Earlier this week, the President released his budget proposals for fiscal year 2017 (the “Proposed Budget”) (Treasury Department’s Green Book). Although it is unlikely that the Proposed Budget will be enacted, it is illustrative of the viewpoints held by the President (and possibly by supporting lawmakers).
The Proposed Budget contains a number of noteworthy provisions that will undoubtedly be the subject of future blog posts. This blog post contains a brief discussion of certain of the provisions that I find particularly interesting.
- Repeal the $150 million non-hospital bond limitation on qualified section 501(c)(3) bonds
Citing a reason for the change, the Green Book says “[t]he $150 million limitation results in complexity and provides disparate treatment depending on the nature and timing of bond-financed expenditures.” Anyone who has sorted through refunding issue after refunding issue to determine whether a small fraction of the issue originated prior to August 5, 1997 knows that complying with this provision is extremely cumbersome. Applying the test-period beneficiary rules adds another layer of complexity. Repealing the $150 Million limitation has long been considered by the IRS and suggested by practitioners; however, it is a statutory provision so an act of Congress is necessary for its repeal.
- Reinstate some of the bank qualified bond provisions from the American Recovery and Reinvestment Act of 2009 (“ARRA”)
Similar to ARRA, the Proposed Budget would expand the qualified small issuer limit in the definition of qualified tax-exempt obligations to include issuers of up to $30 million of tax-exempt bonds annually. In addition, the Proposed Budget expands the ability of financial institutions to deduct up to 80 percent of interest expense allocable to qualifying bonds (and, beginning with bonds issued in 2017, any tax-exempt bond).
The President’s Budget does not appear to implement certain, rather important, provisions of the ARRA. For example, in the case of qualified 501(c)(3) bonds, the $30 million small issuer limitation does not appear to be tested by treating the 501(c)(3) organization for whose benefit the bond was issued as the issuer. This provision in ARRA was extremely borrower friendly (for obvious reasons) and it motivated a large number of financings and refinancings in 2009 and 2010.
- Allow more flexible research arrangements for purposes of private business use limits
Eschewing historical concerns that basic research sponsored by private, for profit corporations can result in excessive private use (and without very much discussion), the President’s Budget expands the type of sponsored research agreements that tax-exempt organizations can enter into without resulting in private business use. The qualified user only need (i) own the research facilities and (ii) be permitted to enter into a bona fide, arm’s-length contractual arrangement with a private business sponsor of basic research regarding the terms for sharing the economic benefits of any products resulting from the research. Ownership of bond-financed facilities is, of course, already a requirement for qualified 501(c)(3) bonds pursuant to section 145(a)(1) so the second prong is the only new requirement for such bonds.
A few things remain unclear. First, the Green Book says that the proposal “would provide an exception to the private business use limits.” It’s likely that this means that agreements that meet the two-prong test will not constitute private business use but the language is not clear and could potentially mean that tax-exempt bond proceeds used to finance research facilities are excluded from the private business use limits. The other uncertainty is that the qualified user needs to “be permitted” to enter into the bona fide, arm’s length contractual arrangement with the sponsor. It’s unclear whether the exception applies if the qualified user actually enters into an arm’s-length arrangement with the sponsor or if the possibility of such an arrangement is sufficient. The latter would result in a significant expansion of the existing safe-harbors.
As a side note, this author believes that the safe-harbors for research agreements are antiquated and difficult to apply to the variety of different types of research agreements that have developed over the years. An expansion of the safe-harbors (or the “exception” to the limits) would be an welcome, if unlikely, change.
- 28% limit on the benefit of tax-exempt interest
The President has proposed limiting the benefit of tax-exempt interest in each of the last few years. It is intended to subject high-income bondholders to a certain degree of federal income taxes (equal to the bondholders tax rate less 28 percent). The repeated failure of the limit to be enacted makes it unlikely that Congress will choose to do so this time although disclosures will continue to include it as a possible legislative action.
More on the President’s Proposed Budget to come.