WASHINGTON -- A U.S. District Court judge in California issued a temporary restraining order that prevents the Internal Revenue Service and the Treasury Department from either collecting arbitrage profits from the $17.5 million Whitewater Gardens black box bond deal or revoking the tax-exempt status of the bonds.
Judge Consuelo B. Marshall of the U.S. District Court for the Central District of California in Los Angeles, issued the order late Friday at the request of the Riverside County Housing Authority and its lawyers.
The judge also scheduled a hearing for July 1 to consider the authority's request for a preliminary injunction that would bar the IRS and the Treasury from applying arbitrage rebate requirements to the Whitewater Gardens bonds.
Judge Marshall gave the IRS and the Treasury until noon, June 27 to show why such an injunction should not be issued. And she gave the Riverside authority and its lawyers until 3:30 p.m., June 28 to respond to the government's arguments. U.S. attorneys representing the IRS said yesterday that they plan to meet the June 27 deadline.
Several IRS officials said yesterday that the judge's action appears to be the first time a temporary restraining order has been issued to block the service from taking enforcement action against a municipal bond issue.
"It's very rare that a [temporary restraining order] is issued in a tax case. I don't think there's ever been one before. But then again, how many bond issues have we ever tried to tax," one official said.
Federal law, the official noted, generally prohibits taxpayers from suing the IRS to prevent the collection of taxes. But the Riverside authority argued in documents filed with the court last week that arbitrage is not a tax.
In making a plea for the court to hear the case, the authority said that because arbitrage is not a tax, it did not have the traditional remedies available in a tax dispute -- paying the tax and suing for a refund in a U.S. district court or filing a suit in the U.S. tax court.
Lawyers with Brown & Wood, the firm representing the authority, were elated yesterday at winning the temporary restraining order but cautioned that the real battle will come at the hearing on July 1.
"It's nice to win one. But this is only the first step," said Henry S. Klaiman, a partner at Brown & Wood. "We just want to get into court and fight them on the substantive issues," he added.
The IRS has charged that the Whitewater Gardens multi-family housing bonds are subject to the arbitrage rebate requirements because they were not validly issued until after those requirements took effect.
The IRS had notified the Riverside Housing Authority that it would revoke the tax-exempt status of the bonds if $2.25 million of arbitrage profits from the deal were not rebated to the government by June 14. The bonds are still outstanding and are not due to be redeemed until Dec. 1, 1993.
The authority and its lawyers, however, claim in documents filed with the court last week that the bonds were validly issued on Dec. 31, 1985, because that was when they were purchased with a check. Under IRS rules and relevant case law, they said, bonds are "issued" when they are exchanged for a check regardless of whether that check is backed with sufficient funds.
Whitewater Gardens is one of 26 deals totaling $1.3 million that Matthews & Wright, the former municipal bond underwriting firm, closed without cash during the mid-1980s in a rush to market to beat the arbitrage rebate restrictions, which were then pending in Congress. In these deals, Matthews & Wright purchased the bonds with a check from an undercapitalized credit union and then temporarily warehoused them with an unlicensed, offshore shell bank, not selling them for cash to public investors until many weeks after the closings. Matthews & Wright is no longer a municipal underwriter.
The Riverside authority told the court last week that it relied on the bond firms participating in the Whitewater Gardens deal and had no reason to question the validity of the closing because the proceeds from the underwriting ultimately were received by the trustee and used, in part, to purchase land for the project. The housing projcet never was completed, it said, because of a sewer problem. The arbitrage profits were used to cover fees and were not retained by the authority, it said.
The authority told the court it would suffer "irreparable harm" if the IRS forced it to rebate arbitrage or taxed the interest earnings of its bonds. The IRS, on the other hand, would "suffer virtually no harm" if blocked from collecting the arbitrage or taxing the bonds' interest, the authority said.