Virginia Resources Authority Governor’s Infrastructure Financing Conference December 14-16, 2016 The Bonds Have Been Issued. Now What? Practical Suggestions on Post-Issuance Compliance and Navigating an IRS Audit: The City of Winchester Experience Mary M. Blowe Chief Financial Officer/Director of Support Services Winchester, VA Christopher G. Kulp Partner Hunton & Williams LLP Richmond, VA
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The Bonds Have Been Issued. Now What? Practical ... are Post-Issuance Tax Compliance Procedures? 4 Procedures that describe the actions to be taken by entity to maximize likelihood
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Virginia Resources AuthorityGovernor’s Infrastructure
Financing ConferenceDecember 14-16, 2016
The Bonds Have Been Issued. Now What?
Practical Suggestions on Post-Issuance Compliance and
Navigating an IRS Audit:
The City of Winchester Experience
Mary M. Blowe
Chief Financial
Officer/Director of
Support Services
Winchester, VA
Christopher G. Kulp
Partner
Hunton & Williams LLP
Richmond, VA
Agenda
2
Introduction of Speakers• Mary M. Blowe, Chief Financial Officer, City of Winchester, VA
• Christopher G. Kulp, Partner, Hunton & Williams LLP, Richmond, VA
Background on Post-Issuance Responsibilities• Federal Tax Compliance
• Continuing Disclosure Compliance
The Winchester Experience• Implementing Policies and Procedures
What Needs to be in Place
Ongoing Monitoring
Working with Internal and External Staff
Background on IRS Enforcement• Soft Contacts
• Hard Contacts
The Winchester Experience• Responding to an Audit
• Preparing and Going Through an Audit – Glad I am a Hoarder!
• Lessons Learned
Background on Post-Issuance
Responsibilities
Federal Tax Compliance
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What are Post-Issuance Tax Compliance
Procedures?
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Procedures that describe the actions to be taken by entity to maximize likelihood that tax rules will be followed for the life of a bond issue
Applicable to all bonds (includes all debt obligations such as bonds, notes, financing leases, etc.) issued on a “tax-advantaged” basis• Tax-exempt bonds• Taxable bonds for which bondholder receives federal tax credits or
issuer receives direct-pay bond subsidy payments (e.g., QZABs, BABs)
Procedures may be part of entity’s general debt management policies or in form of separate policies
Procedures may be adopted by formal action of governing body or incorporated by management
Why Create Written Policies &
Procedures?
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Fulfill entity’s contractual obligation with bondholders to maintain tax-exempt or tax credit status
Default could lead to loss of tax-advantaged status (worst case); loss of federal subsidy for direct-paytax credit bonds
IRS has strongly encouraged governmental entities to create written procedures to manage tax compliance• Currently not a federal tax law requirement, but ignore at one’s peril• IRS Form 8038-G asks about written procedures to address arbitrage
compliance and remedial actions
Practical consideration that entity will have easier time responding to IRS enforcement action• Information related to bond likely to be retained and available• Lower probability of tax errors if ongoing monitoring in place
IRS Form 8038-G
Issuer Certifications
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Form of Written Procedures
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No particular industry standard
IRS has not mandated particular form of written
procedures
Use of common sense in developing written
procedures
• Be comprehensive but need to tailor procedures to particular
entity – taking into account size of entity, type of bond deals,
frequency of bond issuance, availability of resources
Reliance solely on closing documents is not likely to
be sufficient
Primary Elements of an Effective
Post-Issuance Tax Compliance Program
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Primary Elements
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Written policies and procedures
Individual(s) assigned to manage compliance process
Record retention
Arbitrage rebate and yield restriction compliance; final
allocation; and filings with IRS (as applicable)
Monitoring private business use
Staff training and education
Periodic review of procedures and awareness of VCAP and
other remedial actions
Create Written Policies & Procedures –
Where to Start?
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Start by documenting current unwritten procedures
Use bond documents and published information materials as guides
Assign individual(s) (by title) who will be responsible for compliance management
• Depends on size of issuer
• Types of bond deals
Give primary point person broad authority to implement procedures, request information from other departments, participate in decisions by entity to change use of financed assets or sell financed assets
May require team effort
• Project/Facilities Coordinator
• Finance Department
• Outside Consultants – financial advisor, rebate consultant and bond counsel
Address succession issues
Record Retention
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IRS Guidance – IRC Section 6001 – general rule for
proper retention of records for federal tax
purposes:
• Basic records (e.g., transcript)
• Documentation on expenditures of bond proceeds
• Documentation on use of bond-financed property (public vs.
