Regulations Require Declaration of Official Intent
The Internal Revenue Service has revised its regulations concerning the use of tax-exempt financing (bonds, notes and leases, referred to below generally as "bonds") to reimburse expenditures made prior to the date of the financing. Under the new regulations, the proceeds of bonds may be allocated to a prior capital expenditure for a period of time after the expenditure is made, but only if a formal declaration of reasonable intention to reimburse the expenditure with the proceeds of a borrowing (a "declaration of official intent") had been properly made within sixty (60) days after the date the expenditure was paid and certain other requirements, described below, are satisfied. Both governmental bonds and all private activity bonds are subject to these requirements. These rules significantly affect common practices and must be taken into account in planning for all future tax-exempt financings. Potential users of tax-exempt financing must be aware of the steps necessary to permit a later financing when incurring expenditures they may intend later to finance. The regulations, as summarized below, should be consulted to assure compliance.
Private activity bonds for many years have largely been restricted to financing the payment or reimbursement of expenditures made after the date of an "inducement resolution" or "some other official action", but no similar regulations applied to governmental bonds. Until recently, little attention was paid to the practice of reimbursing prior expenditures through the issuance of governmental bonds. However, a potential for abuse existed because the allocation of the proceeds of bond issues to prior expenditures could remove the bond proceeds from arbitrage yield restrictions or from the requirement that excess earnings from investment of the bond proceeds be rebated. The concern existed that government units could escape these restrictions by issuing "pyramid bonds," bonds issued purportedly to "reimburse" the general fund for expenditures "as old as the pyramids." These new regulations replace the "official action" requirement for private activity bonds and impose similar requirements on governmental bonds.
If a declaration of official intent has been made by a "small governmental issuer" (no more than $5,000,000 of governmental bonds expected to be attributed to it in the calendar year), bond proceeds may be allocated to expenditures previously made for a period of up to three (3) years after the later of the date the expenditures were made or the date when the property is placed in service or abandoned. For other issuers, including issuers of private activity bonds, bond proceeds may be allocated to expenditures previously made for a period of up to 18 months after the later of the date the expenditures were made, or when the property is placed in service or abandoned (but not later than three years after the date of the expenditure).
Application of Regulations
The reimbursement bond regulations apply to governmental bonds, bonds for Section 501(c)(3) organizations, and other private activity bonds. (For information concerning governmental bonds, notes and leases, request our Overview of Governmental Financing; for information concerning private activity and Section 501(c)(3) bonds, request our Overview of Private Activity Bond Financing and Incentives.) All bonds issued after June 30, 1993 are subject to these regulations. If an expenditure to be reimbursed was made before June 30, 1993 (August 15, 1993 for private activity bonds), certain regulations previously in effect may be complied with in lieu of these regulations.
Who Must Make Declaration of Official Intent?
In the case of governmental bonds and most private activity bonds, it is the actual issuer of the bonds that must make the declaration of official intent and meet the tests described in the regulations. In a case where a governmental authority issues bonds for facilities for use by a Section 501(c)(3) organization, however, the Section 501(c)(3) organization may make the declaration of official intent and meet those tests. As used herein, the term "bond user" means the bond issuer, except in the case of bonds issued for a Section 501(c)(3) organization, where it means the Section 501(c)(3) organization or the governmental issues. A declaration of official intent to reimburse an expenditure may be made and maintained by the bond user or anyone properly designated by the bond issuer for this purpose.
Required Content of Declaration of Official Intent
A declaration of official intent must indicate that the bond user reasonably expects to reimburse the planned expenditures with the proceeds of a debt to be incurred. The declaration of official intent must generally describe the project for which the expenditure to be reimbursed is paid, such as "school building renovation," "hospital equipment acquisition" or "highway capital improvement program," and a state the maximum principal amount of debt expected to the issued for such purposes. Instead of describing a project, a declaration of official intent may identify a fund or account from which the expenditure to be reimbursed is paid and describe the general functional purpose of the fund or account, such as "parks and recreation fund — recreational facility capital improvement program." Reasonable deviations from the description in the declaration of official intent are permitted. A reasonable deviation would include the acquisition of hospital equipment instead of a hospital building improvement program, but would not include the rehabilitation of a city office building when the declaration described highway improvements.
Exceptions for Preliminary and Unforeseeable Expenditures
No declaration of official intent is required for preliminary expenditures, such as architectural, soil testing, engineering, surveying, bond issuance and similar costs incurred prior to acquisition or construction, that do not exceed 20% of the proceeds of the bonds issued for that project. Costs of land acquisition, site preparation and similar costs are not treated as preliminary expenditures. No declaration of intent is required for costs of issuance of a bond or for other amounts not exceeding the lesser of $100,000 or 5% of an issue of bonds.
"Reasonableness" of Declarations of Official Intent
Declarations of official intent to reimburse expenditures must be "reasonable". Bond users cannot make blanket or routine declarations without a real intent to finance the specific expenditures, but for the purpose of building up reimbursable expenditures to which the proceeds of Bonds for later projects would be artificially allocated.
Anti-abuse rules are included in the regulations, and provide that a purported allocation of bond proceeds to reimburse an expenditure is ineffective if the allocation employs an abusive arbitrage device to avoid arbitrage restrictions.
Consequences of Violation
Failure to comply with the regulations results in the bond proceeds being treated as not expended and as remaining subject to arbitrage, rebate and other restrictions. Such a failure and noncompliance with such restrictions may result in the loss of tax exemption of the bonds.
In light of these regulations, potential bond users must take steps to consider, at or before the time any capital expenditures are made, whether such expenditures might be financed. If a reasonable declaration of intent to reimburse an expenditure is made within 60 days after the date of the expenditure, the expenditure may be reimbursed from the proceeds of a later bond issue for a limited period. Even when another source of funds may be available to recoup an expenditure, such as a grant or expected facility revenue, a declaration of intent to finance the expenditure if the source of revenue does not materialize would be appropriate. Bond users should not, however, adopt declarations of intent to finance expenditures in situations where there is no reasonable likelihood of financing the expenditures with respect to which declarations have been made. Bond users should take care that declarations meet the timing, formality and specificity requirements set forth in the regulations.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.