WASHINGTON - The Internal Revenue Service, concerned that many issuers are not correctly calculating how much they may owe the federal government in arbitrage rebate, plans to broaden its examination of this area, including putting an increased focus on variable-rate debt.
The IRS will also likely get tough on those issuers of private-activity bonds that were part of the agency's recent arbitrage compliance survey and were discovered to have failed to do any rebate calculations. Those issuers -- five of the 89 issuers that were randomly selected for the mandatory survey -- can expect the IRS to eventually start analyzing all their bond transactions for rebate purposes.
"It is safe to say that if an issuer did no calculation on the bond issue examined as part of the survey we may probably look at every issue they have outstanding," said Charles Anderson, manager of the IRS' tax-exempt bond field operations. "We have the manpower now. We will really be alarmed if they are not now in the process of doing the calculations since they are obviously aware of the problem. If they have not done the calculations and failed to pay rebate, we will probably determine that we have arbitrage bonds. Some issuers need to get busy."
The IRS has decided to increase its focus on rebate compliance because of the problems unearthed by the survey. That project showed that 22 of the 89 issuers, or almost 25%, either had not calculated the rebate or did it incorrectly or improperly.
The survey was limited to private-activity bonds sold in 1992 or 1993, a period characterized by little or no rebate for fixed-rate bonds. The IRS is now also considering looking at fixed-rate bonds from a later period, such as between 1995 and 1997, when the lower interest-rate environment was conducive to creating positive rebate, Anderson said.
Although the survey happened to include mostly fixed-rate bond issues, the variable-rate debt examined did show bigger rebate problems since bond yields generally declined through the 1990s even though investments of bond proceeds may have stayed fixed or declined less. In one case, an issuer of variable-rate debt that had not calculated its rebate was found through the survey to owe a "seven figure" dollar amount, Anderson said. The issuer paid the amount promptly after being notified by the IRS over the summer, he said.
"It was an eye-opener," which led to the decision to focus more on variable-rate debt, Anderson said
Despite the payment, this particular issuer may not have the IRS off its back regarding that bond issue quite yet.
"We've got to ascertain whether the failure to calculate was deliberate or not," Anderson said. "That's important. We'll make the assumption for now that it was not deliberate because they paid voluntarily once they got our letter. But we need to go out and at least verify that."
Mitchell Rapaport, a bond lawyer with Nixon Peabody here and a former Treasury official, said he was not surprised that rebate problems are more frequent for variable-rate bonds since they are tougher to compute than rebate for fixed-rate debt. He also said some issuers may have been thrown by changes in the rebate rules over the years.
Rebate problems are an appropriate area for the IRS' enforcement group to target, the former Treasury official said. "I always thought that it made sense for the IRS to focus on rebate, because it's a mechanical calculation. It's much more black and white than figuring out whether a material is solid waste or whether a transaction is an acquisition or a refunding," Rapaport said, referring to bond areas where the IRS appears to be interpreting the tax code differently than many bond lawyers and issuers are.
Anderson said the IRS is also likely to expand its arbitrage compliance effort into governmental bonds, rather than limiting it to private-activity debt. He is expected to discuss that possibility with Mark Scott, the IRS' national director for tax-exempt bonds, and with other IRS officials, he said.
Anderson also said the survey project, and the attention it has received during the last few months, has led to "a lot more awareness of rebate responsibilities now." Among other things, Clifford Gannett, head of the IRS' tax-exempt bond outreach group, has found that more issuers are coming in to settle their problems on a voluntary basis, Anderson said.
"There seem to be a lot of phone calls and interest so that was a good result," he said. "People want to comply and the increased awareness is good for everyone."
