[Federal Register Volume 78, Number 179 (Monday, September 16, 2013)]
[Proposed Rules]
[Pages 56842-56852]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2013-21880]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-148659-07]
RIN 1545-BH38


Arbitrage Restrictions on Tax-Exempt Bonds

AGENCY: Internal Revenue Service (IRS), Treasury.

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

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SUMMARY: This document contains proposed regulations on the arbitrage 
restrictions under section 148 of the Internal Revenue Code applicable 
to tax-exempt bonds and other tax-advantaged bonds. These proposed 
regulations amend existing regulations to address certain current 
market developments, simplify certain provisions, address certain 
technical issues, and make the regulations more administrable. These 
proposed regulations affect issuers of tax-exempt and other tax-
advantaged

[[Page 56843]]

bonds. This document also provides notice of a public hearing on these 
proposed regulations.

DATES: Written or electronic comments must be received by December 16, 
2013. Requests to speak and outlines of topics to be discussed at the 
public hearing scheduled for February 5, 2014, at 10:00 a.m., must be 
received by December 16, 2013.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-148659-07), 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-148659-07), 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-148659-07). 
The public hearing will be held at the Internal Revenue Building, 1111 
Constitution Avenue NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Zoran Stojanovic at (202) 622-3980; concerning submissions of comments 
and the hearing, Oluwafunmilayo Taylor at (202) 622-7180 (not toll-free 
numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collection of information contained in this notice of proposed 
rulemaking has been submitted to the Office of Management and Budget 
for review in accordance with the Paperwork Reduction Act of 1995 (44 
U.S.C. 3507(d)). Comments on the collection of information should be 
sent to the Office of Management and Budget, Attn: Desk Officer for the 
Department of the Treasury, Office of Information and Regulatory 
Affairs, Washington, DC 20503, with copies to the Internal Revenue 
Service, Attn: IRS Reports Clearance Officer, SE:CAR:MP:T:T:SP, 
Washington DC 20224. Comments on the collection of information should 
be received by November 15, 2013.
    Comments are sought on whether the proposed collection of 
information is necessary for the proper performance of the Internal 
Revenue Service, including whether the information will have practical 
utility;
    The accuracy of the estimated burden associated with the proposed 
collection of information;
    How the quality, utility, and clarity of the information to be 
collected may be enhanced;
    How the burden of complying with the proposed collection of 
information may be minimized, including through the application of 
automated collection techniques and other forms of information 
technology; and
    Estimates of capital or start-up costs and costs of operation, 
maintenance, and purchase of service to provide information.
    The collection of information in this proposed regulation is in 
Sec.  1.148-4(h)(2)(viii) which contains a requirement that the issuer 
maintain in its records a certificate provided by the hedge provider. 
Existing regulations require, among other items, that a hedge must be 
identified by the actual issuer on its books and records to be a 
qualified hedge. The identification must specify the hedge provider, 
the terms of the contract, and the hedged bonds. The proposed 
regulations require that the identification also include a certificate 
provided by the hedge provider specifying certain information regarding 
the hedge. The respondents are issuers of tax-exempt bonds that enter 
into hedges on their bonds and the hedge providers.
    Estimated total annual recordkeeping burden: 232 hours.
    Estimated average annual burden hours per respondent: 1 hour 45 
minutes.
    Estimated number of respondents: 130.
    Estimated annual frequency of responses: 130.
    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 assigned by the Office of Management and Budget.
    Books or 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 section 6103.

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) and related 
provisions. On June 18, 1993, the Department of the Treasury (Treasury) 
and the IRS published comprehensive final regulations in the Federal 
Register (TD 8476, 58 FR 33510) on the arbitrage investment 
restrictions and related provisions for tax-exempt bonds under sections 
103, 148, 149, and 150, 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). A Notice of Proposed Rulemaking was published in 
the Federal Register (72 FR 54606; REG-106143-07) on September 26, 2007 
(2007 Proposed Regulations), which proposes amendments to the Existing 
Regulations to address market developments, simplify certain 
provisions, address certain technical issues, and make the regulations 
more administrable. One notable change in the 2007 Proposed Regulations 
addresses a municipal market development in which issuers seek to 
modify interest rate risks by entering into hedging transactions that 
are based on taxable interest rate indexes (for example, LIBOR-based 
interest rate swaps). The 2007 Proposed Regulations clarify that these 
hedges qualify to be taken into account with the hedged bonds on a net 
basis in determining bond yield for arbitrage purposes. Among the other 
notable changes in the 2007 Proposed Regulations are (1) a revision to 
an investment bidding safe harbor to accommodate certain transparent 
internet-based electronic bidding procedures; (2) removal of the 
authority in the Existing Regulations to permit issuers of 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; and (3) 
clarification that the amount an issuer is entitled to receive under a 
rebate refund claim is the excess of the total amount actually paid 
over the rebate amount. Among the technical changes in the 2007 
Proposed Regulations are changes to the rules that address qualified 
hedges for arbitrage purposes and additions to the rules on permitted 
yield reduction payments. This document (the Proposed Regulations) 
proposes additional amendments to the Existing Regulations.

