF), or 8038-GC (PDF)) and the issuer having reasonable expectations of on-going post-issuance compliance. Additional issuance related requirements might include volume cap allocation limits and public approval of the bond issue.
Post-issuance federal tax requirements generally fall into two categories:
- Qualified use of proceeds and financed property, and
- Arbitrage yield restriction and rebate.
Qualified use requirements apply to the direct and indirect uses of bond-financed property over the life of the bonds. Arbitrage requirements apply over the life of the bonds to limit the yield on investments acquired with bond proceeds and require the issuer to file Form 8038-T (PDF) to pay a yield reduction payment and rebate payment in certain circumstances.
Some federal tax requirements that are generally issuance related might require some level of post-issuance due diligence monitoring. For example, adjustments to the determination of issue price for federal tax purposes can affect compliance with volume cap allocation, arbitrage yield restriction and other federal tax requirements. Similarly, some level of post-issuance monitoring may be required to determine compliance with the issuance costs limitations that apply to qualified private activity bonds.
Importance of Post-Issuance Compliance
Appropriate monitoring of compliance throughout the entire period their bonds remain outstanding improves the issuer’s ability to identify noncompliance and prevent violations from occurring, to timely correct identified violations (when prevention is not possible) and to ensure the continued tax-advantaged status of the bonds.
Written Procedures for Monitoring Compliance
Some issuers may choose to adopt written procedures for post-issuance compliance monitoring that address the issuer’s particular characteristics and requirements. Among other provisions, these written procedures can include provision for:
- Due diligence review at regular intervals,
- Identifying the official or employee responsible for review,
- Training of the responsible official/employee,
- Retention of adequate records to substantiate compliance (such as, records relating to expenditure of proceeds),
- Procedures reasonably expected to timely identify noncompliance, and
- Procedures ensuring that the issuer will take steps to timely correct noncompliance.
Following these procedures can help to identify and resolve noncompliance timely to preserve the preferential status of tax-advantaged bonds.
How Does the IRS Promote Post-Issuance Compliance?
Generally, an issuer will receive more favorable resolution terms under TEB VCAP than for the same tax violation discovered during an examination of the bonds.
Issuers of tax-advantaged bonds are required to file a Form 8038 series information return. Form 8038 and Form 8038-G information returns include questions on whether the issuer has established written procedures to timely identify and correct violations and to ensure compliance with the arbitrage yield restriction and rebate requirements.
The Advisory Committee on Tax Exempt and Government Entities (ACT) issued several reports related to post-issuance compliance. Specific ACT recommendations on post-issuance compliance procedures are included in an exhibit to its June 2007 report.