[Federal Register Volume 59, Number 89 (Tuesday, May 10, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-11104]
[[Page Unknown]]
[Federal Register: May 10, 1994]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 602
[TD 8538]
RIN 1545-AS50
Arbitrage Restrictions on Tax-Exempt Bonds
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final and temporary regulations.
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SUMMARY: This document contains final and temporary regulations on the
arbitrage and related restrictions applicable to tax-exempt bonds
issued by State and local governments. Changes to the applicable law
were made by the Tax Reform Act of 1986, the Technical and
Miscellaneous Revenue Act of 1988, the Revenue Reconciliation Act of
1989, and the Revenue Reconciliation Act of 1990. These regulations
affect issuers of tax-exempt bonds and provide guidance for complying
with the arbitrage and related restrictions. The text of the temporary
regulations also serves as the text of a portion 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 on June 9, 1994.
For dates of applicability of these regulations, see Sec. 1.148-
11T.
FOR FURTHER INFORMATION CONTACT: William P. Cejudo at 202-622-3980 (not
a toll-free number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
These regulations are being issued without prior notice and public
procedure pursuant to the Administrative Procedure Act (5 U.S.C. 553).
For this reason, the collection of information contained in these
regulations has been reviewed and, pending receipt and evaluation of
public comments, approved by the Office of Management and Budget under
control number 1545-1347.
For further information concerning this collection of information,
and where to submit comments on the collection of information and the
accuracy of the estimated burden, and suggestions for reducing this
burden, please refer to the preamble to the cross-referencing notice of
proposed rulemaking published in the Proposed Rules section of this
issue of the Federal Register.
Background
Section 148 restricts the use of proceeds of tax-exempt State and
local bonds to acquire higher yielding investments. Proposed
regulations relating to the arbitrage and related rules were published
at Secs. 1.148-0 through 1.148-11, 1.149(d)-1, 1.149(g)-1, 1.150-1, and
1.150-2 in the Federal Register for November 6, 1992. Written comments
were received on the proposed regulations, and additional public
comments were received at a public hearing held on February 2, 1993.
After consideration of the comments, the proposed regulations were
modified and adopted in final form in the Federal Register for June 18,
1993 (the June 1993 regulations).
This document contains temporary and final regulations amending the
Income Tax Regulations (26 CFR part 1) under sections 103, 148, 149,
and 150 of the Internal Revenue Code to clarify and revise certain
provisions of the June 1993 regulations. The amended provisions of the
June 1993 regulations contain references to applicable provisions of
the temporary regulations, and the final regulations apply as if the
changes contained in the appropriate portion of the temporary
regulations were incorporated therein. For example, Sec. 1.148-
1(c)(4)(ii)(A) is amended to reference Sec. 1.148-1T(c)(4)(ii)(A),
which contains provisions that apply in lieu of those formerly
contained in Sec. 1.148-1(c)(4)(ii)(A).
Explanation of Provisions
A. Sec. 1.103-8T--Interest on Bonds To Finance Certain Exempt
Facilities
The June 1993 regulations amended the ``official action'' rules of
Sec. 1.103-8(a)(5) to better coordinate those rules and the
reimbursement bond rules of Sec. 1.150-2. The temporary regulations
clarify the application of these rules to situations in which the
financed facility is placed in service after the issuance of the bonds.
B. Sec. 1.148-1T--Definitions and Elections
The June 1993 regulations provide that replacement proceeds may
arise if a working capital reserve is financed but not to the extent
that the issuer maintained a working capital reserve. The temporary
regulations provide guidance to determine whether an issuer has
maintained a working capital reserve.
C. Sec. 1.148-4T--Yield on an Issue of Bonds
1. Certain Variable Yield Bonds Aggregated for Fixed Yield Treatment
The temporary regulations expand the types of bonds eligible for
fixed yield treatment to include certain variable yield bonds that, if
aggregated and treated as a single bond, would be a fixed yield bond.
2. Qualified Hedging Transactions
The June 1993 regulations permit certain qualified hedges to be
taken into account in determining the yield on an issue. The temporary
regulations revise and clarify these rules. Most significantly, the
temporary regulations amend the rules treating certain variable yield
bonds as fixed yield bonds to provide fixed yield treatment for bonds
that are hedged with certain other hedges, such as certain interest
rate caps. Municipal financing transactions with so-called embedded
derivative products raise significant policy issues under any
contingent interest regulations that may be promulgated under section
1275. For this reason, under the original issue discount regulations,
certain of these transactions do not qualify as ``variable rate debt
instruments'' and are subject to the contingent payment rules. The
modifications to the qualified hedging rules do not imply a conclusion
by the IRS and Treasury that the ``interest'' payments in these
financings are properly treated as tax-exempt. It is expected that
future regulations will deal specifically with these issues. In a
related change, the temporary regulations clarify that a hedge (other
than a qualified hedge) may constitute investment-type property. The
proposed amendments to the arbitrage regulations also provide special
rules for purposes of determining whether interest rate caps are
investment-type property.
D. Sec. 1.148-5T--Yield and Valuation of Investments
1. Permissive Single Investment Rule
The temporary regulations limit the rule that permits yield
restricted investments to be treated as a single investment for
arbitrage rebate purposes to nonpurpose investments in a refunding
escrow fund and in a sinking fund that is related to the refunding
escrow fund.
2. Fair Market Valuation
The temporary regulations limit the exception to the fair market
valuation rule for certain transferred proceeds allocations, universal
cap allocations, and investments in a commingled fund to those
involving exclusively tax-exempt bond issues.
