H.R. 1- The American Recovery and Reinvestment Act of 2009 (the “Act”) contains numerous provisions that will affect bonds issued by states and political subdivisions. The Act’s provisions are intended to increase the attractiveness of certain obligations to investors and provide additional types of tax-favored bonds to assist issuers in financing a variety of projects.
- The two percent safe harbor on tax-exempt bonds is extended to financial institutions for 2009 and 2010.
- The “bank qualified bond” amount is increased to $30 million per year, up from $10 million, for 2009 and 2010 and calculated on an issuerby- issuer basis.
- Tax-exempt interest on private activity bonds issued in 2009 and 2010 will not be subject to the alternative minimum tax (“AMT”) and will not be an adjustment to current earnings for purposes of the corporate income tax.
- For 2009 and 2010, small issue bonds for manufacturing purposes may finance facilities that produce intangible property. Additionally, a “functionally related and subordinate” test will be in place instead of the more restrictive 25 percent ancillary facilities rule.
- A qualified school construction bond is created that permits the use of tax credit bonds in 2009 and 2010 for public school construction, repair and rehabilitation, as well as land acquisition for such facilities.
- The authorization for qualified zone academy bonds (“QZABs”) is extended through 2010 and the allocation is increased to $1.4 billion annually.
- A new recovery zone bond is created as a tax-credit bond for use in recovery zones – areas with significant levels of poverty, unemployment, home foreclosures and military base closures in 2009 and 2010.
- A new type of exempt facility bond - recovery zone facility bonds - can be issued on a tax-exempt basis in 2009 and 2010 to finance depreciable property used in any trade or business, subject to exclusions with respect to certain prohibited facilities and residential rental property, located in recovery zones.
- A new tax credit bond called “Build America Bonds” is created for issuance in 2009 and 2010 that permits the issuance of taxable bonds for projects that would otherwise qualify for tax-exempt financing. Issuers may either permit the holders to receive a tax credit on the interest received or elect to receive a subsidy from the Treasury equal to the credit.
- Clean renewable energy bonds are extended and the national allocation is raised to $1.6 billion each year for 2009 and 2010.
- Qualified energy conservation bonds are extended and the national allocation is raised to 3.2 billion each year for 2009 and 2010.
A new type of tribal economic development bond is available to finance certain activities of Native American tribes.
- The federal prevailing wage law, commonly known as the “Davis-Bacon Act” is made applicable to all projects financed with qualified school construction bonds, clean renewable energy bonds, qualified energy conservation bonds, qualified zone academy bonds and recovery zone economic development bonds.
Two Percent Safe Harbor for Financial Institutions.
The Internal Revenue Code of 1986 (the “Code”), as amended, currently disallows the interest expense deduction for indebtedness incurred to purchase or carry tax-exempt bonds. A safe harbor exists that provides, to the extent that the adjusted basis of a taxpayer’s tax-exempt assets do not exceed two percent of the taxpayer’s assets used in its business, such assets will be presumed to not to have been purchased or carried with indebtedness, and no deduction disallowance will occur. The Act extends this safe harbor to financial institutions (essentially, depositary institutions), thus increasing the yield to financial institutions on investments in tax-exempt bonds. However, tax-exempt bonds will continue to be considered financial institution preference items for purposes of Section 291 of the Code.
The safe harbor applies to bonds issued in 2009 and 2010. Refundings are treated as being issued at the time the refunded bond (or, in the case of a series of refundings, the original bond) was issued. The effect of this provision is that a refunding of a bond issued before the effective date of the Act will not get the benefit of the safe harbor if purchased by a financial institution.
Bank Qualified Bond Exception Increased. Under current law, issuers may issue up to $10 million of bonds annually that financial institutions may purchase without being subject to the interest deduction disallowance rules of Section 291 – the so-called “bank qualified bond” exception. The Act increases this amount to $30 million for each of 2009 and 2010. Additionally, a 501(c)(3) entity that borrows the proceeds of a qualified 501(c)(3) bond, rather than the governmental issuer, is treated as the issuer for purposes of the $30 million limit. Further, the limit is to be applied on an issuer by issuer basis, rather than an aggregate basis, in the case of pooled issues. For example, a composite issue of $100 million for four borrowers at $25 million apiece would be bank eligible. However, if any of the “issues” within such a composite or pool arrangement ceases to qualify, the entire $100 million would cease to be bank eligible.
Alternative Minimum Tax and Adjustment to Current Earnings. The Act exempts interest on private activity bonds from the alternative minimum tax for 2009 and 2010. Additionally, such interest during these years will not be treated as an adjustment to current earnings for purposes of the corporate income tax. The effect of these provisions will increase the attractiveness of private activity bonds to investors by permitting more of the interest on such obligations to be excluded from taxation.
Refunding bonds are treated as being issued on the date of the issuance of the refunded bonds except for private activity bonds issued after December 31, 2003 and before January 1, 2009.
Small Issue Manufacturing Bonds Liberalization. For 2009 and 2010, small issue manufacturing bonds may be issued to finance facilities that create intangible property. Previously, a manufacturing facility, by definition, had to produce or process tangible property. Intangible property includes patents, copyrights, processes, designs, knowhow, formulas or other similar items. Examples of intangible property include computer software and pharmaceuticals.
