NEW ORLEANS — The Internal Revenue Service has advised several community development districts in Florida that they may not be political subdivisions that can issue tax-exempt bonds if they do not have public electors within five years of their bonds' issuance, a bond lawyer said.
The warning, made at the conclusion of audits, is "a pretty scary, a pretty out there advisory," said Richard Chirls, a tax partner at Orrick, Herrington and Sutcliffe in New York. He and others spoke about the political subdivision issue on Thursday and Friday during the National Association of Bond Lawyers' Tax and Securities Law Institute here.
In May 2013, the IRS issued a technical advice memorandum (TAM) that concluded that the Village Center Community Development District in Florida is not a political subdivision because its board was, and always will be, controlled by the developer and not members of the public. Chirls is co-counsel for the Villages in the years-long audit, along with Perry Israel, a Sacramento, Calif.-based lawyer with his own firm.
The IRS has closed several audits of other community development districts in Florida with no change to the bonds' tax-exempt status. But the IRS also advised the districts that they need to have public electors within five years of the bonds' issuance or their bonds may be taxable and the districts may not be political subdivisions retroactive to the issuance date, Chirls said.
He said the advisory strikes him as an "odd way, uneven way for the IRS to be administering the TAM and administering the definition of a political subdivision."
At a different session during the conference, Mark Norell, an attorney at Sidley Austin in New York, said that "there's a pretty uniform consensus" that the TAM seems to be changing the fundamentals of the law about the definition of a political subdivision. "I think that's really where the practicing bar is struggling with it the most," he said.
The TAM seems to create a standard that political subdivisions be accountable to an electorate. Norell said that public accountability is subjective, and any rules that are written need to be principled and not too rigid.
Victoria Ozimek, a partner at Bracewell and Guiliani in Austin, said that there are different types of governmental entities within and across the states. She thinks a good safe harbor for whether an entity is a political subdivision with properly delegated powers could be based on where the entity's assets would revert to if it is dissolved.
Guidance on the definition of a political subdivision is one of the items on the Treasury Department's guidance plan. John Cross, associate tax legislative counsel in the Treasury Department, said this is a "very hard topic." He noted that Congress has recommended that any guidance on political subdivisions be prospective.
Cross said most of the developed law on political subdivisions has focused on whether the entity has sovereign powers. Part of the exercise with doing potential guidance on this topic is to determine what other principles should there be for political subdivisions. In addition to discussing the political subdivision issue, bond lawyers also discussed the IRS' latest notice of proposed issue that concluded that the Village Center CDD's recreation bonds are taxable private-activity bonds. The CDD recently responded to the notice.
One of the IRS' arguments was that the bonds were used in the trade or business of a private entity because the developer controls the district's board. Chirls said that under Florida law, the district and the developer have a great deal of independence from each other. The IRS was ignoring the law, and ignoring the facts.
A second argument made by the IRS was that the developer had a special legal entitlement to the bond-financed property. Chirls said that the IRS was not allocating the bond proceeds properly.
"I think we've got a strong response," he said.
A third reason the IRS asserted that the bonds were PABs is because the developer had a special economic benefit to facilities that are restricted to residents of the Villages retirement community and are not available to the general public. But Chirls said there are about 104,000 members of the community and there are liberal guest policies for using the facilities.
Ozimek said the notice raises the question of whether people who are residents of planned communities are part of the general public.
