LOS ANGELES — Officials of Bell, Calif., the los Angeles-area city where the former administration was jailed earlier this year for misappropriation of funds, said the tax-exempt status of $35 million in general obligation bonds that came under review by the Internal Revenue Service has been preserved.
The IRS launched an audit in January 2011 questioning the tax exempt status of $35 million in GOs issued on Sept. 6, 2007, because the agency believed the bond issue was a hedge bond.
The city and the IRS entered into a closing agreement that resolved the issues raised by the agency with no change to the tax-exempt status of the bonds, according to a letter from IRS Acting Manager/Tax Exempt Bonds Bob Griffo to Bell City Manager Doug Willmore. The city received the IRS letter on Nov. 4 giving notice the agency's examination had been completed and posted notice of the material event on Nov. 25 to the Municipal Securities Rulemaking Board's EMMA website.
Under federal tax law, a hedge bond is any part of a bond issue that meets two requirements: the issuer reasonably expects that less than 85% of the net proceeds of the issue will be used to finance its qualified purpose within three years of the bond issuance date; and more than 50% of the proceeds are invested in non-purpose investments having a substantially guaranteed yield for four or more years.
The IRS launched its audit of the bonds to determine compliance with the internal revenue code in January 2011 over concerns that the city hadn't met the requirement that 85% of tax-exempt G.O. bonds be spent within three years of issuance, Willmore said.
"The goal is for [municipalities] to get funding for a project after the plans are done, or get them done soon after, then start construction immediately and get the project built," Wilmore said. "What the IRS wants to protect against is that [municipalities] are not borrowing money at low interest rates and then investing it at high interest rates to hedge and make money on the spread. That is why they have the spend-down requirement."
The old administration - two city administrators and five elected officials sentenced earlier this year for misappropriating funds - didn't meet the spend-down requirements, Willmore said. The entire city council, city manager and assistant manager were replaced in 2010 after the fraud came to light and charges were lodged against the since-convicted city leaders.
Under an agreement reached with the IRS, he said, the city paid a $257,000 fine in October.
"The IRS was looking to see who was harmed in the marketplace and if there should be penalties," Willmore said.
The amount of the fine could have been up to $1 million, but Willmore said the IRS questioned further penalizing the taxpayers for the transgressions of members of a former administration, who are all in prison now.
"I think they saw we did everything to fix it," Willmore said. "We agreed that the city didn't meet the spend-down requirements, but the bondholders weren't harmed and we argued that the taxpayers should not continue to be harmed by the acts of the old administration now serving time."
He added that "obviously Bell didn't want to have the bonds declared taxable," because that would have been the worst thing for everyone involved, for the bondholders and the city.
"I think it is a reasonable settlement with the IRS, so we can put everything behind us, repair the situation and move on."
The city conducted a buy-back plan involving the bonds two years ago, during which it was able to purchase half of the bonds from investors. It has $18 million of the original GO bonds left and is using that amount to pay off debt. The money was issued for municipal projects including a sports complex that was never built, and never fully planned. Some of the bond proceeds were used for minor repairs to parks, he said.
The city now has about $74 million in bond debt. When Willmore was named city manager in June 2012, bond debt totaled $137 million. Since then the city has refunded some, and has paid off a substantial amount, including a $35 million bond privately-placed through Dexia, a Franco-Belgian bank.
The city defaulted on the bonds held by Dexia that were secured by lease revenue from certain properties, and the lease was invalidated by a lawsuit.
The city closed Dec. 6, 2013 on an agreement with Dexia in which the city paid the company $29 million, rather than the $35 million owed for principal and interest on the bonds.
