[Federal Register Volume 62, Number 90 (Friday, May 9, 1997)]
[Rules and Regulations]
[Pages 25502-25514]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-12062]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 602
[TD 8718]
RIN 1545-AS49
Arbitrage Restrictions on Tax-Exempt Bonds
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
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SUMMARY: This document contains final 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.
DATES: These regulations are effective May 9, 1997.
For dates of applicability of these regulations, see Secs. 1.103-
8(a)(5), 1.142-4(d), 1.148-11, 1.148-11A, 1.149(d)-1(g)(3), and 1.150-
1(a)(2).
FOR FURTHER INFORMATION CONTACT: Brigitte Finley, (202) 622-3980 (not a
toll-free number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collections of information contained in these final regulations
have been reviewed and approved by the Office of Management and Budget
in accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under
control number 1545-1347. Responses to these collections of information
are required to obtain a benefit from treating a contract as a
qualified hedge or treating certain general obligation bonds as a
single issue.
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 estimated average annual burden hours per recordkeeper: 2
hours.
Comments concerning the accuracy of this burden estimate and
suggestions for reducing this burden should be sent to the Internal
Revenue Service, Attn: IRS Reports Clearance Officer, T:FP, Washington,
DC 20024, and 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.
Books or records relating to collections 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 are confidential, as required by 26 U.S.C. 6103.
Background
Section 148 of the Internal Revenue Code restricts the use of
proceeds of tax-exempt State and local bonds to acquire higher yielding
investments. On June 18, 1993, final regulations (TD 8476) relating to
the arbitrage restrictions and related rules under sections 103, 148,
149, and 150 (the June 1993 regulations) were published in the Federal
Register (59 FR 33510). Corrections to the June 1993 regulations were
published in the Federal Register on August 23, 1993 (58 FR 44451), and
May 11, 1994 (59 FR 24350).
On May 10, 1994, temporary and final regulations (TD 8538) to
clarify and revise certain provisions of the June 1993 regulations were
published in the Federal Register (59 FR 24039). A notice of proposed
rulemaking (FI-7-94) cross-referencing the temporary regulations and
proposing additional changes to the June 1993 regulations was published
in the Federal Register on the same day (59 FR 24094). Written comments
were received, and a public hearing was held on September 25, 1995.
After consideration of all the comments, the proposed regulations
have been modified and are adopted in final form, and the corresponding
temporary regulations are redesignated as final regulations. The
principal changes to the regulations, as well as the major comments and
suggestions, are discussed below. Comments relating to regulations
under section 148 other than those in the proposed regulations also
were received. The changes requested by those comments are not
addressed in these final regulations, but are under consideration.
Explanation of Provisions
A. Section 1.142-4--Interest on Bonds To Finance Certain Exempt
Facilities
The proposed regulations provide generally that costs incurred
before the issue date of an exempt facility bond may not be financed
with the proceeds of that bond unless an official action was taken
within 60 days of the date those costs were incurred. For tax-exempt
bonds subject to Sec. 1.150-2, however, a reimbursement allocation may
be made if the official action was taken within 60 days of the date
that the costs were paid. One commentator requested that the official
action and reimbursement allocation rules for exempt facility bonds be
the same as the rules in Sec. 1.150-2. The final regulations generally
adopt this suggestion. The final regulations also clarify that a
refinancing of a taxable debt other than a State or local bond is not
treated as a refunding for purposes of this rule. In addition, the
final regulations redesignate this provision, which was previously
contained in Sec. 1.103-8(a)(5), as new Sec. 1.142-4.
B. Section 1.148-1--Definitions and Elections
1. Bonds Financing a Working Capital Reserve
The June 1993 regulations provide that replacement proceeds may
arise if a working capital reserve is directly or indirectly financed
with bond proceeds, but not to the extent the issuer has maintained a
working capital reserve. The proposed regulations provide a method for
determining whether an issuer has maintained a working capital reserve.
This method is based on the average amount of working capital
[[Page 25503]]
maintained by the issuer before the issue date of the bonds.
One commentator stated that start-up operations are unable to
demonstrate any average reserves for past periods and, therefore,
cannot show that they have not indirectly financed a working capital
reserve with bond proceeds.
The determination of whether an issuer has financed a working
capital reserve with bond proceeds is based on facts and circumstances.
The method in the proposed regulations provides one way of making that
determination. An issuer may use alternative methods to establish that
a working capital reserve is not indirectly financed with bond
proceeds. Therefore, the final regulations adopt the provision in the
proposed regulations.
2. Definition of Investment-Type Property
The proposed regulations clarify that the definition of investment-
type property includes a contract that would be a hedge under
Sec. 1.148-4(h) except that it contains a significant investment
element. The proposed regulations also provide that an interest rate
cap contains a significant investment element if the payments for the
cap are made more quickly than in level annual installments over the
term of the cap, the cap hedges a bond that is not a variable rate debt
instrument (VRDI) under Sec. 1.1275-5, or the cap rate is less than the
on-market swap rate on the date the cap is entered into.
Commentators requested that the provisions relating to whether an
interest rate cap contains a significant investment element be deleted
because they asserted that those conditions do not give rise to an
expected return from the cap. One commentator stated that these rules
were misplaced and should be included in the provision in Sec. 1.148-
4(h) dealing with significant investment element.
The final regulations modify the proposed regulations in several
ways. First, the provision that a cap contains a significant investment
element if the cap rate is less than the on-market swap rate has been
deleted. The deletion of this rule is balanced by another rule
addressing the timing of payments for a cap. (See discussion below.)
Second, the requirement relating to the pattern of payments for a cap
and the prohibition on hedging an instrument other than a VRDI have
been moved to Sec. 1.148-4(h). (See discussion below.) Third, the final
regulations clarify that investment-type property includes only the
investment element of a hedge that contains a significant investment
element. This element does not necessarily include all payments on or
receipts from a hedge.
C. Section 1.148-4--Yield on an Issue of Bonds
1. Yield on Certain Mortgage Revenue and Student Loan Bonds
The proposed regulations provide that, 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 the issue is computed over the term of the issue,
and Sec. 1.148-4(d) (relating to conversion from a variable yield issue
to a fixed yield issue) does not apply. The proposed regulations also
address how to compute yield over the term of the issue.
One commentator requested that this rule be amended so it applies
only for yield restriction purposes or only to variable yield issues
that are expected to convert to fixed yield issues. The commentator
explained that applying the rule for rebate purposes may be
inappropriate. The final regulations generally adopt this comment by
providing that the rule applies only to issues that are expected to
convert to a fixed yield and only for purposes of applying sections 148
and 143(g) to purpose investments.
2. Qualified Hedging Transactions
a. Definition of hedge. The final regulations expand the definition
of hedge to include certain hedges of bonds of an issue that would
otherwise be a fixed yield issue (a fixed-to-variable hedge).
