On April 11, 2018, the Internal Revenue Service published Revenue Procedure 2018-26, a copy of which can be accessed here, which provides new guidance to issuers on the availability of remedial actions to preserve the tax-advantaged status of their bonds in the face of a violation of the tax rules. Rev. Proc. 2018-26 applies to tax-advantaged bonds generally, i.e. traditional tax-exempt bonds under section 103 of the Code, as well as federally taxable bonds that carry with them tax credit or direct pay subsidy benefits. The impact of Rev. Proc. 2018-26 can be summarized as follows:
- Authorizes application of a modified “alternative use of disposition proceeds” remedial action in connection with a lease of a facility financed by tax-advantaged bonds to a nongovernmental person;
- Authorizes issuers of direct pay bonds to take as a remedial action the voluntary reduction the amount of the refundable credit requested; and
- Authorizes issuers of direct pay and tax credit bonds to apply the “alternative use of disposition proceeds” and “redemption/defeasance” remedial actions found under current regulations (section 1.141-12).
Each of these items is considered below. For more information about the application of the remedial action rules generally, please see our prior writing on this topic.
Alternative Use of Disposition Proceeds in connection with a Lease
Rev. Proc. 2018-26 authorizes lessors of bond-financed facilities to apply a modified version of the existing “alternative use of disposition proceeds” remedial action under section 1.141-12(e) of the regulations. In order to qualify, the lease must be equal to the lesser of 20 years or 75% of the economic life of the leased facility. In addition, the lease payments must be exclusively cash, and not have been financed with proceeds of another issue of tax-advantaged bonds.
To determine the amount of “disposition proceeds” that must be spent on a qualifying “alternative use,” the lessor must calculate the present value of all payments to be made under the lease, using the yield on the issue as the discount rate. The “disposition proceeds” must be spent within two years, in accordance with the existing regulations.
Voluntary Reduction of Requested Credit for Direct Pay Bonds
Rev. Proc. 2018-26 authorizes issuers of direct pay bonds to undertake as a remedial action a voluntary reduction in the amount of the refundable Federal tax credit that would otherwise be payable to the issuer. To take advantage of this provision, affected issuers must disclose, on the first Form 8038-CP filed after the nonqualified use occurs, the occurrence of the nonqualified use, and explain how the amount of the foregone credit was calculated. The IRS is not going to issue a revised Form 8038-CP; rather, affected issuers are expected to simply mark up the existing form and attach the requested explanatory information.
Extension of “Alternative Use of Disposition Proceeds” and “Redemption/Defeasance” Remedial Actions
Rev. Proc. 2018-26 generally extends the above-noted remedial action provisions to tax credit and direct pay bonds. Worthy of mention is section 7.04 of the Revenue Procedure, which reads as follows:
Reissuance. For purposes of determining whether the establishment of a defeasance escrow under section 7.02 of this revenue procedure results in an exchange under § 1.1001-1(a), the defeased bonds are treated as tax-exempt bonds for purposes of § 1.1001-3(e)(5)(ii)(B)(1).
Section 1.1001-3(e)(5)(ii)(B)(1) provides for an exception, in the context of tax-exempt bonds, to the general rule that a change in the nature of a debt instrument from recourse to nonrecourse causes a reissuance for tax purposes. Pursuant to this exception, the legal defeasance of a tax-exempt bond will not result in a reissuance, despite the obligation being converted from a recourse obligation to a nonrecourse obligation.
It would appear, then, that this section of Rev. Proc. 2018-26 is extending the application of this exception to tax credit and direct pay bonds. Now this is where things get interesting: back in 2014, the IRS issued a Chief Counsel Advice Memorandum (CCA 2014009) in which it took the opposite position on this question in the context of a refunding, where it concluded that a legal defeasance of a series of taxable, direct pay Build America Bonds would result in a reissuance.
Rev. Proc. 2018-26 makes no mention of the 2014 Chief Counsel Advice Memorandum, and it should not be assumed that the IRS intended to withdraw the 2014 CCA memorandum in publishing the revenue procedure. As of the date of this writing, the 2014 CCA memorandum is still available on the IRS’ website. And, in a Private Letter Ruling issued in early 2017, the author of that PLR (who also happens to be a co-author of the revenue procedure) took pains to avoid expressing any opinion on the issue.
While on first consideration it appears odd that the IRS would adopt two, seemingly conflicting positions on this issue, one can make a legal justification for it. In the context of a reissuance, the IRS, under section 1.141-12(h), has authority to provide additional remedial actions – and, in proposing new remedial actions, can create whatever rules of application it sees fit. And, for that matter, it would be counter-intuitive to permit the establishment of a defeasance escrow in this context as a remedial action, only for the issuer to lose the benefit of it through a reissuance.
Still, we are hopeful that the IRS revisits the 2014 guidance, and adopts a consistent position on this issue, so that issuers may use a defeasance escrow for both a refunding of taxable direct pay bonds, and a disposition of the bond-financed facility resulting in a need to take a remedial action.