[Federal Register Volume 75, Number 146 (Friday, July 30, 2010)]
[Rules and Regulations]
[Pages 44901-44907]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2010-18678]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

[TD 9495]
RIN 1545-BC61


Qualified Zone Academy Bonds; Obligations of States and Political 
Subdivisions

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations and removal of temporary regulations.

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SUMMARY: This document removes the temporary regulations and provides 
final regulations that provide guidance to state and local governments 
that issue qualified zone academy bonds and to banks, insurance 
companies, and other taxpayers that hold those bonds on the program 
requirements for qualified zone academy bonds. The final regulations 
implement the amendments to section 1397E (discussed in this preamble) 
and provide guidance on the maximum term, permissible use of proceeds, 
and remedial actions for qualified zone academy bonds.

DATES: Effective Date: These regulations are effective on July 30, 
2010.
    Applicability Date: For dates of applicability, see Sec.  1.1397E-
1(m) of these regulations.

FOR FURTHER INFORMATION CONTACT: Zoran Stojanovic, (202) 622-3980 (not 
a toll-free number).

SUPPLEMENTARY INFORMATION: 

Paperwork Reduction Act

    The collection of information contained in these final regulations 
has

[[Page 44902]]

been reviewed and approved by the Office of Management and Budget in 
accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d)) 
under control number 1545-1908. This information will be used to 
identify issuers of qualified zone academy bonds that have established 
a defeasance escrow as a remedial action taken because of failure to 
satisfy certain requirements of section 1397E.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless it displays a valid 
control number.
    Books and records relating to a collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax return information are confidential, as required by 26 U.S.C. 6103.

Background

    Section 1397E(a) of the Internal Revenue Code (Code) provides that 
an eligible taxpayer (within the meaning of section 1397E(d)(6)) that 
holds a qualified zone academy bond (``QZAB'' or ``QZABs'') on a credit 
allowance date is allowed a credit against Federal income tax for the 
taxable year that includes the credit allowance date. In general, a 
QZAB is a bond issued by a state or local government to finance certain 
eligible public school purposes under section 1397E(d). Section 
1397E(b) provides that the amount of the QZAB credit equals the product 
of the credit rate and the face amount of the bond held by the taxpayer 
on the credit allowance date. Under section 1397E(b)(2), the credit 
rate is determined by the Treasury Department and equals the percentage 
that the Department estimates generally will permit the issuance of 
QZABs without discount and without interest cost to the issuer. Section 
1397E(i)(1) defines credit allowance date as the last day of the one-
year period beginning on the issue date of the issue and the last day 
of each successive one-year period thereafter. Under section 
1397E(d)(3), the maximum term of a QZAB is determined by the Treasury 
Department and equals the term that the Department estimates will 
result in the present value of the obligation to repay the principal on 
the bond being equal to 50 percent of the face amount of the bond.
    Section 1397E(j) provides that the amount of the QZAB credit 
allowed to the taxpayer is included in the taxpayer's gross income.
    Section 1397E(e) imposes a national limitation on the amount of 
QZABs that may be issued for each calendar year. The limitation is 
allocated by the Treasury Department among the States on the basis of 
their respective populations of individuals below the poverty line.
    Section 1397E was amended by section 107 of the Tax Relief and 
Health Care Act of 2006, Public Law 109-432, 120 Stat. 2922 (2006) (the 
``2006 Act''), by adding certain requirements for a bond to be a QZAB. 
In general, the 2006 Act added a new five-year spending period 
requirement, arbitrage investment restrictions, and information 
reporting requirements. Specifically, the 2006 Act added new section 
1397E(f), which generally imposes spending period restrictions under 