Generally, a fixed-to-variable hedge must be entered into no later than
15 days after the issue date of the issue (or the deemed issue date
under Sec. 1.148-4(d)) or no later than the expiration of another
qualified hedge with respect to the bonds. The permitted fixed-to-
variable hedges are limited in this manner to minimize the complex
computations and potential for abuse that may arise if an issue
switches between fixed yield treatment and variable yield treatment
during the term of the issue. Comments are requested on the extent to
which other fixed-to-variable hedges should be treated as a hedge.
b. Significant investment element. The definition of investment-
type property in the proposed regulations provides that an interest
rate cap contains a significant investment element if the payments for
the cap are made more quickly than in level annual installments.
Commentators requested that this provision be deleted because they
asserted that early payment of a cap premium never gives rise to an
expected return from the cap.
Amounts paid for an interest rate cap generally relate increasingly
to the later years of the term of the cap. Thus, this rule reflects the
concern that the issuer receives an arbitrage benefit by making a
prepayment. This prepayment concern also arises in connection with
other types of hedges when an issuer makes payments before the period
to which those payments relate. Therefore, the final regulations
provide that a hedge contains a significant investment element if the
issuer's payments for the hedge are significantly front-loaded. In
addition, a hedge contains a significant investment element if the
issuer's payments are significantly back-loaded. The final regulations
also include a special rule for caps that permits cap fees to be paid
in level installments over the term of the cap.
c. Interest based. The definition of investment-type property in
the proposed regulations provides that an interest rate cap contains a
significant investment element if the cap hedges a bond that is not a
VRDI within the meaning of Sec. 1.1275-5. Commentators requested that
this provision be deleted because they asserted that hedging a bond
that is not a VRDI does not give rise to an expected return from the
cap.
The final regulations clarify that a contract meets the requirement
that it be interest based only if, (i) before the contract is taken
into account, each hedged bond is a type of obligation that is
respected as solely tax-exempt debt under the original issue discount
regulations (i.e., a fixed rate bond, a VRDI within the meaning of
Sec. 1.1275-5 that is not based on an objective rate other than a
qualified inverse floating rate or a qualified inflation rate, a tax-
exempt obligation described in Sec. 1.1275-4(d)(2), or an inflation-
indexed debt instrument within the meaning of Sec. 1.1275-7T), and (ii)
after the contract is taken into account, each hedged bond is
substantially the same as one of these types of debt instruments.
d. Timing and allocation of payments. The proposed regulations
provide that the period to which a payment made by the issuer relates
is based on general Federal income tax principles, and that generally 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.
The final regulations amend these rules to provide that payments made
or received by the issuer under a qualified hedge are taken into
account in the period that those amounts would be treated as income or
deductions under Sec. 1.446-4 (without regard to the
[[Page 25504]]
exclusion from Sec. 1.446-4 for tax-exempt obligations).
e. Certain variable yield bonds treated as fixed yield bonds--
certain terminations disregarded. Under the June 1993 regulations, a
variable yield issue is treated as a fixed yield issue if the issuer
enters into a qualified hedge that meets certain requirements. The
proposed regulations in general provide that upon a termination of this
type of qualified hedge, the issue of which the hedged bonds are a part
is treated for purposes of Sec. 1.148-3 (relating to rebate) as if it
were reissued as of the termination date. The proposed regulations also
provide that the termination will be disregarded (i.e., the issue will
continue to be treated as a fixed yield issue) if (i) the issuer
immediately replaces the terminated hedge and there is no change in the
yield or (ii) the termination is caused by the bankruptcy or insolvency
of the hedge provider and the Commissioner determines that the
termination occurred without any action by the issuer. The final
regulations modify the proposed regulations by deleting the provision
relating to terminations of a qualified hedge caused by the bankruptcy
or insolvency of the hedge provider because, unless the issuer enters
into a replacement hedge, any termination of the hedge may cause a
change in the yield on the bonds.
f. Certain acquisition payments. The proposed regulations provide
that if an issuer receives a single, up-front payment relating to the
off-market portion of an otherwise qualified hedge, the hedge does not
fail to be a qualified hedge as long as the off-market rates are
separately identified and are not taken into account in determining
yield on the bonds. The proposed regulations also provide that the on-
market rates are determined as of the date the parties enter into the
contract. The final regulations adopt this rule. In the case of hedges
entered into before the issue date (e.g., a forward swap), the on-
market rate is the forward on-market rate on the date the parties enter
into the hedge.
g. Treatment of hedges entered into before issue date of hedged
bonds. The proposed regulations provide that a hedge entered into
before the issue date may be a qualified hedge, even if the payments
received by the issuer do not correspond to interest payments on the
hedged bonds. Commentators requested clarification about what other
special rules apply to these types of hedges. In particular,
commentators suggested that payments made or received by an issuer
before the issue date should not prevent these types of hedges from
treatment as a qualified hedge.
The final regulations clarify the treatment of two different types
of hedges entered into before the issue date. First, if an issuer
expects that a hedge will be closed in connection with the issuance of
bonds, payments on the hedge made or received, or deemed made or
received, adjust the issue price of the hedged bonds. For this purpose,
issue price is adjusted by taking into account the future value as of
the issue date of the payments made or received before the issue date.
Second, if an issuer does not expect that a hedge will be closed in
connection with the issuance of the bonds and does not close the hedge
in connection with the issuance of the bonds, the payments and receipts
on the hedge adjust payments and receipts on the hedged bonds in the
same manner as other qualified hedges. Payments on the hedge made by
the issuer before the issue date, however, are not taken into account
for purposes of determining yield on the hedged bond.
h. Authority of Commissioner. The proposed regulations permit the
Commissioner to determine that a contract is not a qualified hedge if
treating the contract as a qualified hedge provides a material
potential for arbitrage. In addition, the proposed regulations permit
the Commissioner to recompute the yield on an issue by taking into
account a hedge if the issuer fails to meet the qualified hedge rules
and the failure distorts the yield or otherwise fails to clearly
reflect the economic substance of the transaction.
Some commentators asserted that this grant of authority is too
broad and adds uncertainty about the proper treatment of certain
transactions that are not specifically addressed by the regulations,
such as asset hedges.
In general, an issuer may choose whether a hedge is treated as a
qualified hedge, as long as that choice is prospective. Section 1.148-
10(e) gives the Commissioner the authority to depart from the rules of
Secs. 1.148-1 through 1.148-11 to reflect the economic substance of a
transaction if a principal purpose of the transaction is to obtain an
arbitrage benefit that is inconsistent with the purposes of section
148. Therefore, in general a separate anti-abuse rule is unnecessary.
The final regulations amend Sec. 1.148-10(e) to clarify that the
actions the Commissioner may take to clearly reflect the economic
substance of a transaction include treating a hedge as a qualified
hedge or treating a hedge as other than a qualified hedge. Because
special considerations apply to identification of hedges entered into
before the issue date of the hedged bonds, the final regulations also
provide that this type of hedge will be treated as a hedge of bonds
that are similar to the bonds that the issuer expected to issue when it
entered into the hedge.
i. Asset hedging. The proposed regulations do not provide specific
rules for the treatment of hedges of assets allocable to the proceeds
of tax-exempt bonds. One commentator suggested that the regulations
extend the integration principles currently applicable to qualified
hedges to include comparable principles for hedges of assets allocable
to the proceeds of tax-exempt bonds. The final regulations do not adopt
this comment or provide specific rules for asset hedging. However,
comments are requested relating to the proper treatment of asset hedges
for purposes of section 148.
