leveraging new market tax credits to finance...

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Leveraging New Market Tax Credits to Finance Community Development: Latest Regs, Guidance and Legal Developments Using EB-5 Funds in NMTC Structures, Twinning With Historic Tax Credits, Allocating COD Income to Partners and More

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

TUESDAY, SEPTEMBER 20, 2016

Presenting a live 90-minute webinar with interactive Q&A

Thomas Boccia, CPA, Partner, Novogradac & Company, Cleveland

Michael I. Sanders, Partner, Blank Rome, Washington, D.C.

Myriam Sido Simmons, Director, Credits and Incentives Consulting, Ryan, Dallas

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5

LEVERAGING NEW MARKET

TAX CREDITS TO FINANCE

COMMUNITY DEVELOPMENT:

LATEST REGS, GUIDANCE AND

LEGAL DEVELOPMENTS

Presented by: Michael I. Sanders

[email protected]

6

NMTC STRUCTURE

OVERVIEW 2016 I. CDFI Fund Update 2016

The CDFI Fund has made 912 awards totaling $43.5

billion in allocation authority. In allocation calendar year

rounds 2002-2014, the CDFI Fund received 3,243

applications for allocations of NMTCs. These entities

collectively requested nearly $296.2 billion in allocation

authority. As of March 1, 2016, over $41.6 billion in

QEIs have been made into CDEs since the NMTC

Program’s inception. Through the fiscal year 2013

reporting period, CDEs disbursed a total of $35.3 billion

in QEI proceeds to 4,224 Qualified Active Low-Income

Community Businesses (QALICBS).

7

II. CDFI Fund: $7 Billion in

Allocation Authority Available for

Combined CY 2015-2016 NMTC

Round. In April, 2016, CDFI Fund amended its NOAA to make

$7 billion in allocation authority available for the

combined calendar year (CY) 2015 and 2016 rounds of

the New Markets Tax Credit (NMTC) program. PATH

Act of 2015 in December, 2015 extended authorization for

the NMTC program for five calendar years (CY 2015

through CY 2019) with $3.5 billion in annual allocation

authority. The CDFI Fund said combining the CY 2015

and 2016 allocation rounds will allow it to announce the

allocation of NMTCs in the year for which they are

authorized, as set forth in the PATH Act.

8

III. Financial Benefit

1. Opportunity for nonprofits to subsidize

or provide gap financing for

developments in a qualified census

tracts (low income, high

unemployment).

2. Financial benefits to developers,

businesses and charities.

9

3. Major investors such as Goldman,

Bank of America, JP Morgan, US

Bank or PNC buy credits for cash

infusion to the development which

may not be paid back at the end of

the 7-year compliance period.

4. Under leverage structure, investor

may receive in excess of 9 to 10

percent return after tax.

10

New Markets Tax Credit – A Government Sponsored Joint

Venture Vehicle

Purpose: The new markets tax credit (NMTC) serves as a way to provide subsidy or

gap financing to real estate developments, business activities, or charitable

operations planned in qualified census tracts (high unemployment or

poverty rate, low median family income).

What does it provide? 39% tax credit on the capital invested in a community development entity

(CDE), over 7 years (5% in yrs 1-3; 6% in yrs 4-7).

Who benefits from the

credit?

The investor (typically national banks, insurance companies) making an

investment in a CDE gets a tax credit of $0.39 for every $1 invested and

CRA credit, which under a “leveraged” structure yields in excess of a 10%

after-tax return. The CDE directs capital into qualified projects or

businesses. The investor is not repaid its equity investment.

Eligible Investments: • Community businesses, including e.g. hospitals, charter schools.

• Commercial or mixed-use real estate projects (at least 20% of gross

income from commercial component).

11

Examples • rPlanet Earth, a newly formed Los Angeles manufacturing company,

closed the first of a likely series of new market tax credit financing

transactions (valued at $21M) with Citi Bank as the investor.

rPlanet Earth was formed to capitalize on the growing demand by global,

national, and regional food and beverage companies for food-grade

rPlanet Earth packaging productions. Food-grade recycled polyethylene

terephthalate, commonly referred to as “rPET,” is suitable for use in food

and beverage containers – enough so that major users such as Coke,

Pepsi, Nestle, Walmart, and Costco cannot meet their objectives for

recycled PET content in their products’ packaging. rPlanet Earth’s first

manufacturing facility will produce 55 million pounds of bottle-grade rPET

flake at the completion of Phase I of the Vernon, CA, build-out.

