WASHINGTON -- An American Bar Association committee has developed a two-year plan of action which includes creating a task force of its members to consider alternative penalties to taxing bond-holders that could be used by the Internal Revenue Service.
The plan, which would provide recommendations and guidance to the IRS on several regulatory issues, was discussed by the association's committee on tax-exempt financing in Atlanta on Friday.
The committee has been reluctant to leap into the debate on whether the Internal Revenue Service needs alternative penalties since the issue has been controversial among its members. But Dean M. Weiner, the ommittee's new chairman, said in a written description of the plan that the issue should be addressed because the IRS's recent enforcement actions against some bond transactions have been perceived as unfair to bondholders.
The IRS historically has threatened, but failed, to tax bondholders. The agency, however, recently moved to tax the intrest earnings of investors who held bonds from a 1984 issue that was sold by the Sevier County, Tenn., Industrial Development Board to finance expansion and rehabilitation of a hotel. In addition, the IRS has been pursuing the names of bondholders for other mid-1980's issues that it believes violated tax laws.
The committee's task force is chaired by Clifford M. Gerber, a lawyer with Brown & Wood, the law firm representing the Riverside County, Calif. Housing Authority in its court dispute with the IRS over the $17.5 million Whitewater Garden bond issue.
The task force's initial focus will be on whether new procedures for coordinated audits of large partnerships can be applied to municipal bond issues, Mr. Weiner said.
Under the new procedures, one member of a partnership is designated to deal with the IRS while the agency audits the partnership. Any tax liabilities discovered are shared by all partners based on percentages of ownership.
If these procedures were applied to bonds, Mr. Weiner said, the issuer could be designated to deal with the IRS. And tax liabilities could be shared by all of the bondholders based on the amount of bonds they held.
The task force also will consider the possibility of a system of monetary penalties for tax law violations, Mr. Weiner said.
Other regulatory issues to be considered by the committee include:
* Current developments in tax-exempt financing techniques. The committee plans to spend more time discussing new financing techniques and the tax law issues that arise from them, Mr. Weiner said. The goal, he said, is to make sure committee members have the latest information available on which to base bond opinions, which must be unqualified for market acceptance.
* Reissuance and synthetics. Synthetic products, such as stripped coupons, call busters and hedges, result when an underwriter repackages and adds new features to bond issues in secondary market sales. Controversy exists about whether certain synthetic products create new obligations or cause the underlying bonds to be reissued and made subject to new tax law restrictions.
The committee has created a task force, chaired by Richard L. Kornblith, a lawyer with the firm of Johnson & Gibbs, to consider these issues. One of the task force's first actions will be to assess the impact of a recent Supreme Court decision in Cottage Savings Association v. Commissioner of Internal Revenue Service. The high court's ruling could be interpreted as setting new standards for reissuance that supersede IRS rules.
* Private-activity bond tests. Under the tax law, a bond is a private-activity bond and may be subject to state volume limits or taxable, if more than 10% of the proceeds are used in a private trade or business and more than 10% of the debt service is derived from, or secured by, private payments.
But bond lawyers have always had questions about how the tests should be applied in certain tranactions. The need for guidance has increased as public- private partnerships have become more common. The committee has created a Private Activity Bond Subcommittee, chaired by Henry Bettendorf, of Thompson & Mitchell, to propose rules on these private activity bond issues.
* Definition of refunding. the committee has set up a group, led by Arthur M. Miller, a vice president of Goldman, Sachs & Co., to try to provide guidance on refundings. The group will look at refunding restrictions and will try to determine when trasactions are, and are not, refundings.
* Working capital. Many lawyers have been perplexed about how to treat working capital -- capital used to pay operating expenses -- under tax law restrictions. For example, rules on 501(c)(3) bonds say that for the bonds to be tax-exempt, the bonds can not have a maturity of more than 120% of the useful life of the assets being financed. In 501(c)(3) transactions that involve working capital then, the question is what is the useful life of working capital. The committee has set up a task force headed by Judith Lidsky, of Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C., to address these issues.
* Single issues. IRS rules on private-activity bonds and arbitrage contain two differing sets of standards for determining when more than one bond issue should be considered a single issue. And both sets of rules have caused problems for some legitimate transactions. The committee set up a task force, chaired by William L Henn Jr., with Piper & Marbury, to provide guidance.
* 501(c)(C) status. The committee set up a group, chaired by R. Todd Greenwalt, with Vinson & Elkins, to develop some guidance for the IRS on how to prevent 501(c)(3) organizations from using their nonprofit, tax-exempt status to benefit private parties. The IRS created a stir in the bond community recently by telling some new 501(c)(3) organizations that they would have to reaffirm their status if they planned to issue tax-exempt bonds. The group chaired by Greenwalt is expected to focus on how the IRS can revise application forms and annual financial forms to determine the potential for abuse.
