DeJongh calls Senate into session, seeking $13.6M to settle IRS issue and $5M for HOVENSA litigation


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Gov. John deJongh Jr. has called the 30th Legislature into special session on Tuesday to consider three bills, including one that would authorize a $13.6 million payout to settle Internal Revenue Service audit findings and another that would finance litigation with HOVENSA.

The governor on Thursday sent Senate President Shawn-Michael Malone a letter calling for the special session.

According to the letter, the three proposals senators will consider at the session are:

- A bill that would finance a $13,635,104 settlement with the IRS, stemming from a 2012 IRS audit of a $219,490,000 bond issuance by the V.I. Public Finance Authority in 2006.

- A bill that would appropriate $5 million in the Fiscal Year 2014 budget to the V.I. Justice Department to fund the government's response to the HOVENSA closure, including legal, financial and consultant and industry expert advice and representation, and any litigation costs.

- A bill that would authorize the issuance of Public Finance Authority Revenue Refunding Bonds to provide "cash-flow relief" for the FY 2014 budget.

HOVENSA

As HOVENSA and the V.I. government edge closer to litigation after the 30th Legislature's Aug. 7 rejection of a proposed amendment to the company's agreement with the government, deJongh is requesting a $5 million appropriation for FY 2014 for litigation and other costs associated with the government's response to HOVENSA's closure.

The money would be available until expended - although deJongh makes it clear in his letter that the possible legal battle that is brewing with HOVENSA is likely to cost far more.

"Rest assured that this is not a one-time funding requirement," deJongh wrote. "Our best estimate at this time indicates that this process could stretch over 7 years and cost in excess of $15 million. This is a path I did not want for us, but it is clear that we have no choice but to pursue it."

HOVENSA attorney George Dudley said that he sees the request for funding as the governor being consistent in his public statements.

As part of a statement released Tuesday, deJongh said that "with the resources the Senators provide for our next steps, I am confident all will be done in the best interest of our community."

Dudley also noted that he believes a lawsuit with HOVENSA likely would cost the government more than $5 million.

"Speaking as a lawyer, I can tell you $5 million is a conservative budget," Dudley said. "This is not going to be a cheap lawsuit."

No lawsuit has been filed at this time.

IRS audit

The settlement agreement arises from a random IRS audit of a series of tax-exempt bonds the Public Finance Authority issued on Sept. 28, 2006 in the amount of $219,490,000, according to V.I. Finance Commissioner and PFA Executive Director Angel Dawson Jr.

The tax-exempt bonds were for several things: new money capital project financing; payment of a termination fee related to the termination of a 2003 interest rate swap agreement; and advance refunding of some outstanding long-term working capital bonds originally issued in 1999.

"This began as a random audit, where the IRS just selects bond issuances throughout the nation, randomly, for audit," Dawson said. The IRS audit began in March 2012.

The IRS has very strict rules regarding the issuance of tax-exempt bonds, according to Dawson.

Those rules differ for tax-exempt bonds that provide working capital and tax-exempt bonds that are for capital projects, and the rules are stricter for working capital, he said.

The IRS is asserting that a portion of the Series 2006 bonds - the portion for the refunding of some long-term working capital bonds originally issued in 1999 - violated the regulations and was issued in an amount that overburdened the tax-exempt bond market, he said.

Based on the government's financial statements, money was available that could have been used to retire the 1999 bonds instead of refunding them, Dawson said.

However, the government invested that "available" money in obligations that had higher yields than refunding the Series 2006 Bonds, according to the governor's letter.

"The big picture is that the federal government has an interest in tax-exempt bonds not being issued more than necessary, in that it deprives the federal government of revenue," Dawson said, noting that if a jurisdiction issues over and above what the federal regulations permit, it is considered "overburdening the tax-exempt bond market."

IRS settlement

"The original determination on the part of the IRS was that the entire $219,490,000 aggregate principal amount of the Series 2006 Bonds was tainted by the inappropriate issuance of the advance refunding bonds," deJongh wrote in the letter to Malone. "We have succeeded in persuading the IRS not to take such a drastic position in respect of the Series 2006 Bonds."

Dawson said that after months of negotiation, the government was able to get the amount the IRS considers "tainted" reduced to $80 million, reflecting the portion of the bonds that were used for the 1999 refunding.

The $13.6 million that the territory must pay under the settlement agreement reflects the tax revenue lost to the U.S. Treasury from the portion of the bonds that the IRS considers "tainted," for the three years immediately before the settlement and continuing until the final maturity date of the bonds in 2016, according to Dawson.

Paying the $13.6 million settlement "will ensure that the owners of the outstanding Series 2006 Bonds will not have their investment income recharacterized as taxable," deJongh wrote in his letter. "The IRS has agreed to a remedy that will protect the investors while still making the U.S. Treasury whole with respect of these bonds."

According to the letter, all outstanding claims against the Public Finance Authority and the government in the Series 2006 IRS audit will be satisfied under the agreement.

The bill would appropriate the $13.6 million settlement from the General Fund for the initial payment and authorizes refinancing the payment through bonds or borrowing.

DeJongh wrote that it is necessary because the IRS calculated the settlement amount using a settlement date no later than Aug. 27, after which interest will accrue.

The governor said the Public Finance Authority and the administration have engaged legal counsel "and are actively pursuing legal action to seek recovery against any responsible parties to offset the payment of such settlement amount. Any recovery would be applied to the repayment of the borrowing being sought."

Dawson said that legal counsel is currently in discussions with the Public Finance Authority's former bond counsel, who Dawson said had issued a "tax certificate" indicating that the 2006 bond issuance complied with IRS regulations.

PFA refunding bonds

The issuance of Revenue Refunding bonds that deJongh is requesting would authorize the Public Finance Authority to issue up to $90 million in bonds to refund and restructure 2004 and 2009 series bonds for a more favorable interest rate, Dawson said.

Officials project that they would get approximately $26 million from the refunding and restructuring.

That money would then be used "for cash flow relief" to close an anticipated budget gap for FY 2014.

- Contact Joy Blackburn at 714-9145 or email jblackburn@dailynews.vi.

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