WASHINGTON — The Cabazon Band of Mission Indians will pay $5.4 million to settle a long-standing Internal Revenue Service audit of $145 million of bonds sold by the California Statewide Communities Development Authority, disappointing some lawyers who want to see controversial tribal tax issues litigated. Under the terms of the settlement, revealed in unusual detail Tuesday in a material event notice filed with the nationally recognized municipal securities information repositories, the tribe will also take $108.5 million of the Series 2003 debt off the market on Aug. 6. The California authority sold the bonds for a hotel and convention center constructed near the tribe’s casino in Palm Springs, Calif. Merrill Lynch & Co. was underwriter and Orrick Herrington & Sutcliffe LLP was bond counsel. In July 2004, the tribe learned it was under audit. The IRS argued in a 2005 preliminary adverse determination that the facilities did not qualify as “essential government functions.” The federal tax code treats Indian tribes as states for purposes of tax-exempt governmental bonding only if proceeds are used for those functions. In this and several other audits, tribes have argued with the IRS over the meaning of “essential government function,” namely whether hotels, golf courses, parking garages, and other facilities qualify, and tribes and bond attorneys have disputed whether the law applies the same way to conduit financings done by state or local issuers. In the Cabazon tribe’s case, the authority and the East Valley Tourist Development Authority, the tribe’s conduit borrower subsidiary, have “in good faith contested the assertion of taxability by the IRS,” the material event notice stated. The tribe sought technical advice from the IRS’ Office of Chief Counsel, which in October 2005 said that the tribe’s debt was only tax-exempt if it used the proceeds for an essential government function. A second, controversial technical advice memo, however, said that all bonds issued by a state entity where an Indian tribal government is the conduit borrower are private-activity bonds, even if the proceeds are used for an essential government function. The memo’s finding was disclosed in a material event notice filed late last year by the California authority. IRS officials have since said the interpretation was incorrect, and that they have taken consistent positions in tribal audits. On July 5, the California authority, the tribe, and the IRS reached a closing agreement, the authority said in the notice filed this week. Steven Chamberlin, manager of the IRS tax-exempt bond office’s compliance and program management division, and tribal representatives declined to comment yesterday. “Some day, one of these will go to court,” commented one attorney who handles tribal cases and wished to remain unidentified. “Just as an observer, I am a bit disappointed that the tribe didn’t pursue the matter in the courts,” said David Caprera of Kutak Rock LLP. “While I understand there may have been many reasons why it made good business and economic sense to settle, by doing so the legal issue remains unresolved and the Service is given further incentive to challenge the exemption of bonds where the law may not be, at best, clear. Until issuers and bondholders are willing to take the Service to court, we will continue to be forced to defend the tax-exempt status of bonds in a forum that is heavily weighted against us.” Chief counsel and the Treasury Department currently are developing regulations for tribal bonds. A notice of proposed rulemaking, issued last August, indicated that the rules are likely to require tribes to issue bonds — or borrow proceeds — only for noncommercial, nonindustrial activities performed by “numerous” state and local governments with taxing powers that have been financing the activities with munis “for many years.”
