On April 26, 2010, the Internal Revenue Service (IRS) released IRS Notice
2010-35 (the Notice) that provides guidance on certain qualified tax credit
bonds (QTCBs) and build America bonds (BABs). BABs are taxable municipal
obligations for which the issuer may receive a direct federal subsidy, in the
form of a cash payment, to offset the interest cost of the BAB. Alternatively,
an issuer of BABs may elect that the subsidy be delivered as a non-refundable
federal income tax credit to the BAB investor, although that option is generally
less attractive and is not being utilized on a widespread basis. QTCBs are
taxable municipal obligations that were originally conceived with a subsidy in
the form of a refundable tax credit for the investor. However, the Hiring
Incentives to Restore Employment Act of 2010, enacted on March 18, 2010,
authorized issuers of new clean renewable energy bonds, qualified energy
conservation bonds, qualified zone academy bonds and qualified school
construction bonds (collectively, Direct Pay QTCBs) the option of receiving a
federal subsidy in the form of a direct cash payment to offset the interest cost
of the borrowing.
The amount of the direct cash subsidy for qualified zone academy bonds and
qualified school construction bonds with respect to any interest payment date is
equal to the lesser of (i) 100 percent of the amount of interest payable under
the bond on such date, or (ii) 100 percent of the amount of interest that would
have been payable under such bond on such date if such interest were determined
at the applicable tax credit bond rate determined under Section 54A(b)(3). For
new clean renewable energy bonds and qualified energy conservation bonds, the
amount of the direct cash subsidy with respect to any interest payment date
under the bond is equal to the lesser of (i) 100 percent of the amount of any
interest payable under the bond on such date, or (ii) 70 percent of the amount
of interest that would have been payable under such bond on such date if such
interest were determined at the applicable tax credit bond rate determined under
The following summarizes certain key reporting, qualification and other rules
identified in the Notice for Direct Pay QTCBs. By the terms of the Notice,
certain of these rules also apply to BABs issued after March 18, 2010.
Qualification and Reporting Rules
- Election to Issue Direct Pay QTCBs. An
issuer must make an irrevocable election to issue QTCBs as Direct Pay QTCBs
on its books and records on or before the date of their issuance.
- Form 8038-TC.
- Form 8038-TC must be filed with the IRS upon issuance of Direct Pay
QTCBs, generally must be filed at least 30 days before the first Form
8038-CP (described below), and must include as an attachment a debt
service schedule in a form specified by the IRS.
- The IRS expects Form 8038-TC to be available on its website by June
- Revised Form 8038-CP.
- For Direct Pay QTCBs or BABs, revised Form 8038-CP must be filed by
an issuer to receive the direct cash subsidy payments.
- Revised Form 8038-CP will be available on the IRS website on or
before June 25, 2010. For BABs, revised Form 8038-CP will be processed
upon receipt. For Direct Pay QTCBs, the IRS expects to be prepared to
process Form 8038-CP by July 12, 2010, and to make timely payments of
direct cash subsidy payments beginning with interest payment dates
occurring on or after September 1, 2010.
- Issuers of Direct Pay QTCBs with interest payment dates prior to
September 1, 2010, may submit a revised Form 8038-CP and, for purposes
of processing such Form 8038-CP, the first date treated as an interest
payment date shall be September 1, 2010. In other words, receipt of the
subsidy should not be expected before September 1, 2010.
Other Rules for Direct Pay QTCBs and BABs
- Premium Limitation (Direct Pay QTCBs and BABs).
- As with BABs, Direct Pay QTCBs may not be issued with more than a
“de minimis” amount of premium.
- For purposes of determining whether a bond has too much premium, a
“make whole” call option requiring the payment of a call premium in an
amount that preserves the bond’s original yield to maturity will be
disregarded, because the exercise of the call usually will not produce a
lower yield on the bond.
- Reimbursement and Short-Term Financing Limitations (Direct Pay QTCBs).
- Proceeds of Direct Pay QTCBs may be used to reimburse eligible
expenditures that were paid or incurred by the issuer prior to the issue
- Proceeds of Direct Pay QTCBs may not be used to refinance eligible
expenditures for qualified purposes in refunding issues. However, Direct
Pay QTCBs issued to reimburse otherwise eligible expenditures for
qualified purposes that were incurred after March 18, 2010, and that
were financed originally with temporary short-term financing issued
after March 18, 2010, will not be treated as a refunding issue.
- Treatment of Original Issue Discount (OID) and Preissuance Accrued
Interest (PAI). OID and PAI are not taken into account in the
calculation of direct cash subsidy payments with respect to Direct Pay QTCBs
If you have any questions regarding BABs, Direct Pay QTCBs or QTCBs in
general, please contact one of the authors, or visit McGuireWoods’ Public
Finance practice website. You also can refer to prior alerts on QTCBs and other
newly available financing tools, such as Build America Bonds, Recovery Zone
Economic Development Bonds and Recovery Zone Facility Bonds in our
news archive and the
Stimulus Package section.