WASHINGTON – The Internal Revenue Service’s Office of Appeals has withdrawn the tax-exempt bond office’s proposed determinations of taxability for nine of eleven of the student loan bond issues issued by the New Hampshire Health and Education Facilities Authority.
The withdrawals were disclosed in an event notice posted Friday on the Municipal Securities Rulemaking Board’s EMMA system. The notice did not state the reasons for them.
This case has been closely watched in the muni market because the authority initially tried to settle the tax dispute under a special voluntary closing agreement for student loan bonds, but then withdrew its settlement request. It didn't want to admit to wrongdoing, as the IRS requested, because it didn’t think it had done anything wrong.
TEB had been concerned about these and other student loan bonds because of “loan swapping,” or reallocating student loans made from one bond issue to another issue. But the authority and its lawyer, Brad Waterman, claimed there was nothing wrong with loan swapping.
The appeals office still maintained that two of the bond issues are taxable for reasons other than loan swapping. The authority made a settlement payment of about $8,500 for a 2011 bond issue to preserve its tax exemption, and the IRS issued a final determination of taxability for a 1998 issue. However, there is no taxpayer exposure for that issue because it would be time-barred under the IRS’ statute of limitations, according to the event notice. Generally the statute of limitations for the IRS to assess taxes on a taxpayer is three years from the due date or filing date of the return.
The authority had submitted a request to the IRS to settle the tax dispute under the student-loan VCAP in July 2012. Earlier that year the IRS announced a special VCAP for student-loan issuers in Announcement 2012-14. The special VCAP was established after the Pennsylvania Higher Education Assistance Agency paid $12.3 million to preserve the tax-exempt status of its student loan bonds.
In the announcement for the VCAP, the IRS said that some student loan issuers reallocated loans made, or acquired with the proceeds, of one issue to another issue. “The issuers were unable to establish the bond issues to which the student loans were properly allocable as purpose investments and, as a consequence, the issuers could not establish that the bond issues involved were other than issues of arbitrage bonds,” the IRS said.
Treasury Department regulations state that the yield on student loans cannot be more than two percentage points higher than the yield on related bonds.
Under the special VCAP, issuers could settle the tax disputes for an amount that was equal to the sum of 40% of the taxpayer exposure on each affected bond issue and the excessive arbitrage profit on the bonds from the issue date to the start of the first year included in the calculation of taxpayer exposure. Bond lawyers said at the time of the announcement that the formula was too costly.
There were 15 requests for settlements under the special VCAP. Those cases accounted for the vast majority of the nearly $67 million in VCAP settlement amounts collected in the federal government’s 2013 fiscal year, according to TEB director Rebecca Harrigal. The authority’s VCAP request pertained to $720 million of student-loan bonds from a total of 11 issues sold from 1998 to 2011. Two of the issues were issued by the authority when it had a different name. The authority issued the bonds on behalf of the New Hampshire Higher Education Loan Corp., which used the proceeds to acquire student loans.
All of the bond issues were redeemed by 2011 with the exception of the bonds issued in 2011. That issue was deemed to have been reissued and thus redeemed for tax purposes in 2014, according to the event notice.
The authority requested the VCAP despite the fact that the corporation believed that loan swapping complied with federal tax requirements, the event notice stated.
The authority and the corporation were prepared to make the settlement payment sought by TEB. But the issuer, conduit borrower and IRS ultimately were unable to negotiate an agreement because the IRS wanted the authority to admit that loan swapping violated Treasury regulations. The authority withdrew its request for a VCAP settlement in June 2013.
“Loan swapping was undertaken to facilitate administration and otherwise conserve resources and to ensure that issuers and conduit borrowers received the full amount of the reimbursement allowed for the cost of administering student loan programs on behalf of the federal government,” said Waterman, who represented the corporation as well as the authority. “Loan swapping did not deprive the federal government of revenue to which it was entitled. TEB did not explain in Announcement 2012-14 or elsewhere why it believed otherwise. In any event, its general assertion to the contrary clearly was incorrect."
Several weeks after authority withdrew its VCAP request, the IRS started auditing the bonds. In November 2013, the IRS issued notices of proposed issue in which it stated it believed the bonds “violate one or more of the requirements for interest to be excluded from gross income of the bondholders.” The notices explained that TEB was concerned about the loan-swapping.
The NOPIs stated that if the authority disagreed with the IRS’ position, it could request a conference with an IRS supervisor by Dec. 26, 2013. Waterman requested a conference in a letter dated Dec. 20, 2013. However, two days earlier, TEB issued a notice of proposed adverse determination that found that the bonds were taxable and incorrectly stated that the authority’s representative had notified the IRS that it would not provide a written response to the NOPIs, according to the event notice.
The authority responded to the proposed adverse determination by requesting a review by the appeals office. The withdrawals and other actions were the result from that review.
Tom Vander Molen, a partner at Dorsey and Whitney who was not involved in the case, said that “it is good to see appeals exercising its independent judgment on a tax-exempt bond matter” and providing an opinion that is different from TEB’s. For the system to work, the appeals office can’t always agree with TEB. In this case, the appeals office didn’t request any payment from the authority for most of the bond issues, he said.
