THE IRS VS. THE VCCDD AND THE SLCDD
A BRIEF CHRONOLOGY OF EVENTS
First investigation - 1999 Bonds
7/6/2001 - The IRS initiates an investigation of the tax exempt status of the 1999 Recreational Revenue bonds issued by the VCCDD.
1/29/2003 - After a year and a half review the IRS rules that the 1999 Bonds meet the criteria for federal tax exemption. However, in their determination letter the IRS advised the Center District of a number of concern. The 1/29/2003 IRS letter stated, "Our closing of these cases, however, should not be construed as an approval of your method of operations. We have concerns regarding: the amount of control the developer has over the issuer; the questions of value of the assets sold by the developer to the issuer as these are not arm's length transactions; the treatment of income and expenses (whether income is properly reported and expenses deducted only once); compliance with state law. While we are closing this examination, evidence of noncompliance revealed through a state audit or by other means could result in a need to open another examination of this bond."
1/30/2003 - To the Present - The developer and the VCCDD/SLCDD continue to issue tax exempt bonds on the same basis (except that they hired two appraisers instead of one) as they did before the IRS 1999 Bond audit.
Second investigation - 2003 Bonds
1/7/2008 - The IRS initiates an investigation of the tax exempt status of the 2003 Recreational Bonds issued by the VCCDD and submit's requests for various documents on January 7, March 17, May 1, July 31, and October 31, 2008.
2/23/09 - The IRS Agent notifies the VCCDD that after reviewing all of the documents, he has three proposed issues regarding the tax exempt status of the bonds which are as follows:
1. Is the Village Center Community Development District, the Issuer of the Bonds under investigation, a qualified issuer of tax exempt bonds?
2. Did the Series 2003 Facilities acquisition price reflect the fair market value of the assets? Was the Bond Issue properly sized to carry out the government purpose of the Bonds? How does the Developer's control over the District's governing board and the related party aspects of this relationship impact the use and/or allocation of Bond proceeds to a governmental purpose or an essential government function?
3. Were the Bond proceeds used for an essential governmental function or do the nature of the Facilities acquired with the Bonds result in private business use, and hence the Bonds are Private Activity Bonds?
April, 2009 - The VCCDD provided responses from its attorneys and the appraisers involved in the 2003 Bond issue.
5/4/2009 - The IRS Agent responded to the VCCDD attorneys April, 2009 correspondences. In concluding he stated that "… In light of the fact that the issues under consideration here potentially impact all of the outstanding tax-exempt bonds issued by the District, I would instead encourage the District to consider the most expeditions and efficient way to structure a possible settlement agreement that would encompass not just the 2003 Bonds, but the other Bonds as well.
5/18/2009 - The IRS Agent sends a settlement offer to the VCCDD and states that "…settlement agreements are ultimately approved by senior management and the terms outlined here are viewed as those that my immediate supervisor and myself feel would meet their minimum requirements at this point in time." The IRS Agent offered to settle his investigation if the VCCDD would (a) repurchase about $355 million in bonds; (b) pay about $3 million (out of $16.5 million that the IRS agent claims is due) in back taxes on the interest on the bonds; and (c) agree not to issue tax exempt bonds in the future. If the settlement offer by the IRS Agent was not accepted, then the IRS agent suggested that it might expand its investigation into additional bonds that both Center Districts (VCCDD and SLCDD) claimed were tax exempt. The District does not respond to the IRS Agent who presented the settlement offer, but did request a meeting with IRS Senior Management.
7/2/2009 - The IRS follows through on his 5/18 threat that if the settlement offer is not accepted the IRS will expand the current examination to include the other bonds. He sends Information Document Requests for all of the remaining tax exempt bonds they have issued to both the VCCDD and the SLCDD.
7/8/2009 - Center Districts' attorney has telephone conversation with Agent's Manager
7/10/2009 - Center Districts' attorney sends correspondence to IRS Agent's Manager summarizing the status of the substantive issues raised on the examination of the 2003 Bonds.
7/23/2009 - The IRS Agent advises that he has made a referral for assistance with the valuation of the 2003 Facilities and requested additional information for the appraiser.
