WASHINGTON -- A New York Bar Association committee is urging the Internal Revenue Service to issue a notice or ruling as soon as possible assuring the municipal market that the Supreme Court's Cottage Savings decision does not set new standards governing bond reissuance.

In a letter to IRS Commissioner Shirley Peterson, the association's committee on taxation of corporations said the bond market needs to know that in the wake of the Cottage Savings decision, certain minor changes to a bond issue will not make the bonds subject to more restrictive tax laws.

These changes include: de minimis changes in bond yield; elimination or modification of covenants in bond documents; minor extensions in bond maturities; and transactions involving defeasance in which an issuer buys U.S. government securities and puts them in an escrow to defeat, or pay off, bonds over time.

The committee urged Ms. Peterson not to view the Cottage Savings decision as establishing a new "hair-trigger" standard for reissuance under which even the slightest modification to a bond issue would cause the bonds to be re-issued and made subject to the more restrictive tax laws.

"Adopting a hair-trigger rule not only would disrupt legitimate business transactions," the committee told Ms. Peterson, but also would invite inappropriate taxpayer manipulation." Taxpayers would be able to make minor changes in their debt and claim losses while deferring gains, it said.

Instead, Cottage Savings should be viewed as "simply reaffirming the well-established principle that a change of both obligor and collateral will generally result in a reissuance," the committee said.

The committee's letter comes as both Treasury and IRS officials are struggling to develop a position on the Supreme Court's decision last year in Cottage Savings Association v. Commissioner of Internal Revenue.

The ruling dealt with thrifts but touched on an area of the tax code that governs municipal bond reissuance.

The high court's decision in that case -- that thrifts could deduct losses claimed from the exchange of substantially similar pools of mortgages -- found that the loans exchanged by the thrifts were "materially different" because they embodied "legally distinct entitlements." The loans had different obligors and different sources of collateral.

The decision raised questions among some IRS officials and bond lawyers about whether the court was establishing a new standard for the term "materially different" -- a term in section 1001 of the tax code that generally deals with whether a taxpayer has realized losses or gains for tax purposes from an exchange or sale of property as well as with bond reissuance.

However, the committee of New York lawyers told Ms. Peterson that the Cottage Savings decision "did not eliminate the materiality requirement of section 1001; instead it expressly affirmed it." The decision simply established "administrable rules" to determine when certain changes are material, it said.

The committee said the bond market would be disrupted if the IRS interpreted Cottage Savings as establishing a "hair-trigger" standard for reissuance. Such a standard would run counter to a series of rulings published over the years by the IRS as well as some common industry practices, it said.

For example, two private-letter rulings in 1988 and 1989 concluded that de minimis changes in yields of three basis points or less than 12.5 basis points would not cause bonds to be reissued, the committee said.

Revenue ruling 73-160, which the IRS issued in 1973, concluded that if the maturity of a debt obligation is extended without affecting its yield, there is no reissuance. IRS officials have said they are rethinking that ruling. But the committee said that even if the IRS revokes that ruling, "we urge that minor maturity extensions, and extensions resulting from the financial difficulties of the debtor in meeting its obligation at maturity, not cause a reissuance."

In revenue ruling 85-42, the IRS concluded that a defeasance -- in which the issuer puts U.S. government securities in escrow to make debt service payments until the debt can be retired -- does not result in the retirement of the debt for tax purposes even though the collateral changes and the defeasance result in a retirement of the debt for financial purposes.

The committee said that it is not uncommon for covenants in loan agreements to be eliminated or modified to give lenders and borrowers the ability to cope with changed circumstances.

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