[Federal Register Volume 67, Number 69 (Wednesday, April 10, 2002)]
[Proposed Rules]
[Pages 17309-17312]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-8655]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-165706-01]
RIN 1545-BA46


Obligations of States and Political Subdivisions

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 definition 
of refunding issue applicable to tax-exempt bonds issued by States and 
local governments. This document provides a notice of public hearing on 
these proposed regulations.

DATES: Written or electronic comments must be received by July 9, 2002. 
Outlines of topics to be discussed at the public hearing scheduled for 
July 30, 2002, at 10 a.m., must be received by July 9, 2002.

ADDRESSES: Send submissions to: CC:ITA:RU (REG-165706-01), room 5226, 
Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, 
DC 20044. Submissions may be hand delivered between the hours of 8 a.m. 
and 5 p.m. to: CC:ITA:RU (REG-165706-01), courier's desk, Internal 
Revenue Service, 1111 Constitution Avenue NW., Washington, DC. 
Alternatively, submissions may be made electronically to the IRS 
Internet site at www.irs.gov/regs. The public hearing will be held in 
the Auditorium, Internal Revenue Building, 1111 Constitution Avenue 
NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Michael P. 
Brewer, (202) 622-3980; concerning submissions and the hearing, Treena 
Garrett, (202) 622-7190 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

    Section 150 of the Internal Revenue Code (Code) provides certain 
definitions and special rules for purposes of applying the tax-exempt 
bond limitations contained in sections 103 and 141 through 150. On June 
18, 1993, final regulations (TD 8476) under section 150 were published 
in the Federal Register (58 FR 33510). On May 9, 1997, additional final 
regulations (TD 8718) under section 150 were published in the Federal 
Register (62 FR 25502). This document proposes to modify the definition 
of refunding issue under Sec. 1.150-1(d).

Explanation of Provisions

    Section 1.150-1(d) of the current regulations provides a definition 
of refunding issue. In general, a refunding issue is an issue of 
obligations the proceeds of which are used to pay principal, interest, 
or redemption price on another issue. The current regulations contain 
certain exceptions to this general rule. One exception (the change in 
obligor exception) provides that an issue is not a refunding issue to 
the extent that the obligor of one issue is neither the obligor of the 
other issue nor a related party with respect to the obligor of the 
other issue. Another exception (the six-month exception) provides that 
if a person assumes (including taking subject to) obligations of an 
unrelated party in connection with an asset acquisition (other than a 
transaction to which section 381(a) applies if the person assuming the 
obligation is the acquiring corporation within the meaning of section 
381(a)), and the assumed issue is refinanced within six months before 
or after the date of the debt assumption, the refinancing issue is not 
treated as a refunding issue.
    Section 1.150-1(b) of the current regulations provides that the 
term related party means, in reference to a governmental unit or a 
501(c)(3) organization, any member of the same controlled group. 
Section 1.150-1(e) of the current regulations provides that the term 
controlled group means a group of entities controlled directly or 
indirectly by the same entity or group of entities. The determination 
of control is made on the basis of all the relevant facts and 
circumstances. One entity or group of entities (the controlling entity) 
generally controls another entity or group of

[[Page 17310]]

