WASHINGTON - The Agua Caliente Band of Cahuilla Indians is appealing the Internal Revenue Service's proposed adverse determination that $22.5 million of revenue bonds it issued in 2003 for a golf course project and recreation center are taxable - the latest development in a long-standing dispute over the kinds of projects tribal governments can finance with tax-exempt bonds.
The appeal was disclosed in a material event notice that the tribe filed yesterday with the nationally recognized municipal securities information repositories.
The bonds were issued to finance the renovation of the Canyon South Golf Course in Palm Springs, Calif., which is operated by the tribe; the construction and equipping of a clubhouse on the golf course; a community and recreation center for the tribe and related infrastructure, according to the notice.
The tribe said it received a proposed adverse determination from the IRS on Sept. 25, and that it filed a protest and a request for a review from the IRS Office of Appeals a month later. That request is currently pending, according to the notice. The determination stems from an IRS audit of the bonds, which began in March of 2005.
The tribe said in the notice that it "continues to believe that all requirements relating to the excludability of interest paid to the holders of the bonds were satisfied."
The disclosure of the appeal comes in the midst of a lengthy and contentious debate over whether golf course, hotel, and other projects can be considered "essential government functions" for tribal governments and therefore can be financed with tax-exempt debt.
While state and local governments issue tax-exempt debt to finance municipal golf courses and hotels, the IRS contends that some tribal governments are building high-end courses and other projects for commercial purposes and that, as a result, the bonds used to finance them do not adhere to the tax code and are not tax-exempt.
The issue reached a fever pitch in 2005 when the IRS mistakenly released a field service advice memo pertaining to a 2002 audit of a bond-financed golf course built by the Las Vegas Paiute Tribe that suggested the IRS might not be able to prevail if it were legally challenged over the issue.
When the Aug. 21, 2002 memo was disclosed, certain portions of the document were redacted by the IRS and neither the tribe nor the bonds were identified. An unredacted version of the document was mistakenly released in 2005 by the IRS. It still did not identify the issuer. But over the years, market participants learned the memo involved the Paiute Tribe and $12 million of bonds it issued in the 1990s to finance the golf course.
The unredacted memo revealed that then-IRS acting assistant chief counsel Timothy L. Jones had advised enforcement officials that despite the agency's "legitimate" case regarding the commercial nature of the bonds, they should not take the case to court because of "substantial litigating hazards." Jones said in the memo that a court would likely rule in favor of the tribe.
"It is probable that a court, faced with this fairly common activity of state and local governments, and taking into account the interpretative standard accorded tribal governments, would conclude that the golf course meets the statutory standard for an essential government function," the unredacted memo stated.
Jones' comments led bond attorneys to accuse the IRS of taking unsubstantiated actions against tribal governments.
The IRS clarified its position in August 2006 in a notice of proposed rulemaking that stated an "essential governmental function" does not include any function that is not typically financed with tax-exempt bonds. The IRS reasoned that, since non-municipal golf courses are not typically financed with tax-exempt bonds, courses owned by tribes should not qualify for tax-exempt financing. The IRS also republished the field service advice memo, once again with portions redacted.
Bond attorneys have been frustrated that the IRS has continued to audit tribal government bonds used to finance such projects, even after the memo revealed that the agency has doubts about the strength of its arguments.
"The service can take a very, very weak position and use it as a hammer," said Mark Jarboe with Dorsey & Whitney LLP in Minneapolis.
"They definitely, as far as I can tell, are sticking to their position, not withstanding Tim Jones' advice that they might have a tough time in court," said Tom Vander Molen, also with Dorsey & Whitney.
"Somehow the argument that 'Public courses are kind of crummy courses, and if it's too nice it's not OK,' just doesn't conform to reality," Vander Molen said, adding, "I think they've kind of left that argument and gone more towards the argument, 'Well, is this course primarily being used by the residents of the community or primarily for tourists?'"
Noting that many municipal courses attract tourists, he said, "We don't think that argument makes any sense either."
Bradley S. Waterman, a tax controversy attorney who has his own firm and is representing the Agua Caliente Band, declined to comment on the notice yesterday.
Orrick, Herrington & Sutcliffe LLP served as bond counsel on the deal, and Banc One Capital Markets, Inc. was the underwriter.