WASHINGTON — A Little Rock issuer is appealing an Internal Revenue Service ruling alleging that $3 million of its enterprise zone bonds are taxable because it violated an employment requirement.

The Arkansas Residential Housing and Public Facilities Board, which issued the bonds in 2004, disclosed the appeal in a material event notice filed with the Municipal Securities Rulemaking Board’s EMMA system on Wednesday. 

The board lent the bond proceeds to conduit borrower HLR LLC to finance the acquisition and renovation of a 263-bed Hilton hotel near the state capital.

The IRS sent the board a proposed adverse determination on June 6, claiming the bonds were taxable because the project did not meet a tax-law requirement for enterprise zone bonds that at least 35% of the employees of the bond-financed facility, the hotel, be residents of an empowerment zone or enterprise community, which are economically distressed.

No date has been scheduled for the appeal hearing, during which the issuer will argue its case before an IRS appeals office official.

The case is somewhat unique because the IRS had already reached a closing agreement to settle the tax dispute with the board and HLR.

On April 25, 2008, the board and the IRS entered into a closing agreement under which it and HLR agreed to make a payment to the IRS and redeem all of the outstanding bonds by Aug. 1, 2008.

They made the payment, but on Jan. 10 of this year, the board reported to the IRS that it was unable to redeem the bonds and HLR said it was still unable to meet the 35% requirement.

As a result, the IRS opened another audit of the bonds on Jan. 11 and that led to the agency’s determination earlier this month that the bonds were taxable.

According to the IRS, the issuer contends that the closing agreement settled the tax dispute and that the agency therefore is not permitted to take any further enforcement action pertaining to the bonds, even if the issuer failed to meet the terms of the agreement. The issuer claims the bonds must remain tax-exempt.

The closing agreement states, in part: “The matters determined hereunder shall be final and conclusive, except that … the matter it relates to may be reopened in the event of fraud, malfeasance, or misrepresentation of a material fact.” The issuer notes it has not committed any fraud or malfeasance and has not misstated any material facts.

But the IRS insists it can tax bondholders’ interest earnings from the bonds for violations arising after the effective date of the closing agreement.

“The conduit borrower failed to meet the continuing annual requirements of an enterprise zone business for all periods subsequent to Aug. 1, 2008,” the IRS said. “Accordingly, the bonds are not qualified enterprise zone facility bonds for the period subsequent to the period covered under the 2008 closing agreement.”

The IRS maintains that the interest paid on the bonds after Aug. 1, 2008, is taxable.

In a closing agreement, an issuer typically settles tax-law violations by agreeing to pay the IRS money or take remedial action, such as redeeming its bonds, in return for the agency’s permitting the bonds to remain tax-exempt.

The disclosure documents show that Bradley S. Waterman is representing HLR and M. Jane Dickey, a partner at the Rose Law Firm, is representing the issuer. Neither of them would comment.

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