WASHINGTON - The American Bar Association's tax-exempt financing committee has urged the Internal Revenue Service to provide guidance on what constitutes prohibition on federal guarantees, arguing that regulatory clarification "has become even more acute" in light of increased government cooperation in financing some projects.
The ABA committee hopes the IRS will consider the federal guarantee issue in 2001. That may be a long shot, since the agency then may have leftover issues from this year's business plan to work out, as well as other questions that the industry and government officials prioritize.
Still, IRS and Treasury Department officials agreed with the ABA yesterday that guidance is needed on federal guarantees, which generally prohibit interest on bonds to be tax-exempt if the debt service is directly or indirectly guaranteed by the federal government.
In its 10-page letter to the IRS, the ABA committee, led by main author Scott Lilienthal, a bond lawyer with Hogan & Hartson here, said the lack of guidance has "sometimes resulted in issuers having to forego the use of tax-exempt financing" because bond counsel have not felt comfortable that the IRS would agree that the debt would not violate the federal guarantee prohibition. The group pointed to several specific areas where this regulatory uncertainty has especially confounded market participants.
One such area is the federal guarantee of subordinated debt. There has been "some concern," the letter said, that if a project is financed both by senior tax-exempt bonds and by subordinated debt the latter may be deemed an indirect guarantee of the senior tax-exempt bonds. Such a conclusion may be reached because the subordinated debt provides additional funds for the project, thereby improving the security to the senior bondholders.
"We believe that such an argument would expand the reach of the federal guarantee prohibition far beyond both the statutory language ... and the intent of Congress," the letter said. "Under such a structure ... the risk of nonpayment has not been shifted to the federal government, and therefore there is no federal guarantee of the senior bonds."
Lilienthal said questions about federal guarantees do not occur in most bond issues, but said that it is a major issue and sometime deal killer when it does show its face. "Every few months it seems to pop up as an issue," he said. "It's just difficult to deal with because of the lack of guidance."
Another area plagued by the federal guarantee uncertainty is when a bond-financed facility is leased to the federal government. The ABA group argued that such leases should not constitute an improper guarantee unless the federal government has an unconditional obligation to make payments under the lease regardless any circumstances.
Some bond issues currently under audit may be in trouble because of federal guarantees. For instance, a $67 million tax-exempt bond deal by high-profile real estate developer Franklin Haney is being scrutinized by the IRS partly because the bulk of the bond proceeds was used to invest in a District of Columbia office building, which now is being leased to the federal government.
Lilienthal said he is optimistic the IRS will address the issue next year. "It seems like the topic is relatively narrow, so maybe it wouldn't be as large an undertaking as some of the other things they might look at." Steve Watson, the Treasury Department's attorney-adviser on tax-exempt bonds, said it is too early to tell whether the issue will be a priority next year, but he recognized the need for guidance. "I think it is an area where we do need to provide guidance," Watson said.
Rebecca Harrigal, an official in the IRS' Chief Counsel's Office, agreed. "I think there are a lot of unanswered questions on the federal guarantee issue ," Harrigal said. "Where I put that in the order of priorities for next year's agenda , I'm not sure."
The IRS is still working on several regulatory issues from this year's business plan, and observers have said it could be next year until the next item is released. One top priority is new electricity output regulations, which expire in late January. Once the smoke clears from the current work, officials said they can start focusing on next year's agenda. "It'll be a couple of months probably before we sit down and put together the business plan for next year," Watson said.
