WASHINGTON -- The Internal Revenue Service contends that $1.26 billion of economic development revenue bonds as well as refunding bonds issued for Indiana-based Midwest Fertilizer Company may be taxable.

The company disclosed on July 27 that the IRS had issued a “Notice of Proposed Issue” stating that the tax regulator "has contended that the bonds and the refunded bonds do not meet certain requirements of the Internal Revenue Code of 1986, as amended (the "Code"), and are therefore not valid tax-exempt bonds and the interest paid to the holders thereof is not excludable from gross income under Section 103(a) of the Code."

The disclosure, contained in an event notice posted on the Municipal Securities Rulemaking Board’s EMMA site, does not provide any specific information about the cause of the IRS concerns. But the company said it was responding to the IRS and that it and its counsel “continue to be confident that there should be no change to the tax-exempt status of the bonds or the refunding bonds.”

Several bond counsel involved in the transactions, Indiana officials and Posey County, Ind. officials, either did not return calls or refused to comment on the dispute with the IRS or provide any information on the financing of the project. A company official referred The Bond Buyer to the EMMA notice disclosing the IRS Notice of Proposed Issue.

But there are several interesting aspects of the financing, according to bond documents.

First, the Indiana Finance Authority rushed to market with nearly $1.3 billion of bonds for the project in the latter half of December 2012 to take advantage of the Midwestern Disaster Area Bond program, which expired at the end of 2012.

The state of Indiana later dropped out of the project and was replaced by Posey County, Ind., which then refunded or remarketed the bonds six times between July 2013 and November 2015.

Also, Posey County and the company agreed to a tax incentive package under which certain tax increment revenues and special assessments would be applied over a 25-year period to repay tax increment and special assessment bonds, according to bond documents. However, Charles Henck, a partner at Ballard Spahr who is representing the company in the tax dispute said on Tuesday, "The proposed TIF bonds and the questions raised by the IRS [in other deals] relating to developers and TIF bonds have nothing to do with the Posey County bonds."

The nearly $1.3 billion of bonds were issued in late 2012 to build a state-of-the-art, nitrogen fertilizer production plant on 220 acres in the county, which is located in the Southwestern corner of the state. The cost of the plant is now expected to be almost $3 billion, according to a Midwest Fertilizer press release dated July 27 of this year.

The plant is to be one of the largest in the U.S. in more than 20 years. Groundbreaking of the project is expected in 2018 and the plant is expected to begin operating in 2022 to produce about 2 million tons annually of ammonia, urea ammonium nitrate solution and diesel exhaust fluid, a diesel additive that reduces diesel exhaust emissions, the press release said.

Midwest Fertilizer chose to base the plant in Indiana because the Indiana Economic Development Corp. (IEDC) had offered an incentive package accepted by the company on Nov. 30, 2012, that included access to tax-exempt financing through the allocation of a portion of the state’s volume cap under the disaster bond program.

According to the company, the IEDC offered it up to $2.9 million of conditional tax credits and up $400,000 training grants based on the company’s job creation estimates. It also offered the company up to $300,000 in conditional incentives from the Hoosier Business Investment tax credit. But the IEDC made clear that the company would have to create jobs and invest in Indiana to receive the incentives.

The company told the state it would create more than 2,500 construction jobs and as many as 200 ongoing regulator and contract employment opportunities. It also said U.S. farmers in the state would benefit from its fertilizer product.

Midwest Fertilizer is a U.S. company owned by multinational investors, the principal one being Fatima Group, one of the largest conglomerates in Pakistan. The company calls Fatima Group “a leader in the south Asian fertilizer industry.” Midwest Fertilizer hopes to add other multinational investors.

Just before the bonds were issued in late 2012, a representative of the U.S. Defense Department’s Joint-Improvised-Threat Defeat Agency (JIDA) testified during a congressional hearing that the Fatima Group had been “less than cooperative” in implementing security for its fertilizer products to prevent them from being used in explosive devices deployed against American soldiers in Afghanistan and Pakistan.

Then-Gov. Mike Pence, a day after taking office in January 2013, halted state support of the project and then formally dropped all state involvement in mid-May of that year, according to bond documents.

Fatima met with representatives of the FIDA and agreed on a range of voluntary cooperative measures to appease them, including by suspending fertilizer sales in two Pakistani provinces bordering Afghanistan. It also reformulated a fertilizer product that would be less susceptible to misuse as an explosive.

Midwest Fertilizer turned to Posey County to take the state’s place. In October 2013, Posey County offered the company tax increment incentives valued at $144 million and up to $480,000 in employment incentives, according to bond documents.

In 2014, Pence, who was still governor at the time, announced he would reopen talks with Fatima about the bond-funded fertilizer plant and said that he was hopeful the state would be able to renew its support for the project.

But in January 2015, the company withdrew its request for the state incentive package and decided to devote its efforts to support Posey County in securing state funding and county incentives, according to offering documents.

On July 7, 2015, Posey County and the company agreed to a revised tax incentives package. “The agreement applies certain tax increment revenues and special assessments for the proceeds of which will fund project costs,” an official statement said. “A portion of the proceeds … will fund project costs and a portion … will finance the Western Bypass, a road planned around Mount Vernon and near the project.”

As of late 2015, the company said in an official statement that it had spent $76.7 million to develop the project, not including expected issuance costs associated with remarketing the bonds, and that it had executed agreements for additional project expenditures totaling $280.4 million.

According to a company press release attached to the recent EMMA notice, the Indiana Economic Development Corp. has now offered Midwest Fertilizer up to $2.9 million in conditional tax credits and up to $400.000 in training grants based on the company's job creation plans. The IEDC also offered up to $300,000 in conditional incentives from the Hoosier Business Investment tax credit based on the company's planned investment. These incentives are performance based, meaning the company must create jobs and invest in Indiana in order to be eligible to receive incentives.

The IRS opened its audit of the bond financings in January of this year. It issued its Notice of Proposed Issue stating its preliminary finding that the bonds were taxable less than six months later.

In an annual report dated Aug. 29, Midwest Fertilizer said that on Aug. 2, 2016, the bonds became subject to a mandatory tender for purchase and were remarketed for an extended initial period. The company said that, following the remarketing, it purchased all of the bonds and intends to remain sole owner.

The first bonds, issued by the Indiana Finance Authority, were underwritten by Guggenheim Securities, LLC. Ice Miller was bond counsel. Counsel for the issuer was Benesch, Friedlander, Coplan & Aronoff. Underwriter’s counsel was Sidley Austin. Counsel for the company was Pillsbury Winthrop Shaw Pittman.

Citigroup joins Guggenheim in later refundings. Barnes & Thornburg becomes bond counsel and it is joined by Ballard Spahr as co-bond counsel in the last refunding.