• $100M charter high school in Mott Haven, Bronx. Robin Hood

Foundation was sponsor; JPMorgan Chase was investor.

12

NONPROFIT

RISKS/NMTC 1. Meet with NP Board in advance and explain risks:

(a) guaranty obligations if any, recapture

risks/indemnification

(b) Net benefit of transaction, especially if

Equity Investor doesn’t exercise the Put.

Cost of exercise of Call.

2. Potential UBIT on exit; location in a QCT isn’t enough.

3. Agreement in advance on the Leverage Loan being

forgiven at end of the compliance period.

4. Examine CDE fees.

13

KEY STRUCTURAL ISSUES:

TRAPS FOR THE UNWAY

1. If the QALICB is structured as a LLC, with multiple

parties or members, and taxed as a partnership, the OA

should contain specific language covering the allocation

of the COD income, if any. It is important to define

“Refinancing Proceeds” relative to exercise of a put.

2. A “straw party” should not be used to acquire the equity

interest pursuant to the exercise of the put. The approach

may backfire on the QALICB under the related party

rules, i.e., direct or indirect acquisition of debt.

3. A Phase II NMTC funding should be anticipated by a

QALICB operating business/plant expansion/purchase of

additional equipment in manufacturing. The closing

documents in Phase I NMTC should include language to

allow Phase II without the consent of the Phase I CDEs.

14

4. If the equity investor does not exercise the put at the end

of the Compliance period (7 years), tax counsel should

discuss the downside of having to exercise the call (and

the possible increased costs to the QALICB).

5. In the case of a NonProfit QALICB, there may not be an

“understanding” or “anticipation” that the Leverage Loan

will be forgiven at the end of the 7-year Compliance

Period.

6. The closing documents should designate which party or

parties bear the cost of the various steps of the unwind –

put exercise, redemption of investor interest in CDE,

assignment of loan documents, various assignment

documents. Which party is in charge of an audit and/or

preparation of the tax returns for the year of unwind? Are

there any outstanding amounts due from the QALICB or

any remaining reserves?

15

7. The parties should not forget to dissolve the Investment

Fund after acquiring the investor interest pursuant to the

put and notify registered agent of dissolution, and

withdraw any foreign registrations for the Fund (to avoid

ongoing fees).

8. The parties should plan in advance (at least 6 months prior

to the exercise) to be involved in the unwind process. Do

the accountants need to be involved? Do the lawyers need

to be involved? Are opinions required? How is a

“significant modification” of the loan to be handled?

9. What issues arise if the Leverage Loan remains

outstanding post-unwind, e.g., how do the mortgage,

guaranty or other collateral/security originally granted to

the Sub-CDE get conveyed to the Leverage Lender?

16

10. As a condition of eligibility for the 2015 Allocation

Round, the applicant will not be permitted the use of the

proceeds of QEIs to make QLICIs in QALICBs where

QLICI proceeds are used to repay or refinance any debt

or equity provider or a party related to any debt or equity

provider whose capital was used to fund the QEI except

if:

(i) the QLICI proceeds are used to repay

documented reasonable expenditures that are

directly attributable to the qualified business of

the QALICB, and such past expenditures were

incurred no more than 24 months prior to the

QLICI closing date; or

(ii) no more than 5 percent of the QLICI proceeds

are used to repay or refinance prior investment

in the QALICB.

17

Refinancing for this purpose includes transferring cash or

property directly to any debt or equity provider or

indirectly to a party related to any debt or equity provider.

• Under the CY 2015 round, a QALICB is not permitted

to use QLICI proceeds to pay a debt or equity provider

whose capital is used to monetize an asset owned or

controlled by the QALICB or an affiliate of a QALICB

if that capital provider directly or indirectly funded a

QEI. This provision does not apply to allocation

awards made prior to the CY 2015 round.

18

• Beginning with the CY 2015 round, only documented

reasonable expenditures that are directly attributable to

the qualified business of the QALICB can be paid or

reimbursed from QLICI proceeds to directly or

indirectly fund a QEI, provided that these expenditures

have either been (i) incurred no more than 24 months

prior to the date on which the QLICI transaction closes,

or (ii) represent no more than 5 percent of the total

QLICIs made by the CDE into the QALICB.

