The Fresno, Calif., Unified School District disclosed late Friday that the Internal Revenue Service has preliminarily determined that $58.04 million of Series B general obligation refunding bonds it issued in 2004 are arbitrage bonds and therefore taxable.

The school district made the disclosure in a material event notice sent to nationally recognized repositories.

The event notice comes almost two months after the district disclosed it had received a similar IRS notice on a similar transaction. In a Nov. 20 material event notice, the school said the IRS had preliminarily determined that $65.4 million of 2002 Series A refunding GOs were taxable.

Both are among 26 transactions totaling about $800 million that were sold from 1993 to 2003, with Solana Beach, Calif.-based Kinsell, Newcomb & De Dios Inc. serving as underwriter and Riverside, Calif.-based Best Best & Krieger LLP as bond counsel.

The transactions were part of a forward-refunding program developed by the Kinsell firm in the early 1990s for California school districts with outstanding debt that carried fairly low interest rates. Under the program a school district, such as the one in Fresno, would enter into a forward agreement to sell advance refunding bonds at a future date and use the proceeds to defease the outstanding bonds to their maturity dates.

A third party bidding agent would take bids on Treasury securities for the escrow, and the Kinsell firm always won the bid. Kinsell also canvassed at least three potential purchasers of the bonds to establish the bonds’ issue price. At the forward delivery date, six to 15 months later, the firm would purchase the refunding bonds from the district and sell them to the public at prevailing market rates, which tended to be higher due to interest rate movements during the forward periods.

But in its letter to the Fresno Unified School District, the IRS contended that the escrow securities were not purchased at fair market value and that the yield on the bonds was computed on an incorrect issue price, such that the bond yield is below the yield of the escrow securities. As a result, the bonds are arbitrage bonds and are taxable, the IRS told the district.

J. Jeffrey Kinsell, executive vice president of the Kinsell firm, recently told The Bond Buyer that he wants to settle the tax law charges with the IRS because the audits are hurting the school districts and investors.

But an evaluation of the prices of bonds from 12 transactions in which the IRS notified the school districts that the bonds might not be tax-exempt, found that bond prices were in the same range for trades done before and after the IRS findings were made public.

Senior market reporter Michael Scarchilli contributed to this story.


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