[Federal Register Volume 68, Number 139 (Monday, July 21, 2003)]
[Proposed Rules]
[Pages 43059-43063]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-18327]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-132483-03]
RIN 1545-BC40


Remedial Actions for Tax-exempt Bonds

AGENCY: Internal Revenue Service (IRS), Treasury.

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

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SUMMARY: This document contains proposed regulations that amend the 
final regulations that provide certain permitted remedial actions for 
tax-exempt bonds issued by State and local governments. This document 
also contains a notice of public hearing on these proposed regulations.

DATES: Written or electronic comments must be received by October 14, 
2003.

[[Page 43060]]

Outlines of topics to be discussed at the public hearing scheduled for 
November 4, 2003, at 10 a.m., must be received by October 14, 2003.

ADDRESSES: Send submissions to CC:PA:RU (REG-132483-03), 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 4 p.m. to CC:PA:RU (REG-132483-03), 
Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue, 
NW., Washington, DC. Alternatively, taxpayers may submit comments 
electronically to the IRS Internet site at http://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, Gary W. 
Bornholdt, (202) 622-3980; concerning submissions of comments, the 
hearing, and requests to be placed on the building access list to 
attend the meeting, Sonya M. Cruse, (202) 622-7180 (not toll-free 
numbers).

SUPPLEMENTARY INFORMATION:

Background

    Section 103(a) of the Internal Revenue Code (Code) provides that, 
generally, interest on any State or local bond is not included in gross 
income. However, this exclusion does not apply to any private activity 
bond that is not a qualified bond.

A. Governmental Bonds

    Under section 141, a bond is a private activity bond if the bond is 
issued as part of an issue that meets either (1) the private business 
use test and the private security or payment test (the private business 
tests), or (2) the private loan financing test.
    The private business use test is met if more than 10 percent of the 
proceeds of an issue are to be used for any private business use. 
Section 141(b)(6) defines private business use as use directly or 
indirectly in a trade or business that is carried on by any person 
other than a governmental unit.
    The private security or payment test is met if the payment of the 
principal of, or the interest on, more than 10 percent of the proceeds 
of an issue is directly or indirectly (1) secured by an interest in 
property used or to be used for a private business use, (2) secured by 
an interest in payments in respect of such property, or (3) to be 
derived from payments, whether or not to the issuer, in respect of 
property, or borrowed money, used or to be used for a private business 
use.
    The private loan financing test is satisfied if more than the 
lesser of $5 million or 5 percent of the proceeds of an issue are to be 
used to make or finance loans to persons other than governmental units.
    Under Sec.  1.141-2(d) of the Income Tax Regulations, an issue is 
an issue of private activity bonds if the issuer reasonably expects, as 
of the issue date, that the issue will meet either the private business 
tests or the private loan financing test. Under Sec.  1.141-2(d), an 
issue is also an issue of private activity bonds if the issuer takes a 
deliberate action, subsequent to the issue date, that causes the 
conditions of either the private business tests or the private loan 
financing test to be met.
    Section 1.141-12 sets forth certain remedial actions that prevent a 
deliberate action with respect to property financed by an issue from 
causing that issue to meet the private business use test or the private 
loan financing test. Specifically, if an issuer satisfies certain 
conditions, an issuer may take one of the following three remedial 
actions to cure a deliberate action. First, the issuer may redeem or 
defease the nonqualified bonds. However, a defeasance is not a 
permitted remedial action if the period between the issue date and the 
first call date of the bonds is more than 10\1/2\ years (the 10\1/2\ 
year limitation). Second, if the deliberate action is a disposition of 
the bond-financed property for which the consideration is exclusively 
cash, and certain other requirements are met, the issuer may use the 
cash for an alternative qualifying use. Third, in certain cases, the 
facility with respect to which the deliberate action occurs may be used 
in an alternative qualifying manner (for example, the facility may be 
used for a qualifying purpose by a nongovernmental person or used by a 
501(c)(3) organization rather than a governmental person). The second 
and third types of remedial action may cause a deemed reissuance of the 
nonqualified bonds (that is, a deemed issuance of new bonds to refund 
the nonqualified bonds) for certain purposes of the Code.
    Section 1.141-12(j) provides that the percentage of outstanding 
bonds that are nonqualified bonds equals the highest percentage of 
private business use in any 1-year period commencing with the 
deliberate action. In addition, Sec.  1.141-12(j) provides that the 
determination of the bonds of an issue that are treated as the 
nonqualified bonds must be made on a pro rata basis, except that, for 
purposes of the remedial action that involves the redemption or 
defeasance of the nonqualified bonds, an issuer may treat bonds with 
longer maturities (determined on a bond-by-bond basis) as the 
nonqualified bonds.
    In general, Sec.  1.141-15 provides that Sec.  1.141-12 applies to 
bonds issued on or after May 16, 1997, that are subject to section 1301 
of the Tax Reform Act of 1986. However, issuers may apply the remedial 
action provisions in Sec.  1.141-12 to any bonds to which Sec.  1.141-
12 does not otherwise apply.

