Lease and COP Matters

October 12, 2011

A.  Non-Substitution Clauses in Leases

The following is an excerpt from “Common Questions about Tax-Exempt Leases” published online by Municipal Funding of Zephyrhills, Florida, available at http://municipal-funding.com/tax-exempt_leasing_faq.htm:

A non-substitution clause is a provision in a 103 lease that prevents the government from non-appropriating and then acquiring equipment to perform the same function as the previously leased equipment.

Although non-substitution clauses still appear in 103 leases, the majority view (with which the author agrees) seems to be that having a non-substitution clause in a 103 lease actually damages the lessor’s interest. Here is the rationale: If the non-substitution clause prohibits the government from performing an essential government function, such a clause may be used to show that the lessor, while purporting to recognize the unrestricted right of the government to non-appropriate, nevertheless imposed coercive sanctions on the government in the event that the government exercised such right. The right to non-appropriate becomes illusory.

The non-substitution clause becomes the basis for an argument that the 103 lease creates debt. The government still has to perform the essential government function being served by the equipment. If it is unable to acquire new equipment to perform that function subsequent to a non-appropriation, non-appropriation is not a real option and the lease is essentially a multiyear hell or high-water obligation.

Courts in several states, including Texas, Oregon, Colorado, and Florida, have already found that including a non-substitution clause turns the 103 lease into debt. In each of these cases, because the procedures for incurring debt were not complied with, the 103 lease was void.

In light of this and because experience shows the clause is rarely if ever enforced, it offers no real benefit to lessors. Limiting its reach by the phrase “to the extent permitted by law” may mitigate some of the negative consequences, but it does little to make the provision more helpful.

B. Lessor Entities

For purposes of IRS Form SS-4, Application for Employer Identification Number (EIN), does the lessor entity check the “Corporation” box or the “State/local government” box on line 9a?  Does the lessor entity need to file an income tax return?

Generally, if an entity is separate from (not an “integral part” of) the government, its income will be subject to tax unless an exclusion or exemption applies. If the income is subject to income tax, the entity may need to file a return.  An exclusion in I.R.C. 115, however, excludes from gross income, income (1) derived from any public utility or the exercise of any essential governmental function, and (2) accruing to a state or political subdivision (including the District of Columbia).

The IRS Exempt Organizations training material provides the following discussion:

What activities involve exercise of an “essential governmental function” is generally decided on a case-by-case basis. Factors considered include whether the activity is one traditionally considered “governmental” (as opposed to private or proprietary), whether it involves the exercise of governmental (sovereign) powers, the extent of government control over the activity, and the extent of government financial interest in the activity. Qualifying activities may include public education; investment of public funds, Rev. Rul. 77-261, 1977-2 C.B. 45; operating a municipal insurance pool; operating a public hospital or other public health facilities; or providing public recreation facilities.

Income must be derived from a qualifying activity; it is not enough that it be paid over to or benefit a qualifying activity. For example, that a university uses income derived from operating a commercial television station to conduct educational programs does not render the income excludable; the income must have been derived from educational activities. See Iowa State University of Science & Technology v. United States, 500 F.2d 508 (Ct. Cl. 1974).

The second requirement under IRC 115(1) is that income “accrue to” a state or political subdivision. Income “accrues” where the state or subdivision has an unrestricted right to a proportionate share of the income. Rev. Rul. 77-261, 1977-2 C.B. 45. The “accrual requirement” may also be met by less direct means. What is required is a substantial degree of government dominance over the enterprise. While many organizations that are “instrumentalities” for employment tax purposes (discussed below) will also have income excluded under IRC 115, the two are conceptually distinct. It is therefore conceivable that an “instrumentality” may be subject to income taxation.

If the lessor entity constitutes an entity described in I.R.C. 115, bond counsel will generally identify the lessor entity as a “State/local government” entity on the SS-4 form.  It is not entirely clear whether the lessor or the governmental lessee will need to file a tax return for the lessor.  The IRS Exempt Organizations training material provides the following statement:

Return Requirements. Under Rev. Rul. 78-316, 1978-2 C.B. 304, states and political subdivisions (including their “integral parts”) are generally not required to file income tax returns with respect to activities they directly conduct. Separatelyorganized instrumentalities, however, are subject to the general rule requiring taxable corporations to file returns, regardless of whether they have income or owe tax. Rev. Rul. 77-261, 1977-2 C.B. 45. Specific provisions may require a return even if an entity is an “integral part” of a state or political subdivision. For example, if an entity is an “insurance company” for federal tax purposes, it must file a return even if it is not otherwise considered a taxable corporation. See Rev. Rul. 83-132, 1983-2 C.B. 270.

