WASHINGTON — The Internal Revenue Service plans to ask issuers of negotiated Build America Bond transactions, in a revised “compliance-check questionnaire,” if any investors who bought their bonds in the primary market paid more than the price the bonds were initially offered at.
The IRS also will ask the issuers to provide summaries of the underwriters’ explanations for any prices paid above the initial offering price. And it will ask if the underwriters certified in writing that each maturity of a BAB issue was offered to the public “in a bona fide public offering … at the initial offering price” as well as if any of the bonds were purchased by affiliates or affiliated accounts of the dealer.
The questions appear in a revised compliance-check questionnaire released late Wednesday by the IRS as part of its efforts to increase scrutiny of BABs, for which the government makes subsidy payments to issuers equal to 35% of the interest costs.
Steve Chamberlin, manager of the IRS tax-exempt bond office’s compliance and program management section, said the agency does not plan to send the questionnaire to BAB issuers until it gives market participants a chance to see if they understand the questions or need clarifications. The IRS might not begin sending it out to BAB issuers until late June, he said.
Chamberlin and George Gurrola, a TEB tax specialist, said yesterday that the responses to the questionnaires, along with information from the Municipal Securities Rulemaking Board’s Electronic Municipal Market Access system and other sources, will be used to determine the criteria for audits of up to 50% of all BABs issues.
“We’re going to be auditing up to potentially half of all transactions, but we haven’t decided on the exact amount,” Chamberlin said.
The TEB office has put together a seven-person “cross-functional team” from compliance and program management as well as field operations. It will gather information about BABs and make recommendations to senior management about how many audits should be conducted and what they should entail, he said.
Chamberlin and Gurrola stressed during an interview Thursday that there is no tax law requirement for issuers to research EMMA to obtain BAB pricing data.
“What is a tax law requirement is that the issue price be set properly as defined in the regulations,” Chamberlin said. “And the proper setting of the issue price is fundamental to us for a whole slew of tax law requirements,” including that BABs not be sold at more than a de minimis amount of premium.
“EMMA is a fantastic tool to use to see if all of your bonds were, in fact, sold to the public at the initial offering price,” Chamberlin said. The initial offering price is the price stated on the official statement and the price at which the underwriter sells the bonds in the primary market.
IRS officials say they are seeing BAB prices go up during initial offerings. They are concerned about whether issuers are violating the de minimis premium restriction. They also want to make sure the government is making the lowest subsidy payments possible. BAB subsidy payment rates are equal to 35% of interest costs. The higher the BAB price, the lower the yield. Lower interest rates would mean the IRS could make lower subsidy payments.
Market participants say underwriters are responsible for selling bonds to the public at the initial offering price, but cannot ensure investors will buy them at that price.
But Gurrola said: “If they’re not willing to buy them at that price and the price goes up, you might ask yourself why were they not willing to pay less … You would think that if you can’t sell them at the initial offering price, the prices would go down.”
Issuers and bond lawyers have complained they do not have the expertise to check EMMA for pricing irregularities.
But Chamberlin and Gurrola said it is not difficult. “When you run through and identify all of the trading data for particular Cusip or bond issue, it is possible to extract that data into an Excel spreadsheet, run a data sort, and isolate all of the trades,” Chamberlin said. “You can actually sort them in a couple of different ways to isolate what appear from the trading data to be the primary sales of the bonds. You can pretty quickly tell how many were sold at the initial offering price in initial purchases.”
The two IRS officials have asked issuers and their advisers to pay attention to whether BAB prices are trending upward in initial offerings of the bonds; some of the bonds are sold to the underwriter, its affiliates, or for its affiliated accounts; or dealers are purchasing some of the bonds and then offering them to customers at prices above the initial offering price.
Some market participants contend the IRS is using issuers to try to pressure the underwriters on BAB prices.
“That’s a funny thing about issue price — it’s always going to be dependent on information that someone gives the issuer,” Gurrola said.
“At its core, the IRS is looking at … tax compliance,” Chamberlin said. “We look to the taxpayers for information and the issuers are the taxpayers. In many instances, the taxpayer has to look to other sources to get information they can use to substantiate their compliance with tax requirements. This is not unique to municipal bonds.”