Reasonable expenditures are expenditures for a

legitimate business purpose that occur during the

normal course of operation, and must be similar in

amount and scope when compared to expenditures by a

similar entity for a similar project under similar

circumstances. Such expenditures may be made

directly by the project sponsor on behalf of the

QALICB or be funded through a loan or equity

investment made by the project sponsor to the

QALICB.

19

• In summary, the QALICB may elect to either

reimburse reasonable expenditures incurred within 24

months of the QLICI closing date or reimburse

reasonable expenditures that represent up to 5 percent

of the QLICI proceeds incurred prior to the QLICI

closing date. It may not do both. If the QALICB is

using QLICI proceeds to reimburse or repay the project

sponsor for documented, reasonable expenditures

directly attributable to the qualified business of the

QALICB that were incurred within the previous 24

months, it may not use QLICI proceeds to repay or

reimburse the project sponsor for any expenditures that

occurred outside of 24 months.

20

UNWIND EXIT STRATEGIES: 7-

YEAR STRATEGY: PUT-CALL

OPTIONS, PLANNING

OPPORTUNITIES TO MITIGATE

BURDENS OF TAX CONSEQUENCES

AT EXIT

At the end of the 7-year compliance

period, when the investor has received all

the NMTCs for which it is eligible, it,

along with the CDE, will likely want to

unwind the transaction and exit the

structure.

21

This is typically accomplished through the use of a

“put/call” technique that generates a subsidy or grant

equivalent to the QALICB.

• There is often tension manifested between the

equity investor and the QALICB in negotiating

the put/call structure. Equity investors are

interested in protecting the value of their

cushion while the QALICB is interested in

“assurance” that the investor will indeed

exercise the put and may attempt to use

techniques that would devalue the call (through

the use of a fair market value formula, annual

interest accruals and a significant partial

payment in year 7). The investor, however,

wants to be assured that it will be treated as the

owner of the equity piece.

22

• Under one version of this technique,

the investor has the right to require

the QALICB, over a specified

period, to purchase the investor’s

interest in the Fund for a specified

price (the “put”). In the event the

put is not exercised, the QALICB

(or an affiliate) has the right to

purchase the investor’s interest in

the Fund over a specified period for

fair market value (the “call”).

23

• The put and call will likely be priced

substantially below the investor’s original

investment in the Fund.

• If either the put or the call are exercised, the

investor would be removed from the structure.

An affiliate of the QALICB typically would be

substituted in place of the investor, thereby

controlling the Fund, and would take steps to

redeem the managing member of the CDE.

The result here is a net benefit to the project

measured by the amount of the investor’s

original funds less fees, professional and

administrative costs and the price of the

put/call.

24

After the investor is removed, the

QALICB may then cause the Fund

to liquidate the CDE, often using the

QLICI “A” Note previously held by

the CDE to repay the leverage

lender, and subsequently liquidate

the Fund, leaving the QALICB on its

own and the leverage lender holding

the A Note.

25

• In the event that the leverage

lender is controlled by a

§501(c)(3) entity or is itself a

charity, it may decide to forgive

all or a portion of the leverage

loan at the end of the compliance

period, but it must not be legally

obligated to do so at inception.

26

The QALICB may repay or

“refinance” the property and use the

funds it receives to repay to the CDE

the QLICI note that mirrors the

leverage loan (but not the QLICI

note that mirrors the investor’s

equity). The CDE will then use the

funds received from the QALICB to

repay the leverage lender.

27

There is additional concern at the

QALICB level that there could be a

change of administration and attitude

by the investor at the end of the

compliance period as compared to its

present intent, especially by an

institutional investor, who may

decide not to exercise the put.

28

Cancellation of Indebtedness – COD Income

● Discharge of indebtedness: under Section

61(a)(12) a discharge of indebtedness, for

example, by the debtors acquisition of its

own debt for less than the principal

amount of the debt, constitutes gross

income to the debtor. Under Code

Section 108(e)(4)(A) for purposes of

determining income of the debtor of the

discharge of indebtedness the acquisition

of debt by a party “related” to the debtor

is considered to be the acquisition of

indebtedness by the debtor.

29

• If the QALICB has operating losses,

it may offset COD ordinary income.

• If not, the B Note could be payable

in 25-30 years which would defer

the taxability. However, the

QALICB would need to pay interest

annually during the life of the Note.

• Related party acquisition uses the

attribution and constructive

ownership rules under Section

267(b) or 707(b)(1).