which an issuer of QZABs must reasonably expect, as of the issue date, 
that: (1) At least 95 percent of the proceeds from the sale of the 
issue are to be spent for one or more qualified purposes with respect 
to qualified zone academies within the 5-year period beginning on the 
issue date of the QZAB; (2) a binding commitment with a third party to 
spend at least 10 percent of the proceeds from the sale of the issue 
will be incurred within the six-month period beginning on the issue 
date of the QZAB; and (3) such purposes will be completed with due 
diligence and the proceeds from the sale of the issue will be spent 
with due diligence. New section 1397E(f)(2) added by the 2006 Act 
provides authority to the Secretary of the Treasury to extend the five-
year spending period. To the extent that less than 95 percent of the 
proceeds of the issue are spent within the five-year spending period 
(plus any extension granted by the Secretary of the Treasury), the 2006 
Act requires the issuer to redeem the nonqualified bonds within 90 days 
after the end of such period.
    In addition, the 2006 Act added new section 1397E(g), which 
generally requires that an issue of QZABs satisfy the arbitrage 
investment restrictions of section 148 with respect to the proceeds of 
the issue.
    Finally, the 2006 Act added new section 1397E(h), which generally 
requires that issuers of QZABs submit information reporting returns to 
the IRS similar to the information reporting returns required to be 
submitted to the IRS under section 149(e) for tax-exempt state or local 
bonds.
    Section 15316 of the Food, Conservation, and Energy Act of 2008, 
Public Law 110-246, 122 Stat. 1651 (2008) (the ``2008 Energy Act''), 
added section 54A to the Code. Section 54A(a) provides that a taxpayer 
that holds a qualified tax credit bond on one or more credit allowance 
dates of the bond occurring during any taxable year is allowed as a 
credit against Federal income tax for the taxable year an amount equal 
to the sum of the credits determined under section 54A(b) with respect 
to such dates. Section 54A(d)(1) provides that the term qualified tax 
credit bond (``QTCB'') means a certain bond which is part of an issue 
that meets the requirements of section 54A(d)(2), (3), (4), (5), and 
(6) regarding expenditures of bond proceeds, information reporting, 
arbitrage, maturity limitations, and prohibitions against financial 
conflicts of interest. At the time of its enactment, the 2008 Energy 
Act did not treat QZABs as QTCBs.
    Section 313 of the Tax Extenders and Alternative Minimum Tax Relief 
Act of 2008, Div. C of Public Law 110-343, 122 Stat. 3765 (2008) (the 
``2008 Act'') added new section 1397E(m) providing that section 1397E 
shall not apply to any obligation issued after the date of the 
enactment of the 2008 Act on October 3, 2008. Effective for obligations 
issued after October 3, 2008, the 2008 Act amended section 54A(d)(1) 
defining a QTCB to include a qualified zone academy bond under section 
54E of the Code. The 2008 Act also added section 54E, which provides 
revised program provisions for QZABs in lieu of the existing provisions 
under section 1397E and amended section 54A(d)(2)(C) to provide that, 
for purposes of section 54A(d)(2), the term ``qualified purpose'' for a 
QZAB means a purpose specified in section 54E(a)(1).
    Section 301 of the Hiring Incentives to Restore Employment Act, 
Public Law 111-147, 124 Stat. 71 (2010) (the ``HIRE Act'') added 
subsection (f) to section 6431 of the Code, which authorizes issuers to 
elect irrevocably to receive Federal direct payments of allowances of 
refundable tax credits to subsidize a prescribed portion of their 
borrowing costs instead of the Federal tax credits that otherwise would 
be allowed to holders of certain qualified tax credit bonds under 
section 54A. Under section 6431(f)(3)(A)(iii), the direct payment 
subsidy option under section 6431(f) applies to qualified zone academy 
bonds issued under section 54E that meet the requirements to be 
qualified tax credit bonds under section 54A.
    Temporary regulations (TD 8755) interpreting section 1397E were 
published on January 7, 1998 (63 FR 671), and amended on July 1, 1999 
(TD 8826; 64 FR 35573). Final regulations under section 1397E (TD 8903) 
were published on September 26, 2000 (65 FR 57732) (the ``First Final 
Regulations''). On March 26, 2004, a notice of proposed

