Washington — There needs to be clarity about the definition of a political subdivision in light of an internal revenue service ruling from last year, bond lawyers said on Friday.
Lawyers at a meeting here of the tax-exempt financing committee of the American Bar Association's taxation section discussed what should be included the group's comments about political subdivisions to regulators.
Uncertainty over the definition of a political subdivision arose from an technical advice memorandum issued last May in which the IRS ruled that the Village Center Community Development District in Florida was not a political subdivision that could issue tax-exempt bonds. The TAM took issue with the fact that the Village Center CDD's board is, and always will be, controlled by private parties rather than elected officials.
As part of its work, the tax-exempt financing committee has been looking at regulations and past court rulings going back decades that concern political subdivisions.
Under Treasury Department regulations, a political subdivision is "any division of any state or local government unit, which is a municipal corporation or which has been delegated the right to exercise the sovereign power of the unit."
Nancy Lashnits, chair of the committee and an attorney at Steptoe & Johnson PLLC in Phoenix, said that the IRS has over the years extensively addressed the "sovereign powers" part of the regulations. But until the TAM, the IRS hadn't really said that an issuer needs to meet a two-part test, determining: first, that it's a division of a state or local government; and second, that it's a municipal corporation or has been delegated sovereign powers.
Stefano Taverna, vice chair of the committee and a lawyer at McCall, Parkhurst & Horton LLP in Dallas, said that historically, when regulators and the courts have looked at whether an entity is a division of the state, they've focused on whether the entity was formed pursuant to state law and whether the proceeds of bonds are being used for a public purpose. That's basically all that was looked at, as opposed to whether the entity was accountable to a public electorate.
Treasury Associate Legislative Tax Counsel Vicky Tsilas said there seems to be the perception that the TAM created a new requirement to be a political subdivision that didn't exist before. Tsilas acknowledged that most court cases go straight to discussing sovereign powers but that over the years, the IRS has issued private-letter rulings and revenue rulings that look at what is a division of a state. She wanted to know if the lawyers thought that the language about the need for a public electorate is important to having an issuer being a division of the state.
Perry Israel, a Sacramento, Calif.-based lawyer who represents the Village Center CDD, said that the TAM makes it seem like a public electorate is a necessary factor.
Treasury's priority guidance plan includes guidance on the definition of a political subdivision. Guidance can come in different forms, such as regulations or revenue procedures, but Tsilas said she could not comment on what form the guidance would take.
The bond lawyers discussed what type of guidance they would like to see. One lawyer wondered what the committee could request in terms of guidance if it feels the public electorate requirement isn't actually the law. Linda Schakel, an attorney with Ballard Spahr in Washington, said that with a TAM, lawyers don't have enough of the specific facts of the underlying case to determine if it applies to certain other cases. She said that guidance that explains several variations of the facts would be something that lawyers could better rely on.
Lon Smith, who works in the IRS chief counsel's office and used to be chief counsel's tax-exempt bond branch chief, asked if any of the lawyers thought the IRS's conclusion in the TAM makes sense even if the analysis was wrong. And if people thought the answer might make sense, what would the analysis be to get there under current law, he asked.
Lashnits said one of the problems is that the lawyers don't know all of the facts, so they don't know if the TAM was correct. The committee wants to come up with an analysis that follows the law and makes sense.
Given the concern about a lack of knowledge of the facts, Smith suggested that perhaps the committee's comments include examples of facts where the IRS' conclusion would or would not be correct. Others replied that there are so many different states and districts with their own laws that there would be too many different examples, and that there has to be some deference to state law.
Lashnits said that the TAM is theoretically an interpretation of existing law. The committee's feeling is that if it is law that a political subdivision has to be answerable to a general electorate, then the law should only apply to districts in the future "so that any existing community development district or any of these kind of districts would not fear that their bonds will now be treated as taxable bonds, she said. Taverna asked lawyers who were interested in working on the committee's comments to participate. "We're going to have to address this somehow," he said.
In November, the National Association of Bond Lawyers warned IRS and Treasury officials that the TAM had a "chilling effect" on the issuance of bonds by special purpose districts. NABL recently sent the regulators a memorandum to supplement their earlier comments.
The memo provided three examples of circumstances where NABL believes an issuer is a political subdivision, and one example where NABL believes an issuer is not, based on the group's application of "standards underlying existing legal authority."
NABL also analyzed more than 250 private-letter rulings that dealt with the political subdivision issue. No more than 10 of the rulings specifically analyzed whether an entity is a division of a state or local government, and none of those rulings stated that "responsibility to a public electorate" is a requirement to be a division, NABL said.
Only one of the rulings mentioned control by an electorate as a relevant factor. However, that ruling listed control by an electorate as one of a number of factors to be considered rather than a requirement, included no requirement of a minimum number of voters and favorably ruled on an election process that was generally limited to property owners in the district, NABL said.
