WASHINGTON — The Agua Caliente Band of Cahuilla Indians in California has reached a closing agreement with the Internal Revenue Service over $22.5 million of revenue bonds it issued in 2003 to finance a golf course and accompanying facilities.

The tribe announced the agreement in a material event notice filed with the Municipal Securities Rulemaking Board's online EMMA system late Wednesday. However, the notice did not detail the terms of the agreement, which typically involves some sort of payment from the issuer in exchange for which the IRS will agree to keep the bonds tax-exempt.

The bonds were issued to finance the renovation of the Canyon South Golf Course in Palm Springs, which is operated by the tribe; the construction and equipping of a clubhouse on the golf course; a community and recreation center for the tribe, and related infrastructure, according to the notice.

The agreement brings to a close the long-standing audit, which began in 2005. On Sept. 25, 2007, the IRS tax-exempt bond office issued a proposed adverse determination saying it believed the bonds were taxable. The tribe responded a month later by appealing the decision to the IRS office of appeals, which ultimately paved the way for the closing agreement nearly three years later.

The agreement also marks the latest development in the long-standing dispute between tribal governments and the IRS about the "essential governmental function" test, which tribes typically must meet to finance projects with tax-exempt bonds.

State and local governments have relied on tax-exempt financing to build hotels and municipal golf courses on several occasions. However, the IRS has cast a skeptical eye on tribes engaging in the practice, arguing that the high-end facilities they are building are commercial projects and as a result the bonds used to finance them cannot be tax-exempt.

The issue reached a fever pitch in 2005 when the IRS mistakenly released a field service advice memo pertaining to a 2002 audit of a bond-financed golf course built by the Las Vegas Paiute Tribe that suggested the IRS might not be able to prevail if it were legally challenged over the issue.

When the Aug. 21, 2002, memo was disclosed, certain portions were redacted by the IRS and neither the tribe nor the bonds were identified. An unredacted version of the document was mistakenly released in 2005 by the IRS. Though it still did not identify the issuer, market participants learned over the years that the memo involved the Paiute Tribe and $12 million of bonds it issued in the 1990s to finance the golf course.

The unredacted memo revealed that then-IRS acting assistant chief counsel Timothy Jones had advised enforcement officials that despite the agency's "legitimate" case regarding the commercial nature of the bonds, they should not take the case to court because of "substantial litigating hazards." Jones said in the memo that a court would likely rule in favor of the tribe.

The IRS clarified its position in August 2006 in a notice of proposed rulemaking that stated an "essential governmental function" does not include any function that is not typically financed with tax-exempt bonds. The IRS reasoned that, since non-municipal golf courses are not typically financed with tax-exempt bonds, courses owned by tribes should not qualify for tax-exempt financing. The IRS also republished the field service advice memo, once again with portions redacted. Bond attorneys have been frustrated by the IRS taking what they believe are unsubstantiated adverse positions against tribal governments.

Recently, the controversy was partially tabled by the American Recovery and Reinvestment Act, which authorized the issuance of $2 billion of tribal economic development bonds, or TEDs. Tribal governments can use those bonds to finance any projects a state or local government could finance with tax-exempt debt, and they are not required to meet the essential-government function test. Gaming facilities and projects located off an Indian reservation cannot be financed with TEDs.

In June, the Indian tribal governments group of the advisory committee on tax-exempt and government entities told the IRS that TED bonds should be expanded or made permanent given the clear demand that exists for the debt.

However, currently there are no legislative proposals to expand the program.

Bradley Waterman, a tax controversy attorney who has his own firm and represented the Agua Caliente Band, declined to comment on the agreement.

Orrick, Herrington & Sutcliffe LLP served as special tax counsel on the deal, and Banc One Capital Markets Inc. was the underwriter, according to bond documents.

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