WASHINGTON — Colorado Springs has paid $95,000 in a settlement with the Internal Revenue Service over $344.875 million of utilities system refunding bonds that were issued in 1991 and later associated with an allegedly undervalued forward-float contract.
The city disclosed the Jan. 28 settlement — which preserves the tax-exempt status of the bonds as well as related refunding bonds — in a material event notice sent to nationally recognized municipal securities information repositories late Tuesday.
The 1991 Series A, B, and C bonds were redeemed in August 2001, but the city has been concerned that the IRS might also challenge $418.24 million of related refunding bonds that were issued in 2001 and 2004. While the settlement specifies only the 1991 bonds, the city’s material event notice covers not only the 1991 bonds, but also the 2001, and 2004 bonds.
Several municipal market participants said that $95,000 seems like a very small settlement amount.
“It’s almost like a nuisance payment,” said one lawyer who was not involved in the case and did not want to be identified.
The settlement marks the first in which the IRS applied its new methodology for valuing forward-float agreements.
“That’s where they started, but we were able to negotiate,” said James Lane, an attorney at Sherman & Howard LLC in Denver, which represented Colorado Springs in its dispute with the IRS and was also bond counsel for the 1991 transaction.
The settlement comes as the IRS has also questioned the tax-exempt status of another bond issue with an allegedly undervalued forward-float agreement. That case involves $422.7 million of senior parkway revenue refunding bonds sold by the New Jersey Turnpike Authority in 1992. In both that and the Colorado Springs cases, Mitsui Taiyo Kobe Global Capital, which became Sakura Global Capital Inc. and is now SMBC Capital Markets Inc., was the provider of the forward-float agreement.
But sources said the facts surrounding the bonds in the two cases are different.
Further, the closing agreement between Colorado Springs and the IRS, a copy of which was attached to the material event notice, stated: “This agreement may not be cited or relied upon by any person or entity whatsoever as precedent in the disposition of any other case.”
The closing agreement noted that the IRS preliminarily determined on Sept. 5 that the Colorado Springs bonds were taxable because the fee amount received by the issuer for the float agreement was not fair market value.
“When the issuer does not receive fair market value for the float agreement, an underpayment of interest on the float agreement occurs, reducing the escrow fund yield below the bond yield, diverting the arbitrage profits from the underpayment to the purchaser of the float agreement,” the closing agreement stated. “While the city disagrees with the IRS’ position with respect to the alleged violation, the city nonetheless desires to settle this matter with the IRS without admission as to liability as to the matters alleged.”
The agreement also stated: “The IRS has not formally asserted any claims against the issuer, or sought to tax any holders of the bonds on interest income.”
Municipal issuers use forward floats to cover gaps in cash flow between the time the securities in advance refunding escrows mature and the time funds are needed to pay debt service on the related bonds.
In the Colorado Springs case, George K. Baum & Co. solicited bids for the float agreement on Jan. 27, 1992, according to IRS documents previously released by the city. Bids were to be faxed by 11:30 a.m. eastern time. Two bids were received by that time. The third bid was received from the Mitsui firm at 11:40, after the bids were due, leading the IRS to question whether an “arm’s length” bidding process occurred.
Colorado Springs received an up-front fee of $1.6 million for the float. The IRS contended the forward-float contract was undervalued by as much as $894,341.