[Federal Register Volume 64, Number 166 (Friday, August 27, 1999)]
[Proposed Rules]
[Pages 46876-46878]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-21877]


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DEPARTMENT OF TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-105565-99]
RIN 1545-AX22


Arbitrage Restrictions Applicable to Tax-Exempt Bonds Issued by 
State and Local Governments

AGENCY: Internal Revenue Service (IRS), Treasury.

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

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SUMMARY: This document contains proposed regulations on the arbitrage 
restrictions applicable to tax-exempt bonds issued by State and local 
governments. The proposed amendments affect issuers of tax-exempt bonds 
and provide a safe harbor for qualified administrative costs for 
brokers' commissions and similar fees incurred in connection with the 
acquisition of a guaranteed investment contract or investments 
purchased for a yield restricted defeasance escrow.

DATES: Written comments must be received by November 26, 1999.
    Outlines of topics to be discussed at the public hearing scheduled 
for December 14, 1999, at 10 a.m. must be received by Tuesday, November 
23, 1999.

ADDRESSES: Send submissions to CC:DOM:CORP:R (REG-105565-99), 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-
105565-99), 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 the Auditorium, Internal Revenue Building, 1111 
Constitution Avenue, NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Rose M. Weber, (202) 622-3980; concerning submissions of comments, the 
hearing, and/or requests to be placed on the building access list to 
attend the hearing, Michael Slaughter, (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 May 9, 1997, 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). The final regulations (TD 8718) were amended on December 
30, 1998 (63 FR 71748). This document proposes to modify Sec. 1.148-
5(e)(2) to provide a safe harbor for determining whether brokers' 
commissions and similar fees incurred in connection with the 
acquisition of guaranteed investment contracts or investments purchased 
for a yield restricted defeasance escrow are treated as qualified 
administrative costs.

Explanation of Provisions

    Section 1.148-5(e)(2)(iii) and (iv) of the regulations provides 
rules for determining whether a broker's commission or similar fee is 
treated as a qualified administrative cost. Section 1.148-5(e)(2)(iii) 
provides that, 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, generally, 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 or the present value 
of annual payments equal to .05 percent of the weighted average amount 
reasonably expected to be invested each year of the term of the 
contract. 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.
    Section 1.148-5(e)(2)(iv) provides that, for investments purchased 
for a yield restricted defeasance escrow, a fee paid to a bidding agent 
is a qualified administrative cost only if the fee is comparable to a 
fee that would be

[[Page 46877]]

charged for a reasonably comparable investment if acquired with a 
source of funds other than gross proceeds of tax-exempt bonds, and it 
is reasonable. The fee is deemed to meet both the comparability and 
reasonableness requirements if it does not exceed the lesser of $10,000 
and .1 percent of the initial principal amount of investments deposited 
in the yield restricted defeasance escrow.
    Unlike Sec. 1.148-5(e)(2)(iv), Sec. 1.148-5(e)(2)(iii) does not 
provide parameters under which the reasonableness test will be deemed 
to have been met. Practitioners have noted that they are uncertain 
about how to determine reasonableness and whether the .05% test may be 
used as a safe harbor without regard to whether the resulting amount is 
a reasonable fee.
    Practitioners have also noted that the computation required by 
Sec. 1.148-5(e)(2)(iii) is too complex and results in different fees 
being paid for the same services provided.
    Finally, having different rules for guaranteed investment contracts 
and investments purchased for a yield restricted defeasance escrow 
provides an unnecessary tax incentive to structure investments in a 
certain manner.
    To eliminate these complexities and to provide a rule that is 
easily administered by issuers, the proposed regulations create a 
single rule for qualified administrative costs that applies to a 
broker's commission or similar fee incurred in connection with a 
guaranteed investment contract or investments purchased for a yield 
restricted defeasance escrow. The proposed regulations also set forth a 
safe harbor, which allows a broker's commission or similar fee incurred 
in connection with the acquisition of a guaranteed investment contract 
or investments purchased for a yield restricted defeasance escrow to be 
treated as a qualified administrative cost. To fairly compensate most 
brokers, the proposed safe harbor provides a higher safe harbor limit 
than is currently provided for in Sec. 1.148-5(e)(2)(iv).
    The proposed safe harbor sets forth two requirements. Under the 
first requirement, the amount of the broker's commission or similar fee 
incurred in connection with the acquisition of a guaranteed investment 
contract or other investments purchased for a yield restricted 
defeasance escrow and treated by the issuer as a qualified 
administrative cost cannot exceed the lesser of $25,000 and .2 percent 
of the computational base. For guaranteed investment contracts, the 
computational base is the aggregate amount reasonably expected to be 
deposited over the term of the contract. For investments, other than 
guaranteed investment contracts, deposited in a yield restricted 
defeasance escrow, the computational base is the initial amount 
invested in those investments. For example, for a guaranteed investment 
contract purchased for a debt service fund, the aggregate amount 
reasonably expected to be deposited includes all periodic deposits 
reasonably expected to be made pursuant to the terms of the contract. 
Under the second requirement, for any issue of bonds, the issuer cannot 
treat as qualified administrative costs more than $75,000 in brokers' 
commissions and similar fees with respect to all guaranteed investment 
contracts and investments for yield restricted defeasance escrows 
purchased with gross proceeds of the issue.
    The proposed regulations eliminate the special rule in Sec. 1.148-
5(e)(2)(iii) for issues that meet section 148(f)(4)(D)(i). These bond 
issues will be permitted to use the safe harbor.
    These regulations are proposed to apply to bonds sold on or after 
the date 90 days after the issuance of the final regulations.

