[Federal Register Volume 64, Number 164 (Wednesday, August 25, 1999)]
[Proposed Rules]
[Pages 46320-46322]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-21878]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG-113526-98]
RIN 1545-AW44
Arbitrage and Related Restrictions Applicable to Tax-Exempt Bonds
Issued by State and Local Governments; Investment-Type Property
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
and related restrictions applicable to tax-exempt bonds issued by State
and local governments. The proposed amendments affect issuers of tax-
exempt bonds and provide guidance on the definition of investment-type
property to help issuers comply with the arbitrage and related
restrictions.
DATES: Written comments must be received by December 23, 1999. Outlines
of topics to be discussed at the public hearing scheduled for January
12, 2000, at 10 a.m. must be received by December 15, 1999.
ADDRESSES: Send submissions to CC:DOM:CORP:R (REG-113526-98), room
5226, Internal Revenue Service, POB 7604, Ben Franklin Station,
Washington, DC 20044. Submissions may be hand delivered Monday through
Friday between the hours of 8 a.m. and 5 p.m. to CC:DOM:CORP:R (REG-
113526-98), Courier's Desk, Internal Revenue Service, 1111 Constitution
Avenue, NW., Washington, DC.
Alternatively, taxpayers may submit comments electronically via the
Internet by selecting the ``Tax Regs'' option on the IRS Home Page, or
by submitting comments directly to the IRS site at http://
www.irs.ustreas.gov/tax__regs/regslist.html. The public hearing is in
room 2615, Internal Revenue Building, 1111 Constitution Avenue, NW.,
Washington, DC.
FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations,
Barbara Jane League, (202) 622-3980; concerning submissions of
comments, the hearing, and/or requests to be placed on the building
access list to attend the hearing, LaNita Van Dyke, (202) 622-7180 (not
toll-free numbers).
SUPPLEMENTARY INFORMATION:
Background
Section 148 of the Internal Revenue Code provides rules addressing
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 were published in the Federal Register
(58 FR 33510). Corrections to these regulations were published in the
Federal Register on August 23, 1993 (58 FR 44451), May 11, 1994 (59 FR
24350), and July 9, 1999 (64 FR 37037). On May 9, 1997, additional
final regulations (TD 8718) relating to the arbitrage restrictions and
related rules under sections 103, 148, 149, and 150 were published in
the Federal Register (62 FR 25502). This document proposes to modify
Sec. 1.148-1(e) to clarify which prepayments are investment-type
property under section 148(b)(2)(D).
Explanation of Provisions
The current regulations, at Sec. 1.148-1(e)(2), provide that
prepayments for property or services give rise to investment-type
property if a principal purpose for prepaying is to obtain an
investment return from the time that the payment is made until the time
that payment otherwise would be made. A prepayment does not give rise
to investment-type property if (1) 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
(2) prepayments on
[[Page 46321]]
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.
Recently, an issue arose about whether investment-type property
includes the prepayment of a contract for property or services after
the date that the contract is entered into. In City of Columbus v.
Commissioner, 112 F.3d 1201 (D.C. Cir. 1997), the court held that a
prepayment for property cannot occur after the property is acquired.
The court's holding suggests that an issuer could avoid investment-type
property by entering into a contract for property or services and, at a
later date, prepaying that contract. This result is inconsistent with
the intent of section 148. The legislative history indicates that
Congress intended that the arbitrage rules apply broadly. For example,
the Conference Report to the Tax Reform Act of 1986 provides that
investment property includes the acquisition of any property held for
investment (other than another tax-exempt bond). H.R. Conf. Rep. No.
841, 99th Cong., 2d Sess. II-747, 1986-3 C.B. (Vol. 4) 747.
This document proposes modifications to the regulations to
establish that prepayments that give rise to investment-type property
can occur after the contract for property or services is entered into
and to make other non-substantive, clarifying changes. It is intended
that these regulations address only the potential issue created by the
City of Columbus opinion as noted above. Comments are requested on
whether the affect of the changes proposed in this document is broader
than intended.
In addition to comments on the proposed regulations, comments are
requested on whether additional guidance is needed to clarify other
aspects of the investment-type property definition. For example,
comments are requested on whether clarification is needed on which
prepayments of an obligation will be treated as a prepayment for
property or services that gives rise to investment-type property, and
whether a contract under which property or services are to be provided
over time and the payments for those property or services are to be
made over time gives rise to investment-type property when the payment
schedule does not match the schedule for the provision of the property
or services.
