U.S. Court Dismisses Texas Agency's IRS Suit

WASHINGTON - A federal claims court ruled it did not have jurisdiction over a Texas nonprofit housing corporation's claim that the Internal Revenue Service abused its authority when it demanded $267,440 of arbitrage be rebated from a lease-to-own deal before concluding an audit.

Judge Margaret M. Sweeney of the U.S. Court of Federal Claims dismissed the Travis County Strategic Housing Finance Corp.'s suit against the IRS on Feb. 27 after ruling the SHFC erred in not filing an administrative claim with the IRS before suing it.

W. Mark Scott, a lawyer who has his own firm, formerly headed the IRS' tax-exempt bond office, and is representing the SHFC, said yesterday: "We're considering our options."

The SHFC filed suit against the IRS in October 2006, demanding a refund of $267,440 it paid to the agency in September after the IRS told the corporation to rebate the arbitrage, which it said was earned on $35 million of Series 2004 lease-purchase revenue bonds.

Normally the arbitrage payment, if it was owed, would have been due in 2010, the SHFC told the court. But the tax rules permit the IRS to demand the payment if the agency is worried about receiving it.

The agency claimed the demand constituted a deprivation of the its property without due process; a violation of the Fifth Amendment.

The case stems from a letter that the IRS' tax-exempt bond office sent to the Travis County corporation on May 31, 2006, notifying it of potential arbitrage violations, according to court documents. The SHFC had disclosed that the bonds were under audit.

The deal is one of several so-called lease-to-own bonds that have been under IRS scrutiny for credit enhancement fee schemes that allegedly created arbitrage windfalls that were diverted to several deal participants.

On June 26, the IRS sent a notice to the SHFC asking for the arbitrage to be rebated, citing the section of federal income tax regulations that allows it to take such action if it determines an issuer is likely to fail to meet normal rebate requirements.

The so-called jeopardy notice required the corporation to pay $267,444 in arbitrage rebate more than four years before it would normally be due under tax code rules for municipal bonds. Nov. 30, 2010, would have been the first date arbitrage normally would have to be rebated to the under tax rules, the SHFC told the court.

The corporation paid the arbitrage on Sept. 21, but noted it was doing so "under protest with all rights reserved," according to court documents.

The SHFC told the court that the IRS' conduct denied them the chance to refute or contest the agency's findings, and amounted to "an illegal exaction by the IRS and an illegal taking of plaintiff's property."

The agency also claimed that the IRS never advanced beyond the initial stages of the audit, and did not issue either a preliminary adverse determination letter or a proposed adverse determination letter warning the bonds might be taxable. Further, the IRS has taken no steps to advance the audit since receiving the rebate payment, nor has it provided "any substantiation, theory, or rationale to support its finding of jeopardy," the SHFC told the court.

The housing corporation also challenged the amount of arbitrage owed the IRS, telling the court that its own experts calculated the amount owed to be just $229,060.

But the IRS claimed the SHFC had no standing in court because it had "failed to exhaust its administrative remedies with the IRS prior to bringing this suit," and called for the court to dismiss the case.

The IRS pointed to Section 7422 of the tax code, which states that no court shall hear a suit regarding the recovery of any tax alleged to be wrongly assessed until a claim for refund has been filed with the IRS.

The SHFC contended that the arbitrage rebate did not fall under the purview of Section 7422. But Sweeney said the Supreme Court ruled, in U.S. v. Clintwood Elkhorn Mining Co., that Congress intended the section to be broad. In that case, the high court unanimously found that a coal company had to file a refund claim with the IRS even if it could obtain a larger amount of back taxes through the court system.

Sweeney also noted the section's language regarding how refunds should be pursued, particularly the inclusion of the word "sum," in addition to "tax" and "penalty," is broad enough to include arbitrage rebate.

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