The attached letter (click here) discusses certain issues regarding new market tax credits (NMTC) arrangements and was submitted to the IRS and Treasury during January 2015. In response to a request for comments, the letter discusses leveraged loans, the qualified active low-income community business (QALICB) as a holding company renting real property to a related entity, and certain short-term loans.
Since that submission, the Community Development Financial Institutions Fund (CDFI) has added questions to its 2015 Allocation Application and added Q/As to its Compliance and Monitoring FAQs that address the use of the Qualified Low Income Community Investments (QLICIs) to refinance a QALICB’s debt or equity. These questions must be answered and complied with by community development entities (CDEs) in connection with their application for NMTC allocations. The questions and FAQs address, in part, the portion of the attached letter relating to certain short-term loans. CDEs that respond NO, meaning that they would permit QLICI proceeds to refinance debt or equity that are outside the permitted uses, would not be eligible to submit a NMTC Allocation Application. These provisions are now part of the 2016 NMTC Allocation Agreement (Section 3.3(j)).
CDFI 2015 Allocation Application
13. QLICI Uses and Activities
(a) Will the Applicant commit that it will not permit the use of the proceeds of Qualified Equity Investments (QEIs) to make any Qualified Low-Income Community Investments (QLICIs) in Qualified Active Low-Income Community Businesses (QALICBs) where QLICI proceeds are used to repay or refinance any debt or equity provider or a party related to any debt or equity provider whose capital was used to fund the QEI except if: (i) the QLICI proceeds are used to repay documented reasonable expenditures that are directly attributable to the qualified business of the QALICB, and such past expenditures were made no more than 24 months prior to the QLICI closing date; or (ii) no more than five percent of the QLICI proceeds are used to repay or refinance prior investment in the QALICB? Refinance includes transferring cash or property directly to any debt or equity provider or indirectly to a party related to any debt or equity provider.
____ Yes ____ No
Compliance and Monitoring FAQ
42. What are the restrictions on the use of QLICI proceeds to directly or indirectly reimburse expenditures incurred by a QALICB or Project Sponsor (an entity that owns or Controls the QALICB) and to directly or indirectly fund a QEI?
Beginning with the CY 2015 round, only documented reasonable expenditures that are directly attributable to the qualified business of the QALICB can be paid or reimbursed from QLICI proceeds to directly or indirectly fund a QEI, provided that these expenditures have either been (i) incurred no more than 24 months prior to the date on which the QLICI transaction closes, or (ii) represent no more than 5 percent of the total QLICIs made by the CDE into the QALICB.
Reasonable expenditures are expenditures for a legitimate business purpose that occur during the normal course of operation, and must be similar in amount and scope when compared to expenditures by a similar entity for a similar project under similar circumstances. Such expenditures may be made directly by the Project Sponsor on behalf of the QALICB or be funded through a loan or equity investment made by the Project Sponsor to the QALICB.
Of note, the IRS has not issued guidance on what costs are reimbursable under §45D. Until such guidance is made public, the CDFI Fund supports the use of the above parameters for transactions involving the reimbursement of incurred cost. The following examples are offered for additional clarity.
Example 1: Project Expenditures within 24 Months
Within 24 months prior to the closing of the QLICI transaction, a Project Sponsor uses funds it has raised from various sources to obtain development permits, begin construction, acquire or install equipment, or acquire other property related to the project; all of which represent reasonable expenditures and for which the Project Sponsor has retained documentation (i.e. invoices, receipts, proof of payment, etc.) totaling $1,000,000 and are directly attributable to the qualified business of the QALICB.
Out of $10,000,000 in total QLICIs, up to $1,000,000 of the QLICI proceeds can be used to reimburse the Project Sponsor for these documented expenditures and to directly or indirectly fund a leverage loan. The remaining QLICI proceeds ($9,000,000) could be used for operating needs, working capital needs, equipment, additional construction expenditures, or other needs related to the project or business of the QALICB.
Example 2: Project Expenditures up to 5% of QLICI Proceeds
Same facts as Example 1, except an additional 700,000 of documented, reasonable expenditures incurred by the Project Sponsor were incurred greater than 24 months prior to the closing of the QLICI transaction.
The QALICB may use no more than 5% of QLICI proceeds to reimburse documented, reasonable expenditures that are directly attributable to the qualified business of the QALICB regardless of when those expenditures were incurred. In this scenario, if the total QLICIs to the QALICB was $10 million, the QALICB could use up to $500,000 to reimburse expenditures that were incurred prior to the QLICI closing.
In summary, the QALICB may elect to either reimburse reasonable expenditures incurred within 24 months of the QLICI closing date as in the first example ($1,000,000) or reimburse reasonable expenditures that represent up to 5% of the QLICI proceeds incurred prior to the QLICI closing date ($500,000). It may not do both. If the QALICB is using QLICI proceeds to reimburse or repay the Project
Sponsor for documented, reasonable expenditures directly attributable to the qualified business of the QALICB that were incurred within the previous 24 months ($1,000,000), it may not use QLICI proceeds to repay or reimburse the Project Sponsor for any expenditures that occurred outside of 24 months.
43. How will the CDFI Fund monitor the restriction on the use of QLICI proceeds to directly or indirectly reimburse expenditures incurred by a QALICB or Project Sponsor required under the CY 2015 NMTC Application?
CDEs must include such covenants in financing agreements with QALICBs as may be necessary to reflect this restriction. The agreements containing such covenants must be available for inspection by the CDFI Fund. Second, the CDE should collect information as may be necessary and maintain documentation to trace the use of QLICI proceeds to use by the QALICB at the time of the initial QLICI is made and at least annually thereafter. Where the QALICB will repay or refinance a debt or equity provider or a party related to a debt or equity provider under the 24-month or five percent exception rules, the CDE should maintain documentation supporting that the reimbursements can be directly traced to actual expenditures. This documentation must be available for inspection by the CDFI Fund. Documentation to support compliance with this restriction must be retained for the period of the QLICI in the QALICB plus three years or the seven-year compliance period plus three years, whichever is shorter.
44. Can a QALICB use QLICI proceeds to pay a debt or equity provider to monetize an asset owned or controlled by the QALICB or an Affiliate of a QALICB, including but not limited to the accreted value of an asset?
Under the CY 2015 round, a QALICB is not permitted to use QLICI proceeds to pay a debt or equity provider whose capital is used to monetize an asset owned or controlled by the QALICB or an Affiliate of a QALICB if that capital provider directly or indirectly funded a QEI. This provision does not apply to allocation awards made prior to the CY2015 round. Question 44 supplements and is not in conflict with the CY 2015 NOAA or Question 42 of this document.