Earlier this year, Congress enacted the watershed American Recovery and Reinvestment Act (ARRA). One provision of the ARRA that was aimed to directly benefit Indian country was allowing Indian tribal governments to issue bonds on a tax-exempt basis. As access to the credit market has begun to improve during the third quarter of 2009, Indian tribes—along with other gaming industry businesses—are now exploring financing options for delayed or new capital projects.
For Indian country, the ARRA offers a new financing tool by allowing tribes to issue Tribal Economic Development (TED) Bonds. On June 23, 2009, the IRS issued long-anticipated guidance, in the form of Notice 2009-51, soliciting Indian tribes to apply for an allocation of the $2 billion national volume cap to issue TED Bonds. The first deadline for applying for a 2009 allocation was Aug. 15, 2009, which has already passed. The second deadline for applying for an allocation is Jan. 1, 2010, which is fast approaching.
In addition to TED Bonds, other innovative financing tools are beginning to receive attention from Indian country. One program, the federal New Market Tax Credit (NMTC) program, which has long been popular outside of Indian country, presents an additional financing tool. The benefit of TED Bonds and NMTC financings for Indian country is that the programs allow Indian tribes to borrow funds at substantially lower interest rates than are otherwise available in traditional commercial markets. TED Bonds and NMTC financings both, however, can involve complicated transactional structures and have limits on the types of projects that are eligible for financing.
TED Bonds
TED Bonds were created by the ARRA. The ARRA added a new provision to the Internal Revenue Code of 1986, as amended, allowing Indian tribal governments to issue bonds on a tax-exempt basis to finance any economic development project or other activities for which state or local governments may issue tax-exempt bonds under Code § 103. The creation of TED Bonds is significant for Indian country because it eliminates the “essential government” functions test in order for tribal governments to issue federally tax-exempt bonds. TED Bonds may not be used to finance facilities where Class II or III gaming is conducted. Thus, TED Bonds allow Indian tribes to access tax-exempt debt markets under substantially the same rules that are applicable to state and local governments.
Notice 2009-51 describes the method the IRS will use to allocate the $2 billion volume cap and the form of application that Indian tribal governments must submit to request a volume cap allocation. The notice further provides a significant safe harbor delineating when structures are considered to be part of a building in which Class II or Class III gaming is conducted. The proceeds of TED Bonds may not be used to finance gaming-related structures.
The notice specifies that the TED Bond volume cap will be allocated in two tranches of $1 billion. The first $1 billion of the volume cap will be allocated to applications received on or prior to Aug. 15, 2009. The IRS will allocate volume cap to “qualified projects” in the first allocation as follows: (1) if the volume cap requested for qualified projects does not exceed $1 billion, then each Indian tribe will receive the amount requested in its application; and (2) if the amount requested exceeds $1 billion, then the requested volume cap allocation will be reduced pro rata. The notice provides that no Indian tribal government will be awarded a total allocation exceeding $30 million from the first allocation.
The second $1 billion of the total volume cap, plus any remaining unused volume cap from the first allocation, will be allocated to applications received on or before Jan. 1, 2010. The IRS will allocate the second allocation using an identical method as described for the first allocation. The notice reserves the ability of the IRS to limit the aggregated volume cap awarded from the second allocation to any Indian tribal government to $30 million or to raise or lower the limitation or abolish it entirely.
Notice 2009-51 includes an application form that Indian tribes must submit to request an allocation of the TED Bond volume cap. Indian tribes seeking an allocation of the volume cap must submit an application substantially in the form of the application attached as Appendix A to the notice. A copy of the notice and the application form is available here.
The general requirements include that the application must contain the following:
• Submission by an “Indian tribal government” as defined by the code. The IRS recognizes eligible tribal entities to include federally recognized Indian tribes as publicly listed by the Department of Interior or as the Department of Interior has acknowledged in a letter to the tribe.
• Designation of one or more contact persons in the application. The contact person need not be an Indian tribal government official but could be an attorney for the tribe.
• Description in reasonable detail of the project to be financed with TED Bonds, including certifications that the project will be located on the Indian tribe’s reservation and that no proceeds of the bond issue will be used to finance any portion of a building used for Class II or Class III gaming. The notice describes eligible projects to include hotels, convention centers and golf courses, as well as other projects that may be financed by state or local governments.
• A statement as to whether all necessary federal, state and local regulatory approvals for the project have been obtained or, if those approvals have not been obtained, the Indian tribal government’s plan for obtaining them and the time frame expected for receipt of such approvals.