30

• Exception for qualified real property

business indebtedness which would

allow income realized pursuant to the

related party rule to be excludable

from gross income to the extent

provided in Section 108(a), whereby

gross income does not include

discharge from indebtedness income if

a taxpayer is not a C-corporation and

the discharge indebtedness is

“qualified real property business

indebtedness.”

31

• Use of equity rather than debt.

• Use of nonprofit as QALICB or

leverage lender: no UBIT realized

if project is substantially related to

the exempt function, such as relief

of the poor, underprivileged,

relieves the burden of government,

etc.

ryan.com

09/20/2016

Leveraging NMTC

**Confidential – For Internal Discussion Purposes

Only**

Myriam Sido Simmons

[email protected]

http://www.ryanco.com/

33

CDE Hot Topics

34

CDFI Guidance – Recent updates to the FAQs

2015/2016 year awards will be combined

– CDEs that did not apply for 2015 round will not be able to apply for

a new round until 2017 round

– $7 Billion will be awarded

When will the allocation announcement be made?

– Awards are anticipated to be made late fall 2016

When will the 2017 round be opened?

– CDFI Fund expects the CY 2017 round opening to be announced

in the first quarter of calendar year 2017 allowing CDFI to

announce and award rounds in the same calendar year for which

they are authorized.

35

Important Update to FAQs

In October 2015, CDFI issued guidance (“Frequently Asked

Questions” as updated in December)

– Added restriction on use of NMTC loan proceeds to pay back “day

loans” (i.e., indirectly fund leverage loans).

– Prior costs must have either been:

Incurred no more than 24 months prior to the date on which the NMTC

transaction closes; OR

Represent no more than 5 percent of the total NMTC loan amount.

36

What Type of Projects are CDEs looking

for and Where are They Located

37

Is the location qualified for the NMTC program

Distressed

– To be eligible for NMTC financing, businesses being financed must,

at a minimum, be located in designated low-income communities,

defined by U.S. Census data as census tracts with a poverty rate of

at least 20 percent or with median family incomes that do not

exceed 80 percent of area median income, qualifying such

businesses as Qualified Active Low Income Community

Businesses (QALICBs).

38


Severely Distressed Primary

– The CDFI Fund pinpoints three indicia of higher distress that could

satisfy the determination of eligibility on their own:

Severe distress: Poverty rate greater than 30 percent; median family

income not exceeding 60 percent of statewide median; or unemployment

rates at least 1.5 times the national average

Targeted populations as permitted by the Internal Revenue Service and

related CDFI Fund guidance to the extent that businesses are 60 percent

owned by low-income persons, at least 60 percent of employees are low-

income persons, or at least 60 percent of customers are low-income

persons

Qualified non-metropolitan counties

39


Severely Distressed Secondary

– Additional indicia require at least two of the following indicia of

higher distress to satisfy the determination:

Poverty rate greater than 25 percent; median family income not exceeding 70

percent; or unemployment rates at least 1.25 times the national average

Federally designated Empowerment Zone, Enterprise Community or Renewal

Community

SBA designated HUB Zone, when NMTC financing will support businesses

that obtain HUB Zone certification by the SBA

Brownfield sites as defined under 42 U.S.C. 9601 (39)

Area encompassed by a HOPE VI redevelopment plan

Native American or Alaskan Native areas, Hawaiian Homelands, or

redevelopment areas by the appropriate Tribal or other authority

40




higher distress to satisfy the determination (Continued):

Areas designated as distressed by the Appalachian Regional

Commission of Delta Regional Authority

Colonias areas as designated by the U.S. Department of Housing and

Urban Development

Federally designated medically underserved area, when NMTC

financing activities will result in the support of health-related

services

State Enterprise Zone, or other similar state/local programs targeted

towards economically distressed communities

41




higher distress to satisfy the determination (Continued):

Counties for which the Federal Emergency Management Agency has

issued a "major disaster declaration" and made a determination that such

county is eligible for both "individual and public assistance" provided that

initial investment be made within 24 months of the disaster declaration

Businesses certified by the Department of Commerce as eligible for

assistance under the Trade Adjustment Assistance for Firms program

Businesses located in food deserts under the Healthy Food Financing

Initiative definition (USDA-ERS) to the extent NMTC financing will

increase access to healthy food

Not Eligible

– None of the above apply

42

What types of projects are CDEs looking for?

