I was delighted to speak at the Tax-Exempt Financing Committee Meeting at the ABA Section of Taxation’s Midyear Tax Meeting. I spoke about a new rule enacted last year in the Inflation Reduction Act that allows state and local governments to cash in tax credits for certain green projects even though they don’t pay tax and can’t ordinarily claim tax credits. In addition, other panels focused on legislative and regulatory developments and dealing with rising interest rates. Some reflections and thoughts:
Rising interest rates are creating the opportunity for the first time in many years for issuers to be able to earn an arbitrage profit on invested bond proceeds. The answers for how to most intelligently invest bond proceeds, particularly in multipurpose issues and those with reserve funds or significant replacement proceeds, within the confines of the arbitrage rules can change when it is actually possible to earn arbitrage. This puts a premium on high-quality bond counsel advice before and after bonds are issued and proceeds are invested.
The Bureau of Public Debt is proposing changes to the SLGS regulations that threaten the viability and flexibility of the program. The changes are in proposed form, and the comment period seemed to pass largely under the radar last fall. The National Association of Bond Lawyers (NABL), where I serve on the Board of Directors, did comment. The changes seem primarily designed to attack a very small subset of bad actors but, as is often the case, the regulations as proposed sweep far beyond that limited scope and would make life much more difficult for honest issuers and borrowers if finalized as proposed.
We continue to hear reports from the field that IRS auditors are taking a hard line on the rules that govern when we can use bond proceeds to reimburse expenditures paid prior to the issuance of the bonds. They are insisting that we must use magic words such as “reimburse” when declaring an intent to finance these previously paid expenditures, or to specifically note the amount of the expected reimbursement. As NABL and others have pointed out, this ignores the history of these rules and the fact that all of these battles have already been fought, back in the early 1990s. Because, as always, it is frustratingly difficult for issuers and borrowers of tax-exempt bonds to combat interpretations of law taken by the IRS examination function that they disagree with without risking a lengthy, costly (and, thanks to the continuing disclosure rules, somewhat public) fight with the IRS at the IRS Appeals Office, issuers and conduit borrowers should redouble their efforts to be sure that their practices and policies surrounding declarations of intent are crystal clear.
Last, but certainly not least: Under last year’s Inflation Reduction Act, governmental entities can now “monetize” certain renewable energy tax credits. On paper, this development is a game-changer and one that state and local governmental issuers, particularly public power providers, have long sought. The change gives them a greater incentive to own renewable energy generation facilities. (Under prior law, if they owned the facility, they couldn’t claim the tax credits because they don’t pay tax, so the tax credits would evaporate unless the project was owned by a taxpayer who could use them). Many expect this provision over time to markedly increase the share of renewable energy technology that is owned by state and local governmental entities and their affiliates. However, the calculation may not be as simple as it sounds. Owning infrastructure brings with it lots of risks that governmental entities may not have borne in the past, and governmental entities will need to do a complex calculation to determine whether it makes sense for them to own projects and, if so, whether to claim the production tax credit (spread over 10 years, and subject to change in law risk and other legal uncertainty that may result in nonpayment) or the investment tax credit (paid all at once, but potentially less lucrative than the production tax credit). Finally, these rules will likely involve the confluence of the tax credit rules and the tax-exempt bond rules. Issuers will have to decide whether, how, and in what amount to use tax-exempt bonds to finance the costs of a renewable energy project that is eligible for monetized tax credits, knowing that the credit will be reduced (although the Inflation Reduction Act lowers the haircut from 50% of the credit amount to a maximum of 15% of the credit amount). The complications inherent in combining these two rules will favor firms like Nixon Peabody that have both sophisticated tax credit and tax-exempt bond practices.