Heads I win, Tails You Lose! Reduced taxes payable by banks may increase interest costs payable by not-for-profits

By Attorney John (Jay) R. GowellNovember 16, 2018Business

The tax reform enacted by Congress last year in the Tax Cuts and Jobs Act provided a nice tax break for businesses. Among other companies, banks have benefited greatly from this windfall, and in addition to rising stock prices, many have announced raises for their employees. This must be good news for everyone, right? Well, as is often the case with tax law, the answer is “Not exactly.”

Many not-for-profit organizations recently have been receiving correspondence from their lenders, that is, banks holding their tax exempt bond indebtedness, informing them that as a result of the change in the maximum marginal statutory rate of federal tax imposed on corporations due to the new tax law effective on January 1, 2018, the interest rate being charged on their loans is going to increase. Whether intended by the new tax law or not, the reduction in income taxes often entitles a bank holding direct purchase tax exempt obligations to increase the amount of interest the borrower must pay. This somewhat ironic result is based on the premise that the lower tax-exempt rate payable by not-for-profit organizations is based on the “taxable equivalent yield” that holders of such debt obligations, such as banks, enjoy by purchasing tax exempt debt.

Buried deep in the documentation evidencing the tax-exempt debt are often provisions requiring the borrower (such as a not-for-profit organization) to pay an increased interest rate if the tax law changes and the income tax payable by the bank is reduced. The concept is to provide the bank with the same taxable equivalent rate of return on its loaned funds as it would have received if the tax rate did not change. So, if properly documented, the tax rate reduction results in the bank being authorized to charge a higher interest rate to make up for the “loss” in yield that resulted from the tax rate reduction. So, the bank pays less in taxes but at the same time can charge more in interest, at the cost of the not-for-profit. Confused yet?

There are two critical questions affecting a bank’s ability to charge more interest as a result of the tax reduction: (1) does the documentation expressly provide for a change in the applicable interest rate based on a change in the federal tax law, and (2) what is the method for calculating the “gross-up” of the interest rate to provide the same taxable equivalent yield? Some bond documents very clearly specify when and how the interest rate increases, and some are quite vague, and may not actually entitle the lender to increase the interest rate charged to the not-for-profit.

Any not-for-profit organization that receives communication from its lender saying that the interest rate is increasing should consult with bond counsel to review the documentation and determine if the interest rate increase is legally warranted. PLDO Partner John (Jay) R. Gowell, who is a nationally recognized bond counsel and listed in the Bond Buyer “Red Book,” is available to assist you and your organization. To contact Attorney Gowell, call 401-824-5100 or email jgowell@pldolaw.com.

 

 

Disclaimer: This blog post is for informational purposes only. This blog is not legal advice and you should not use or rely on it as such. By reading this blog or our website, no attorney-client relationship is created. We do not provide legal advice to anyone except clients of the firm who have formally engaged us in writing to do so. This blog post may be considered attorney advertising in certain jurisdictions. The jurisdictions in which we practice license lawyers in the general practice of law, but do not license or certify any lawyer as an expert or specialist in any field of practice.

Back to Blog

AuthorJohn (Jay) R. Gowell

John (Jay) R. Gowell is a Partner with Pannone Lopes Devereaux & O’Gara LLC and a member of the firm’s Corporate & Business, Real Estate & Commercial Lending and Nonprofit Organizations Teams. Attorney Gowell has extensive experience in the areas of corporate law, finance and real estate development in both the private and public sectors, and has represented many private developers, public agencies and corporate clients in development, permitting, construction, leasing and financing transactions and in the purchase and sale of office buildings, shopping centers, assisted living facilities, nursing homes, marinas and other real estate assets. He is a nationally recognized bond counsel, and is listed in the Bond Buyer “Red Book.” He has served as bond counsel, issuer’s counsel and underwriter’s counsel in a wide range of public bond financing transactions.

Mr. Gowell is a prominent member of the legal community, and has been honored by his peers and judges with the AV Preeminent rating from Martindale Hubbell, which is the highest rating based on both legal ability and ethics. He also has been a Special Lecturer in business ethics and professional responsibility in the Providence College Graduate School of Business.

Mr. Gowell has experience in mergers and acquisitions and divestitures of companies, as well as shareholder disputes and buy-sell agreements. His comprehensive legal portfolio of work also includes corporate law, commercial lending, distressed debt and loan workouts and receiverships. He has considerable experience in the purchase and sale of companies and in syndications, venture capital transactions and securities matters, and frequently represents companies engaged in various sectors of the marine industry. Mr. Gowell also has served in leadership roles and as legal counsel for many charitable and other not-for-profit organizations.

Mr. Gowell has served as counsel to states and municipalities and their departments and agencies, including Nassau County, New York, the Governor of the State of Rhode Island, the Rhode Island Department of Administration, the Rhode Island Department of Transportation and the Rhode Island Commerce Corporation. In connection with his public sector work, he has provided legal counsel and strategic guidance to high visibility projects such as the lease and revitalization of the Nassau Veterans Memorial Coliseum, the development, ground lease and construction of Providence Place Mall and the site acquisition, financing and construction of a 400-acre office campus for a major national financial services company in Smithfield, RI. As counsel to private developers, Mr. Gowell has worked on many residential, industrial, office and hotel projects, public development and urban redevelopment projects, public-private partnerships (P3) and economic development projects.

Mr. Gowell currently is a member of the Rhode Island Industrial Recreational Building Authority, the Rhode Island Sailing Events Commission, the Board of Trustees of the Greater Providence Chamber of Commerce and the Brown University Civic Leadership Council. From 2005 to 2012, he chaired the East Greenwich Public Schools Building Committee, which successfully implemented a $52 million, multi-year building improvement program, including construction of a new 108,000-square foot middle school and major improvements to a high school. For 20 years, he served as a Director of the Rhode Island Philharmonic Orchestra and Music School, including as its President from 2000-2002. From 2003-2009, he chaired the Philharmonic Orchestra’s Building Committee in the successful purchase, financing, redesign and extensive $8 million renovation of a 50,000 square foot building into a nationally-recognized, state-of-the-art community music school.

Attorney Gowell earned his J.D. from the University of Pittsburgh School of Law, where he was a member of the Law Review. He graduated with a B.A. in History from Trinity College. He is admitted to practice in state courts in Rhode Island, Massachusetts and New York and the U.S. District Court for the District of Rhode Island. Mr. Gowell is a member of the Rhode Island Bar Association, the Boston Bar Association and the National Association of Bond Lawyers.

To contact Attorney Gowell, call 401-824-5100 or email jgowell@pldolaw.com.

Leave a Reply