Finally, Treasury and the IRS have become aware of certain
transactions involving prepayments for the purchase of a commodity. In
these transactions, an issuer generally enters into a long-term
contract with a supplier (for example, a natural gas supply company) to
supply over a number of years a fixed amount of the commodity to the
issuer at a fixed price (the ``supply contract''). In return, the
issuer makes a single lump-sum prepayment for the commodity to the
supplier. The prepayment is financed through the issuance of bonds. The
amount of the prepayment is determined in a manner that permits the
issuer to obtain an investment return from the prepayment. The issuer
also enters into other agreements, including one or more swap
agreements, that result in the issuer converting substantially all of
the issuer's cost for the commodity under the supply contract into a
variable cost that approximates the then current price of the commodity
when the issuer takes delivery.
Based on the information received, and viewing the transaction as a
whole, it appears that a principal purpose of the prepayment for the
supply contract was to earn an investment return. If so, the supply
contract is investment-type property unless the requirement of
Sec. 1.148-1(e)(2)(i) or (ii) are met. Treasury and the IRS are
concerned that the supply contract may be investment-type property and
request comments on these transactions.
The regulations, when finalized, will apply to bonds issued after a
date of applicability that will be set forth in the final regulations.
Treasury and the IRS have not yet determined such date of applicability
other than to have made the determination that the date of
applicability will not be before this document is August 25, 1999.
Treasury and the IRS request comments as to the date of applicability
of the final regulations. No inference is intended as to the treatment
of bonds issued prior to the date of applicability of the final
regulations.
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 has also been determined
that section 553(b) of the Administrative Procedure Act (5 U.S.C.
chapter 5) does not apply to these regulations, and, because the
regulations do not impose a collection of information on small
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not
apply. Pursuant to section 7805(f) of the Internal Revenue Code, 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 electronic and written comments (a
signed original and eight (8) copies, if written) that are submitted
timely to the IRS. In particular, the IRS and Department of Treasury
specifically request comments on the clarity of the proposed rule and
how it may be made easier to understand. All comments will be available
for public inspection and copying.
A public hearing has been scheduled for Wednesday, January 12,
2000, beginning at 10 a.m. in room 2615, Internal Revenue Building,
1111 Constitution Avenue, NW., Washington, DC. Due to building security
procedures, visitors must enter at the 10th Street entrance, located
between Constitution and Pennsylvania Avenues, NW. In addition, all
visitors must present photo identification to enter the building.
Because of access restrictions, visitors will not be admitted beyond
the immediate entrance area more than 15 minutes before the hearing
starts. For information about having your name placed on the building
access list to attend the hearing, see the For Further Information
Contact section of this preamble.
The rules of 26 CFR 601.601(a)(3) apply to the hearing.
Persons who wish to present oral comments at the hearing must
submit written comments by December 23, 1999, 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 December 15, 1999. A period
of 10 minutes will be allotted to each person for making comments. An
agenda showing the scheduling of 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 authors of these proposed regulations are Rebecca L.
Harrigal and Barbara Jane League, 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 46322]]
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 in
part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.148-1(e) is amended as follows:
1. Paragraph (e)(1) is revised.
2. Paragraphs (e)(2) introductory text, (e)(2)(i) and (e)(2)(ii)
are redesignated as paragraphs (e)(2)(i) introductory text,
(e)(2)(i)(A), and (e)(2)(i)(B), respectively.
3. Paragraph (e)(2) heading is revised.
4. Newly designated paragraph (e)(2)(i) introductory text is
revised.
5. New paragraph (e)(2)(ii) is added.
The revisions and addition read as follows:
Sec. 1.148-1 Definitions and elections.
* * * * *
(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.
(2) Prepayments. (i) Except as otherwise provided in this paragraph
(e), a prepayment for property or services, including a prepayment of a
contract for property or services that is made after the date that the
contract is entered into, also 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--
* * * * *
(ii) Example. The following example illustrates an application of
paragraph (e)(2)(i) of this section:
Example. In 1996, City A entered into a ten-year contract with
Company Y. Under the contract, Company Y is to provide services to
City A and in return City A will make fixed annual payments to
Company Y. In 1998, Company Y and City A agree that City A will
prepay its obligation under the contract. To finance the prepayment,
City A will issue bonds. The amount of the prepayment is determined
in a manner that permits City A to obtain an investment return from
the prepayment. A principal purpose for City A agreeing to make the
prepayment is to obtain an investment return from the time of the
prepayment until the time payment otherwise would be made. The
prepayment is not made for a substantial business purpose other than
to obtain the investment return and City A had a commercially
reasonably alternative to the prepayment. In addition, prepayments
on substantially the same terms are not made by a substantial
percentage of persons who are similarly situated to City A but who
are not beneficiaries of tax-exempt financing. When the prepayment
is made, City A will have acquired investment-type property. It does
not matter that the prepayment occurred after the date that the
contract was entered into.
* * * * *
Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
[FR Doc. 99-21878 Filed 8-24-99; 8:45 am]
BILLING CODE 4830-01-P