Tax-Exempt Debt Compliance Policy
Policy Number: 600.002.02
Approved by: Board of Trustees December 7, 2013
Effective Date: October 2013
This policy exists to outline the guidelines for proper tax-exempt bond and loan usage in order to ensure that the funding is properly protected and utilized. The tax-exempt status of these bonds and loans is protected for the life of the bond or loan; however failure to comply with federal restrictions can cause a loss of this protection. The restrictions primarily pertain to issues of arbitrage, timing, and the usage of bond and loan proceeds. This policy exists to guide Scripps through the proper procedures to maintain the tax-exempt status of its bonds and loans.
Utilizing tax-exempt bonds and loans provides Scripps with a low cost long-term solution for financing projects. Because public bonding is exempt from federal taxation, Scripps is able to obtain more favorable lending interest rates than with a conventional loan. Tax-exempt financing is a well-established practice among institutions of higher learning as an optimal solution to funding requirements.
Loans are issued by a financial institution, while bonds are issued by the state or federal government, who in turn lends the proceeds to the borrower. Both loans and bonds, if structured properly, may be treated as tax exempt. One of the primary requirements placed on a party seeking tax-exempt lending is that it must be a “501(c)(3) corporation.” A 501(c)(3) corporation will have received a determination letter from the Internal Revenue Service indicating that it qualifies under that code section.
Non-Governmental Person – not belonging to or associated with local, state, or federal government.
Private business use – Examples of private business use include 1) unrelated trade or business use and 2) private use by parties other than the charitable organization of the tax-exempt debt-financed property. Generally, no more than 5% of the proceeds of tax-exempt bonds or loans may be used for private business use of the tax-exempt financed property. For purposes of the 5% limit on private business use, bond or loan issuance costs financed with bond or loan proceeds (approximately 2%) are included as private business use, so typically private use is limited to 3%.
Arbitrage – Investment earnings on bond or loan proceeds in excess of the related interest paid to loan or bondholders or during the construction period, adjusted for certain expenses.
Vice President for Business Affairs
Scripps and CUC staff members involved in any respect to the tax-exempt financing process including:
• Issuance and creation of such bonds and loans.
• Usage of bond or loan proceeds and the requisite usage timing.
• Investment of bond or loan funds and arbitrage processes.
• Property management financed by tax-exempt bonds or loans, such as leases and service agreements.
• Creation and retention of documentation relating to receipts, return filings, proceeds, arbitrage, and private usage.
• Recording financial transactions connected to the bonds or loans.
• Review or consult with bond counsel legal documents including the Tax Agreement.
Responsibilities of Management:
The Vice President for Business Affairs at Scripps College is tasked with ensuring total compliance with all applicable IRS laws and regulations concerning Private Business Use. As a required portion of all new building projects, an analysis must be done to determine if debt financing is a required component of the overall funding of the project being assessed. If it is determined that debt financing is required, approval for the project must include an analysis to determine if Private Business Usage will be incurred with the current plan. If the total level of Private Business Use exceeds the IRS approved limits, then the building plan will either be revised, or the VP for Business Affairs may need to turn to taxable debt financing, despite the generally higher borrowing cost.
The Vice President for Business Affairs, Assistant Treasurer and Director of Investments, and Assistant Controller at CUC are tasked with maintaining the bond or loan for the duration of its lifespan. The following tasks will be performed at least annually:
1. Review any contracts related to the bond or loan funded project with bond counsel to ensure there is no private business use. If it is determined that PBU will result from the contract, management will determine if 1) the contract needs to be changed to meet safe harbor, 2) the contract is allowed because the total PBU is within acceptable limits, or 3) the contract needs to be cancelled.
2. Calculate the appropriate rebate and, if required, remitted to the U.S. Government.
3. Fulfill debt compliance reporting (Continuing Disclosure Agreement) per each outstanding bond issue.
4. Maintain record retention related to all bonds or loans outstanding (and those refinanced by outstanding issues).
5. Calculate allocation of Private Business Use by each bond or loan issue and based on the square footage of the debt-financed project, time of use of the debt financed facilities, or other reasonable method for calculation or allocation of the use of the project.