[[Page 44903]]

rulemaking (REG-121475-03) was published in the Federal Register (69 FR 
15747) (the ``2004 Proposed Regulations''). The 2004 Proposed 
Regulations proposed to amend the First Final Regulations by providing 
guidance on the maximum term, permissible use of proceeds, and remedial 
actions for QZABs. A public hearing was scheduled for July 21, 2004. 
The public hearing was cancelled because no requests to speak were 
received. Written comments on the 2004 Proposed Regulations were 
received. After consideration of the written comments, and in light of 
the statutory changes made by the 2006 Act, the need for regulatory 
guidance on those statutory changes, and the close connection between 
that needed guidance and the guidance in the 2004 Proposed Regulations, 
the IRS and the Treasury Department determined to issue coordinated 
guidance as temporary regulations under TD 9339 which were published in 
the Federal Register on July 16, 2007 (72 FR 38767) and which became 
effective as of September 14, 2007 (the ``Temporary Regulations''), 
with an opportunity for public comment in the corresponding proposed 
regulations (the ``2007 Proposed Regulations''). The 2004 Proposed 
Regulations were withdrawn. No public hearing was requested and no 
written comments were received pursuant to the 2007 Proposed 
Regulations.
    Accordingly, the IRS and the Treasury Department adopt the 2007 
Proposed Regulations, in substantially the same form as the 2007 
Proposed Regulations, as final regulations by this Treasury Decision.

