WASHINGTON -- The Internal Revenue Service and a group of bondholders last week made a last-ditch effort to try to convince a U.S. Tax Court judge to rule in their favor in a tax dispute over the Whitewater Garden and Ironwood black box housing bond issues.
The two sides marshaled their defenses and decried each other's claims in briefs they filed with the court last week.
Both have until the end of October to respond to each other's charges. Then Judge Julian I. Jacobs will begin deciding the case.
Harbor Bancorp, a bank in Long Beach, Calif., and Edward and Elena Keith, residents of Pebble Beach, Calif., are challenging the IRS' right to collect a total of $67,833 in back taxes on their interest earnings from $30.5 million of Whitewater Garden and Ironwood bonds that were issued by the Riverside County, Calif., Housing Authority in the mid- 1980s.
The IRS contends the three bondholders owe the back taxes because the multifamily housing bonds violated tax laws and are therefore not tax-exempt.
The bondholders, however, represented by the law firm of Bryan Cave in St. Louis, claim that the bonds did not violate any tax laws. They say that even if tax law violations did occur, bondholders should not be taxed.
In their brief to the court, the bondholders say that the bonds complied with all of the tax law requirements that were in effect when the bonds were issued on Dec. 31, 1985.
The bondholders say that under the IRS rules interpreting those tax law requirements, bonds are not taxable arbitrage bonds if, based on the issuer's reasonable expectations at the time of issuance, the proceeds are not used in a manner that causes them to be arbitrage bonds. In this case, they say, the housing authority expected the bond proceeds would be used for multifamily housing projects.
In addition, the bondholders contend that the bonds are not subject to the tax law's arbitrage rebate requirements, which took effect for taxexempt multifamily housing bonds that were issued after Dec. 31, 1985.
Even if Judge Jacobs finds that the bonds were issued in 1986, the bondholders say, the rebate requirements are not applicable to them because the issuer received no economic benefit and the guaranteed investment contracts purchased with the proceeds were not "nonpurpose investments" within the meaning of the 1986 tax code.
Nonpurpose investments are those that do not carry out the governmental purpose of the bonds, according to the brief.
Further, the bondholders argue that they should not be taxed even if the court finds that the bonds were taxable arbitrage bonds.
The IRS' only sanction in cases such as this, they say, is to blacklist, or "decertify," the authority and refuse to accept its Nonarbitrage Certificate.
Because it is not the practice or policy of the IRS to tax investors, taxing the bondholders in this case would be "disparate and discriminatory," Harbor Bancorp and the Keiths say.
The IRS, however, says in its brief that the Whitewater Garden and Ironwood bonds are taxable arbitrage bonds because the proceeds were locked into long-term, higher-yielding guaranteed investment contracts.
They are also taxable arbitrage bonds because they were subject to the tax law arbitrage rebate requirements and the housing authority refused to rebate the arbitrage profits to the IRS, the agency says.
The IRS charges that the two bond issues were rushed to market to avoid the tax law's arbitrage rebate restrictions, which were pending in Congress.
But the bond issues did not avoid the restrictions, the IRS says, because they were closed on a "sham" basis through an unlicensed offshore shell bank.
The parties to the deals "merely traded worthless paper," which has no economic significance for tax law purposes, the IRS says.
The bonds were not validly issued until 1986 when they were "remarketed" and sold to public investors, the agency says.
The issuer need not benefit from arbitrage profits for bonds to be arbitrage bonds, the IRS says.
Moreover, the IRS charges, the housing authority failed to meet "the industry's view of the applicable standard" for establishing its reasonable expectations that the bond proceeds would be used for the projects.
The issuer, it says, knew that the proceeds were to be used to purchase the long-term guaranteed investment contracts.
The housing authority's executive director signed the Nonarbitrage Certificate for the bonds before the text was prepared, and neither authority officials nor their representatives were present at the bond closings, the IRS says.
The IRS also charges that the bonds are taxable industrial development bonds because the proceeds were not used for the projects and the authority failed to meet a tax law requirement that a notice of a public hearing be filed in a newspaper for the Whitewater Garden bonds.
The bondholders dispute the charges and say notice of the hearing for the Whitewater Garden bonds was adequate.