E. Sec. 1.148-9--Arbitrage Rules for Refunding Issues
Multipurpose Issue Allocations
The June 1993 regulations provide that allocations of multipurpose
issues must be reasonable. For multipurpose refunding issues, in
addition to the reasonableness requirement, the June 1993 regulations
provide additional limitations. Comments are requested on possible
changes to the allocation rule that generally focuses on matching the
debt service structure of the prior issue that would provide additional
flexibility for refundings involving extensions of maturity.
F. Sec. 1.148-11T--Effective Dates
Overpayment of Rebate
The temporary regulations allow for retroactive application of the
provisions of the June 1993 regulations relating to recovery of
overpayments.
G. Sec. 1.149(d)-1T--Limitations on Advance Refundings
Savings Test
The temporary regulations clarify the application of the
multipurpose issue rules to the section 149(d) requirement that the
refunded bonds in an advance refunding be retired at the first call
date if savings are produced.
H. Sec. 1.150-1T--Definitions
Definition of Issue
The June 1993 regulations define ``issue'' for purposes of the tax-
exempt bond restrictions. The temporary regulations clarify certain
aspects of this definition including whether bonds are expected to be
paid from the same source of funds.
I. Effective Dates
The temporary and final regulations apply to bonds sold after June
6, 1994. In addition, issuers may apply these regulations to other
bonds to which the June 1993 regulations apply.
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 Procedures Act (5 U.S.C. chapter
5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply
to these regulations, and, therefore, a Regulatory Flexibility Analysis
is not required. Pursuant to section 7805(f) of the Internal Revenue
Code, these 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
The principal author of these regulations is William P. Cejudo,
Office of Assistant Chief Counsel (Financial Institutions and
Products), IRS. However, other personnel from the IRS and Treasury
Department participated in their development.
List of Subjects
26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
26 CFR Part 602
Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR parts 1 and 602 are amended as follows:
PART 1--[AMENDED]
PART 602--[AMENDED]
Paragraph 1. The authority citation for part 1 is amended by adding
an entry in numerical order to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.148-11T also issued under 26 U.S.C. 148(f), (g), and
(i). * * *
Par. 2. In Sec. 1.103-8, paragraph (a)(5) is revised to read as
follows:
Sec. 1.103-8 Interest on bonds to finance certain exempt facilities.
(a) * * *
* * * * *
(5) See Sec. 1.103-8T.
* * * * *
Par. 3. Section 1.103-8T is added to read as follows:
Sec. 1.103-8T Interest on bonds to finance certain exempt facilities
(temporary).
(a)(1) through (4) [Reserved]. For guidance see Sec. 1.103-8.
(5) Limitation. (i) A facility qualifies under Sec. 1.103-8 only to
the extent that there is a valid reimbursement allocation under
Sec. 1.150-2 with respect to expenditures that are incurred before the
issue date of the bonds to provide the facility and that are to be paid
with the proceeds of the issue. In addition, if the original use of the
facility begins before the issue date of the bonds, the facility does
not qualify under Sec. 1.103-8 if any person that was a substantial
user of the facility at any time during the 5-year period before the
issue date or any related person to that user receives (directly or
indirectly) 5 percent or more of the proceeds of the issue for the
user's interest in the facility, and is a substantial user of the
facility at any time during the 5-year period after the issue date,
unless--
(A) An official intent for the facility is adopted under
Sec. 1.150-2 within 60 days after the date on which acquisition,
construction, or reconstruction of that facility commenced; and
(B) For an acquisition, no person that is a substantial user or
related person after the acquisition date was also a substantial user
more than 60 days before the date on which the official intent was
adopted.
(ii) A facility the original use of which commences (or the
acquisition of which occurs) on or after the issue date of bonds to
provide that facility qualifies under Sec. 1.103-8 only to the extent
that an official intent for the facility is adopted under Sec. 1.150-2
by the issuer of the bonds within 60 days after the commencement of the
construction, reconstruction, or acquisition of that facility.
Temporary construction or other financing of a facility prior to the
issuance of the bonds to provide that facility will not cause that
facility to be one that does not qualify under this paragraph
(a)(5)(ii).
(iii) For purposes of paragraph (a)(5)(i) of this section,
substantial user has the meaning used in section 147(a)(1); related
person has the meaning used in section 144(a)(3); and a user that is a
governmental unit within the meaning of Sec. 1.103-1 is disregarded.
(iv) Except to the extent provided in Sec. 1.150-2(j) and
Sec. 1.148-11T(i), this paragraph (a)(5) applies to bonds issued after
June 30, 1993.
Par. 4. In Sec. 1.148-0, paragraph (c) is amended as follows:
1. The introductory text is revised.
2. The entry for Sec. 1.148-4, paragraph (b)(5) is redesignated
paragraph (b)(6).
3. A new entry for Sec. 1.148-4, paragraph (b)(5) is added.
4. An entry for Sec. 1.148-11, paragraph (i) is added.
Sec. 1.148-0 Scope and table of contents.
* * * * *
(c) Table of contents. This paragraph (c) lists the table of
contents for Secs. 1.148-1, 1.148-2, 1.148-3, 1.148-4, 1.148-5, 1.148-
6, 1.148-7, 1.148-8, 1.148-9, 1.148-10 and 1.148-11.
* * * * *
Sec. 1.148-4 Yield on an issue of bonds.
* * * * *
(b) * * *
(5) Special aggregation rule treating certain bonds as a single
fixed yield bond.
* * * * *
Sec. 1.148-11 Effective dates.
* * * * *
(i) Transition rule for certain amendments.
Par. 5. In Sec. 1.148-1, paragraph (c)(4)(ii)(A) is revised to read
as follows:
Sec. 1.148-1 Definitions and elections.
* * * * *
(c) * * *
(4) * * *
(ii) * * *
(A) In general. See Sec. 1.148-1T(c)(4)(ii)(A).
* * * * *
Par. 6. Section 1.148-1T is added to read as follows:
Sec. 1.148-1T Definitions and elections (temporary).