Effective/Applicability Dates

    In general, except as otherwise provided, these final regulations 
generally apply to QZABs issued under section 1397E that are sold on or 
after September 14, 2007.
    Pursuant to section 313(b) of the 2008 Act, effective for QZABs 
that are sold on or after October 3, 2008, section 1397E is 
inapplicable and successor modified statutory provisions for QZABs 
apply under sections 54A and 54E. These final regulations generally do 
not apply to QZABs issued under sections 54A and 54E. However, Notice 
2009-30, 2009-16 IRB 852 (April 20, 2009) and Notice 2010-22, 2010-10 
IRB 435 (March 8, 2010) (relating to 2009 and 2010 volume cap 
allocations for QZABs respectively), provide that for QZABs issued 
under sections 54A and 54E that are sold on or after October 4, 2008, 
pending the promulgation and effective date of future administrative or 
regulatory guidance, taxpayers may rely on the interim guidance 
provided in these notices and, to the extent not inconsistent with 
these notices and the provisions of sections 54A and 54E, the Temporary 
Regulations issued under section 1397E. See Sec.  601.601 
(d)(2)(ii)(b).
    The final regulations include a limited reliance provision for 
QZABs issued under sections 54A and 54E. Under this reliance provision, 
except to the extent inconsistent with the successor statutory 
provisions for QZABs in sections 54A and 54E and public administrative 
or regulatory guidance under those provisions and except as otherwise 
provided in a special restriction against reliance on the remedial 
action provisions in the final regulations, issuers and taxpayers may 
rely on the final regulations for QZABs that are issued under sections 
54A and 54E. In the case of QZABs that are issued under sections 54A 
and 54E for which the issuer elects the Federal direct payment subsidy 
option under section 6431(f), issuers and taxpayers may not rely on the 
remedial action provisions in Sec.  1.1397E-1(h) of the final 
regulations. The IRS and Treasury Department expect to announce 
appropriate remedial actions tailored to bonds involving the Federal 
direct payment subsidy option under section 6431 in future public 
guidance.
    In addition, except as otherwise provided, Sec.  1.1397E-1(h)(2), 
(h)(3), (h)(4), (i), and (j) of the final regulations regarding the 
five-year spending period, the arbitrage investment restrictions, and 
the information reporting requirement added by the 2006 Act apply to 
bonds issued under section 1397E pursuant to allocations of the 
national qualified zone academy bond volume cap authority arising in 
calendar years after 2005 and sold on or after September 14, 2007.
    In addition, issuers and taxpayers also may apply the final 
regulations in whole, but not in part, to bonds issued under section 
1397E that are sold before September 14, 2007.
    Certain other special effective dates apply to particular 
provisions under Sec.  1.1397E-1(m).

Special Analyses

    It has been determined that this Treasury decision 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. It is hereby 
certified that the collection of information contained in this 
regulation will not have a significant economic impact on a substantial 
number of small entities. Accordingly, a regulatory flexibility 
analysis is not required. The collection of information in this 
proposed regulation is in Sec.  1.1397E-1(h)(8). This collection of 
information is required by the IRS to verify compliance with section 
1397E. This information will be used to identify issuers of qualified 
zone academy bonds that have established a defeasance escrow as a 
remedial action taken because of failure to satisfy certain 
requirements of section 1397E. The collection of information is 
required to obtain or retain a benefit. The likely respondents are 
states or local governments that issue qualified zone academy bonds. 
The estimated number of respondents is 6, and the estimated average 
annual burden hours per respondent is 30 minutes. In addition, the 
establishment of a defeasance escrow need only be reported once. 
Accordingly, the number of, and the burden on, affected small entities 
is not significant. Pursuant to section 7805(f) of the Code, the notice 
of proposed rulemaking preceding this regulation has been submitted to 
the Chief Counsel for Advocacy of the Small Business Administration for 
comment on its impact on small businesses.

Drafting Information

    The principal author of these regulations is Zoran Stojanovic, 
Office of Associate Chief Counsel, IRS (Financial Institutions and 
Products). However, other personnel from the IRS and the Treasury 
Department participated in their development.

List of Subjects

26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 602

    Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

0
Accordingly, 26 CFR parts 1 and 602 are amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by removing 
the entry for ``1.1397E-1T'' and revising the entry for ``Sec.  
1.1397E-1'' to read as follows:

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

    Section 1.1397E-1 also issued under 26 U.S.C. 1397E. * * *

[[Page 44904]]

0
Par. 2. Section 1.1397E-1 is amended by revising paragraphs (a), (d), 
(h), (i), (j) and (m) to read as follows:


Sec.  1.1397E-1  Qualified zone academy bonds.