D. Section 1.148-5--Yield and Valuation of Investments
1. Permissive Application of Single Investment Rules to Certain Yield
Restricted Investments for all Purposes of Section 148
The proposed regulations provide that for all purposes of section
148, an issuer may blend the yield of all 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. Commentators requested that
this rule be amended to permit blending of the yield on all yield
restricted nonpurpose investments. The final regulations do not adopt
this comment because a more flexible yield blending rule could permit
avoidance of the requirement that rebatable arbitrage must be paid for
periods of no greater than 5 years. In addition, the final regulations
clarify that the rule applies only to sinking funds that are reasonably
expected as of the issue date to be established and maintained solely
to reduce the yield on the investments in the refunding escrow. For
example, the rule does not apply to investments in a reasonably
required reserve fund that the issuer intends to use to reduce the
yield on the investments in a refunding escrow.
2. Manner of Payment of Yield Reduction Payments
The proposed regulations provide that yield reduction payments must
be made at the same time and in the same manner as rebate amounts are
required to be paid under Sec. 1.148-3(f), and that the date a payment
is required to be
[[Page 25505]]
paid is determined without regard to Sec. 1.148-3(h), which allows the
issuer to pay a penalty in lieu of loss of tax-exemption in certain
situations. The proposed regulations also provide that a yield
reduction payment that is paid untimely is not taken into account
unless the Commissioner determines that the failure to pay timely is
not due to willful neglect.
One commentator noted that this rule imposes a procedural standard
that is different from the rules regarding late rebate payments and
requested that this rule be amended to eliminate the requirement of
action by the Commissioner and to otherwise conform to the rules for
late payment of rebate. The final regulations adopt this comment.
3. External Commingled Funds
The June 1993 regulations provide that an issuer that invests in a
commingled fund may take indirect administrative costs of the
commingled fund into account for purposes of determining payments and
receipts on nonpurpose investments if certain requirements are met. In
general, the issuer and any related parties must not own more than 10
percent of the beneficial interest in the fund. The proposed
regulations provide a test for determining whether the 10 percent limit
is met.
One commentator stated that under the method for determining
whether the 10 percent requirement is met the investor is uncertain
whether its deposit will cause it to exceed the 10 percent limit,
whether actions of another investor will cause it to exceed the 10
percent limit at any time for the duration of this investment, whether
the whole fund is tainted if one investor exceeds the 10 percent limit,
whether the impact is limited to those days that the 10 percent limit
is exceeded, how the 10 percent limit is measured, and whether the
semiannual period is a fixed or a floating period. The commentator
suggested that the test should be applied only at the time that a
deposit is made and the result should not be affected by simultaneous
or subsequent activity in the pool.
The final regulations generally adopt this suggestion. The final
regulations clarify that this rule applies only to widely held
commingled funds and that the determination of whether a fund is widely
held is based on the average number of investors during the immediately
preceding, fixed, semiannual period chosen by the fund (e.g.,
semiannual periods ending June 30 and December 31). Thus, the
determination of whether any issuer that has invested in a commingled
fund may take indirect administrative costs into account may change
from one 6-month period to another. The final regulations also provide
that the determination of whether an investor exceeds the 10 percent
limit is made on the date of deposit into the commingled fund and
whether that investor exceeds the 10 percent limit is not affected by
subsequent actions of investors in the fund. In addition, if any
investor exceeds the 10 percent limit, no investor in the fund may take
indirect administrative costs into account until that investor makes
sufficient withdrawals from the fund to meet the 10 percent limit.
Thus, if a fund continues to be widely held and does not accept any
deposits from an investor that exceeds the 10 percent limit, all
issuers that have invested tax-exempt bond proceeds in the fund may
take the indirect administrative costs of the fund into account.
4. Qualified Administrative Costs of Guaranteed Investment Contracts
The June 1993 regulations generally provide that administrative
costs must be reasonable in order to be qualified administrative costs.
The proposed regulations provide that a broker's commission for a
guaranteed investment contract is treated as an administrative cost and
is not a qualified administrative cost to the extent that the present
value of the fee exceeds the present value of annual payments equal to
.05 percent of the weighted average amount reasonably expected to be
invested each year during the term of the contract. The final
regulations clarify that a broker's commission is a qualified
administrative cost to the extent it does not exceed the lesser of a
reasonable amount or the .05 percent limit. No inference should be
drawn that there are necessarily any situations in which a commission
equal to .05 percent is reasonable.
E. Section 1.150-1--Definitions
The proposed regulations define ``issue'' for all purposes of
sections 103 and 141 through 150. The final regulations adopt the
definition as proposed with one modification. The final regulations
delete the rule that a variable yield bond is treated as sold on its
issue date and clarify that the definition of ``sale date'' applies to
all bonds.
The proposed regulations also provide a special rule relating to
the treatment of general obligation bonds sold and issued on the same
dates pursuant to a single offering document as part of the same issue.
Commentators expressed concern that this special rule is mandatory and
conflicts with other rules relating to the determination of whether
bonds are part of a single issue. The commentators requested that the
relationship of the rules be clarified and that the general obligation
rule not be mandatory.
The final regulations generally adopt these comments by permitting
an issuer to elect to treat tax-exempt general obligation bonds sold
and issued on the same dates pursuant to a single offering document as
part of the same issue. However, taxable bonds still must be treated as
a separate issue. A proposed amendment to the exception for taxable
bonds in Sec. 1.150-1(c)(2), proposed in regulations published in the
Federal Register on December 30, 1994, is not addressed by these final
regulations.
F. Effective Dates
The final regulations generally are effective for bonds issued on
or after July 8, 1997. An issuer generally may apply the final
regulations to bonds that are outstanding on July 8, 1997 and to which
certain prior regulations apply. In addition, the rules in the
temporary regulations have been redesignated as Secs. 1.148-1A through
1.148-6A, 1.148-9A, 1.148-10A, 1.148-11A, 1.149(d)-1A, and 1.150-1A
and, together with the applicable provisions of the June 1993
regulations, continue to apply to bonds issued before July 8, 1997.
Special Analysis
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 notice of proposed
rulemaking preceding the regulations was issued prior to March 29,
1996, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not
apply. Pursuant to section 7805(f) of the Internal Revenue Code, the
notice of proposed rulemaking preceding these regulations was submitted
to the Chief Counsel for Advocacy of the Small Business Administration
for comment on its impact on small business.
Drafting Information
The principal authors of these regulations are Brigitte Finley and
William P. Cejudo, Office of Assistant Chief Counsel (Financial
Institutions and Products). However, other personnel from the IRS and
Treasury Department participated in their development.
