Tribal Bonds

Much of the $50 billion in unmet capital need in Indian Country is due to restrictions imposed on tribal access to the capital markets, specifically the ability of tribal governments to issue tax-exempt debt.

In April, 2006, researchers from the Tribal Finance Information Clearinghouse met with officials and researchers from the Tax-Exempt Bond division of the Internal Revenue Service to discuss the issue of tribal tax-exempt bonds. Recent enforcement activity by the IRS had created the perception in Indian Country that the IRS was being overly aggressive against tribal issuers relative to their state and local counterparts.

The preliminary research results arising this meeting indicate that the audit hazard rate for tribal bonds in only their first four years after issuance is more than an order of magnitude greater than the lifetime hazard rate for state and local government bonds.

Only approximately 1% of the more than 15,000 tax-exempt municipal offerings are audited by the IRS each year, but direct tribal tax-exempt bond indentures have a 25% risk of being audited during their lifetime,¹ and have a 12.5% chance of being audited during their first four years.² Additionally, 100% of tribal conduit issuances have been or are currently being challenged by the IRS . The ambiguity of the statute has led to a number of IRS enforcement actions likely taken only against tribes. In at least one instance, the IRS Chief Counsel's office recommended against the enforcement action because of the weakness of the IRS position (see the Field Service Advice memorandum, including the two redacted paragraphs in which counsel advises against enforcement). If the perception exists that tribal bonds are suspect to greater IRS scrutiny, tribes operate at a disadvantage in the market place.

Unfortunately, a much greater audit risk is only one of many ways in which tribal debt is adversely treated. Section 7871 of the Internal Revenue Code requires tribal tax-free bond proceeds to only be used for “essential governmental functions,” a restriction not applicable to state and municipal bonds. Section 7871(e) further limits the scope of available tax-exempt bonding authority by stating that “the term ‘essential government function’ shall not include any function which is not customarily performed by State and local governments with general taxing powers” without providing any guidance as to when a particular activity becomes “customary” for a municipal government. Some activities routinely funded through tax-exempt bonds by municipalities are not permitted or face greater scrutiny when attempted by tribes.

These restrictions have severely limited tribal abilities to access the capital markets, and although American Indians make up more than 1.5% of the population, tribes issued less than 0.1% of the tax-exempt bonds between 2002 and 2004. These restrictions harm the poorer tribes the most, as the differential between tax-exempt and taxable interest rates often determines the feasibility of a project.

When the capital markets face uncertainty, their logical response is to charge a price premium. The ambiguity in the statute coupled with the IRS 's extreme interpretation of that statute causes such uncertainty, and results in higher interest rates for tribal projects. Additionally, IRS actions have effectively destroyed the market for tax-exempt conduit bonds for tribal projects, even if those projects could have been financed by other conduit borrowers.

As reported in Indian Country Today (6-30-06, 6-9-06), Dr. Gavin Clarkson's analysis of IRS data suggests that the audit hazard risk for tribal bonds was far greater than for other similar projects funded by tax-exempt bonds issued by state and local governments. The IRS claims that actual audit risk for tribal bonds was far lower. Much of the apparent difference is a function of Section 103(c) of the Tax Code that treats all obligations as “bonds” even if they are bank loans, finance leases, or installment purchases, or bond indentures. This treatment is the same for tribal debt under Section 7871(c) of the tax code. Thus, while the debt markets differentiate substantially between bank debt and bond indentures, the Tax Code does not.

To counteract the factors that constrain tribes from tapping capital markets effectively, tribes and their supporters in the academic and policy-making communities need a more thorough understanding of modern tribal finance marketplace and the magnitude of the economic harm imposed on Indian Country by the Tax Code. Not only are tribes at an informational disadvantage, but credit insurers and rating agencies also cannot form a complete picture of the tribal finance market. Thus, tribes must pay a significant penalty on tribal financings because of the uncertainty due to the lack of data. Data generated during our research will provide empirical support for ongoing efforts by the NCAI and others working to remove these barriers through legislative and regulatory changes. All tribes will benefit if issuing tax-exempt debt becomes cheaper, easier, and subject to less ambiguity and risk of IRS enforcement action.