C.  COP Matters

PLR 200314024:  Bonds are issued “as certificates of participation” in an installment sale agreement with the City in which the City agrees to make payments to purchase the Center from the Corporation.  Payments will equal the interest and principal due on the COPs.

PLR 9123058:  In a COP financing, the underlying lease as well as the COPs were approved under 147(f), not just the COPs.


Electronic Signatures

July 8, 2011

Electronic Signatures in Colorado:

Colorado has enacted the Uniform Electronic Transactions Act in Article 71.3 of Title 24, Colorado Revised Statutes, as amended.  The Act provides for the enforceability electronic signatures in certain instances.

Sample Language:

Sample contract language might be:

(Electronic Signatures and Electronic Records) Party A consents to the use of electronic signatures by Party B.  This Agreement and any other documents requiring a signature hereunder, may be signed electronically by Party B in the manner specified by Party B.  Party A and Party B agree not to deny the legal effect or enforceability of this Agreement solely because it is in electronic form or because an electronic record was used in its formation.  Party A and Party B agree not to object to the admissibility of this Agreement in the form of an electronic record, or a paper copy of an electronic document, or a paper copy of a document bearing an electronic signature, on the grounds that it is an electronic record or electroni signature or that it is not in its original form or is not an original.

Or the following:

The parties agree that the electronic signature of a party to this Indenture shall be as valid as an original signature of such party and shall be effective to bind such party to this Indenture.  The parties agree that any electronically signed document (including this Indenture) shall be deemed (a) to be “written” or “in writing,” (b) to have been signed and (c) to constitute a record established and maintained in the ordinary course of business and an original written record when printed from electronic files.  Such paper copies or “printouts,” if introduced as evidence in any judicial, arbitral, mediation or administrative proceeding, will be admissible as between the parties to the same extent and under the same conditions as other original business records created and maintained in documentary form.  Neither party shall contest the admissibility of true and accurate copies of electronically signed documents on the basis of the best evidence rule or as not satisfying the business records exception to the hearsay rule.  For purposes hereof, “electronic signature” means a manually signed original signature that is then transmitted by electronic means; “transmitted by electronic means” means sent in the form of a facsimile or sent via the internet as a “pdf” (portable document format) or other replicating image attached to an e mail message; and, “electronically signed document” means a document transmitted by electronic means and containing, or to which there is affixed, an electronic signature.

Important Note:

A review of the Act and its application to particular contracts and transactions should be completed before relying on the provisions of the Act.  The author of this posting has not done this research for documents relating to tax-exempt bond transactions in Colorado or elsewhere.  This is particularly signficant if an attorney or law firm is to opine on the enforceability of the agreement in which the provision is included.


Net Interest Cost, True Interest Cost, All-In True Interest Cost

May 19, 2011

Colorado Statutory Rules:

For purposes of Article 1, Title 32 of the C.R.S.:

“Net effective interest rate” = “Net interest cost” of the bonds / SUM[(principal amount of bonds maturing on maturity date 1 * number of years from their date to that maturity date) + (principal amount of bonds maturing on maturity date 2 * number of years from their date to that maturity date) + (etc.)]

Net effective interest rate must be calculated without regard to any option of redemption price to the designated maturity dates of the bonds.

“Net interest cost” = Total amount of interest to accrue on the bonds from their date to their respective maturities, less the amount of any premium or plus the amount of any discount.  Net interest cost must be calculated without regard to any option of redemption prior to the designated maturity dates of the securities.  In other words, net interest cost is the total interest less the amount of premium or plus the amount of discount.

For purposes of Article 90, Title 24 of the C.R.S.:

“Net effective interest rate” means the net interest cost of securities divided by the sum of the products derived by multiplying the principal amount of the securities maturing on each maturity date by the number of years from their date to their respective maturities.  In all cases, the net effective interest rate shall be computed without regard to any option of redemption prior to the designated maturity dates of the securities.

The “net interest cost” concept is applicable in the following state law circumstances:

  • Refundings under the Public Securities Refunding Act (see 11-56-104, -105, -106, -107, C.R.S.)
  • Colorado Recovery and Reinvestment Finance Act of 2009 (see 11-59.7-105, C.R.S.)
  • Refunding bonds for schools (see 22-43-103, -105, C.R.S.)
  • Refunding bonds for postsecondary education/junior colleges (see 23-71-603, -605, C.R.S.)
  • Refunding bonds for counties (see 30-35-703, C.R.S.)
  • Refunding bonds for municipalities (see 31-21-203, C.R.S.)

Other Related Matters:

The interest payment to investors and the underwriter’s profit together comprise Net Interest Costs, which is the usual measure of bond financing costs. For example, if an underwriter purchases a bond issue at an interest rte of 9.4 percent, and resells (“reoffers”) it to the final investor for 9.1 percent, the NIC is composed of an interest cost of 9.1 percent and an underwriter’s profit or spread of 0.3 percent.

