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NABL Group Poses Tax-Credit Guidance

WASHINGTON - A group of bond attorneys specializing in tax matters has offered the Treasury Department several points to consider on forthcoming muni bond tax guidance, particularly how tax credits should be "stripped" from tax-credit bonds and sold separately.

The group - an executive committee of the National Association of Bond Lawyers - made the suggestions in a five-page letter sent recently to John J. Cross 3d, Treasury's associate tax legislative counsel.

Frederic J. Ballard of Ballard Spahr LP, Scott Lilienthal of Hogan & Hartson LLP, and Perry Israel, who has his own firm in California, addressed technical issues dealing with tax-credit stripping, as well as the definition of a refunding and the determination of issue price for Build America Bonds. But they stressed that their points should be seen "as a basis for discussion rather than as specific recommendations for action."

"Rather than telling them what they ought to do, we're trying to give them the ideas that we've seen in various areas that are current today," Ballard said.

"What we know is that there's sort of a really short time frame for Treasury to address these points, and so what we wanted to do is basically pass along to Treasury, John Cross and others, what our thoughts have been," Israel said.

Congress authorized the stripping of tax credits for tax-credit bonds last summer, inserting a provision into farm legislation. Lawmakers reasoned that stripping would broaden the pool of investors for municipal issuers to include those interested in tax credits as well as those interested in taxable debt. Although Treasury officials have said the stripping guidance is a high priority for the muni market, its complexities have delayed its release.

The lawyers suggested that the initial guidance on stripping focus on straightforward deals with fixed interest credits. Furthermore, they said that Form 8912, which taxpayers file with the Internal Revenue Service to declare credits from tax-credit bonds, could be applied to stripped credits with minor modifications.

The allowance of the credit, stripped or unstripped, should rely on the issuer's compliance with the tax code, regardless of whether there is a default on interest payments, they said.

The attorneys suggested regulations require that the issuer or "middleman" be responsible for reporting the credit on Form 1099 - an information return for reporting miscellaneous income. However, issuers should be given the option of contracting out this obligation, they said.

The regulations could state that a credit would only be accepted if it is reported on Form 1099, but this would make it harder to sell them since the credit purchaser would either run the risk of the issuer failing to file the form, or would have to assume the burden of filing it themselves, the lawyers said.

These suggestions could also apply to tax-credit BABs, but not the more common direct-pay BABs, or the related recovery zone economic development bonds, which also include a cash subsidy component, the group said.

The lawyers noted that the American Recovery and Reinvestment Act provides several incentives for issuers to refund bonds, such as a "holiday" from the alternative minimum tax for bonds issued in 2009 or 2010. However, during the auction-rate crisis of last year, the Treasury offered interim guidance stating that an exchange of old bonds for new bonds with no significant modification of the terms will be treated as a single continuing issue as opposed to a reissuance.

In order to ensure that guidance does not accidentally prevent issuers from refunding outstanding bonds to take advantage of ARRA programs, the lawyers suggested a regulatory provision clarifying how issuers can be certain they are refunding old debt.

They suggested language stating that issuers can use bond proceeds to redeem outstanding debt and that the transaction will be treated as a refunding if the new bonds are issued in a bona fide public offering that is not limited to the holders of the prior bonds, or if the bonds are placed with a purchaser that is not a holder of the prior bonds or a related party.

The lawyers also tackled how issuers should determine issue price for BABs. The ARRA's language establishing the BAB program refers to a section of the tax code that specifies how to determine issue price. But Treasury regulations also define the issue price for tax-exempt bonds and the lawyers want to know if these rules apply to Build America Bonds even though they are taxable

Both the code and the rules are helpful on this issue and should apply to BABs, according to the lawyers.

The law states that a bond will not be treated as a BAB if the issue price has more than a de minimis amount of premium over the stated principal, and the relevant tax code sections define the de minimis amount to be 0.25% times the number of years to maturity.

The rules state that the bonds are issued when a "substantial" amount have been sold to the public and define substantial to mean 10% of the total amount issued.

The lawyers suggested this problem could be addressed by publishing a temporary measure that would effectively state that, pending further study of the Treasury regulations defining issue price, the issue price of BABs shall not be greater than the amount determined by those regulations, minus the pre-issuance accrued interest. BAB issuers could still turn to the tax code for definitions of de minimis, they said.

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