WASHINGTON - Will the new arbitrage rules make it tougher for the Internal Revenue Service to target abusive bond deals?
That's the question that Dean M. Weiner, a lawyer at O'Melveny & Myers, asked a group of lawyers and federal regulatory officials at a meeting of the American Bar Association's committee on tax-exempt financing in New York City earlier this month.
Weiner, who chaired the committee until late spring, wanted to know if the new arbitrage rules would prevent the IRS from concluding that bonds are taxable arbitrage bonds before they mature. Under the new rules, issuers whose bonds are still outstanding can always lower their investment yield by acquiring lower-yielding investments or by making yield reduction payments to the federal government, he said.
Bonds generally are taxable arbitrage bonds if the proceeds are used to acquire higher-yielding investments or if the proceeds are used to replace other funds that were used to acquire higher-yielding investments.
But the new arbitrage rules, which generally took effect for bonds issued after June 30, would permit issuers to lower their investment yield by acquiring lower-yielding investments and blending the yields of their separate investments.
The rules also allow issuers, in some cases, to lower their investment yields by making yield reduction payments to the federal government.
Weiner did not get much of a response at the meeting.
But most bond lawyers and federal regulatory officials interviewed since then reject the idea that the new rules will hamper the IRS' enforcement ability.
"I think the anti-abuse rules are sufficiently broad and tough that they would eliminate the ability to blend investment yields or make yield reduction payments in a transaction that overburdens the tax-exempt bond market, " said one federal official.
A transaction that overburdens the market is one in which bonds are issued in a greater amount, earlier, or for a longer term, than necessary.
The new rules, in fact, prohibit issuers whose tax-exempt bond issues would overburden the municipal market from blending the yields of their investments or making yield reduction payments to the government.
Several of the lawyers said also that the new arbitrage rules do not permit issuers to make yield reduction payments for some transactions, such as advance refundings.
In addition, they said, issuers have always been able to blend the yields of their investments under arbitrage rules, except for a brief period between 1989 and 1992. At that time, temporary arbitrage rules restricted issuers from blending the yields of different investments.
The ability to blend investment yields in the past did not make it difficult to target abusive transactions, they said.
William Loafman, a lawyer with Whitman & Ransom in New York City who currently chairs the American Bar Association's tax-exempt financing committee, noted that general tax law principle would prevent bond market participants from using yield blending or yield reduction payments to skirt tax law violations.
"There's a general principle in tax cases that says generally that people are not allowed to go back and fix something when they get caught." Loafman said.