B. Qualified 501(c)(3) Bonds

    Under section 141(e), a qualified 501(c)(3) bond issued under 
section 145 may be a qualified bond. Section 145(a) provides that, in 
general, a qualified 501(c)(3) bond is any private activity bond issued 
as part of an issue if: (1) All of the property that is to be provided 
by the net proceeds of the issue is to be owned by a 501(c)(3) 
organization or a governmental unit; and (2) such bond would not be a 
private activity bond if section 501(c)(3) organizations were treated 
as governmental units with respect to their activities that do not 
constitute unrelated trades or businesses, determined by applying 
section 513(a). For this purpose, the private business tests are 
applied by using ``5 percent'' instead of ``10 percent'' each place it 
appears and ``net proceeds'' for ``proceeds'' each place it appears. 
Section 1.145-2 provides, in general, that Sec. Sec.  1.141-0 through 
1.141-15 apply to section 145(a).

C. Exempt Facility Bonds

    Under section 141(e), an exempt facility bond issued under section 
142 may be a qualified bond. Under section 142(a), an exempt facility 
bond is any bond issued as part of an issue if 95 percent or more of 
the net proceeds are to be used to provide certain exempt facilities.
    Under Sec.  1.142-2, if less than 95 percent of the net proceeds of 
an exempt facility bond are actually used to provide an exempt 
facility, and for no other purpose, the issue will be treated as 
meeting the use of proceeds requirement of section 142(a) if the issue 
meets a reasonable expectations test, and the issuer takes the remedial 
action described Sec.  1.142-2. The reasonable expectations test 
requires that the issuer must have reasonably expected on the issue 
date of the bonds that at least 95 percent of the net proceeds of the 
issue would be used to provide an exempt facility and for no other 
purpose for the entire term of the bonds (disregarding any redemption 
provisions). The remedial action provided in Sec.  1.142-2 requires 
that the issuer redeem or defease the

[[Page 43061]]

nonqualified bonds of the issue. However, a defeasance is not a 
permitted remedial action if it does not satisfy the 10\1/2\ year 
limitation on defeasances.
    For purposes of Sec.  1.142-2, the nonqualified bonds are a portion 
of the outstanding bonds in an amount that, if the remaining bonds were 
issued on the date on which the failure to properly use the proceeds 
occurs, at least 95 percent of the net proceeds of the remaining bonds 
would be used to provide an exempt facility. If no proceeds have been 
spent to provide an exempt facility, all of the outstanding bonds are 
nonqualified bonds. The nonqualified bonds must be determined on a pro 
rata basis, except that an issuer may treat bonds with longer 
maturities (determined on a bond-by-bond basis) as the nonqualified 
bonds.
    In general, Sec.  1.141-16 provides that Sec.  1.142-2 applies to 
bonds issued on or after May 16, 1997. However, Sec.  1.142-2, together 
with certain other regulations, may be applied in whole, but not in 
part, to bonds outstanding on May 16, 1997.

D. Prior Remedial Action Rules

    Prior to the release of Sec. Sec.  1.141-12 and 1.142-2, Rev. Proc. 
93-17 (1993-1 C.B. 507), provided remedial action rules. Rev. Proc. 93-
17 does not contain the 10\1/2\ year limitation on defeasances. The 
preamble to the regulations that include Sec. Sec.  1.141-12 and 1.142-
2 provides that for actions that occur on or after May 16, 1997, Rev. 
Proc. 93-17 is obsolete.