private use, management contracts, research agreements)
• Documentation on all sources of payment or security for the
bonds
• Documentation on investment of bond proceeds
Record Retention (cont’d)
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Sample records to retain:• Board minutes, resolutions• Feasibility studies, appraisals• Bond transcripts• Newspaper ads, miscellaneous correspondence• Investment records – bank statements, investment transaction
information (e.g., trade confirms), etc.• Expenditure history of bond proceeds – invoices, check images,
documents showing and supporting disbursements• IRS Filings – 8038-T (and related checks), 8038-CP• Records related to acquisition of investment agreements and interest rate
swaps• Payments for a letter of credit or standby bond purchase agreement• Arbitrage rebate and yield restriction compliance reports• Memos to file regarding bad use and other tax questions
Record Retention (cont’d)
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IRS Tax-Exempt Bond FAQs(https://www.irs.gov/tax-exempt-bond-faqs-regarding-record-retention-requirements)
• Why keep records?
• Who may maintain records?
• What are basic records to maintain?
• Are these the only records to be maintained?
• In what format must records be kept?
• How long should records be kept?
• How does general rule apply to refundings?
• What happens if records are not maintained?
• Can failure to properly maintain records be corrected?
• Are there exceptions to the general rule regarding record retention for certain types of records?
Arbitrage Rebate and
Yield Restriction Compliance
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Code Section 148 – Arbitrage and Yield
• Expenditure of bond proceeds (including investment earnings),
reimbursement of prior expenditures, final allocation
Ask questions and analyze whether noncompliance situations
exist
If problems are identified, initiate timely correction of
noncompliance situations
Consider VCAP and other remedial actions
Background on Post-Issuance
Responsibilities
Continuing Disclosure Compliance
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Background — Rule 15c2-12
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SEC Rule 15c2-12• Underwriters may not purchase bonds unless issuer has contractually
promised to provide specific continuing disclosure for the lifetime of the bonds Ongoing financial information
Filing notices of certain events
• Purpose is to provide ongoing information about the issuer in the secondary market
• SEC’s recent Municipalities Continuing Disclosure Corporation (“MCDC”) initiative in 2014 and other regulatory actions have focused attention on the need to have a reliable system in place to manage continuing disclosure
• Filings are made electronically at the Electronic Municipal Market Access (“EMMA”) portal (http://emma.msrb.org)
• Issuers may also choose voluntarily to post other information to EMMA for investor relations purposes
Municipalities Continuing Disclosure Cooperative (MCDC) Initiative• Self-reporting initiative available in 2014 to issuers and underwriters regarding
materially inaccurate statement in official statements relating to an issuer’s prior compliance with continuing disclosure agreements under SEC Rule 15c2-12
• Initiative concerned accuracy of representations (i.e., disclosure) made in official statements about prior continuing disclosure, not whether the issuer actually complied with its prior continuing disclosure undertakings
• First SEC enforcement action taken against California school district in July 2014, when MCDC initiative announced
• SEC filed enforcement actions against total of 72 municipal underwriting firms (June 2015, September 2015 and February 2016)
• In August 2016, SEC announced actions against 71 municipal issuers and other obligated persons for violating applicable securities laws by using offering documents that contained materially false statements or omissions about their compliance with prior continuing disclosure undertakings
• Expect continued emphasis from SEC (and hence underwriters) on continuing disclosure compliance by issuers
Case Study:
Winchester, VA
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Learning to Know What
You Need to Know
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Small city with around 26,000 residents and geographically approximately nine square miles
Six people in City’s Finance Department
Governmental bonds outstanding at June 30, 2016 is $91,122,575
During the past 10 years the City had four new money issuances and three very successful bond refundings
Also issued various revenue bonds through the Virginia Resources Authority for the City’s Utilities Enterprise Fund for water and sewer upgrade projects
Most of the City’s large construction projects have been to finance school remodeling or new construction
Learning to Know What
You Need to Know (cont’d)
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The City actively monitors and manages its policies
Compliance involves reviewing policies annually in conjunction with budget process
Related to debt issuance, the City has a debt policy that states net debt as a percentage of assessed value will not exceed 4% (target of 3.5%)
The City has chosen to hire an outside vendor to complete the arbitrage rebate computation
Director of Finance keeps all calculations together with the corresponding bond issuance
The City has all issuances on file with its rebate consultant to prepare computations as they come due
Learning to Know What
You Need to Know (cont’d)
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City of Winchester Team
• Finance Department Staff
• Financial Advisors
• Governing Body
Outside Professionals
• Bond Counsel
• Arbitrage Rebate Specialist
• Knowing when to call in the professionals
Learning to Know What
You Need to Know (cont’d)
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Implementing Policies and Procedures
• Developing from scratch
• Using guidelines from Bond Counsel (National Association of
Bond Lawyers) and GFOA; Other localities – VGFOA listserve
• General sections of policy include:
Description of the debt issued
Compliance documentation
Compliance responsibilities
• Who prepared, who reviewed and dates when this was
accomplished
Sample of City of Winchester Policy
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Description:
• The City utilizes general obligation bonds to finance long-term capital
assets such as City schools, municipal buildings, utilities projects and
other needs for our community
Compliance Documentation:
• Year-end audit
Compliance Responsibilities:
• The City utilizes the computer system EMMA for continuing
disclosure documentation and financial report postings that are
related to each individual CUSIP in the City’s bond issues
• EMMA can be accessed through emma.msrb.org. The Chief
Financial Officer has the sign on and password to access this system
Sample of City of Winchester Policy (cont’d)
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Arbitrage calculations are prepared by an outside vendor. Vendor has all of our issues on his calendar to ensure all arbitrage deadlines are completed timely. Includes contact information for rebate specialist.
