[Federal Register Volume 72, Number 186 (Wednesday, September 26, 2007)]
[Proposed Rules]
[Pages 54606-54614]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 07-4734]


 ========================================================================
 Proposed Rules
                                                 Federal Register
 ________________________________________________________________________
 
 This section of the FEDERAL REGISTER contains notices to the public of 
 the proposed issuance of rules and regulations. The purpose of these 
 notices is to give interested persons an opportunity to participate in 
 the rule making prior to the adoption of the final rules.
 
 ========================================================================
 

  Federal Register / Vol. 72, No. 186 / Wednesday, September 26, 2007 / 
Proposed Rules  

[[Page 54606]]



DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-106143-07]
RIN 1545-BG41


Arbitrage Guidance for Tax-Exempt Bonds

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of Proposed Rulemaking and Notice of Public Hearing.

-----------------------------------------------------------------------

SUMMARY: This document contains proposed regulations on the arbitrage 
restrictions under section 148 of the Internal Revenue Code applicable 
to tax-exempt bonds issued by State and local governments. These 
proposed regulations are being issued in order to update existing 
regulations to address certain current market developments, to simplify 
and correct certain provisions, and to make existing regulations more 
administrable. These proposed regulations affect State and local 
governmental issuers of tax-exempt bonds. This document also provides 
notice of a public hearing on these proposed regulations.

DATES: Written or electronic comments must be received by December 26, 
2007. Outlines of topics to be discussed at the public hearing 
scheduled for January 30, 2008, at 10 a.m., must be received by January 
2, 2008.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-106143-07), Internal 
Revenue Service, PO Box 7604, Ben Franklin Station, Washington, DC 
20044. Submissions may be hand delivered to: CC:PA:LPD:PR Monday 
through Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR 
(REG-106143-07), Courier's Desk, Internal Revenue Service, 1111 
Constitution Avenue, NW., Washington, DC, or sent electronically via 
the Federal eRulemaking Portal at www.regulations.gov (IRS REG-106143-
07). The public hearing will be held in the Main IRS Auditorium at the 
Internal Revenue Building, 1111 Constitution Avenue, NW., Washington, 
DC.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Carla Young, (202) 622-3980; concerning submissions of comments and the 
hearing, [email protected], or (202) 622-7180 (not 
toll-free numbers).

SUPPLEMENTARY INFORMATION: 

Background

    This document contains proposed amendments to the Income Tax 
Regulations (26 CFR part 1) on the arbitrage investment restrictions 
under section 148 of the Internal Revenue Code (Code). On June 18, 
1993, the Treasury Department and the Internal Revenue Service (IRS) 
published comprehensive final regulations in the Federal Register (TD 
8476, 58 FR 33510) on the arbitrage investment restrictions and related 
provisions on tax-exempt bonds under sections 103, 148, 149, and 
section 150 of the Code, and, since that time, those final regulations 
have been amended in certain limited respects (the regulations issued 
in 1993 and the amendments thereto are collectively referred to as the 
Existing Regulations). The Treasury Department and the IRS have since 
determined that certain provisions in the Existing Regulations need to 
be modified. This document contains proposed discrete amendments to the 
Existing Regulations (the Proposed Regulations) to update the Existing 
Regulations to address certain current market developments, to simplify 
certain provisions in the Existing Regulations, to correct certain 
technical issues in the Existing Regulations, and to make the Existing 
Regulations more administrable.
    In addition, the Treasury Department and the IRS are in the process 
of reviewing the Existing Regulations for future regulatory guidance on 
additional discrete issues for the same purposes.

Explanation of Provisions

I. Existing Regulations

    Section 103(a) of the Code generally excludes from gross income 
interest on a State or local bond. Under section 103(b), however, the 
interest exclusion does not apply to an arbitrage bond, as defined in 
section 148. Section 148 provides two related, but independent types of 
restrictions to determine whether a bond is an arbitrage bond: A yield 
restriction requirement and an arbitrage rebate requirement. Generally, 
these restrictions limit the ability of an issuer to invest bond 
proceeds in investments at a yield that materially exceeds the yield on 
the bond issue and require that certain excess earnings above the yield 
on the bond issue be rebated to the Federal government. Investment 
earnings that exceed the yield on the bond issue are commonly referred 
to as arbitrage.
    Under section 148(a) of the Code, the yield restriction requirement 
generally provides that a bond is an arbitrage bond if an issuer 
reasonably expects to earn arbitrage or if the issuer, subsequent to 
the issuance of the bonds, engages in a deliberate action to earn 
arbitrage on bond proceeds. Exceptions to the yield restriction 
requirement permit an issuer to earn arbitrage in limited 
circumstances, such as during limited temporary periods for prompt 
spending of bond proceeds and other similar temporary periods.
    Under section 148(f) of the Code, the arbitrage rebate requirement 
provides that a bond is an arbitrage bond if the issuer fails to timely 
rebate to the United States arbitrage otherwise permitted to be earned 
on certain investments acquired with bond proceeds. Generally, 
arbitrage rebate is paid every 5 years and upon the redemption of the 
bond issue.
    The Existing Regulations provide detailed rules for applying the 
two types of arbitrage restrictions, including rules for determining 
yield on the bond issue and yield on the investments, and rules for 
computing and paying arbitrage rebate. The Treasury Department and the 
IRS believe that discrete changes need to be made to the Existing 
Regulations to simplify and clarify certain provisions, to make certain 
provisions more administrable, and to update the regulations to reflect 
current market practices.

II. Proposed Regulations

    The Proposed Regulations make a number of discrete changes to the 
Existing Regulations. Highlighted in this preamble are certain more 
substantive changes which are discussed in further detail. In addition, 
certain more minor changes are addressed in summary form.

[[Page 54607]]

    (1) Hedges based on taxable interest rates. The Proposed 
Regulations make revisions to accommodate certain hedges in which 
floating payments under the hedge are based on a taxable interest rate 
and to clarify that bonds covered by such a hedge are ineligible for 
treatment as fixed yield bonds under the special hedging rule in Sec.  
1.148-4(h)(4).
    (2) Joint Bond Yield Authority. The Proposed Regulations remove the 
provision in the Existing Regulations that permits the IRS Commissioner 
to authorize a single yield computation on multiple bond issues.
    (3) Electronic GIC Bidding. The Proposed Regulations revise the 
bidding safe harbor for establishing the fair market value of 
guaranteed investment contracts (GICs) to accommodate electronic 
bidding.
    (4) Refunds of Overpayments of Rebate. The Proposed Regulations 
clarify that the amount that an issuer is entitled to receive under a 
rebate refund claim is the excess of the total amount actually paid 
over the rebate amount.

