WASHINGTON - The dismissal of a lawsuit that blocked the Internal Revenue Service from taking enforcement action against a black box bond deal in California is a major victory for the government and should deter issuers from filing similar suits in the future, Justice Department lawyers said this week.
The lawsuit, which the Riverside County Housing Authority filed last year to prevent the Treasury Department and the IRS from collecting arbitrage or revoking the tax-exempt status of the $17.5 million Whitewater Garden bond issue, was dismissed last week by Judge Consuelo B. Marshall of the U.S. District Court of the Central District of California in Los Angeles.
Judge Marshall ruled that the court did not have jurisdiction over the case because a new IRS rule, which allows issuers to obtain refunds of arbitrage rebates, provides an administrative remedy for the authority.
Under the temporary rule, which was issued in May, the authority could pay the $2.25 million of arbitrage sought by the IRS, file for a refund and, if denied, sue the IRS in the U.S. Claims Court or in a U.S. district court.
Edward M. Robbins Jr., the Justice Department lawyer representing the Treasury and IRS, said that, "assuming other judges follow Judge Marshall, the impact is that it will be impossible to bring this sort of suit in the future."
The ink on the order was barely dry when Justice Department lawyers sent a copy to Judge David F. Levi of U.S. District Court for the Eastern District of California in Sacramento.
Judge Levi is presiding over a similar suit brought by the city of Galt, Calif., earlier this year. That suit, which is scheduled to be heard later this month, seeks to block the Treasury and IRS from taking enforcement action involving a $29.29 million bond issue sold for Galt in 1986. But Justice Department lawyers hope Judge Levi will follow Judge Marshall's lead in the Riverside case and dismiss the Galt suit.
Henry S. Klaiman, a lawyer with Brown & Wood in New York, the firm representing both the Riverside county authority and Galt, agreed that "for anyone seeking a preliminary injunction" against the Treasury and IRS, Judge Marshall's decision "spells trouble."
But he and William Rosenberger, executive director of the Riverside county authority, complained that the Treasury and IRS acted unfairly in the Whitewater Garden case by rushing to issue the rule on arbitrage refunds just before the case was heard by the court.
"It's the bottom of the ninth and two outs and they just changed the rules," said Mr. Klaiman, adding, "They could have done this a year ago and saved us a lot of expense and aggravation."
Mr. Rosenberger, who said he was "disappointed" by the dismissal, added, "I guess I shouldn't be surprised. The IRS seems to be invincible. It's amazing how they can pass a regulation days before we go to court and then have that regulation apply to the decision."
State and local issuers had been begging IRS officials for months to publish procedures allowing them refunds of arbitrage they had overpaid. But it was only after Brown & Wood had argued in the Whitewater Garden case that no provisions for such refunds existed that the IRS issued the temporary rule. And under the rule, the IRS is not obligated to process refund request until Sept. 15.
Both Mr. Rosenberger and Mr. Klaiman said they are sorry the litigation was limited to jurisdictional issues and not extended to the merits of the dispute.
Meanwhile, Mr. Rosenberger said the authority has not decided what action to take in light of Judge Marshall's dismissal of the case. The authority could ask Judge Marshall to rehear the case or it could appeal the case and ask the Ninth Circuit Court of Appeals to overturn her decision. Or the authority could pay the $2.25 million of arbitrage sought by the IRS and file for a refund, he said. It also could try to settle the case with the IRS for a lesser amount.
"We certainly want to keep our communication with the IRS open so we can talk about a potential settlement," Mr. Rosenberger said.
The tax disputes between the IRS and the Riverside county authority and the IRS and Galt focus on the issue date of the bonds.
The IRS contends that because Matthews & Wright Inc., which is no longer in the municipal bond business, purchased the bonds with checks from an undercapitalized credit union, there was no economic substance to the transactions on their closing dates. The bonds were not validly issued until several weeks later, when they were sold to public investors and after the rebate requirements took effect.