Certain tax covenants: the City has covenanted not to permit the proceeds of the Bonds or the facilities financed with the proceeds of the Bonds to be used for more than 5% of private use, without an opinion of bond counsel. Includes contact information for bond counsel.
The City utilizes an asset management system for its fixed assets to account for all assets whether or not they are financed through bonds or other sources.
Sample of City of Winchester Policy (cont’d)
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The Chief Financial Officer will review annually the assets
referenced above to ensure the level of private use is
appropriate. Review annually any lease agreements that
affect any assets financed with tax-exempt bonds. Also, any
utility projects financed with tax-exempt bonds shall be
reviewed for any leases or reservations of capacity, or any
“special” rates that may affect the public use of the system.
Background on IRS Enforcement
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Background on IRS Enforcement
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IRS has two approaches to its enforcement efforts:
• No penalty for failing to respond; however, refusal to participate
will likely lead to an examination
Focused Correspondence
• “We have been provided with certain information”
Hard Contacts with Issuers
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Full Exams
• Random exams selected on Form 8038-G, Form 8038-CP,
Form 8038 data
• Program exams selected on type of bond purpose (e.g., multi-
family; advance refunding; jail facilities)
• Targeted exams for potential abuse
• “Examination” and “audit” mean the same thing
Recent IRS Efforts
(FY 2017 Work Plan Briefing Document)
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Exam priority given to claims and referrals warranting examination resources, including whistleblower referrals
In FY 2016, TEB completed exams of 22 returns selected from referral information – principal issues involved private use of bond financed property and arbitrage compliance failure
For FY 2017, TEB will continue developing examination projects based on identified areas of past noncompliance - including prison financings and “small issue” bonds
For FY 2017, TEB will continue to identify market segments that have higher right of noncompliance
• In FY 2015 and FY 2016 – market segment focus included advance refunding issues (with variable interest rates or escrows funded with open market escrow securities) and solid waste financings for projects that included manufacturing processes
New IRS Internal Guidance
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IRS announced in November 2016 new guidance to agents conducting IRS audits
Specific to the Information Document Request (IDR) process
Meant to be more “taxpayer friendly”
• Agent will discuss bond issue to be examined with issuer prior to issuing the IDR
• Agents required to make IDR more clear and specific as to what information is requested
• Agents required to follow a delinquency notice process if issuer does not timely provide information requested by IDR
Effective April 2017
Case Study:
Winchester, VA
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Audits!
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This wasn’t the letter I was expecting
• Don’t throw it in the back of the drawer
• Discuss with counsel
• Find paperwork affiliated with audit scope
• Contact the IRS
How to prepare
• Pull bond document(s) and any arbitrage (IRS) filings to date
• Collect spreadsheets with disbursements and interest earned
• Collect copies of all invoices and corresponding check copies
Audits! (cont’d)
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What to do when the IRS is in your office – the City of
Winchester Experience:
• The City along with the Jail Authority chose to hire original bond
counsel to be legal representative.
• IRS corresponded with bond counsel and the City/Jail Authority gave
all documentation to bond counsel to return back to the IRS agent.
• IRS agent scheduled 3-4 day onsite visits in finance office.
• IRS agent went through spreadsheets and matched the disbursements
to the check copies.
• By reviewing the dates on spreadsheets, the IRS agent could see when
the funds were spent and how much interest was accrued (and
interest rates for each month).
Audits! (cont’d)
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What the City learned:• Keep all information associated with the bond issuance• Keep all information updated; the City does this monthly• Hire an arbitrage compliance specialist and stay in contact • Upon each new bond issuance put that on their calendar!
What the City now does differently:• Work to train others on arbitrage compliance, particularly those
managing projects• Watch out for staff turnover and train accordingly and timely
Why it sounds worse than it is!• With the support of arbitrage specialists and good record-keeping, an
issuer will have fewer problems in responding to an audit• Speaking honestly and accurately are the best defenses