Special Analysis

    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 Requests for a 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 Tuesday, December 14, 1999, 
beginning at 10 a.m. in the IRS Auditorium, 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 November 26, 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 November 23, 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 Rose M. 
Weber and Rebecca L. Harrigal, Office of the Assistant Chief Counsel 
(Financial Institutions & 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.

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. In Sec. 1.148-5, paragraph (e) is amended as follows:
    1. Paragraph (e)(2)(iii) is revised.
    2. Paragraph (e)(2)(iv) is removed.
    The revision reads as follows:

[[Page 46878]]

Sec. 1.148-5  Yield and valuation of investments.

* * * * *
    (e) * * *
    (2) * * *
    (iii) Special rule for guaranteed investment contracts and 
investments purchased for a yield restricted defeasance escrow--(A) In 
general. An amount paid for a broker's commission or similar fee with 
respect to a guaranteed investment contract or investments purchased 
for a yield restricted defeasance escrow is a qualified administrative 
cost if the fee is reasonable within the meaning of paragraph (e)(2)(i) 
of this section.
    (B) Safe harbor. (1) A broker's commission or similar fee with 
respect to the acquisition of a guaranteed investment contract or 
investments purchased for a yield restricted defeasance escrow is 
reasonable within the meaning of paragraph (e)(2)(i) of this section 
if--
    (i) The amount of the fee that the issuer treats as a qualified 
administrative cost does not exceed the lesser of $25,000 and .2% of 
the computational base; and
    (ii) For any issue, the issuer does not treat as qualified 
administrative costs more than $75,000 in brokers' commissions or 
similar fees with respect to all guaranteed investment contracts and 
investments for yield restricted defeasance escrows purchased with 
gross proceeds of the issue.
    (2) For purposes of paragraph (e)(2)(iii)(B)(1) of this section, 
computational base shall mean--
    (i) For a guaranteed investment contract, the amount the issuer 
reasonably expects as of the issue date to be deposited in the 
guaranteed investment contract over the term of the contract; and
    (ii) For investments (other than guaranteed investment contracts) 
to be deposited in a yield restricted defeasance escrow, the amount of 
gross proceeds initially invested in those investments.
    (C) Example. The following example illustrates an application of 
the safe harbor in paragraph (e)(2)(iii)(B) of this section:

    Example. The issuer of a multipurpose issue uses brokers to 
purchase the following investments with gross proceeds of the issue: 
a guaranteed investment contract for amounts to be deposited in a 
debt service fund (debt service GIC), a guaranteed investment 
contract for amounts to be deposited in a construction fund 
(construction GIC), Treasury securities to be deposited in a yield 
restricted defeasance escrow (Treasury investments) and a guaranteed 
investment contract that will be used to earn a return on what would 
otherwise be idle cash balances from maturing investments in the 
yield restricted defeasance escrow (the float GIC). The issuer uses 
$8,040,000 of the proceeds to purchase the Treasury investments and 
deposits $14,000,000 into the construction GIC. Over the term of the 
construction GIC, the issuer reasonably expects that no further 
deposits will be made. Over the term of the float GIC, the issuer 
reasonably expects that aggregate deposits of $600,000 will be made 
to the float GIC. Over the term of the debt service GIC, the issuer 
reasonably expects that it will make aggregate deposits of 
$22,000,000, plus interest on the bond issue. The brokers' fees do 
not exceed $16,080 for the Treasury investments, $25,000 for the 
construction GIC, $1,200 for the float GIC, and $25,000 for the debt 
service GIC. Assuming the issuer claims no further brokerage or 
similar fees, the issuer can claim all $67,280 in brokerage fees for 
these investments as qualified administrative costs because the fees 
do not exceed the limitations described in paragraph (e)(2)(iii)(B) 
of this section.
* * * * *
Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
[FR Doc. 99-21877 Filed 8-26-99; 8:45 am]
BILLING CODE 4830-01-P