WASHINGTON – In a favorable decision for muni issuers and other market participants, the Internal Revenue Service’s office of chief counsel has concluded that using Build America Bond proceeds to pay for a bond insurance premium is a capital expenditure.
The IRS reached the conclusion in a technical advice memo (TAM) dated May 29, but not released publicly until Wednesday.
“An expenditure of proceeds of an issue of Build America Bonds, ... incurred for [the[ bond insurance premium for the issue, is a capital expenditure within the meaning of 54AA(g)(2)(A),” the office wrote.
A TAM is issued when the audit division of the IRS asks the office of chief counsel to weigh in on a legal question that arises during an audit.
The IRS has conducted more than 30 audits of BABs since they were first issued in 2009, raising concerns over whether the bond insurance premiums paid for with bond proceeds could disqualify the bonds as BABs and jeopardize the federal subsidy payments made to issuers.
The BAB program was created under the 2009 American Recovery and Reinvestment Act and expired in 2010. BABs are taxable bonds where the Treasury Department makes subsidy payments to issuers equaling 35% of their interest costs.
If the IRS had ruled that the use of proceeds for a bond insurance premium was not a capital expenditure, then the bonds would not qualify as BABs and the issuers would not receive subsidy payments.
For bonds to qualify as BABs, 100% of the proceeds had to be used for capital expenditures, other than the cost of issuance and a reasonably required reserve fund. When Congress wrote the legislation, it intended for BABs to finance tangible assets and not be used for refundings of prior issues or for working capital, bond lawyers said.
At issue was whether using BAB proceeds for a bond insurance premium would constitute a capital expense.
“It is clear under general federal tax principles that the payment of an upfront bond insurance premium for the life of the debt is a capital expenditure,” said Tom Vander Molen, a partner in Dorsey & WhitneyLLP’s tax and public finance group.
The TAM appears to override what several tax-exempt bond office agents had told muni market participants at industry conferences. TEB agents had said they had determined it was not a capital expenditure, said Linda Schakel, partner with Ballard Spahr LLP.
The TEB office had worked with some issuers of BABs to reallocate proceeds away from the bond insurance premium, Schakel said. As a result, many of the audits were closed without change to their BAB status.
“We had asked for guidance on this in a letter sent to the service in May 2012 and this reaches what we think is the correct answer,” said Scott Lilienthal, president of the National Association of Bond Lawyers and partner with a partner at Hogan Lovells LLP in Washington, D.C.
Since the BAB program has expired, Lilienthal said he would be surprised if the IRS would use their resources to turn this TAM into formal regulation.
In the TAM, the IRS office of chief counsel wrote: “This advice may not be used or cited as precedent,” but some bond lawyers said that due to the issue’s prominence it will likely resolve any questions as a practical matter.
The IRS has not published formal guidance on bond insurance premium for BABs.
But Vander Molen said, “As a practical matter, bond counsel will be relying on this as much as a prominent private letter ruling even though it is not legal precedent but because it is the correct result.”