Wrapping Your OZ Project: How to Tie a Bow Around the Written Plan Requirement
WRAPPING YOUR OZ PROJECT: HOW TO TIE A BOW AROUND THE WRITTEN PLAN REQUIREMENT
By: Joseph B. Darby III
The final regulations (“Regulations”) issued under Internal Revenue Code section 1400Z-2 (the “OZ Act”) ended up providing a remarkably flexible set of rules called the working capital safe harbor (“WCSH”) that allow a qualified opportunities fund (“QOF”) to invest cash into a qualified opportunity zone business (“QOZB”) for a period of up to 31 months while that money is being held in eligible investments (typically invested short term money market funds or bank accounts) while the OZ project is proceeding and as the money is being spent down.
The Regulations definitely giveth taxpayers a major break with the WCSH, but then the Regulations also (at least somewhat) taketh away, because ultimately the Regulations still want eligible investors to put their money into a QOF, get it down into a QOZB within a reasonable period of time, and then spend that money as promptly and efficaciously as possible in an Opportunity Zone on an eligible business project.
To ensure that the WCHS is not abused or used as a long-term holding device for funds that are not seriously committed to OZ development, the Regulations include three very specific requirements:
1) amounts are designated in writing for the development of a trade or business in a qualified opportunity zone (as defined in section 1400Z–1(a)), including when appropriate the acquisition, construction, and/or substantial improvement of tangible property in such a zone;
2) the plan includes a written schedule consistent with the ordinary start-up of a trade or business for the expenditure of the working capital assets, and such plan provides that the working capital assets must be spent within 31 months of the receipt by the business of the assets; and
3) the working capital assets are actually used in a manner that is substantially consistent with the writing and written schedule described in paragraphs (d)(3)(v)(A) and (B) of this section.
Additionally, if consumption of the working capital assets is delayed by waiting for governmental action the application for which is complete, that delay does not cause a failure of paragraph Treas. Reg. §1.1400Z2(d)-1(d)(3)(v)(C). A QOZB is also allowed to string together subsequent or overlapping WCSHs for a maximum 62-month period.
COVID Authority to Re-Write the Written Plan.
Proposed Regulations issued in the middle of the COVID Emergency, and upon which taxpayers may rely for tax years starting in 2020, recognize that following the original plan may not be feasible, stating: “Although the final regulations provide a qualified opportunity zone business an additional 24 months to expend its working capital assets, the qualified opportunity zone business must do so in a manner substantially consistent with the original, pre-disaster written designation in which the amount of working capital assets subject to the safe harbor are designated and according to the original, pre-disaster written schedule for expending such amounts. … the post-disaster environment facing the qualified opportunity zone business may render the original plan suboptimal or even infeasible.” Accordingly, taxpayers may develop a new written plan to deploy capital so long as they do so within 120 days of the close of the incident period applicable to the disaster.
Specifically, the Proposed Regulations would add the following three new sentences at the end of Treas. Reg. §1.1400Z2(d)-1(d)(3)(v)(D):
For purposes of the preceding sentence, meeting the requirements of paragraph (d)(3)(v) of this section may be determined by reference either to the original amount of working capital assets designated in writing under paragraph (d)(3)(v)(A) of this section and reasonable written schedule under paragraph (d)(3)(v)(B) of this section or to a new or revised written designation and written schedule that satisfy the requirements of paragraph (d)(3)(v)(A) and (B) of this section, respectively. A new or revised written designation of the amount of working capital assets and reasonable written schedule for expending that amount may be used only if adopted not later than 120 days after the close of the incident period, as defined in 44 CFR 206.32(f), with respect to that disaster. In determining whether a new or revised schedule satisfies the requirements of paragraph (d)(3)(v)(B) of this section, the planned completion of spending must take into account the up-to-31 month period originally allowed under paragraph (d)(3)(v)(B) of this section, plus the up to-24 additional months provided in this paragraph (d)(3)(v)(D).
The Proposed Regulations explain that the purpose of these additional sentences is to provide clarity and flexibility for QOZBs to revise or replace their written plans in the event of a Federal Disaster.
The Proposed Regulations also impose a related recordkeeping requirement. A QOZB that changes its written plan must keep a copy of the new plan and any modifications and provide these records to the IRS upon request.
Written Plan Structure
The written documentation requirements in Treas. Reg. §1.1400Z2(d)-1(d)(3)(v)(A)-(C) are referred to common OZ parlance as the “Written Plan Requirement” and practical experience teaches that there are two simultaneous threads to a Written Plan: 1) Formally stating and requiring in writing that the plan will confirm with and satisfy all the specific requirements of the regulations; and 2) creating the actual business pan, including the projected budget, development plan, and execution and implementation schedule that every business needs (both for itself and often others such as banks) in order to implement the project successfully. Experience suggests that the best way to put this together is with a “wrapper” that dots the I’s and crosses the T’s in satisfying the technical requirements of the Regulations, and the actual “business plan” that identifies steps, costs, funds raised, permits needed, expenditure schedules and all similar components of the actual plan, which can be referenced simply as an Exhibit to the “wrapper.” The first should be written by the tax attorney advising the transaction, the second should be written by the business people actually funding, building and executing on the plan.