A. Changes To Accommodate Certain Hedges

    Section 1.148-4 of the Existing Regulations sets forth rules for 
determining the yield on an issue of bonds for purposes of applying the 
arbitrage rules. In general, Sec.  1.148-4(h) of the Existing 
Regulations permits issuers to compute the yield on an issue by taking 
into account payments under ``qualified hedges.'' The Existing 
Regulations provide two ways in which a qualified hedge can be taken 
into account in computing yield on the issue, known commonly as 
``simple integration'' and ``super integration.''
    For both simple integration and super integration, a hedge must be 
a ``qualified hedge,'' which is a hedge that meets a series of 
eligibility requirements. Generally, in order to be a qualified hedge, 
a hedge must be interest based, the terms of the hedge must correspond 
closely with the terms of the hedged bonds, the issuer must duly 
identify the hedge, and the hedge must contain no significant 
investment element. For super integration, the hedge must meet 
additional eligibility requirements which focus on assuring that the 
terms of the hedge and the hedge bonds sufficiently correspond so as to 
warrant treating the hedged bonds as fixed-yield bonds for arbitrage 
purposes.
    In the case of simple integration, generally all net payments on 
the hedge and the hedged bonds are taken into account in determining 
the yield on the bond issue. For example, if an issuer issues bonds 
paying interest at a variable rate and enters into a hedge under which 
the issuer receives floating interest rate payments from the hedge 
provider and pays fixed interest payments to the hedge provider (a 
variable-to-fixed hedge), the variable rate that the issuer pays to the 
bondholders, the floating rate that the issuer receives on the hedge, 
and the fixed payments that the issuer pays on the hedge are all taken 
into account on a net basis in determining the yield on the bond issue. 
In the case of simple integration, the hedged bonds are treated as 
variable yield bonds, which means that the yield on the bond issue is 
periodically recomputed and the rebate the issuer must pay to the 
United States is based on the issuer's actual net payments and receipts 
on the bond and the hedge. Thus, for example, any ``basis risk'' 
difference between the actual interest rate that the issuer pays on its 
variable-yield hedged bond and the actual interest rate it receives on 
the floating interest rate on the hedge (along with the fixed payments 
on the hedge) is taken into account in determining the yield on the 
hedged bonds.
    In the case of super integration where the payments on the hedge 
and the hedged bonds sufficiently correspond so that the yield on the 
hedged bonds is fixed and determinable with certain assumptions, the 
hedged bonds are treated as fixed-yield bonds for arbitrage purposes. 
In the case of super integration, any basis risk difference between the 
floating-rate interest payments on the hedge and the variable-rate 
interest payments on the hedged bonds is ignored in determining the 
yield on the hedged bonds for arbitrage purposes through an assumption 
that treats those floating and variable rates as the same.
    One of the eligibility requirements for a qualified hedge under the 
Existing Regulations is that it be interest based. For simple 
integration, one of the subsidiary aspects used in determining whether 
a variable-to-fixed interest rate hedge is interest based focuses on 
whether the variable interest rate on the hedged bonds and the floating 
interest rate on the hedge are ``substantially the same.'' For super 
integration purposes, such rates must be ``reasonably expected to be 
substantially the same throughout the term of the hedge.'' This aspect 
of the interest-based contract standard has raised technical issues in 
recent years in connection with its application to certain kinds of 
hedges, as discussed further in this preamble.
    In general, hedging plays an increasingly important role in the 
tax-exempt bond market. An issuer of bonds may use hedges to protect 
itself against interest rate risks. For example, an issuer that issues 
variable-rate bonds may hedge or protect itself against unfavorable 
interest rate changes in the market by entering into a variable-to-
fixed interest rate swap. Historically, issuers of tax-exempt bonds 
generally used a type of swap under which the hedge provider paid a 
floating interest rate that was determined based on a market index of 
tax-exempt interest rates, such as the Securities Industry and 
Financial Markets Association (SIFMA) Municipal Swap Index.
    A significant development in the tax-exempt bond market since the 
promulgation of the Existing Regulations has been the trend toward the 
use by issuers of variable-to-fixed interest rate swaps as hedges in 
which the floating interest rate that the swap provider pays to the 
issuer is determined based on a percentage of a market index of taxable 
interest rates, such as the London Interbank Offered Rate (LIBOR) (a 
taxable-index hedge). Issuers have indicated that these taxable-index 
hedges offer more liquidity, more transparency in pricing, and lower 
costs than hedges based on a tax-exempt interest index.
    Issuers have raised interpretative questions about how to apply the 
qualified hedge provisions of the Existing Regulations to taxable-index 
hedges because interest rates on taxable indices generally do not 
correspond as closely as interest rates on tax-exempt market indices to 
actual market interest rates on tax-exempt, variable-rate bonds. These 
interpretative questions are particularly important for taxable-index 
hedges used with advance refunding bond issues because issuers 
generally need to use the qualified hedge rules or some other regime to 
determine with certainty the yield on the tax-exempt advance refunding 
bonds in order to comply with the applicable arbitrage yield 
restrictions on investments in defeasance escrows.
    The IRS and the Treasury Department have determined that taxable-
index hedges based on widely-used taxable indices, such as LIBOR based 
hedges, sufficiently improve the efficiency of the tax-exempt bond 
market to warrant accommodation. The Proposed Regulations accommodate 
these hedges by modifying (1) the provisions for ``yield reduction 
payments,'' which permit an issuer to reduce yield on an investment by 
making payments to the Federal government in certain permitted 
circumstances to comply with yield restriction rules and (2) the 
qualified hedge provisions. The Proposed Regulations make clear, 
however, that while taxable-index hedges can be

[[Page 54608]]

