The Village Center Community Development District in Florida is urging the Internal Revenue Service to allow its $427.2 million of bonds to remain tax-exempt, claiming the IRS’ finding that the bonds are taxable alters long-standing and well-settled law and should not be retroactively applied.
Perry Israel, the Sacramento, Calif.-based lawyer representing the CDD made the request in a 16-page letter to Helen Hubbard, IRS associate chief counsel for financial institutions and products, and a one-page letter to Steve Chamberlin, the acting director of the tax-exempt bond office.
Israel requested the relief under Section 7805(b) of the Internal Revenue Code, which allows taxpayers to request the IRS limit the retroactive effect of any IRS holding in a TAM if there is a change of position.
Israel also sent a two-page letter to IRS chief counsel William Wilkins, telling him that the TAM appears to be based on three major misconceptions.
These letters are the latest development in a five-year dispute between the IRS and the Village Center CDD over 10 bond issues totaling $427.2 million of bonds that were sold from November 1993 through June 2004. The bonds were issued by the CDD to finance its purchase of utility and recreational facilities and properties from the developer for the Villages, a community of at least 92,000 people near the Town of Lady Lake, Fla. T
he bond documents give the CDD the right to charge Village residents so-called amenities fees in exchange for providing recreational and other services. The Village Center CDD is non-residential and contains the utility and recreational facilities.
In May, the IRS chief counsel issued a technical advice memorandum that concluded the CDD does not qualify as a political subdivision, and therefore could not issue tax-exempt bonds, because its board is, and will always be, controlled by the developer rather than publicly-elected officials.
“We believe that an entity that is organized and operated in a manner intended to perpetuate private control, and to avoid indefinitely responsibility to a public electorate, cannot be a political subdivision of a state,” the TAM stated.
But Israel told Hubbard, “In general, the [CDD] believes that the TAM represents a significant change in legal analysis and conclusions that could not have been known from existing precedent and accordingly should be applied only on a prospective basis and not to the bonds that were issued prior to the TAM.”
The letter lists eight reasons why the TAM should not be retroactively applied.
Israel said the TAM’s conclusion that an entity must be controlled by a state or local government “is contrary to prior case law and rulings and presents a novel theory.”
Treasury rules implementing the tax law state that a political subdivision means “any division of any state or local governmental unit which is a municipal corporation or which has been delegated the right to exercise part of the sovereign power of the unit,” he said. Prior to the TAM, the analysis of whether an entity was a political subdivision was based on whether it had a significant delegation of one of three sovereign powers: eminent domain, taxation or police, Israel said. The Village Center CDD is designated as a public agency under Florida law, he said. The state must review and approve the formation of CDDs and these districts get the same tax exemption as states, counties or cities, he said. CDDs can exercise the power of eminent domain in their own names.
The IRS’ finding that the CDD is not a political subdivision because the property is owned or controlled by a single developer “is startling and inconsistent with prior precedent and practice,” Israel said. For CDDs in Florida it is “normal” that all or a vast majority of the land is owned by one entity or a group of related entities at the time they issue bonds. Similar arrangements also exist in Colorado and California, he said.
Israel also said, “There has never previously been any manner of statement, directly or indirectly, that the determination of whether an entity is a political subdivision [that can] issue tax-exempt bonds is based on the manner in which the voting process is applied for governance of the entity.”
In addition, he said, Congress acknowledged this kind of financing practice in its General Explanation of the Tax Reform Act of 1986. Israel also noted that the IRS already audited some of the CDD’s bonds in 2002 and closed the audit a year later without taking any action.
Israel told Hubbard that if the IRS wants to take a new approach in determining whether an entity is a political subdivision, it should do so through rulemaking, giving market participants a chance to comment. In fact, the IRS recently said it plans to propose guidance on the definition of a political subdivision.
In his letter to Wilkins, Israel said he wants to correct three misconceptions the IRS appears to have about the Village CDD. The IRS said the CDD kept changing its boundaries, seemingly to keep out residents and preserve the control of the developer.
Israel said that is “factually inaccurate” and that the land for residential development was moved outside the boundaries of the Center CDD so “residents would not be liable for the relatively costly assessments imposed upon property” in that district. Even if the land had not been moved, the CDD would have gained only 111 residents, less than the 250 that would mandate a move from a landowner to elected board voting process under state law, he said.
The IRS also appears to be concerned that the amenities fees bind persons outside the Village Center CDD to it even though they have no say in the makeup of the board. Israel said the fees were established by contract and have been unchanged through any involvement of the Center CDD, he said.
Finally, Israel said the IRS contends all of the bonds were initially purchased by the developer. “That is simply not true,” he said, adding “all of the bonds, with the exception of one small subordinate series early on, were offered to the general public and sold pursuant to normal underwritings.”
“I would be happy to meet with you to correct the erroneous facts’ concerning the Center District. its bonds, and its operations that appear to be continuing despite my attempts to correct the misstatements and incorrect conclusions reached by the initial examining agent,” Israel said.
