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Memo sparks speculation over IRS auditing bias

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WASHINGTON -- Previously suppressed portions of an internal IRS memo about
its audits of tribal bonds have roused charges of arbitrary and, some say,
prejudiced proceedings by the compliance team, which has so far targeted up
to 12 tribes.

The memo from the IRS Office of General Counsel to the field service team
warned that it faced "litigation hazards" in its first such case. In other
words, the IRS could well lose its case if it were taken to court over an
attempt to deny tax-exempt status for bonds issued to finance a tribal golf
course.

Although the IRS released the bulk of the initial memo previously in
response to a Freedom of Information request by the Dorsey & Whitney law
firm, it withheld the damaging "litigation hazards" section until early
November.

Even worse than the field team's disregard of the memo, in the view of
leading tribal attorneys, was the reaction of the IRS team leader, Charles
Anderson. In a Nov. 3 story on the memo in the Bond Buyer, the trade paper
for the municipal bond industry, Anderson dismissed the memo and described
his "rule of thumb" for the audits in terms of a cliche' frequently heard
from anti-Indian activists.

"If there are more golf holes than tribal members, it is probably
commercial and intended solely for tourists," he said of the golf course
audit. "If no tribal members work there and they all collect a dividend, it
is probably commercial.

"I don't think Congress ever intended several dozen people getting
six-figure checks due to a resort financed by tax-exempt bonds."

These remarks are "astonishing," replied John Dossett, general counsel for
the National Congress of American Indians. "Instead of the rule of law, he
is going by his personal opinion and his impression of the tribes."

The publicity over the memo and the Bond Buyer article has reinforced an
on-going effort to replace the "rule of thumb" of the field team with a
formal rule-making at senior levels of the IRS and the Treasury Department.
This effort has included a letter from Rep. J. D. Hayworth, R.-Ariz., and a
number of congressmen to Treasury Secretary John Snow.

Dossett explained that tribal lobbyists were seeking a rule-making this
year rather than a change in legislation. A tribal coalition mounted a
drive last year to amend federal law to put tribes on equal footing with
states and localities. They succeeded in getting their language in an
omnibus tax bill passed by the Senate. But the provision ran into
opposition from Rep. William Thomas, R.-Calif., chairman of the House Ways
and Means Committee, and was deleted at the last minute.

The long-running controversy stems from ambiguous language in two bills
from the 1980s meant to give tribes access to the tax-exempt bond market,
historically the source of financing for state and local governments. (As
issues of sovereign governments, these bonds are not subject to federal
taxation and sell at the lowest available interest rates.) The statutes
subjected tribes to restrictions not placed on other governments, limiting
their bonds to the most part to "essential government functions." But
Congress failed to define these functions, saying only that the test should
be what was "customarily" done by states and localities.

Although very few tribes have entered the municipal bond market, the IRS
began an "initiative" to audit these bonds in 2001. It announced that its
field team would define "essential government functions" in the course of
the audits, leading some tax attorneys to complain that the audit team
would be making up the rules as it went along,

The first case to reach public view involved a tribal golf course complex.
The internal memo from the IRS Office of General Counsel expressed
misgivings about the case. The IRS lawyer noted that more than 2,600 state
and local governments owned golf courses and concluded that "it is probable
that a court, faced with this fairly common activity of state and local
governments, and taking into account the interpretative standard accorded
Tribal governments, would conclude that the Golf Course meets the statutory
standard for an essential governmental function."

The audit team headed by Anderson ignored this warning and pressed on. It
has focused on two types of bonds, traditional tax-exempt issues for tribal
economic development and a more indirect kind called "conduit financing"
routed through neighboring non-Indian economic development agencies.

Earlier this fall the IRS forced the Seminole Tribe of Florida to issue
$750 million in taxable bonds to retire several series of tax-exempt bonds
dating from 2002. It is still investigating the earlier bonds, which were
issued on behalf of the tribe by a local development body, the Capital
Trust Agency, created by two small Florida Panhandle towns.

The IRS is also known to be auditing tribal bonds issued by the Cabazon
Band of Cahuilla Indians to build a hotel and convention center. According
to press reports, about 10 other tribes are under audit, half for conduit
bonds and half for direct issues.

Although the Seminole Tribe successfully completed its refinancing, and
according to one bond rater might have received a lower interest rate on
its taxable issue than on the original tax-exempts, it has vowed to
continue the fight with the IRS. Seminole Hard Rock Hotel & Casino's Gaming
Operations CEO James Allen told a local paper: "We will continue to 100
percent defend the tribe's tax-exempt status on those bonds. It was a legal
deal, it was the right deal."

In spite of the controversy, the IRS field team has not yet been challenged
in court -- or even through the IRS appeals procedure, said Mary Streitz,
head of the tribal tax practice at Dorsey & Whitney. She said it was hard
for the tribes to bring suit, since the burden of the IRS rulings
technically fell on the bond holders, not the issuer.

She said, however, that the attention paid to the release of the IRS memo
might finally mean that senior officials would step into the conflict.

Senior staff reporter David Melmer contributed to this report.