(a) [Reserved]. For guidance see Sec. 1.148-1.
(b) Certain definitions.
Investment-type property. See Sec. 1.148-1(b). Investment-type
property also includes a contract that would be a hedge (within the
meaning of Sec. 1.148-4(h)) except that it contains a significant
investment element.
(c) through (c)(4)(i) [Reserved]. For guidance see Sec. 1.148-1.
(c)(4)(ii) Bonds financing a working capital reserve--(A) In
general. Except as otherwise provided in Sec. 1.148-1(c)(4)(ii)(B),
replacement proceeds arise to the extent a working capital reserve is,
directly or indirectly, financed with the proceeds of the issue
(regardless of the expenditure of proceeds of the issue). Thus, for
example, if an issuer that does not maintain a working capital reserve
borrows to fund such a reserve, the issuer will have replacement
proceeds. To determine the amount of a working capital reserve
maintained, an issuer may use the average amount maintained as a
working capital reserve during annual periods of at least one year, the
last of which ends within a year before the issue date. For example,
the amount of a working capital reserve may be computed using the
average of the beginning or ending monthly balances of the amount
maintained as a reserve (net of unexpended gross proceeds) during the
one year period preceding the issue date.
Par. 7. In Sec. 1.148-2, paragraph (b)(2)(ii) is revised to read as
follows:
Sec. 1.148-2 General arbitrage yield restriction rules.
* * * * *
(b) * * *
(2) * * *
(ii) Exception to certification requirements. See Sec. 1.148-
2T(b)(2)(ii).
* * * * *
Par. 8. Section 1.148-2T is added to read as follows:
Sec. 1.148-2T General arbitrage yield restriction rules (temporary).
(a) through (b)(2)(i) [Reserved]. For guidance see Sec. 1.148-2.
(b)(2)(ii) Exceptions to certification requirement. An issuer is
not required to make a certification for an issue under Sec. 1.148-
2(b)(2)(i) if--
(A) The issuer reasonably expects as of the issue date that there
will be no unspent gross proceeds after the issue date, other than
gross proceeds in a bona fide debt service fund (e.g., equipment lease
financings in which the issuer purchases equipment in exchange for an
installment payment note); or
(B) The issue price of the issue does not exceed $1,000,000.
Par. 9. In Sec. 1.148-3, paragraph (h)(3) is amended by adding a
sentence after the last sentence to read as follows:
Sec. 1.148-3 General arbitrage rebate rules.
* * * * *
(h) * * *
(3) * * * See also Sec. 1.148-3T(h)(3).
* * * * *
Par. 10. Section 1.148-3T is added to read as follows:
Sec. 1.148-3T General arbitrage rebate rules (temporary).
(a) through (h)(2) [Reserved]. For guidance see Sec. 1.148-3.
(h)(3) Waivers of the penalty. For purposes of Sec. 1.148-3(h)(3),
willful neglect does not include a failure that is attributable solely
to the permissible retroactive selection of a short first bond year if
the rebate amount that the issuer failed to pay is paid within 60 days
of the selection of that bond year.
Par. 11. Section 1.148-4 is amended as follows:
1. Paragraph (b)(5) is redesignated as paragraph (b)(6).
2. New paragraph (b)(5) is added.
3. Paragraph (g) is revised.
4. Paragraph (h)(1) is revised.
5. Paragraph (h)(2)(vii) is revised.
6. Paragraph (h)(2)(ix) is revised.
7. Paragraphs (h)(3), (4), and (5) are revised.
8. The revised and added provisions read as follows:
Sec. 1.148-4 Yield on an issue of bonds.
* * * * *
(b) * * *
(5) Special aggregation rule treating certain bonds as a single
fixed yield bond. See Sec. 1.148-4T(b)(5).
* * * * *
(g) Yield on certain mortgage revenue and student loan bonds. See
Sec. 1.148-4T(g).
(h) * * *
(1) In general. See Sec. 1.148-4T(h)(1).
(2) * * *
* * * * *
(vii) Timing and duration. See Sec. 1.148-4T(h)(2)(vii).
* * * * *
(ix) Identification. See Sec. 1.148-4T(h)(2)(ix).
(3) Accounting for qualified hedges. See Sec. 1.148-4T(h)(3).
(4) Certain variable yield bonds treated as fixed yield bonds. See
Sec. 1.148-4T(h)(4).
(5) Authority of the Commissioner. See Sec. 1.148-4T(h)(6).
Par. 12. Section 1.148-4T is added to read as follows:
Sec. 1.148-4T Yield on an issue of bonds (temporary).
(a) through (b)(4) [Reserved]. For guidance see Sec. 1.148-4.
(b)(5) Special aggregation rule treating certain bonds as a single
fixed yield bond. Two variable yield bonds of an issue are treated in
the aggregate as a single fixed yield bond if--
(i) Aggregate treatment would result in the single bond being a
fixed yield bond; and
(ii) The terms of the bonds do not contain any features that could
distort the aggregate fixed yield from what the yield would be if a
single fixed yield bond were issued. For example, if an issue contains
a bond bearing interest at a floating rate and a related bond bearing
interest at a rate equal to a fixed rate minus that floating rate,
those two bonds are treated as a single fixed yield bond only if
neither bond may be redeemed unless the other bond is also redeemed at
the same time.
(c) through (f) [Reserved]. For guidance see Sec. 1.148-4.
(g) Yield on certain mortgage revenue and student loan bonds. For
purposes of section 148 and Sec. 1.148-4, section 143(g)(2)(C)(ii)
applies to the computation of yield on an issue of qualified mortgage
bonds or qualified veterans' mortgage bonds. For purposes of applying
sections 148 and 143(g) to a variable yield issue of qualified mortgage
bonds, qualified veterans' mortgage bonds, or qualified student loan
bonds, the yield on that issue is computed over the term of the issue,
and Sec. 1.148-4(d) does not apply to the issue. As of any date before
the final maturity date, the yield over the term of the issue is based
on the actual amounts paid or received to that date and the amounts
that are reasonably expected (as of that date) to be paid or received
over the remaining term of the issue.
