WASHINGTON — New York City Comptroller John Liu is calling on the state’s congressional delegation to press the Internal Revenue Service to provide consistent and specific guidance on controversial issues surrounding the Build America Bond program.
Furthermore, in its attempts to clarify its stance on BABs and issue price, the IRS has relied on “unconventional channels,”
The uncertainty driven by the agency’s actions has had a detrimental impact on the BAB market, according to Liu.
“These actions have not only discouraged some issuers from taking advantage of the BABs program, but have also increased volatility in the BABs market,” he added.
In June, Iowa pointed to heightened IRS scrutiny as its reason for passing on BABs for two deals, even though it had used the program in the past.
Liu’s letter also references a separate letter his office sent to the IRS on June 30. Although that letter was not made public, it detailed the office’s concerns on several specific points. They included the application of the “reasonable expectations” standard when establishing issue price; the reliance on the Municipal Securities Rulemaking Board’s Electronic Municipal Market Access system to establish the issue price; and the lack of guidance on the definition of an “affiliate” or “affiliated account” of the underwriter for purposes of determining if a bona fide public offering occurred.
Although BABs have quickly become a significant player in the municipal bond market and have been highlighted as a major success story of the American Recovery and Reinvestment Act by the Obama administration, the program has recently become steeped in controversy over how the IRS plans to monitor and regulate the financing tool.
Market participants were initially concerned by a questionnaire the IRS is sending out to BAB issuers, which asks if someone besides the underwriter or initial purchaser is tracking the secondary market trading of BABs on EMMA between the sale date and issue date.
It also asks if issuers have written procedures in place to make sure their BABs are not issued with more than a de minimis amount of premium, which is a unique requirement of the program. If the premium is too high, it’s possible the IRS would determine the bonds would not qualify as BABs and would block subsidy payments equal to 35% of interest costs.
The controversy peaked after an IRS official indicated that the agency might audit up to half of all BAB deals — a statement that was quickly walked back by top IRS enforcement officials, who instead said it was premature to know the audit rate on BABs.
Nonetheless, the heightened interest in BABs from the IRS continues to drive concern among market participants about what steps need to be taken to ensure they do not endanger an issuer’s subsidy payment.
Traditionally, the issue price for bonds is set once 10% of the bonds are sold to the public. The issue price rule, in Section 1.148-1(b) of the tax rules, states: “Generally, the issue price of bonds that are publicly offered is the first price at which a substantial amount of the bonds is sold to the public. Ten percent is a substantial amount.”
The Treasury Department has clarified that BAB issuers currently can rely on the tax-exempt bond rules pertaining to issue price, and that any future changes will be made on a strictly prospective basis.
The letter has been positively received by New York lawmakers, a spokesman for the comptroller’s office said Thursday.