Additionally, the Act permits the financing of functionally related and subordinate facilities located at the site of the manufacturing facilities. Previously, not more than 25 percent of the proceeds could be used to finance ancillary “non-core manufacturing” facilities. This change will permit the financing of a wider range of facilities related to manufacturing without the sometimes difficult determination of whether the financed facility is “core” manufacturing, ancillary to manufacturing or ineligible.
Qualified School Construction Bonds. The Act creates new tax credit bond called “qualified school construction bonds.” The holder of such bonds will be permitted to take a tax credit computed on the principal amount of the bonds. Hundred percent of the available project proceeds (sale proceeds less issuance expenses, not in excess of two percent, plus investment earnings) of qualified school construction bonds must be used to construct, repair or rehabilitate public school buildings, or to acquire the land on which such buildings are to be located. $11 billion of such bonds may be issued in each of 2009 and 2010. Sixty percent of this amount will be allocated to the states based on the proportion of amounts received under the Elementary and Secondary Education Act of 1965 and 40 percent will be allocated to certain “large schools”. A state’s share will be reduced by any amount allocated to any large schools within the state.
Any proceeds of bonds not used within three years for qualified purposes must be used within 90 days of the anniversary of the issuance of the bonds to redeem such bonds in order to preserve the tax credit. Exemption from rebate and arbitrage limitations is available if all the proceeds are spent within three years and certain other requirements relating to the amount of investment earnings are met. Reserve funds are permitted provided that limitations with respect to the speed of funding, amounts held and yield on investments are observed.
The term of the qualified school construction bonds is that length of time resulting from present valuing the face amount of the obligation to 50 percent of such amount, using as the discount rate the average interest rate for ten year tax exempt bonds issued in the month of the qualified school construction bond’s issuance. The credits will be established by the Secretary of the Treasury at a rate that is 100 percent of the rate that would permit the issuance of such bonds without any discount or interest payable by the issuer. Credits may be stripped from the bonds in the same way that interest coupons may be severed from bonds.
Issuers will be required to certify the financial disclosure requirements and applicable state and local law regarding conflicts of interest are satisfied with respect to the issue, as well as any other additional conflict of interest rules prescribed by the Secretary of the Treasury.
QZAB Extension. Qualified zone academy bonds, the original tax credit school financing vehicle, is extended through 2010 at $1.4 billion of allocation each year.
Recovery Zone Economic Development Bonds. The Act creates an additional tax credit bond for use in recovery zones – recovery zone economic development bonds. A recovery zone is an area designated by the issuer that contains a significant amount of poverty, unemployment, general distress, home foreclosures or military base closings. Empowerment zones or renewal communities also qualify as recovery zones.
$10 billion is allocated in 2009 and 2010 to states based on the ratio such state’s decline in employment bears to the national decline in employment. The amount allocated to each state is then further allocated to communities within the state on the basis of the ratio of such community’s decline to the state’s decline. The tax credit rate is established at 45 percent for recovery zone bonds. A reasonably required reserve fund may be funded with the proceeds of such bonds.
One hundred percent of the available project proceeds of the bonds must be used for capital expenditures paid or incurred with respect to property located in the recovery, and expenditures for public infrastructure and construction of public facilities in the recovery zone.
Recovery Zone Facility Bonds. A new type of taxexempt facility bond is created by the Act. Recovery zone facility bonds means 95 percent of the net proceeds are used to acquire “recovery zone property” before 2011. Recovery zone property must be subject to an allowance for depreciation, its original use must commence with the taxpayer/borrower and substantially all of the use of such property is used in the active conduct of a qualified business in the recovery zone. A qualified business is any trade or business other than residential rental property and any “prohibited facilities” under current law.
Recovery zone facility bonds are not subject to the annual volume cap limitation on private activity bonds, although there is a national limitation of $15 billion allocated to the states and local communities in the same fashion as with recovery zone economic development bonds.
Build America Bonds. The Act creates a new tax credit bond called the Build America Bond. Bonds, other than private activity bonds, that could otherwise be issued as tax exempt bonds may be designated as tax credit bonds by the issuer in 2009 and 2010. Holders will receive a tax credit equal to 35 percent of the interest received, an arrangement that is estimated to result in interest rates equal to 74.1 percent of taxable rates.
In lieu of the tax credit, the issuer may elect to receive a cash subsidy from the Treasury in an amount equal the sum that otherwise would have been taken as a credit by the holder.
One hundred percent of the available project proceeds must be used for capital expenditures, however, bond proceeds may be used to fund a reasonably required reserve fund.
Tribal Economic Development Bonds. Facilities that could be financed on a tax exempt basis if issued under Section 103 of the Code but would be taxable under Section 7871 may be designated as tribal economic development bonds and thereby qualify for financing with tax exempt bonds. There is a national $2 billion limitation. Certain facilities (e.g., casinos) are not eligible for financing through tribal economic development bonds.
Clean Renewable Energy Bonds and Energy Conservation Bonds. Each of these tax credit bonds is extended through 2010. The annual volume available for allocation to the states in 2009 and 2010 is $1.6 billion with respect to the clean renewable energy bonds and $3.2 billion for energy conservation bonds.
Davis-Bacon Applicability. The federal prevailing wage law is made applicable to projects financed with clean renewable energy bonds, energy conservation bonds, qualified school construction bonds, qualified zone academy bonds and recovery zone economic development bonds.