[Federal Register Volume 63, Number 4 (Wednesday, January 7, 1998)]
[Rules and Regulations]
[Pages 671-673]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-21]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 8755]
RIN 1545-AV74
Qualified Zone Academy Bonds
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Temporary regulations.
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SUMMARY: This document contains temporary regulations relating to the
federal income tax treatment of qualified zone academy bonds. The
regulations in this document provide needed guidance to holders and
issuers of qualified zone academy bonds. The text of the temporary
regulations also serves as the text of the proposed regulations set
forth in the notice of proposed rulemaking on this subject in the
Proposed Rules section of this issue of the Federal Register.
DATES: These regulations are effective January 1, 1998.
FOR FURTHER INFORMATION CONTACT: Timothy L. Jones, (202) 622-3980 (not
a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
Section 226(a) of the Taxpayer Relief Act of 1997, Pub. L. No. 105-
34, 111 Stat. 788 (1997), amended the Internal Revenue Code (Code) by
redesignating section 1397E as section 1397F and adding a new section
1397E. Section 1397E authorizes a new type of debt instrument known as
a qualified zone academy bond.
Explanation of Provisions
In General
A qualified zone academy bond is a taxable bond issued by a state
or local government the proceeds of which are used to improve certain
eligible public schools. In lieu of receiving periodic interest
payments from the issuer, an eligible holder of a qualified zone
academy bond is generally allowed annual federal income tax credits
while the bond is outstanding. These credits compensate the holder for
lending money to the issuer and function as payments of interest on the
bond.
These temporary regulations provide rules for the federal income
tax treatment of qualified zone academy bonds. These regulations
generally treat the allowance of the credit as if it were a payment of
interest on the bond. These regulations also provide rules to determine
(1) the credit rate, (2) the discount rate used to present value
private business contributions, and (3) the discount rate used to
determine the maximum term of a qualified zone academy bond.
These regulations generally do not provide guidance on the
statutory requirements that must be met for a bond to qualify as a
qualified zone academy bond. Section 1397E(d) sets forth a number of
detailed requirements that must be met for a bond to qualify
[[Page 672]]
as a qualified zone academy bond. In particular, section 1397E(d)(1)(C)
requires the issuer to certify (1) that it has written assurances that
private entities have agreed to contribute a certain level of goods or
services to the qualified zone academy, and (2) that it has the written
approval of the eligible local education agency for the bond issuance.
The Treasury and the IRS intend that these certifications will be
respected and may be relied on by taxpayers if the certifications are
reasonably made.
In addition, section 1397E(d)(1)(A) requires that 95 percent or
more of the proceeds of an issue of qualified zone academy bonds are to
be used for a qualified purpose described in section 1397E(d)(5) with
respect to a qualified zone academy as defined in section 1397E(d)(4).
The Treasury and the IRS intend that the qualified purposes set forth
in section 1397E(d)(5) are to be broadly interpreted. The Treasury and
the IRS also intend that, if an issuer is unable to actually spend 95
percent or more of the proceeds of a qualified zone academy bond for a
qualified purpose, the issuer may apply remedial actions similar to the
remedial actions set forth in Sec. 1.142-2 to preserve the
qualification of a bond. Further, the Treasury and the IRS intend that
taxpayers may rely on an issuer's determination that a public school
(or academic program within a public school) is a qualified zone
academy for purposes of section 1397E(d)(4) if the determination has a
reasonable basis. The Treasury and IRS request comments on whether
additional guidance is needed with respect to the section 1397E(d)
requirements.
Section 1397E(e) imposes a national limitation on the amount of
qualified zone academy bonds that can be issued. For 1998 and 1999, the
IRS will publish a revenue procedure allocating the national limitation
among the States and the possessions.
The Credit Allowance
A qualified zone academy bond provides an annual federal income tax
credit to certain holders. Under the regulations, the credit is deemed
paid on the credit allowance date--the last day of each one-year
accrual period on the bond. A taxpayer that receives a credit on a
credit allowance date may use the credit to offset its income tax
liability for the taxable year that includes the credit allowance date.
There are two limitations on the use of the credit. First, only
eligible taxpayers holding the bond on the credit allowance date may
claim the credit. Section 1397E(d)(6) defines an eligible taxpayer as a
bank, an insurance company, or a corporation actively engaged in the
business of lending money. Second, an eligible taxpayer may claim the
credit only to the extent the taxpayer has a tax liability for the
taxable year that includes the credit allowance date. See section
1397E(c). The credit is nonrefundable.
