WASHINGTON -- The Internal Revenue Service was told by issuers and bond lawyers this week that its proposed reimbursement rules are overly restrictive and should be substantially revised or withdrawn and rewritten.

Associations representing the issuers and lawyers, in comments filed with the IRS, all said the proposed rules would be troublesome, costly, and in some cases unworkable for state and local governments. Most of the groups urged that the rules be simplified so they are more in line with existing reimbursement rules for private-activity bonds.

The purpose of the rules, which were proposed by the IRS last April primarily for governmental and 501(c)(3) issues, is to help draw the line between a legitimate use of tax-exempt bonds to reimburse for prior expenditures and an abusive, arbitrage-driven bond transaction.

The rules, scheduled to become effective for bonds issued after Sept. 7, are supposed to clarify when the proceeds of a reimbursement bond financing can be treated as spent so that they are no longer subject to arbitrage restrictions. In a legitimate reimbursement deal, the proceeds are treated as spent as soon as the bonds are issued and can be invested on an unrestricted basis.

Many of those who commented complained the rules were so restrictive that they would complicate, rather than clarify, reimbursement bond issuance.

Two issuers' groups -- the Government Finance Officers Association and the National Association of State Treasurers -- said the rules do not take into account the accounting systems or financial planning and budgetary practices that currently exist among state and local governments.

The GFOA said the rules were "fundamentally flawed" and "overly intrusive" and warned "they could have a profound impact on governmental units by requiring changes in practices that will impose new and unnecessary burdens on these governments."

All the groups said the proposed rules were clearly written and very readable. They praised the Treasury Department and the IRS for soliciting input and said they believed the rules were well-intentioned.

"Given these circumstances," the GFOA said, "we are surprised and dismayed by the over regulation of state and local government financial planning and budgetary practices embodied in the proposed reimbursement rules."

All the groups said they understood the need for guidance on reimbursement financings, but said the proposed rules are overly restrictive.

"While clarification of the 'reimbursement problem' is desirable, it is not a problem requiring some 40 pages of regulations which include no less than 12 separate tests to be satisfied in order for compliance to be achieved," said the American Bar Association's Committee on Tax-Exempt Financing.

Most of the respondents complained that the proposed rules are far more restrictive thatn the long-standing rules that apply to private-activity bonds.

The private-activity bond rules say a reimbursement financing is legitimate if there was an "official action" sanctioning the bond financing before the expenditures were made and if the bonds were issued within a year of when the facility being financed was put into service.

The proposed rules for governmental and 501(c)(3) bonds, however, contain four basic requirements. The issuer must declare a "reasonable official intent" to reimburse. That intent generally must be declared within the two-year period before expenditures are made. The reimbursement must occur either one year after the expenditures were made or one year after the facility being financed was placed in service, whichever is later. The expenditure being reimbursed must also be used for property that has a "reasonably expected" economic life of at least one year.

But the proposed rules go further than these basic requirements, saying for example, that the declaration of intent should describe the facility being financed and identify the sources of funds that will be used to pay the expenditures to be reimbursed.

"There can be no justification for saddling governmental issuers with rules that are more stringent than those applying to certain private-activity bonds," the GFOA said.

The National Association of Bond Lawyers recommended that the proposed rules "be significantly simplified" so they are more in line with the "format and approach" of the private-activity bond reimbursement rules.

One of the most troubling requirements of the proposed rules was that the declaration of intent be consistent with the "budgetary and financial circumstances of the issuer."

The GFOA said this requirement "is extremely overreaching" and worried it would become "a dangerous precedent" for restricting tax and revenue anticipation note financings. The NABL said that while Treasury officials have said the rules do not require issuers to be "broke to borrow," the proposed rules "come very close to doing just that."

The groups were also concerned that the rules, because of the tracking that will be required, will be unworkable for state and local governments that sell large bond issues to finance many projects at one time.

The National Association of State Treasurers complained that the proposed rules "assume that states maintain their records on a project-by-project basis" and said "this is not true for most states.

"It is illogical to assume that states need to change their systems and budgetary practices merely to accommodate compliance with the regulations covering reimbursements," it continued.

The issuers' groups were extremely upset by the proposed rules' "controlled group" concept, under which an issuer could not use bonds to reimburse if an entity within its "control group" has other funds available. The GFOA, the treasurers association, and some of the other groups called this concept unworkable.

Many of the commenters asked the Treasury and the IRS to postpone the Aug. 8 public hearing and the Sept. 7 effective date so the rules could be reworked.

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