Explanation of Provisions

    Comments have been received suggesting that the definition of the 
amount of nonqualified bonds contained in Sec.  1.141-12 be limited to 
the excess of the actual amount of the private business use or private 
loans over the permitted amount of private business use or private 
loans under section 141. The comments note that this approach is 
consistent with the statutory language of section 141, which permits 
certain de minimis amounts of private business use and private loans 
without jeopardizing the tax-exempt status of bonds, and with the 
definition of the amount of nonqualified bonds contained in Sec.  
1.142-2.
    The comments also suggest simplifying the rules for determining the 
bonds to be treated as the nonqualified bonds. The comments recommend 
granting an issuer greater discretion in its selection of bonds, to the 
extent that the issuer, through such selection, does not effectively 
extend the remaining weighted average maturity of the bond issue with 
respect to which the deliberate action occurred.
    Finally, the comments request clarification of the remedial action 
rules applicable to bonds issued prior to May 16, 1997. In particular, 
the comments request that issuers be permitted to apply Sec. Sec.  
1.141-12 and 1.142-2 to bonds issued before May 16, 1997, without 
regard to the 10\1/2\ year limitation on defeasances contained in those 
regulations. The comments indicate that it is unfair to require issuers 
to comply with the 10\1/2\ year limitation for bonds issued prior to 
the release of Sec. Sec.  1.141-12 and 1.142-2 because issuers could 
not have known about the limitation when structuring those bonds.
    The proposed regulations generally adopt these suggestions.
    First, the proposed regulations reduce the amount of outstanding 
bonds that are nonqualified bonds under Sec.  1.141-12. The proposed 
regulations provide that the nonqualified bonds are a portion of the 
outstanding bonds in an amount that, if the remaining bonds were issued 
on the date on which the deliberate action occurs, the remaining bonds 
would not satisfy the private business use test or private loan 
financing test, as applicable. For this purpose, the amount of private 
business use is the greatest percentage of private business use in any 
one-year period commencing with the deliberate action.
    Second, the proposed regulations amend the provisions of Sec.  
1.141-12 relating to redemption or defeasance and the provisions of 
Sec.  1.142-2 relating to allocations of nonqualified bonds. Under the 
proposed regulations, allocations of nonqualified bonds must be made on 
a pro rata basis, except that an issuer may treat any bonds of an issue 
as the nonqualified bonds so long as (i) the remaining weighted average 
maturity of the issue, determined as of the date on which the 
nonqualified bonds are redeemed or defeased (determination date), and 
excluding from the determination the nonqualified bonds redeemed or 
defeased by the issuer, is not greater than (ii) the remaining weighted 
average maturity of the issue, determined as of the determination date, 
but without regard to the redemption or defeasance of any bonds 
(including the nonqualified bonds) occurring on the determination date.
    Finally, the proposed regulations amend Sec. Sec.  1.141-15(e) and 
1.141-16(c) to provide that for bonds issued before May 16, 1997, 
issuers may apply Sec. Sec.  1.141-12 and 1.142-2 without regard to the 
10\1/2\ year limitation on defeasances contained in those regulations.

Proposed Effective Dates

    The proposed regulations that amend Sec. Sec.  1.141-12 and 1.142-2 
will apply to deliberate actions or failures to properly use proceeds, 
as applicable, that occur on or after the date of publication of final 
regulations in the Federal Register, to the extent Sec.  1.141-12 or 
1.142-2, as applicable, applies to the bonds. The proposed regulations 
that amend Sec. Sec.  1.141-15(e) and 1.141-16(c) will apply to bonds 
issued before May 16, 1997, that are subject to Sec. Sec.  1.141-12 or 
1.142-2, as applicable, for purposes of deliberate actions or failures 
to properly use proceeds, as applicable, that occur on or after April 
21, 2003. Issuers may apply the proposed regulations to deliberate 
actions or failures to properly use proceeds, as applicable, that occur 
on or after April 21, 2003, and before the date of publication of final 
regulations in the Federal Register, to the extent (1) Sec.  1.141-12 
or Sec.  1.142-2, as applicable, applies to the bonds, and (2) with 
respect to the amendments to Sec.  1.141-15(e) and 1.141-16(c), the 
bonds were issued before May 16, 1997.