By Industry

– Grocery/healthy foods related

– Healthcare

– Manufacturing

– Retail

– Educational facilities

– Community facilities

– Mixed-use

By Community Benefit

– Job creation/retention

– Union jobs

– New/increased services

– Increased revenue to low-

income community

– Energy

efficient/Environmentally

friendly

43

Targeted States

ALL 50 states as well as US Territories qualify for NMTC

The CDFI Fund has identified the following states and territories

as priority targets for deployment of allocation:

– Wyoming (2015)

– Arkansas (2015)

– Alabama (2014 and prior)

– Florida

– Georgia

– Idaho

– Kansas

– Nebraska (2014 and prior)

– Nevada

– Tennessee

– Texas

– West Virginia

– Puerto Rico

– Guam

– Northern Mariana Islands

– US Virgin Islands

– Federal Indian Reservations, Off-

Reservation Trust Lands, Hawaiian

Home Lands, and Alaska Native

Village Statistical Areas

44

Detailed Explanation of a NMTC

Transaction

45

Ideal NMTC Timing (but not always required) – after site

opportunity has been identified, but before lease execution,

permitting or construction. But/For requirement becoming more

important.

Timing – Average 6 – 9 months

1. Project Assessment

• Opportunity Identification

• Concept Development

2. Financial Analysis

• Financial Model Development

• Financial Model Approval

3. Land Purchase/Lease

Execution

• Site Selection

• Capital Committee Approval

• Lease Signed or Land Purchased

4. Construction

• Architectural design

• Floor Plan, Permits

• Construction

5. Project Complete

NMTC Process (Ideal) NMTC Process (Possible but rare)

46

Leveraged NMTC transaction $20M example

Leveraged Lender

QALICB (Single Purpose Entity)

Leveraged Lender

Receives collateral

assignment of the

Investment Fund’s interest

in Sub-CDE

Sub CDE

Makes Loan A to

QALICB = $13,370,000

Sub CDE

Makes Loan B to QALICB = $5,630,000

Leveraged

Lender

Makes Leveraged

Loan =

$13,370,000

NMTC Investor

Makes Equity

Investment =

$6,630,000

NMTC Investor

Receives tax credits of

$7,800,000 over 7 years

Sub CDE

Issues tax credit certificates

worth $7,800,000 over 7

years to Investor

Investment Fund

Makes a QEI = $20,000,000

CDE

Provides NMTC Sub-

allocation to Sub CDE =

$20,000,000 and $1000

cash

CDE

Earns closing/project fees

via Sub CDE = $1,000,000

99.99%

LP

interest

100% interest

.01%

GP

interest

Put/Call Agreements

New Markets Tax

Credit Investor

Community

Development

Entity

(Allocatee)

Investment Fund

Subsidiary CDE

(LLC or LP)

**Confidential – For Internal Discussion Purposes Only**

47

Leveraged NMTC transaction: Loans and Equity

• The Investor provides an equity investment into the Investment Fund and in

return receives tax credit certificates allowing them to take 39% of the

investment over a 7 year period

– The credit price is determined prior to the setup of the transaction

• Simultaneously, the Leveraged Lender makes a loan to the Investment Fund

equal to the Allocation amount less the Investor’s equity

Leveraged Lender

Leveraged Lender

Receives collateral

assignment of the

Investment Fund’s interest

in Sub-CDE

Leveraged

Lender

Makes Leveraged

Loan (Loan A) =

$13,370,000

NMTC Investor

Makes Equity

Investment (Loan B)

= $6,630,000

NMTC Investor

Receives tax credits of

$7,800,000 over 7 years 100% interest

Put/Call Agreements

New Markets Tax

Credit Investor

Investment Fund


48

Leveraged NMTC transaction: CDE Sub Allocation

• The Investment Fund now holds $20,000,000 (from the Investor’s equity investment

and the Leveraged Lenders loan)

• The Investment Fund makes a QEI (qualified equity investment) into the Sub CDE

• The CDE provides the sub allocation to the Sub CDE, which in turn issues tax credit

authority back up the structure (to the Investors)

• The CDE takes back a fee (taken from the B loan proceeds)

CDE

Provides NMTC Sub-

allocation to Sub CDE =

$20,000,000

CDE

Earns closing/project fees

via Sub CDE = $1,000,000

99.99%

LP

interest

.01%

GP

interest

Community

Development

Entity

(Allocatee)

Investment Fund

Subsidiary CDE

(LLC or LP)