11/2009 - District is notified that agent number 1 has been promoted and will no longer be involvedwith the investigation
1/15/2010 - Center Districts' Attorney formally requests technical advice as to whether the District is properly treated as a political subdivision for purposes of section 103 of the Internal Revenue Code and submits a statement of pertinent facts and legal analysis.
3/24/10 - District receives request for historical information from second agent.
6/2010 - VCCDD attorney submitted and received Tolling Agreements from the other parties involved in the 2003 transaction. (Purpose is to extend the statute of limitations.)
9/29/2010 - District advised by IRS that second agent has been promoted and moved to another division. A third agent was assigned several months later.
3/16/2011 - The third IRS agent submits a response to the VCCDD's January 2010 request for Technical Advise on the issue of whether or not the VCCDD, the Issuer of the Bonds under investigation, is a qualified issuer of tax exempt bonds which spells out the IRS position regarding the facts related to the issue.
4/4/2011 - District attorney responds to IRS statement of facts.
IRS: ISSUE No. ONE UPDATES
At the August 18th, 2011 VCCDD meeting, District Manager Janet Tutt reported to the Board that, "On August 3rd, the District's attorneys and I met with the Chief Counsel's office of the Internal Revenue Service. The purpose of the meeting was to clarify the time frame involved for the Technical Advice, identify any additional documents and information being requested, and to clarify issues. The meeting was very productive. We are providing the requested documents and we are revising the legal analysis to incorporate additional information requested…"
The parties agreed to a tentative submission date of September 2nd for both the District's and IRS Agent's legal analysis. The VCCDD was ready on the 2nd, but the IRS Agent requested more time. The IRS Agent did not submit the requested documents and information until early October. According to Ms. Tutt, "…Chief Counsel has advised while they will address this issue in a timely manner after document submission, no scheduled response time has been or will be provided as they wish to conduct a thorough review of the issues."
Issue number one - Does the Villages Community Development District (VCCDD) meet the IRS requirements to be classified as a political subdivision within the meaning of section 1.103-1(b) of the Income Tax Regulations ("Treas. Reg.")? (Note: Rev. Rule 78-276, 1978-02C.B. 256, states "…that the term 'political subdivision' has been defined consistently for all Federal tax purposes as denoting either (1) a division of a state or local government that is a municipal corporation, or (2) a division of such state or local government that has been delegated the right to exercise sovereign power.")
The District's submission concluded as follows:
"IV Conclusion: The Center District is properly treated as a political subdivision of the State of Florida.
As discussed above, if it is a separate requirement that a political subdivision be treated as a 'division' of a state or local government, the Center District is properly treated as a division of the State of Florida. In addition, the Center District has been delegated significant eminent domain, police and taxing powers. The Center District only needs to possess more than an insubstantial amount of any one of these powers to be considered a political subdivision of the State of Florida under Section 103 of the Code. Even if it were determined that the Center District did not possess a substantial amount of any of these powers, the Service has taken the position that two or more sovereign powers that are marginal on grounds of substantiality can be aggregated to support a determination that an entity has substantial authority to exercise sovereign power. In fact, however, the Center District has significant amounts of all three sovereign powers. Accordingly, the Center District is properly treated as a political subdivision for purposes of Section 103 of the Code."
The IRS Agent's Submission concluded as follows:
1) "Based on the foregoing, we determine that the Center District was not controlled by a state or local government and was not motivated by a wholly public purpose during the period of November 29, 1993 through June 1, 2004. We conclude that the Center District did not qualify as a division of a state or local government and was not therefore a political subdivision under Treas. Reg. section 103-1(b)."
2) "In summary, during the period of November 29, 1993 through June 1, 2004 the Center District was delegated no police power under Florida law (in fact the police power has been expressly withheld), no taxing power that could be exercised (and no realistic possibility that it will ever be exercised), and the power of eminent domain for only limited purposes within its boundaries and even more limited power beyond its boundaries sugject to the control of units of local government. Based on the foregoing, we conclude the Center District was not delegated a sufficient amount of any sovereign power to allow it to qualify as a political subdivision."
The Complete Legal Analysis documents of both the VCCDD and IRS Agent can be found on the VCCDD web page. Go to Districtgov.org, scroll down and on the left you will see a link identified as IRS UPDATES.
