WASHINGTON -- The School District of Philadelphia has settled a tax dispute with the Internal Revenue Service by paying an undisclosed amount in return for the IRS taking no adverse action with regard to its bonds.
The settlement involves $7.42 million of direct-pay qualified school construction bonds the district’s fiscal agent and sinking fund depository for the bond, the Bank of New York Mellon Trust Company, erroneously redeemed in September 2014.
“They screwed up. They redeemed bonds that weren’t supposed to be redeemed,’’ said Uri Monson, chief financial officer for the district, which is the largest in Pennsylvania.
Monson said the early redemption of the QSCBs was entirely due to human error. “They misread the redemption notice,’’ he said. “There’s no reason for what they did.’’
The bonds were part of a $144.6 million of series of taxable, direct-pay qualified school construction bonds, in which the district received a subsidy payment from the Treasury Department equal to a percentage of its interest costs. QSCBs were created under the 2009 American Recovery and Reinvestment Act, allowing the lender to receive a federal tax credit or subsidy payment.
The direct-pay bonds were issued in December 2011 as part of a larger $219.1 million bond issue that also included tax-exempt general obligation bonds. All of the direct-pay bonds mature in September 2030.
Money from the 2011 bond sale was used for a variety of purposes, including rehabilitation of schools, technology improvements and the purchase of new school buses.
The Philadelphia school system reported the error in each of its last two annual audited financial statements, Monson said.
The Bank of New York Mellon went back to the bondholders after the error was discovered, successfully reversing the redemption and reinstating all but $550,000 of the bonds, which were held by investors who did not want to reverse the redemption, according to the school district and the event notice it filed on the Municipal Securities Rulemaking Board's EMMA system.
The IRS discovered the erroneous redemption during a routine audit and raised questions about whether it caused $7.42 million of the bonds to lose their qualified QSCB status, the event notice said.
Under the tax law, 100% of the available proceeds of QSCBs must be spent on the construction, rehabilitation, or repair of public school facilities or on acquisition of land for those facilities. The IRS suggested the school district might not have been entitled to some of its subsidy payments.
But the parties agreed to settle the tax dispute. The school district made a payment to the IRS representing a return of the interest subsidies it received on the QSCBs between March 1, 2015 and Sept. 1, 2015. In return the IRS agreed to take no action on the subsidy payments or bonds.
The city’s school board is scheduled to vote on the IRS settlement it at Aug. 17 public meeting during which the dollar amount will be disclosed.
In the meantime, the school district has asked for full indemnification by BNY Mellon for its error.
“They acknowledge their full mistake,’’ Monson said in a telephone interview Thursday.
The Bank of New York Mellon declined to comment.