Investment Fund

Makes a QEI = $20,000,000

Sub CDE

issues tax credit certificates

worth $7,800,000 over 7

years to tax credit Investor


49

Leveraged NMTC transaction: Loans to the QALICB

• The Sub CDE makes two loans, Loan A & Loan B, to the QALICB

• The A Loan is equal to the leveraged loan provided by the Leveraged Lender The B Loan is

equal to the Investor equity less the CDE fee

• Interest only payments will be made over the 7 year compliance period

– The A loan interest through the structure to the Investment Fund so it can pay its debt service on the

Leveraged Loan

– The B loan interest are distributed to the CDE so that it can pay its asset management and tax and

audit fees. If there are tax and audit fees at the Investment Fund level those are distributed to the

Investment Fund

• There is a Put Option entered into on Day 1 of Closing between the Investor and QALICB or one of its related entities, which obligates that entity to purchase the Investor’s interest in the Investment Fund if the Investor exercises the Put Option. This is typically a nominal fee, usually around $1,000.

• As protection, if the Investor doesn’t exercise the Put Option, the entity has the option to exercise its Call Option to force the Investor to sell it’s interest in the Investment Fund to the entity for FMV of the Investment Fund.

QALICB

(Single Purpose

Entity)

Sub CDE

Makes Loan A to

QALICB = $13,370,000

Sub CDE

Makes Loan B to QALICB = $5,630,000 Subsidiary CDE

(LLC or LP)

50

Leveraged NMTC transaction: Unwinding the NMTC

Structure

New Markets Tax

Credit Investor

(Bank)

Community

Development

Entity

(Allocatee)

Leveraged Lender

Investment Fund

Subsidiary CDE

(LLC or LP)

$1,000

0.01% GP

Interest

100% Interest

Redemption of

99.99% interest

in Subsidiary

CDE

Redemption of

interest in

Investment Fund

for Loans A and B

Put/Call Option

QALICB

Single Purpose

Entity

$13,370,000

A Loan

$5,630,000

B Loan

Step 1: Investment Fund

redeems its 99.99%

interest in the Sub CDE

for the A Loan and B

Loan receivables

51


Structure

New Markets Tax

Credit Investor

(Bank)

Leveraged Lender

Investment Fund

QALICB

Single Purpose

Entity

$1,000

100% Interest

Put/Call Option

$13,370,000

A Loan

$5,630,000

B Loan

Step 2: If the Investor exercises its put

option. $1,000* is paid by an entity

related to the QALICB to the Investor.

This is often the related entity that is

also the Leveraged Lender.

*Some put options may exceed $1,000;

it is a case by case basis.

52


Structure

Leveraged Lender

Investment Fund

QALICB

Single Purpose

Entity

100% Interest

$13,370,000

Loan A

$13,370,000

Loan A $5,630,000

B Loan

$5,630,000

B Loan

Step 3: If the put option is exercised, an

entity related to the QALICB will now own

its debt. There will be cancellation of debt

income on the B Loan since it was debt

owed to a third party that was acquired by

a related entity.*

Step 4: QALICB can collapse the remaining

structure

*QALICB will need to discuss tax impact

with their tax and audit provider

53

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LEVERAGING NEW MARKET

TAX CREDITS TO FINANCE

COMMUNITY DEVELOPMENT:

LATEST REGS, GUIDANCE AND

LEGAL DEVELOPMENTS

Thomas Boccia

[email protected]

• Twinning Historic Tax Credits and New

Markets

• Overview of key HTC guidance and regs. • Revenue Procedure 2014-12 – Safe harbor guidance

• Temporary treasury regulations on IRC 50(d)income

• EB-5 Funds and how are they used in NMTC

transactions

AGENDA

Twinning of HTC and NMTC

The new markets tax credit (NMTC) is a credit to encourage

investment in low-income communities.

Most businesses located in low-income communities could

qualify for loans or equity investments using the NMTC. Typical

businesses include: small technology firms, inner-city shopping

centers, manufacturers, retail stores or micro-entrepreneurs

and other non-residential real estate. Residential rental

property does not qualify as a qualified active low-income

business.

The taxpayer will be eligible to claim a tax credit equal to 5

percent of its equity investment for each of the first three years

and a 6 percent credit for each of the next four years (39

percent total).

56


57

Side-by-Side HTC/NMTC Structure

58


NMTC challenges with a twinned structure

Compliance with Safe harbor guidance Reliance on reasonable expectations

• Is CDE deemed to be “related” to the QALICB -- Rules have changed!

