Ohio County Uses 3d-Party Payment to Settle Tax Law Dispute With IRS

WASHINGTON -Clinton County, Ohio, has settled tax law disputes with the Internal Revenue Service over two hospital revenue bond issues totaling over $300 million, using an unidentified third-party payment to fund the settlement in order to protect the tax-exempt status of the bonds.

The county disclosed the settlement in a material event notice filed Wednesday with the nationally recognized municipal securities information repositories. Neither the notice, nor the individuals connected with the transaction, would disclose the third party or the amount it paid under the settlement.

The bonds, $148.4 million in 1998 and $153 million in 1999, were issued on behalf of Ohio Hospital Capital Inc. to finance various capital improvement projects at hospitals.

The notice stated that the bonds were all either retired or refunded by Dec. 31, 2002. It added that the tax-exempt status of several subsequent refunding bonds also were reaffirmed by the IRS as part of the agreement.

The settlement marks the latest development in several hospital pool bond deals involving variable-rate demand revenue bonds underwritten by George K. Baum & Co. that have been, or currently are, being investigated by the IRS.

In each of these transactions, the IRS has charged that the underwriter rigged bids for the guaranteed investment contract in which the bond proceeds were invested, in an attempt to divert arbitrage. The material event notice issued yesterday said the IRS claimed some of that arbitrage was used to pay issuance costs.

When pooled bonds are issued, a municipality normally invests the proceeds in a GIC until the funds are needed. A GIC provider is typically selected via a competitive bidding process.

The material event notice said the IRS determined that "certain aspects of the bidding process for the [GIC] ... appeared to facilitate the issuance of arbitrage bonds."

"Specifically, the IRS has informed the county that it believes that actions by the persons involved in the bidding (excluding the county) served to divert arbitrage normally rebated to the government to the underwriter to be used in part to fund issuance costs," the notice stated.

In similar pooled bond audits, the IRS contended that a winning, below-market GIC bid essentially diverted arbitrage to the GIC provider. By overpaying for other investment or remarketing fees in "separate" transactions with the underwriter, the GIC provider can share the profits with other deal participants, according to the IRS.

Bradley S. Waterman, the tax controversy attorney representing the county, declined to discuss the settlement yesterday.

Peck, Shaffer & Williams LLP in Cincinnati was bond counsel on the deal.

Other recent settlements of pooled bond deals involving George K. Baum include one disclosed in February over $63 million of bonds issued by Henderson County, Ky. In June of last year, the West Virginia Hospital Finance Authority disclosed that it had settled with the IRS regarding an examination of roughly $140 million of bonds in a similar deal. In 2005, the Knox County, Tenn., Health, Educational, and Housing Facility Board disclosed a similar agreement in connection with $250 million of Series 1999 pooled bonds.

Meanwhile, the New Jersey Highway Authority, now merged with the New Jersey Turnpike Authority, disclosed that it has received written confirmation from the IRS that it has reversed an earlier preliminary adverse determination and closed an audit with no change to the tax-exempt status of $422.7 million of revenue refunding bonds that were issued in 1992. In May, the authority announced the IRS had verbally told it that the audit would be closed with no change to the bonds' tax-exempt status.

Morgan, Lewis & Bockius LLP of Philadelphia and Waters, McPherson, McNeill PC of Secaucus, N.J., were underwriters' counsel, and Carella, Byrne, Bain, Gilfillan, Cecchi & Stewart, now Carella, Byrne, Bain, Gilfillan, Cecchi, Stewart & Olstein PA of Roseland, N.J., was bond counsel. LeBoeuf, Lamb, Leiby & MacRae of Newark, N.J., now Dewey & Leboeuf LLP, was special tax counsel.

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