Panel Develops Arbitrage Compliance Guidance for Small Issuers

WASHINGTON — A tax-exempt bond advisory panel to the Internal Revenue Service has recommended that the agency publish three documents to provide guidance to issuers of small governmental bond issues and conduit borrowers of small 501(c)(3) nonprofit bond issues about complying with arbitrage rebate and yield restriction requirements.

The recommendations were presented to acting IRS Commissioner Danny Werfel at a meeting here on Thursday by the Advisory Committee on Tax-Exempt and Government Entities and its five subcommittees, including one on tax-exempt bonds.

The three documents are: a roadmap or chart to arbitrage requirements, guidance on establishing written post-issuance compliance procedures, and information about whether and how to engage arbitrage compliance professionals.

Steve Chamberlin, the acting director of the IRS' tax-exempt bond office who participated in the meeting by phone, said TEB would put the roadmap on its work plan for fiscal 2014. But he said the IRS could not issue the other two documents. However, he said they are important guidance and he hopes market participants will use them.

Two of three subcommittee members — Lorraine Tyson, a partner at Pugh, Jones & Johnson in Chicago, and Katherine Newell, director of risk management and ethics liaison officer at the New Jersey Educational Facilities Authority in Princeton, N.J. — explained Chamberlin's remarks after the meeting.

They said the IRS has its own more detailed guidance and does not want to appear to endorse the panel's more general documents for fear issuers and conduit borrowers will think this is all they need to use for compliance.

The other subcommittee member is Sue Painter, system director and chief information officer/treasurer of Providence Health & Services in Seattle.

In their report to the IRS, the subcommittee members said that while most of the publicity and news in the tax-exempt bond market focuses on large bond issues, tax-exempt governmental bond issues with par values under $10 million accounted for about 85% of the total number of all such bond issues for the tax report years of 2006 to 2010, according to the IRS.

"The arbitrage requirements are among the most complicated rules applicable to tax-exempt bonds, the report said. "Although the rebate rules have applied since the enactment of the Tax Reform Act of 1986 and the concept of yield restriction dates to the tax reform act of 1969, many issuers and borrowers still find the rules difficult to understand and apply."

"There are recurring areas of difficulty with compliance among smaller issuers such as the lack of awareness of the yield restriction rules, failure to apply the spending exceptions to rebate correctly and failure to calculate variable bond yield correctly," the panel said. "Failure to apply the disbursement method correctly and failure to properly value investments at the end of the computation period are other frequent errors."

IRS officials, who worked closely with the panel on the report, attributed these frequent errors to a lack of policies and procedures, the assumption that a conduit borrower rather than the issuer is responsible for complying with the arbitrage requirements, and confusing the concept of a small issuer of bank-qualified bonds with the $5 million small issuer exemption from rebate requirements.

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