(h) Qualified hedging transactions--(1) In general. Payments made
or received by an issuer under a qualified hedge (as defined in
Sec. 1.148-4(h)(2)) relating to bonds of an issue are taken into
account (as provided in paragraph (h)(3) of this section) to determine
the yield on the issue. Except as provided in paragraphs (h)(4) and
(h)(5)(ii)(C) of this section, the bonds to which a qualified hedge
relates are treated as variable yield bonds. These hedging rules apply
solely for purposes of sections 143(g), 148, and 149(d).
(2) (i) through (vi) [Reserved]. For guidance see Sec. 1.148-
4(h)(2).
(2)(vii) Timing and duration. For a contract to be a qualified
hedge under Sec. 1.148-4(h)(2), payments must not begin to accrue under
the contract on a date earlier than the issue date of the hedged bonds
and must not accrue longer than the hedged interest payments on the
hedged bonds.
(viii) [Reserved]. For guidance see Sec. 1.148-4(h).
(ix) Identification. For a contract to be a qualified hedge under
Sec. 1.148-4(h)(2), the contract must be identified by the actual
issuer on its books and records maintained for the hedged bonds not
later than three days after the date on which the parties enter into
the contract. The identification must specify the hedge provider, the
terms of the contract, and the hedged bonds. The identification must
contain sufficient detail to establish that the requirements of
Sec. 1.148-4(h)(2), and if applicable, paragraph (h)(4) of this section
are satisfied. The existence of the hedge must be noted on all forms
filed with the Internal Revenue Service for the issue on or after the
date on which the hedge is entered into.
(3) Accounting for qualified hedges--(i) In general. Except as
otherwise provided in paragraph (h)(4) of this section, payments made
or received by the issuer under a qualified hedge are treated as
payments made or received, as appropriate, on the hedged bonds that are
taken into account in determining the yield on those bonds. These
payments are reasonably allocated to the hedged bonds in the period to
which the payments relate, as determined under paragraph (h)(3)(iii) of
this section. Payments made or received by the issuer include payments
deemed made or received when a contract is terminated or deemed
terminated under this paragraph (h)(3). Payments reasonably allocable
to the reduction of risk of interest rate changes and to the hedge
provider's overhead under this paragraph (h) are included as payments
made or received under a qualified hedge.
(ii) Exclusions from hedge. Payments for services or other items
under the contract that are not expressly treated as payments under the
qualified hedge under paragraph (h)(3)(i) of this section are not
payments with respect to a qualified hedge.
(iii) Timing and allocation of payments. The period to which a
payment made by the issuer relates is determined under general Federal
income tax principles, including, without limitation, Sec. 1.446-3, and
adjusted as necessary to reflect the end of a computation period and
the start of a new computation period. Except as provided in paragraphs
(h)(3)(iv) and (h)(5)(ii) of this section, a payment received by the
issuer is taken into account in the period that the interest payment
that the payment hedges is required to be made.
(iv) Termination payments--(A) Termination defined. A termination
of a qualified hedge includes any sale or other disposition of the
hedge by the issuer, or the acquisition by the issuer of an offsetting
hedge. A deemed termination occurs when the hedged bonds are redeemed
and when a hedge ceases to be a qualified hedge of the hedged bonds. In
the case of an assignment by a hedge provider of its remaining rights
and obligations on the hedge to a third party or a modification of the
hedging contract, the assignment or modification is treated as a
termination with respect to the issuer only if it results in a deemed
exchange of the hedge and a realization event under section 1001.
(B) General rule. A payment made or received by an issuer to
terminate a qualified hedge, including loss or gain realized or deemed
realized, is treated as a payment made or received on the hedged bonds,
as appropriate. The payment is reasonably allocated to the remaining
periods originally covered by the terminated hedge in a manner that
reflects the economic substance of the hedge.
(C) Special rule for terminations when bonds are redeemed. Except
as otherwise provided in this paragraph (h)(3)(iv)(C) and in paragraph
(h)(3)(iv)(D) of this section, when a qualified hedge is deemed
terminated because the hedged bonds are redeemed, the fair market value
of the contract on the redemption date is treated as a termination
payment made or received on that date. When hedged bonds are redeemed,
any payment received by the issuer on termination of a hedge, including
a termination payment or a deemed termination payment, reduces, but not
below zero, the interest payments made by the issuer on the hedged
bonds in the computation period ending on the termination date. The
remainder of the payment, if any, is reasonably allocated over the bond
years in the immediately preceding computation period or periods to the
extent necessary to eliminate the excess.
(D) Special rules for refundings. To the extent that the hedged
bonds are redeemed using the proceeds of a refunding issue, the
termination payment is accounted for under paragraph (h)(3)(iv)(B) of
this section by treating it as a payment on the refunding issue, rather
than the hedged bonds. In addition, to the extent that the refunding
issue, rather than the hedged bonds, has been redeemed, paragraph
(h)(3)(iv)(C) of this section applies to the termination payment by
treating it as a payment on the redeemed refunding issue.
(E) Safe harbor for certain non-level payments. A non-level payment
to terminate a hedge does not result in that hedge failing to satisfy
the applicable provisions of paragraph (h)(3)(iv)(B) of this section if
the payment is allocated to each bond year for which the hedge would
have been in effect in accordance with this paragraph (h)(3)(iv)(E).
