The recently enacted American Recovery and Reinvestment Act of 2009 (the “Act”) provides significant new opportunities for Indian tribes to finance commercial developments using tax-exempt bonds and tax-credit bonds.1 While state and local governments are able to offer tax-exempt bonds to fund a wide variety of purposes, including commercial development, prior to passage of the Act, tribes were able to offer tax-exempt bonds only to finance “essential government functions” and certain manufacturing activities.2 This “essential government function” requirement has been interpreted very narrowly by the United States Internal Revenue Service (the “IRS”) and has prevented tribes from offering tax-exempt bonds to fund commercial and industrial development, including financing casinos, hotels and related amenities. The Act enables tribes to issue in the aggregate up to $2 billion of tax-exempt Tribal Economic Development Bonds and tax-credit Build America Bonds to finance commercial developments, including hotels, convention centers and other amenities. However, as discussed below, the bonds may not be used to finance casinos.
Tribal Economic Development Bonds
The Act enables tribes to issue Tribal Economic Development Bonds to finance any commercial activity that may be financed on a tax-exempt basis by a state or local government, including hotels, convention centers and other amenities, subject to the following restrictions:
- the bonds may not be used to finance any portion of a building in which class II or class III gaming is conducted or housed or any other property actually used in the conduct of such gaming;3
- the project must be located on an Indian reservation;
- the bonds must be issued pursuant to an allocation of a portion of the $2 billion volume limitation available for all tribes; and
- the bonds may not be “private activity bonds,”4 other than certain “qualified bonds.”5
As a result of the prohibition on the bonds being used to finance a casino or property actually used in the conduct of gaming, the project being financed must be structurally independent of the casino. This requirement does not prevent the non-casino portions of the project from being connected to the casino by a covered walkway or other means, so long as the buildings are separate structures. While each project will need to be separately evaluated, we believe that these new rules provide significant opportunities for tribes to use tax-exempt financings to finance the non-casino portions of a project.6
Build America Bonds
The Act also provides for the issuance of Build America Bonds as an alternative for any project that is eligible to be funded with Tribal Economic Development Bonds (other than private activity bonds).7 With Build America Bonds, the tribe can elect either to provide bondholders with a tax-credit equal to 35 percent of the interest paid on the bonds or to receive a payment from the United States Treasury (the “Treasury”) equal to 35 percent of the interest paid on the bonds.
Build America Bonds must meet the requirements of Tribal Economic Development Bonds and the following additional restrictions:
- the bonds must be issued in 2009 or 2010;
- where the tribe receives the federal subsidy of 35 percent of the interest payments from the Treasury, the proceeds of the bonds must be used only for capital expenditures and a reasonably required reserve fund (which generally is up to ten percent of the proceeds of the bonds held for debt service in case the issuer encounters financial difficulty) and may not be used to repay other debt; and
- the bonds may not be issued with more than an insignificant premium (i.e. no more than 25 basis points multiplied by the number of complete years until maturity of the bonds).
One important advantage of the Build America Bonds where the tribe elects to receive the federal subsidy of 35 percent of the interest payments is that there is no restriction on the use of those funds. They can be pledged as collateral for the bonds or can be used for any other purpose. However, the mechanism for the payment to the tribe of the subsidy has not yet been determined and could delay the issuance of such bonds. It should be noted that the National Association of Bond Lawyers is seeking to have the IRS clarify that such bonds can be used to refund debt issued after the date of the Act or to reimburse expenditures made after the date of the Act. This would enable tribes to raise financing or incur project costs prior to the $2 billion allocation and the mechanism for payment of the 35 percent subsidy being finalized, and then reimburse the tribe or refinance when the Build America Bonds are issued. We believe this is the correct interpretation of the Act.
It is also worth noting that in the case of Build America Bonds where the tribe elects to receive the federal subsidy for 35 percent of the interest payments, the risk of the bonds qualifying as tax exempt in order to qualify as Build America Bonds would fall on the tribe and not the holders, so that such bonds should be able to be marketed as typical taxable bonds.