[[Page 25506]]
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--INCOME TAXES
Paragraph 1. The authority citation for part 1 is amended by
removing the entry for Sec. 1.148-11T to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
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) Limitation. (i) A facility qualifies under this section 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 this section 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 this section 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 Secs. 1.142-4(d), 1.148-
11A(i), and 1.150-2(j), this paragraph (a)(5) applies to bonds issued
after June 30, 1993, and sold before July 8, 1997. See Sec. 1.142-4(d)
for rules relating to bonds sold on or after July 8, 1997.
* * * * *
Sec. 1.103-8T [Removed]
Par. 3. Section 1.103-8T is removed.
Par. 4. Section 1.142-4 is added to read as follows:
Sec. 1.142-4 Use of proceeds to provide a facility.
(a) In general. [Reserved].
(b) Reimbursement allocations. If an expenditure for a facility is
paid before the issue date of the bonds to provide that facility, the
facility is described in section 142(a) only if the expenditure meets
the requirements of Sec. 1.150-2 (relating to reimbursement
allocations). For purposes of this paragraph (b), if the proceeds of an
issue are used to pay principal of or interest on an obligation other
than a State or local bond (for example, temporary construction
financing of the conduit borrower), that issue is not a refunding
issue, and, thus, Sec. 1.150-2(g) does not apply.
(c) Limitation on use of facilities by substantial users--(1) In
general. If the original use of a facility begins before the issue date
of the bonds to provide the facility, the facility is not described in
section 142(a) 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--
(i) 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
(ii) 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.
(2) Definitions. For purposes of paragraph (c)(1) 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.
(d) Effective date--(1) In general. This section applies to bonds
sold on or after July 8, 1997. See Sec. 1.103-8(a)(5) for rules
applicable to bonds sold before that date.
(2) Elective retroactive application. An issuer may apply this
section to any bond sold before July 8, 1997.
Par. 5. In Sec. 1.148-0, paragraph (c) is amended as follows:
1. An entry for Sec. 1.148-1, paragraph (e) is added.
2. The entries for Sec. 1.148-4, paragraph (h)(4) and (h)(5) are
revised.
3. An entry for Sec. 1.148-4, paragraph (h)(6) is added.
4. An entry for Sec. 1.148-11, paragraph (b)(3) is added.
5. Entries for Sec. 1.148-11, paragraphs (c)(1) and (g) are
revised.
6. Entries for Sec. 1.148-11, paragraphs (h) and (i) are removed.
The revised and added provisions read as follows:
Sec. 1.148-0 Scope and table of contents.
* * * * *
(c) * * *
Sec. 1.148-1 Definitions and elections.
* * * * *
(e) Investment-type property.
* * * * *
Sec. 1.148-4 Yield on an issue of bonds.
* * * * *
(h) * * *
(4) Certain variable yield bonds treated as fixed yield bonds.
(5) Contracts entered into before issue date of hedged bond.
(6) Authority of the Commissioner.
* * * * *
Sec. 1.148-11 Effective dates.
* * * * *
(b) * * *
(3) No elective retroactive application for hedges of fixed rate
issues.
(c) * * *
(1) Retroactive application of overpayment recovery provisions.
* * * * *
(g) Provisions applicable to certain bonds sold before effective
date.
[[Page 25507]]
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 [Redesignated as Secs. 1.148-1A,
1.148-2A, 1.148-3A, 1.148-4A, 1.148-5A, 1.148-6A, 1.148-9A, 1.148-10A,
and 1.148-11A]
Par. 6. Sections 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 are redesignated as
Secs. 1.148-1A, 1.148-2A, 1.148-3A, 1.148-4A, 1.148-5A, 1.148-6A,
1.148-9A, 1.148-10A, and 1.148-11A, respectively, and added under an
undesignated centerheading immediately preceding the undesignated
centerheading ``Deductions for Personal Exemptions'' to read as
follows:
Regulations Applicable to Certain Bonds Sold Prior to July 8, 1997.
Par. 6a. The section headings of newly designated Secs. 1.148-1A,
1.148-2A, 1.148-3A, 1.148-4A, 1.148-5A, 1.148-6A, 1.148-9A, 1.148-10A,
and 1.148-11A are amended by removing the language ``(temporary)''.
Par. 7. Section 1.148-1 is amended as follows:
1. Paragraph (b) is amended by revising the definition of
Investment-type property, by adding the definition of Replacement
proceeds in alphabetical order, and by adding a new sentence at the end
of the definition of Sale proceeds.
2. Paragraph (c)(4)(ii)(A) is revised.
3. Paragraph (e) is added.
The revised and added provisions read as follows:
Sec. 1.148-1 Definitions and elections.
* * * * *
(b) * * *
* * * * *
Investment-type property is defined in paragraph (e) of this
section.
* * * * *
Replacement proceeds is defined in paragraph (c) of this section.
* * * * *
Sale proceeds * * * See also Sec. 1.148-4(h)(5) treating amounts
received upon the termination of certain hedges as sale proceeds.
* * * * *
(c) * * *
(4) * * *
(ii) Bonds financing a working capital reserve--(A) In general.
Except as otherwise provided in paragraph (c)(4)(ii)(B) of this
section, 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 a working capital 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 1 year, the
last of which ends within 1 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 1
year period preceding the issue date.
* * * * *
(e) Investment-type property--(1) In general. Investment-type
property includes any property, other than property described in
section 148(b)(2) (A), (B), (C), or (E), that is held principally as a
passive vehicle for the production of income. For this purpose,
production of income includes any benefit based on the time value of
money, including the benefit from making a prepayment.
(2) Non-customary prepayments. Except as otherwise provided in this
paragraph (e), a prepayment for property or services gives rise to
investment-type property if a principal purpose for prepaying is to
receive an investment return from the time the prepayment is made until
the time payment otherwise would be made. A prepayment does not give
rise to investment-type property if--
(i) The prepayment is made for a substantial business purpose other
than investment return and the issuer has no commercially reasonable
alternative to the prepayment; or
(ii) Prepayments on substantially the same terms are made by a
substantial percentage of persons who are similarly situated to the
issuer but who are not beneficiaries of tax-exempt financing.
(3) Certain hedges. Investment-type property also includes the
investment element of a contract that is a hedge (within the meaning of
Sec. 1.148-4(h)(2)(i)(A)) and that contains a significant investment
element because a payment by the issuer relates to a conditional or
unconditional obligation by the hedge provider to make a payment on a
later date. See Sec. 1.148-4(h)(2)(ii) relating to hedges with a
significant investment element.
Par. 8. 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) Exceptions to certification requirement. An issuer is not
required to make a certification for an issue under paragraph (b)(2)(i)
of this section 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, the last sentence of paragraph (h)(3) is
revised to read as follows:
Sec. 1.148-3 General arbitrage rebate rules.
* * * * *
(h) * * *
(3) * * * For purposes of this paragraph (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. 10. Section 1.148-4 is amended as follows:
1. Paragraphs (b)(5), (g), (h)(1), (h)(2) introductory text, and
(h)(2)(i) are revised.
2. Paragraph (h)(2)(vi) and (h)(2)(vii) are removed.
3. Paragraphs (h)(2)(ii) through (h)(2)(v) are redesignated as
paragraphs (h)(2)(iii) through (h)(2)(vi) and paragraphs (h)(2)(viii)
and (h)(2)(ix) are redesignated as paragraphs (h)(2)(vii) and
(h)(2)(viii).