For a variable yield issue, an equal amount (or for any short bond
year, a proportionate amount of the equal amount) must be allocated to
each bond year such that the sum of the present values of the annual
amounts equals the present value of the non-level payment. Present
value is computed as of the day the hedge is terminated, using the
yield on the hedged bonds, determined without regard to the non-level
payment. The yield used for this purpose is computed for the period
beginning on the first date the hedge is in effect and ending on the
date the hedge is terminated. On the other hand, for a fixed yield
issue, the non-level payment is taken into account as a single payment
on the date it is paid.
(4) Certain variable yield bonds treated as fixed yield bonds--(i)
In general. Except as otherwise provided in this paragraph (h)(4), if
the issuer of variable yield bonds enters into a qualified hedge, the
hedged bonds are treated as fixed yield bonds paying a fixed interest
rate if:
(A) Start date. The date on which payments begin to accrue on the
hedge is not later than 15 days after the issue date of the hedged
bonds.
(B) Maturity. The term of the hedge is equal to the entire period
during which the hedged bonds bear interest at variable interest rates.
(C) Payments closely correspond. Payments to be received under the
hedge correspond closely in time to the hedged portion of the payments
on the hedged bonds. Hedge payments received within 15 days of the
related payments on the hedged bonds generally so correspond.
(D) Aggregate payments fixed. Taking into account all payments made
and received under the hedge and all payments on the hedged bonds
(i.e., after netting all payments), the issuer's aggregate payments are
fixed and determinable as of a date not later than 15 days after the
issue date of the hedged bonds. Payments on bonds are treated as fixed
for purposes of this paragraph (h)(4)(i)(D) if payments on the bonds
are based, in whole or in part, on one interest rate, payments on the
hedge are based, in whole or in part, on a second interest rate that is
substantially the same as, but not identical to, the first interest
rate and payments on the bonds would be fixed if the two rates were
identical. Rates are treated as substantially the same if they are
reasonably expected to be substantially the same throughout the term of
the hedge. For example, an objective 30-day tax-exempt variable rate
index or other objective index (e.g., J.J. Kenny Index, PSA Municipal
swap index, a percentage of LIBOR) may be substantially the same as an
issuer's individual 30-day interest rate.
(ii) Accounting. Except as otherwise provided in this paragraph
(h)(4)(ii), in determining yield on the hedged bonds, all the issuer's
actual interest payments on the hedged bonds and all payments made and
received on a hedge described in paragraph (h)(4)(i) of this section
are taken into account. If payments on the bonds and payments on the
hedge are based, in whole or in part, on variable interest rates that
are substantially the same within the meaning of paragraph (h)(4)(i)(D)
of this section (but not identical), yield on the issue is determined
by treating the variable interest rates as identical. For example, if
variable rate bonds bearing interest at a weekly rate equal to the rate
necessary to remarket the bonds at par are hedged with an interest rate
swap under which the issuer receives payments based on a short-term
floating rate index that is substantially the same as, but not
identical to, the weekly rate on the bonds, the interest payments on
the bonds are treated as equal to the payments received by the issuer
under the swap for purposes of computing the yield on the bonds.
(iii) Effect of termination--(A) In general. Except as otherwise
provided in this paragraph (h)(4)(iii) and paragraph (h)(5) of this
section, the issue of which the hedged bonds are a part is treated as
if it were reissued as of the termination date of the qualified hedge
covered by paragraph (h)(4)(i) of this section in determining yield on
the hedged bonds for purposes of Sec. 1.148-3. The redemption price of
the retired issue and the issue price of the new issue equal the
aggregate values of all the bonds of the issue on the termination date.
In computing the yield on the new issue for this purpose, any
termination payment is accounted for under paragraph (h)(3)(iv) of this
section, applied by treating the termination payment as made or
received on the new issue under this paragraph (h)(4)(iii).
(B) Effect of early termination. Except as otherwise provided in
this paragraph (h)(4)(iii), the general rules of paragraph (h)(4)(i) of
this section do not apply in determining the yield on the hedged bonds
for purposes of Sec. 1.148-3 if the hedge is terminated or deemed
terminated within 5 years after the issue date of the issue of which
the hedged bonds are a part. Thus, the hedged bonds are treated as
variable yield bonds for purposes of Sec. 1.148-3 from the issue date.
(C) Certain terminations disregarded. This paragraph (h)(4)(iii)
does not apply to a termination if, based on the facts and
circumstances (e.g., taking into account both the termination and any
qualified hedge that immediately replaces the terminated hedge), there
is no change in the yield. In addition, this paragraph (h)(4)(iii) does
not apply to a termination caused by the bankruptcy or insolvency of
the hedge provider if the Commissioner determines that the termination
occurred without any action by the issuer (other than to protect its
rights under the hedge).
(5) Special rules for certain hedges--(i) Certain acquisition
payments. A payment to the issuer by the hedge provider (e.g., an up-
front payment for an off-market swap) in connection with the
acquisition of a hedge that, but for that payment, would be a qualified
hedge, does not cause the hedge to fail to be a qualified hedge
provided the payment to the issuer and the issuer's payments under the
hedge in excess of those that it would make if the hedge bore rates
equal to the on-market rates for the hedge are separately identified in
a certification of the hedge provider and not taken into account in
determining the yield on the issue of which the hedged bonds are a
part. The on-market rates are determined as of the date the parties
enter into the contract.
(ii) Anticipatory hedges--(A) In general. A contract does not fail
to be a hedge under Sec. 1.148-4(h)(2)(i)(A) solely because it is
entered into with respect to an anticipated issuance of tax-exempt
bonds. The identification required under Sec. 1.148-4T(h)(2)(ix) must
specify the reasonably expected governmental purpose, principal amount,
and issue date of the hedged bonds, and the manner in which interest is
reasonably expected to be computed.
