For some time IOU’s have had a tax incentive For some time IOU’s have had a tax incentive for development of renewable energy resources for development of renewable energy resources
2005 Energy Policy Act provides additional 2005 Energy Policy Act provides additional tax creditstax credits
Public Power and Coops have made tremendous Public Power and Coops have made tremendous effort to obtain legislation to provide similar effort to obtain legislation to provide similar incentives for public powerincentives for public power
Tax Credit bonds are an alternative to the Tax Credit bonds are an alternative to the politically unpopular tradable tax creditspolitically unpopular tradable tax credits
2005 Energy Policy Act permits Clean 2005 Energy Policy Act permits Clean Renewable Energy Bonds to be issued as tax Renewable Energy Bonds to be issued as tax credit bondscredit bonds
Designed to provide an interest free loan to Designed to provide an interest free loan to munis and coops for qualified projectsmunis and coops for qualified projects
CREBs may be issued in 2006 and 2007CREBs may be issued in 2006 and 2007 Based on “QZAB” programBased on “QZAB” program
Wind, closed and open-loop biomass (including Wind, closed and open-loop biomass (including agricultural livestock waste nutrients), agricultural livestock waste nutrients), geothermal, solar, small irrigation power, landfill geothermal, solar, small irrigation power, landfill gas, hydropower, and trash combustiongas, hydropower, and trash combustion
Applies to expenditures made after August 8, Applies to expenditures made after August 8, 20052005
Reimbursement and refinancing permitted for Reimbursement and refinancing permitted for post-8/8/05post-8/8/05
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CREBs Volume CapCREBs Volume Cap
In total, $800 million of CREBs may be In total, $800 million of CREBs may be issued but at least $300 million is reserved issued but at least $300 million is reserved for cooperatives for cooperatives
Treasury is responsible for allocating this Treasury is responsible for allocating this volume cap among projects but no guidance volume cap among projects but no guidance on how this is to be doneon how this is to be done
6
CREBs: Maturity and YieldsCREBs: Maturity and Yields
Must pay principal in level annual installmentsMust pay principal in level annual installments Limited final maturity: number of years such Limited final maturity: number of years such
that final maturity has a PV equal to 50% of that final maturity has a PV equal to 50% of its face amount its face amount
Intended to be issued at par with a tax credit Intended to be issued at par with a tax credit equivalent to a taxable couponequivalent to a taxable coupon
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Marketing Challenges – Marketing Challenges – Lessons From QZABs PricingLessons From QZABs Pricing
Prices set by Treasury once a dayPrices set by Treasury once a day 2005 rates ranged from 4.90% to 5.64%2005 rates ranged from 4.90% to 5.64% ‘‘One size fits all’ pricing does not address One size fits all’ pricing does not address
differing credit quality of issuersdiffering credit quality of issuers Issued at prices as low as 80%Issued at prices as low as 80% Levelized principal payments present Levelized principal payments present
additional pricing complexity over bullet additional pricing complexity over bullet maturitiesmaturities
Tax credits cannot be stripped from underlying Tax credits cannot be stripped from underlying bondbond Assumes investor will continue to have tax Assumes investor will continue to have tax
liability for the life of the bondliability for the life of the bond Assumes tax credits will be valid for life of the Assumes tax credits will be valid for life of the
bondbond Impact on pricingImpact on pricing
Any OID reduces the benefit of the “interest Any OID reduces the benefit of the “interest free” borrowingfree” borrowing
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CREBs: ExpenditureCREBs: Expenditureand Other Requirementsand Other Requirements
95% of the proceeds must be spent within 5 95% of the proceeds must be spent within 5 years of the issuance of the CREBs unless years of the issuance of the CREBs unless extended by the IRS extended by the IRS
If this requirement is not satisfied, a portion of If this requirement is not satisfied, a portion of the CREBs must be redeemed within 90 daysthe CREBs must be redeemed within 90 days
CREBs are subject to arbitrage and rebate CREBs are subject to arbitrage and rebate rulesrules
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The Allocation ProcessThe Allocation Process
The application process to Treasury has not The application process to Treasury has not yet been developedyet been developed
Not yet determined what criteria Treasury Not yet determined what criteria Treasury will use to allocate bonds among competing will use to allocate bonds among competing applicantsapplicants
Opportunity for input to Treasury/IRSOpportunity for input to Treasury/IRS
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Overview Of CurrentOverview Of CurrentLegislative AtmosphereLegislative Atmosphere
JCT proposalsJCT proposals
Potential SFC proposalsPotential SFC proposals
Budget Picture – search for revenue raisersBudget Picture – search for revenue raisers
Tax reformTax reform
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JCT ProposalsJCT Proposals
Eliminate advance refundings of bonds Eliminate advance refundings of bonds issued after enactmentissued after enactment Not retroactiveNot retroactive
Information reportingInformation reporting Require issuers to provide 1099 type information to Require issuers to provide 1099 type information to