4. New paragraph (h)(2)(ii) is added.
5. Newly designated paragraphs (h)(2)(iv), (h)(2)(v), (h)(2)(vi),
and (h)(2)(viii) and paragraphs (h)(3), (h)(4), and (h)(5) are revised.
6. Paragraph (h)(6) is added.
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. 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
[[Page 25508]]
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.
* * * * *
(g) Yield on certain mortgage revenue and student loan bonds. For
purposes of section 148 and this section, 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
section 148 and section 143(g) with respect to purpose investments
allocable to a variable yield issue of qualified mortgage bonds,
qualified veterans' mortgage bonds, or qualified student loan bonds
that is reasonably expected as of the issue date to convert to a fixed
yield issue, the yield may be computed over the term of the issue, and,
if the yield is so computed, paragraph (d) of this section does not
apply to the issue. As of any date, the yield over the term of the
issue is based on--
(1) With respect to any bond of the issue that has not converted to
a fixed and determinable yield on or before that date, 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 with
respect to that bond over the remaining term of the issue (taking into
account prepayment assumptions under section 143(g)(2)(B)(iv), if
applicable); and
(2) With respect to any bond of the issue that has converted to a
fixed and determinable yield on or before that date, the actual amounts
paid or received before that bond converted, if any, and the amount
that was reasonably expected (on the date that bond converted) to be
paid or received with respect to that bond over the remaining term of
the issue (taking into account prepayment assumptions under section
143(g)(2)(B)(iv), if applicable).
(h) Qualified hedging transactions--(1) In general. Payments made
or received by an issuer under a qualified hedge (as defined in
paragraph (h)(2) of this section) 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)(E) of this section, the bonds to which a
qualified hedge relates are treated as variable yield bonds from the
issue date of the bonds. This paragraph (h) applies solely for purposes
of sections 143(g), 148, and 149(d).
(2) Qualified hedge defined. Except as provided in paragraph (h)(5)
of this section, the term qualified hedge means a contract that
satisfies each of the following requirements:
(i) Hedge--(A) In general. The contract is entered into primarily
to modify the issuer's risk of interest rate changes with respect to a
bond (a hedge). For example, the contract may be an interest rate swap,
an interest rate cap, a futures contract, a forward contract, or an
option.
(B) Special rule for fixed rate issues. If the contract modifies
the issuer's risk of interest rate changes with respect to a bond that
is part of an issue that, absent the contract, would be a fixed rate
issue, the contract must be entered into--
(1) No later than 15 days after the issue date (or the deemed issue
date under paragraph (d) of this section) of the issue; or
(2) No later than the expiration of a qualified hedge with respect
to bonds of that issue that satisfies paragraph (h)(2)(i)(B)(1) of this
section; or
(3) No later than the expiration of a qualified hedge with respect
to bonds of that issue that satisfies either paragraph (h)(2)(i)(B)(2)
of this section or this paragraph (h)(2)(i)(B)(3).
(C) Contracts with certain acquisition payments. If a hedge
provider makes a single payment to the issuer (e.g., a payment for an
off-market swap) in connection with the acquisition of a contract, the
issuer may treat a portion of that contract as a hedge provided--
(1) The hedge provider's payment to the issuer and the issuer's
payments under the contract in excess of those that it would make if
the contract bore rates equal to the on-market rates for the contract
(determined as of the date the parties enter into the contract) are
separately identified in a certification of the hedge provider; and
(2) The payments described in paragraph (h)(2)(i)(C)(1) of this
section are not treated as payments on the hedge.
(ii) No significant investment element--(A) In general. The
contract does not contain a significant investment element. Except as
provided in paragraph (h)(2)(ii)(B) of this section, a contract
contains a significant investment element if a significant portion of
any payment by one party relates to a conditional or unconditional
obligation by the other party to make a payment on a different date.
Examples of contracts that contain a significant investment element are
a debt instrument held by the issuer; an interest rate swap requiring
any payments other than periodic payments, within the meaning of
Sec. 1.446-3 (periodic payments) (e.g., a payment for an off-market
swap or prepayment of part or all of one leg of a swap); and an
interest rate cap requiring the issuer's premium for the cap to be paid
in a single, up-front payment.
(B) Special level payment rule for interest rate caps. An interest
rate cap does not contain a significant investment element if--
(1) All payments to the issuer by the hedge provider are periodic
payments;
(2) The issuer makes payments for the cap at the same time as
periodic payments by the hedge provider must be made if the specified
index (within the meaning of Sec. 1.446-3) of the cap is above the
strike price of the cap; and
(3) Each payment by the issuer bears the same ratio to the notional
principal amount (within the meaning of Sec. 1.446-3) that is used to
compute the hedge provider's payment, if any, on that date.
* * * * *
(iv) Hedged bonds. The contract covers, in whole or in part, all of
one or more groups of substantially identical bonds in the issue (i.e.,
all of the bonds having the same interest rate, maturity, and terms).
Thus, for example, a qualified hedge may include a hedge of all or a
pro rata portion of each interest payment on the variable rate bonds in
an issue for the first 5 years following their issuance. For purposes
of this paragraph (h), unless the context clearly requires otherwise,
hedged bonds means the specific bonds or portions thereof covered by a
hedge.
(v) Interest based contract. The contract is primarily interest
based. A contract is not primarily interest based unless--
(A) The hedged bond, without regard to the contract, is either a
fixed rate bond, a variable rate debt instrument within the meaning of
Sec. 1.1275-5 provided the rate is not based on an objective rate other
than a qualified inverse floating rate or a qualified inflation rate, a
tax-exempt obligation described in Sec. 1.1275-4(d)(2), or an
inflation-indexed debt instrument within the meaning of Sec. 1.1275-7T;
and
(B) As a result of treating all payments on (and receipts from) the
contract as additional payments on (and receipts from) the hedged bond,
the resulting bond would be substantially similar to either a fixed
rate bond, a variable rate debt instrument within the meaning of
Sec. 1.1275-5 provided the rate is not based on an objective rate other
than a qualified inverse floating rate or a
[[Page 25509]]
qualified inflation rate, a tax-exempt obligation described in
Sec. 1.1275-4(d)(2), or an inflation-indexed debt instrument within the
meaning of Sec. 1.1275-7T. For this purpose, differences that would not
prevent the resulting bond from being substantially similar to another
type of bond include a difference between the index used to compute
payments on the hedged bond and the index used to compute payments on
the hedge where one index is substantially the same, but not identical
to, the other; the difference resulting from the payment of a fixed
premium for a cap (e.g., payments for a cap that are made in other than
level installments); and the difference resulting from the allocation
of a termination payment where the termination was not expected as of
the date the contract was entered into.
(vi) Payments closely correspond. The payments received by the
issuer from the hedge provider under the contract correspond closely in
time to either the specific payments being hedged on the hedged bonds
or specific payments required to be made pursuant to the bond
documents, regardless of the hedge, to a sinking fund, debt service
fund, or similar fund maintained for the issue of which the hedged bond
is a part.