qualified hedges, and therefore eligible for simple integration, they 
are not eligible for super integration because there is an insufficient 
correlation between tax-exempt bond interest rates and taxable market 
interest rate indices. However, the IRS and the Treasury Department 
understand that issuers have recently issued variable-rate bonds that 
bear interest equal to a percentage of LIBOR, and seek public comments 
on whether special accommodation under the super integration rule is 
required for those bond issues.
    Yield reduction payments effectively integrate the yield 
restriction requirements with the arbitrage rebate requirements. For 
certain limited situations, Sec.  1.148-5(c) of the Existing 
Regulations permits yield reduction payments to be paid to the United 
States to satisfy yield restriction requirements on certain 
investments. Yield reduction payments are similar to, but not identical 
to, rebate payments. In general, the purpose of the yield reduction 
payment rules is to simplify compliance with the sometimes overlapping 
yield restriction and arbitrage rebate requirements by allowing issuers 
to make payments similar to rebate payments to the United States to 
satisfy yield restriction and rebate in appropriate circumstances. For 
example, an issuer may effectively reduce the yield on an investment to 
a yield that will not violate the yield restriction rules and also 
satisfy the arbitrage rebate requirement through a yield reduction 
payment.
    The Proposed Regulations modify the yield reduction payment rules 
to permit issuers to make yield reduction payments on certain variable-
yield advance refunding issues in which the issuer has entered into a 
qualified hedge in the form of a variable-to-fixed interest rate swap 
to hedge its interest rate risk. This modification to the yield 
reduction rule applies for nonpurpose investments allocable to gross 
proceeds of an advance refunding issue deposited into an advance 
refunding escrow when: (1) The issuer has entered into a qualified 
hedge in the form of a variable-to-fixed interest rate swap on all of 
its variable-rate bonds that are allocable to the yield restricted 
defeasance escrow, (2) the hedge covers a period from the issue date of 
the bonds until the final payment is made from the defeasance escrow, 
and (3) the yield on the advance refunding escrow is not reasonably 
expected to exceed the yield on the issue, determined by taking into 
account the fixed payments that the issuer is expected to make under 
the hedge and by assuming that the corresponding variable interest 
payments to be made by the issuer on the hedged bonds and to be 
received by the issuer on the hedge are equal and paid on the same 
date. In effect, the Proposed Regulations allow yield reduction 
payments in this context only to be made to cover the basis risk 
differences between the hedge and the hedged bonds.
    The Proposed Regulations also modify the qualified hedge provisions 
to provide that the floating rate on the taxable-index hedge and the 
variable rate on the hedged bonds will be treated as substantially the 
same for purposes of Sec.  1.148-4(h)(2)(v)(B) if: (1) The difference 
between the two rates is not greater than one-quarter of one percent 
(.25 percent, or 25 basis points) on the date the issuer enters into 
the hedge, and (2) for a three-year period that ends on the date the 
issuer enters into the hedge, the average difference between the 
issuer's actual tax-exempt interest rate on comparable variable-rate 
bonds (or, if no such comparable bonds exist, a reasonable tax-exempt 
interest rate index, such as the SIFMA Municipal Swap Index, for that 
same period) and an interest rate determined in the same manner as the 
floating interest rate on the hedge does not exceed one-quarter of one 
percent (.25 percent, or 25 basis points). For example, if the floating 
rate on the hedge is 67 percent of LIBOR, then 67 percent of LIBOR, 
determined on the same days as the issuer's actual interest rates (or 
tax-exempt index, if applicable) are determined, is compared to the 
issuer's actual interest rates (or the tax-exempt index, if applicable) 
for the three-year period ending on the date the hedge is entered into 
and the differences are averaged to determine whether the average 
difference exceeds one-quarter of one percent. For this purpose, a 
reasonable sample may be used if the sample for the issuer's actual 
rates (or tax-exempt market index rates, if applicable) and the sample 
of floating rates used for the hedge are determined as of the same 
dates.
    The Proposed Regulations also make certain other limited changes to 
the hedging and yield reduction rules which are discussed with other 
miscellaneous changes in this preamble.

B. Joint Yield Authority

    In general, for arbitrage purposes, the yield on a bond issue is 
determined on an issue-by-issue basis. Section 1.148-4(a) of the 
Existing Regulations, however, authorizes the IRS Commissioner to 
permit issuers of certain types of tax-exempt bonds, specifically 
qualified mortgage bonds and qualified student loan bonds, to compute a 
single joint bond yield for purposes of applying the arbitrage 
restrictions to two or more issues of these types of tax-exempt bonds.
    Since the promulgation of the Existing Regulations, the IRS has 
received numerous private letter ruling requests for joint bond yield 
computations and has ruled on one of these requests. The Treasury 
Department and the IRS, based on what the IRS has learned from these 
ruling requests, are concerned about the highly factual nature of the 
requests, and the potential for arbitrage manipulations with joint 
yield computations that would not be apparent from a private letter 
ruling request and that could not reasonably be discovered in the 
context of such a request. For these reasons, the Proposed Regulations 
eliminate the regulatory provision that permits joint yield 
computations. However, the Treasury Department and the IRS are 
considering whether generally applicable, objective standards can be 
created under which joint yield computations should be allowed. 
Accordingly, the Proposed Regulations solicit public comments on when 
joint yield computations are needed for sound business reasons and 
whether objective standards can be created that would allow these 
computations in a manner that is consistent with the purposes of 
section 148. In addition, comments are sought on the following: The 
treatment of open-ended joint yield calculations that allow future 
issues to be included in the joint yield computation, the treatment of 
qualified hedges or guarantees that cover some but not all of the 
bonds, the treatment of reserves, the application of prepayment 
assumptions, the effect of partial refundings, and other issues that 
impact the administrability of joint yield calculations. Pending final 
resolution of this issue, the IRS will not entertain any private letter 
ruling requests for permission to use a joint yield computation.

C. Modified Fair Market Value Safe Harbor for Guaranteed Investment 
Contracts

    Under Sec.  1.148-5(d)(3) of the Existing Regulations, investments 
purchased with bond proceeds must be valued at fair market value. 
Section 1.148-5(d)(6)(iii) of the Existing Regulations provides a safe 
harbor for establishing the fair market value of a guaranteed 
investment contract (GIC) for arbitrage purposes. That safe harbor 
generally relies on a prescribed bidding procedure and the receipt of 
at least three bids from independent parties. The bidding process 
requirements under the safe harbor include a requirement that all 
bidders be given an equal opportunity to bid with no opportunity to 
review other

[[Page 54609]]

bids (that is, the ``no last look'' rule) and a requirement that the 
bid specifications be provided to prospective bidders ``in writing.''
    In the past several years, the tax-exempt bond market has seen the 
advent of various electronic bidding procedures and internet platforms 
for bidding GICs. While the particular features of specific GIC bidding 
procedures may vary, characteristics of these electronic GIC bidding 
procedures generally include using the internet to receive bid 
specifications and to make bids. The electronic bidding process permits 
providers, under prescribed times and procedures, to continuously bid 
and to continuously view the current highest bids (without 
identification of the bidders). The electronic platforms also provide 
the capability to print out the results of the GIC bidding process. The 
electronic GIC bidding procedures have raised certain technical issues 
regarding whether they can comply with the fair market value safe 
harbor for GICs under the Existing Regulations.
    The Treasury Department and the IRS believe that electronic GIC 
bidding procedures generally offer the constructive potential for 
increasing the transparency of pricing of investments purchased with 
proceeds of tax-exempt bonds. Accordingly, the Proposed Regulations 
amend the fair market value safe harbor for GICs to accommodate 
electronic bidding procedures by (1) permitting bid specifications to 
be sent electronically over the Internet or by fax and (2) amending the 
no last look rule to provide that there is not a prohibited last look 
if all bidders have an equal opportunity for a last look.

