IRS tells Puerto Rico issuer it may deny credit payments

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The Internal Revenue Service has notified the Puerto Rico Public Buildings Authority that it has found the authority was not eligible for some direct-pay bond credits it received and will not receive some others it has applied for.

The Puerto Rico Fiscal Agency and Financial Advisory Authority disclosed the IRS’s finding on the Municipal Securities Rulemaking Board's EMMA website on behalf of the Public Buildings Authority. It is a follow up to a previously-disclosed audit that includes $121.5 million in Series 2011 T direct-pay qualified zone academy bonds and four Series 2011 R taxable school construction bonds that totaled $756.4 million.

“The issuer is currently evaluating its options,” said Kristin Franceschi, a partner at DLA Piper who represents the Puerto Rico Public Buildings Authority.

The notice from the IRS, which the disclosure indicates the authority received Nov. 22, opens a 30 day window for the issuer to respond and make a case that the bonds not be stripped of their tax-advantaged status. Many issuers choose to settle and negotiate a solution with the IRS.

The federal tax issue that is at stake here and in several other audits of tax-advantaged Puerto Rico bonds announced in recent months involve federal payments for direct-pay subsidies. Both the qualified zone academy bond and qualified school construction bond programs were authorized under the 2009 American Recovery and Reinvestment Act enacted during the Obama administration.

The notice posted to EMMA says the IRS “notified PBA of the proposed adjustments to the amount of the direct pay bond credits under Internal Revenue Code Section 6431 for certain interest payment dates with respect to which the IRS had paid credits to the PBA, as well as the IRS’ full disallowance of PBA’s claim for direct pay bond credits for the periods that corresponding to interest payment dates for which the PBA had filed for credits but with respect to which no amounts have yet been received.”

The audit the latest notice stems from was first disclosed in February, and another audit of Build America Bonds issued by the Puerto Rico Electric Power Authority surfaced only a few days later. The number swelled to eight audits over the next six months, all of Puerto Rico direct-pay bonds, the most recent of which came to light in September.

Franceschi, who is handling all of the audits in question, declined to comment on the path forward aside from her statement that the issuer is weighing its options.

The IRS has said examinations can be part of an initiative, project or referral, due to a questionable or unusual item on the return, or a random selection.

The IRS did not include Puerto Rico in its published 2019 or 2020 enforcement plans. The 2020 IRS compliance strategy announced Oct. 16 will focus on jail bonds with respect to whether federal government use and management contracts cause excessive private business use; whether sinking fund over-funding causes the tax credit bonds to be arbitrage bonds; and whether variable rate bonds comply with the rebate and yield restriction rules under Internal Revenue Code Section 148.

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Direct-pay bonds Build America Bonds Munis The Recovery Act IRS Washington DC Puerto Rico