NEW ORLEANS - The Internal Revenue Service's much-criticized memorandum on the defeasance of Build America Bonds is the product of the fact that BABs were a short-term program, an official with the Internal Revenue Service chief counsel's office said Thursday.
Timothy Jones, senior counsel in the tax-exempt bond branch of the chief counsel's office, explained the IRS' reasoning in the memo while on a panel at the National Association of Bond Lawyers' Tax and Securities Law Institute here.
The chief counsel advice memo, released in December, concludes that the legal defeasance of BABs causes them to be reissued. It treats BABs differently from tax-exempt bonds, which are not reissued when they are defeased.
BABs, which were authorized by the American Recovery and Reinvestment Act, could only be issued in 2009 and 2010. Jones said the IRS had started working on regulations for BABs, but they didn't get a lot of interest from the Treasury Department because the program was going to expire. Had the IRS really thought about the BAB defeasance issue in the context of a new regulation, the agency might have treated BABs like tax-exempt bonds under the reissuance rules. However, the IRS didn't get to that, Jones said.
"What we were doing here is nothing more than just a legal analysis, and I can't see why anybody thinks that we should have adopted some type of policy perspective," in this type of document, he said.
Generally under the reissuance regulations, the legal defeasance of debt obligations is considered a significant modification that causes the debt to be reissued. There is a provision in the regulations that exempts the legal defeasance of tax-exempt bonds from being a significant modification.
Tom Vander Molen, a partner at Dorsey & Whitney in Minneapolis who was also on the panel, pointed out that "the regulation itself has a self-contained definition of what is eligible for the [tax-exempt bond] exception." BABs fall under the definition of tax-exempt bonds as they are defined in the rules, and Congress intended BABs to be equivalent to but more efficient than exempt bonds, he said.
But Jones said the definition is ambiguous, and that when the regulations were created in the 1990s, they meant bonds whose interest is tax-exempt. At the time the regulations came out, there wasn't any intent to have the definition include future taxable bonds that meet the requirements for tax-exempt bonds, he said.
Jones also said that BABs were intended to be a substitute for tax-exempt bonds, but they were not expected to be exactly the same as tax-exempts.
Many bond lawyers have critiqued the IRS memo, and NABL recently asked the IRS to modify or withdraw it. NABL's comments on the memo recommended that any future guidance on BAB defeasances provide that short defeasance escrows not give rise to reissuances.
Jones said that if the IRS were to write regulations and had a good policy reason to exempt short defeasances from triggering reissuances, such an exception could exist. But the problem with writing regulations on BABs is that the program has expired.
Jones said he wasn't why bond lawyers were surprised by the conclusion in the memo, given that there was a 2011 private-letter ruling that applied the reissuance regulations as if BABs were simply taxable bonds.
When the memo came out, several bond lawyers thought that it stemmed from an audit. However, Jones said the memo wasn't connected with an audit. The memo came about because issuers were defeasing Building America Bonds and "weren't reading the regulations," he said.
One audience member asked how the IRS memo treats economic defeasances of BABs. Unlike in legal defeasances, economic defeasances do not cause the issuer to be relieved of its liability to pay debt service on the bonds once refunding bonds are issued and the proceeds of those bonds are placed in an escrow. Jones said that economic defeasances don't create modifications.
If BABs are reissued when they are defeased, issuers may not receive subsidy payments for the period from when the bonds are defeased to when they're redeemed. Also, the bondholders could have to realize taxable gains when the bonds are defeased, NABL has said.
