ICI Supplements Comments on Application of Circular 230 to State, Local Bond Opinions

The Investment Company Institute (the "Institute")¹ submits this letter to reiterate our strong support for the treatment of State or local bond opinions under the proposed amendments to Circular 230.² Our views on this issue previously have been provided in letters dated March 4, 2004, March 16, 2004 and March 1, 2005 (attached). We continue to believe, as discussed in these letters, that unqualified opinions relating to the section 103 status of municipal bond interest must be excepted from the rules that apply to covered opinions under section 10.35.

As noted in our prior letters, an extensive discussion of tax considerations in an unqualified opinion on a bond's tax-exempt status would disrupt significantly the municipal bond markets without providing meaningful offsetting benefits. In addition, a discretionary ability to utilize "non-reliance" disclaimers in such opinions would be problematic for the efficient operation of the municipal bond markets. Only by treating state or local bond opinions as exempt from covered opinion status will the continued issuance of short, unqualified tax opinions for municipal bonds be ensured; these short, unqualified tax opinions are critical for buy-side investors. Absent this treatment, the municipal bond markets will not function efficiently -- to the detriment of bond issuers, bond purchasers and the Internal Revenue Service.

Proposed Discretionary Opt Out for Certain State or Local Bond Opinions

Suggestions that disclaimed opinions relating to a bond's section 103 status should be permitted apparently assume that municipal bond purchasers (i.e., the "buy-side") can perform the "gate-keeper role" provided today by bond counsel. As discussed in our prior letters, the buy-side simply cannot perform this role. While the buy-side carefully evaluates municipal bond fund offerings before purchasing them, bond purchasers do not have the necessary information, or the resources, to independently determine the tax status of every municipal bond. Maintaining the current high standard for unqualified tax opinions, upon which the buy-side relies, is important to the efficient operation of the municipal bond markets.³

We disagree strongly with any suggestion that the buy-side can analyze risk and price municipal bonds regardless of whether an opinion is unqualified or disclaimed. The experienced-based view of Institute members is that the tax analysis function is performed most effectively by bond counsel. Support for the fund industry's view is found in the market disruption arising in March 2004 from issuers' disclosures regarding the effective date of any Circular 230 changes. As discussed in our March 16, 2004 letter, some bond counsel were disclosing the potential impact of Circular 230 changes on bonds -- including statements that disclosure changes could affect bond prices. These disclosures, by themselves, were enough to affect a municipal bond fund's ability to decide whether a bond is an appropriate investment and the fair market value for the bond offering.

The likely result of permitting disclaimed opinions on section 103 status will be an increase in the number of municipal bond offerings that the Service ultimately determines are taxable. No one will benefit from this result.

Proposed Exception for Opinions "Not Directed to the Bondholder"

We also disagree with any suggestion that an opinion not directed to the bondholder (e.g., because the opinion is not addressed to the bondholder or intended to be relied upon by the bondholder) should be governed by rules similar to those under section 10.35. Bond counsel opinions regarding the exemption of a bond's interest payments under section 103 are critically important; these opinions are relied upon heavily by bondholders -- regardless of to whom they are directed.

A no-adverse-effect opinion -- which may not be directed formally to bondholders -- was identified in the Institute's March 1, 2005 letter as an opinion that should not be subject to the rules applicable to covered opinions under section 10.35. As noted in the March 2005 letter, these opinions provide bondholders with comfort that no disqualifying changes have been made, as a result of a change in remarketing mode or credit enhancement provider, which will affect the bonds' tax-exempt status.

No-adverse-effect opinions are important to bondholders regardless of to whom they are addressed or intended and whether the issues addressed are discrete and/or fairly routine in nature. By addressing an opinion to the bond's trustee, bond counsel effectively is providing important tax information to the party acting on behalf of the bondholders -- who do not have direct access to bond counsel or the information necessary to evaluate the bond. Bond purchasers often request to see such opinions, whether or not their reliance on the opinion is intended. Moreover, discrete and/or fairly routine issues are precisely the type that should be addressed in an unqualified opinion. Applying the rules of section 10.35, including the ability to disclaim the opinion, to opinions on these issues would deprive the buy-side of an avenue for evaluating whether such issues truly are routine.