    (a) In general--(1) Overview. In general, a qualified zone academy 
bond (QZAB or QZABs) is a taxable bond issued by a state or local 
government the proceeds of which are used to improve certain eligible 
public schools. An eligible taxpayer that holds a QZAB generally is 
allowed annual Federal income tax credits in lieu of periodic interest 
payments. These credits compensate the eligible taxpayer for lending 
money to the issuer and function as payments of interest on the bond. 
Accordingly, this section generally treats the allowance of a credit as 
if it were a payment of interest on the bond. This section also 
provides other rules for QZABs, including rules governing the credit 
rate, the private business contribution requirement, the maximum term, 
use and expenditure of proceeds, remedial actions, eligible issuers, 
arbitrage investment restrictions, and information reporting.
    (2) Certain definitions--(i) In general. For purposes of this 
section, except as otherwise provided in this section, the following 
definitions apply: the definitions set forth in this section; the 
definitions used for general tax-exempt bond purposes in Sec.  1.150-1; 
and the definitions used for purposes of the arbitrage investment 
restrictions on tax-exempt bonds in Sec.  1.148-1(b).
    (ii) Applicable definition of proceeds--(A) Use and expenditure 
provisions. Except as provided in paragraphs (a)(2)(ii)(B) and 
(a)(2)(ii)(C) of this section, for purposes of all applicable 
requirements regarding use and expenditure of proceeds of QZABs under 
section 1397E and this section, ``proceeds'' means ``sale proceeds,'' 
as defined in Sec.  1.148-1(b), plus ``investment proceeds,'' as 
defined in Sec.  1.148-1(b).
    (B) Private business contribution requirement. For purposes of the 
private business contribution requirement of section 1397E(d)(2), 
``proceeds'' means ``sale proceeds,'' as defined in Sec.  1.148-1(b).
    (C) Arbitrage investment restrictions. For purposes of the scope of 
application of the arbitrage investment restrictions under section 
1397E(g) and paragraph (i) of this section, ``proceeds'' generally 
means gross proceeds, as defined in Sec.  1.148-1(b). In addition, in 
applying the arbitrage investment restrictions under paragraph (i) of 
this section and under section 148, the various applicable definitions 
of the various types of proceeds of tax-exempt bonds under Sec.  1.148-
1(b) shall apply.
* * * * *
    (d) Maximum term. The maximum term for a QZAB is determined under 
section 1397E(d)(3) by using a discount rate equal to 110 percent of 
the long-term adjusted applicable Federal rate (AFR), compounded semi-
annually, for the month in which the bond is sold. The Internal Revenue 
Service publishes this figure each month in a revenue ruling that is 
published in the Internal Revenue Bulletin. See Sec.  
601.601(d)(2)(ii)(b) of this chapter. A bond is sold on the sale date, 
as defined in Sec.  1.150-1(c)(6), which is the first day on which 
there is a binding contract in writing for the sale or exchange of the 
bond.
* * * * *
    (h) Use of proceeds--(1) In general. Section 1397E(d)(1) provides 
that a bond issued as part of an issue is a QZAB only if, among other 
requirements, at least 95 percent of the proceeds of the issue are to 
be used for a qualified purpose with respect to a qualified zone 
academy established by an eligible local education agency (as defined 
in section 1397E(d)(4)(B)), and the issue meets the requirements of 
section 1397E(f) and (g). Section 1397E(d)(5) defines qualified 
purpose, with respect to any qualified zone academy, as rehabilitating 
or repairing the public school facility in which such academy is 
established, providing equipment for use at such academy, developing 
course materials for education to be provided at such academy, and 
training teachers and other school personnel in such academy. Section 
1397E(d)(4)(A) defines qualified zone academy as any public school (or 
academic program within a public school) that is established by and 
operated under the supervision of an eligible local education agency to 
provide education or training below the postsecondary level and that 
meets the requirements of section 1397E(d)(4)(A)(i), (ii), (iii) and 
(iv).
    (2) Use of proceeds requirements. An issue meets the requirements 
of sections 1397E (d)(1)(A) and (f) only if--
    (i) The issuer reasonably expects, as of the issue date of the 
issue, that--
    (A) At least 95 percent of the proceeds from the sale of the issue 
are to be spent for qualified purposes with respect to qualified zone 
academies within the 5-year period beginning on the issue date of the 
QZAB;
    (B) A binding commitment with a third party to spend at least 10 
percent of the proceeds from the sale of the issue will be incurred 
within the 6-month period beginning on the issue date of the QZAB;
    (C) At least 95 percent of the proceeds from the sale of the issue 
will be spent for qualified purposes with respect to a qualified zone 
academy with due diligence (with due diligence measured by the 
reasonableness standard under Sec.  1.148-1(b)); and
    (D) At least 95 percent of the proceeds of the issue will be used 
for qualified purposes with respect to a qualified zone academy for the 
entire term of the issue (without regard to any redemption provision); 
and
    (ii) Except as otherwise provided in paragraph (h)(8) of this 
section, at least 95 percent of the proceeds of the issue are actually 
used for qualified purposes with respect to a qualified academy for the 
entire term of the issue (without regard to any redemption provision).
    (3) Extension of 5-year period. The Commissioner may extend the 
period described in paragraph (h)(2)(i)(A) of this section if the 
issuer, prior to the end of such period, submits a private ruling 
request, and establishes to the satisfaction of the Commissioner that--
    (i) The failure to satisfy the 5-year spending requirement is due 
to reasonable cause; and
    (ii) The expenditure of at least 95 percent of the proceeds from 
the sale of the issue for a qualified purpose with respect to a 
qualified zone academy will continue to proceed with due diligence.
    (4) Unspent proceeds. For purposes of paragraphs (h)(2)(i)(D) and 
(h)(2)(ii) of this section, during the period described in paragraph 
(h)(2)(i)(A) of this section, including any extension under paragraph 
(h)(3) of this section, unspent proceeds are treated as used for a 
qualified purpose with respect to a qualified zone academy if the 
issuer reasonably expects to proceed with due diligence to spend those 
proceeds for a qualified purpose with respect to a qualified zone 
academy during that period.
    (5) Proceeds spent for rehabilitation, repair or equipment--(i) In 
general. Under section 1397E(d)(5)(A) the term qualified purpose with 
respect to any qualified zone academy includes rehabilitating or 
repairing the public school facility in which such academy is 
established. For this purpose, in determining whether proceeds are 
spent for rehabilitation, rules similar to those under section 47(c) 
(other than sections 47(c)(1)(B) and 47(c)(2)(B)(iv)) shall apply. 
Under section 1397E(d)(5)(B) the term qualified purpose also includes 
providing equipment for use at such academy. If proceeds of an issue 
are spent for a purpose described in section