* * * * *
(viii) Identification. The contract must be identified by the
actual issuer on its books and records maintained for the hedged bonds
not later than 3 days after the date on which the issuer and the hedge
provider 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 this paragraph (h)(2) and, if applicable, paragraph
(h)(4) of this section are satisfied. In addition, the existence of the
hedge must be noted on the first form relating to the issue of which
the hedged bonds are a part that is filed with the Internal Revenue
Service on or after the date on which the contract is identified
pursuant to this paragraph (h)(2)(viii).
(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 modification 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. If any payment for services or other
items under the contract is not expressly treated by paragraph
(h)(3)(i) of this section as a payment under the qualified hedge, the
payment is not a payment with respect to a qualified hedge.
(iii) Timing and allocation of payments. Except as provided in
paragraphs (h)(3)(iv) and (h)(5) of this section, payments made or
received by the issuer under a qualified hedge are taken into account
in the same period in which those amounts would be treated as income or
deductions under Sec. 1.446-4 (without regard to Sec. 1.446-
4(a)(2)(iv)) and are adjusted as necessary to reflect the end of a
computation period and the start of a new computation period.
(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
or 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 under 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 to the
issuer.
(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 qualified hedge 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 is redeemed during the period to which the termination payment
has been allocated to that issue, 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 allocation of certain termination payments. A
payment to terminate a qualified 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 in accordance with this
paragraph (h)(3)(iv)(E). For an issue that is a variable yield issue
after termination of a qualified hedge, an amount must be allocated to
each date on which the hedge provider's payment, if any, would have
been made had the hedge not been terminated. The amounts allocated to
each date must bear the same ratio to the notional principal amount
(within the meaning of Sec. 1.446-3) that would have been used to
compute the hedge provider's payment, if any, on that date, and the sum
of the present values of those amounts must equal the present value of
the termination payment. Present value is computed as of the day the
qualified hedge is terminated, using the yield on the hedged bonds,
determined without regard to the termination payment. The yield used
for this purpose is computed for the period beginning on the first date
the qualified hedge is in effect and ending on the date the qualified
hedge is terminated. On the other hand, for an issue that is a fixed
yield issue after termination of a qualified hedge, the termination
payment is taken into account as a single payment on the date it is
paid.
[[Page 25510]]
(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) Maturity. The term of the hedge is equal to the entire period
during which the hedged bonds bear interest at variable interest rates,
and the issuer does not reasonably expect that the hedge will be
terminated before the end of that period.
(B) Payments closely correspond. Payments to be received under the
hedge correspond closely in time to the hedged portion of payments on
the hedged bonds. Hedge payments received within 15 days of the related
payments on the hedged bonds generally so correspond.
(C) 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)(C) 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 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
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)(C) 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.
(5) Contracts entered into before issue date of hedged bond--(i) In
general. A contract does not fail to be a hedge under paragraph
(h)(2)(i) of this section solely because it is entered into before the
issue date of the hedged bond. However, that contract must be one to
which either paragraph (h)(5)(ii) or (h)(5)(iii) of this section
applies.
(ii) Contracts expected to be closed substantially
contemporaneously with the issue date of hedged bond--(A) Application.
This paragraph (h)(5)(ii) applies to a contract if, on the date the
contract is identified, the issuer reasonably expects to terminate or
otherwise close (terminate) the contract substantially
contemporaneously with the issue date of the hedged bond.
(B) Contract terminated. If a contract to which this paragraph
(h)(5)(ii) applies is terminated substantially contemporaneously with
the issue date of the hedged bond, the amount paid or received, or
deemed to be paid or received, by the issuer in connection with the
issuance of the hedged bond to terminate the contract is treated as an
adjustment to the issue price of the hedged bond and as an adjustment
to the sale proceeds of the hedged bond for purposes of section 148.
Amounts paid or received, or deemed to be paid or received, before the
issue date of the hedged bond are treated as paid or received on the
issue date in an amount equal to the future value of the payment or
receipt on that date. For this purpose, future value is computed using
yield on the hedged bond without taking into account amounts paid or
received (or deemed paid or received) on the contract.
(C) Contract not terminated. If a contract to which this paragraph
(h)(5)(ii) applies is not terminated substantially contemporaneously
with the issue date of the hedged bond, the contract is deemed
terminated for its fair market value as of the issue date of the hedged
bond. Once a contract has been deemed terminated pursuant to this
paragraph (h)(5)(ii)(C), payments on and receipts from the contract are
no longer taken into account under this paragraph (h) for purposes of
determining yield on the hedged bond.
(D) Relation to other requirements of a qualified hedge. Payments
made in connection with the issuance of a bond to terminate a contract
to which this paragraph (h)(5)(ii) applies do not prevent the contract
from satisfying the requirements of paragraph (h)(2)(vi) of this
section.
(E) Fixed yield treatment. A bond that is hedged with a contract to
which this paragraph (h)(5)(ii) applies does not fail to be a fixed
yield bond if, taking into account payments on the contract 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.
(iii) Contracts expected not to be closed substantially
contemporaneously with the issue date of hedged bond--(A) Application.
This paragraph (h)(5)(iii) applies to a contract if, on the date the
contract is identified, the issuer does not reasonably expect to
terminate the contract substantially contemporaneously with the issue
date of the hedge bond.
[[Page 25511]]
(B) Contract terminated. If a contract to which this paragraph
(h)(5)(iii) applies is terminated in connection with the issuance of
the hedged bond, the amount paid or received, or deemed to be paid or
received, by the issuer to terminate the contract is treated as an
adjustment to the issue price of the hedged bond and as an adjustment
to the sale proceeds of the hedged bond for purposes of section 148.
(C) Contract not terminated. If a contract to which this paragraph
(h)(5)(iii) applies is not terminated substantially contemporaneously
with the issue date of the hedged bond, no payments with respect to the
hedge made by the issuer before the issue date of the hedged bond are
taken into account under this section.
(iv) Identification. The identification required under paragraph
(h)(2)(viii) of this section must specify the reasonably expected
governmental purpose, issue price, maturity, and issue date of the
hedged bond, the manner in which interest is reasonably expected to be
computed, and whether paragraph (h)(5)(ii) or (h)(5)(iii) of this
section applies to the contract. If an issuer identifies a contract
under this paragraph (h)(5)(iv) that would be a qualified hedge with
respect to the anticipated bond, but does not issue the anticipated
bond on the identified issue date, the contract is taken into account
as a qualified hedge of any bond of the issuer that is issued for the
identified governmental purpose within a reasonable interval around the
identified issue date of the anticipated bond.
(6) Authority of the Commissioner. The Commissioner, by publication
of a revenue ruling or revenue procedure (see Sec. 601.601(d)(2) of
this chapter), may specify contracts that, although they do not meet
the requirements of paragraph (h)(2) of this section, are qualified
hedges or, although they do not meet the requirements of paragraph
(h)(4) of this section, cause the hedged bonds to be treated as fixed
yield bonds.