• Test is performed after the QEI but before the QLICI is made

• Benefits – Allows CDEs to invest greater than 50% of the equity and maintain greater than 50% capital or profits interest in QALICB and not violate the allocation agreement

• Practical limitation – IRS Regulations – “Control” provisions for reliance on “reasonable expectations” for QALICB status

59

Overview of IRC 50(d) Regulations

Background to Internal Revenue Code Section 50(d)

• IRC 50(d) income applies to projects using lease pass-through

structure that generate HTC or ITC whereby the lessee is deemed to

have incurred the qualifying expenditures

• For HTC projects, 50(d) income is recognized generally over 27 ½ or

39 years.

• Most investors have taken the position that 50(d) income is includible

by the partnership and that the partners are entitled to increase their

bases in the partnership as a result of the income inclusion.

• Before the new guidance, a widely held assumption existed that the

50(d) income inclusion was a partnership item, reported on the

partnership tax return, and that the partner got capital account credit

and tax basis for the income.

60


Summary of temporary regulations

• Defines “ultimate credit claimant” as the taxpayer that claims the

tax credits

• 50(d) income is reported in proportion to the tax credit claimed

• 50(d) income is NOT a partnership item and this does increase a

partner’s basis in its partnership interest

• Provides for rules when lease terminates or investor’s interest is

terminated after recapture period :

• One time election to accelerate remaining 50(d) income or

• Investor continues to report 50(d) income over the remaining

required time period

61


Summary of temporary regulations (continued)

• Regulations will be applicable to property placed in service

on or after September 19, 2016

• Questions arise as to how is “property” defined under the

proposed regulations?

• Treasury statement in the temporary regulations

“Temporary Regulations should not be construed to create

any inference concerning the proper interpretation of

section 50(d)(5) prior to the effective date of the

regulations.”

62

Overview of Rev Proc 2014-12

Impact of the Third Circuit Court’s decision on the Historic Tax Credit investment market on August 27, 2012

The result of the Court’s ruling was for the industry to get guidance on HTC transaction structuring from the Treasury and IRS

Resulting guidance issued in late December 2013 as Revenue Procedure 2014-12

This revenue procedure establishes the requirements (the Safe Harbor) under which the Internal Revenue Service will not challenge partnership allocations of § 47 rehabilitation credits by a partnership to its partners

63

Review of IRS Revenue Procedure 2014-12

64


Partners’ Partnership Interest

Partnership interest defined

• Principal (developer) minimum partner’s interest -

must have a minimum 1% interest in all material

partnership items

• Investor’s minimum partnership interest - generally

99% at inception but must be not be reduced to

less than 5% of the highest %

• Applies to single tier and lease pass-through

structures

65


Bona fide Equity Investment

1. Investment must constitute a bone Fide equity investment

Investor must participate in the upside and downside of the

partnership’s activities in a manner that is not limited to a

preferred return

2. Arrangements to reduce the value of the Investor’s interest

• Value of interest may not be reduced through fees, lease terms,

disproportionate rights to distributions or other arrangements

• Such arrangements must be reasonable – comparison is to real

estate development projects that do not qualify for IRC Section 47

credits (HTC)

• Lease arrangements deemed unreasonable - Generally prohibits

sandwich lease structures

66


Bona fide Equity Investment (Continued)

3. Investor’s minimum unconditional contribution

Minimum contribution must equal 20% of total

expected contributions made prior to placed in service

o Generally made at time of transaction closing

Minimum contribution must not be protected against

loss by principal partner

At least 75% of investor’s total expected capital must

be fixed before building is placed in service

67


Guarantees and Loans

1. Permissible Guarantees

• Allowed for the avoidance of any act or omission that would

result in loss of HTCs

• Examples include construction completion, operating deficit,

financial covenants and environmental guarantees

• Must not be funded or reserved

• Reasonable reserves can be established no greater than

one year’s of operating expenses

2. Impermissible Guarantees

• Transaction structure guarantees

68


Guarantees and Loans (continued)

1. The developer, master tenant or principal of either may

not lend any Investor the funds to acquire any part of the

investor’s interest.

2. Has implications in NMTC/HTC twinned transactions

69


Puts and Calls

1. No call options are allowed

2. Put options are allowed but cannot exceed the fair market

value of the investor’s interest

70

EB-5 and NMTC

EB-5 Program Overview

• Created by Congress in 1990 to stimulate the U.S.

economy through job creation and capital investment by

foreign investors

• Administered by the U.S. Citizenship and Immigration

Services (under the Department of Homeland Security)

• President Obama signed Public Law 112-176 on Sept 28,

2012, which extends EB-5 until Sept. 30, 2015, which was

subsequently extended to Sept. 30, 2016.

