CHICAGO — The Internal Revenue Service will begin limited-scope examinations of bond anticipation notes in July and then examinations of filed 8038-T forms on arbitrage rebate later in the year, an IRS official said at a conference Sunday.

The IRS will send out letters for 25 bond anticipation note examinations beginning July 1 as part of their ongoing effort to focus on compliance with arbitrage rules and regulations, acting IRS tax-exempt bond field manager Allyson Dodd said on an enforcement panel at the Government Finance Officers Association’s annual conference here.

Bond anticipation notes are short-term borrowings that have their principal repaid from the proceeds of long-term municipal bond issues sold at a later date. Typically they are issued until long-term funding is available.

Mitch Rapaport, partner with Nixon Peabody LLP, and moderator Ben Watkins, Florida’s director of bond finance, joined Dodd on the panel and discussed key areas the IRS is focusing on for examinations and what issuers should expect when they are faced with an audit. Specifically, Dodd described how the TEB office is organized and how officers choose bonds to be audited.

Rapaport and Watkins talked about the IRS’ evolution of enforcement. They said the agency has moved away from solely focusing on abuses and instead have made audits a normal part of their program to ensure compliance.

Closely following the start of its new fiscal year, which begins Oct. 1, the IRS will send out examinations focused on filed 8038-T forms, which must be filed if issuers have to pay rebates on their bond issues. As part of its fiscal 2012 work plan, the IRS is currently sending out audit letters where no 8038-T forms were filed to determine if the filings did not have to be made.

“The purpose of that is to make a determination as to whether any yield-restriction amount paid or rebate amount paid as part of that filing was the appropriate amount,” Dodd said about their upcoming initiative.

Under federal tax law, issuers of many tax-exempt bonds are required to rebate the arbitrage profits that result when the yield on the invested proceeds exceeds the bond yield. Issuers also are required to keep records of certain interest-rate hedges so that they can be taken into account in determining arbitrage profits.

Dodd addressed the IRS’ increased use of questionnaires, which has targeted post-issuance compliance and issue price as areas of high importance. Post-issuance compliance procedures are one of many factors the IRS considers when determining what a settlement amount might look like as part of a closing agreement, she said.

“If the issuer and-or borrower can demonstrate that there are post-issuance compliance procedures and that they are adhering to those procedures then there is an economic benefit to that,” Dodd said. “It also allows issuers or borrowers to identify problems on their own and come to the service through the process of what we call the voluntary closing agreement program, or VCAP, and seek to identify to the service what that violation is and resolve it.”

Closing agreements that occur within the compliance and program-management section of the TEB office through a VCAP submission “are more generous settlements than those that occur as part of field examinations,” she said.

The IRS recently issued a tax-law compliance guide for issuers in conduit bond transactions and offered suggestions as to what the agency would like to see as part of the development of post-issuance written procedures.

Regarding issue price, Dodd said the biggest takeaway from the questionnaires for issuers is that “certification of issue price in a bond issue can absolutely have an impact with compliance of rules and regulations, particularly as they relate to arbitrage compliance.”

“Our real focus is trying to gain an understanding of the process itself by which issue price was determined as a part of that particular financing,” Dodd said. “If there are certain things that are occurring as a part of that process or if we observe certain anomalies, then there should be an explanation for that.”

Issue price is key to determining the bond yield for tax purposes, in the case of tax-exempt bonds, and for subsidy amounts, in the case of Build America Bonds. The determination of bond yield has a bearing on whether an issuer of tax-exempt bonds is meeting arbitrage requirements and whether an issuer of BABs is receiving the correct amount of subsidy payment from the Treasury.

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. The public “does not include bond houses, brokers, or similar persons or organizations acting in the capacity of underwriters or wholesalers,” the rules state.

Dodd urged issuers and borrowers as part of their best practices to have conversations with underwriters about how the pricing was determined and how the financing team reviews some of the records that relate to the determination of issue price.

Muni market groups have been pressing the Treasury Department to develop guidance on the definition of issue price for tax-exempt bonds, Build America Bonds and other direct-pay tax credit bonds. Treasury officials say the guidance will be issued soon.

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