entities (the controlled entity) if the controlling entity possesses 
either of the following rights or powers and the rights or powers are 
discretionary and non-ministerial: (i) The right or power both to 
approve and to remove without cause a controlling portion of the 
governing body of the controlled entity; or (ii) the right or power to 
require the use of funds or assets of the controlled entity for any 
purpose of the controlling entity.
    Recently, questions have arisen regarding the application of these 
provisions with respect to certain issuances of bonds for 501(c)(3) 
organizations that operate hospital systems. In question generally is 
whether bonds issued in connection with the combination of two or more 
501(c)(3) organizations to refinance outstanding bonds should be 
characterized as refunding bonds. One question is how the change in 
obligor exception and the six-month exception should be applied when 
the obligor of the new issue becomes related to the obligor of the 
other issue as part of the refinancing transaction. Another question is 
whether the acquisition by a 501(c)(3) organization of the sole 
membership interest in another 501(c)(3) organization should be treated 
as an asset acquisition for purposes of the six-month exception. A 
third question is what assets should be treated as financed by the new 
bonds under both the change in obligor exception and the six-month 
exception.
    In general, the proposed regulations retain the change in obligor 
exception and the six-month exception, with certain modifications. The 
proposed regulations clarify that the determination of whether persons 
are related for purposes of the change in obligor exception and the 
six-month exception is generally made immediately before the 
transaction. However, a refinancing issue is a refunding issue under 
the proposed regulations if the obligor of the refinanced issue (or any 
person that is related to the obligor of the refinanced issue 
immediately before the transaction) has or obtains in the transaction 
the right to appoint the majority of the members of the governing body 
of the obligor of the refinancing issue (or any person that controls 
the obligor of the refinancing issue).
    The proposed regulations state that the six-month exception applies 
to acquisition transactions. An acquisition transaction is a 
transaction in which a person acquires from an unrelated party: (i) 
Assets, other than an equity interest in an entity, if the acquirer is 
treated as acquiring such assets for all Federal income tax purposes; 
(ii) stock of a corporation with respect to which a valid election 
under section 338 is made; or (iii) control of a governmental unit or a 
501(c)(3) organization through the acquisition of stock, membership 
interests or otherwise.
    The proposed regulations retain the exclusion under which the six-
month exception does not apply to transactions to which section 381(a) 
applies, and broaden its scope. In particular, under the proposed 
regulations the exclusion may apply even if the person assuming the 
obligations is not the acquiring corporation within the meaning of 
section 381(a) (for example, a transaction in which a corporation 
assumes the obligations of a target corporation in a transaction to 
which section 381(a) applies and then contributes all of the assets of 
the target corporation to a controlled subsidiary). The proposed 
regulations also extend the application of this rule for section 381(a) 
transactions to the change in obligor exception.
    The proposed regulations provide two new, additional requirements 
for purposes of the change in obligor exception and the six-month 
exception. In certain circumstances where the obligors of the issues 
are affiliated before the transaction or become affiliated as part of 
the transaction, the proposed regulations provide that an issue will be 
treated as a refunding issue unless: (i) The refinanced issue is 
redeemed on the earliest date on which the issue may be redeemed, and 
(ii) the new issue is treated as being used to finance the assets that 
were financed with the proceeds of the refinanced issue. These new 
requirements are intended to further the Congressional policy against 
overburdening the tax-exempt bond market, as expressed in sections 148 
and 149(d). In particular, they are intended to prevent overburdening 
in the case of transactions between affiliated persons that contain 
certain economic characteristics of a refunding.

Proposed Effective Date

    The proposed regulations will apply to bonds sold on or after the 
date of publication of final regulations in the Federal Register. 
However, issuers may apply the proposed regulations in whole, but not 
in part, to any issue that is sold on or after the date the proposed 
regulations are published in the Federal Register and before the 
applicability date 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 Executive Order 
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 written comments that are submitted 
timely (preferably a signed original and eight copies) to the IRS. All 
comments will be available for public inspection and copying.
    A public hearing has been scheduled for July 30, 2002, at 10:00 
a.m. in the Auditorium, Internal Revenue Building, 1111 Constitution 
Avenue, NW., Washington, DC. Because of access restrictions, visitors 
will not be admitted beyond the lobby more than 15 minutes before the 
hearing starts.
    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 July 9, 2002 and submit an outline of the 
topics to be discussed and the amount of time to be devoted to each 
topic by July 9, 2002.
    A period of 10 minutes will be allotted to each person for making 
comments.
    An agenda showing the scheduling of the speakers will be prepared 
after the deadline for receiving outlines has passed. Copies of the 
agenda will be available free of charge at the hearing.

Drafting Information

    The principal authors of these regulations are Bruce M. Serchuk, 
Office of Chief Counsel (Tax-exempt and Government Entities), Internal 
Revenue Service and Stephen J. Watson, Office of Tax Legislative 
Counsel, Department of the Treasury. 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 17311]]

Proposed Amendments to the Regulations

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

PART 1--INCOME TAXES

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

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

    Par. 2. Section 1.150-1 is amended as follows:
    1. Paragraph (a)(2)(iii) is added.
    2. Paragraphs (d)(2)(ii) and (d)(2)(v) are revised.
    The added and revised provisions read as follows:


Sec. 1.150-1  Definitions.

