Cities, counties and school districts in Georgia (“Local Governments”) often issue tax anticipation notes (“Tans”) to finance their cash flow needs. Property taxes are a significant source of revenue for Local Governments. However, property taxes are typically only levied and collected once each year in the fall. As a result, Local Governments often experience cash flow difficulties, necessitating the issuance of Tans.
The principal amount of the Tan is a function of (a) Georgia laws, (b) federal tax laws and (c) the actual cash flow needs of the Local Government. Georgia laws are easy to comply with and rarely act as a limitation on the amount of a Tan. Article IX, Section V, Paragraph V of the Constitution and O.C.G.A Section 36-80-2 provide that (a) the principal amount of the Tan may not exceed 75% of the total gross income from taxes collected by the Local Government in the prior calendar year and (b) the principal amount of the Tan, together with other contracts, notes, warrants or obligations of the Local Government for current expenses in the current calendar year, may not exceed the total anticipated revenues of the Local Government for the current calendar year. In other words, Local Governments shouldn’t borrow more than they can pay back.
Federal tax laws work more “hand in glove” with the actual cash flow needs of the Local Governments. Federal tax laws allow a Local Government to borrow an amount equal to the “cumulative cash flow deficit” plus a “reasonable working capital reserve.” The “cumulative cash flow deficit” means the excess of the expenses paid during the period which would ordinarily be paid out of or financed by anticipated tax or other revenues over the aggregate amount “available” (other than from the proceeds of any Tan issue) during such period for the payment of such expenses. For purposes of computing the cumulative cash flow deficit, a Local Government must consider all cash, investments and other amounts held in accounts or otherwise by the Local Government or a “related party” as available for the payment of expenditures to the extent that such amounts may be used by the Local Government for working capital expenditures of the type being financed by the Tan without legislative or judicial action and without a legislative, judicial or contractual requirement that those amounts be reimbursed. As a practical matter, cities and counties should consider whether amounts in an open-ended enterprise fund must be treated as available and taken into account in determining the cumulative cash flow deficit.
Once the Local Government has calculated the cumulative cash flow deficit, it must decide if it wants to increase the size of the Tan in order fund a reasonable working capital reserve. Federal tax laws acknowledge that the cash flow projections are imperfect and allow a Local Government to increase the principal amount of the Tan to fund a reasonable working capital reserve. A reasonable working capital reserve may not exceed 5 percent of the actual working capital expenditures of the Local Government for the preceding fiscal year.
After the Tan is issued, a Local Government must determine if it has to pay arbitrage rebate on the Tan. Arbitrage is defined as the investment earnings on the Tan proceeds over and above the yield on the Tan. For example, assume that a Local Government issues a Tan that has a yield of 2% and invests the Tan proceeds at 2.5%. The arbitrage is the .5% earned on the Tan proceeds over and above the 2.5% yield on the Tan. The Local Government must rebate the arbitrage on the Tan to the Treasury unless it satisfies the six-month arbitrage rebate exception.
Section 148(f)(4) of the Code generally provides an exemption from the arbitrage rebate requirement of 148(f)(2) if the gross proceeds of an issue are expended for the governmental purposes for which the issue was issued no later than the day which is six months after the date of issuance of the issue. In the case of a Tan, the net proceeds of the Tan (including earnings thereon) will be treated as expended for the governmental purpose of the Tan on the first day after the date of issuance that the cumulative cash flow deficit to be financed by the Tan exceeds 90 percent of the proceeds of the Tan.
If a Local Government has increased the size of its Tan to fund a reasonable working capital reserve, it will likely not be able to satisfy the six-month arbitrage rebate exception. For the last decade or more, this has not mattered because Local Governments have not been able to invest their Tan proceeds at a yield higher than the yield on their Tan. However, that may be changing. In the first three months of 2019, the Georgia local government investment pool paid over 2.43%. It is possible that a Local Government will be able to invest Tan proceeds at a rate that exceeds the yield on its Tan and will therefore have to pay arbitrage rebate.
We recommend that Local Governments either (a) not borrow an amount that exceeds their cumulative cash flow deficit (i.e., not borrow for a working capital reserve) or (b) retain an arbitrage rebate analyst who will assist will the calculation and payment of any arbitrage rebate. Don’t hesitate to call Roger Murray or any Murray Barnes Finister lawyer if you have any questions.