Treatment of the Credit as Interest
The regulations treat the credit on a qualified academy zone bond
as if it were a payment of qualified stated interest. This treatment
effectively conforms the treatment of the credit with the treatment of
interest income on debt instruments. Thus, for example, a holder that
uses an accrual method of accounting accrues the credit amount over the
one-year accrual period that ends on the credit allowance date.
Adjustment When Credit is Limited or Disallowed
In two situations the holder of a qualified zone academy bond on a
credit allowance date will not be able to use some or all of the credit
to offset its tax liability. First, if the holder on a credit allowance
date is not an eligible taxpayer (a bank, insurance company, or
corporation actively engaged in the business of lending money), no
credit is allowed. Second, the amount of the credit may exceed the
income tax liability of a holder that is an eligible taxpayer. In this
second case, because the credit is nonrefundable, some or all of the
credit will not be used.
In these situations, the regulations allow the holder to adjust its
income by deducting the amount of the unused credit. This deduction is
allowed for the taxable year that includes the credit allowance date.
The Treasury and the IRS request comments on whether this adjustment
works appropriately when an eligible taxpayer holds a qualified zone
academy bond on the credit allowance date but has an income tax
liability (determined without regard to the credit) that is less than
the amount of the credit.
Credit Rate
Section 1397E(b)(2) authorizes the Treasury to establish a single,
uniform credit rate that will permit the issuance of qualified zone
academy bonds without discount and without interest cost to the issuer.
This section also requires the Treasury to adjust the credit allowance
rate on a monthly basis to reflect changes in market interest rates.
It is not possible to determine a uniform credit rate that would
permit all qualified zone academy bonds to be issued at par. Some
borrowers are less creditworthy than others and, therefore, borrow at
less favorable rates. In addition, because section 1397E(b)(2) requires
the Secretary to set the credit rate in the month before the bond is
issued, changes in market interest rates between the time the rate is
set and the time a qualified zone academy bond is issued can result in
a bond being issued at a price that is different than par.
The regulations provide a single monthly rate that will minimize
the discount or premium on qualified zone academy bonds. Specifically,
the regulations provide that the credit rate is 110 percent of the
long-term applicable Federal rate (AFR), compounded annually, for the
month of issuance. Tying the credit rate to the AFR ensures that the
rate will be adjusted on a monthly basis to reflect changes in market
interest rates. In addition, the Treasury and the IRS believe the 10
percent spread over the long-term AFR is appropriate, in part, because
qualified zone academy bonds bear more credit and liquidity risk than
long-term Treasury bonds.
Maximum Term
Section 1397E(d)(3) sets out a formula for determining the maximum
term of a qualified zone academy bond. The formula requires the use of
a discount rate equal to the average annual interest rate of tax-exempt
obligations having a term of ten years or more. Because there is no
readily available source for this discount rate, the regulations
provide that the discount rate is 110 percent of the long-term adjusted
AFR, compounded semi-annually. The long-term adjusted AFR is published
on a monthly basis and is designed to reflect the current yield of a
risk-free tax-exempt obligation having a term of 9 years or more.
Taxable Obligation
It is possible that some qualified zone academy bonds may either
(1) provide for payments of stated interest, or (2) be issued at a
discount. The Treasury and the IRS have determined that qualified zone
academy bonds are not obligations the interest on which is excluded
from gross income under section 103(a). There are a number of reasons
for treating a qualified zone academy bond as a taxable obligation. For
example, the requirement in section 1397E(g) that a holder include the
allowed amount of the credit in gross income evidences an intention to
treat qualified zone academy bonds as taxable, not tax-exempt,
obligations.
[[Page 673]]
Coordination With Estimated Tax Rules
The regulations do not address the estimated tax consequences of
holding a qualified zone academy bond. The Treasury and the IRS request
comments on whether there is a need to coordinate the regulations with
the estimated tax rules and, if so, how they might be coordinated.
Special Analyses
It has been determined that this Treasury decision is not a
significant regulatory action as defined in EO 12866. Therefore, a
regulatory assessment is not required. It also has been determined that
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5)
does not apply to these regulations and, because the regulations do not
impose a collection of information on small entities, the Regulatory
Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to
section 7805(f) of the Internal Revenue Code, these temporary
regulations will be submitted to the Chief Counsel for Advocacy of the
Small Business Administration for comment on their impact on small
business.
