WASHINGTON - The Town of Brookfield, Conn. has disclosed that water facilities financed with some of its tax-exempt bonds may have private business use and that it is assessing whether this would create a tax problem for the bonds.

Brookfield, which is located about 70 miles from New York City, disclosed the tax issue in an event notice posted on the Municipal Securities Rulemaking Board's EMMA system on Nov. 14.

"The town has determined that the use of its water facilities do not meet safe-harbor guidelines relating to the management and operation of governmentally-owned facilities financed with the proceeds of tax-exempt obligations," Brookfield said in the event notice.

Brookfield discovered the error with portions of its 2010 and 2013 general obligation bonds during the tax due diligence process ahead of the issuance of tax-exempt and taxable bond anticipation notes that are dated Nov. 20, according the event notice and Brookfield First Selectman Bill Tinsley.

The event notice listed the CUSIPS for three bond series: $9.58 million of GO bonds issued in 2010, $8.58 million of general obligation bonds issued in 2013 and $4.63 million of general obligation bond anticipation notes. The 2014 tax-exempt BANs were issued to refund most of the 2013 notes and were not used to refinance any of the water facilities at issue.

The 2010 and 2013 GO bonds were issued to finance multiple projects, including water projects. However, "the water projects are not tax-exempt because we've turned the lines over to a for-profit company called Aquarion [Water Company]," Tinsley said during a videotaped Nov. 12 meeting of the town's board of finance. "Aquarion uses those lines to deliver water through and charge customers, and they're a profit-making company." The town's water has been provided by non-municipal companies since before the bonds were issued, he added.

Under federal tax law, governmental bonds can become taxable private-activity bonds if more than 10% of the proceeds are used for private business use and more than 10% of the debt service is paid for or secured by private parties.

Management contracts can cause private business use. An Internal Revenue Service 1997 revenue procedure provided some safe harbors about when contracts don't result in private use., These guidelines generally limit the length of the contract and the methodology used to determine compensation under the contract.

Last month, IRS interim guidance created an additional safe harbor that appears to encompass at least some of the provisions in the 1997 guidance. If a contract doesn't meet any of the safe harbors, the issuer has to look at the facts and circumstances of it.

Brookfield said in the event notice that it "is taking steps to assess the effect on certain previously issued indebtedness of having failed to comply with the referenced safe-harbor guidelines."

Tinsley said the town will have to refund 2010 and 2013 bonds and pay a roughly 28% tax penalty because of the error. "It will not have a budgetary impact. It will be an expensive process, but basically this is going to end up in the cost of the water projects," he said.

The 2010 and the 2013 GO bonds were underwritten by Janney Montgomery Scott LLC, the 2013 notes were underwritten by TD Securities, the 2014 tax-exempt notes were underwritten by Eastern Bank, and the 2014 taxable notes were underwritten by Oppenheimer & Co., Inc. On all of the deals, Hawkins Delafield & Wood LLP served as bond counsel and FirstSouthwest was financial advisor, according to bond documents.

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