WASHINGTON -- The Treasury and Internal Revenue Service will modify the proposed reimbursement rules to make compliance easier for issuers whose budgetary and accounting systems are based on broad programs or purposes, rather than on specific projects, a Treasury official said yesterday.
"The problem is that the proposed rules don't take into account people who do fund- or program-accounting," David A. Walton, Treasury's attorney-adviser for tax-exempt bonds, said at a public hearing held yesterday on the rules, which were proposed last April.
"The rules clearly are based on project-accounting. And that's something that we realize we need to rectify," he said.
Mr. Walton made the remarks after state officials said that they sell bonds to finance hundreds of projects at a time and do not have the capability to identify or track specific projects for which expenditures are to be reimbursed with bonds. The state officials said they authorize expenditures and bond reimbursements on a program basis.
Mr. Walton said he thought most large issuers would have trouble tracking specific projects. He said Treasury and IRS might consider allowing such issuers to identify the programs in which expenditures are to be reimbursed by bonds.
However, Virginia Rutledge, past president of the Government Finance Officers Association, said many issuers would have trouble tracking specific projects. She told the panel that the level of detail in the rules is a problem for any issuer that spends its available funds on a variety of projects and then issues bonds later to reimburse the expenditures.
Although Treasury and IRS officials told those attending the hearing that they will consider a number of revisions to the reimbursement rules, they would not predict if the rules' Sept. 8 effective date would be postponed.
The rules generally take effect for governmental and 501(c)(3) bonds issued after Sept. 7 and are designed to discourage state and local governments from using tax-exempt bond reimbursements to avoid arbitrage restrictions. In a legitimate bond reimbursement, the proceeds are treated as spent and can be invested freely as soon as the bonds are issued.
Agency officials told issuers and lawyers at the hearing that they might consider exempting small issuers from the reimbursement rules.
Jeffrey D. Berry, a lawyer with Chapman and Cutler, questioned why, if the rules are supposed to discourage arbitrage abuse they apply to small issuers who are exempt from arbitrage rebate requirements Under the tax law, issuers who sell less than $5 million of governmental bonds per year are exempt from arbitrage rebate requirements.
John J. Cross 3d, assistant to the assistant chief counsel for IRS's financial institutions and products division, responded to Mr. Berry, saying, "that's an interesting idea that we might take a good look at." But Mr. Walton said it would be important to ensure that such an exemption would not allow these issuers to abuse arbitrage yield restriction requirements.
The federal officials also said they would consider easing the rules' concept of the "controlled group," which broadly defines an issuer as not only itself, but also any entities that it controls.
Maryland officials complained that this concept might make the state responsible for the actions of school boards, whose officials are appointed by the governor but whose finances and operations are completely independent from the state.
After the hearing, Mr. Cross said that the agencies might adopt a more narrow definition that would include, besides the issuer, only "entities that the issuer forms or avails itself of." He explained the term "avails itself of" is in existing rules and would mean, for example, entities that the issuer uses or funds.
Mr. Cross also assured issuers that the agencies would correct a "glitch" in the rules' provisions on working capital and make clear that bonds could be used to reimburse expenditures made for land.
State officials cited numerous examples of how the rules would limit their flexibility and, as a result, cause them to issue more bonds on a more frequent basis.
Louisiana officials, for example, said that their system -- in which the state bond commission allows agencies and political subdivisions to borrow from capital accounts and then to reimburse the accounts later with bonds -- allowed the state to avoid issuing bonds during the three years that its credit rating was at an undesirable level. Had these rules been in effect, they said, the state would have had to sell several bond issues during that time.
Maryland officials said that the proposed rules would cause them to increase by 3% to 6% or $70 million to $200 million the amount of general obligation bonds outstanding.
Lucille Maurer, the treasurer of Maryland who spoke on behalf of the National Association of State Treasurers, said that the rules would require states to make major changes in their capital programs at a cost of millions of dollars. "It's not like going to the Safeway to pick up something," she said, adding, that capital programs are complex and have developed over many years.
Mark Page, deputy director and general counsel of New York City's Office of Management and Budget, said that authorizations to bond finance in the city do not distinguish between bonds that will be used for new projects and bonds to be used for reimbursement. If the city says it is going to do more bond reimbursements than it actually does, he said, it runs the risk of winding up with a pattern of failure to reimburse under the rules.
Mr. Page and other issuers told IRS and Treasury officials that it would be impossible to describe in detail the projects for which expenditures are to be reimbursed, as required by the rules, because the projects change over time along with the need for them.