At the October 20, 2011, VCCDD meeting, Ms. Tutt advised the Board that, "…you will quickly and easily note when reading the document (prepared by the IRS Field Agent) that there are a number of factual errors. The District is considering the submittal of a brief in response to clarify the facts."
IRS ISSUE No. ONE - 2nd UPDATE
Issue Number One is the question of whether or not the Villages Center Community Development District (VCCDD), the issuer of the 2003 bonds, meets the IRS requirement to qualify as a political subdivision of the State of Florida. On 12/28/11, the VCCDD received Information Document Request (IDR) #10. On 2/16/12, Ms. Tutt provided the VCCDD & SLCDD with the Districts attorney's January 1/20/12 response to the IRS regarding the five items that were requested in IDR #10. The Districts' Attorney supplied as much of the requested information as they had legal access to and concluded, "…the VCCDD wishes to reemphasize that the relevance of the information requested seems remote. As detailed in pages 3 through 5 and page 10 of the legal analysis of the VCCDD submitted in connection with the request for technical advice, the determination of whether a governmental entity is a political subdivision is not properly based on an analysis of who owns property within the geographic bounds of the entity at the time the bonds are issued. A conclusion otherwise would mandate conclusion that most bonds issued by the over 500 community development districts in Florida and the thousands of other developer districts throughout the country were also not issued by political subdivisions. All of the documents referenced above can be found on the Villages Community Development District website: www.districtgov.org. Upon arriving on the home page, go to the left hand column and scroll down to 'IRS Updates'.
IRS: ISSUE No. TWO UPDATES
On July 27, 2011, the VCCDD (Village Center Community Development District) received the Report of Alice Price, State Certified General Real Estate Appraiser, State of Florida, which was solicited by the IRS, to address the 2nd issue presented by the original IRS investigator which is as follows:
"The Opinions of Value (Fishkind and Public Resources Management Group-PRMG- appraisals) do not support the price paid by the District to the Developer - facilities were purchased from a related party, the Developer, who has controlling ownership of the property within the District and thereby maintains control of the governing board of the District… The proceeds of the Bonds exceeded the amount necessary for the governmental purpose of the issue by more than 5% of such amount. This is considered an 'overissuance' and therefore interest is not excludable… The payment of the $59+M sales price to the Developer by the District is the payment of gross proceeds of the Bonds to a related party and therefore not a governmental use of those Proceeds… Using tax-exempt bond proceeds to provide private golf courses not available for use to the general public on the same basis as the residents of a private gated community is not an essential government function. Therefore, these Bonds are taxable bonds…"
Ms. Price's conclusions were as follows:
"Based upon my review of the PRMG, Inc. report, I have concluded that the estimate of the value of the amenity stream of $60,500,000 is overestimated and not credible.
It should be noted that for analytical purposes and using data contained in the appraisal report under review as well as data provided by the VCCDD, I developed an opinion of the value of the Subject Purchased Assets. Based upon my analysis as outlined within the attached Appraisal Review Report was as follows:
Real Estate and Personal Property$3,990,000
Amenity Fees Income Stream$24,000,000
Total Market Value of Purchased Assets$27,900,000
Excerpts from Ms. Tutt's email to the VCDD Supervisors on July 27, 2011, regarding this finding by the IRS are as follows:
"…Importantly, the Appraisal Review does correct the essential error that was made by the initial IRS agent handling the audit, by not excluding the value of the amenities fees from the value of the assets purchased with the proceeds of the bonds. However, I believe the value arrived at in the Appraisal Review is substantially less than the actual value of the purchased assets…"
"…it has been my experience that while bond issues may vary in length, municipal bonds issued for infrastructure and other governmental operations such as water and sewer systems (which is the model the District used) have used a 30 year income stream when determining value based upon the capitalization of revenue method. I believe that Ms. Price's use of a 15 year period is based on the assumption that is the typical holding period for a business or property, which is not an assumption that is applicable to this purchase by the District…" (Mr. Ori from PRMG, had advised Ms. Tutt that the 30 year holding period was appropriate because the time frame for such period was equal to or less than the useful life of the capital facilities acquired and the revenue stream being generated supported the acquisition. Additionally he said that he also recognized the 30 year holding period has been a typical holding period for state and local governments.)
