WASHINGTON -- Two dealer groups are urging the Internal Revenue Service to rescind its proposed rules on political subdivisions, warning the rules would be overly burdensome and restrictive as well as costly for state and local issuers.

Bond Dealers of America and the Securities Industry and Financial Markets Association also said the proposed rules would disrupt the ability of state and local governments to build public infrastructure projects.

The groups issued their warnings in separate letters sent to IRS after the Treasury Department listed the rules among eight tax regulations that were either proposed, issued as temporary, or finalized between Jan. 1, 2016 and April 21, 2017 , are significant, and would create undo tax burdens.

Treasury was directed by President Trump’s Executive Order 13789, issued in April, to decide which of its rules acted on during that timeframe would impose undo financial burdens on taxpayers, add unnecessary complexity to tax laws, or exceed IRS authority.

The proposed rules, which would define political subdivisions that could issue tax-exempt bonds, were released in February 2016 and have drawn overwhelming opposition from market participants.

Under longstanding federal case law and rules, an entity is a political subdivision that can issue tax-exempt bonds if it has the ability to exercise a substantial amount of at least one of three sovereign powers – taxation, eminent domain and policing.

But Treasury and the IRS became concerned that some community development districts in Florida that were political subdivisions were controlled by private developers. The agencies proposed rules that would add two more requirements to that longstanding definition. They said a political subdivision must also be governmentally controlled and serve a governmental purpose “with no more than incidental private benefit.”

BDA CEO Mike Nicholas
Mike Nicholas, chief executive officer of Bond Dealers of America
BDA's Mike Nicholas

In a three-and-a-half page letter, BDA chief executive officer Mike Nicholas said the IRS already has the ability to identify projects with excessive private control and prohibit them from accessing the tax-exempt bond market, particularly under private activity bond limitations.

“There is no better example of unnecessary burden and complexity than a broad rewrite of a longstanding rule to address a narrow problem that could be addressed under existing rules,” Nicholas said.

He also said that requiring a project to have a governmental purpose “with no more than incidental private benefit is particularly problematic.”

That language “introduces a level of subjectivity and complexity that would threaten the economic viability of development projects and inject a significant level of uncertainty for issuers, investors, underwriters and counsel that would prevent some tax-exempt finances from going forward,” Nicholas added.

SIFMA managing director Michael Decker said in a one-and-a-half page letter that the proposed rules would narrow the types of state and local government entities that are eligible to issue tax-exempt bonds.

“It would also impose new mandates regarding the governance and organizational structure of certain governmental entities such as development districts, adding significant complexity even for those issuers who remain eligible to use tax-exempt financing,” Decker added.

“In some cases,” Decker said, “infrastructure needed to further the development of cities and towns would not be constructed at all.”

“If approved,” said Nicholas, “the proposal will disrupt the ability of many communities to build valuable infrastructure projects and will increase the cost of financing infrastructure projects as some governmental entities would unnecessarily lose the ability to issue tax-exempt bonds.”

Both groups warned the proposed rules would force some issuers to sell taxable bonds instead of less-costly tax-exempt bonds.

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