    (a) * * *
    (2) * * *
    (iii) Special effective date for paragraphs (d)(2)(ii) and 
(d)(2)(v). Paragraphs (d)(2)(ii) and (d)(2)(v) of this section apply to 
bonds sold on or after the date of publication of final regulations in 
the Federal Register, and may be applied by issuers in whole, but not 
in part, to any issue that is sold on or after April 10, 2002.
* * * * *
    (d) * * *
    (2) * * *
    (ii) Certain issues with different obligors--(A) In general. An 
issue is not a refunding issue to the extent that the obligor (as 
defined in paragraph (d)(2)(ii)(B) of this section) of one issue is 
neither the obligor of the other issue nor a related party with respect 
to the obligor of the other issue. The determination of whether persons 
are related for this purpose is generally made immediately before the 
issuance of the refinancing issue. This paragraph (d)(2)(ii)(A) does 
not apply to any issue that is issued in connection with a transaction 
to which section 381(a) applies.
    (B) Definition of obligor. The obligor of an issue means the actual 
issuer of the issue, except that the obligor of the portion of an issue 
properly allocable to an investment in a purpose investment means the 
conduit borrower under that purpose investment. The obligor of an issue 
used to finance qualified mortgage loans, qualified student loans, or 
similar program investments (as defined in Sec. 1.148-1) does not 
include the ultimate recipient of the loan (e.g., the homeowner, the 
student).
    (C) Certain integrated transactions. If, within six months before 
or after a person assumes (including taking subject to) obligations of 
an unrelated party in connection with an acquisition transaction (other 
than a transaction to which section 381(a) applies), the assumed issue 
is refinanced, the refinancing issue is not a refunding issue. An 
acquisition transaction is a transaction in which a person acquires 
from an unrelated party--
    (1) Assets (other than an equity interest in an entity);
    (2) Stock of a corporation with respect to which a valid election 
under section 338 is made; or
    (3) Control of a governmental unit or a 501(c)(3) organization 
through the acquisition of stock, membership interests or otherwise.
    (D) Special rule for affiliated persons. Paragraphs (d)(2)(ii)(A) 
and (C) of this section do not apply to any issue that is issued in 
connection with a transaction between affiliated persons (as defined in 
paragraph (d)(2)(ii)(E) of this section), unless--
    (1) The refinanced issue is redeemed on the earliest date on which 
it may be redeemed (or otherwise within 90 days after the date of 
issuance of the refinancing issue); and
    (2) The refinancing issue is treated for all purposes of sections 
103 and 141 through 150 as financing the assets that were financed with 
the refinanced issue.
    (E) Affiliated persons. For purposes of paragraph (d)(2)(ii)(D) of 
this section, persons are affiliated persons if--
    (1) At any time during the six months prior to the transaction, 
more than 5 percent of the voting power of the governing body of either 
person is in the aggregate vested in the other person and its 
directors, officers, owners, and employees; or
    (2) During the one-year period beginning six months prior to the 
transaction, the composition of the governing body of the acquiring 
person (or any person that controls the acquiring person) is modified 
or established to reflect (directly or indirectly) representation of 
the interests of the acquired person or the person from whom assets are 
acquired (or there is an agreement, understanding, or arrangement 
relating to such a modification or establishment during that one-year 
period).
    (F) Reverse acquisitions. Notwithstanding any other provision of 
this paragraph (d)(2)(ii), a refinancing issue is a refunding issue if 
the obligor of the refinanced issue (or any person that is related to 
the obligor of the refinanced issue immediately before the transaction) 
has or obtains in the transaction the right to appoint the majority of 
the members of the governing body of the obligor of the refinancing 
issue (or any person that controls the obligor of the refinancing 
issue). See paragraph (d)(2)(v) Example 2 of this section.
* * * * *
    (v) Examples. The provisions of this paragraph (d)(2) are 
illustrated by the following examples:

