The Internal Revenue Service's tax-exempt bond office has issued a report that examines the potential problems that can occur during the three main phases of a bond transaction and suggests how issuers can avoid them.
But some lawyers attending the National Association of Bond Lawyers' 13th annual Tax and Securities Law Institute here questioned whether the IRS should be writing a report that is oriented toward providing best practices rather than the tax law.
The 38-page report, "Avoiding Troubled Tax-Advantaged Bonds: A Study of Issuer Compliance Considerations," released late Wednesday, said it is intended to be a "starting point from which to develop tools to facilitate issuer adoption of practices and procedures that work for their individual needs to avoid abusive or questionable transactions."
The report is the first of a series of public resource products designed to serve as best practices for issuers to avoid troubled transactions. It was developed by TEB's new compliance practice research team headed by Isabel Guerra, senior tax law specialist and Carl Scott, technical advisor for TEB field operations. The team, which was officially launched last spring, has been identifying red flags for issuers that are likely to occur over the life of a bond issue from the planning stages through the final redemption.
"The municipal market has seen many types of fraud and other criminal activity, such as pay to play, contractor fraud, and securities law violations," the report said. "In many cases, the fraud and corruption can result in the bond transaction violating federal tax law. In all cases, fraud and corruption can greatly increase the cost of borrowing."
IRS suggested it's uniquely positioned to write such a report because of its involvement in helping to expose yield-burning and bid-rigging schemes.
But initial reaction from bond lawyers here at the NABL meeting was that the IRS may be overstepping its boundaries because the report had little to do with tax law.
"The document has a lot of information in there that may be described as best practices that issuers should follow but basically have nothing to do with tax," said Perry Israel, a Sacramento-based lawyer speaking on a hot topics panel.
"The IRS has a special relationship with state and local governments that it doesn't have with taxpayers," said Mike Bailey, partner with Foley & Lardner LLP in Chicago. "It is an unusual type of guidance because this more than any other past release is reaching beyond tax administration to address other general best practices for state and local government issuers."
There will be a discussion within the industry as whether that is the appropriate province for the IRS, Bailey said, who called the report a novel approach to written material. Bailey also said that the report would be of great interest to issuers but not without some controversy.
Brad Waterman, a tax controversy lawyer, said the report bothers him because it "intrudes to some extent on the relationship between bond counsel and the issuer."
"I just see this as being pretty far afield of the responsibilities and duties that I think of the IRS doing," Waterman said.
The report covers three phases of the life cycle of bond transactions: the transaction development phase, the transaction execution phase and the post-issuance phase.
In the transaction development phase the IRS emphasizes the importance of "quality professionals" for a successful transaction. "Issuers who actively evaluate both the qualifications and performance of transaction participants are more likely to get the quality of service they expect," the report said. The guidance for this phase will also be featured as a webinar presentation from the TEB scheduled for the fall.
For the transaction execution phase, the IRS said the ultimate goal for issuers is to avoid unpleasant surprises and offers suggestions how to do that. An issuer should evaluate whether a transaction meets the goals established during the development phase; determine that transaction participants are ready to close prior to the closing date; follow clear procedures to monitor comparable sales and evaluate the actual price received for their bonds, and develop and monitor investment policies to maximize return on investments.
Finally, the IRS warned issuers that the failure to meet post-issuance requirements under federal tax law make up the majority of violations as identified by TEB. The report said issuers should establish who is responsible for how bond proceeds are to be used and determining that they are not arbitrage bonds.
James Polfer, IRS chief counsel, said his office was involved in the process but said this is not formal guidance. He emphasized to NABL attendees that the report was intended to assist issuers and that the agency welcomes market feedback.
"Please look at this as a dialogue with the community instead of a back door way of getting out precedential guidance," Polfer said on a tax hot topics panel. "There may be subsequent drafts of this or other informal guidance."
Rick Ballard, partner with Ballard Spahr, said he predicts that within the next year this document will be recommended to younger bond lawyers as an introduction to what is going on in the municipal bond industry.
"This is something that will be widely read and should be," Ballard said.
One fundamental point the report makes is that transactions that are brought to the issuer by an investment banker or Wall Street tend to have a higher incidence of trouble, Ballard said.
Similarly, former NABL president Kristen Franceschi, a partner at DLA Piper LLP in Baltimore, said the report is in plain English and encouraged attendees to read the document.
"What surprised me the most was it is a holistic discussion of what TEB believes issuers should think about in their bond financing," Franceschi said. "When I say holistic, I mean it does not just deal with tax compliance."
Throughout the entire document, TEB outlines a handful of scenarios for issuers and then offers multiple actions that can be taken to avoid serious consequences.
For example, based on its own investigations, TEB believes that many abusive transactions are developed before the issuer's need for financing has actually been determined.
In a scenario where the transaction was not originally the issuer's idea, it urges the issuer to analyze the proposed transaction to recognize and mitigate risks. In another scenario, the IRS said t if the issuer is unsure who the transaction participants are and what they are doing, the issuer should identify who is truly working in its best interests.
The report concludes that there is not one single approach to protect an issuer from potential problems or abusive transactions, failed projects, and compliance issues. Instead, TEB strongly urges that the issuer become involved in the planning and monitoring of each phase of a transaction as an essential element of municipal finance.
Comments and feedback about the report can be sent to: TaxExemptBondQuestions@irs.gov inserting "Avoiding Troubled Tax-Advantaged Bonds Question" on the subject line.