CARES Act Not as Friendly to Tax-Exempt Borrowers as was ARRA
The COVID-19 pandemic is in many ways reminiscent of the Great Recession. Our federal government’s response in the tax exempt market however has been very different. Unlike the American Recovery and Reinvestment Act of 2009, the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”, HR 748, signed by President Trump on March 27, 2020) contains no new types of tax exempt bonds, such as the Build America Bonds, nor does it provide any loosening of requirements, such as the designation of bank qualified status by the 501(c)(3) conduit borrower rather by the issuer of the bonds. Nor does the CARES Act reinstate advance refundings.
Of interest to borrowers of tax exempt bonds is the response of federal agencies, financial institutions, and Congress to encourage the restructuring of “troubled debt” resulting from the adverse impact of COVID-19. CARES Act Section 4013.
Restructuring is intended to provide relief to borrowers from the financial distress caused by the pandemic. Restructuring may take many forms: forbearance, reduction in interest rate, interest holiday, reduction of principal, extension of term including a re-amortization, and covenant changes or waiver of a default, among others.
Generally, a restructuring results in a modification of the terms of the loan, and such modification if “significant” results in a tax exempt bond being deemed “reissued”. That is, for federal income tax purposes, the loan is treated as the original loan being exchanged for a new loan (that is subject to the new terms). That exchange is both a disposition of the original loan instrument for federal income tax purposes and the creation of a new loan instrument for federal income tax purposes. Unfortunately, neither the CARES Act, nor guidance from United States Treasury (Treasury) or the Internal Revenue Service (IRS) provides any new relief from that reissuance treatment. Treasury Regulation Section 1.1001-3, as modified by certain unexpired provisions of Notices 2008-41 and 2008-88 issued by Treasury and the IRS during the Great Recession remain in effect.
If a modification results in a reissuance, the “new” loan needs to meet all of the requirements applicable to a tax exempt bond if the interest on that loan is to be tax exempt. Thus in the case of a Qualified 501(c)(3) Bond or an exempt facility bond, the issuer must authorize the issuance of the new instrument, a new public hearing (a TEFRA hearing) may be required, new tax certificates will need to be delivered, and a new Form 8038 will need to be filed.
Borrowers (that is issuers and conduit borrowers, as applicable) should consult their bond counsel when considering the modification of tax exempt debt. The modification may be structured in a manner that does not result in a significant modification (and thus no reissuance) or if a reissuance is unavoidable, the proper steps can be taken to continue the tax exempt status of the loan.
We note that the National Association of Bond Lawyers and other organizations advocating for borrowers of tax exempt debt have requested relief from the “reissuance” provisions and related issues, such as the TEFRA requirements (social distancing is making in person meetings impossible).
This News Alert has been prepared for informational purposes only and should not be construed as, and does not constitute, legal advice on any specific matter. For more information, please see the disclaimer.