[[Page 44905]]

1397E(d)(5)(A) or (B) with respect to a qualified zone academy, then 
those proceeds are treated as used for a qualified purpose with respect 
to the academy during any period after such expenditure that--
    (A) The property financed with those proceeds is used for the 
purposes of the academy; and
    (B) The academy maintains its status as a qualified zone academy 
under section 1397E(d)(4).
    (ii) Retirement from service. The retirement from service of 
financed property due to normal wear or obsolescence does not cause the 
property to fail to be used for a qualified purpose with respect to a 
qualified zone academy.
    (6) Proceeds spent to develop course materials or train teachers. 
Section 1397E(d)(5)(C) and (D) provides that the term qualified purpose 
with respect to any qualified zone academy includes developing course 
materials for education to be provided at such academy, and training 
teachers and other school personnel in such academy. If proceeds of an 
issue are spent for a purpose described in section 1397E(d)(5)(C) or 
(D) with respect to a qualified zone academy, then those proceeds are 
treated as used for a qualified purpose with respect to the academy 
during any period after such expenditure.
    (7) Special rule for determining status as qualified zone academy. 
Section 1397E(d)(4)(A)(iv) provides that a public school (or academic 
program within a public school) is a qualified zone academy only if, 
among other requirements, the public school is located in an 
empowerment zone or enterprise community (as defined in section 1393), 
or there is a reasonable expectation (as of the issue date of the 
issue) that at least 35 percent of the students attending the school or 
participating in the program (as the case may be) will be eligible for 
free or reduced-cost lunches under the school lunch program established 
under the Richard B. Russell National School Lunch Act. For purposes of 
determining whether an issue complies with section 1397E(d)(4)(A)(iv)--
    (i) A public school is treated as located in an empowerment zone or 
enterprise community for the entire term of the issue if the public 
school is located in an empowerment zone or enterprise community on the 
issue date of the issue; and
    (ii) The determination of whether there is a reasonable expectation 
(as of the issue date of the issue) that at least 35 percent of the 
students attending the school or participating in the program (as the 
case may be) will be eligible for free or reduced-cost lunches under 
the school lunch program established under the Richard B. Russell 
National School Lunch Act is based on expectations regarding the one-
year period following the issue date.
    (8) Remedial actions--(i) General rule. If less than 95 percent of 
the proceeds of an issue are properly used (as determined under 
paragraph (h)(8)(ii)(D) of this section), the issue will be treated as 
meeting the requirements of section 1397E(d)(1)(A) if the issue met the 
requirements of paragraph (h)(2)(i) of this section and a remedial 
action is taken under paragraph (h)(8)(ii) or (iii) of this section.
    (ii) Redemption or defeasance--(A) In general. A remedial action is 
taken under this paragraph (h)(8)(ii) if the requirements of paragraphs 
(h)(8)(ii)(B) and (C) of this section are met.
    (B) Retirement of nonqualified bonds--(1) In general. The 
requirements of this paragraph (h)(8)(ii)(B) are met if--
    (i) All of the nonqualified bonds of the issue (as determined under 
Sec.  1.142-2(e)) are redeemed within 90 days after the date on which 
the failure to properly use proceeds occurs; or
    (ii) To the extent proceeds of the issue that have been actually 
spent for a qualified purpose with respect to a qualified zone academy, 
if any nonqualified bonds of the issue are not redeemed within 90 days 
after the date on which the failure to properly use such proceeds 
occurs (the unredeemed nonqualified bonds), a defeasance escrow is 
established for the unredeemed nonqualified bonds within 90 days after 
the date on which the failure to properly use proceeds occurs.
    (2) Special rule for dispositions for cash. If the failure to 
properly use proceeds occurs because of a disposition of financed 
property described in section 1397E(d)(5)(A) or (B) and the 
consideration for the disposition is exclusively cash, the requirements 
of this paragraph (h)(8)(ii)(B) are met if all of the disposition 
proceeds (as defined in paragraph (h)(8)(iv) of this section) are used 
within 90 days after the date of the disposition to redeem, or 
establish a defeasance escrow for, the nonqualified bonds (as 
determined under Sec.  1.142-2(e)).
    (3) Definition of defeasance escrow. For purposes of this section, 
a defeasance escrow is an irrevocable escrow established to retire 
nonqualified bonds on the earliest call date after the date on which 
the failure to properly use proceeds occurs in an amount that is 
sufficient to retire nonqualified bonds on that call date. At least 90 
percent of the weighted average amount in a defeasance escrow must be 
invested in investments (as defined in Sec.  1.148-1(b)), except that 
no amount in a defeasance escrow may be invested in any investment the 
obligor (or any person that is a related party with respect to the 
obligor within the meaning of Sec.  1.150-1(b)) of which is a user of 
proceeds of the bonds. All purchases or sales of an investment in a 
defeasance escrow must be made at the fair market value of the 
investment within the meaning of Sec.  1.148-5(d)(6).
    (C) Additional rules--(1) Limitation on source of funding. Proceeds 
of an issue of QZABs (other than unspent proceeds of the issue for 
which the failure to properly use proceeds occurs) must not be used to 
redeem or defease nonqualified bonds under paragraph (h)(8)(ii)(B) of 
this section.
    (2) Rebate requirement. The issuer must pay to the United States, 
at the same time and in the same manner as rebate amounts are required 
to be paid under Sec.  1.148-3 (or at such other time or in such other 
manner as the Commissioner may prescribe), any investment earnings on 
amounts in a defeasance escrow established under paragraph 
(h)(8)(ii)(B) of this section that are in excess of the yield on the 
issue of QZABs with respect to which the defeasance escrow was 
established. For this purpose, the first computation period begins on 
the date on which the defeasance escrow is established.
    (3) Notice of defeasance. The issuer must provide written notice to 
the Commissioner, at the place designated in Sec.  1.150-5(a), of the 
establishment of the defeasance escrow within 90 days of the date the 
defeasance escrow is established.
    (D) When a failure to properly use proceeds occurs--(1) Unspent 
proceeds. For unspent proceeds, a failure to properly use proceeds 
occurs on the earliest of--
    (i) The first date on which the public school (or academic program 
within the public school) fails to constitute a qualified zone academy;
    (ii) The first date on which the issuer fails to have a reasonable 
expectation to proceed with due diligence to spend at least 95 percent 
of the proceeds of the issue for a qualified purpose with respect to a 
qualified zone academy; or
    (iii) The last day of the period described in paragraph 
(h)(2)(i)(A) of this section, including any extension, if less than 95 
percent of the proceeds of the issue are actually spent for a qualified 
purpose with respect to a qualified zone academy.
    (2) Proceeds spent for rehabilitation, repair or equipment. For 
proceeds that