D. Recovery of Overpayment of Rebate

    Generally, an issuer computes the amount of arbitrage rebate that 
it owes under a method that future values payments and receipts on 
investments using the yield on the bond issue. Under this method, an 
arbitrage payment made on one computation date is future valued to the 
next computation date to determine the amount of arbitrage rebate owed 
on that subsequent computation date. Section 1.148-3(i)(1) of the 
Existing Regulations provides that an issuer may recover an overpayment 
of arbitrage rebate with respect to an issue of tax-exempt bonds if the 
issuer establishes to the satisfaction of the IRS Commissioner that an 
overpayment occurred. Section 1.148-3(i)(1) further defines an 
overpayment as the excess of ``the amount paid'' (emphasis added) to 
the United States for an issue under section 148 over the sum of the 
rebate amount for that issue as of the most recent computation date and 
all amounts that are otherwise required to be paid under section 148 as 
of the date the recovery is requested. Thus, even if the future value 
of the issuer's arbitrage rebate payment on a computation date, 
computed under the method for determining arbitrage rebate, is greater 
than the issuer's rebate amount on that date, an issuer is only 
entitled to a refund to the extent that the amount actually paid 
exceeds that rebate amount. The Existing Regulations limit the amount 
of the refund in this manner because the Treasury Department and the 
IRS were concerned about whether the IRS had statutory authority to pay 
interest on arbitrage rebate payments. To permit a refund in an amount 
calculated in whole or in part based upon a future value of the amount 
actually paid would effectively result in an interest payment on that 
payment.
    Example 2(iii)(D) in Sec.  1.148-3(j) of the Existing Regulations 
has caused confusion because it could be interpreted to mean that an 
issuer can receive a refund of a rebate payment when the future value 
of such rebate payment exceeds the rebate amount on the next 
computation date, even though the actual amount of the previous rebate 
payment does not exceed the rebate amount on that next computation 
date. The Proposed Regulations make a technical amendment to this 
example to conform this example to the intended purpose of Sec.  1.148-
3(i)(1). Because the proposed change does not change the regulatory 
rule, but merely makes an existing example conform to that rule, the 
Proposed Regulations provide that the effective date for this provision 
is the same as the effective date for the regulatory rule. However, the 
IRS will not reopen rebate refund claims that have been processed 
before the date the Proposed Regulations are published in the Federal 
Register.

E. Other Miscellaneous Changes

1. Qualified Hedge Provisions
    The Proposed Regulations make the following additional changes to 
the hedging rules in Sec.  1.148-4(h) and specifically seek the 
following comments on the hedging rules.
    a. Cost of Funds Hedges. The Proposed Regulations clarify that for 
purposes of applying the definition of periodic payment under Sec.  
1.446-3(e)(1) to determine whether a hedge has a significant investment 
element under Sec.  1.148-4(h)(2)(ii)(A), a ``specified index'' under 
Sec.  1.446-3(c)(2) (upon which periodic payments are based) is deemed 
to include payments under a cost-of-funds swap, thereby eliminating any 
doubt that these hedges can be qualified hedges.
    b. Size and Scope of a Qualified Hedge. The Proposed Regulations 
add an express requirement under Sec.  1.148-4(h)(2)(v) that limits the 
size and scope of a qualified hedge to a level that is reasonably 
necessary to hedge the issuer's risk with respect to interest rate 
changes on the hedged bonds. This proposed limitation is comparable to 
a former provision that was in the arbitrage regulations from 1993 to 
1997, but was removed in connection with 1997 amendments to the 
Existing Regulations. The Treasury Department and the IRS believe that 
this principle was implicitly carried forward in the subsidiary 
standards under the interest-based contract requirement in the Existing 
Regulations in 1997. The Proposed Regulations, however, provide an 
explicit separate requirement to clarify the continued application of 
this principle.
    c. Correspondence of Payments for Simple Integration. Commentators 
have requested guidance on what time period satisfies the rule under 
Sec.  1.148-4(h)(2)(vi) that requires payments on a hedge to correspond 
closely in time to the payments on the hedged bonds. The Proposed 
Regulations add a rule for simple integration that treats payments as 
corresponding closely in time for this purpose if the payments are made 
within 60 calendar days of each other. This proposed rule contrasts 
with the rules for super integration, which require that payments be 
made within 15 days of each other. The Proposed Regulations provide a 
more flexible time period for correspondence of payments for simple 
integration purposes consistent with the fact that simple integration 
results in more accurate accounting for all net payments.
    d. Time for Identification of Qualified Hedges. Commentators have 
indicated that the three-day period for identifying a hedge under Sec.  
1.148-4(h)(2)(viii) of the Existing Regulations raises practical 
difficulties, particularly with respect to hedges that are not entered 
into contemporaneously with the issuance of the hedged bonds. The 
Proposed Regulations extend the time in Sec.  1.148-4(h)(2)(viii) for 
when an issuer must identify a qualified hedge from three days to 
fifteen days and clarify that these are calendar days. The Proposed 
Regulations, however, retain the requirement that the actual State or 
local governmental issuer, rather than the conduit borrower, identify 
the hedge because the Treasury Department and the IRS believe that it 
is important for State and local governments to be

[[Page 54610]]