“True interest cost” (TIC) = Par value + accrued interest + premium – discount – underwriter’s discount (but not costs of issuance and not other amounts) = target value for present value calculation.  Figure the yield at which the present values of the payments made on the bonds equal this target value.

“All-in true interest cost” (All-In TIC) = Par value + accrued  interest + premium – discount – underwriter’s discount – costs of issuance – other amounts = target value for present value calculations.

“Arbitrage yield” (Arb Yield) = Par value + accrued interest + premium – discount = target value for present value calculations.  Because none of the expenses are deducted for purposes of coming up with the arbitrage yield, the arbitrage yield necessarily is lower than the TIC or All-In TIC.


State Securities Laws

December 22, 2009

Colorado:

Bonds issued by the Colorado Health Facilities Authority (CoHFA) are exempt from registration requirements imposed by the Colorado Securities Act.  See 25-25-118, C.R.S.  See also 11-51-307, C.R.S.


Miscellaneous District Financing Rules

September 3, 2009

Filing Form DLG-32

Section 32-1-1604, C.R.S., requires a special district to file a notice of any authorization or incurrence of general obligation debt and a description of such debt in a form prescribed by the director of the division of local government in the department of local affairs with the county clerk and recorder in each county in whcih the district is located.  The recording must be done within 30 days after authorizing or incurring the debt.  This requirement does not apply to debt or lease purchase agreements that are not general obligation debt. In other words, revenue bonds or lease purchase agreements are not subject to this requirement.

Special Districts (Colorado)

Special Districts are created pursuant to Title 32 of the Colorado Revised Statutes, as amended (“C.R.S.”).

Community Development Districts (Florida)

Community development districts are created pursuant to the Uniform Community Development District Act of 1980, Chapter 190, Florida Statutes, as amended (“F.S.”).

Established for the purpose of providing basic community development services.

The initial board of five persons is designated when the district is created.  Each member holds office for a term of 2 or 4 years.  Within 90 days following the rule or ordinance establishing the district, there is to be held a meeting of the landowners at which the landowners elect five supervisors of the district.  Each landowner is entitled to case one vote per acre of land owned by him or her located within the district, for each person to be elected.

If the district intends to exercise ad valorem taxing power, the board must call an election at which members of the board of supervisors will be elected by “qualified electors.”

Regardless of whether the taxing power is to be exercised, generally by 6 years after the initial appointment of members and only if there are at least 250 qualified electors in the district, the position of each member whose term has expired must be filled by a qualified elector of the district.  If fewer than 250 qualified electors are in the district, members of the board will continue to be elected by landowners.

The power of eminent domain permits the district to exercise the power over any property within the state, except certain governmental and federal property, for the uses and purposes of the district.

Assessments may be imposed for the types of public improvements listed in F.S. 170.01.


Exemption from State Securities Registration

August 17, 2009

General

It is unlawful for any district to issue bonds or for any other person to make a distribution of such bonds unless they are first registered with the securities commissioner under section 11-59-108, C.R.S. or unless the issuance of bonds is exempted under section 11-59-110, C.R.S.

Claims for exemption must be filed at least five days (not business days) prior to the first sale of such bonds (Section 11-59-110(2), C.R.S.).

Procedure for Private Placements

In the case of a private placement without disclosure documents, the exemption form is to be submitted to the state division of securities indicating an expected issue date along with a substantially final resoluton (and indenture, if applicable). Upon issuance and delivery, the final resolution (and indenture) is to be accompanied by a copy of the approved exemption form on which the final issue date is noted. Procedures may vary by state, and the description above applies only to one particular state, intentionally not identified by the author.

Entities Subject to Exemption Form

Entities subject to exemption include special districts, municipal general improvement districts, municipal special improvement districts, county local improvement districts and county public improvement districts (Section 11-59-103, C.R.S.).  Parks and recreation districts are special districts (Section 32-1-103(14), C.R.S.).  No exemption filing is needed for business improvement districts.

Related Entries

State Securities Laws

Miscellaneous District Financing Rules (Form DLG-32)


Calendar of Assessments in Colorado

July 9, 2009

Preliminary Assessed Valuations:

Preliminary assessed valuations available by August 25 of each year. The valuations are certified by the county assessor to the State (Section 39-5-128 C.R.S.). The various state and county entities then calculate mill levies based on the preliminary valuations.

Final Assessed Valuations:

If changes occur to the assessed valuations between August 25 and December 10, county assessors must re-certify final assessed valuations to the state and various taxing entities. This will allow such entities to recalibrate mill levies, if necessary (Section 39-1-111, C.R.S.).

See the Assessor’s Reference Library for a general discussion of the role of assessors and the assessment certification process in Colorado.