On April 26, 2010, the Internal Revenue Service (IRS) released IRS Notice 2010-35 (the Notice) that provides guidance on certain qualified tax credit bonds (QTCBs) and build America bonds (BABs). BABs are taxable municipal obligations for which the issuer may receive a direct federal subsidy, in the form of a cash payment, to offset the interest cost of the BAB. Alternatively, an issuer of BABs may elect that the subsidy be delivered as a non-refundable federal income tax credit to the BAB investor, although that option is generally less attractive and is not being utilized on a widespread basis. QTCBs are taxable municipal obligations that were originally conceived with a subsidy in the form of a refundable tax credit for the investor. However, the Hiring Incentives to Restore Employment Act of 2010, enacted on March 18, 2010, authorized issuers of new clean renewable energy bonds, qualified energy conservation bonds, qualified zone academy bonds and qualified school construction bonds (collectively, Direct Pay QTCBs) the option of receiving a federal subsidy in the form of a direct cash payment to offset the interest cost of the borrowing.
The amount of the direct cash subsidy for qualified zone academy bonds and qualified school construction bonds with respect to any interest payment date is equal to the lesser of (i) 100 percent of the amount of interest payable under the bond on such date, or (ii) 100 percent of the amount of interest that would have been payable under such bond on such date if such interest were determined at the applicable tax credit bond rate determined under Section 54A(b)(3). For new clean renewable energy bonds and qualified energy conservation bonds, the amount of the direct cash subsidy with respect to any interest payment date under the bond is equal to the lesser of (i) 100 percent of the amount of any interest payable under the bond on such date, or (ii) 70 percent of the amount of interest that would have been payable under such bond on such date if such interest were determined at the applicable tax credit bond rate determined under Section 54A(b)(3).
The following summarizes certain key reporting, qualification and other rules identified in the Notice for Direct Pay QTCBs. By the terms of the Notice, certain of these rules also apply to BABs issued after March 18, 2010.
Qualification and Reporting Rules
- Election to Issue Direct Pay QTCBs. An issuer must make an irrevocable election to issue QTCBs as Direct Pay QTCBs on its books and records on or before the date of their issuance.
- Form 8038-TC.
- Form 8038-TC must be filed with the IRS upon issuance of Direct Pay QTCBs, generally must be filed at least 30 days before the first Form 8038-CP (described below), and must include as an attachment a debt service schedule in a form specified by the IRS.
- The IRS expects Form 8038-TC to be available on its website by June 25, 2010.
- Revised Form 8038-CP.
- For Direct Pay QTCBs or BABs, revised Form 8038-CP must be filed by an issuer to receive the direct cash subsidy payments.
- Revised Form 8038-CP will be available on the IRS website on or before June 25, 2010. For BABs, revised Form 8038-CP will be processed upon receipt. For Direct Pay QTCBs, the IRS expects to be prepared to process Form 8038-CP by July 12, 2010, and to make timely payments of direct cash subsidy payments beginning with interest payment dates occurring on or after September 1, 2010.
- Issuers of Direct Pay QTCBs with interest payment dates prior to September 1, 2010, may submit a revised Form 8038-CP and, for purposes of processing such Form 8038-CP, the first date treated as an interest payment date shall be September 1, 2010. In other words, receipt of the subsidy should not be expected before September 1, 2010.
Other Rules for Direct Pay QTCBs and BABs
- Premium Limitation (Direct Pay QTCBs and BABs).
- As with BABs, Direct Pay QTCBs may not be issued with more than a “de minimis” amount of premium.
- For purposes of determining whether a bond has too much premium, a “make whole” call option requiring the payment of a call premium in an amount that preserves the bond’s original yield to maturity will be disregarded, because the exercise of the call usually will not produce a lower yield on the bond.
- Reimbursement and Short-Term Financing Limitations (Direct Pay QTCBs).
- Proceeds of Direct Pay QTCBs may be used to reimburse eligible expenditures that were paid or incurred by the issuer prior to the issue date.
- Proceeds of Direct Pay QTCBs may not be used to refinance eligible expenditures for qualified purposes in refunding issues. However, Direct Pay QTCBs issued to reimburse otherwise eligible expenditures for qualified purposes that were incurred after March 18, 2010, and that were financed originally with temporary short-term financing issued after March 18, 2010, will not be treated as a refunding issue.
- Treatment of Original Issue Discount (OID) and Preissuance Accrued Interest (PAI). OID and PAI are not taken into account in the calculation of direct cash subsidy payments with respect to Direct Pay QTCBs or BABs.
If you have any questions regarding BABs, Direct Pay QTCBs or QTCBs in general, please contact one of the authors, or visit McGuireWoods’ Public Finance practice website. You also can refer to prior alerts on QTCBs and other newly available financing tools, such as Build America Bonds, Recovery Zone Economic Development Bonds and Recovery Zone Facility Bonds in our news archive and the Stimulus Package section.