Muni groups pleased at plans to withdraw proposed political subdivision rules

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CHICAGO – Municipal market groups applauded the Treasury Department's announcement that it plans to withdraw its proposed political subdivision rules, but tax regulators said they will work on more targeted guidance.

The proposed withdrawal of the rules, which was widely expected, was hailed by the groups, which have been critical of the proposed rules since they were issued in February 2016.

Michael Decker, managing director and co-head of the municipal securities division for the Securities Industry and Financial Markets Association said, “SIFMA commends the Treasury Department for withdrawing its proposal related to the definition of political subdivision. That change would have excluded important local issuers from accessing the tax-exempt market, imposed undue requirements on issuers who would have remained eligible, and raised the cost of financing infrastructure.”

"Tens of thousands of political subdivisions across the country are relieved of this potential worry,” said Emily Brock, director of the Government Finance Officers Association's federal liaison center. “Their access to the municipal bond market is, without a doubt, fundamental to improving and maintaining our nation’s vast infrastructure network.”

Mike Nicholas, CEO of the Bond Dealers of America, said his organization is pleased “the complex and burdensome political subdivision rule” is being withdrawn.

“The proposal would have hampered economic growth by denying communities of the ability to issue tax-exempt bonds to finance worthy and beneficial public projects,’’ Nicholas said.

Treasury, however, said in the announcement that it “continues to believe that some enhanced standards for qualifying as a political subdivision may be appropriate.”

“If we do anything on that, it will be in a future targeted guidance,” John Cross, Treasury's associate tax legislative counsel said, speaking during a Tax Hot Topics panel at the National Association of Bond Lawyers' Bond Attorneys’ Workshop here.

Treasury Secretary Steven Mnuchin made the announcement earlier in the day, publishing recommendations for dealing with eight regulations in an 11-page report called "Identifying and Reducing Tax Regulatory Burdens."

The Treasury report was the result of Executive Order 13789 issued by President Donald Trump earlier this year asking federal agencies to reduce regulatory burdens.

That executive order asked Treasury to review significant tax regulations issued since Jan. 1, 2016 and identify those that: "impose an undue financial burden on United States taxpayers; add undue complexity to the Federal tax laws; or exceed the statutory authority of the Internal Revenue Service.''

“Treasury received over 140 comments from the public – as well as thousands of duplicate form comments – concerning the potential modification or revocation of the eight regulations identified,” the report said. “The thrust of the comments varied widely, with some recommending that Treasury withdraw one or more of the regulations and others requesting that Treasury retain those same regulations.”

The proposal political subdivision rules grew out of a 2013 technical advice memorandum issued by the Internal Revenue Service's Office of Chief Counsel in connection with an examination of bonds issued in Florida by two community development districts to finance infrastructure development that was part of The Villages retirement community.

Historically, under case law, an entity has been considered to be a political subdivision that can issue tax-exempt bonds if it has the ability to exercise a substantial amount of at least one of three sovereign powers -- taxation, eminent domain and policing.

But the IRS became concerned that some political subdivisions were controlled by private developers and proposed adding two additional requirements that the political subdivision be governmentally controlled and serve a governmental purpose “with no more than an incidental private benefit.’’

NABL, the American Bar Association's Section of Taxation, and many other muni market groups, strongly opposed that proposed definition. The lawyers groups insisted that the 1944 federal appellate court ruling in Commissioner of Internal Revenue v. Shamberg’s Estate describing the sovereign powers test should be the sole basis for defining a political subdivision that can issue tax-exempt bonds. They say this is well-settled law.

Many commenters also argued that the proposed regulations would force costly and burdensome changes in entity structure to meet the new requirements.

"After careful consideration of the comments on the proposed regulations ... Treasury and the IRS now believe that regulations having as far-reaching an impact on existing legal structures as the proposed regulations are not justified," the agencies said in the report.

They said they "will continue to study the legal issues" relating to political subdivisions and "may propose more targeted guidance in the future after study of the relevant issues."

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