bondholders and IRS. Alternatively, require issuers bondholders and IRS. Alternatively, require issuers to maintain bondholders lists to be provided to the IRS to maintain bondholders lists to be provided to the IRS if requestedif requested
Designed to improve the IRS’ ability to tax Designed to improve the IRS’ ability to tax bondholders on “bad” dealsbondholders on “bad” deals
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JCT Proposals – cont’dJCT Proposals – cont’d
Changes that will reduce investor demand for Changes that will reduce investor demand for tax-exempt bonds:tax-exempt bonds: Eliminate de minimis rule for corporate investors in Eliminate de minimis rule for corporate investors in
tax-exempt bondstax-exempt bonds Eliminate special rules for insurance companies that Eliminate special rules for insurance companies that
invest in tax-exempt bondsinvest in tax-exempt bonds Proposals would eliminate tax deductions for Proposals would eliminate tax deductions for
corporate and insurance company investments in corporate and insurance company investments in tax-exempt bonds – reduces after tax returntax-exempt bonds – reduces after tax return
P&Cs hold almost 15% of outstanding bondsP&Cs hold almost 15% of outstanding bonds
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JCT Proposals – cont’dJCT Proposals – cont’d
Potential impact on issuers if enactedPotential impact on issuers if enacted Advance refundingAdvance refunding Demand side changesDemand side changes Information reportingInformation reporting
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Potential SFC ProposalsPotential SFC Proposals
SFC staff investigation of tax-exempt bondsSFC staff investigation of tax-exempt bonds Follows from investigation of nonprofit Follows from investigation of nonprofit
organizationsorganizations Goes beyond JCT proposalsGoes beyond JCT proposals Involves research, interviews with market Involves research, interviews with market
participants, and extensive discussions with participants, and extensive discussions with IRS audit groupIRS audit group
Staff call for industry to develop its own reform Staff call for industry to develop its own reform proposalsproposals
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Potential SFC Proposals Potential SFC Proposals – cont’d– cont’d Interest of Senator Grassley, SFC ChairInterest of Senator Grassley, SFC Chair
Grassley focus on nonprofits and tax-exempt bonds Grassley focus on nonprofits and tax-exempt bonds in complimenting JCT on its report proposalsin complimenting JCT on its report proposals
Need for revenueNeed for revenue Sen. Grassley led the charge against “abusive” Sen. Grassley led the charge against “abusive”
leasing transactions involving state and local leasing transactions involving state and local governmentsgovernments
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Potential SFC Proposals Potential SFC Proposals – cont’d– cont’d Areas of concern and possible proposalsAreas of concern and possible proposals
Very supportive of JCT proposals and JCT Very supportive of JCT proposals and JCT in generalin general
Belief that IRS lacks resources to effectively police Belief that IRS lacks resources to effectively police the industrythe industry
Concern with issuer/borrower failures to spend bond Concern with issuer/borrower failures to spend bond proceeds – led to mandatory redemption proceeds – led to mandatory redemption requirement for unspent CREB proceedsrequirement for unspent CREB proceeds
SFC staff belief that there are lots of problems with SFC staff belief that there are lots of problems with tax-exempt bonds and QZABstax-exempt bonds and QZABs
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Longer Term Risks – Longer Term Risks – Tax ReformTax Reform
Tax reform statusTax reform status Presidential Commission report due September Presidential Commission report due September
30, 200530, 2005 Report to be followed by Administration proposalsReport to be followed by Administration proposals
Potential changesPotential changes Eliminate tax on all investment earningsEliminate tax on all investment earnings Subject tax-exempt entities to income taxSubject tax-exempt entities to income tax Eliminate deductibility of state and local taxesEliminate deductibility of state and local taxes Potential impact on tax-exempt bondsPotential impact on tax-exempt bonds
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Circular 230Circular 230
What is Circular 230?What is Circular 230? Proposed rules for tax-exempt bond opinionsProposed rules for tax-exempt bond opinions Why is this being done?Why is this being done? The rules govern how bond counsel renders their The rules govern how bond counsel renders their
opinionsopinions Requires a written description by bond counsel of Requires a written description by bond counsel of
facts, law and analysis of tax issuesfacts, law and analysis of tax issues
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Circular 230 – Potential Circular 230 – Potential Consequences for IssuersConsequences for Issuers
Additional transaction costsAdditional transaction costs Potential disclosure issue and higher Potential disclosure issue and higher
interest ratesinterest rates Provides audit roadmap for IRSProvides audit roadmap for IRS Opinion “disclaimer”?Opinion “disclaimer”? Immediate problem for “long” forward transactionsImmediate problem for “long” forward transactions Bond counsel become more conservative? Bond counsel become more conservative?
More aggressive?More aggressive?
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Circular 230 - FutureCircular 230 - Future
Impact of Final Regulations for other transactionsImpact of Final Regulations for other transactions What happens next?What happens next? Regulatory processRegulatory process Are bond counsel already reacting?Are bond counsel already reacting?