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 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. The 
IRS and Treasury request comments on the clarity of the proposed 
regulations and how they may be made easier to understand. All comments 
will be available for public inspection and copying.
    A public hearing has been scheduled for November 4, 2003, at 10 
a.m. in the Auditorium, Internal Revenue Building, 1111 Constitution 
Avenue, NW., Washington, DC. Because of access

[[Page 43062]]

restrictions, visitors will not be admitted beyond the lobby more than 
30 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 October 14, 2003, and submit an outline of 
the topics to be discussed and the amount of time to be devoted to each 
topic by October 14, 2003.
    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.
    Comments are requested on all aspects of the proposed regulations.

Drafting Information

    The principal authors of these regulations are Rebecca L. Harrigal 
and Gary W. Bornholdt, Office of Associate Chief Counsel (Tax-exempt 
and Government Entities), IRS, and Bruce M. Serchuk, Office of Tax 
Policy, Treasury Department. 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 Adoption of Amendments to the Regulations

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

PART 1--INCOME TAXES

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

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

    2. Section 1.141-0 is amended by adding an entry to the table for 
Sec.  1.141-16(d) to read as follows:


Sec.  1.141-0  Table of contents.

* * * * *


Sec.  1.141-16  Effective dates for qualified private activity bond 
provisions.

* * * * *
    (d) Certain remedial actions.
* * * * *
    3. In Sec.  1.141-12, paragraphs (j) and (k) Example 8 are revised 
to read as follows:


Sec.  1.141-12  Remedial actions.

* * * * *
    (j) Nonqualified bonds--(1) Amount of nonqualified bonds. The 
nonqualified bonds are a portion of the outstanding bonds in an amount 
that, if the remaining bonds were issued on the date on which the 
deliberate action occurs, the remaining bonds would not satisfy the 
private business use test or private loan financing test, as 
applicable. For this purpose, the amount of private business use is the 
greatest percentage of private business use in any one-year period 
commencing with the deliberate action.
    (2) Allocation of nonqualified bonds. Allocations of nonqualified 
bonds must be made on a pro rata basis, except that, for purposes of 
paragraph (d) of this section (relating to redemption or defeasance), 
an issuer may treat any bonds of an issue as the nonqualified bonds so 
long as--
    (i) The remaining weighted average maturity of the issue, 
determined as of the date on which the nonqualified bonds are redeemed 
or defeased (determination date), and excluding from the determination 
the nonqualified bonds redeemed or defeased by the issuer in accordance 
with this section, is not greater than
    (ii) The remaining weighted average maturity of the issue, 
determined as of the determination date, but without regard to the 
redemption or defeasance of any bonds (including the nonqualified 
bonds) occurring on the determination date.
    (k) * * *

    Example 8. Compliance after remedial action. In 2000, City G 
issues bonds with proceeds of $10 million to finance a courthouse. 
The bonds have a weighted average maturity that does not exceed 120 
percent of the reasonably expected economic life of the courthouse. 
G uses $1 million of the proceeds for a private business use and 
more than 10 percent of the debt service on the issue is secured by 
private security or payments. In 2004, in a bona fide and arm's 
length arrangement, G enters into a management contract with a 
nongovernmental person that results in private business use of 40 
percent of the courthouse per year during the remaining term of the 
bonds. G immediately redeems the nonqualified bonds, or 44.44 
percent of the outstanding bonds. This is the portion of the 
outstanding bonds that, if the remaining bonds were issued on the 
date on which the deliberate action occurs, the remaining bonds 
would not satisfy the private business use test, if the amount of 
private business use is the greatest percentage of private business 
use in any one-year period commencing with the deliberate action (50 
percent). This percentage is computed by dividing the percentage of 
the facility used for a government use (50 percent) by the minimum 
amount of government use required (90 percent), and subtracting the 
resulting percentage (55.56 percent) from 100 percent (44.44 
percent). For purposes of subsequently applying section 141 to the 
issue, G may continue to use all of the proceeds of the outstanding 
bonds in the same manner (that is, for the courthouse and the 
private business use) without causing the issue to meet the private 
business use test. The issue, however, continues to meet the private 
security or payment test. The result would be the same if G, instead 
of redeeming the bonds, established a defeasance escrow for those 
bonds, provided that the requirement of paragraph (d)(4) of this 
section was met.

