ATLANTA — Issuers need to be aware that Build America Bonds can lead to not only savings on issuance, but also heightened scrutiny from the Internal Revenue Service, members of the Government Finance Officers Association’s governmental debt management committee said Saturday.
The group agreed that it needs to augment its advisory statement on issuing BABs to make sure issuers are aware that the IRS is taking a long, hard look at the debt instruments, starting with questionnaires and ending with a higher likelihood of audit than on tax-exempt debt. The decision came during a committee meeting ahead of the start of the 104th Annual Conference here.
But they also discussed the extreme option of pushing back against the IRS by advising members not to fill out a compliance check questionnaire the IRS is sending to every BAB issuer. Committee members argued that the service could not audit every issuer that failed to respond if the failure was widespread. In other recent survey projects, the IRS has audited parties that did not respond. Committee members ultimately tabled the idea, in part because they thought such a decision should be made by an issuer with their tax counsel, not by the committee.
The changes to the advisory, which would update the original BAB advisory approved by the GFOA’s executive board in March, would stop short of telling members whether or not they should issue BABs, but instead aim to highlight issues the committee identified as troublesome.
The advisory also will include more information about the risk that BAB subsidy payments to issuers could be reduced or stopped to “offset” money an issuer owes the federal government.
Members agreed on the concepts to be added to the advisory document and made plans to finalize language via teleconference in the upcoming weeks. They said they hope to quickly send it to the board, which in turn could approve it before its October meeting.
Members want the advisory to make clear that every single BAB issuer will get a questionnaire, what they need to know about filling it out, and that they should be sure to consult their bond counsel when they receive it. They said the advisory also should say that issuing BABs could lead to an increased likelihood of an IRS audit.
Furthermore, the advisory should point out that even though the current questionnaire asks if issuers are following the secondary market trading of their bonds, that there is no regulatory requirement that they do so.
The questionnaires have been a topic of continuing controversy since they were first unveiled in February because the document asks issuers if they follow the trading of their bonds, which is something not typically done and not required of issuers. Issuers have usually relied on underwriters to certify the bonds were offered and sold properly for purposes of determining the issue price of the bonds. Further complicating matters regarding BABs is the fact that there is no explicit guidance on how issuers should determine BAB issue price, leading some members to worry that a new responsibility is being imposed on them without the rules needed to ensure compliance with it.
“The tenor of the questionnaire doesn’t seem to be fostering a lot of communication and cooperation,” said Ben Watkins, Florida’s bond finance director. “[And] make no mistake about it, this compliance check questionnaire is an audit by any other name.”
Determining issue price is of particular importance for BABs due to a tax law requirement stating that BABs cannot be sold at more than a de minimis amount of premium, with the implication that if the sales premium is too high, issuers’ bonds would not qualify as BABs and therefore would not qualify to receive subsidy payments.
Concern was only heightened last month when an IRS official said the service could end up auditing up to 50% of all BABs. The service backed away from that statement just days later, with officials saying it was far too premature to know how many BABs could end up being audited. The service also has released a revised questionnaire it plans on sending out in the upcoming months.
On offsets, several committee members aired concerns over the potential for BAB payments to be shrunk or withheld, citing recent cases in Maryland, Austin, Tex, and Los Angeles World Airports where that had occurred to offset other money the issuer might owe the federal government.
In particular, issuers were concerned about the fact that the automated offset system simply looks at the taxpayer identification number, which is sometimes shared among several related entities. As a result, an issuer could find its payment affected by a separate entity. And members worried that entering into a BAB pool deal could result in the subsidy payments for those bonds being offset due to an offset on an entity related to one of those in the pool.
“We don’t want our BAB subsidy withheld because they screwed up,” said one committee member.
But others on the committee downplayed the offset issue, saying it amounted to more of an accounting error than anything else.
Debt committee members also discussed the possibility of urging states and localities not to participate in a program being pushed by the Securities and Exchange Commission that would allow the Municipal Securities Rulemaking Board to indicate on its EMMA site whether issuers have voluntarily agreed to include in their continuing disclosure agreements any of three enhanced disclosure commitments, including filing annual financial information within 120 days of the end of their fiscal years.
Members complained that even though they demonstrated to SEC staff that such a speedy turnaround was impossible for the vast majority of issuers, the commission was “nonresponsive in terms of hearing what our concerns are and modifying their position accordingly,” Watkins said.
“The SEC is using the MSRB and the EMMA system to set standards for the industry and regulate us in a backdoor way,” said Watkins, adding that unless there’s a good reason for them, the initiatives posed an unreasonable burden and that the SEC was “tone deaf” to issuer concerns.
One debt manager for a large West Coast city said that during this period of financial stress for states and localities, issuers are unlikely to deploy their resources into hiring more accountants to get their annual financials filed in under six months.
The meeting also marked the last one chaired by Frank Hoadley, Wisconsin’s capital finance director. Hoadley had led the committee for the last three years, and his term officially ends at the end of the calendar year. A new chair will be appointed in the fall.