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SLGS - OverviewSLGS - Overview
Flexibility of prior SLGS regulations provided Flexibility of prior SLGS regulations provided significant advantages:significant advantages: Ability to lock in rates even if transaction is not a Ability to lock in rates even if transaction is not a
sure thingsure thing Ability to use the “free option” in SLGS to Ability to use the “free option” in SLGS to
restructure escrows to eliminate negative arbitragerestructure escrows to eliminate negative arbitrage Interest rate setting process provides opportunities Interest rate setting process provides opportunities
to eliminate negative arbitrageto eliminate negative arbitrage
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SLGS – New RulesSLGS – New Rules Changes to SLGS regulations:Changes to SLGS regulations:
Mandatory use of SLGS-SafeMandatory use of SLGS-Safe New interest rate setting procedureNew interest rate setting procedure Elimination of ability to change delivery dateElimination of ability to change delivery date Elimination of penalty free cancellationElimination of penalty free cancellation Requirement that subscriptions be filed Requirement that subscriptions be filed
by 10 p.m. Eastern timeby 10 p.m. Eastern time Eliminate ability to increase yield in purchase or Eliminate ability to increase yield in purchase or
redemption of SLGSredemption of SLGS Why did this happen?Why did this happen?
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IRS Audit Program – StatusIRS Audit Program – Status
Status of Audit ProgramStatus of Audit Program Areas of IRS focus:Areas of IRS focus:
Largely aimed at “abuses” blind pools, escrow Largely aimed at “abuses” blind pools, escrow puts, yield burningputs, yield burning
Selected other areas (solid waste)Selected other areas (solid waste) Development of IRS “expertise”Development of IRS “expertise” Possible expansion of audit topicsPossible expansion of audit topics Are swaps the next big problem area?Are swaps the next big problem area?
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IRS Audit Program IRS Audit Program –– Risks and Problems Risks and Problems
Impact on outstanding bondsImpact on outstanding bonds Whether to disclose auditWhether to disclose audit Impact of disclosure – Variable rate bondsImpact of disclosure – Variable rate bonds Impact of disclosure – Fixed rate bondsImpact of disclosure – Fixed rate bonds Impact of disclosure – New IssuesImpact of disclosure – New Issues
The audit process is stacked against issuersThe audit process is stacked against issuers Difficult to convince the auditors that they Difficult to convince the auditors that they
are wrongare wrong
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IRS Audit Program – IRS Audit Program – Risks and Problems (cont.)Risks and Problems (cont.)
No real ability to obtain an independent review No real ability to obtain an independent review of the matterof the matter
IRS doesn’t like to go away empty handedIRS doesn’t like to go away empty handed 6700 penalty threat to issuers, underwriters, 6700 penalty threat to issuers, underwriters,
bond counsel, etcbond counsel, etc
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IRS Audit Program – IRS Audit Program – Risks and Problems (cont.)Risks and Problems (cont.)
Is there any hope for improvement?Is there any hope for improvement? NABL ADR proposalNABL ADR proposal Treasury/IRS interestTreasury/IRS interest
Analyzing tax risks to avoid auditsAnalyzing tax risks to avoid audits How do issuers protect themselves?How do issuers protect themselves? Avoiding “abusive” transactionsAvoiding “abusive” transactions Reliance on counsel – is it enough?Reliance on counsel – is it enough? What if you find a problem? VCAP programWhat if you find a problem? VCAP program
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Transmission and Private Use Transmission and Private Use
RTOs: private use rules are very favorable for RTOs: private use rules are very favorable for transmission in an RTOtransmission in an RTO
Other open access: Transmission is subject to Other open access: Transmission is subject to the private use rules if used in open access but the private use rules if used in open access but not as part of an RTOnot as part of an RTO
Private use regulatory relief not as generous Private use regulatory relief not as generous as relief provided to IOUs and Coops in as relief provided to IOUs and Coops in recent legislationrecent legislation
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Equity First Equity First
Equity first Equity first –– the problem the problem IRS Proposal IRS Proposal –– advance notice of proposed advance notice of proposed
rulemakingrulemaking For output facilities, private use may be allocated to equity For output facilities, private use may be allocated to equity
first.first. ““Equity” only includes taxable bond proceeds and issuer Equity” only includes taxable bond proceeds and issuer
funds at closing.funds at closing. For the equity first rule to apply, bond proceeds and equity For the equity first rule to apply, bond proceeds and equity
must have been spent contemporaneously.must have been spent contemporaneously. The private use and equity must be “allocable” to the same The private use and equity must be “allocable” to the same
facility for the equity first rule to apply.facility for the equity first rule to apply.
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Equity First – CommentsEquity First – Comments
Comments:Comments: The contemporaneous expenditure requirement The contemporaneous expenditure requirement
should be eliminated (especially for older should be eliminated (especially for older transactions)transactions)
““Equity” should be defined to include retired Equity” should be defined to include retired tax-exempt bondstax-exempt bonds
More flexible allocation rules are needed for More flexible allocation rules are needed for this purposethis purpose
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Equity First – Status of Equity First – Status of Allocation and Accounting Allocation and Accounting
Regulations and Next Steps Regulations and Next Steps
TimingTiming ScopeScope Opportunity for inputOpportunity for input
