WASHINGTON — Municipal market participants should not expect the Treasury Department to simply rubber-stamp the existing tax-exempt bond rules for issue price when it comes to Build America Bonds, a Treasury official told bond lawyers at a recent meeting.
John Cross 3d, the Treasury’s associate tax legislative counsel, said at the American Bar Association’s tax-exempt financing committee meeting in Toronto two weeks ago that the Treasury is “actively working” on guidance pertaining to issue price and BABs, and that it likely will depart to some degree from the existing rules in an effort to improve them.
“I would encourage you to try and appreciate that this is a big issue … that the government is receiving different kinds of information from different sectors and [it] is by no means clear that we’re going to end up in exactly the same place we are now,” he said. “We’re going to try and improve things. The needs of the market for more certainty doesn’t necessarily lead to leaving the rule the same way it has been forever.”
Cross’s comments came one month after several major muni market groups sent him a letter calling for the Treasury to apply the existing issue-price rules for tax-exempt bonds to BABs and other direct-pay bonds, saying it would be the most efficient and least disruptive way to provide clarity on the subject.
How issue price should be determined for BABs has been a hot topic of conversation among bond professionals for months, due in part to Internal Revenue Service queries into BAB pricing, as well as a tax law provision prohibiting BABs to be sold with more than a de minimis amount of premium.
Cross did not say exactly what steps the Treasury might take in future guidance, but he did run down a list of questions that need to be answered. They included whether 10% of bonds sold should qualify as a substantial amount for purposes of determining issue price and if there should be some safe harbors that could provide issuers with confidence they are complying with the tax rules.
Under tax rules, issue price for tax-exempt bonds typically is determined by the first price at which a substantial amount of the bonds is sold to the public, with 10% understood to be a substantial amount.
Although Cross did not delve into specifics, he also said the Treasury plans to issue guidance “very soon” on draw-down bonds, following a push from bond attorneys for clarification on the fate of BABs and bank-qualified bonds with draw-down structures if stimulus law provisions expire at the end of the year.
Draw-down bonds are a popular way for smaller issuers to finance construction projects with bonds without having to make initial interest payments on the entire issue.
Typically, an issuer agrees to sell a certain amount of the bonds to a bank in a private-placement transaction. The bank, in turn, agrees to loan the bond proceeds to the issuer in small periodic amounts. The issuer is only obligated to pay interest on the amounts that have been tapped.
In addition, regulations outlining remedial actions for BABs are in the works, with the goal being to tailor remedies that match the scope of the infraction, according to Cross.
Using a tennis reference, he said the Treasury Department wants to “make sure that small foot-faults have small foot-fault cures,” adding that it is a “priority project.”
But in terms of what will most likely be next out of the hopper in terms of guidance, Cross said final regulations on solid-waste disposal facilities “will probably be the next thing out the door.” An update to those rules was proposed one year ago, with officials saying they hoped to finalize them quickly.
A final version of public approval requirements for projects financed by private-activity bonds also is in the works, he said. They were originally proposed in September 2008.
At the same meeting, Clifford Gannett, the IRS’ tax-exempt bond office director, upped to more than 1,500 the amount of audits his office plans to close this fiscal year. He stated in May that his office was aiming to close 1,200 exams.
The TEB office is continuing to shift to quicker, more targeted examinations of certain market sectors where issuers receive letters from the IRS asking “very specific questions.”
“It affords us the opportunity to do more exams and actually have broader coverage,” Gannett said. “This is what you’re going to see in the future.”
A recurring problem the IRS has found with these exams is that issuers, especially smaller ones, fail to file their returns on time.
“That continues to be a problem,” he said, especially when it comes to filing Form 8038-GC, the information return filed on bond issues totaling less than $100,000.
The areas of focus for the audits include current refundings, multifamily housing, pool financings, developer-driven deals, and tax increment financing, he said.
On BAB pricing, Gannett said the IRS is using the Municipal Securities Rulemaking Board’s EMMA system as a tool to see how the bonds are trading, but is not initiating audits based solely on what agents see there.
“We haven’t opened or closed a single examination based on EMMA data,” he said. However, he did voice concerns about seeing interdealer trades bump right against the de minimis limit.
“When interdealer trades are taking place exactly at the de minimis premium line, leaving no room for public customers … that gives us pause,” he said.
Gannett also used the platform to again “emphatically” deny that his office plans to audit up to 50% of all BABs issued, saying it is handling them pretty much like any sector of the muni market in terms of enforcement.