WASHINGTON – The Treasury Department and Internal Revenue Service could issue final arbitrage rules, guidance on management contracts, and final issue price rules before the November elections, John Cross, Treasury's associate tax legislative counsel told bond lawyers meeting here.
Cross talked about the agencies' tax-exempt bond regulatory projects at the National Association of Bond Lawyers' 14th annual Tax and Securities Law Institute.
At a panel session on Thursday, bond lawyers noted that not much happens in Washington, D.C. in an election year and asked Cross if there is any likelihood that Treasury and the IRS could move forward with tax-exempt bond rules and guidance this year, given the presidential election in November.
"I think there's probably a window of about six months to do regulatory guidance," Cross said, adding, "I think we're pretty far along on a few of these topics," referring to projects he had just discussed.
Cross said the best candidates for moving forward in the next few months are final arbitrage rules, guidance on management contracts, and final issue price rules.
The fastest moving may be the rules that would consolidate and finalize arbitrage rules that were proposed in 2007 and 2013. The issue price rules had been part of the 2013 arbitrage proposals, but were broken out as a separate regulatory project.
The tax agencies are expected to issue a revenue procedure that updates and liberalizes safe harbors for longer term management contracts so they do not create a significant amount of private use and payments that would make tax-exempt bonds taxable.
Bond and tax lawyers have complained that the tax agencies' previous guidance on management contracts is not flexible enough to allow tax-exempt bonds to be used in transportation or infrastructure projects financed by public-private partnerships. President Obama has made infrastructure financing a priority and has also encouraged P3s.
The IRS issued guidance in 2013, Rev. Proc. 97-13, that set up safe harbors for longer term management contracts. For a contract up to 10 years, at least 80% of the manager's annual compensation had to be based on a fixed fee. For one of 15 years, at least 95% of the annual compensation had to be based on a fixed fee.
Then in October 2014, the IRS issued Notice 2014-67 covering management contracts that included most types of fixed or variable rate compensation for contracts of five years or less. But it did not permit compensation based on a share of net profits.
The final issue price rules are expected to be similar to the ones the agencies re-proposed last June, but with some special provisions or safe harbors for competitive deals, according bond lawyers.
Issue price is important because it is used to help determine the yield on bonds and whether an issuer is complying with arbitrage rebate or yield restriction requirements, as well as whether federal subsidy payments for direct-pay bonds such as Build America Bonds are appropriate.
Under existing rules, the issue price of each maturity of bonds that are publicly offered is generally the first price at which a substantial amount, defined as 10%, are reasonably expected to be sold to the public.
But tax regulators became concerned that some dealers were "flipping" bonds -- selling then to another dealer or institutional investor who then sold them again almost simultaneously, with the prices continually rising before the bonds were eventually sold to retail investors. They felt the issue prices reported for each maturity of bonds were not the issue prices actually obtained for the bonds.
Treasury and the IRS tried to tighten the rules in 2013 by proposing new ones that replaced the "reasonable expectations" standard with actual sales and increased the definition of "substantial amount" to 25% instead of 10%. But those rules drew many complaints so Treasury and IRS scrapped them.
The agencies proposed new rules last June, under which the issue price of a maturity would generally be the price at which the first 10% of the bonds are actually sold to the public.
If 10% of a maturity hasn't been sold by the sale date, the issue price will be the initial offering price of the bonds sold to the public, as long as the lead or sole underwriter certifies to the issuer that no underwriter filled an order from the public after the sale date and before the issue date at a higher price than the initial offering price. An exception can be made if the market moved after the sale date, but the underwriter must document any market movements justifying a higher price.
Muni market participants have asked for safe harbors or special rules for bonds sold in competitive deals, where there is less opportunity for pricing abuses.
