WASHINGTON - Municipal issuers and bond attorneys are concerned about when the Build America Bond cash payments issuers plan to use to make debt-service payments could be disrupted or even reclaimed by the Internal Revenue Service if it finds the BABs violate tax laws or rules.
Their concerns stem from remarks made earlier this month by tax-exempt bond director Cliff Gannett that his office would stop sending BAB payments if it uncovers fraud during an audit. In cases where BABs under audit are suspected of lesser tax violations, he said his office would immediately stop the payments when it sends a proposed adverse determination letter to the issuer.
Gannett also said the IRS also could issue a notice of deficiency and attempt to reclaim BAB payments already made to the issuer. The notices would only be issued after an issuer had exhausted the IRS appeals process, he said.
BAB audits are expected to be discussed Friday in Chicago when Gannett speaks to members of the American Bar Association's committee on tax-exempt financing.
Some bond attorneys and issuers question whether it makes sense for the IRS to halt BAB payments, which equal 35% of interest expenses, before the examination process is exhausted, particularly if it threatens the issuer's ability to pay debt service on the bonds.
"We see transactions from time to time where the IRS disagrees with one thing or another and they issue proposed adverse determination letters that are ultimately resolved," said David Caprera of Kutak Rock LLP. "I just hope that they're going to have a very high standard that they're going to impose [for halting BAB payments], perhaps higher than the one they have for tax-exempt bonds."
"TEB confronts a significant challenge in determining when to exercise its discretion to stop payments," said Bradley S. Waterman, a Washington, D.C.-based tax controversy lawyer. "The service should suspend payments only in cases in which there is an obvious, egregious failure to comply with the requirements."
Frank Hoadley, Wisconsin's capital finance director, said he does not think the IRS' stated approach to BAB enforcement "does anything to give comfort to investors."
These concerns come as rating agencies already are warning they are going to be scrutinizing a BAB issuer's ability to cover its debt service if the payments from the federal government are stopped.
"When we do our ratings, a key question when there are BABs being issued is if the issuer is planning to stand behind 100% of the debt service payment," said Gabriel Petek, a director with Standard & Poor's.
Petek's agency issued a report in May stating that it would be weighing the ability of BAB issuers to cover debt service costs if the subsidy payments are late. Petek said Standard & Poor's outlook could also apply to the IRS blocking payments.
"It could be [payments arrive late in] the mail, it could be the IRS determines the projects didn't qualify ... or the federal law could change," he said.
Bond lawyers said it is unclear what steps the IRS would take to reclaim previous BAB payments from municipalities.
However, BAB issuers would have the option of challenging any such IRS actions in the U.S. Tax Court.
Historically, tax-exempt bond issuers have not been able to litigate IRS rulings because it is actually the holders of the bonds whose interests are at stake in an audit, not the issuers. But since BAB issuers would be directly affected by the halting or reclaiming of subsidies, bond lawyers believe they would have standing to challenge the IRS in court.
IRS officials could not be reached for comment.
