IRS Suggesting NJHCFFA 1993 Bonds May Be Taxable

WASHINGTON — The Internal Revenue Service has suggested that some of the revenue bonds issued in 1993 by the New Jersey Health Care Facilities Financing Authority for Deborah Heart and Lung Center may not be tax-exempt because of a “total return swap,” and has asked NJHCFFA for more information.

The authority said in an event notice recently filed with the Municipal Securities Rulemaking Board’s EMMA system that the IRS had sent it a “Form 5701 Notice of Proposed Issue” detailing its concerns about the transaction.

The authority issued $37.41 million of tax-exempt revenue bonds in March 1993 and lent the proceeds to Deborah, a tax-exempt nonprofit that owned and operated an acute care hospital on a 49-acre campus in Browns Mills, NJ. The bonds were to be used to renovate and add to the hospital facilities, and acquire and install equipment, fund a debt service reserve fund, and refund some bonds previously issued in March 1978. Only about $19.21 million of the bonds remain outstanding, NJHCFFA.

Representatives of the issuer declined to comment. But sources said the borrower may have entered into a total return swap at a later date. At the end of a TRS, a payment is made based on the value of the bonds at that time.

The IRS seems to be suggesting that the swap modified the terms of the bonds so that they were considered to be reissued as taxable bonds. If Deborah entered into the swap and the bonds were reissued, they would be taxable because Deborah cannot issue tax-exempt bonds, one source said. It is only a borrower.

The IRS also suggested the swap may have caused the issuer’s investments to yield more than the bond yield so that the issuer improperly earned arbitrage. If the swap was not a qualified hedge, or integrated, then it could not be taken into account in computing the bond yield and the investment yield could have been higher than the bond yield, sources said. Typically, for a hedge to be qualified it must reduce interest rate risk and it may be hard to show a TRS was a qualified hedge, they said.

NJHCFFA said in its notice: “The subject of the Notice of Proposed Issue relates to certain post-issuance transactions specific to the bonds, including a ‘total return swap.’ The IRS contends ... that the ‘transactions amounted to an amendment to the terms of the bonds, without approval of any governmental entity authorized to approve the terms of tax-exempt obligations, resulting in the ‘reissuance’ of taxable bonds. The transactions also utilized an abusive arbitrage device effectively modifying the yield on the bonds and creating additional arbitrage investment opportunities for the borrower.”

The authority said it disagrees with the IRS' tentative conclusions and will cooperate with the issuer in preparing a response.

McCarter & English LLP appears to be handling the dispute for the issuer, but declined comment.

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Healthcare industry Tax New Jersey
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