responsible for qualified hedges on their bonds.
    e. Termination of Hedges at Fair Market Value. The Proposed 
Regulations clarify that under Sec.  1.148-4(h)(3)(iv)(B), the 
termination payment for a termination or a deemed termination is equal 
to the fair market value of the hedge on the termination date.
    f. Solicitation of Comment on Offsetting Hedges. The Treasury 
Department and the IRS have received requests for clarification of the 
scope of the rule that treats offsetting hedges as deemed terminations 
of qualified hedges under Sec.  1.148-4(h)(3)(iv)(A). The Treasury 
Department and the IRS seek express public comment regarding the types 
of offsetting hedges that are necessary for valid business purposes and 
recommendations on how to clarify the scope of this rule on offsetting 
hedges.
2. Yield Reduction Payment Rules
    The Proposed Regulations permit issuers to make yield reduction 
payments for nonpurpose investments allocable to proceeds of an issue, 
including an advance refunding issue, that an issuer purchases on a 
date when the issuer is unable to purchase State and Local Government 
Series Securities (SLGS) because the Department of Treasury, Bureau of 
Public Debt, has suspended sales of SLGS. This provision incorporates 
and expands Revenue Procedure 95-47, 1995-2 CB 417, which permits yield 
reduction payments in more limited situations than the Proposed 
Regulations when SLGS are unavailable.
    The Proposed Regulations also reorganize the yield reduction rules 
to make them easier to read.
3. Modification of Yield Computation for Yield-to-Call Premium Bonds
    The Proposed Regulations simplify the rules for computing yield on 
an issue that has certain callable premium bonds. Existing Regulations 
generally provide that the yield on an issue is based on the yield to 
maturity, taking into account certain assumptions. The Existing 
Regulations have a special rule for certain callable bonds issued with 
significant amounts of bond premium (sometimes called yield-to-call 
bonds), which requires a determination of yield to a call date, based 
on certain assumed optional redemptions. The general purpose of this 
rule is to recognize that a yield-to-maturity computation may not be 
economically accurate in this circumstance because these yield-to-call 
bonds are more likely than other bonds to be called before maturity and 
before amortization of the premium.
    Section 1.148-4(b)(3)(i) of the Existing Regulations treats a 
yield-to-call bond as redeemed at the stated redemption price on the 
optional redemption date that would produce the lowest yield on the 
issue (as contrasted with the lowest yield on the particular premium 
bond). This methodology, which considers the lowest yield on the issue 
for these yield-to-call bonds, requires computations of possible 
combinations of redemption dates in circumstances in which the 
variations of redemption dates may have very limited impact on yield.
    The Proposed Regulations simplify the yield calculations for these 
yield-to-call bonds to focus on the redemption date that results in the 
lowest yield on the particular premium bond (rather than the more 
complex existing focus on the lowest yield on the issue). This change 
corresponds to a former version of this regulatory rule which was in 
effect under applicable arbitrage regulations from 1989 through 1992.
4. Arbitrage Rebate Computation Credit
    Section 1.148-3(d)(1)(iv) of the Existing Regulations provides that 
an issuer may take certain credits against payment of arbitrage rebate 
in the amount of $1,000 for each rebate computation date, subject to 
certain limitations, to help offset the cost of computing rebate. The 
Proposed Regulations increase this rebate credit to $1,400 for any bond 
year ending in the year 2007 to reflect the change in the Consumer 
Price Index since the $1,000 rebate credit was published. The Proposed 
Regulations further adjust the computation date credit for inflation 
for bond years ending in each year thereafter.
5. External Commingled Investment Funds
    The Existing Regulations provide certain preferential rules for the 
treatment of administrative costs to certain widely-held ``external 
commingled funds,'' as defined in Sec.  1.148-5(e)(2)(ii)(B). Under the 
Existing Regulations, a fund is treated as widely held if the fund, on 
average, has more than 15 unrelated investors, each of which maintains 
prescribed minimum average investments in the fund. The Proposed 
Regulations make a technical change to allow additional smaller 
investors to invest in an external commingled fund without 
disqualifying the fund so long as at least 16 unrelated investors each 
maintain the required minimum average investments in the fund.
6. Pooled Bonds
    The Proposed Regulations make conforming changes to Sec.  1.148-
8(d) to reflect legislative changes made to section 148(f)(4)(D) by 
section 508 of the Tax Increase Prevention and Reconciliation Act of 
2005, Pub. L. No. 109-222, 120 Stat. 345 (TIPRA). Under TIPRA, Congress 
eliminated the rule in Sec.  148(f)(4)(D)(ii)(II) that permitted a pool 
bond issuer to ignore its pool bond issue in computing whether it had 
exceeded its $5 million limit for purposes of the small issuer rebate 
exception of section 148(f)(4)(D). Correspondingly, the Proposed 
Regulations eliminate the provisions in the Existing Regulations that 
permit a pool bond issuer to ignore the amount of its pool bond issue 
in determining whether the issuer meets the small issuer exception of 
section 148(f)(4)(D). The Proposed Regulations retain the provision 
that permits a State or local governmental conduit borrower to ignore 
the amount of certain pool bond issues in excess of the amount it 
borrows from that pool. Consistent with the statutory change, the 
Proposed Regulations provide that the change for pool bond issuers is 
effective for bonds issued after May 17, 2006, the effective date of 
the relevant provision of TIPRA.

III. Effective Dates

    The Proposed Regulations are proposed to apply to bonds sold on or 
after a date that is 90 days after publication of final regulations in 
the Federal Register, but an issuer may apply certain specified 
provisions of the Proposed Regulations to bonds sold before the date 
that is 90 days after publication of the final regulations in the 
Federal Register as provided in proposed Sec.  1.148-11(k). Except for 
the changes to the qualified hedging rules which must be applied in 
their entirety, issuers that are permitted, but not required, to apply 
the proposed changes may apply some or all of the changes to a bond 
issue.
    The Proposed Regulations contain a technical amendment to the 
example in the general arbitrage rebate rules. This change applies to 
bonds subject to Sec.  1.148-3(i), the dates of applicability for which 
are set forth in the Existing Regulations.
    The Proposed Regulations contain a special effective date provision 
for the regulatory change that conforms the arbitrage regulations to 
the legislative change made to the small issuer rebate exception for 
pooled bond issuers. This change applies to bonds issued after May 17, 
2006, the effective date of the relevant provision of TIPRA.

[[Page 54611]]

Effect on Other Documents

    On the date of applicability of the final regulations, Revenue 
Procedure 95-47, 1995-2 CB 417, will be obsoleted.

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 is hereby certified that 
these proposed regulations will not have a significant economic impact 
on a substantial number of small entities. Therefore, a Regulatory 
Flexibility Analysis under the Regulatory Flexibility Act (5 U.S.C. 
chapter 6) is not required. Some of the proposed changes clarify 
existing regulatory provisions, conform the regulations to a recent 
statutory change, or otherwise involve simplifying or clarifying 
changes that will not have a significant economic impact on 
governmental jurisdictions or other entities of any size. Other 
proposed changes involve the treatment of certain hedging transactions, 
such as interest rate swaps, for purposes of the arbitrage investment 
restrictions on tax-exempt bonds issued by State and local governments. 
Although there is a lack of available data regarding the extent of 
usage of these hedging transactions by small entities, the IRS and the 
Treasury Department understand that these hedging transactions are used 
primarily by larger State and local governments and other eligible 
larger entities. The IRS and the Treasury Department specifically 
solicit comment from any party, particularly affected small entities, 
on the accuracy of this certification. Pursuant to section 7805(f) of 
the Internal Revenue Code, this regulation has been submitted to the 
Small Business Administration for comment on its impact on small 
governmental jurisdictions.

Comments and Public Hearing

    Before these Proposed Regulations are adopted as final regulations, 
consideration will be given to any written (a signed original and eight 
(8) copies) or electronic comments that are submitted timely to the 
IRS. The Treasury Department and IRS request comments on the clarity of 
the proposed rules and how they can be made easier to understand. All 
comments will be available for public inspection and copying.
    A public hearing has been scheduled for January 30, 2008 at 10 a.m. 
in the Main IRS Auditorium, Internal Revenue Service Building, 1111 
Constitution Avenue, NW., Washington, DC. Due to building security 
procedures, visitors must enter at the Constitution Avenue entrance. 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 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 or 
electronic comments and an outline of the topics to be discussed and 
the time to be devoted to each topic (a signed original and eight (8) 
copies) by January 2, 2008. 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 Rebecca L. Harrigal 
and Carla A. Young, Office of Associate Chief Counsel (Financial 
Institutions and Products), IRS. 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 * * *

    Sections 1.148-0, 1.148-3, 1.148-4, 1.148-5, 1.148-8 and 1.148-
11 also issued under 26 U.S.C. 148(i).

    Par. 2. Section 1.148-0(c) is amended as follows:
    1. Add entry for new paragraph (d)(4) in the table of contents for 
Sec.  1.148-3.
    2. Revise entry for paragraph (d) in the table of contents for 
Sec.  1.148-8.
    3. Remove entries for paragraph (d)(1) and paragraph (d)(2) in the 
table of contents for Sec.  1.148-8.
    4. Add entries for new paragraphs (k), (k)(1), (k)(2), (k)(3) and 
(k)(4) in the table of contents for Sec.  1.148-11.
    The revised and added provisions read as follows:


Sec.  1.148-0  Scope and Table of Contents.