(B) Special rules. Payments made in connection with the issuance of
a bond to terminate or otherwise close (terminate) an anticipatory
hedge of that bond do not prevent the hedge from satisfying the
requirements of Sec. 1.148-4(h)(2)(vi) and paragraph (h)(2)(vii) of
this section. Amounts received or deemed to be received by the issuer
in connection with the issuance of the hedged bonds to terminate an
anticipatory hedge are treated as proceeds of the hedged bonds.
(C) Fixed yield treatment. A bond that is hedged with an
anticipatory hedge is a fixed yield bond if, taking into account
payments on the hedge that are made or fixed on or before the issue
date of the bond and the payments to be made on the bond, the bond
satisfies the definition of fixed yield bond. See also paragraph (h)(4)
of this section.
(6) Authority of the Commissioner--(i) In general. A contract is
not a qualified hedge if the Commissioner determines, based on all the
facts and circumstances, that treating the contract as a qualified
hedge would provide a material potential for arbitrage, or a principal
purpose for entering into the contract is that arbitrage potential. For
example, a contract that requires a substantial nonperiodic payment may
constitute, in whole or part, an embedded loan, investment-type
property, or other investment.
(ii) Other qualified hedges. The Commissioner, by publication of a
revenue ruling or revenue procedure, may specify contracts that do not
otherwise meet the requirements of Sec. 1.148-4(h)(2) as qualified
hedges and contracts that do not otherwise meet the requirements of
paragraph (h)(4) of this section as causing the hedged bonds to be
treated as fixed yield bonds.
(iii) Recomputation of yield. If an issuer enters into a hedge that
is not properly identified, fails to properly associate an anticipatory
hedge with the hedged bonds, or otherwise fails to meet the
requirements of this section, the Commissioner may recompute the yield
on the issue taking the hedge into account if the failure to take the
hedge into account distorts that yield or otherwise fails to clearly
reflect the economic substance of the transaction.
Par. 13. Section 1.148-5 is amended as follows:
1. Paragraph (b)(2)(iii) is revised.
2. Paragraph (c)(2)(i) is revised.
3. Paragraph (c)(3)(ii) is revised.
4. Paragraph (d)(3)(ii) is revised.
5. A sentence is added at the end of paragraph (e)(2)(ii)(B).
6. Paragraph (e)(2)(iii) is revised.
7. The revised provisions read as follows:
Sec. 1.148-5 Yield and valuation of investments.
* * * * *
(b) * * *
(2) * * *
(iii) Permissive application of single investment rules to certain
yield restricted investments for all purposes of section 148. See
Sec. 1.148-5T(b)(2)(iii).
* * * * *
(c) * * *
(2) * * *
(i) In general. See Sec. 1.148-5T(c)(2)(i).
* * * * *
(3) * * *
(ii) Exception to yield reduction payments rule for advance
refunding issues. See Sec. 1.148-5T(c)(3)(ii).
(d) * * *
(3) * * *
(ii) Exception to fair market value requirement for transferred
proceeds allocations, universal cap allocations, and commingled funds.
See Sec. 1.148-5T(d)(3)(ii).
(e) * * *
(2) * * *
(ii) * * *
(B) * * * See also Sec. 1.148-5T(e)(2)(B).
(iii) Special rule for guaranteed investment contracts. See
Sec. 1.148-5T(e)(2)(iii).
* * * * *
Par. 14. Section 1.148-5T is added to read as follows:
Sec. 1.148-5T Yield and valuation of investments (temporary).
(a) through (b)(2)(ii) [Reserved]. For guidance see Sec. 1.148-5.
(b)(2)(iii) Permissive application of single investment rules to
certain yield restricted investments for all purposes of section 148.
For all purposes of section 148, an issuer may treat all of the yield
restricted nonpurpose investments in a refunding escrow and a sinking
fund that is reasonably expected as of the issue date to be maintained
to reduce the yield on the investments in the refunding escrow as a
single investment having a single yield, determined under
Sec. 1.148(b)(2).
(b) (2)(iv) through (c)(1) [Reserved]. For guidance see Sec. 1.148-
5.
(c)(2) Manner of payment--(i) In general. Except as otherwise
provided in Sec. 1.148-5(c)(2)(ii), an amount is paid under Sec. 1.148-
5(c) if it is paid to the United States at the same time and in the
same manner as rebate amounts are required to be paid or at such other
time or in such manner as the Commissioner may prescribe. For example,
yield reduction payments must be made on or before the date of required
rebate installment payments as described in Sec. 1.148-3(f). The date a
payment is required to be paid is determined without regard to
Sec. 1.148-3(h). An amount that is paid untimely is not taken into
account under this paragraph (c) unless the Commissioner determines
that the failure to pay timely is not due to willful neglect. The
provisions of Sec. 1.148-3(i) apply to payments made under Sec. 1.148-
5(c).
(c)(2)(ii) through (c)(3)(i) [Reserved] For guidance see
Sec. 1.148-5.
(c)(3)(ii) Exception to yield reduction payments rule for advance
refunding issues. Section 1.148-5(c)(1) does not apply to investments
allocable to gross proceeds of an advance refunding issue, other than--
(A) Transferred proceeds to which Sec. 1.148-5(c)(3)(i)(C) applies;
(B) Replacement proceeds to which Sec. 1.148-5(c)(3)(i)(F) applies;
and
(C) Transferred proceeds to which Sec. 1.148-5(c)(3)(i)(E) applies,
but only to the extent necessary to satisfy yield restriction under
section 148(a) on those proceeds treating all investments allocable to
those proceeds as a separate class.
(d)(1) through (d)(3)(i) [Reserved]. For guidance see Sec. 1.148-5.
