[Federal Register Volume 61, Number 125 (Thursday, June 27, 1996)]
[Proposed Rules]
[Pages 33405-33407]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-16378]


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DEPARTMENT OF THE TREASURY
26 CFR Part 1

[FI-28-96]
RIN 1545-AU39


Arbitrage Restrictions on Tax-Exempt Bonds

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document contains proposed regulations on the arbitrage 
restrictions applicable to tax-exempt bonds issued by state and local 
governments. Changes to applicable law were made by the Tax Reform Act 
of 1986. These proposed regulations affect issuers of tax-exempt bonds 
and would provide guidance for complying with the arbitrage 
regulations.

DATES: Written comments must be received by September 25, 1996. 
Requests to speak (with outlines of oral comments) at a public hearing 
scheduled for Thursday, October 24, 1996, at 10 a.m. must be received 
by October 3, 1996.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (FI-28-96), room 5226, 
Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, 
DC 20044. In the alternative, submissions may be hand delivered between 
the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (FI-28-96), Courier's 
Desk, Internal Revenue Service, 1111 Constitution Avenue NW., 
Washington, DC. The public hearing will be held in the Commissioner's 
Conference Room, Internal Revenue Building, 1111 Constitution Avenue, 
NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Loretta J. Finger, (202) 622-3980; concerning submissions and the 
hearing, Michael Slaughter, (202) 622-7190 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collections of information contained in this notice of proposed 
rulemaking have been submitted to the Office of Management and Budget 
for review in accordance with the Paperwork Reduction Act of 1995 (44 
U.S.C. 3507).
    Comments on the collections of information should be sent to the 
Office of Management and Budget, Attn: Desk Officer for the Department 
of the Treasury, Office of Information and Regulatory Affairs, 
Washington, DC 20503, with copies to the Internal Revenue Service, 
Attn: IRS Reports Clearance Officer, T:FP, Washington, DC 20224. 
Comments on the collections of information should be received by August 
26, 1996.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless the collection of 
information displays a valid control number.
    The collections of information are in proposed Sec. 1.148-5(d)(6) 
(v), (vi), and (vii). This information is required by the IRS to verify 
compliance with section 148. This information will be used to establish 
a rebuttable presumption that a Treasury obligation is purchased at 
fair market value. The likely respondents and/or recordkeepers are 
state or local governments. Responses to this collection of information 
are required to establish a rebuttable presumption that a Treasury 
obligation is purchased at fair market value.
    Books or records relating to a collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax return information

[[Page 33406]]

are confidential, as required by 25 U.S.C. 6103.
    Estimated total annual reporting and recordkeeping burden: 2,400 
hours.
    The estimated annual burden per respondent/recordkeeper varies from 
2 hours to 30 hours, depending on individual circumstances, with an 
estimated average of 6 hours.
    Estimated number of respondents/recordkeepers: 400.
    Estimated annual frequency of responses: on occasion.

Background

    This document contains proposed regulations amending the Income Tax 
Regulations (26 CFR part 1) under section 148 of the Internal Revenue 
Code to provide guidance on nonpurpose investments for purposes of 
arbitrage yield restrictions under section 148.

Explanation of Provisions

A. Background of Proposed Regulations

    Section 148 provides rules concerning the use of proceeds of state 
and local bonds to acquire higher yielding investments. Section 148(a) 
provides that, except as otherwise permitted by section 148, interest 
on a state or local bond generally is tax-exempt only if the issuer 
invests bond proceeds at a yield not exceeding the bond yield. Section 
148(f) provides, in general, that interest on a state or local bond is 
tax-exempt only if the issuer rebates to the United States certain 
earnings from investing bond proceeds at a yield exceeding the bond 
yield.
    Section 1.148-6(c) provides that gross proceeds of an issue of 
bonds are not allocated to a payment for a nonpurpose investment in an 
amount greater than the fair market value of that investment on the 
purchase date. For this purpose only, the fair market value of a 
nonpurpose investment is adjusted to take into account qualified 
administrative costs allocable to that investment.
    Regulations relating to the arbitrage yield restriction rules are 
in Secs. 1.148-0 through 1.148-11 and in Secs. 1.148-1T, 1.148-2T, 
1.148-3T, 1.148-4T, 1.148-5T, 1.148-6T, 1.148-9T, 1.148-10T, and 1.148-
11T. The proposed regulations would clarify and revise certain 
provisions of these regulations.

