WASHINGTON – The National Association of Bond Lawyers is calling for the Internal Revenue Service and Treasury Department to revise and re-propose rules that would determine when entities are political subdivisions that can issue tax-exempt bonds.
The group made its request in a letter recommending 11 projects, including three new ones, to be included in the agencies’ priority guidance plan for 2016-2017.
The April 7 letter, which was signed by NABL president Ken Artin but developed with input from the group’s tax committee, also include recommendations to revise and update several bond-related regulations, add several projects to facilitate financing of public infrastructure, and simplify allocation rules.
Matthias Edrich, a tax attorney at Kutak Rock and head of NABL’s tax committee, said the group wants to see the political subdivision regulations revised and re-proposed rather than revised and finalized.
“We think the regulations aren’t ready to be used because there are still a lot of open questions that need to be answered by Treasury,” Edrich said. ”There is a lot of concern in the bond community.”
States, for many years, have set up political subdivisions within their jurisdictions under state laws that specify that an entity is a political subdivision if it has been delegated a substantial amount of at least one of three sovereign powers: eminent domain, taxation and policing.
The proposed political subdivision rules would add two new additional requirements – that political subdivisions serve a government purpose “with no more than an incidental private benefit” and that they be governmentally controlled.
Bond lawyers sharply criticized the proposed political subdivision rules at the NABL Tax and Securities Law Institute in March, claiming they would infringe upon states’ rights and jeopardize the tax-exempt status of millions of dollars of municipal bonds. Several NABL members said there is no need to introduce new a definition of political subdivision.
John Cross, Treasury’s associate tax legislative counsel, said at that conference that IRS audits revealed that political subdivisions were vulnerable to control by private entities, and that this created substantial concerns within the federal government. He said the tax exemption of munis “is a federal subsidy” and that Treasury plays a role in determining how that subsidy is used.
The first of NABL’s three new recommendations is for the IRS and Treasury to develop regulations for allocating bonds under multipurpose rules “less restrictive and more flexible.” The rules generally apply primarily to determine what portion of bonds can be advance refunded.
Current Treasury regulations say that allocating bonds to refund a prior issue can be done in three instances: if it is done on a pro-rata basis, or a piece of each bond is subject to advance refunding; if the allocation results in savings during each bond year; or if the allocation is based on the useful life of what the bond financed compared to the weighted average maturities of the bond.
Although the NABL committee’s recommendation relates to all three allocation methods, Edrich said it places specific emphasis on the third, which has is not very clear in current regulation on how it can be applied.
“The wording is clear but it is very difficult to put into practice or what the rule means in given situations,” Edrich said. “In most cases, it would improve the usefulness of the provision if the IRS can provide guidance maybe in the form of examples or clarifying statements.”
Another new NABL recommendation is for Treasury to eliminate or limit the scope of a step transaction rule in the regulations. The step transaction rule may cause reimbursements from bond proceeds to be treated as unspent bond proceeds (and not as valid reimbursements) when amounts equal to the reimbursements are used in a manner that gives rise to replacement proceeds, for instance when such amounts are used to fund a sinking fund.
NABL is recommending Treasury consider revisions to the rule to reduce the likelihood of penalizing borrowers for reimbursing themselves from bond proceeds.
NABL’s third new recommendation is for the agencies to simplify Treasury’s remedial action rules, which Edrich said the bond community has had some trouble interpreting.
Under current Treasury regulations, remedial action rules can be used in two contexts: to fix a transaction that otherwise gives way to private business use, or when bond proceeds may have been used to finance something not permitted. How to deal with the question of appreciation and depreciation and the sale of proceeds has created confusion, according to Edrich.
The IRS and Treasury’s office of tax policy use the annual priority guidance plan to identify tax issues that will be addressed in the coming year through “regulations, revenue rulings, revenue procedures, notices and other published administrative guidance,” according to the agencies.
Treasury and the IRS began seeking public comment on recommendations for the 2016-17 priority guidance plan in March. Recommendations for the 2016-17 plan – which will include projects the IRS and Treasury will work on from July 1, 2016 to June 30, 2017 -- are due by May 16. The agencies’ priority guidance plan is generally released in July or August. NABL also asked the IRS and Treasury in 2016-2017 to revise and finalize the set of rules on arbitrage investment restrictions proposed in Sept. 2007 as well as the proposed Sept. 2013 regulations concerning non-issue price arbitrage matters.
The group’s other suggestions, many of which it has made in previous years included revising and finalizing regulations concerning issue price, as well as updating the management and service contract safe harbors to facilitate the funding of public infrastructure.