Par. 11. In Sec. 1.148-5, paragraphs (b)(2)(iii), (c)(2)(i),
(c)(3)(ii), (d)(3)(ii), (e)(2)(ii)(B) and (e)(2)(iii) are revised to
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. For all
purposes of section 148, if an issuer reasonably expects as of the
issue date to establish and maintain a sinking fund solely to reduce
the yield on the investments in a refunding escrow, then the issuer may
treat all of the yield restricted nonpurpose investments in the
refunding escrow and that sinking fund as a single investment having a
single yield, determined under this paragraph (b)(2). Thus, an issuer
may not treat the nonpurpose investments in a reasonably required
reserve fund and a refunding escrow as a single investment having a
single yield under this paragraph (b)(2)(iii).
* * * * *
(c) * * *
(2) Manner of payment--(i) In general. Except as otherwise provided
in paragraph (c)(2)(ii) of this section, an amount is paid under this
paragraph (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 Secs. 1.148-3(f),
(g), and (h). The provisions of Sec. 1.148-3(i) apply to payments made
under this paragraph (c).
* * * * *
(3) * * *
(ii) Exception to yield reduction payments rule for advance
refunding issues. Paragraph (c)(1) of this section does not apply to
investments allocable to gross proceeds of an advance refunding issue,
other than--
(A) Transferred proceeds to which paragraph (c)(3)(i)(C) of this
section applies;
(B) Replacement proceeds to which paragraph (c)(3)(i)(F) of this
section applies; and
(C) Transferred proceeds to which paragraph (c)(3)(i)(E) of this
section 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) * * *
(3) * * *
(ii) Exception to fair market value requirement for transferred
proceeds allocations, universal cap allocations, and commingled funds.
Paragraph (d)(3)(i) of this section 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, paragraph
(d)(3)(i) of this section 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) * * *
(2) * * *
(ii) * * *
(B) External commingled funds. A widely held commingled fund in
which no investor in the fund owns more than 10 percent of the
beneficial interest in the fund. For purposes of this paragraph
(e)(2)(ii)(B), a fund is treated as widely held only if, during the
immediately preceding fixed, semiannual period chosen by the fund
(e.g., semiannual periods ending June 30 and December 31), the fund had
a daily average of more than 15 investors that were not related
parties, and the daily average amount each investor had invested in the
fund was not less than the lesser of $500,000 and 1 percent of the
daily average of the total amount invested in the fund. For purposes of
this paragraph (e)(2)(ii)(B), an investor will be treated as owning not
more than 10 percent of the beneficial interest in the fund if, on the
date of each deposit by the investor into the fund, the total amount
the investor and any related parties have on deposit in the fund is not
more than 10 percent of the total amount that all investors have on
deposit in the fund. For purposes of the preceding sentence, the total
amount that all investors have on deposit in the fund is equal to the
sum of all deposits made by the investor and any related parties on the
date of those deposits and the closing balance in the fund on the day
before those deposits. If any investor in the fund owns more than 10
percent of the beneficial interest in the fund, the fund does not
qualify under this paragraph (e)(2)(ii)(B) until that investor makes
sufficient withdrawals from the fund to reduce its beneficial interest
in the fund to 10 percent or less.
(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 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, does not exceed the lesser of a
reasonable amount within the meaning of paragraph (e)(2)(i) of this
section or the present value of annual payments equal to .05 percent of
the
[[Page 25512]]
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, the yield to the issuer on
the investment contract or other reasonable taxable discount rate.
* * * * *
Par. 12. 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. 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 that the fund is
reasonably necessary as part of the organization's permanent capital.
* * * * *
Par. 13. In Sec. 1.148-9, paragraphs (c)(2)(ii)(B) and (h)(4)(vi)
are revised to read as follows:
Sec. 1.148-9 Arbitrage rules for refunding issues.
* * * * *
(c) * * *
(2) * * *
(ii) * * *
(B) Permissive allocation of non-proceeds to earliest expenditures.
Excluding amounts covered by paragraph (c)(2)(ii)(A) of this section
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.
* * * * *
(h) * * *
(4) * * *
(vi) Exception for refundings of interim notes. Paragraph (h)(4)(v)
of this section 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. 14. Section 1.148-10 is amended as follows:
1. Paragraphs (b)(2), (c)(2)(viii) and (c)(2)(ix) are revised.
2. Paragraph (c)(2)(x) is added.
3. Paragraph (e) is revised.
The revised and added provisions read as follows:
Sec. 1.148-10 Anti-abuse rules and authority of Commissioner.
* * * * *
(b) * * *
(2) Application. The provisions of this paragraph (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) * * *
(2) * * *
(viii) Replacement proceeds in a sinking fund for the refunding
issue;
(ix) Qualified guarantee fees for the refunding issue or the prior
issue; and
(x) Fees for a qualified hedge for the refunding issue.
* * * * *
(e) Authority of the Commissioner to clearly reflect the economic
substance of a transaction. If an issuer enters into a transaction for
a principal purpose of obtaining a material financial advantage based
on the difference between tax-exempt and taxable interest rates in a
manner that is inconsistent with the purposes of section 148, the
Commissioner may exercise the Commissioner's discretion to depart from
the rules of Sec. 1.148-1 through Sec. 1.148-11 as necessary to clearly
reflect the economic substance of the transaction. For this purpose,
the Commissioner may recompute yield on an issue or on investments,
reallocate payments and receipts on investments, recompute the rebate
amount on an issue, treat a hedge as either a qualified hedge or not a
qualified hedge, or otherwise adjust any item whatsoever bearing upon
the investments and expenditures of gross proceeds of an issue. For
example, if the amount paid for a hedge is specifically based on the
amount of arbitrage earned or expected to be earned on the hedged
bonds, a principal purpose of entering into the contract is to obtain a
material financial advantage based on the difference between tax-exempt
and taxable interest rates in a manner that is inconsistent with the
purposes of section 148.
* * * * *
Par. 15. Section 1.148-11 is amended as follows:
1. Paragraphs (a), (b)(1), (c)(1), and (g) are revised.
2. Paragraph (b)(3) is added.
3. Paragraphs (h) and (i) are removed.
The revised and added provisions read as follows:
Sec. 1.148-11 Effective dates.
(a) In general. Except as otherwise provided in this section,
Secs. 1.148-1 through 1.148-11 apply to bonds sold on or after July 8,
1997.
(b) Elective retroactive application in whole--(1) In general.
Except as otherwise provided in this section, and subject to the
applicable effective dates for the corresponding statutory provisions,
an issuer may apply the provisions of Secs. 1.148-1 through 1.148-11 in
whole, but not in part, to any issue that is outstanding on July 8,
1997, and is subject to section 148(f) or to sections 103(c)(6) or
103A(i) of the Internal Revenue Code of 1954, in lieu of otherwise
applicable regulations under those sections.
* * * * *
(3) No elective retroactive application for hedges of fixed rate
issues. The provisions of Sec. 1.148-4(h)(2)(i)(B) (relating to hedges
of fixed rate issues) may not be applied to any bond sold on or before
July 8, 1997.
