United States: IRS Tax-Exempt Bond Work Plan Signals Heightened Review of How Issuers Actually Comply With Tax Requirements

The IRS's FY2010 Work Plan (Work Plan) provides specific program priorities, goals, guidance, and direction to IRS employees within the Tax-Exempt Bond program. The Work Plan also gives practical insights into how the IRS is administering the tax-exempt bond and tax-credit bond eligibility requirements.

Many issuers, conduit borrowers, and indenture trustees of tax-exempt bonds and tax-credit bonds will be directly affected by the Work Plan. Among other things, the Work Plan expresses concern over use of the "disbursement method" of calculating arbitrage rebate.

Investment Method Versus Disbursement Method

One method of calculating arbitrage rebate is the "investment method," which considers, by date and amount, the cash inflow and outflow for each investment made with bond proceeds. Another method of calculating arbitrage rebate is the disbursement method, which considers, by date and amount, the cash outflow for each payment from bond proceeds. The disbursement method is simpler but in many situations less accurate than the investment method.

The Work Plan emphasizes that the IRS will review the use of the disbursement method of calculating rebate in instances where proceeds of maturing investments are allowed to remain idle rather than immediately reinvested.

This program priority is consistent with less formal, previously expressed concerns by key personnel within the Tax-Exempt Program that the applicable regulations require the investment method to be used, while acknowledging that the disbursement method is used by some service providers and in some packaged software and often produces the same result. As is the case with the Work Plan, the concerns over discrepant results are directed at uninvested amounts.

Foley's Arbitrage Rebate Company uses the investment method — except in unusual circumstances, in which case we provide an explanation that a possibly less accurate method is being used.

Recovery of Overpayments

The Work Plan also says that the IRS will review the form required to request a recovery of overpayments under the arbitrage rebate provisions (Form 8038-R). The review determines the actions that the IRS will take when it receives such a request.

Compliance Checks and a New Form for Build America Bonds

The Work Plan also announced that the IRS would develop a compliance questionnaire that collects additional compliance information on Build America Bond issuances. As a reminder, the arbitrage rebate rules apply to Build America Bonds, with the tax credit being taken into account to reduce the yield on the bonds for arbitrage rebate purposes.

When the IRS released the form of its Direct Pay Compliance Check Questionnaire in February 2010, it stated that it intends to send this questionnaire to all issuers of "direct pay" Build America Bond in phases. Many issuers have already received this questionnaire. The questionnaire primarily asks whether an issuer has adopted written procedures to establish compliance with the tax credit bond eligibility requirements, including compliance with the arbitrage yield restriction and rebate requirements.

The IRS also has released a new Form 8038-B for Build America Bonds. One important new question that each issuer will need to answer is whether "the issuer has established written procedures to monitor the requirements of section 148" (concerning arbitrage and arbitrage rebate). One of the procedures to consider is whether an issuer should use the disbursement method or investment method to determine rebate.

The Work Plan, the Build America Bonds Compliance Check Questionnaire, and the new Form 8038-B together reflect a greatly increased IRS emphasis on the procedures used by issuers of tax-exempt bonds and tax-credit bonds to monitor tax compliance..

Other Arbitrage Matters

The Work Plan identifies other arbitrage matters of concern — matters that directly affect the structuring of bond issues more than the post-issuance determination of rebate liability. In particular, the Work Plan emphasizes that the IRS will continue to focus its enforcement efforts on reviewing the use of interest-rate swaps, guaranteed investment contracts, and other sophisticated financial products that sometimes have been used in connection with tax-exempt bond issues such as the use of "escrow puts" and "forward floats" in advance refunding escrows. The Work Plan also indicates that the IRS will focus on late arbitrage and yield-reduction payments and the treatment of administrative costs such as costs to purchase or sell an investment.

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