On Wednesday the Internal Revenue Service issued a notice of proposed adverse determination to the Port of Port Arthur Navigation District of Jefferson County, Texas, indicating that a 2017 $55 million bond issuance will be considered taxable, though attorneys caution that such situations nearly always resolve without impact to the investors.
According to the notice posted on EMMA, the infraction is related to “alleged noncompliance with requirements of Section 149(g) of the Internal Revenue Code, which prescribes certain expectations for the timely expenditure of tax‐exempt bond proceeds.
In the same notice, which is not a final determination, the port says it “believes it has complied with the applicable provisions of the federal Internal Revenue Code and intends to defend its position.” Issuers have 30 days to make a request for an administrative appeal of its case.
Section 149(g) was added to the tax code by the Omnibus Budget Reconciliation Act of 1989 and is designed to discourage municipalities from taking advantage of low interest rate for ill-defined uses while the excess debt remains shielded from taxes.
According to the IRS “Prior to 149(g), municipalities could issue bonds when interest rates were low, even though there was not an immediate need for financing. Congress viewed this practice as a drain on the federal treasury because the bonds were outstanding longer than necessary.”
Rich Moore, a tax partner at Orrick, Herrington & Sutcliffe points out that the devil is in the details of expectations about spending the money.
“The law is not that expenditures have to occur within a certain time frame. The law is that, as of the issue date, the issuer had to reasonably expect to spend the proceeds within a certain time frame, generally 85% of the proceeds within three years of the issue date.”
Expectations and reality can be complicated by the reasons behind spending delays which can include supply chain issues, labor disruptions, litigation about the project and the inability to get approvals.
“All of the same sorts of hassles that go into any construction project, but often at a much grander scale given the scope of projects often financed with tax-exempt bonds,” said Johnny Hutchinson, partner, Nixon Peabody LLP.
The rule has a complicated history among tax attorneys who believe that in the past the IRS was sometimes over aggressive when analyzing the issue by applying 20/20 hindsight to the reasonableness of the issuer’s expectations. Debate about cases can come down to judgment calls about whether the issuer had the correct reasonable expectations at closing.
Hutchinson says the counter move is diligent bookkeeping. “Our advice is always to ‘build the record’ to gather and preserve all the facts and documents from the time of issuance to show what their expectations were. I’m sure that’s what the issuer did here and that’s how they’ll return fire.”
In July the Government Finance Officers Association awarded the port with a Certificate of Achievement for Excellence in Financial Reporting.
Despite the anxiety of the ruling by the Treasury, Moore predicts minimal pain to investors in the outcome. “These matters almost always are resolved via a settlement between the IRS and the issuer that does not involve taxation of bondholders,” he said.
Judy Bettis, Port of Port Arthur’s chief financial officer could not be reached for comment.