Two fees paid by a borrower for credit enhancement and a mortgage on a solid-waste disposal facility will not be considered issuance costs for purposes of determining if the bonds issued to finance the facility are tax-exempt qualified private-activity bonds, the Internal Revenue Service ruled recently.
The IRS detailed its ruling on the facility in a private-letter ruling that was publicly released earlier this month. The ruling, dated Nov. 20, did not identify the bonds or the issuer. Private-letter rulings, while technically applicable only to the issuer that requested them, are seen as important guidance on the IRS' thinking on tax matters.
While the ruling is not seen as a significant change by bond counsel, it is "comforting," David Caprera, a partner at Kutak Rock LLP in Denver, said yesterday.
The letter ruling centers around a section of the tax code that sets issuance cost restrictions on qualified private-activity bonds. Section 147(g) states that a private-activity bond cannot be considered qualified - meaning tax-exempt - if the issuance costs exceed 2% of the bond proceeds. The IRS determined both fees addressed in the ruling are not issuance costs, but placed each of them in separate categories.
The agency determined that attorneys' fees paid by the borrower for credit enhancement can be included as additional interest on the bonds, with the yield adjusted accordingly. "The bond counsel community has long been in agreement with the conclusion reached by the IRS," according to Caprerea, and the decision merely serves as the first time the IRS has officially stated its position on the fees. "I would expect most people breathed a sigh of relief," he added.
The IRS said the title insurance paid by the borrower in the course of its acquiring a mortgage to back the payment of the bonds is not considered additional bond interest. However, it determined that since the borrower may have had to obtain a mortgage regardless of whether it used bonds or pursued credit enhancement, and because the borrower, not the issuer, is paying for the insurance, it also will not count against the issuance cost limitations.
Caprera said that the decision falls in the middle of what bond counsel would like to see.
"It's not really a credit enhancement fee, so you can't adjust the yield for it, but [the IRS is] not going to treat it as a cost of issuance on the bonds so it doesn't count against the two percent limit," he said.
Caprera said that the decision regarding the title insurance fee could prove useful to bond counsel, but they should be cautious to avoid overextending its application.
He said it is helpful for the IRS to hand down a decision that appears to indicate that if a cost is not attributed to the issuer and is not found on a list of issuance costs established as part of the Tax Reform Act of 1986 - which includes as costs fees paid to bond counsel and rating agencies - it may not be considered an issuance cost.
But Caprera added that "a note of caution" is needed, as the IRS may be applying the decision strictly to this particular situation, and bond counsel should be wary about suggesting to issuers that any costs assumed by a borrower would not be considered issuance costs.