B. Bona Fide Solicitation

    Section 1.148-5(d)(6)(iii) provides that the purchase price of a 
guaranteed investment contract is treated as its fair market value on 
the purchase date if the issuer makes a bona fide solicitation for a 
guaranteed investment contract that meets the requirements of that 
section. The proposed regulations would clarify that a solicitation for 
a guaranteed investment contract is rebuttably presumed to be bona fide 
if the following requirements are met: (i) If the issuer uses an agent 
to conduct the bidding process, the agent does not bid to provide the 
investment; (ii) all bidders have equal opportunity to bid so that, for 
example, no bidder is given the opportunity to review other bids (a 
last look) before bidding; and (iii) all bidders are reasonably 
competitive providers of investments of the type purchased.

C. Rebuttable Presumption for Establishing Fair Market Value

    Section 1.148-5(d)(6)(iii) provides a safe harbor for establishing 
fair market value for guaranteed investment contracts. The definition 
of guaranteed investment contract generally does not include the 
purchase of investments for an escrow for an advance refunding 
transaction.
    The proposed regulations would provide a rebuttable presumption for 
establishing fair market value for United States Treasury obligations 
purchased other than directly from the United States Treasury. The 
proposed regulations would apply the principles underlying the safe 
harbor in the regulations for establishing fair market value for 
guaranteed investment contracts.

D. Qualified Administrative Costs

    Section 1.148-5(e)(2)(i) provides in general that, in determining 
payments and receipts on nonpurpose investments, qualified 
administrative costs are taken into account. Thus, qualified 
administrative costs increase the payments for, or decrease the 
receipts from, the investments.
    The proposed regulations would provide a special rule to determine 
qualified administrative costs for United States Treasury obligations 
purchased other than directly from the United States Treasury.

Proposed Effective Dates

    The regulations are proposed to apply to bonds sold on or after the 
date 60 days after the adoption of final regulations. In addition, 
these regulations are proposed to apply after that date to permit an 
issuer to apply these regulations to bonds to which certain other 
regulations under section 148 apply that were sold prior to that date.

Special Analyses

    It has been determined that this notice of proposed rulemaking 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) 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, this notice of proposed rulemaking will be 
submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on its impact on small business.

Comments and Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written comments (a signed original 
and eight (8) copies) that are submitted timely to the IRS. All 
comments will be available for public inspection and copying.
    A public hearing has been scheduled for Thursday, Ocotber 24, 1996, 
at 10 a.m., in the Commissioner's Conference Room, Internal Revenue 
Building, 1111 Constitution Avenue, NW., Washington, DC. Because of 
access restrictions, visitors will not be admitted beyond the Internal 
Revenue Building lobby more than 15 minutes before the hearing starts.
    The rules of 26 CFR 601.601(a)(3) apply to the hearing.
    Persons that wish to present oral comments at the hearing must 
submit written comments by September 25, 1996 and submit an outline of 
the topics to be discussed and the time to be devoted to each topic 
(signed original and eight (8) copies) by October 3, 1996.
    A period of 10 minutes will be allotted to each person for making 
comments.
    An agenda showing the scheduling of the speakers will be prepared 
after the deadline for receiving outlines has passed. Copies of the 
agenda will be available free of charge at the hearing.

Drafting Information

    The principal author of these regulations is Loretta J. Finger, 
Office of Assistant Chief Counsel (Financial Institutions and 
Products). However, other personnel from the IRS and Treasury 
Department participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

[[Page 33407]]

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 continues to read as 
follows:

    Authority: 26 U.S.C. 7805 * * *

    Par. 2. Section 1.148-5 is amended by adding paragraphs (d)(6)(iv) 
through (d)(6)(viii) and (e)(2)(iv) to read as follows:


Sec. 1.148-5  Yield and valuation of investments.