Changing the equation: Using IRS data to help tribes

As governments, when tribes enter issue debt obligations they are required by the IRS to file Form 8038G (Information Return for Tax-Exempt Governmental Obligations). If the obligation is for an amount less than $100,000, tribes use a Form 8038GC (Information Return Small Tax-Exempt Governmental Bond Issues, Leases, and Installment Sales).

With the assistance of tribal leaders and decision makers our research team will document the economic harm to Indian Country and compel changes in the law and agency rules. Making this case requires a comprehensive understanding of the market for tribal tax-exempt bonds in order to make comparisons with non-tribal issuers and demonstrate the differential treatment

The assistance we need is permission for our research team to access each 8038G and 8038GC forms filed by a tribe. The only information collected on the 8038 form series relate to the specific tax-exempt bond and a indication of which general type of activity it funds (e.g., housing, public safety).

Unlike many other IRS forms tribes must file, neither the 8038G nor the 8038GC include financial information about a tribe or its various governmental and business operations. There is no information about the financial operations of the tribe, its market position, revenue and expenses, etc.

By aggregating the data that are included on the form, it will be possible to demonstrate empirically what economic harm to tribes, if any, is caused by the treatment of tribal debt under the law or due to IRS enforcement.

There are three ways by which a tribe can make available their 8038 filings.

1. Mail copies of all 8038 forms filed by your tribe.
   

   	Tribal Finance Information Clearinghouse
   	Dr. Gavin Clarkson 
   	University of Houston Law Center  
   	100 Law Center
   	Houston, TX 77204-6060
   

2. Email electronic documents or scans (e.g. pdfs) of all 8038 forms to a secure account.
   gclark@central.uh.edu
3. Sign and submit a waiver to the IRS permitting them to release a tribe's 8038 forms.
   

   Because no tax information or financial information about the tribe is included on form 8038, the IRS will release the information to an appointee designated by an authorized tribal authority using the IRS 8821 Tax Information Authorization form.

   A tribal authority should complete the form, and designate Dr. Gavin Clarkson, University of Houston Law Center, as the appointee. Specifically, in section three, column 2, a person completing the form should enter 8038 as the form authorized for release, and identify the period of records authorized for release (a valid pool should include the years since at least 2001).

   Mail one copy of each form the following addresses:

   	Tribal Finance Information Clearinghouse
   	Dr. Gavin Clarkson 
   	University of Houston Law Center  
   	100 Law Center
   	Houston, TX 77204-6060
   

   	Clifford Gannett  
   	Dir. Tax Exempt Bonds
   	Internal Revenue Service
   	1111 Constitution Ave., Rm PE 583
   	Washington, D.C. 20224
   

Despite the limited information disclosed on form 8038, our team has included a number of strong measures to protect all information tribal leaders authorize for disclosure. These measures include:

• Secure storage: all paper forms are stored in a safe and all electronic files are stored on a secure server. Only team members are permitted access to either file type and each instance of access is cataloged.
• Anonymized results: after compiling and analyzing the data we collect we will report only aggregate-level data (e.g. total and total share of tax exempt bonds by category or size). Sophisticated anonymization protocols will prevent public parties from inferring the identity of any tribe and its project.

¹ An earlier estimate of 40% was based on data provided by Thompson Financial. This estimate is being revised downward based on information provided by the IRS . Unfortunately, section 103(c) of the Tax Code defines “state or local bond” for IRS (and IRS enforcement) purposes as an obligation of a State or political subdivision, including bank loans, bond indentures, installment purchases or finance leases. We are currently working with the IRS to determine what percentage of tribal tax-exempt obligations are actually bond indentures. While a survey of the nation's leading tribal bond lawyers as to the ratio of bank loans to bond indentures provides some insight, at the time these materials were submitted to NCAI, the process of working with the IRS to get a more complete picture and understanding of the numbers is ongoing.

² This estimate is similarly based on data provided by the IRS and the survey of tribal bond lawyers, but is also subject to revision as the research project with the IRS proceeds.