WASHINGTON — The Internal Revenue Service has told the Nebraska Public Power District that $10 million of the $50.36 million of Series A Build America Bonds it issued in June 2009 do not qualify for the 35% subsidy payment it receives from the U.S. Treasury.

The NPPD disclosed the IRS decision in a material event notice filed with the Municipal Securities Rulemaking Board’s EMMA system, the latest in a dispute of at least eight-months over the issue price of the BABs.

In a notice filed with EMMA in February — the first publicly disclosed tax dispute over BABs — the NPPD said the IRS had warned it that the BABs might not qualify for the subsidy because of a dispute over the issue price. That notice has been removed from the EMMA website and this latest one does not mention issue price.

The loss of the subsidy would equal about $260,000 per year or $6.5 million over the term of the bonds, the NPPD said in both notices.

But the NPPD is challenging the IRS’ decision.

“The District does not agree with the position taken by the Service and plans to provide the Service with a written response explaining the reasons that the District does not agree with the position taken by the Service,” the NPPD said in this latest notice.

If the dispute cannot be resolved, the NPPD could take the IRS to court over the subsidy payment, according to several bond lawyers. In BAB transactions, the issuer is the taxpayer and the subsidy payment is considered to be a refund. The tax law permits taxpayers to sue the IRS in federal district courts over refunds. In a tax-exempt bond deal, each bondholder is a taxpayer and typically they do not know who each other is and individually do not have the resources to sue the IRS.

Christine Pillen, deputy assistant treasurer at the NPPD, Nebraska’s largest electric utility, declined comment and James Marlin, a partner at Fulbright & Jaworski LLP in New York, was unavailable for comment. The firm was bond counsel for the BAB deal and is representing the district in the dispute.

BABs are taxable but the Treasury makes subsidy payments to issuers equal to 35% of interest costs.

Issuers are prohibited from issuing BABs with more than a de minimis amount of premium, with de minimis defined as one-quarter of 1% of the stated redemption price at maturity for the bond, multiplied by whichever comes first: the number of complete years to the maturity date or the first optional redemption date.

In addition, IRS officials have been concerned about issue price. Under IRS rules, the issue price for each maturity of bonds is the first price at which a substantial amount of them are sold to the public, with 10% considered to be a substantial amount. However, the rule only applies if all of the bonds of a specific maturity are offered to the public at that price and the public “does not include bond houses, brokers, or similar persons or organizations acting in the capacity of underwriters or wholesalers.”

IRS officials contend that the issue price stated for some BABs in bond documents is not the actual issue price because after the BABs were initially issued, they immediately began trading up at higher prices between dealers or between dealers and institutional investors that same day. As a result, the Treasury may be making higher subsidies than necessary, they warn.

The determination of the issue price has a bearing on whether an issuer of BABs is both receiving the correct level of subsidy payments from the federal government and meeting federal arbitrage requirements. Even though BABs are taxable, they must still comply with the same tax laws and rules as tax-exempt bonds, the idea being that the issuer is getting a subsidy and should not be able to earn arbitrage as well.

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