WASHINGTON – The Treasury Department and Internal Revenue Service should modify their tax rules so that more tax-exempt bonds can be used for infrastructure projects, Bond Dealers of America told the tax regulators.

The two agencies should also abandon or make significant changes in their proposed rule for political subdivisions, BDA said.

These were two recommendations the dealers’ group made for inclusion in the Treasury/IRS 2017-2018 priority guidance plan. The June 1 letter BDA sent to the tax regulators also said they should both review the use of “issue price” in non-arbitrage-related rules to see if a reasonable expectations standard could apply and monitor the impact of the new rules, which take effect on June 8, on the muni market.

The National Association of Bond Lawyers made seven recommendations for the priority guidance plan in a letter it sent to Treasury and the IRS on May 31. Those recommendations revolved around revising, clarifying, or moving forward with rules on public approval requirements for private activity bonds, reissuance, allocation and accounting, remedial actions for change-of-use situations, multipurpose allocations involving refundings, step transactions, and determining the “amount” of bonds for various tax requirements.

BDA’s letter, which was signed by its CEO Mike Nicholas, said the group was pleased to see that President Trump’s infrastructure principles released with his fiscal 2018 budget request called for expanding the types of facilities that can be financed with the use of tax-exempt PABs. The principles also included eliminating PAB volume caps for these bonds. In addition, the document proposed expanding the Transportation Infrastructure Finance and Innovation Act and Water Infrastructure Finance and Innovation Act programs, which provide credit assistance for transportation and water projects.

Bond Dealers of America CEO Mike Nicholas
The political subdivision rules the Treasury and IRS proposed in February 2016 are “unnecessarily restrictive” and “overly burdensome,” said BDA CEO Mike Nicholas.

“While legislative changes to expand the ability to use tax-exempt bonds for infrastructure should be made, the BDA believes there are changes to the tax-exempt bond regulations that would also facilitate greater investment without an act of Congress,” Nicholas said.

The dealers" group said it would particularly like to see further modifications to rules on management contracts and to rules governing when tax-exempt bond-financed facilities change from public-purpose to private-purpose after the bonds were issued.

BDA said the political subdivision rules the Treasury and IRS proposed in February 2016 are “unnecessarily restrictive” and “overly burdensome.”

The proposed rules would add two new requirements to the definition of a political subdivision that can issue tax-exempt bonds. The existing rule is that a political subdivision must have the ability to exercise a substantial amount of at least one of three sovereign powers – taxation, eminent domain, and policing. But the tax regulators proposed to add that a political subdivision issuing tax-exempt bonds must be governmentally controlled and serve a governmental purpose “with no more than an incidental private benefit.”

BDA said that while the proposed rules seem to be motivated by concerns about a narrow class of transactions, they “would change the rules for all issuers,” forcing some to lose their ability to issue tax-exempt bonds and “disrupt[ing] the ability of many communities to build valuable public infrastructure projects.”

On issue price rules, BDA noted that the Treasury and IRS finalized the rules under Section 148 of the U.S. tax code relating to arbitrage but that issue price is important in other areas of the tax rules.

“We believe that the Treasury and the IRS should review the use of ‘issue price’ in the context of non-arbitrage-related rules to determine whether a reasonable expectations-based determination of issue price can be used in some or all of those contexts without creating tax policy concerns,” Nicholas said.

Until June 8, the rules were based on the reasonable expectations of what prices would be for the first 10% of bonds sold. The new rules drop the reasonable expectations standard and instead generally are based on the prices of bonds actually sold, with a special rule for situations where 10% of maturities of bonds aren’t sold and an exemption for competitive deals.

“We believe that after industry participants have worked with the new issue price rules for a period of time, it will be important to study the effect that these rules are having in the market,” Nicholas said.

NABL recommended Treasury and the IRS revise and then finalize the public approval requirements for PABs. The IRS proposed rules in September 2008 but never finalized them. The bond lawyers want several revisions and clarifications to those rules. For example, they want the rules to clarify that an issuer doesn’t have to state in a public notice or hearing that some of the proceeds may be used for working capital. PAB rules say that 95% of the proceeds must be used for “qualified facilities.” But an issuer may have to use some of the remaining proceeds to help pay for such things as start-up costs or it may have to use a reserve fund to pay operating expenses when a project is in financial difficulty default, sources said.

NABL also wants the tax regulators to provide some additional guidance and clarifications on reissuance – when a change in the terms of bonds causes the bonds to be considered reissued as new bonds or bonds that refund the outstanding bonds. The bond lawyers would like the rules to address, among other things, whether there is a reissuance or refunding when there is an interest rate reset or other change in a private placement.

The bond lawyers are seeking clarifications on rules issued in 2015 governing the allocation and accounting of private activity bond proceeds and investments. The lawyers want to better understand how to allocate proceeds between governmental use and private use.

NABL would like the tax regulators to come up with a better, more flexible set of rules governing allocations of bond proceeds for refunding purposes in so called multipurpose bond issues, where the deal finances multiple things. The bond lawyers think the current rules in Section 1.148-9(h)(4)(v) of the arbitrage rules are difficult to apply other than on a pro rata basis, which isn’t always desirable. Sometimes it is critical that the allocations be done properly because bonds can only be advance refunded once, said Tom Vander Molen, a partner at Dorsey & Whitney in Minneapolis who is head of NABL’s tax committee.

The bond lawyers also would like the tax regulators to eliminate or ease a “step transaction” rule that applies under rules governing bond proceeds used for reimbursement. Under Section 1.150-2, an issuer can issue bonds and use some of the proceeds to reimburse itself for some expenditures it made before the bonds were issued if it meets certain conditions. But the issuer can’t take the reimbursement money and use it to defease or retire the bonds.

Finally, NABL would like the Treasury and IRS to clarify in several sections of the tax code whether the “amount” of bonds refers to the bonds’ stated principal amount or their issue price.

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