(d)(3)(ii) Exception to fair market value requirement for
transferred proceeds allocations, universal cap allocations, and
commingled funds. Section 1.148-5(d)(3)(i) does not apply if the
investment is allocated from one issue to another issue as a result of
the transferred proceeds allocation rule under Sec. 1.148-9(b) or the
universal cap rule under Sec. 1.148-6(b)(2), provided that both issues
consist exclusively of tax-exempt bonds. In addition, Sec. 1.148-
5(d)(3)(i) does not apply to investments in a commingled fund (other
than a bona fide debt service fund) unless it is an investment being
initially deposited in or withdrawn from a commingled fund described in
Sec. 1.148-6(e)(5)(iii).
(e)(1) through (e)(2)(ii)(A) [Reserved]. For guidance see
Sec. 1.148-5.
(e)(2)(ii)(B) External commingled funds. For any semiannual period,
a commingled fund satisfies the 10 percent requirement of Sec. 1.148-
5(e)(2)(ii)(B) if--
(1) Based on average amounts on deposit, this requirement was
satisfied for the prior semiannual period; and
(2) The fund does not accept deposits that would cause it to fail
to meet this requirement.
(iii) Special rule for guaranteed investment contracts. For a
guaranteed investment contract, a broker's commission or similar fee
paid on behalf of either an issuer or the provider is treated as an
administrative cost and, except in the case of an issue that satisfies
section 148(f)(4)(D)(i), is not a qualified administrative cost to the
extent that the present value of the commission, as of the date the
contract is allocated to the issue, exceeds the present value of annual
payments equal to .05 percent of the weighted average amount reasonably
expected to be invested each year of the term of the contract. For this
purpose, present value is computed using the taxable discount rate used
by the parties to compute the commission or, if not readily
ascertainable, a reasonable taxable discount rate.
Par. 15. In Sec. 1.148-6, paragraph (d)(3)(iii)(C) is revised to
read as follows:
Sec. 1.148-6 General allocation and accounting rules.
* * * * *
(d) * * *
(3) * * *
(iii) * * *
(C) Qualified endowment funds treated as unavailable. See
Sec. 1.148-6T(d)(3)(iii)(C).
* * * * *
Par. 16. Section 1.148-6T is added to read as follows:
Sec. 1.148-6T General allocation and accounting rules (temporary).
(a) through (d)(3)(iii)(B) [Reserved]. For guidance see Sec. 1.148-
6.
(d)(3)(iii)(C) Qualified endowment funds treated as unavailable.
For a 501(c)(3) organization, a qualified endowment fund is treated as
unavailable. A fund is a qualified endowment fund if--
(1) The fund is derived from gifts or bequests, or the income
thereon, that were neither made nor reasonably expected to be used to
pay working capital expenditures;
(2) Pursuant to reasonable, established practices of the
organization, the governing body of the 501(c)(3) organization
designates and consistently operates the fund as a permanent endowment
fund or quasi-endowment fund restricted as to use; and
(3) There is an independent verification (e.g., from an independent
certified public accountant) that the fund is reasonably necessary as
part of the organization's permanent capital.
Par. 17. Section 1.148-9 is amended as follows:
1. Paragraph (c)(2)(ii)(B) is revised.
2. Paragraph (h)(4)(vi) is added.
3. The revised and added provisions read as follows:
Sec. 1.148-9 Arbitrage rules for refunding issues.
* * * * *
(c) * * *
(2) * * *
(ii) * * *
(B) Permissive allocation of non-proceeds to earliest expenditures.
See Sec. 1.148-9T(c)(2)(ii)(B).
* * * * *
(h) * * *
(4) * * *
(vi) See Sec. 1.148-9T(h)(4)(vi).
* * * * *
Par. 18. Section 1.148-9T is added to read as follows:
Sec. 1.148-9T Arbitrage rules for refunding issues (temporary).
(a) through (c)(2)(ii)(A) [Reserved]. For guidance see Sec. 1.148-
9.
(c)(2)(ii)(B) Permissive allocation of non-proceeds to earliest
expenditures. Excluding amounts covered by Sec. 1.148-9(c)(2)(ii)(A)
and subject to any required earlier expenditure of those amounts, any
amounts in a mixed escrow that are not proceeds of a refunding issue
may be allocated to the earliest maturing investments in the mixed
escrow, provided that those investments mature and the proceeds thereof
are expended before the date of any expenditure from the mixed escrow
to pay any principal of the prior issue.
(d) through (h)(4)(v) [Reserved]. For guidance see Sec. 1.148-9.
(h)(4)(vi) Exception for refundings of interim notes. Section
1.148-9(h)(4)(v) need not be applied to refunding bonds issued to
provide permanent financing for one or more projects if the prior issue
had a term of less than 3 years and was sold in anticipation of
permanent financing, but only if the aggregate term of all prior issues
sold in anticipation of permanent financing was less than 3 years.
Par. 19. Section 1.148-10 is amended as follows:
1. Paragraph (b)(2) is revised.
2. A sentence is added at the end of paragraph (c)(2)(ix).
3. The added and revised provisions read as follows:
Sec. 1.148-10 Anti-abuse rules and authority of Commissioner.
* * * * *
(b) * * *
(2) Application. See Sec. 1.148-10T(b)(2).
(c) * * *
(2) * * *
(ix) * * * See also Sec. 1.148-10T(c)(2)(ix).
* * * * *
Par. 20. Section 1.148-10T is added to read as follows:
Sec. 1.148-10T Anti-abuse rules and authority of Commissioner
(temporary).
(a) through (b)(1) [Reserved]. For guidance see Sec. 1.148-10.
(b)(2) Application. The provisions of Sec. 1.148-10(b) only apply
to the portion of an issue that, as a result of actions taken (or
actions not taken) after the issue date, overburdens the market for
tax-exempt bonds, except that for an issue that is reasonably expected
as of the issue date to overburden the market, those provisions apply
to all of the gross proceeds of the issue.
