On October 26, 2018, the IRS released a memorandum from its Office of Chief Counsel, confirming that issuers may issue tax-exempt bonds to advance refund taxable bonds without running afoul of the prohibition on tax-exempt advance refundings contained in the Tax Cuts and Jobs Act. The release of the memorandum follows the request in March by the National Association of Bond Lawyers for guidance on this issue, following public statements earlier in the year by IRS and Treasury officials in favor of the approach.
Chief Counsel Advice Memorandum No. 201843009 was addressed to the use of tax-exempt bonds to advance refund a prior issue of tax-advantaged Build America Bonds. However, the conclusion reached in the memorandum relied on the fact that there will not be two sets of tax-advantaged bonds outstanding for the same project or activity. The author noted that the tax advantaged bonds that were to be advance refunded were legally defeased upon the issuance of the refunding bonds, through the establishment of a defeasance escrow which provided the sole source of security for the refunded bonds following the issuance of the refunding bonds. Upon such defeasance, the author noted, the tax-advantaged bonds were reissued for tax purposes, and consequently lost their tax-advantaged status.
Thus, upon the issuance of the advance refunding bonds, there was only one issue of tax-advantaged bonds outstanding – the advance refunding bonds. The transaction therefore was properly analyzed under section 1.149(d)-1(e), which provides that an advance refunding of a taxable issue is not taken into account unless that taxable issue is a conduit loan of a tax-exempt conduit financing issue. This regulation, which prior to the enactment of TCJA was intended to exempt such advance refundings from the otherwise applicable “one advance refunding” limitation, can be read as exempting from TCJA’s advance refunding prohibition tax-exempt advance refundings of taxable issues.
While lacking the weight of a formal regulation on the topic, the memorandum should resolve any lingering questions about issuers’ ability after the January 1, 2018 effective date of the Tax Cuts and Jobs Act to issue tax-exempt bonds to advance refund a prior issue of taxable bonds, including taxable, tax-advantaged bonds, so long as the tax-advantaged bonds lose their status as such at the time of the issuance of the refunding bonds.
However, Issuers should take care not to go beyond the limited circumstances expressed in the memorandum. For example, issuers may not issue taxable bonds to advance refund a prior, non-callable tax-exempt issue, and then refund those taxable bonds with a series of tax-exempt bonds (regardless of their characterization as advance refunding or current refunding bonds). In such a case, the prior, non-callable tax-exempt issue would remain outstanding, and therefore there would be two tax advantaged issues of bonds outstanding at the same time for the same project or activity. In general, any strategy employed to avoid TCJA’s prohibition on advance refundings may be disallowed by the IRS. In all cases, issuers should consult experienced bond counsel for advice on these issues prior to embarking on an advance refunding transaction.