Specific Technical Requirements Included In The Wrapper
The following are elements that should be included in the Wrapper:
1. State that the entity adopting the Written Plan is a QOZB, has been funded by a QOF with the specified capital contribution in exchange for newly issued and outstanding equity of the QOZB entity, and will expend each capital contribution within the lesser of the plan schedule or 31 months of investment. In theory, the Written Plan requirement applies to EACH contribution to the QOZB, and an additional Written Plan can arguably be repeated for each new contribution. However, practical experience suggests that the BUSINESS PLAN in fact is the part that should be updated, keeping the various versions and date- and time-stamping each version to identify how each new contribution will be earmarked for expenditure.
2. Recapitulate in the Written Plan the entirely business purpose of the QOZB, which in turn should state that the QOZB is a “qualified opportunity zone business” (“QOZB”) within the meaning of Section 1400Z-2(d)(2)(C)(ii) of the Code and to comply with all requirements for qualification as a QOZB within the meaning of Code Section 1400Z-2(d)(3) and Treas. Reg. Section 1.1400Z2(d)-1(d).
3. Identify that the QOZB has determined that cash amounts contributed are necessary and will be used and spent by Company for the “development of a trade or business in a qualified opportunity zone (as defined in section 1400Z-1(a)), including, when appropriate, the acquisition, construction, and/or substantial improvement of tangible property in such a zone” within the meaning of Treasury Regulations Section 1.1400Z2(d)-1(d)(3)(v)(A)-(C) (or any successor regulations) and that such cash will be held and spent in accordance with Company’s written plan created pursuant to Treasury Regulations Section 1.1400Z2(d)-1(d)(3)(v)(A).
4. Identify with reasonable specificity the actual business(es) that the QOZB will engage in, that such businesses meet the definition of a trade or business within the meaning of Code Section 162, and, if a start up, state that the QOZB will engage in a trade of business upon completion of the project described in the Written Plan.
5. State that Company believes Written Plan accurately and comprehensively describes the intended nature and scope of Project, and the use and commitment of all required funds, including both Initial Capital Contribution and those capital contributions anticipated to be contributed and/or borrowed in the future.
6. State that the Company’s By-Laws and Articles are drafted expressly to provide that the business purpose of Company “is to be organized and operated at all times as a ‘qualified opportunity zone business’ (“QOZB”) within the meaning of Section 1400Z-2(d)(2)(C)(ii) of the Code and to comply with all requirements for qualification as a QOZB within the meaning of Code Section 1400Z-2(d)(3).”
7. State that the Company believes that the amounts comprising Initial Capital Contribution will be considered a “reasonable amount of working capital”, as described in Final Regulation § 1.1400Z2(d)-1(d)(5)(v) (or any successor regulation), and that the use of such working capital has been fully and properly designated in writing as provided in Final Regulation §1.1400Z2(d)-1(d)(5)( v)((A) (or any successor regulation). As of QOF Contribution Date, the estimated costs necessary to complete the Project are equal to or exceed the aggregate amount of Initial Capital Contribution.
8. Reference the written schedule and state that the exact amount of Initial Capital Contribution, the sources and uses, and all other relevant factors, are and have been set forth with the required specificity in Written Plan as of and from QOF Contribution Date and the applicable schedule, consistently with the ordinary start-up of a trade or business, provides in reasonable detail for the expenditure of the applicable working capital assets. The Written Plan provides that all working capital assets comprising Initial Capital Contribution will be spent within a period of up to 31 months of receipt by Company, all as required by and in accordance with Regulation §1.1400Z2(d)-1(d)(5)(v)((B).
9. State that the Company expects the working capital assets comprised of Initial Capital Contribution will be consumed within thirty-one months in a manner that is substantially consistent with the budgeted monthly consumption schedule set forth in the attachment hereto. No portion of the Capital Contribution will be spent on the Project later than the date that is thirty-one months from QOF Contribution Date or for any purpose other than the implementation and completion of Project.
All of these comments are intentionally self-serving (that is the whole point of a good Written Plan) and most of them are subject to actual implementation of the relevant project, but at the very least they set forth key aspirational objectives of a successful OZ project. It does not assure that the WCSH requirements will ultimately be met, but it does exactly specify everything that the Regulations require.
NEXT WEEK: DRAFTING AND THEN IMPLEMENTING THE BUSINESS PLAN
 Treas. Reg. §1.1400Z2(d)-1(d)(3)(v)(A).  Treas. Reg. §1.1400Z2(d)-1(d)(3)(v)(B).  Treas. Reg. §1.1400Z2(d)-1(d)(3)(v)(C).  Treas. Reg. §1.1400Z2(d)-1(d)(5)(iv)(C).  Treas. Reg. §1.1400Z2(d)-1(d)(5)(v)(E).  Federal Register, Vol. 86, No. 70, Wednesday April 14, 2021, pp. 19590.  Id.  As the COVID-19 pandemic is ongoing, the “incident period” has yet to close.  Federal Register, Vol. 86, No. 70, Wednesday April 14, 2021, see pp. 19590 and 19591.