WASHINGTON — The American Bar Association's taxation section warned the Internal Revenue Service and Treasury Department that their proposed issue price rules will upend long established market practices and increase uncertainty for issuers and other market participants.
In a comment-letter sent to agency officials on Thursday, the lawyers asked that the proposed regulations be withdrawn, echoing the sentiments of many other groups from across the municipal bond market. A public hearing about the proposed rules is to be held on Feb. 5.
Issue price is extremely important because it is used to help determine the yield on bonds and whether the issuer is complying with arbitrage rebate or yield restriction requirements, as well as the amount of federal subsidy payments issuers receive for direct-pay bonds such as Build America Bonds. Issue price also plays a role in complying with other rules such as the 2% limit on issuance costs for private activity bonds and the size of debt service reserve funds.
Under the current tax rules, the issue price for each maturity of bonds publicly offered is the first price at which a substantial amount of the bonds is reasonably expected to be sold to the public, with substantial defined as 10%. The issue price is usually determined based on reasonable expectations when the bonds are priced, before a deal closes.
However, the proposed rules would eliminate the reasonable expectations standard and instead base the determination of issue price on actual bond sales. The Treasury has proposed a safe harbor under which the issue price is the price at which the first 25% of the bonds is actually sold to the public. Under the proposed rules, "the public" would be any person other than an underwriter, a term that would be defined as "any person that purchases bonds from the issuer for the purpose of effecting the original distribution of the bonds, or otherwise participates directly or indirectly in the original distribution."
The lawyers said that "the greatest virtue of the existing regulations is certainty," and the proposed rules do not provide that level of assurance.
"The committee does not believe that the Service and Treasury have made the case that the savings either to the federal government or to issuers will be sufficient to justify the loss of certainty," they said in their comments.
The proposed rules provide incentives for issuers and underwriters to ensure that there are no unsold maturities on the sale date. To do so, issuers and underwriters will have to accept lower prices and higher yields in negotiated sales. And it will be difficult for issuers to use the competitive sale method under the proposed rules because it is "virtually impossible" to eliminate the possibility of unsold maturities with such sales. A number of states are required by law to use competitive sales, and they generally ensure the lowest borrowing costs for issuers, the lawyers said.
If issuers continue to sell bonds with the possibility of unsold maturities, they will need to add personnel or have additional legal and financial advisory costs so that they can try to determine an issue price based on actual sales to the public, and they will likely issue more bonds to cover the increased costs, the committee said.
State and local government finance officials may bear a particularly heavy burden if they have to determine a market participants' intent when purchasing bonds. Intent cannot be determined through the Municipal Securities Rulemaking Board's EMMA system, and it may be impossible for issuers to comply with the actual sales standard in the short-term if they have to determine bond purchasers' intentions, the group said.
The ABA letter recommended the IRS and Treasury determine if the benefits of the proposed rules would be greater than its costs. They should see if the benefits may be offset by the higher bond yields that may occur due to the incentive not to use competitive sales. The agencies should also see if the benefits of the proposed rules would be offset by other ways the rules could narrow the market and the need for issuers to pay higher fees to lawyers and financial advisors.
Additionally, the group wants Treasury and the IRS to consider the administrative burdens on state and local finance officials if they have to monitor information about the identity of bond purchasers to satisfy the actual sales standard.
Treasury and the IRS' concerns about the existing rules appear to stem from the actions of dealers and underwriters, rather than issuers, the group said. As a result, the agencies need to consider whether MSRB or Securities and Exchange Commission rules could address these concerns without changing the issue price rules and placing a burden on issuers, it said.
Although the ABA taxation section does not want the proposed regulations to be adopted, it believes the existing regulations would benefit from additional guidance so that they could work more effectively. The group made suggestions about issue price to the IRS in 2010, and would welcome those suggestion to be included in any re-proposed issue price definition.
Additionally, the committee proposed changes to the proposed rules, if the IRS and Treasury insist on moving forward with them. These include maintaining the substantial amount threshold at 10% and allowing the reasonable expectations standard to be maintained in competitive sales that meet certain requirements.