* * * * *
    (d) * * *
    (6) * * *
    (iv) Rebuttable presumption for establishing that a solicitation 
for a guaranteed investment contract is bona fide. For purposes of 
paragraph (d)(6)(iii)(A) of this section, a solicitation for a 
guaranteed investment contract is rebuttably presumed to be bona fide 
if the other requirements of paragraph (d)(6)(iii) of this section and 
the following requirements are satisfied:
    (A) If the issuer uses an agent to conduct the bidding process, the 
agent does not bid to provide the investment;
    (B) All bidders have equal opportunity to bid so that, for example, 
no bidder is given the opportunity to review other bids (a last look) 
before bidding; and
    (C) All bidders are reasonably competitive providers of investments 
of the type purchased.
    (v) Rebuttable presumption for establishing fair market value for 
United States Treasury obligations purchased other than directly from 
the United States Treasury. The purchase price of United States 
Treasury obligations that are purchased other than directly from the 
United States Treasury is rebuttably presumed to be the fair market 
value on the purchase date if all of the following requirements are 
satisfied:
    (A) The issuer conducts in good faith a solicitation for the 
purchase of Treasury obligations that meets the requirements of 
paragraphs (d)(6)(iv)(A) through (C) of this section, and the issuer 
receives at least three bona fide bids from providers that have no 
material financial interest in the issue. For this purpose, 
underwriters and financial advisors for an issue are considered to have 
a material financial interest in the issue.
    (B) The issuer purchases the highest-yielding Treasury obligations 
for which a qualifying bid is made.
    (C) The yield on the Treasury obligations purchased is not 
significantly less than the yield then available from the provider on 
reasonably comparable Treasury obligations offered to other persons for 
purchase on terms comparable to those offered to the issuer from a 
source of funds other than gross proceeds of tax-exempt bonds. If 
closely comparable forward prices are not offered to other persons for 
purchase from a source other than gross proceeds of tax-exempt bonds, a 
reasonable basis for this comparison may be by reference to implied 
forward prices for Treasury obligations based on standard financial 
formulas. In general, a certificate provided by an agent conducting the 
bidding process detailing this comparison establishes that this 
comparability standard is met.
    (D) In no event is the yield on any Treasury obligation purchased 
less than the highest yield then available on a United States Treasury 
security--State and Local Government Series from the United States 
Department of the Treasury, Bureau of Public Debt, with the same 
maturity.
    (E) The terms of the agreement to purchase the Treasury obligations 
are reasonable.
    (F) The issuer retains the items enumerated in paragraphs (d)(vi) 
and (vii) of this section with the bond documents.
    (vi) Copies. The items described in this paragraph (d)(vi) are a 
copy of each of the following--
    (A) The purchase agreement or confirmation and a statement 
detailing any oral and other terms of the agreement;
    (B) The receipt or other record of the amount actually paid by the 
issuer for the Treasury obligations, including a statement setting out 
the amount of any brokerage commission, broker fee, or bidding fee paid 
to or by the seller of the Treasury obligations; and
    (C) Each bid that is received with respect to the solicitation of 
the Treasury obligations (clearly stamped to show date and time when 
the bid was received) and a description of the bidding procedure used.
    (vii) Statement. The item described in this paragraph (d)(vii) is a 
statement from the issuer, dated as of the issue date of the bonds, 
certifying, under penalties of perjury, that--
    (A) If the issuer used an agent to conduct the bidding process, the 
agent did not bid to provide the investment;
    (B) All bidders had equal opportunity to bid so that, for example, 
no bidder had an opportunity to review other bids before bidding;
    (C) All bidders are reasonably competitive sellers of Treasury 
obligations; and
    (D) The issuer received at least three bona fide bids from 
providers that have no material financial interest in the issue.
    (viii) For purposes of paragraphs (d)(6) (v) through (vii) of this 
section, the term issuer means only the entity that actually issues the 
bonds and not a conduit borrower of the issuer.
    (e) * * *
    (2) * * *
    (iv) Special rule for United States Treasury obligations purchased 
other than directly from the United States Treasury. For Treasury 
obligations purchased other than directly from the United States 
Treasury, a fee paid to a bidding agent is a qualified administrative 
cost only if the following requirements are satisfied:
    (A) The fee must be reasonable. In general, a fee must be 
separately stated in order for the issuer to have a basis for 
determining that a fee is reasonable. The fee is presumed to be 
reasonable if it does not exceed .02 percent of the amount invested in 
Treasury obligations.
    (B) The fee must be comparable to a fee that would be charged for a 
reasonably comparable investment of Treasury obligations if acquired 
with a source of funds other than gross proceeds of tax-exempt bonds. 
This comparability standard must be applied even if no identical 
investments are customarily acquired with a source of funds other than 
gross proceeds of tax-exempt bonds. In general, reference must be made 
to the bidding fees paid by investors that are not issuers of tax-
exempt bonds in those transactions that are most closely comparable to 
the purchase of investments by the issuer of tax-exempt bonds. For 
example, reference to the bidding fees generally paid for the purchase 
of forward contracts for Treasury obligations is ordinarily a 
reasonable method of determining whether bidding fees are reasonable.
* * * * *
Margaret Milner Richardson,
Commissioner of Internal Revenue.
[FR Doc. 96-16378 Filed 6-26-96; 8:45 am]
BILLING CODE 4830-01-U