Can a Sub-CDE Redeploy Principal Proceeds to a Non-QALICB?

Published by Owen P. Gray, CPA on Wednesday, October 3, 2018
Journal cover thumb October 2018

Question: A subsidiary community development entity (sub-CDE) made loans to a qualified low-income community business (QALICB). After the new markets tax credit (NMTC) compliance period has ended, the QALICB repaid the loans. Is it permissible for a sub-CDE to redeploy the principal repayments by making new loans to non-QALICBs?

Answer: There are a couple of items that the sub-CDE should consider before making the loans to non-QALICBs. First is whether doing so would have any potential tax credit recapture implications. A sub-CDE is required to continuously invest substantially all (substantially all test) of the proceeds from qualified equity investments (QEIs) in qualified low-income community investments for seven years from the date of the QEI. If the sub-CDE received more than one QEI, it will have multiple seven-year compliance periods and it will need to satisfy all the NMTC requirements until the end of the last seven-year compliance period. So the sub-CDE should ensure that all of the compliance periods have expired. Assuming they have, then the sub-CDE no longer has to meet the substantially all test.

A sub-CDE is required to remain a qualified CDE while it is party to the NMTC allocation agreement. This includes maintaining its primary mission and accountability to low-income communities. Failure to do so may result in a default under the allocation agreement. If the sub-CDE plans to use the principal proceeds in a manner that causes the sub-CDE to no longer have primary mission of serving low-income communities or low-income persons, the allocatee should have the sub-CDE removed as a party to the allocation agreement. To do this, the allocatee must notify the CDFI Fund via the sub-CDE dissolution portal available in the Awards Management Information System.

The last item an allocatee should consider before allowing its sub-CDE to use the principal repayments to make loans to non-QALICBs, is how it completed its prior NMTC allocation applications. In past allocation applications, the CDFI Fund has inquired about the use of residual NMTC equity proceeds. The allocatee will want to ensure that any actions taken are generally consistent with the responses they provided to such question in their allocation application. Failure to do so could have a negative impact on future NMTC allocation applications.

In conclusion, it is possible for a sub-CDE to use the principal repayments from QALICBs to make new loans to non-QALICBs, however the sub-CDE, in consultation with their tax advisors, should consider the above items before doing so.