WASHINGTON — The American Bar Association’s section on taxation has asked the Treasury Department to clarify a number of points in tax-regulatory guidance of Build America Bonds and other new programs under the American Recovery and Reinvestment Act to ensure issuers don’t do anything when issuing the bonds or spending the proceeds that could jeopardize the federal subsidy on the bonds.
The group of lawyers last week sent Treasury and Internal Revenue Service officials a 17-page document outlining 25 different issues that have emerged with BABs, as well as recovery zone economic development and facility bonds.
The attorneys wrote that they hope the various “interpretative issues” can be addressed in upcoming regulatory guidance.
“These are questions that have arisen in the trenches,” said Perry Israel, a Sacramento lawyer with his own firm who headed the ABA effort. “We would love to have answers for [them] so we can really give our clients the type of advice that we want to be able to give them.”
Treasury officials said last month that guidance addressing several technical issues surrounding BABs is high on their priority list in the coming year. Initial guidance on the BAB program was released in April.
The group recognized that addressing every issue on the lengthy list could bog down regulatory guidance, so they highlighted nine topics as top priorities.
At the top of the list was clarification on whether BABs and other bonds, if issued at the same time, are considered part of the same issue. This topic is significant because if BABs and other taxable bonds are considered part of the same issue, it is possible lumping thems together could cause the BABs to inadvertently run afoul of some of the tax rules.
In the past, the Treasury has addressed this issue as it pertains to tax-exempt bonds by stating that taxable and tax-exempt bonds are never considered part of the same issue. The ABA group asked the Treasury to similarly clarify that BABs should be evaluated on a stand-alone basis, even if issued at the same time as tax-exempt bonds, tax-credit bonds, or other taxable bonds that are not directly subsidized by the federal government.
Doing so would “prevent a gaming of the tax rules designed to subvert the intention of the tax-exempt bond rules and the BABs rules,” the lawyers said.
“This is one that [Treasury officials] know they have to solve — I think there’s an easy solution,” Israel said.
Another point the lawyers seek clarification on is related to issue price. The issue price of taxable bonds is usually determined when 10% of the bonds have been sold. But for tax-exempt bonds, “issue price for each substantially identical bond is determined at the sale date based upon reasonable expectations if the bonds are offered in a bona fide public offering,” the ABA group said.
This issue re-emerges with BABs because issuers need to know the issue price at the time of closing because of a special rule stating BABs cannot include more than a “de minimis” amount of premium. The lawyers recommended the Treasury allow them to apply the tax-exempt bond rule for issue price to BABs.
The lawyers also asked the Treasury to permit BAB issuers the right to utilize the same remedial actions for correcting post-issuance compliance problems as are available to tax-exempt bond issuers. The remedies enable tax-exempt issuers to address errors while protecting their bonds’ tax exemption.
BAB issuers should be able to pursue the same remedies, and the Treasury should also put in place some additional remedies specific to BABs. For example, by law, 100% of BAB proceeds less issuance costs and a reserve fund must go towards capital expenditures. However, if an issuer finishes a capital project with proceeds outstanding, they should be allowed to redeem the BABs or defease them to their first optional call date without jeopardizing the interest-rate subsidy on the rest of the BAB issue, the lawyers wrote.
If BAB issuers determine that a portion of an issue no longer qualifies for the federal interest subsidy, the issuer should be able to notify the IRS and request a reduced subsidy payment from the government for the remaining qualified bonds.
The lawyers report also explores the question of what exactly constitutes a “capital expenditure” for purposes of the BAB rules. The lawyers suggested that the Treasury permit grants made by an issuer to another entity for capital purposes to be considered such an expenditure. Doing so would permit state issuers, which “may have more efficient access to credit markets,” to issue BABs and grant the proceeds to small issuers.
“This may be particularly important for use of BABs to benefit local communities that might have important but small dollar needs and, in the case of RZEDBs, a small allocation of volume cap,” they stated.
Another high priority for the attorneys is clarification stating that issuers can pledge BAB subsidy payments to pay off tax-exempt bonds without it constituting a federal guarantee of those bonds. In general, bonds with a federal guarantee are not permitted to be tax-exempt. In its initial BAB guidance, the Treasury specifically stated that the federal subsidies should not be considered a federal guarantee for BABs, but was silent on how the subsidy might affect tax-exempt bonds if it were pledged to their repayment.
The ABA group said the Treasury should also clarify whether BABs can be refunded with tax-exempt bonds. This point could become particularly relevant if the BAB program is not extended beyond its current deadline of Dec. 31, 2010. Without such clarification issuers seeking to refund BABs would either be unable to refund them, or would have to use taxable debt for refundings, which without the BAB subsidy could be costly for issuers.
The lawyers’ group also sought clarification of issues related to the expanded small-issuer exemption created by the stimulus law. The provision allows banks to deduct 80% of the cost of buying and carrying the tax-exempt bonds sold by an issuer in 2009 and 2010, so long as its annual bond issuance is less than $30 million. However, the lawyers said it is not clear from the law whether BABs sold by the issuer count towards the $30 million limit. The ABA group contends that “a literal reading of the statute indicates that BABs will not be counted,” and asked the Treasury to confirm that reading.
Tthe group also used the document as another opportunity to reiterate to the Treasury the great need for guidance on how to “strip” the tax credits from tax-credit bonds and sell them separately. BABs can be sold with a tax credit for investors as opposed to a subsidy check for issuers, but none have been issued yet.
On recovery zones, the lawyers contended that there do not appear to be any limitations that would prevent an issuer from designating its entire jurisdiction as a “recovery zone,” defined as an area of economic distress within which projects are eligible for recovery zone bond financing. If the Treasury did not intend to give issuers that ability, it needs to clarify that as soon as possible, the lawyers wrote.