(c) through (c)(2)(viii) [Reserved]. For guidance see Sec. 1.148-
10.
(c)(2)(ix) For purposes of Sec. 1.148-10(c)(2), excess gross
proceeds do not include gross proceeds allocable to fees for a
qualified hedge for the refunding issue.
Par. 21. Section 1.148-11 is amended by adding paragraph (i) to
read as follows:
Sec. 1.148-11 Effective dates.
* * * * *
(i) Transition rule for certain amendments. See Sec. 1.148-11T(i).
Par. 22. Section 1.148-11T is added to read as follows:
Sec. 1.148-11T Effective dates (temporary).
(a) through (c)(3) [Reserved]. For guidance see Sec. 1.148-11.
(c)(4) Retroactive application of overpayment recovery provisions.
An issuer may apply the provisions of Sec. 1.148-3(i) to any issue that
is subject to section 148(f) or to sections 103(c)(6) or 103A(i) of the
Internal Revenue Code of 1954.
(d) through (h) [Reserved]. For guidance see Sec. 1.148-11.
(i) Transition rule for certain amendments. Sections 1.103-8(a)(5),
1.148-1 through 1.148-11, 1.149(d)-1, and 1.150-1, as amended on June
6, 1994 (the effective date) to reflect amendments to Secs. 1.103-
8(a)(5), 1.148-1 through 1.148-11, 1.149(d)-1, and 1.150-1 (as
contained in 26 CFR Part 1 edition revised April 1, 1994), and sections
1.103-8T, 1.148-1T, 1.148-2T, 1.148-3T, 1.148-4T, 1.148-5T, 1.148-6T,
1.148-9T, 1.148-10T, 1.148-11T, 1.149(d)-1T, and 1.150-1T apply in
whole, but not in part,--
(1) To bonds sold after the effective date;
(2) To bonds issued prior to July 1, 1993, if the issuer, after the
effective date, first applies Secs. 1.148-1 through 1.148-11, to the
bonds under Sec. 1.148-11 (b) or (c); and
(3) At the option of the issuer, to bonds to which Secs. 1.148-1
through 1.148-11, as in effect before the effective date, apply.
Par. 23. In Sec. 1.149(d)-1, paragraph (f)(3) is revised to read as
follows:
Sec. 1.149(d)-1 Limitations on advance refundings.
* * * * *
(f) * * *
(3) Application of savings test to multipurpose issues. See
Sec. 1.149(d)-1T.
* * * * *
Par. 24. Section 1.149(d)-1T is added to read as follows:
Sec. 1.149(d)-1T Limitations on advance refundings (temporary).
(a) through (f)(2) [Reserved]. For guidance see Sec. 1.149(d)-1.
(f)(3) Application of savings test to multipurpose issues. Except
as otherwise provided in this paragraph (f)(3), the multipurpose issue
rules in Sec. 1.148-9(h) apply for purposes of the savings test. If any
separate issue in a multipurpose issue increases the aggregate present
value debt service savings on the entire multipurpose issue or reduces
the present value debt service losses on that entire multipurpose
issue, that separate issue satisfies the savings test.
Par. 25. Section 1.150-1 is amended as follows:
1. Paragraph (c)(1) is revised.
2. The paragraph heading for (c)(4) is revised.
3. Paragraph (c)(4)(iii) is added.
4. The revised and added provisions read as follows:
Sec. 1.150-1 Definitions.
* * * * *
(c) Definition of issue--(1) In general. See Sec. 1.150-1T(c)(1).
* * * * *
(4) Special rules for certain financings--(i) * * *
* * * * *
(iii) See Sec. 1.150-1T(c)(4)(iii).
* * * * *
Par. 26. Section 1.150-1T is added to read as follows:
Sec. 1.150-1T Definitions (temporary).
(a) through (b) [Reserved]. For guidance see Sec. 1.150-1.
(c) Definition of issue--(1) In general. Except as otherwise
provided, the provisions of this paragraph (c) apply for all purposes
of sections 103 and 141 through 150. Except as otherwise provided in
this paragraph (c), two or more bonds are treated as part of the same
issue if all of the following factors are present:
(i) Sold at substantially the same time. The bonds are sold at
substantially the same time. Bonds are treated as sold at substantially
the same time if they are sold less than 15 days apart. For this
purpose only, a variable yield bond is treated as sold on its issue
date.
(ii) Sold pursuant to the same plan of financing. The bonds are
sold pursuant to the same plan of financing. Factors material to the
plan of financing include the purposes for the bonds and the structure
of the financing. For example, generally--
(A) Bonds to finance a single facility or related facilities are
part of the same plan of financing;
(B) Short-term bonds to finance working capital expenditures and
long-term bonds to finance capital projects are not part of the same
plan of financing; and
(C) Certificates of participation in a lease and general obligation
bonds secured by tax revenues are not part of the same plan of
financing.
(iii) Payable from same source of funds. The bonds are reasonably
expected to be paid from substantially the same source of funds,
determined without regard to guarantees from parties unrelated to the
obligor.
(2) through (4)(ii) [Reserved]. For guidance see Sec. 1.150-1
(c)(3) through (c)(4)(ii).
(c)(4)(iii) Certain general obligation bonds. Bonds are part of the
same issue if secured by a pledge of the issuer's full faith and credit
(or a substantially similar pledge) and sold and issued on the same
dates pursuant to a single offering document.
(5) [Reserved]. For guidance see Sec. 1.150-1(c)(5).
(6) Sale date. The sale date of a bond is the first day on which
there is a binding contract in writing for the sale or exchange of the
bond.
Dated: April 14, 1994.
Margaret Milner Richardson,
Commissioner of Internal Revenue.
Approved:
Leslie Samuels,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 94-11104 Filed 5-5-94; 2:17 pm]
BILLING CODE 4830-01-U
