IRS auditors determine Midwest Fertilizer Company bonds are taxable

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WASHINGTON – Internal Revenue Service auditors have determined that almost $1.26 billion of economic development revenue and refunding bonds issued for the Indiana-based Midwest Fertilizer Company are taxable.

The company posted a material event notice on the Municipal Securities Rulemaking Board’s EMMA site Friday afternoon stating that the IRS has sent it a Notice of Proposed Adverse Determination that the bonds are not qualified Midwestern Disaster Area Bonds and that the interest paid to bondholders is therefore not tax-exempt.

Midwest Fertilizer, which purchased the bonds in the fall of 2016, is a U.S. company owned by multinational investors, the principal one of which is Fatima Group, one of the largest conglomerates in Pakistan and a leader in the south Asian fertilizer industry, according to company documents.

The bonds were issued in late 2012 by the Indiana Finance Authority to build a state-of-the-art nitrogen fertilizer production plant on 220 acres in Posey County, Ind. They were rushed to market in the latter half of December to take advantage of the Midwestern Disaster Area Bond program, which expired at the end of that year.

In its event notice, the company said that while it “cannot predict the outcome of any such response, the company and counsel continue to be confident that there should be no change to the tax-exempt status of the bonds or the refunded bonds,” said Midwest Fertilizer.

The company said it is “considering its response” to the IRS, “which may include an administrative appeal to the IRS’s Office of Appeals.”

Charles Henck, a partner at Ballard Spahr, is representing the company and Posey County, Ind., which took over as issuer after the Indiana Finance Authority dropped out and then refunded or remarketed the bonds six times between July 2013 and November 2015.

“The project continues to have very strong support of county, state and federal officials,” he said. “We believe we complied with the rules and that the IRS analysis is incorrect.”

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.

No work has begun on the fertilizer plant, which was to be one of the largest in the U.S. in more than 20 years. Groundbreaking of the project was expected in 2018 and the plant was 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, according to a Midwest Fertilizer press release.

The company 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.

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 officials 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 an EMMA notice last year, the Indiana Economic Development Corp. 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.

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