[[Page 44906]]

have been spent for a purpose described in section 1397E(d)(5)(A) or 
(B) with respect to a qualified zone academy, a failure to properly use 
proceeds occurs on the earlier of--
    (i) The first date on which the public school (or academic program 
within the public school) fails to constitute a qualified zone academy; 
and
    (ii) The first date on which an action is taken that causes the 
issuer to fail actually to use at least 95 percent of the proceeds of 
the issue for a qualified purpose with respect to a qualified zone 
academy.
    (3) Proceeds spent for course materials or training. If proceeds 
have been spent for a purpose described in section 1397E(d)(5)(C) or 
(D) with respect to a qualified zone academy, no event subsequent to 
such expenditure shall constitute a failure to properly use such 
proceeds.
    (iii) Alternative use of disposition proceeds. A remedial action is 
taken under this paragraph (h)(8)(iii) if all of the requirements of 
paragraphs (h)(8)(iii)(A) through (D) of this section are met--
    (A) The failure to properly use proceeds (as determined under 
paragraph (h)(8)(ii)(D) of this section) is a disposition of financed 
property described in section 1397E(d)(5)(A) or (B) and the 
consideration for the disposition is exclusively cash;
    (B) The issuer reasonably expects as of the date of the disposition 
that--
    (1) All of the disposition proceeds will be spent within the two-
year period beginning with the date of the disposition for a qualified 
purpose with respect to a qualified zone academy; or
    (2) To the extent not expected to be so spent, the disposition 
proceeds will be used within 90 days after the date of the disposition 
to redeem or defease bonds in a manner that meets the requirements of 
paragraph (h)(8)(ii) of this section;
    (C) The disposition proceeds are treated as proceeds for purposes 
of section 1397E; and
    (D) If all of the disposition proceeds are not actually used in the 
manner described in paragraph (h)(8)(iii)(B) of this section, the 
remainder of such amounts are used within 90 days after the end of the 
period described in paragraph (h)(8)(iii)(B)(1) of this section for a 
remedial action that meets the requirements of paragraph (h)(8)(ii) of 
this section.
    (iv) Definition of disposition proceeds and allocation among 
multiple funding sources. For purposes of this paragraph (h)(8), 
disposition proceeds means disposition proceeds, as defined in Sec.  
1.141-12(c)(1), plus amounts derived from investing disposition 
proceeds. If property has been financed with an issue of QZABs and one 
or more other funding sources, any disposition proceeds from that 
property are allocated to the issue under the principles of Sec.  
1.141-12(c)(3).
    (9) Payment of principal, interest or redemption price--(i) In 
general. Except as provided in paragraphs (h)(9)(ii) and (h)(9)(iii) of 
this section, the use of proceeds of a bond to pay principal, interest, 
or redemption price of the bond or another bond is not a qualified 
purpose within the meaning of section 1397E(d)(5).
    (ii) Exception for certain eligible reimbursements of interim 
refinancings. The use of proceeds of a bond (the refinancing bond) to 
pay principal, interest, or redemption price of another bond (the prior 
bond) is a qualified purpose within the meaning of section 1397E(d)(5) 
to the extent that--
    (A) The prior bond was not a QZAB (and, in the case of a series of 
refinancings, no earlier bond in the series was a QZAB);
    (B) The proceeds of the prior bond (or the original bond in the 
case of a series of refinancings, as applicable) were spent for a 
qualified purpose under section 1397E(d)(5) with respect to a qualified 
zone academy (the original expenditure); and
    (C) The issuer makes a valid reimbursement allocation to allocate 
the proceeds of the refinancing bond to the payment of the original 
expenditure (the reimbursement allocation), which allocation satisfies 
the requirements for reimbursements under paragraph (h)(10) of this 
section. For purposes of applying the rules for reimbursement, a 
refinancing bond which otherwise meets the requirements of this 
paragraph (h)(9)(ii) is eligible for reimbursement and is not treated 
as a disqualified refunding under Sec.  1.150-2(g).
    (iii) Reissuance of a QZAB. For purposes of determining whether the 
establishing of a defeasance escrow under paragraph 
(h)(8)(ii)(B)(1)(ii) of this section results in an exchange under Sec.  
1.1001-1(a), the QZAB is treated as a tax-exempt bond under Sec.  
1.1001-3(e)(5)(ii)(B)(1).
    (10) Reimbursement. An expenditure for a qualified purpose may be 
reimbursed with proceeds of a QZAB. For this purpose, rules similar to 
those on reimbursement of expenditures in Sec.  1.142-4(b) and Sec.  
1.150-2 shall apply. In applying these reimbursement rules, 
expenditures eligible for reimbursement under Sec.  1.150-2(d)(3) shall 
be deemed to mean any expenditure for a qualified purpose under section 
1397E(d)(5).
    (i) Arbitrage investment restrictions--(1) In general. Under 
section 1397E(g) and this paragraph (i), and except as otherwise 
provided in this paragraph (i), the arbitrage investment restrictions 
and rebate requirements under section 148 and Sec. Sec.  1.148-1 
through 1.148-11, inclusive, and the exceptions to those restrictions, 
apply broadly to gross proceeds of QZABs issued under section 1397E to 
the same extent and in the same manner as they apply to gross proceeds 
of tax-exempt state or local governmental bonds. For this purpose, 
references in those sections to tax-exempt bonds generally shall be 
deemed to refer to QZABs and, to the extent that any particular 
arbitrage restriction depends on whether bonds are private activity 
bonds under section 141, the determination of whether QZABs are private 
activity bonds shall be based on the general definition of private 
activity bonds under section 141. In applying section 148 and the 
regulations under that section to QZABs, the modifications set forth in 
paragraphs (i)(2) through (i)(6) of this section shall apply.
    (2) 5-year temporary period exception to arbitrage yield 
restriction. If an issue of QZABs meets the requirements of section 
1397E(f)(1) and paragraph (h)(2)(i) of this section, then the proceeds 
of the issue of QZABs are treated as qualifying for a 5-year temporary 
period exception to arbitrage yield restriction under Sec.  1.148-
2(e)(2) beginning on the issue date of the issue.
    (3) Disregard QZAB credit in QZAB yield for arbitrage purposes. In 
determining the yield on an issue of QZABs for arbitrage purposes under 
Sec.  1.148-4, the QZAB credit allowed under section 1397E(a) is 
disregarded.
    (4) Non-AMT tax-exempt bond investment exception inapplicable. The 
exception to arbitrage yield restriction for investments of gross 
proceeds of tax-exempt bonds in specified tax-exempt bond investments 
not subject to section 148(b)(3)(B) (relating to an exception to the 
definition of ``investment property'' for specified tax-exempt bonds) 
and Sec.  1.148-2(d)(2)(v) (relating to a corresponding exception to 
arbitrage yield limitations) is inapplicable.
    (5) Application of small issuer exception to the arbitrage rebate 
requirement. Except as otherwise provided in paragraph (i)(6) of this 
section, for purposes of the small issuer exception to the arbitrage 
rebate requirement under section 148(f)(4)(D) and Sec.  1.148-8, QZABs 
that are actually issued or reasonably expected to be issued by the 
QZAB issuer (and applicable entities aggregated under section 
148(f)(4)(D)) within a calendar

