The Internal Revenue Service announced Friday that issuers that purchased and still hold their auction-rate securities can enter into voluntary closing agreements under which the securities will continue to exist if the issuers pay a fee and meet certain conditions.

Absent such voluntary closing agreements, the issuers' ARS would no longer exist for tax-law purposes, even if they continued to exist under state law.

At issue is guidance the IRS issued during the last three years that provided issuers with relief from the liquidity constraints that occurred in the tax-exempt bond market during the financial crisis.

During the crisis, the ARS market collapsed and issuers were unable to remarket their securities.

The IRS issued guidance in March and April 2008, as well as January 2010, that allowed the issuers to purchase their own ARS until they could resell them or current refund them.

Under the most recent guidance, issuers were only permitted to hold the ARS until the end of 2010, after which the they were considered retired or extinguished for tax law purposes. In other words, the securities no longer exist for tax-law purposes, making it impossible for issuers to resell or current refund them.

Some issuers that purchased their ARS were unable to resell or current refund them before the Dec. 31 deadline. Other issuers have said they needed to purchase and hold their own bonds after Dec. 31 because of certain market challenges.

A number of these issuers approached the IRS about the possibility of entering into voluntary closing agreements that would give them more time to resell or current refund their bonds.

The IRS has decided to allow these issuers to enter into voluntary closing agreements. They would have up to 180 days after signing the voluntary closing agreements to resell or current refund their bonds. The issuers could agree to a shorter period of time than the 180 days.

Under the voluntary closing agreements, issuers would have to pay a fee equal to the par value of the outstanding ARS they hold times 0.029% for each month from Jan. 1. 2011, or any later date that they purchased securities, until the end of the period of the closing agreement.

For example, an issuer has $1 million bonds outstanding as of Jan. 1 and it and the IRS execute a voluntary closing agreement on April 1. The agreement has a closing date of Oct. 1, meaning the issuer must resell the bonds by that date. The issuer would pay a fee for the nine period of $2,610.

The fee amount was based on an analysis of the yields of comparable tax-exempt securities, sources close to the matter said.

In addition, the issuer would have to adopt and submit a resolution stating it intends to resell or current refund the extinguished bonds as tax-exempt bonds within the specified period. The resolution would have to be based on an opinion from the issuer's financial adviser or other expert that this is feasible within the specified time.

The issuer or its bond counsel also would have to "represent" in writing that the bonds to be resold or current refunded are still outstanding under state law, and that nothing has occurred that would make the bonds invalid under state law or taxable under federal tax laws other than the extinguishment.

The IRS said that generally a VCAP request will be processed and a closing agreement will be sent to the issuer for signing within 45 days of the agency's receipt of all of the documentation. The issuer will have to submit the payment before returning the signed closing agreement to the IRS.

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