WASHINGTON -- The IAH Public Facility Corp. has reached a proposed settlement with the Internal Revenue Service to resolve a tax dispute over roughly $49 million of tax-exempt bonds it issued in 2004 and 2006 to finance a jail in Polk County, Texas.
Under the agreement, the trustee, U.S. Bank National Association, would pay the IRS nearly $980,000 on behalf of the issuer. Also, interest on the bonds accrued and paid on or before Nov. 2, 2015 would remain federally tax-exempt, but interest accrued and paid after that date would be federally taxable. U.S. Bank described the proposed agreement in an event notice posted on the Municipal Securities Rulemaking Board's EMMA system on Thursday.
The IRS has provided the corporation with a draft closing agreement, and the issuer's board has voted to approve the execution of a final agreement that's consistent with the terms of the draft, according to the event notice.
The agreement with the IRS is contingent upon approval by the District Court of Ramsey County, Minn., where U.S. Bank has a corporate trust office. U.S. Bank filed a petition to get authorization to make the settlement payment and to amend bond documents to reflect that interest on the bonds accrued and paid after Nov. 2 would be taxable. The court has scheduled a hearing on the petition for Oct. 19.
The issuer sold $24.22 million of bonds in 2004 and $24.82 million of bonds in 2006 to finance a 1054-bed detention center. A total of about $38.6 million of the two issues is outstanding, according to the petition, which was included as an appendix to the event notice.
For both deals, Herbert J. Sims and Municipal Capital Markets Group were underwriters and Jenkens & Gilchrist was bond counsel, according to the official statements for the bonds.
As of Sept. 19, the detention center had 355 inmates, with is about 34% of its capacity, according to the event notice.
The IRS began auditing the bonds in 2012. In 2014, the IRS sent the corporation a notice of proposed issue that asserted the bonds are taxable private-activity bonds, according to the petition.
The petition did not say why the IRS claimed the bonds were taxable PABs, but in other audits of jail bonds, the IRS has claimed bonds are taxable PABs because the facilities housed a significant portion of federal inmates, which are considered private rather than governmental individuals, and because the owner of the facilities may have signed a management contract with a private party. The private use and payments would make the bonds PABs and jail facilities are not permitted to the financed with tax-exempt PABs under the tax law.
The issuer disagreed with IRS' claim and had discussions with the agency to resolve the matter. The IRS continued to argue the bonds are taxable PABs, and it also said that the aggregate tax exposure to bondholders for interest accrued and paid on the bonds through Nov. 2 was about $3.27 million. The IRS told the issuer that unless the matter was resolved by a settlement or agreement, it would issue a final determination of taxability and take steps to impose tax liability on those who have received interest payments on the bonds since they were issued, according to the petition.
The issuer and the IRS reached the proposed settlement after "extensive discussions and negotiations," according to the petition.
In order to amend certain bond documents to convert the bonds into taxable bonds as of Nov. 2, holders of two-thirds, or 66 2/3%, of the principal amount of each of the series 2004 bonds and series 2006 need to consent. U.S. Bank has received consent from a group that own or represent beneficial owners of about 70.8% of the outstanding aggregate principal amount of the series 2004 bonds but only about 64.9% of the outstanding aggregate principal amount of the series 2006 bonds.
U.S. Bank has asked the court to allow it to make amendments to documents to reflect that interest accrued and paid on the bonds after Nov. 2 will be taxable, even though they have not received consent from those holding the required percentage of the series 2006 bonds. The trustee said in the petition that it believes the amendments are necessary because, without the settlement, the IRS may take steps to collect taxes from bondholders with respect to interest accrued and paid since the bonds were issued.
Since bond documents do not explicitly grant U.S. Bank the authority to use trust funds to make the settlement payment, U.S. Bank also is asking the court for additional authority to do so, according to the petition.
U.S. Bank, the issuer, Polk County and the project operator had entered into a forbearance agreement. Because of obligations under the agreement and decreased project revenues resulting from a declining prisoner population at the detention center, the balance of funds on deposit with U.S. Bank was materially reduced. The group of bondholders directed U.S. Bank to withhold making principal payments on the bonds on May 1, according to an event notice from April.
When Moody's Investors Service downgraded Polk County's limited-tax general obligation debt to A2 from A1 in June and revised its outlook to negative, it said that the outlook "reflects the fiscal uncertainty surrounding the recent IAH Public Facility Corporation bonds default" and that a negative ruling from the IRS "could induce further financial pressures and limit the Corporation's ability to exit the forbearance period." While the bonds are not liabilities of the county, the county receives financial support from the corporation.
