The Internal Revenue Service requested public comments on several proposed changes to the tax code and got an earful regarding an amendment that would change the basic framework of allocating expenditures.
"The proposed regulations are significant changes that ignore that framework, increasing financing costs and reducing flexibility without identifying any demonstrated abuse that justifies such a result," said Taylor Klavan, a shareholder with Greenberg Traurig's Houston office.
"NABL will respectfully request that Treasury withdraw the proposed regulation."
Klavan represented the National Association of Bond Lawyers at today's IRS public hearing on proposed regulation changes in Washington D.C.
Multiple provision in sections 148 and 150 of the tax code are being considered for clarifications. Section 148 deals with questions related to arbitrage, while section 150 deals with bond proceeds.
Proposed changes to Section 148-6, which covers cash outlays, are attracting lots of heat from the tax attorneys.
"For decades, the existing allocation regulations have recognized that infrastructure projects are financed through multiple funding sources that become available over time under multiple overlapping sets of rules and procedures that apply to each source," said Klavan.
The original rule was written during the time of paper checks and was put in place to ensure that "current" cash outlays from bond proceeds were made "not later than five banking days after the date as of which the allocation of gross proceeds to the expenditure is made."
The rule also requires the issuer to account for the allocation of proceeds no later than 18 months after the expenditure is paid or when the project is placed in service.
The agency believes the rules about what can be paid for using bond proceeds and the timing is causing confusion.
Treasury believes the proposed change "would eliminate this confusion by clarifying that to allocate funds from a specific source to an expenditure, those funds must be held by or on behalf of the issuer on the date of the cash outlay."
The lawyers believe the clarification will fundamentally and detrimentally change the way infrastructure is financed.
"That change converts a narrow timing rule into a broad source of funds tracing rule, and we do not believe anything in Section 148 suggests that allocation flexibility should depend upon whether a future funding source had already been received when an expenditure was paid," said Klavan.
The proposed change caught the attention of the American Bar Association, which is also opposed.
"Under the proposed amendment to the regulations, the problem arises where the timing of the various sources of funding do not match up with the timing of when expenditures are being made on the different portions of the project," said Scott Lilienthal, a partner with Hogan Lovells Cadwalader.
Lilienthal spoke on behalf of the ABA and pointed out that how bond proceeds are handled is already covered in other sections of the tax code.
Both attorneys cited real world examples, including housing, hospitals, and airports, that rely on mix of funds in their capital stack along with flexibility in financing methods.
"The main concern we have with the proposed regulations is the impact that they would have on issuers in complying with these requirements and use to finance facilities in a very common situation where a project is financed in part with proceeds of tax-exempt bonds and in part from other sources, which happens often because a portion of the project is not eligible for tax exempt financing," said Lilienthal.
The proposed change would be especially treacherous for smaller bond issuers including schools, and rural utilities who don't have the reserves needed to pay for improvements upfront.
"Ironically, the entities that depend on tax-exempt financing the most would be the ones most adversely affected by the proposed regulation," said Klavan.
The IRS was hoping the proposed changes will reduce the chance of abusing arbitrage rules, but the attorneys aren't convinced changing 148-6 will have any effect.
"Proposed regulations instead risk penalizing ordinary project financing rather than preventing abusive transactions," said Klavan.
"Effective rulemaking requires a clear connection between the problem being addressed and the solution being proposed, and that connection does not continue demonstrated here."
The IRS will consider the comments about the proposed rule changes and eventually release a final version.