"The second item of concern is the Amenity Fee Cash Flow Analysis prepared by Ms. Price. . . Initial review of the figures indicates that some of the analysis and assumptions are not accurate which lead her to assert an incorrect value of the net amenity fee cash flow after taking into account the expenses allocable to the amenity fees purchased…"
"Finally, it appears an arbitrary decision was made to change the capitalization rate assumption used to determine the present value of the cash flow…"
Ms. Tutt concluded the report to the VCCD by stating that, "…staff will be reviewing the valuation, addressing the issues with the District's attorneys, and preparing questions and comments for the IRS regarding Ms. Price's Appraisal Review."
The following are highlights of the November 14, 2011, Village Center Community Development District (VCCDD) response to Ms. Price's Review:
In summary, the VCCDD Attorney's position is that "The Appraisal Review properly recognizes that the purchase resulted in the transfer of a significant revenue stream to the Center District as well as the tangible assets purchased. The Center District also agrees with the Appraisal Review (and the two valuations prepared for the Center District in 2003) that the best way to value the revenue stream is a capitalization of the net revenue stream acquired by the Center District in the transaction. However, the Appraisal Review makes a number of errors as described below in calculating the net revenue stream which result in a substantial understatement of the fair market value of the Amenities Fees.
1. Expenses applicable to 2003 Amenities Fees. Summary: The Appraisal Review presents a decreased valuation by calculating a significantly reduced level of net operating income derived from the 2003 Amenity Fees by improperly taking into account operating expenses that are not associated with the assets purchased with the 2003 Bonds…
2. Period of Capitalization. Summary: The 2003 Amenities Fees constitute fees required to be paid by homeowners into perpetuity and represent a lien on the homeowners' properties second only to any purchase money mortgage. Accordingly, the 2003 Amenities Fees are more appropriately capitalized over at least a 30-year period, rather than the 15-year period adopted by the Appraisal Review…
3. Capitalization rate: Summary: The Appraisal Review applies an inappropriately low capitalization rate for determining the current value of the 2003 Amenities Fees…
4. Inflation of Base Level of Amenities Fees. Summary: The Appraisal Review starts with the wrong base level of Amenities Fees determined by the Center District in 2003 for purposes of projecting future Amenities Fees adjusted for inflation…
5. Conclusion: As shown in the attached calculations, the errors cited above result in a substantial understatement of the value of the 2003 Amenities Fees as of the March 2003 purchase. Once these errors have been corrected, the value of the 2003 Amenities Fees becomes substantially greater and more than supports the values shown in the two appraisals prepared for Center District and the amount paid by the Center District for the 2003 Amenities Fees and tangible property as financed by the 2003 Bonds. Accordingly, the Appraisal Review should be corrected to eliminate those errors and it will then properly reflect that the value of the property acquired was at least equal to the price paid by the Center District for that property." The entire November 14, 2011, correspondence with all attachments can be found on the District website: www.districtgov.org. Upon arriving on the home page, go to the left hand column and scroll down to 'IRS Updates'.
The POA'S Position in the IRS Matter.
The POA has not taken a position on the relative merits of the positions of the IRS and the VCCDD in this controversy, although we sincerely hope that the VCCDD is able to prevail. In regard to the current IRS investigation, the POA's primary objective is to try to protect the rights and interests of the residents of the Villages, who have made The Villages their retirement home. Any action that takes away what Villagers have worked so hard to gain is an action that the POA opposes. In this regard, we continue to follow closely the developments in order to try to ensure that any resolution of the IRS investigation does not jeopardize the residents' amenities or result in the costs of an IRS victory being passed on to the residents..
1) If you are new to the area or want a 'refresher course' about the issues we would suggest you review the article entitled "How the IRS Bond Inquiry Affects You" in the August, 2009 Bulletin on our website.
2) Both Janet Tutt's memo to the VCDD Supervisors and Ms. Price's Report are on the District web site. (districtgov.org - left hand column of home page - click on IRS Updates)