² These amendments include the proposed regulations to amend Circular 230 (69 Fed. Reg. 75887; REG 159824-04) and the revised definition of "State or local bond opinion" provided in Notice 2005-47 (2005-26 I.R.B., June 27, 2005).

³ See pp. 2-3 of our March 4, 2004 letter (for a discussion of municipal bond funds' reliance on unqualified tax opinions) and p. 8 of the March 4, 2004 letter (for a discussion of the only circumstances in which buy-side counsel could serve as an effective gate-keeper).

Dear Greg:

The Investment Company Institute (the "Institute")¹ has been advised by its members that the proposed revisions to Circular 230's definition of tax shelter opinions are beginning to disrupt the municipal ("muni") bond market. This impact (discussed below) arises because any changes to Circular 230 are proposed to become effective immediately on the date (presently unknown) that the final Circular 230 rules are published in the Federal Register. To alleviate this impact, we urge that the Treasury Department announce promptly that any change to the tax opinion disclosure requirements -- with respect to those opinions that would be covered by the Institute's March 4 proposal² -- will apply only to opinions rendered on bond offerings and remarketings that close some reasonable period of time (such as 90 days) after the Circular 230 rules are finalized.

The market impact of the proposed revisions arises in large part because of the uncertainty regarding what disclosures might be required by Circular 230 for deals currently being reviewed by potential buyers. Some bond counsel are disclosing the potential impact of the proposed revisions to Circular 230 and the various steps they would take (discussed below) if Circular 230 is finalized before a muni bond deal closes. Other bond counsel apparently are not disclosing any issues arising from the proposed revisions to Circular 230. Consequently, investment companies purchasing these bonds (hereinafter "muni bond funds") are already beginning to have the difficulties (discussed in our March 4 letter) that we did not anticipate would arise before revisions to Circular 230 were finalized.

Those bond offerings discussing the potential application of Circular 230 typically describe the proposed revisions and the disclosures that they would add to the tax opinion if the proposed amendments to Circular 230 have been adopted on the date the deal closes. One such offering includes this disclosure:

Perhaps most significantly, in certain bond offerings the underwriter is reserving the right (pursuant to a contract with the issuer) to refuse to purchase the bonds if the final regulations require disclosure different from that contemplated by bond counsel based on the proposed revisions to Circular 230. These offering documents typically then note that, if the underwriter chooses to purchase the bonds in these circumstances, bond counsel expect that their opinions will be modified in whatever fashion is required to conform with the requirements of the final regulations.

These disclosures (including disclosure of an underwriter's right to refuse to purchase bonds in certain cases) can affect a muni bond fund's ability to determine whether a bond is an appropriate investment for the fund and the fair market value for the bond offering. These effects are particularly detrimental if, as suggested by the Institute, final guidance effectively exempts from the Circular 230 disclosure requirements the unqualified tax opinions received by muni bond funds on the section 103 status of a muni bond and the tax opinions on synthetic municipal investments meeting the requirements of Revenue Procedure 2003-84 (or the grandfathering provisions of the Revenue Procedure).

If it would be helpful to you and/or members of your staff to meet with us to discuss either our request for a delayed effective date for Circular 230 guidance or the issues addressed in our March 4 letter, please do not hesitate to contact me at 202/326-5832. Thank you.

² Specifically, the Institute proposed that the Circular 230 definition of tax shelter opinion exclude an unqualified tax opinion concluding that interest on a municipal bond is exempt to the recipient under section 103 and a tax opinion with respect to those synthetic municipal investments meeting the requirements of Revenue Procedure 2003-84 (or the grandfathering provisions of the Revenue Procedure).