(c) Elective retroactive application of certain provisions and
special rules--(1) 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.
* * * * *
(g) Provisions applicable to certain bonds sold before effective
date. Except for bonds to which paragraph (b)(1) of this section
applies--
(1) Section 1.148-11A provides rules applicable to bonds sold after
June 6, 1994, and before July 8, 1997; and
(2) Sections 1.148-1 through 1.148-11 as in effect on July 1, 1993
(see 26 CFR part 1 as revised April 1, 1994), and Sec. 1.148-11A(i)
(relating to elective retroactive application of certain provisions)
provide rules applicable to
[[Page 25513]]
certain issues issued before June 7, 1994.
Par. 16. In newly designated Sec. 1.148-11A, paragraph (i) is
revised to read as follows:
Sec. 1.148-11A Effective dates.
* * * * *
(i) Transition rules for certain amendments--(1) In general.
Section 1.103-8(a)(5), Secs. 1.148-1, 1.148-2, 1.148-3, 1.148-4, .148-
5, 1.148-6, 1.148-7, 1.148-8, 1.148-9, 1.148-10, 1.148-11, 1.149(d)-1,
and 1.150-1 as in effect on June 7, 1994 (see 26 CFR part 1 as revised
April 1, 1997), and Secs. 1.148-1A through 1.148-11A, 1.149(d)-1A, and
1.150-1A apply, in whole, but not in part--
(i) To bonds sold after June 6, 1994, and before July 8, 1997;
(ii) To bonds issued before July 1, 1993, that are outstanding on
June 7, 1994, if the first time the issuer applies Secs. 1.148-1
through 1.148-11 as in effect on June 7, 1994 (see 26 CFR part 1 as
revised April 1, 1997), to the bonds under Sec. 1.148-11 (b) or (c) is
after June 6, 1994, and before July 8, 1997;
(iii) At the option of the issuer, to bonds to which Secs. 1.148-1
through 1.148-11, as in effect on July 1, 1993 (see 26 CFR part 1 as
revised April 1, 1994), apply, if the bonds are outstanding on June 7,
1994, and the issuer applies Sec. 1.103-8(a)(5), 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, 1.148-11, 1.149(d)-1, and 1.150-1 as in effect on June 7,
1994 (see 26 CFR part 1 as revised April 1, 1997), and Secs. 1.148-1A
through 1.148-11A, 1.149(d)-1A, and 1.150-1A to the bonds before July
8, 1997.
(2) Special rule. For purposes of paragraph (i)(1) of this section,
any reference to a particular paragraph of 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, 1.148-11T,
1.149(d)-1T, or 1.150-1T shall be applied as a reference to the
corresponding paragraph of Secs. 1.148-1A, 1.148-2A, 1.148-3A, 1.148-
4A, 1.148-5A, 1.148-6A, 1.148-9A, 1.148-10A, 1.148-11A, 1.149(d)-1A, or
1.150-1A, respectively.
(3) Identification of certain hedges. For any hedge entered into
after June 18, 1993, and on or before June 6, 1994, that would be a
qualified hedge within the meaning of Sec. 1.148-4(h)(2), as in effect
on June 7, 1994 (see 26 CFR part 1 as revised April 1, 1997), except
that the hedge does not meet the requirements of Sec. 1.148-
4A(h)(2)(ix) because the issuer failed to identify the hedge not later
than 3 days after which the issuer and the provider entered into the
contract, the requirements of Sec. 1.148-4A(h)(2)(ix) are treated as
met if the contract is identified by the actual issuer on its books and
records maintained for the hedged bonds not later than July 8, 1997.
Par. 17. Section 1.149(d)-1 is amended as follows:
1. Paragraph (f)(3) is revised.
2. Paragraph (g)(3) is added.
The revised and added provisions read as follows:
Sec. 1.149(d)-1 Limitations on advance refundings.
* * * * *
(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.
(g) * * *
(3) Special effective date for paragraph (f)(3). Paragraph (f)(3)
of this section applies to bonds sold on or after July 8, 1997 and to
any issue to which the election described in Sec. 1.148-11(b)(1) is
made. See Secs. 1.148-11A(i) for rules relating to certain bonds sold
before July 8, 1997.
Sec. 1.149(d)-1T [Redesignated as Sec. 1.149(d)-1A]
Par. 18. Section 1.149(d)-1T is redesignated as Sec. 1.149(d)-1A,
is transferred immediately following Sec. 1.148-11A, and the section
heading is amended by removing the language ``(temporary)''.
Par. 19. Section 1.150-1 is amended as follows:
1. Paragraph (a)(2) is revised.
2. Paragraphs (c)(1) and (c)(4)(iii) are revised.
3. Paragraph (c)(6) is added.
The revised and added provisions read as follows:
Sec. 1.150-1 Definitions.
(a) * * *
(2) Effective date--(i) In general. Except as otherwise provided in
this paragraph (a)(2), this section applies to issues issued after June
30, 1993 to which Secs. 1.148-1 through 1.148-11 apply. In addition,
this section (other than paragraph (c)(3) of this section) applies to
any issue to which the election described in Sec. 1.148-11(b)(1) is
made.
(ii) Special effective date for paragraphs (c)(1), (c)(4)(iii), and
(c)(6). Paragraphs (c)(1), (c)(4)(iii), and (c)(6) of this section
apply to bonds sold on or after July 8, 1997 and to any issue to which
the election described in Sec. 1.148-11(b)(1) is made. See Sec. 1.148-
11A(i) for rules relating to certain bonds sold before July 8, 1997.
* * * * *
(c) Definition of issue--(1) In general. Except as otherwise
provided in this paragraph (c), the term issue means two or more bonds
that meet all of the following requirements:
(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.
(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.
* * * * *
(4) * * *
(iii) Certain general obligation bonds. Except as otherwise
provided in paragraph (c)(2) of this section, bonds that are 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 may be treated as part of the same issue if
the issuer so elects on or before the issue date.
* * * * *
(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.
* * * * *
Sec. 1.150-1T [Redesignated as Sec. 1.150-1A]
Par. 20. Section 1.150-1T is redesignated as Sec. 1.150-1A, is
transferred immediately following Sec. 1.149(d)-1A, and the section
heading
[[Page 25514]]
is amended by removing the language ``(temporary)''.
PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT
Par. 21. The authority citation for part 602 continues to read as
follows:
Authority: 26 U.S.C. 7805.
Par. 22. In Sec. 602.101, paragraph (c) is amended by adding an
entry in numerical order to the table to read as follows:
Sec. 602.101 OMB Control numbers.
* * * * *
(c) * * *
------------------------------------------------------------------------
Current OMB
CFR part or section where identified and described control No.
------------------------------------------------------------------------
* * * * *
1.150-1................................................. 1545-1347
* * * * *
------------------------------------------------------------------------
Margaret Milner Richardson,
Commissioner of Internal Revenue.
Approved: May 1, 1997.
Donald C. Lubick,
Acting Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 97-12062 Filed 5-8-97; 8:45 am]
BILLING CODE 4830-01-U