* * * * *


Sec.  1.148-3  General arbitrage rebate rules.

* * * * *
    (d) * * *
    (4) Cost-of living adjustment.
* * * * *


Sec.  1.148-8  Small issuer exception to rebate requirement.

* * * * *
    (d) Pooled financings--treatment of conduit borrowers.
* * * * *


Sec.  1.148-11  Effective dates.

* * * * *
    (k) Certain arbitrage guidance updates.
    (1) In general.
    (2) Permissive earlier application.
    (3) Rebate overpayment recovery.
    (4) Small issuer exception to rebate requirement for conduit 
borrowers of pooled financings.
* * * * *
    Par. 3. Section 1.148-3 is amended by revising paragraph (d)(1)(iv) 
and adding a new paragraph (d)(4) as follows:


Sec.  1.148-3  General arbitrage rebate rules.

* * * * *
    (d) * * *
    (1) * * *
    (iv) On the last day of each bond year during which there are 
amounts allocated to gross proceeds of an issue that are subject to the 
rebate requirement, and on the final maturity date, a computation 
credit of $1,400 for any bond year ending in 2007 and, for bond years 
ending after 2007, a computation credit in the amount determined under 
paragraph (d)(4) of this section; and
* * * * *
    (4) Cost-of-living adjustment. For any calendar year after 2007, 
the $1,400 computation credit set forth in paragraph (d)(1)(iv) shall 
be increased by an amount equal to such dollar amount multiplied by the 
cost-of-living adjustment determined under section 1(f)(3) for such 
year as modified by this paragraph (d)(4). In applying section 1(f)(3) 
to determine this cost-of-living adjustment, the reference to 
``calendar year 1992'' in section 1(f)(3)(B) shall be changed to 
``calendar year 2006.'' If any such increase determined under this 
paragraph (d)(4) is not a multiple of $10, such increase shall be 
rounded to the nearest multiple thereof.
* * * * *

[[Page 54612]]

    Par. 4. Section 1.148-3(j) is amended by revising Example 2(iii)(D) 
to read as follows:


Sec.  1.148-3  General arbitrage rebate rules.

* * * * *
    (j) * * *

    Example 2. * * *
    (iii) * * *
    (D) If the yield during the second computation period were, 
instead, 7.0000 percent, the rebate amount computed as of July 1, 2004, 
would be $1,320,891. The future value of the payment made on July 1, 
1999, would be $1,471,007. Although the future value of the payment 
made on July 1, 1999 ($1,471,007), exceeds the rebate amount computed 
as of July 1, 2004 ($1,320,891), Sec.  1.148-3(i) limits the amount 
recoverable as a defined overpayment of rebate under section 148 to the 
excess of the total ``amount paid'' over the sum of the amount 
determined under the future value method to be the ``rebate amount'' as 
of the most recent computation date and all other amounts that are 
otherwise required to be paid under section 148 as of the date the 
recovery is requested. Because the total amount that the issuer paid on 
July 1, 1999 ($1,042,824.60), does not exceed the rebate amount as of 
July 1, 2004 ($1,320,891), the issuer would not be entitled to recover 
any overpayment of rebate in this case.
* * * * *
    Par. 5. Section 1.148-4(a) is revised to read as follows:


Sec.  1.148-4  Yield on an issue of bonds.

    (a) In general. The yield on an issue of bonds is used to apply 
investment yield restrictions under section 148(a) and to compute 
rebate liability under section 148(f). Yield is computed under the 
economic accrual method using any consistently applied compounding 
interval of not more than one year. A short first compounding interval 
and a short last compounding interval may be used. Yield is expressed 
as an annual percentage rate that is calculated to at least four 
decimal places (for example, 5.2525 percent). Other reasonable, 
standard financial conventions, such as the 30 days per month/360 days 
per year convention, may be used in computing yield but must be 
consistently applied. The yield on an issue that would be a purpose 
investment (absent section 148(b)(3)(A)) is equal to the yield on the 
conduit financing issue that financed that purpose investment.
* * * * *
    Par. 6. Section 1.148-4 is amended by:
    1. Revising paragraph (b)(3)(i), and adding a new sentence at the 
end of paragraph (h)(2)(ii)(A).
    2. Revising the heading and introductory text of paragraph 
(h)(2)(v).
    3. Amending paragraph (h)(2)(v)(B) by revising the last sentence.
    4. Adding paragraphs (h)(2)(v)(B)(1), (2) and (3).
    5. Adding a new sentence at the end of paragraph (h)(2)(vi).
    6. Revising the heading and first sentence of paragraph 
(h)(2)(viii).
    7. Amending paragraph (h)(3)(iv)(B) by adding a new sentence 
immediately after the first sentence.
    8. Adding a new sentence at the end of paragraph (h)(4)(i)(C).
    The revised and added provisions read as follows:


Sec.  1.148-4  Yield on an issue of bonds.

* * * * *
    (b) * * *
    (3) Yield on certain fixed yield bonds subject to optional early 
redemption--(i) In general. If a fixed yield bond is subject to 
optional early redemption and is described in paragraph (b)(3)(ii) of 
this section, the yield on the issue containing the bond is computed by 
treating the bond as redeemed at its stated redemption price on the 
optional redemption date that would produce the lowest yield on that 
bond.
* * * * *
    (h) * * *
    (2) * * *
    (ii) * * *
    (A) * * * For purposes of applying the definition of periodic 
payment under Sec.  1.446-3 to determine whether a hedge has a 
significant investment element under this paragraph (h)(2)(ii)(A), the 
definition of ``specified index'' under Sec.  1.446-3 (upon which 
periodic payments are required to be based) is deemed also to include 
payments an issuer receives under a hedge that are computed to be equal 
to the issuer's cost of funds, such as the issuer's actual market-based 
tax-exempt variable interest rate on its bonds.
* * * * *
    (v) Interest-based contract and size and scope of hedge. The 
contract is primarily interest-based (for example, a hedge based on a 
debt index rather than an equity index). In addition, the size and 
scope of the hedge under the contract is limited to that which is 
reasonably necessary to hedge the issuer's risk with respect to 
interest rate changes on the hedged bonds. For example, a contract is 
limited to hedging an issuer's risk with respect to interest rate 
changes on the hedged bonds if the hedge is based on the issuer's 
principal amount of bonds and reasonably expected interest requirements 
rather than based on a greater notional amount or an interest rate 
level greater than the expected interest requirements. A contract is 
not primarily interest based unless--
* * * * *
    (B) * * * For this purpose, differences that would not prevent the 
resulting bond from being substantially similar to another type of bond 
or to result in overhedging include:
    (1) A difference between the interest rate used to compute payments 
on the hedged bond and the interest rate used to compute payments on 
the hedge where one interest rate is substantially the same as, but not 
identical to, the other. For this purpose, if an interest rate swap 
under which the issuer pays the hedge provider a fixed interest payment 
and receives from the hedge provider a floating interest rate that is 
based on a taxable interest rate or a taxable market interest rate 
index, the floating rate on the hedge and the variable rate on the 
hedged bonds will be treated as being substantially the same only if:
    (i) The difference between the interest rate on the issuer's hedged 
bonds and the floating interest rate on the hedge does not exceed one 
quarter of one percent (.25 percent, or 25 basis points) on the date 
that the issuer enters into the hedge; and
    (ii) For a three-year period that ends on the date the issuer 
enters into the hedge, the average difference between the issuer's 
actual tax-exempt interest rate on comparable variable-rate bonds (or, 
if no such comparable bonds exist, rates from a reasonable tax-exempt 
interest rate index, such as the SIFMA Municipal Swap Index, for that 
same period) and interest rates determined in the same manner as the 
floating interest rate on the hedge and as of the same dates as the 
issuer's comparable variable-rate bonds (or the tax-exempt market 
index, if applicable) does not exceed one-quarter of one percent (.25 
percent, or 25 basis points). For example, if the floating rate on the 
hedge is 67 percent of LIBOR, then 67 percent of LIBOR, determined as 
of the same dates as the issuer's actual interest rates (or tax-exempt 
market index, if applicable) is compared to those actual interest rates 
(or the tax-exempt market index, if applicable) for the three-year 
period ending on the date the hedge is entered into and the differences 
are averaged to determine whether the average difference exceeds one-
quarter of one percent. For this purpose, a reasonable sample may be 
used if the sample for the issuer's actual rates (or tax-exempt market 
index rates, if applicable) and the sample of floating rates used for 
the hedge are determined as of the same dates.
    (2) A difference resulting from the payment of a fixed premium for 
a cap (for example, payments for a cap that