If the potential of failure to comply with post issuance compliance activities is identified, the Vice President for Business Affairs will seek the opinion of bond counsel in order to assess the need to take remedial actions described under section 1.141-12 of the Income Tax Regulations or enter into a closing agreement under the Tax-Exempt Bonds Voluntary Closing Agreement Program described in Notice 2008-31. Self-remediation may be done by establishing an irrevocable defeasance escrow or by redeeming the nonqualified bond. If no self-remediation actions are available, an attempt to negotiate a closing agreement with the IRS under the Voluntary Closing Agreement Program will be made.
Private Business Use:
Most Private Business Use in a tax-exempt financed facility arises from the following types of arrangements:
1. Ownership: A sale or transfer of ownership to a Non-Governmental Person of tax-exempt financed property. Ownership is determined under federal income tax principles.
2. Leases: Any arrangement that is properly characterized for federal income tax purposes as a lease to a Non-Governmental Person.
3. Management Contracts: A management contract is any arrangement whereby a Non-Governmental Person actively manages the operations of a facility. Management contracts include, for example, contracts for dining services, facility management, or vivarium services (management of an animal facility).
4. Research Agreements: Any non-government sponsored research agreement. Rules regarding sponsored research are set forth in the IRS Revenue Procedure 2007-47. Qualifying research agreements must be for “basic research” and the rights of the sponsor to the results of the research must comply with stated rules.
5. Cost of Issuance: Costs incurred in connection with issuing the bonds or loans, such as underwriter’s discount or fees, fees of bond counsel and other lawyers and consultants, rating agency fees, trustee’s fees and the like, may be included in the bond or loan issue, subject to a cap of 2% of the bond or loan issue.
6. Other Actual or Beneficial Use: Any other arrangement that conveys special legal entitlements to a Non-Governmental Person for beneficial use of tax-exempt financed property, such as an arrangement that conveys priority rights to use a tax-exempt financed facility, will result in Private Business Use. Examples of such “special legal entitlements” include summer camps having the exclusive right to use an athletic facility; specially designed courses open only to one company, or use of a parking garage for a private event.
There are some exceptions under which private business use will not impact the tax-exempt status of the bond or loan issue.
1. General public use
2. Short-term use: The activity is irregular and infrequent
3. Incidental use: The activity does not take place in a space that is held exclusively for that purpose.
4. Safe Harbor: However, there are exceptions for certain contracts meeting the Safe Harbors set forth in Rev. Proc. 97-13. In order to meet the Safe Harbors, the contract must provide for reasonable compensation to the Non-Governmental Person for services rendered with no compensation based in whole or in part on a share of net profits. Arrangements that generally are not treated as net profit arrangements and therefore satisfy the Safe Harbor requirements include contracts for a percentage of gross revenues or expenses (but not both), or a per person or per unit fee. Any management contracts should be analyzed prior to entering to assess any impact on tax-exempt financed facilities.
The IRS requires that all records related to the sale, expenditures and use of loan or bond- funded facilities be retained for three years beyond the final maturity date. This would include at a minimum the following records:
• Basic records relating to the bond or loan transaction (including the trust indenture, loan agreements, and bond counsel opinion-bond sale transcript);
• Documentation evidencing expenditure of bond or loan proceeds (both internal and external);
• Documentation evidencing use of loan or bond-financed property by public and private sources (i.e., copies of management contracts and research agreements);
• Documentation evidencing all sources of payment or security for the bonds or loans; and
• Documentation pertaining to any investment of bond or loan proceeds (including the purchase and sale of securities, SLGs subscriptions, yield calculations for each class of investments, actual investment income received the investment of proceeds, guaranteed investment contracts, and rebate calculations).