Explanation of Provisions

I. Definitions and Elections (Sec.  1.148-1)

    A. Issue price definition. Section 148(h) provides that yield on an 
issue is to be determined on the basis of the issue price (within the 
meaning of sections 1273 and 1274). The issue price definition under 
the Existing Regulations generally follows the issue price definition 
used for computing

[[Page 56844]]

original issue discount on debt instruments under sections 1273 and 
1274 of the Code, with certain modifications. Specifically, the issue 
price definition under the Existing Regulations applies a reasonable 
expectations standard (rather than a standard based on actual sales) 
for determining the issue price of bonds that are publicly offered. 
Under this standard, the first price at which a substantial amount 
(defined to mean ten percent) of the bonds is reasonably expected to be 
sold to the public is treated as the issue price and is used in 
determining the yield on the issue.
    The standard uses reasonable expectations to allow issuers of 
advance refunding bonds to estimate the yield on the issue before the 
actual sales prices of the bonds are known so that the issuer can 
purchase yield-restricted investments for a refunding escrow to defease 
the prior bonds at the time of the sale of the refunding bonds. The 
issue prices of bonds with different payment and credit terms are 
determined separately. Notice 2010-35 (2010-19 IRB 660) provides that 
the arbitrage definition of issue price also applies to other tax-
advantaged bond programs, including Build America Bonds under section 
54AA and other Qualified Tax Credit Bonds under section 54A. See 26 CFR 
601.601(d)(2).
    The Treasury Department and the IRS are concerned that certain 
aspects of the Existing Regulations for determining the issue price of 
tax-exempt bonds are no longer appropriate in light of market 
developments since those regulations were published. In particular, the 
Treasury Department and the IRS are concerned that the ten-percent test 
does not always produce a representative price for the bonds. 
Underwriters of tax-exempt bonds may sell bonds of an issue with the 
same payment and credit terms in an initial public offering at 
different prices but execute the first ten percent of the sales of 
those bonds at the lowest price (and thus the highest yield), causing 
the issue price of the bonds to be a lower price than is representative 
of the prices at which the remaining bonds were sold.
    In addition, increasing transparency about pricing information in 
the municipal bond market (for example, publicly-available pricing 
information from the Municipal Securities Rulemaking Board through its 
Electronic Municipal Market Access (EMMA) platform) has led to 
heightened scrutiny of issue price standards. The reported data has 
shown, in certain instances, actual sales to the public at prices that 
differed significantly from the issue price used by the issuer. These 
price differences have raised questions about the ability of the 
reasonable expectations standard to produce a representative issue 
price. The reported trade data has also called into question whether 
sales to underwriters and security dealers have been included as sales 
to the public in determining issue price in certain instances.
    To address these concerns and to provide greater certainty, the 
Proposed Regulations amend the issue price definition used for 
arbitrage purposes in certain significant respects. Consistent with 
section 148(h), the Proposed Regulations retain the rule that issue 
price generally will be determined under the rules of sections 1273 and 
1274. The Proposed Regulations remove the reference to issue price of 
bonds that are ``publicly offered'' because the existing section 1273 
regulations do not distinguish between public offering and private 
placement. The Proposed Regulations parallel the language in the 
existing section 1273 regulations that refer to debt instruments issued 
for money.
    The Proposed Regulations provide that the issue price of tax-exempt 
bonds issued for money is the first price at which a substantial amount 
of the bonds is sold to the public. (As described further below, the 
Proposed Regulations define the term ``public'' to mean any person 
other than an ``underwriter'' and provide a new definition of the term 
``underwriter.'') The Proposed Regulations, however, remove the 
definition of substantial amount as ten percent. Instead, the Proposed 
Regulations provide a safe harbor under which an issuer may treat the 
first price at which a minimum of 25 percent of the bonds in an issue 
(with the same credit and payment terms) is sold to the public as the 
issue price, provided that all orders at this price received from the 
public during the offering period are filled (to the extent that the 
public orders at such price do not exceed the amount of bonds sold). 
Consistent with section 1273, the Proposed Regulations base the 
determination of issue price on actual sale prices instead of 
reasonably expected sale prices.
    The Treasury Department and the IRS understand that, in the case of 
a refunding issue, an issuer may need to estimate the yield on the 
issue before the actual issue price can be determined so that the 
issuer can purchase yield-restricted investments for a refunding escrow 
to defease the prior bonds at the time of the sale of the refunding 
bonds. The Proposed Regulations provide relief in these situations by 
permitting issuers to make curative payments to the IRS, called ``yield 
reduction payments,'' to reconcile differences between expected and 
actual issue prices of the refunding bonds for arbitrage compliance 
purposes.
    The Existing Regulations disregard sales to ``underwriters'' or 
``wholesalers'' in determining the issue price of tax-exempt bonds that 
are offered to the public. The Proposed Regulations provide that the 
issue price of tax-exempt bonds issued for money is the first price at 
which a substantial amount of the bonds is sold to the public and, for 
this purpose, define the term ``public'' to mean any person other than 
an ``underwriter.'' The Proposed Regulations also define the term 
``underwriter'' to mean any person that purchases bonds from the issuer 
for the purpose of effecting the original distribution of the bonds, or 
otherwise participates directly or indirectly in the original 
distribution. An underwriter includes a lead underwriter and any member 
of a syndicate that contractually agrees to participate in the 
underwriting of the bonds for the issuer. A securities dealer (whether 
or not a member of the issuer's underwriting syndicate) that purchases 
bonds (whether or not from the issuer) for the purpose of effecting the 
original distribution of the bonds is also treated as an underwriter 
for this purpose. An underwriter generally includes a related party to 
an underwriter.
    The Proposed Regulations eliminate the reference to ``wholesalers'' 
in the issue price definition, because the revised, more comprehensive 
definition of underwriter includes those persons who would otherwise be 
treated as ``wholesalers'' under the Existing Regulations.
    Under the Proposed Regulations, a person that holds bonds for 
investment is not an underwriter with respect to those bonds. The 
Treasury Department and the IRS solicit public comment on whether 
specific identification rules, such as the section 1236(b) 
identification rules, should be provided for determining when a bond is 
held for investment.
    B. Working capital expenditures and replacement proceeds 
definition. The Existing Regulations impose a number of arbitrage 
investment restrictions to limit arbitrage incentives for excessive use 
of tax-exempt bond financing for ``working capital expenditures'' 
(working capital), such as operating expenses or seasonal cash flow 
deficits (as distinguished from capital projects). The Proposed 
Regulations amend the treatment of working capital financings in 
several respects to simplify this area and to provide objective 
parameters for longer-term working capital financings.