71

EB-5 and NMTC

EB-5 Program Overview

• Capital investment must create or preserve at least 10 full-

time jobs for qualifying U.S. workers within two years (or

under certain circumstances, within a reasonable time after

the two-year period) of the immigrant investor’s admission

to the United States as a Conditional Permanent Resident.

72

EB-5 and NMTC

Employee Parameters

• Qualified Employee – U.S. citizen, permanent resident or other immigrant

authorized to work in the United States. The individual may be a conditional

resident, an asylee, a refugee, or a person residing in the United States under

suspension of deportation.

• Full-time employment – A position that requires a minimum of 35 working

hours per week.

• Job-sharing arrangement - Whereby two or more qualifying employees share

a full-time position will count as full-time employment provided the hourly

requirement per week is met.

– The position must be permanent, full-time and constant. The two qualified employees sharing

the job must be permanent and share the associated benefits normally related to any permanent,

full-time position, including payment of both workman’s compensation and unemployment

premiums for the position by the employer.

73

EB-5 and NMTC

Capital Investment Requirements

• Capital – Cash, equipment, inventory, other tangible property, etc.

• Cannot be acquired by unlawful means

• Cannot be borrowed

• Minimum investments:

– $1 million –OR–

– $500 thousand if made within a Targeted Employment Area (TEA)

• High Unemployment Area – an area that, at the time of investment, is a rural

area or an area experiencing unemployment of at least 150 percent of the

national average rate

• Rural Area – any area outside a metropolitan statistical area (as designated by

the Office of Management and Budget) or outside the boundary of any city or

town having a population of 20,000 or more according to the decennial census

74

EB-5 and NMTC

Regional Centers

• Regional centers are associated with the EB-5 “Pilot

Program,” which was created in 1992

• Investment requirements are the same in the pilot program,

except that investments affiliated with Regional Centers

allow for less restrictive job creation requirements

– Direct vs. Indirect job creation

75

EB-5 and NMTC

Regional Centers

• Direct jobs are actual identifiable jobs for qualified employees located within

the commercial enterprise into which the EB-5 investor has directly invested

his or her capital.

• Indirect jobs are those jobs shown to have been created collaterally or as a

result of capital invested in a commercial enterprise affiliated with a

regional center by an EB-5 investor. A foreign investor may only use the

indirect job calculation if affiliated with a regional center.

– The number of indirect jobs created through an EB-5 investor’s capital

investment is based upon a business plan and a detailed economic

analysis, which is evaluated and approved by USCIS during the application

and review process of the Regional Center being designated as such for

participation in the pilot program

76

EB-5 and NMTC

Regional Centers

• A Regional Center is not merely a defined geographical area but rather is a

business entity that coordinates foreign investment within the area

• Regional Centers do NOT hold sole jurisdiction over their geographic region

• Must focus on a contiguous geographical region of the United States

• Must focus on economic growth through

– Increased export sales (if any)

– Improved regional productivity

– Job creation

– Increased domestic capital investment

77

EB-5 and NMTC

Regional Centers

• Must demonstrate in verifiable detail how jobs will be

created, either directly or indirectly

• Must commit sufficient funds to promote and oversee

capital investment opportunities in the Regional Center

• Under Public Law No. 102-395, priority must be given

to Regional-Center-affiliated individual petitions (but

no criteria for USCIS to prioritize amongst those

petitions)

78

EB-5

Lender

QALICB

Sponsor

Sub- CDE

Fund

Leverage

Lender

100% Owner

100% Owner

33.33% Owner

66.67% Owner

99.99% Owner

32-Year Lease

QALICB

QLICI Loans

HTC Pass-Through

Master Tenant

Leverage

Loan

EB-5

Loan

Sample EB-5/NMTC/HTC Transaction diagram

EB-5

New Markets Tax Credits

Historic Rehab Tax Credit

NMTC

Investor

79

EB-5 and NMTC

Pros

Cons

80

EB-5 and NMTC

Key EB-5 & NMTC Similarities

• Able to invest in real estate and operating businesses

• Provides financing with below market terms

• Targets distressed areas

• Creates jobs

• Created by US Government to stimulate economy through job

growth

-

81

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