The Internal Revenue Service has preliminarily determined that $45.6 million of general obligation refunding bonds issued in 2000 and 2001 by California's Pomona Unified School District are taxable.
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The two sets of Series A GO refunding bonds - $21.5 million issued in 2000 and $24.1 million issued in 2001 - are among 26 transactions totaling about $800 million that were sold from 1993 to 2003, with Solana Beach, Calif.-based Kinsell, Newcomb & De Dios Inc. as underwriter and Riverside-based Best Best & Krieger LLP as bond counsel, J. Jeffrey Kinsell, president of the underwriting firm, said yesterday.
The transactions were part of a forward-refunding program developed by Kinsell Newcomb in the early 1990s for California school districts with outstanding debt that carried fairly low interest rates. Under the program, a district like Pomona would enter into a forward agreement to sell advance refunding bonds at a future date and use those proceeds to defease the outstanding bonds to their maturity dates.
A third party agent would take bids on Treasury securities for the escrow, but Kinsell always won the bid. The firm also canvassed at least three potential purchasers of the bonds to establish the bonds' issue price. At the forward delivery date, six to 15 months later, the firm would purchase the refunding bonds from the district and sell them to the public at prevailing market rates, which typically were higher due to interest rate movements during the forward period.
However, in its letter, the IRS contends that the escrow securities were not purchased at a fair-market value and that the yields on the bonds were computed based on an incorrect issue price, resulting in bond yields that were below the yields of the escrow securities. As a result, the IRS preliminarily concluded, the bonds are considered arbitrage bonds and are taxable.
Jeffrey Kinsell said in an interview in December that the IRS simply does not understand the transactions.
"Ultimately, at the end of the day, I think it's that they are deals that had lots of moving parts," he said. "Usually, lack of understanding creates a doubt."
Nonetheless, he has said he is pursuing a settlement with the agency, claiming that the audits are hurting the school districts and investors.
Kinsell said yesterday that he is scheduling meetings with the IRS to discuss a settlement, and hopes to have it completed as soon as possible. He declined to offer a specific timeframe.
