WASHINGTON — The Internal Revenue Service recently clarified that "on-behalf-of" issuers, such as authorities and unincorporated enterprises, can issue tribal economic development bonds.
The IRS also issued a private-letter ruling that determined an issuer's plan to current refund advance refunding bonds would not cause there to be transferred proceeds and potentially create taxable arbitrage bonds.
Tribal economic development bonds, or TED bonds, are bonds that Indian tribal governments can issue to finance anything that state and local governments can finance with tax-exempt bonds, as long as the project is on an Indian reservation and is not for gambling.
Tribal governments can use TED bonds to finance a broader range of projects than those they can generally finance with tax-exempt bonds. Historically, tribal governments have been required to use tax-exempt bonds only to finance "essential government function" activities that are "customarily" performed by state and local governments with general taxing powers.
The American Recovery and Reinvestment Act of 2009 created TED bonds and authorized the issuance of up to $2 billion of them. A Treasury official said in March that about $1.3 billion of the volume cap was still unused.
An IRS notice issued in 2009, which solicited applications for allocations of the national TED bond volume available, noted that tribal governments that receive allocations can designate on behalf of issuers to issue TED bonds. But a notice in 2012 soliciting applications dropped the language about on behalf of issuers.
The second notice caused uncertainty about whether the omitted reference to on behalf of issuers was intentional, and whether those issuers could no longer directly issue TED bonds, said Townsend Hyatt, a partner at Orrick, Herrington & Sutcliffe in Portland, Ore.
In a memorandum dated June 9 and released June 13, the IRS chief counsel's office affirmed that tribal governments can designate on behalf of issuers to issue TED bonds, and that the proceeds of bonds issued by authorities would be treated as if they were proceeds of bonds issued by the tribal government itself.
Bond lawyers were pleased with the IRS' clarification.
"The memo is an important confirmation because many Indian tribes use unincorporated enterprises or authorities ... as primary obligors in TED borrowings," Hyatt said.
Perry Israel, a lawyer with his own practice in Sacramento, Calif., said that because of the IRS' advice, "I think we'll see more TED bonds." Israel said he was one of the people who asked the IRS to issue advice on the topic.
The private-letter ruling on transferred proceeds was dated Feb. 25 but was not released to the public until June 13.
The issuer that requested the ruling owns and operates a water and sewer utility system. It financed the construction of the system and improvements to it with several bond issues.
The issuer issued advance refunding bonds, some of which were non-callable, to defease a number of issues of its revenue bonds. The proceeds to the advance refunding bonds were deposited in an escrow fund and used to purchase investments to pay off the prior issues, the letter ruling said.
Some of the prior issues have been redeemed using a portion of the escrow, and the issuer expects to use the rest of the proceeds in the escrow to pay the debt service on the prior issues that are still outstanding.
The issuer wants to issue tax-exempt bonds to current refund the callable advance refunding bonds that refunded the bonds already redeemed. It also wants to issue taxable bonds to refund the callable advance refunding bonds issued to refund the prior issues that are still outstanding, the ruling said. In current refundings, the bonds must be redeemed within 90 days of when the refunding bonds are issued. Before the current refunding bonds are issued, the issuer plans to allocate the bonds, proceeds and investments of the advance refunding bonds into separate issues, with the purpose of each issue being to refund one of the prior issues. It will allocate the investments in the escrow to the separate issues based on how much of the prior issues' debt service the investments are expected to pay. Since the investments in the escrow only pertain to the outstanding prior issues, none of the investments would be allocated to the bonds that would be current refunded by tax-exempt bonds.
At issue is whether any of the advance refunding bond proceeds in the escrow would become transferred proceeds of the proposed tax-exempt current refunding bonds. When proceeds of a refunding issue are used to discharge a prior issue, the proceeds and investments of the prior issue become transferred proceeds of the refunding issue.
Transferred proceeds are subject to yield restriction requirements. They cannot be invested at a yield higher than the yield of the bonds to which they are tied. As a result, if the money in the issuer's advance refunding escrow was invested at a higher yield than the yield of the current refunding bonds, the issuer would have to make yield-reduction payments known as transferred proceeds penalties. Failing to pay the penalties could lead the bonds to become taxable arbitrage bonds.
For none of the unspent proceeds to become transferred proceeds and investments of the tax-exempt current refunding issue, they have to have been allocated to issues other than the ones that would be refunded by the tax-exempts. That is the case here, the IRS said.
Bond lawyers thought that the IRS' ruling was correct. "I think it confirms what most of us assume the rules to say," said Mike Larsen, a partner at Parker Poe in Charleston, S.C.
Israel said the ruling is right because the IRS is permitting the issuer to take apart a multipurpose issue and treat it as separate issues. "The IRS is allowing the issuer to use the multipurpose regulations the way they were designed to be used," he said.