    Example 1. Consolidation of 501(c)(3) hospital organizations. 
(i) A and B are unrelated hospital organizations described in 
section 501(c)(3). A has assets with a fair market value of $175 
million, and is the obligor of outstanding tax-exempt bonds in the 
amount of $75 million. B has assets with a fair market value of $145 
million, and is the obligor of outstanding tax-exempt bonds in the 
amount of $50 million. In response to significant competitive 
pressures in the healthcare industry, and for other substantial 
business reasons, A and B agree to consolidate their operations. To 
accomplish the consolidation, A and B form a new 501(c)(3) hospital 
organization, C. A and B each appoint one-half of the members of the 
initial governing body of C. Subsequent to the initial appointments, 
C's governing body is self-perpetuating. On December 29, 2003, State 
Y issues bonds with sale proceeds of $129 million and lends the 
entire sale proceeds to C. The 2003 bonds are collectively secured 
by revenues of A, B and C. Simultaneously with the issuance of the 
2003 bonds, C acquires the sole membership interest in each of A and 
B. C's ownership of these membership interests entitles C to 
exercise exclusive control over the assets and operations of A and 
B. C uses the $129 million of sale proceeds of the 2003 bonds to 
defease the $75 million of bonds on which A was the obligor, and the 
$50 million of bonds on which B was the obligor. All of the defeased 
bonds will be redeemed on the first date on which they may be 
redeemed. In addition, C treats the 2003 bonds as financing the same 
assets as the defeased bonds. The 2003 bonds do not constitute a 
refunding issue because the obligor of the 2003 bonds (C) is neither 
the obligor of the defeased bonds nor a related party with respect 
to the obligors of those bonds immediately before the issuance of 
the 2003 bonds. In addition, the requirements of paragraph 
(d)(2)(ii)(D) of this section have been satisfied.
    (ii) The facts are the same as in paragraph (i) of this Example 
1, except that C acquires the membership interests in A and B 
subject to the obligations of A and B on their respective bonds, and 
the 2003 bonds are sold within six months after the acquisition by C 
of the membership interests. The 2003 bonds do not constitute a 
refunding issue.
    Example 2. Reverse acquisition. D and E are unrelated hospital 
organizations described in section 501(c)(3). D has assets with a 
fair market value of $225 million, and is the obligor of outstanding 
tax-exempt bonds in the amount of $100 million. E has assets with a 
fair market value of $100 million. D and E agree to consolidate 
their operations. On May 18, 2004, Authority Z issues bonds with 
sale proceeds of $103 million and lends the entire sale proceeds to 
E. Simultaneously with the issuance of the 2004 bonds, E acquires 
the sole membership interest in D. In addition, D obtains the right

[[Page 17312]]

to appoint the majority of the members of the governing body of E. E 
uses the $103 million of sale proceeds of the 2004 bonds to defease 
the bonds of which D was the obligor. All of the defeased bonds will 
be redeemed on the first date on which they may be redeemed. In 
addition, E treats the 2004 bonds as financing the same assets as 
the defeased bonds. The 2004 bonds constitute a refunding issue 
because the obligor of the defeased bonds (D) obtains in the 
transaction the right to appoint the majority of the members of the 
governing body of the obligor of the 2004 bonds (E). See paragraph 
(d)(2)(ii)(F) of this section.
    Example 3. Relinquishment of control. The facts are the same as 
in Example 2, except that D does not obtain the right, directly or 
indirectly, to appoint any member of the governing body of E. 
Rather, E obtains the right both to approve and to remove without 
cause each member of the governing body of D. In addition, prior to 
being acquired by E, D experiences financial difficulties as a 
result of mismanagement. Thus, as part of E's acquisition of D, all 
of the former members of D's governing body resign their positions 
and are replaced with persons appointed by E. The 2004 bonds do not 
constitute a refunding issue.
* * * * *

Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
[FR Doc. 02-8655 Filed 4-5-02; 2:41 pm]
BILLING CODE 4830-01-P