Yesterday’s Bond Buyer (a national newspaper focused on municipal bonds) highlighted a concern of the IRS in recent audits of “Build America Bonds” (or, BABs). Some issuers used BAB bond proceeds to pay for the premium to the bond insurance company (that insures that principal and interest payments will be made – even if the issuer fails to do so). Note: The law that allows BABs to be issued has expired, and there is no mention of any Kansas issuers are being audited.
For bonds to qualify as BABs, all of the proceeds except those used to pay cost of issuance and a reasonably required reserve fund must be used for capital expenditures. But the IRS has questioned whether the payment of a premium for bond insurance constitutes a capital expenditure.
IRS audits of BABs show a number of issuers thought their insurance premiums were capital expenditures. Those issuers whose audits were closed without change in status to the BABs were able to avoid IRS concerns by reallocating their proceeds within certain periods of time.
Long-standing tax rules on expenditures for tax-exempt bonds, which also apply to BABs, allow issuers to reallocate how they used their bond proceeds within 18 months of when a bond-financed project was placed in service and no later than five years from when the bonds were issued.
But some BAB issuers may not be able to reallocate their insurance premium payments, the lawyers said.
A number of bond attorneys believe insurance premiums are clearly capital expenditures.
“It seems curious that they’re spending time looking at whether bond insurance on a long-term bond issue is a capital expenditure because it seems clear it is,” said Charles Cardall, a partner at Orrick, Herrington & Sutcliffe LLP in San Francisco. In the corporate bond market, insurance premiums are treated as capital expenditures that are amortized over the life of the debt, he said.
Another bond lawyer said the IRS may take the position that the issuer only gets to capitalize the portion of the premium payment allocable to the construction period.
Read the full story here.