[[Page 44907]]

year are taken into account in measuring the applicable size 
limitation.
    (6) Certain defeasance escrow earnings. With respect to a 
defeasance escrow established in a remedial action for an issue of 
QZABs that meets the special rebate requirement under paragraph 
(h)(8)(ii)(C)(2) of this section, the QZAB issuer is treated as 
ineligible for the small issuer exception to arbitrage rebate under 
section 148(f)(4)(D) and paragraph (i)(5) of this section and 
compliance with that special rebate requirement is treated as 
satisfying applicable arbitrage investment restrictions under section 
148 for that defeasance escrow.
    (j) Information reporting requirement. Under section 1397E(h) and 
this paragraph (j), issuers of QZABs are required to submit information 
reporting returns to the IRS similar to the information reporting 
returns required to be submitted to the IRS under section 149(e) for 
tax-exempt state or local governmental bonds at the same time and in 
the same manner as those reports are required to be submitted to the 
IRS on such forms as shall be prescribed by the Commissioner for such 
purpose.
* * * * *
    (m) Effective/applicability dates--(1) In general. Except as 
otherwise provided in this paragraph (m), this section applies to bonds 
issued under section 1397E that are sold on or after September 14, 
2007.
    (2) Special effective dates--(i) Effective dates for paragraphs 
(h)(2), (h)(3), (h)(4), (i), and (j) of this section in general. 
Paragraphs (h)(2), (h)(3), (h)(4), (i), and (j) of this section apply 
to bonds issued under section 1397E pursuant to allocations of the 
national qualified zone academy bond volume cap authority for calendar 
years after 2005 and sold on or after September 14, 2007.
    (ii) Permissive retroactive application--(A) In general. Except as 
otherwise provided in this paragraph (m), issuers and taxpayers may 
apply this section in whole, but not in part, to bonds issued under 
section 1397E that are sold before September 14, 2007.
    (B) Special rule for certain provisions. For purposes of the 
permissive retroactive application rule in paragraph (m)(2)(ii)(A) of 
this section, paragraphs (h)(2), (h)(3), (h)(4), (i), and (j) of this 
section need not be applied to any bonds issued under section 1397E to 
which those provisions do not otherwise apply under the general 
effective date provisions for those provisions in paragraph (m)(2)(i) 
of this section.
    (C) Definition of proceeds. Issuers and taxpayers may apply 
paragraph (h) of this section, without regard to the definition of 
proceeds in paragraph (a)(2)(ii) of this section, to bonds issued under 
section 1397E that are sold before September 14, 2007.
    (D) Bonds issued before July 1, 1999. Paragraphs (b) and (h)(10) of 
this section may not be applied to bonds issued under section 1397E 
that are issued before July 1, 1999.
    (3) Scope of reliance for bonds issued under sections 54A and 54E. 
Except to the extent inconsistent with the successor statutory 
provisions for QZABs in sections 54A and 54E or applicable public 
administrative or regulatory guidance under those provisions and except 
as otherwise provided in this paragraph (m)(3), issuers and taxpayers 
may apply these regulations to QZABs issued under sections 54A and 54E 
that are sold on or after October 3, 2008. In the case of QZABs that 
are issued under sections 54A and 54E for which the issuer makes an 
irrevocable election under section 6431(f) to receive payments with 
respect to credits under section 6431, issuers and taxpayers may not 
apply the remedial action provisions under paragraph (h)(8) of this 
section.


Sec.  1.1397E-1T  [Removed]

0
Par. 3. Section 1.1397E-1T is removed.

PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

0
Par. 4. The authority citation for part 602 continues to read as 
follows:


    Authority:  26 U.S.C. 7805.

0
Par. 5. In Sec.  602.101, paragraph (b) is amended by removing the 
entry for ``1.1397E-1T''and adding the following entry in numerical 
order to the table to read as follows:


Sec.  602.101  OMB Control numbers.

* * * * *
    (b) * * *

------------------------------------------------------------------------
                                                            Current OMB
   CFR part or section where identified and described       control No.
------------------------------------------------------------------------
 
                                * * * * *
1.1397E-1...............................................       1545-1908
 
                                * * * * *
------------------------------------------------------------------------


Steven T. Miller,
Deputy Commissioner for Services and Enforcement.
    Approved: July 16, 2010.
Michael Mundaca,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2010-18678 Filed 7-29-10; 8:45 am]
BILLING CODE 4830-01-P