WASHINGTON — The Treasury Department should permanently apply existing regulations on issue price to all tax-exempt and direct-pay bonds, while clarifying several aspects of the rules, according to the American Bar Association’s taxation section.
The group of tax attorneys argued in a letter sent Nov. 9 to Treasury and Internal Revenue Service officials that crystallizing and clarifying issue-price regulations would help issuers and market participants determine bond pricing, which in turn would “enhance compliance” with several tax requirements that rely on an accurate issue-price determination.
The letter comes after Treasury officials indicated they are considering ways to improve the existing rules, while IRS officials are taking a long look at bond pricing, asking issuers if they are tracking the pricing of their Build America Bonds after the original offering.
The attorneys argued in their letter that issue price should continue to be established using the reasonable expectations of the managing underwriter in a negotiated deal, or the successful bidder in a competitive one.
“Those prices are appropriate because they best reflect the underwriter’s (or the successful bidder’s) expectations for the initial prices at which the bonds will be offered to the public and at which a substantial amount of each maturity of the bonds will be sold to the public.
Existing rules on issue price state that it is determined by the first price at which a substantial amount of bonds are sold to the public, and that 10% is a substantial amount. Issuers are permitted to use the reasonable expectations of the underwriter or bidder.
The IRS has asked issuers if they are tracking pricing of their BABs on public resources like the Municipal Securities Rulemaking Board’s EMMA online system.
Bond attorneys in the past have pointed out that issuers are not obligated to follow the pricing of their bonds and have traditionally relied on an underwriter’s certification as to the issue price, but the IRS has argued that issuers should want to look at public information to determine if they are getting the best price on their debt.
In the letter, the attorneys contended that the underwriter remains the “most appropriate entity” to determine issue price, and that issuers should be permitted to rely on the underwriter’s certification, assuming there is no “clear abuse” like bid-rigging, pay to play or price-fixing.
“The issuer has no contact with the buying public, and data that is available on public websites cannot be easily interpreted to identify the status of the buyers,” they wrote.
In fact, asking issuers or underwriters to modify the offering process by, for example, limiting who can initially buy the bonds “will increase inefficiencies and interest rates and likely harm taxpayers as much as the government,” the lawyers argued.
The American Recovery and Reinvestment Act, which created BABs, included a provision stating they could not be sold at more than a de minimis amount of premium.
The provision referred to a section of the tax code that defines de minimis as 1/4 of 1% of the stated redemption price at maturity for the bond, multiplied by whichever comes first: the number of complete years to the maturity date for the bonds or the first optional redemption date for the bond.
The premium limit was put in place to ensure that issuers do not artificially inflate the interest rates of their BABs to obtain larger subsidy payments, according to market participants. The Treasury makes direct payments to BAB issuers equaling 35% of their interest costs.
The attorneys added in their letter that financial institutions buying bonds —unless they are members of the underwriting team or have a contract with the underwriter confirming its role as another underwriter or wholesaler — should be treated as public buyers for purposes of determining issue price.
Issue price is determined based on the pricing of bonds sold to the public, so the issue could be muddied if the IRS were to contend that some institutions buying the bonds were not acting as members of the public, but rather as wholesalers or additional underwriters.