• A detailed description of the plan of financing.
• The dollar amount of volume cap requested.
• A statement that the issuer reasonably expects to issue TED Bonds for (1) the first allocation by Dec. 31, 2010; or (2) the second allocation by Dec. 31, 2011.
When issuing TED Bonds, an Indian tribe is permitted to make “insubstantial” deviations from the information described in the initial application without jeopardizing the tax-exempt status of the bonds. Rules similar to those applicable to other tax-exempt bonds apply for purposes of determining whether a deviation is substantial.
TED Bonds may not be issued to finance any portion of a building in which Class II or Class III gaming is conducted or housed or any other property actually used to conduct such classes of gaming. The notice provides a safe harbor for determining whether a structure will be treated as a separate building for purposes of the limitations prohibiting the financing of gaming-related facilities with TED Bonds. The safe harbor is extremely important because it opens the possibility for Indian tribes to finance ancillary structures that may be connected to a gaming floor, such as convention facilities or hotels. The safe harbor provides that “a structure will be treated as a separate building if it has an independent foundation, independent outer walls and an independent roof.” The notice specifies that connections, such as covered walkways or other enclosed common areas, may be disregarded if the connections do not affect the structural independence of either wall.
NMTC Financing
The NMTC program is by no means a new program. It came into existence in 2000 when it was enacted as part of the Community Renewal Act of 2000. The NMTC program was designed to encourage investment in targeted low-income communities, and it allows investors to receive a federal tax credit equal to 39 percent of the amount of a “qualified equity investment,” which is claimed over a seven-year period. Indian tribes may not necessarily be interested in the federal tax credits generated from an eligible NMTC investment, however, tribes can still benefit from NMTC financings by obtaining a loan at below-market interest rates.
A typical NMTC deal structure involves:
(1) investors contributing equity to a community development entity (CDE), often through a lower-tiered entity of the CDE that has received a sub-allocation of NMTC;
(2) the subsidiary allocatee makes a “qualified equity investment” (QEI), which is ordinarily accomplished by loaning funds to a qualified active low-income community business (QALICB);
(3) the loan allows a QALICB to obtain below-market financing; and
(4) the loan generates NMTC for the CDE, or its lower-tiered entity, ultimately to be used by investors.
The activities financed by a tribe with an NMTC would need to constitute a QALICB. An important requirement in order for a QEI to be eligible as a qualified low-income community investment, and to therefore generate NMTC, is for the investment to be made in a “qualified business.” The code—as is often the case with federal tax law—creates several traps for the unwary with respect to determining whether an activity is a qualified business and, further, determining if the qualified business meets the criteria to be a QALICB. Importantly, the code, through a series of cross-references, identifies activities that do not qualify as a qualified business. Non-qualifying business activities are typically what could be characterized as “weekend recreational” events. The activities include any: (a) private or commercial golf course; (b) country club; (c) massage parlor; (d) hot tub facility; (e) suntan facility; (f) racetrack or gambling facility; or (g) any store that has the principal business of selling alcohol for off-premises consumption.
The QALICB must also be located in a qualified low-income community. The code defines at length the communities that meet the criteria to be a qualified low-income community. In practice, eligibility is determined by U.S. census tract data, which identifies the communities meeting code eligibility standards.
Although gaming facilities and golf courses represent significant capital expenditures for Indian tribes, the NMTC program can still be beneficial with respect to financing other tribal businesses that complement a casino that would otherwise be ineligible to finance on a tax-exempt basis. For example, a tribe may be able to use the NMTC to finance the construction of a shopping mall owned by a tribe, which could complement the tribe’s casino complex.
Final Thoughts
TED Bonds and NMTC financings offer Indian country greater access to lower-interest costs of borrowing funds to finance projects that may complement tribal casino facilities. Although both programs expressly forbid using the proceeds of such financings to directly finance gaming facilities, there are other significant projects that can be financed by either program. Both financing structures impose limitations with respect to the types of projects that may be financed. As a general matter, TED Bonds may only be used to finance activities that qualify as typical governmental projects. TED Bonds, thus, ordinarily cannot be used to finance business activities. The proceeds of an NMTC financing, on the other hand, must be used for a qualified business, which expressly excludes certain activities. The activities ineligible for NMTC financing may, if properly structured, be eligible for financing through TED Bonds. Thus, using these two innovative financing tools in conjunction opens new doors to Indian country to finance projects that complement casino developments.