Private Activity Restriction
In order to qualify for financing with Tribal Economic Development Bonds or Build America Bonds, the project cannot be used in a private business of a person other than the tribe. The private use rules are complex and require an analysis of each particular project. The private use concern arises in financings of hotels, convention centers and other amenities if the tribe enters into a management contract with a non-tribal entity to manage all or a portion of the financed project, such as a hotel management agreement. Management contracts with fees based on the net profits of the facility are generally prohibited. However, the IRS has permitted hotel management contracts for facilities financed by state and local issuers that call for a larger periodic fixed fee and a smaller fee based on gross revenues or expenses, with a one time bonus based on a gross revenue or expense target. Some examples of hotel management contract terms that the IRS has found permissible contain the following fee structures: (1) a periodic fixed fee that constitutes 95 percent of the total fees where the management contract has a term of 80 percent of the facility’s expected useful life or 15 years, whichever is shorter, (2) a periodic fixed fee that constitutes 80 percent of the total fees where the management contract has a term of 80 percent of the facility’s expected useful life or ten years, whichever is shorter, and (3) a periodic fixed fee that constitutes 50 percent of the total fees and the management contract has a five-year term that is terminable without penalty after three years.8 Other fee structures may also be permissible, but will need to be considered on a case-by-case basis. In addition, leasing all or a portion of the project to a non-tribal entity, such as leasing stores in a shopping mall, could cause a loss of the tax-advantaged status of such bonds if in excess of ten percent of the financed facility is subject to such leases over the term of the bonds or the expected useful life of the project. Measuring the amount of private use of a facility is generally done annually on the basis of, for example, square footage in the case of real property, output in the case of generating facilities, days of use for arenas or other measures of capacity for their facilities. A management contract for a facility would be considered use of the entire facility or such lesser portion as is subject to the contract. To compute the ten percent limitation on private use, private use is compared to total use of the facility.9
In addition, the project cannot be used in a manner that provides “special legal entitlements” to any person other than the tribe, such as a right of preferential use or the ability to set rates. If an amount in excess of ten percent of the financed facility is subject to “special legal entitlements,” the bonds could be “private activity bonds,” which will cause them to lose their status as tax-exempt or tax-credit bonds. For example, the limitation on granting “special legal entitlements” could arise if (1) the casino is managed pursuant to a management contract that is treated under IRS guidelines as giving rise to private use and (2) there are arrangements between the casino and the hotel or other aspects of the project that gave the casino “special legal entitlements,” such as granting of comps in excess of the ten percent limitation. The “special legal entitlements” restrictions would not be implicated if the casino is run by the tribal government, since in that case it is the tribe that is receiving the entitlement. Generally, tribal governments and wholly owned instrumentalities of tribal governments, such as gaming authorities, are treated as the same for this purpose.
Which to Choose?
Several factors can influence which of these bonds a tribe should issue. Interest rates and bond terms demanded by tax-exempt and taxable bond investors can vary depending on conditions in their respective markets. In addition, if Build America Bonds are being issued, the tribe’s decision whether to elect to receive the 35 percent federal subsidy or to allocate the tax-credit to the bondholders may depend on the tax situation of the potential investors. For example, if the bonds are marketed to investors that have experienced capital losses, and are therefore not able to take advantage of the tax-credit, it may be more advantageous for the tribe to elect to receive the 35 percent federal subsidy. Tribes should work closely with their financial advisors when deciding which of these bonds is most advantageous. Many of the procedures that must be followed in issuing Tribal Economic Developments Bonds and Build America Bonds were not specified in the Act and will require further guidance. Recently, an official of the US Department of the Treasury (the “Treasury Department”) stated that some initial guidance with respect to the these procedures should be released by the IRS or the Treasury Department within 30 days.10
Allocation of $2 Billion Cap
The $2 billion of Tribal Economical Development Bonds and Build America Bonds is to be allocated by the Treasury Department among all Indian tribes in such a manner as the Treasury Department, in consultation with the Department of the Interior, determines is appropriate.11 Neither the method of allocation nor the process for obtaining an allocation has been determined. Factors that may be considered include reservation population, tribal membership, project feasibility and project benefits, but the Act does not specify any particular criteria.
There are restrictions on the tax-exempt financing of projects after spending on such projects has begun. Reimbursement of project costs incurred is generally allowed only if the bond issuer adopts a notice of official intent to reimburse those costs from the proceeds of tax-exempt bonds. Certain preliminary expenditures, such as architectural, engineering, surveying, soil testing and similar costs incurred prior to the commencement of construction, can be reimbursed with tax-exempt bond proceeds without a notice of intent to reimburse, but only in an amount up to 20 percent of the principal amount of tax-exempt bonds issued.12 If such a notice is adopted, the proceeds of the Tribal Economic Development Bonds or the Build America Bonds can be used to reimburse the tribe for expenditures made up to 60 days prior to the date of adoption. Therefore, we recommend that tribes adopt a notice of official intent to reimburse the project costs as early in the project as possible. The notice can be in any reasonable form, such as a resolution of the tribe, and should generally describe the project involved, state the maximum principal amount of obligations expected to be issued for the project and identify the source of funds for the project expenditures. To take advantage of the reimbursement, the allocation of the bond proceeds to such expenditures must be made not more than 18 months after the later of the date the expenditure is made or the date the project is placed in service or abandoned, but in no event more than three years after the original expenditure is paid.
Tribal Economic Development Bonds and Build America Bonds may not be used to refinance the debt of issuers other than the tribal government. As a result, a tribe may not issue these bonds to refinance debt incurred by tribal corporations and authorities. However, if the project costs are funded with the proceeds of debt issued by the tribe, then such debt can be refinanced with the proceeds of Tribal Economic Development Bonds or Build America Bonds (other than Build America Bonds where the issuer elects to receive the 35 percent interest subsidy from the Treasury Department) if (1) the debt was tax-exempt debt or (2) if the debt was taxable debt and the payment of the project costs is sufficiently traceable to such taxable debt.