Last week’s NABL Tax and Securities Law Institute included a discussion featuring John Cross (Associate Tax Legislative Counsel – Treasury) and Vicky Tsilas (Chief Branch 5 — IRS General Counsel’s Office) of whether tax-exempt bonds can be issued to advance refund taxable bonds, including build America bonds (BABs) despite the prohibition of tax-exempt advance refundings by the 2017 tax legislation. The prohibition, set forth in Internal Revenue Code (Code) section 149(d)(1), states: “Nothing in section 103(a) or in any other provision of law shall be construed to provide an exemption from Federal income tax for interest on any bond issued to advance refund another bond.” The Code provides that “[t]he term ‘bond’ includes any obligation.” Code section 150(a)(1). Thus the question is whether a taxable bond is a “bond” as that term is used in the advance refunding prohibition. BABs are included in the question because interest on BABs is included in gross income under Code section §54AA(f)(1). So with this statutory backdrop, can tax-exempt bonds be issued to advance refund taxable bonds?
Before getting to the analysis and the statements of Ms. Tsilas and Mr. Cross, several regulations must be added to the list of relevant authorities. First, Reg. 1.150-1(b) defines “bond” as “any obligation of a State or political subdivision thereof under section 103(c)(1).” “Obligation” is defined as “any valid evidence of indebtedness under general Federal income tax principles.” Id. Finally, the regulations interpreting the former statutory rule generally permitting only one advance refunding state:
(e) Taxable refundings —
(1) In general. Except as provided in paragraph (e)(2) of this section, for purposes of section 149(d)(3)(A)(i), an advance refunding issue the interest on which is not excludable from gross income under section 103(a) (i.e., a taxable advance refunding issue) is not taken into account. In addition, for this purpose, an advance refunding of a taxable issue is not taken into account unless the taxable issue is a conduit loan of a tax-exempt conduit financing issue.
(2) Use to avoid section 149(d)(3)(A)(i). A taxable issue is taken into account under section 149(d)(3)(A)(i) if it is issued to avoid the limitations of that section. For example, in the case of a refunding of a tax-exempt issue with a taxable advance refunding issue that is, in turn, currently refunded with a tax-exempt issue, the taxable advance refunding issue is taken into account under section 149(d)(3)(A)(i) if the two tax-exempt issues are outstanding concurrently for more than 90 days.
Reg. 1.149(d)-1(e) (emphasis added).
The concern as to whether tax-exempt bonds can still be issued to advance refund taxable bonds can be stated simply: Because the definition of bond in the Code and regulations does not limit the term to tax-exempt bonds, but includes any State or local evidence of indebtedness under general Federal income tax principles, the prohibition of tax-exempt advance refundings in the 2017 tax legislation might extend to tax-exempt advance refundings of State and local taxable bonds.
Fortunately, however, at the Tax and Securities Law Institute last week, John Cross and Vicky Tsilas strongly expressed the opposite conclusion, i.e., that tax-exempt bonds can be issued to advance refund taxable bonds. They extend this conclusion to BABs provided the federal payments associated with the BABs are terminated.
Mr. Cross reasoned that the Section 149(d) regulation quoted above, which generally excludes a tax-exempt advance refunding of a taxable bond from the former tax-exempt advance refunding limitation, survives the statutory revisions to Code Section 149(d) despite the elimination of the statutory provision (Code section 149(d)(3)(A)(i)) referenced in that regulation. The intent of the former one-advance-refunding rule was to limit, and of the new prohibition is to eliminate, the opportunity for multiple issues of tax-exempt bonds financing a single project to be outstanding for Federal income tax purposes simultaneously for an extended period. This policy objective is reflected in the anti-abuse provision of the regulation – that an advance refunding involving taxable bonds is generally counted against the limitation of advance refundings under prior law only if multiple tax-exempt issues for a project are outstanding simultaneously for more than 90 days. This policy is not violated by a tax-exempt advance refunding of a taxable bond. As for any concern arising from the technical wording of the statute – namely, the prohibition against any tax-exempt advance refunding of a “bond” – Mr. Cross observes that the Code and regulations often do not explicitly limit the term bond to tax-exempt bonds, but such a limitation should be inferred when appropriate to further the obvious policy behind the provision. For all the foregoing reasons, Mr. Cross and Ms. Tsilas conclude that tax-exempt advance refundings undertaken today are permitted under the new statutory prohibition against tax-exempt advance refundings.
As for the refunding of BABs, Ms. Tsilas and Mr. Cross apply the same logic as long as the federal payments for the BABs are terminated. In the view of Treasury and IRS, as informally set forth in Chief Counsel Advice Memorandum Number AM 2014-009 (available here), this can be done by a legal defeasance and resulting reissuance of the BABs, although we and many others have questioned whether a legal defeasance of a BAB (or any other form of direct payment subsidy bonds) results in a reissuance (discussed here). Further, Mr. Cross described forthcoming remedial action guidance for BABs that will instruct issuers how to voluntarily waive the federal payments for BABs. The waiver to be described will not be limited to the remedial action but could also be used to facilitate tax-exempt advance refunding of BABs.
When asked previously and at last week’s Tax and Securities Law Institute whether guidance would be issued reflecting the above positions, Mr. Cross responded that these conclusions are sufficiently clear under the Code and regulations and no further guidance is necessary. While this may be the case, the fact that this question has repeatedly been asked of Treasury and the IRS reflects a desire for such guidance, which could be satisfied by a brief notice or other announcement reflecting these conclusions. We at Squire Patton Boggs join with others in requesting this confirming guidance.