    4. Section 1.141-15 is amended as follows:
    1. Paragraph (b)(4) is added.
    2. Paragraph (e) is revised.
    The amendments read as follows:


Sec.  1.141-15  Effective dates.

* * * * *
    (b) Effective dates. * * *
    (4) Certain remedial actions. For bonds subject to Sec.  1.141-12, 
the provisions of Sec. Sec.  1.141-12(j) and 1.141-12(k), Example 8, 
apply to deliberate actions that occur on or after the date of 
publication of final regulations in the Federal Register and may be 
applied by issuers to deliberate actions that occur on or after April 
21, 2003 and before the date of publication of final regulations in the 
Federal Register.
* * * * *
    (e) Permissive application of certain sections--(1) In general. 
Except as otherwise provided in paragraph (b)(4) of this section and 
this paragraph (e), the following sections may each be applied by 
issuers to any bonds--
    (i) Section 1.141-3(b)(4);
    (ii) Section 1.141-3(b)(6); and
    (iii) Section 1.141-12.
    (2) Transition rule for pre-effective date bonds. For purposes of 
paragraphs (e)(1) and (h) of this section, issuers may apply Sec.  
1.141-12 to bonds issued before May 16, 1997, without regard to 
paragraph (d)(4) thereof with respect to deliberate actions that occur 
on or after April 21, 2003.
* * * * *
    5. Section 1.141-16 is amended by revising paragraph (c) and adding 
paragraph (d) to read as follows:


Sec.  1.141-16  Effective dates for qualified private activity bond 
provisions.

* * * * *
    (c) Permissive application. The regulations designated in paragraph 
(a) of this section may be applied by issuers in whole, but not in 
part, to bonds outstanding on the effective date. For this purpose, 
issuers may apply Sec.  1.142-2 without regard to paragraph (c)(3) 
thereof to failures to properly use

[[Page 43063]]

proceeds that occur on or after April 21, 2003.
    (d) Certain remedial actions. For bonds subject to Sec.  1.142-2, 
the provisions of Sec.  1.142-2(e) apply to failures to properly use 
proceeds that occur on or after the date of publication of final 
regulations in the Federal Register and may be applied by issuers to 
failures to properly use proceeds that occur on or after April 21, 2003 
and before the date of publication of final regulations in the Federal 
Register.
    6. Section 1.142-0 is amended by revising the entries to the table 
for Sec.  1.142-2 paragraph (d), (d)(1) and (d)(2) to read as follows:


Sec.  1.142-0  Table of contents.

* * * * *


Sec.  1.142-2  Remedial actions.

* * * * *
    (d) * * *
    (1) Amount of nonqualified bonds.
    (2) Allocation of nonqualified bonds.
* * * * *
    7. Section 1.142-2 is amended by revising paragraph (e) to read as 
follows:


Sec.  1.142-2  Remedial actions.

* * * * *
    (e) Nonqualified bonds--(1) Amount of nonqualified bonds. The 
nonqualified bonds are a portion of the outstanding bonds in an amount 
that, if the remaining bonds were issued on the date on which the 
failure to properly use the proceeds occurs, at least 95 percent of the 
net proceeds of the remaining bonds would be used to provide an exempt 
facility. If no proceeds have been spent to provide an exempt facility, 
all of the outstanding bonds are nonqualified bonds.
    (2) Allocation of nonqualified bonds. Allocations of nonqualified 
bonds must be made on a pro rata basis, except that an issuer may treat 
any bonds of an issue as the nonqualified bonds so long as--
    (i) The remaining weighted average maturity of the issue, 
determined as of the date on which the nonqualified bonds are redeemed 
or defeased (determination date), and excluding from the determination 
the nonqualified bonds redeemed or defeased by the issuer in accordance 
with this section, is not greater than
    (ii) The remaining weighted average maturity of the issue, 
determined as of the determination date, but without regard to the 
redemption or defeasance of any bonds (including the nonqualified 
bonds) occurring on the determination date.

Robert E. Wenzel,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 03-18327 Filed 7-18-03; 8:45 am]
BILLING CODE 4830-01-P