Drafting Information
Several persons from the Office of Chief Counsel and the Treasury
Department participated in developing these regulations.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR part 1 is amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 is amended by
adding an entry in numerical order to read as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.1397E-1T also issued under 26 U.S.C. 1397E(b) and
1397E(d). * * *
Par. 2. Section 1.1397E-1T is added to read as follows:
Sec. 1.1397E-1T Qualified zone academy bonds (temporary).
(a) Overview. In general, a qualified zone academy bond is a
taxable bond issued by a state or local government the proceeds of
which are used to improve certain eligible public schools. An eligible
taxpayer that holds a qualified zone academy bond generally is allowed
annual federal income tax credits in lieu of periodic interest
payments. These credits compensate the eligible taxpayer for lending
money to the issuer and function as payments of interest on the bond.
Accordingly, this section generally treats the allowance of a credit as
if it were a payment of interest on the bond. In addition, this section
provides rules to determine the credit rate, the present value of
qualified contributions from private entities, and the maximum term of
a qualified zone academy bond.
(b) Credit rate. The credit rate for a qualified zone academy bond
is equal to 110 percent of the long-term applicable Federal rate (AFR),
compounded annually, for the month in which the bond is issued. The
Internal Revenue Service publishes this figure each month in a revenue
ruling that is published in the Internal Revenue Bulletin. See
Sec. 601.601(d)(2)(ii)(b) of this Chapter.
(c) Private business contribution requirement. To determine the
present value (as of the issue date) of qualified contributions from
private entities under section 1397E(d)(2), the issuer must use a
reasonable discount rate. The credit rate determined under paragraph
(b) of this section is a reasonable discount rate.
(d) Maximum term. The maximum term for a qualified zone academy
bond is determined under section 1397E(d)(3) by using a discount rate
equal to 110 percent of the long-term adjusted AFR, compounded semi-
annually, for the month in which the bond is issued. The Internal
Revenue Service publishes this figure each month in a revenue ruling
that is published in the Internal Revenue Bulletin. See
Sec. 601.601(d)(2)(ii)(b) of this Chapter.
(e) Tax credit--(1) Eligible taxpayer. An eligible taxpayer (within
the meaning of section 1397E(d)(6)) that holds a qualified zone academy
bond on a credit allowance date is allowed a tax credit against the
federal income tax imposed on the taxpayer for the taxable year that
includes the credit allowance date. The amount of the credit is equal
to the product of the credit rate and the outstanding principal amount
of the bond on the credit allowance date. The credit is subject to a
limitation based on the eligible taxpayer s income tax liability. See
section 1397E(c).
(2) Ineligible taxpayer. A taxpayer that is not an eligible
taxpayer is not allowed a credit.
(f) Treatment of the allowance of the credit as a payment of
interest--(1) General rule. The holder of a qualified zone academy bond
must treat the bond as if it pays qualified stated interest (within the
meaning of Sec. 1.1273-1(c)) on each credit allowance date. The amount
of the deemed payment of interest on each credit allowance date is
equal to the product of the credit rate and the outstanding principal
amount of the bond on that date. Thus, for example, if the holder uses
an accrual method of accounting, the holder must accrue as interest
income the amount of the credit over the one-year accrual period that
ends on the credit allowance date.
(2) Adjustment if the holder cannot use the credit to offset a tax
liability. If a holder holds a qualified zone academy bond on the
credit allowance date but cannot use all or a portion of the credit to
reduce its income tax liability (for example, because the holder is not
an eligible taxpayer or because the limitation in section 1397E(c)
applies), the holder is allowed a deduction for the taxable year that
includes the credit allowance date. The amount of the deduction is
equal to the amount of the unused credit deemed paid on the credit
allowance date.
(g) Not a tax-exempt obligation. A qualified zone academy bond is
not an obligation the interest on which is excluded from gross income
under section 103(a).
(h) Cross-references. See section 171 and the regulations
thereunder for rules relating to amortizable bond premium. See
Sec. 1.61-7(c) for the seller s treatment of a bond sold between
interest payment dates (credit allowance dates) and Sec. 1.61-7(d) for
the buyer s treatment of a bond purchased between interest payment
dates (credit allowance dates).
(i) [Reserved]
(j) Effective date. This section applies to a qualified zone
academy bond issued on or after January 1, 1998.
Michael P. Dolan,
Deputy Commissioner of Internal Revenue.
Approved: December 19, 1997.
Donald C. Lubick,
Acting Assistant Secretary of the Treasury.
[FR Doc. 98-21 Filed 1-6-98; 8:45 am]
BILLING CODE 4830-01-U