[[Page 54613]]

are made in other than level installments).
    (3) A difference resulting from the allocation of a termination 
payment if the termination was unexpected as of the date that the 
parties entered into the hedge contract.
    (vi) * * * For this purpose, such payments will be treated as 
corresponding closely in time under this paragraph (h)(2)(vi) if they 
are made within 60 calendar days of each other.
* * * * *
    (viii) Reasonably contemporaneous identification. The contract must 
be identified by the actual issuer on its books and records maintained 
for the hedged bonds not later than 15 calendar days after the date on 
which the issuer and the hedge provider enter into the hedge contract. 
* * *
    (3) * * *
    (iv) * * *
    (B) * * * The amount of the termination payment in a termination or 
deemed termination is equal to the fair market value of the qualified 
hedge on the date of the termination. * * *
* * * * *
    (4) * * *
    (i) * * *
    (C) * * * Except for an anticipatory hedge that is terminated or 
otherwise closed substantially contemporaneously with the hedged bond 
in accordance with paragraph (h)(5)(ii) or (h)(5)(iii) of this section, 
a hedge based on a taxable interest rate or taxable interest index (for 
example, the London Interbank Offered Rate or LIBOR) does not meet the 
requirements of this paragraph (C).
* * * * *
    Par. 7. Section 1.148-5(c) is amended by:
    1. Removing existing paragraph (c)(3)(ii).
    2. Adding introductory language to paragraph (c)(3).
    3. Removing the heading in paragraph (c)(3)(i) and redesignating 
the existing text in paragraph (c)(3)(i)(A) as the text in paragraph 
(c)(3)(i).
    4. Redesignate existing paragraphs (c)(3)(i)(B), (c)(3)(i)(C), 
(c)(3)(i)(D), (c)(3)(i)(E), (c)(3)(i)(F), and (c)(3)(i)(G) as 
paragraphs (c)(3)(ii), (c)(3)(iii), (c)(3)(iv), (c)(3)(v), (c)(3)(vi), 
and (c)(3)(vii), respectively.
    5. Redesignate existing paragraphs (c)(3)(i)(C)(1) and 
(c)(3)(i)(C)(2) as paragraphs (c)(3)(iii)(A) and (c)(3)(iii)(B), 
respectively, in newly redesignated paragraph (c)(3)(iii).
    6. Redesignate existing paragraphs (c)(3)(i)(E)(1) and 
(c)(3)(i)(E)(2) as paragraphs (c)(3)(v)(A) and (c)(3)(v)(B), 
respectively, in newly redesignated paragraph (c)(3)(v).
    7. Amend newly redesignated paragraph (c)(3)(i), (c)(3)(ii), 
(c)(3)(iii), (c)(3)(iv), (c)(3)(v), (c)(3)(vi) and (c)(3)(vii) by 
adding headings to each paragraph.
    8. Revise newly redesignated paragraph (c)(3)(v).
    9. Revise newly redesignated paragraph (c)(3)(vi).
    10. Amend newly redesignated paragraph (c)(3)(vii) by removing the 
period at the end of the paragraph and replacing it with a semicolon.
    11. Amending paragraph (c)(3) by adding new paragraphs (c)(3)(viii) 
and (c)(3)(ix).
    The revised and added provisions read as follows:


Sec.  1.148-5  Yield and valuation of investments.

* * * * *
    (c) * * *
    (3) Applicability of special yield reduction rule. Except as 
otherwise expressly provided in paragraphs (c)(3)(i) through (ix) of 
this section, paragraph (c) applies only to investments listed in 
paragraphs (c)(3)(i) through (c)(3)(ix) of this section that are 
allocated to proceeds of an issue other than gross proceeds of an 
advance refunding issue.
    (i) Nonpurpose investments allocated to proceeds of an issue that 
qualified for certain temporary periods. * * *
    (ii) Investments allocable to certain variable yield issues. * * *
    (iii) Nonpurpose investments allocable to certain transferred 
proceeds. * * *
    (A) * * *
    (B) * * *
    (iv) Purpose investments allocable to certain qualified student 
loans. * * *
    (v) Nonpurpose investments allocable to gross proceeds in certain 
reserve funds. Nonpurpose investments allocable to gross proceeds of an 
issue in a reasonably required reserve or replacement fund or a fund 
that, except for its failure to satisfy the size limitation in Sec.  
1.148-2(f)(2)(ii), would qualify as a reasonably required reserve or 
replacement fund, but only to the extent the requirements in paragraphs 
(c)(3)(v)(A) or (B) of this section are met. This paragraph (c)(3)(v) 
includes nonpurpose investments described in this paragraph that are 
allocable to transferred proceeds of an advance refunding issue, 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.
    (A) * * *
    (B) * * *
    (vi) Nonpurpose investments allocable to certain replacement 
proceeds of refunded issues. Nonpurpose investments allocated to 
replacement proceeds of a refunded issue, including a refunded issue 
that is an advance refunding issue, as a result of the application of 
the universal cap to amounts in a refunding escrow;
    (vii) Investments allocable to replacement proceeds under a certain 
transition rule. * * *
    (viii) Nonpurpose investments allocable to proceeds when SLGS are 
unavailable. Nonpurpose investments allocable to proceeds of an issue, 
including an advance refunding issue, that an issuer purchases on a 
date when the issuer is unable to purchase State and Local Government 
Series Securities (SLGS) because the U.S. Department of Treasury, 
Bureau of Public Debt, has suspended sales of those securities; and
    (ix) Nonpurpose investments allocable to proceeds of certain 
variable-yield advance refunding issues. Nonpurpose investments 
allocable to proceeds of a variable-yield advance refunding issue (the 
hedged bond issue) deposited in a yield restricted defeasance escrow 
if--
    (A) The issuer has entered into a qualified hedge under Sec.  
1.148-4(h)(2) with respect to all of the variable-yield bonds of the 
issue allocable to the yield restricted defeasance escrow and that 
hedge is in the form of a variable-to-fixed interest rate swap under 
which the issuer pays the hedge provider a fixed interest rate and 
receives from the hedge provider a floating interest rate;
    (B) Such qualified hedge covers a period beginning on the issue 
date of the hedged bond issue and ending on or after the date on which 
the final payment is to be made from the yield restricted defeasance 
escrow; and
    (C) The issuer restricts the yield on the yield restricted 
defeasance escrow to a yield that is not greater than the yield on the 
hedged bond issue, determined by taking into account the issuer's fixed 
payments to be made under the hedge and by assuming that the issuer's 
variable yield payments to be paid on the hedged bonds are equal to the 
floating payments to be received by the issuer under the qualified 
hedge and are paid on the same dates (that is, such yield reduction 
payments can only be made to address basis risk differences between the 
variable yield payments on the hedged bonds and the floating payments 
received on the hedge).
* * * * *
    Par. 8. Section 1.148-5(d)(6) is amended by revising paragraphs 
(d)(6)(iii)(A)(1) and (d)(6)(iii)(A)(6) to read as follows:

[[Page 54614]]

Sec.  1.148-5  Yield and valuation of investments.

* * * * *
    (d) * * *
    (6) * * *
    (iii) * * *
    (A) * * *
    (1) The bid specifications are in writing and are timely forwarded, 
or are made available on an internet website or other similar 
electronic media that is regularly used to post bid specifications, to 
potential bidders. For purposes of this paragraph (d)(6)(iii)(A), a 
writing includes a hard copy, a fax, or an electronic e-mail copy.
* * * * *
    (6) All potential providers have an equal opportunity to bid. If 
the bidding process affords any opportunity for a potential provider to 
review other bids before providing a bid, then providers have an equal 
opportunity to bid only if all potential providers have an equal 
opportunity to review other bids. Thus, no potential provider may be 
given an opportunity to review other bids that is not equally given to 
all potential providers (that is, no exclusive ``last look'').
* * * * *
    Par. 9. Section 1.148-5(e)(2) is amended by revising the second 
sentence of paragraph (e)(2)(ii)(B) to read as follows:


Sec.  1.148-5  Yield and valuation of investments.

* * * * *
    (e) * * *
    (2) * * *
    (ii) * * *
    (B) External commingled funds. * * * 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 (for 
example, 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 at least 16 of the unrelated investors each maintained a 
daily average amount invested in the fund that was not less than the 
lesser of $500,000 and one percent (1%) of the daily average of the 
total amount invested in the fund (with it being understood that 
additional smaller investors will not disqualify the fund). * * *
* * * * *
    Par. 10. Section 1.148-8(d) is revised to read as follows:


Sec.  1.148-8  Small Issuer Exception to Rebate Requirement.

* * * * *
    (d) Pooled financings--treatment of conduit borrowers. A loan to a 
conduit borrower in a pooled financing qualifies for the small issuer 
exception, regardless of the size of either the pooled financing or of 
any loan to other conduit borrowers, only if--
    (1) The bonds of the pooled financing are not private activity 
bonds;
    (2) None of the loans to conduit borrowers are private activity 
bonds; and
    (3) The loan to the conduit borrower meets all the requirements of 
the small issue exception.
* * * * *
    Par. 11. Section 1.148-11 is revised by adding new paragraph (k) as 
follows:


Sec.  1.148-11  Effective Dates.

* * * * *
    (k) Certain arbitrage guidance updates.
    (1) In general. Sections 1.148-3(d)(1)(iv); 1.148-3(d)(4); 1.148-
4(a); 1.148-4(b)(3)(i); 1.148-4(h)(2)(ii)(A); 1.148-4(h)(2)(v); 1.148-
4(h)(2)(vi); 1.148-4(h)(2)(viii); 1.148-4(h)(3)(iv)(B); 1.148-
4(h)(4)(i)(C); 1.148-5(c)(3); 1.148-5(d)(6)(iii)(A) and 1.148-
5(e)(2)(ii)(B), as in effect on the effective date of the final 
regulations (the revised provisions), apply to bonds sold on or after 
the date that is 90 days after publication of the final regulations in 
the Federal Register, for bonds subject to such applicable section of 
the regulations as in effect before the effective date of the final 
regulations.
    (2) Permissive earlier application. To the extent provided in 
paragraphs (k)(2)(i) through (vi) of this section, issuers may apply 
the proposed regulations to bonds sold before the date that is 90 days 
after publication of the final regulations in the Federal Register.
    (i) Section 1.148-3(d)(1)(iv) and Sec.  1.148-3(d)(4) may be 
applied for bond years ending on or after the date of publication of 
the proposed regulations in the Federal Register for bonds to which 
1.148-3(d)(1)(iv) applies.
    (ii) Section 1.148-4(b)(3)(i) may be applied for bonds sold on or 
after the date of publication of the proposed regulations in the 
Federal Register for bonds to which that section applies.
    (iii) Sections 1.148-4(h)(2)(ii)(A), 1.148-4(h)(2)(v), 1.148-
4(h)(2)(vi), 1.148-4(h)(2)(viii), 1.148-4(h)(3)(iv)(B), and 1.148-
4(h)(4)(i)(C) may be applied, in whole but not in part, for qualified 
hedges entered into on or after the date of publication of the proposed 
regulations in the Federal Register for bonds to which Sec.  1.148-4(h) 
applies.
    (iv) Section 1.148-5(c)(3) may be applied for investments purchased 
on or after the date of publication of the proposed regulations in the 
Federal Register for bonds to which that section applies.
    (v) Section 1.148-5(d)(6)(iii)(A) may be applied to guaranteed 
investment contracts entered into on or after the date of publication 
of the proposed regulations in the Federal Register for bonds to which 
Sec.  1.148-5(d)(6)(iii) applies.
    (vi) Section 1.148-5(e)(2)(ii)(B) may be applied with respect to 
investors investing in the fund on or after the date of publication of 
the proposed regulations in the Federal Register for bonds to which 
that section applies.
    (3) Rebate overpayment recovery. Section 1.148-3(j) applies to 
bonds subject to Sec.  1.148-3(i).
    (4) Small issuer exception to rebate requirement for conduit 
borrowers of pooled financings. Section 1.148-8(d) applies to bonds 
issued after May 17, 2006.

Linda E. Stiff,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 07-4734 Filed 9-24-07; 8:45 am]
BILLING CODE 4830-01-P