IRS: Treat Conduit Borrowers as Taxpayers

An advisory committee to the Internal Revenue Service recommended that it treat conduit borrowers as taxpayers for compliance matters so it can deal with them directly and cause less unnecessary burdens for transaction participants.

The 21-member Advisory Committee on Tax-Exempt and Government Entities, known as ACT, made the recommendation in a report on conduit bonds that it presented to IRS officials on Wednesday.

Currently, the agency treats conduit issuers as taxpayers for compliance matters. This has been the IRS’ policy even though the conduit borrower is the true obligor of the bonds for federal tax purposes, according to the report.

Treating the conduit borrower as the taxpayer in a deal “creates [an] unnecessary administrative burden for both the service and for conduit issuers and conduit borrowers,” the committee said in its report.

The IRS “generally requires full participation of the conduit issuer, even if the conduit issuer serves no meaningful role” in a request for a voluntary closing agreement, the report said. In such cases, the issuer voluntarily discloses tax-law violations to the IRS in return for more lenient treatment.

The advisory committee stressed that it is not suggesting the issuer be exempted from taxpayer responsibilities. Rather, it is calling for both the issuer and the borrower to “be appropriately treated as a taxpayer with respect to tax-exempt bond compliance matters,” the report said.

The recommendation was presented to IRS commissioner Douglas Shulman, acting director of government entities Clifford Gannett and other agency officials by Michael Bailey, a partner with Foley & Lardner LLP and outgoing chairman of the ACT committee.

The report was based in part on the results of a survey of 20 conduit issuers. The questionnaire asked about the relationship between issuer and borrower when the IRS has questions about a conduit deal.

The respondents were generally large conduit issuers with 70% of them selling at least $500 million of bonds a year. The deals included governmental bonds, 501(c)(3) bonds and private-activity bonds.

The survey found less than half of respondents had specific required procedures for responding to an IRS examination of conduit bonds. Additionally, most of the respondents said they do not have procedures in place for dealing with applications for relief under the IRS’ voluntary closing agreement program. A third of respondents said they do not keep records at all.

Gannett said during the advisory meeting that he found it interesting that some of the conduit issuers have no procedures for responding to the IRS.

“We will seriously consider the recommendations in the report,” particularly the suggestion that conduit issuers and borrowers be treated equally as taxpayers, he said.

Finally, the report included an information pamphlet on the responsibilities of conduit issuers that it said the IRS should consider publishing.

Gannett agreed the pamphlet would be “really useful” to the tax-exempt bond community and addresses a need to more fully understand the role of conduit issuers.

The ACT recommendations were well-received by members of the conduit financing community who said in telephone interviews that, with greater IRS oversight, investors can feel more comfortable there is a regulator watching over the deals.

“We’ve long thought that we need to make sure [conduit] issuers are accountable with the utmost fair playing field,” said Toby Rittner, president and chief executive officer of the Council of Development Finance Agencies, whose members include conduit issuers. He said there has been “a big confusion between government and conduit issuers” and that “everyone would like more clarity and clarification” from the IRS.

Ritter said the ACT recommendations strike the right balance between oversight and the cost of compliance. “Those two things can happen together,” he said. “Ultimately the goal is for investors to feel secure.”

The IRS also heard advice from the advisory committee’s Indian Tribal Governments group, which urged that tribal economic development, or TED, bonds be freed from certain restrictions, primarily the requirement that the bonds be used to finance projects with “essential governmental functions.”

Of the $1 billion of first tranche TED bonds authorized by the American Recovery and Reinvestment Act, only 58 deals have gone to market. About two-thirds of the first tranche will be forfeited, the report said.

The IRS has received 16 requests from tribes to extend the deadline for issuing TEDs through the end of the year, the report said. To help facilitate the sale of the bonds, tribes are “resoundingly” calling for a repeal of the “essential governmental functions” requirement, according to Wendy Pearson, of counsel with Bennett, Bigelow & Leedom,  who presented the report of the tribal governments group. The ARRA temporarily removed the essential-government function requirement for bond financings of tribal governments, a hurdle the tribes felt put them at a disadvantage. But the provision expired on Dec. 31.

Advisory committee members are selected by the IRS and serve a two-year term, which is typically extended to three years.

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