WASHINGTON -- The Internal Revenue Service has told its field agents that they must contact the agency's national office before conducting full-blown audits of municipal bond issues in which issuers applied for a refund of arbitrage rebate overpayments.

The written guidance made public yesterday also cautioned field agents that requests for arbitrage rebate refunds .should not automatically trigger full-blown investigations.

Although field agents need to examine refund requests to determine the accuracy and validity of a claim, "it is not intended that each request for rebate trigger the commencement of an audit of the underlying bond issue," the IRS said in an Oct. 14 statement.

"To do so would impair the issuer's decision to seek a refund of rebate that is overpaid," the agency said.

If a field agent who receives a refund request has deeper questions about the underlying bond issue, "an audit of the bond issue may be required. Before contacting the issuer, however, you should discuss the situation with the National Office," the IRS advised its field agents.

The IRS said field agents need to remember that "consistency is essential if we are to treat all issuers in a uniform and fair manner." The agency's statement also included two samples of letters that field agents could use when seeking additional information from issuers that may have filed deficient claims for rebate refunds.

IRS regulations on the arbitrage rebate requirement permit tax-exempt bond issuers to seek refunds when they have made mathematical errors in their arbitrage calculations or when they are able to reduce their arbitrage liability by retroactively applying the final arbitrage rules issued in 1993.

The guidance issued yesterday from the IRS came in response to complaints this year from issuers and bond lawyers, who said requests for rebate refunds appeared to be triggering bond audits. They said they were concerned that many issuers would be dissuaded from seeking rebate refunds if they thought they would be forced to go through the audit process.

"I think this is helpful," Catherine Spain, the director of the Government Finance Officers Association's federal liaison center, said of the IRS guidance. "Issuers will be comforted to know that just the mere fact they have applied for a refund of rebate overpayment will not automatically trigger an audit."

Richard Chirls, a lawyer with Orrick, Herrington & Sutcliffe, said that as a result of the guidance, he is "hopeful that the message it appears they are attempting to convey to field agents is implemented."

Chirls said he has seen many issuers shy away from applying for rebate refunds because of the concern that an audit would be automatically triggered. The IRS' guidance will probably not cause an immediate rush to file claims because issuers are likely to first observe how field agents handle the new instructions, he said.

"I think there will be a period of tentativeness on the part of issuers" because "there have been so many automatic audits that have arisen" from rebate refund claims, Chirls said.

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