WASHINGTON — The federal government should make tribal economic development bonds a permanent tool for Indian tribes and should consider raising or removing the current $2 billion ceiling on the program given the clear demand that exists for the bonds, an advisory committee said in a report sent to the Internal Revenue Service this week.
The committee also recommended a detailed process under which an issuer of new direct-pay bonds like Build America Bonds could voluntarily come to the IRS and have its subsidy payment reduced to resolve inadvertent violations of tax law requirements.
The suggestions were made by the Advisory Committee on Tax-Exempt and Government Entities at its annual meeting with the IRS here on Wednesday.
The ACT’s Indian Tribal Governments group told the IRS that the overwhelming number of applications submitted to participate in the tribal economic development, or TED, bond program “leaves little doubt that tribes wish to use tax exempt financing where possible.”
Traditionally, tribal governments have been significantly limited in their access to tax-exempt financing. Unlike state and local governments, they could only issue tax-exempt bonds to finance “essential governmental functions,” which has been a contentious point between tribal governments and the IRS over the years.
However, the American Recovery and Reinvestment Act allowed tribes to issue up to $2 billion of TED bonds without having to meet the essential governmental function test.
The Treasury Department received 134 applications totaling $4.3 billion for the $2 billion of TED bonds that were authorized. All qualified applicants received a reduced, pro rata allocation.
“The over-subscription should not come as a surprise,” the advisory group said in its report. “The depth and breadth of need for infrastructure and economic development in Indian country is longstanding and well documented.”
The group said the $2 billion limit on the program “is impractical,” considering “the well-known and persistent economic conditions prevailing in Indian country.” Given the need for low-cost financing in these areas, the program should be made permanent and expanded or uncapped, it said.
ARRA required the Treasury to report on the effectiveness of the bonds, but the advisory group warned it is too early to make such a determination. A handful of factors hinder tribal access to the muni market, including inexperience from both tribal issuers and potential investors on tax-exempt bonds in general and a lack of clear regulations specifically devoted to tribal bonds, the group said.
In addition, the ACT reported it was difficult to disseminate the information tribes need to apply for allocations. For example, no Alaska Native tribes applied for the program. The advisory group’s informal surveys indicated tribes there were “wholly unaware of the opportunity or misunderstood the application process.”
In the same report, the tax-exempt bond advisory group recommended that the IRS modify its voluntary closing agreement program to allow issuers of direct-pay bonds to rectify minor violations of tax rules by reducing the amount of subsidy payment they receive from the federal government.
Under the proposal, direct-pay issuers that discover inadvertent violations on their bonds could voluntarily enter into VCAP as soon as possible and would determine what portion of the bond issue no longer qualifies as BABs. The issuer would then file a direct-pay reduction form that would notify the IRS how much its future payments should be reduced, which would be directly proportional to the amount of disqualified bonds.
In cases where a violation was discovered after the issuer had already received payments, it would have to make a “correction amount” payment to the IRS, which would be equal to the amount that should not have been received on the disqualified bonds. As an alternative, the issuer could have future payments reduced to account for that amount.
If more than 18 months passed between when the violation occurred and when the issuer approached the IRS to enter into VCAP, an additional penalty could be assessed. The ACT recommended such a penalty not exceed 10% if the violation occurred within five years of the VCAP settlement, but said the penalty should not be automatically rendered for long-standing violations. It could be waived in cases where it was determined the issuer was acting in good faith.
Two requirements specific to BABs are that the bonds not be issued with more than a de minimis amount of premium and that 100% of the proceeds minus issuance costs be spent on capital expenditures.
The advisory committee recommended that if an issuer violated the de minimis premium restriction, the reduction in subsidy payments should not exceed the amount of excess premium, provided the bonds still have at least 12 years between the issue date and maturity date. If an issuer discovers it may not be able to spend all of the BAB proceeds on permitted uses, its reduction in its subsidy payments should be at least equal to the amount of unspent or wrongly spent proceeds.
The group made similar recommendations for the possibility that additional penalties could be applied if the violations occurred 18 months or more before the issuer entered into VCAP.
IRS tax-exempt bond chief Clifford Gannett told state and local finance officials meeting in Atlanta on Wednesday that his office is taking the recommendations under consideration.