[[Page 56845]]

    An issuer is relieved of arbitrage investment restrictions on bond 
proceeds only after the proceeds are spent. The Existing Regulations 
impose a strict ``bond proceeds-spent-last'' accounting assumption for 
spending proceeds of tax-exempt bonds on working capital. This 
accounting rule recognizes that sources of funds are fungible and 
treats bond proceeds as spent for working capital purposes only after 
the issuer depletes other ``available amounts'' that the issuer 
otherwise could use for this purpose. An issuer, however, need not be 
``broke to borrow'' for working capital purposes. Here, the Existing 
Regulations allow an issuer to maintain a ``reasonable working capital 
reserve'' fund that need not be spent before spending bond proceeds on 
working capital. The Existing Regulations provide a general rule that 
the permitted size of this reasonable working capital reserve fund is 
an objective measure equal to five percent of the issuer's actual 
working capital expenditures in the previous fiscal year from 
operations. In addition, the Existing Regulations include a broad 
prohibition against direct or indirect financing of a working capital 
reserve itself. This prohibition against financing working capital 
reserves imposes another complex limit on the size of the permitted 
working capital reserve fund that requires analysis of amounts 
previously maintained for such purpose.
    The Proposed Regulations remove the restriction against financing a 
working capital reserve. This restriction inappropriately penalizes 
those State and local governments that have previously maintained the 
least amount of working capital reserves and that may have the most 
bona fide need to finance working capital expenditures. Further, this 
restriction is complex. The Proposed Regulations retain the existing 
general five percent test for the size of a permitted reasonable 
working capital reserve fund.
    The Existing Regulations also limit working capital financings 
through the concept of replacement proceeds. The arbitrage rules apply 
to more than the actual proceeds of the issue; they apply to gross 
proceeds, which include proceeds and replacement proceeds of an issue. 
The Existing Regulations provide broadly that replacement proceeds 
arise if an issuer reasonably expects as of the issue date that (1) the 
term of an issue will be longer than reasonably necessary for the 
governmental purposes of the issue, and (2) there will be available 
amounts for expenditures of the type being financed during the period 
that the issue remains outstanding longer than necessary. One purpose 
of the replacement proceeds rules is to discourage issuers from issuing 
tax-exempt bonds with unduly long maturities or leaving tax-exempt 
bonds outstanding longer than reasonably necessary. The replacement 
proceeds rules particularly affect working capital financings.
    The Existing Regulations provide a safe harbor against the creation 
of replacement proceeds for short-term working capital bond financings 
that are outstanding for no longer than two years. To address concerns 
about arbitrage incentives associated with certain short-term financing 
practices, however, Rev. Proc. 2002-31 (2002-1 CB 916) shortened the 
safe-harbor for these financings from two years to 13 months in most 
circumstances. Questions have arisen with respect to the interaction 
between the Existing Regulations and Rev. Proc. 2002-31. See 26 CFR 
601.601(d)(2).
    The Proposed Regulations provide that the maturity safe harbor 
against the creation of replacement proceeds for short-term working 
capital financings is 13 months. This change conforms the regulatory 
safe harbor to the more recent administrative standard under Rev. Proc. 
2002-31 for the traditional short-term working capital financings for 
seasonal cash flow deficits.
    The Existing Regulations, however, provide no safe harbors against 
the creation of replacement proceeds or other specific guidance 
regarding appropriate limits for longer-term working capital 
financings, such as longer-term deficit financings for issuers 
experiencing financial distress. State and local governments have 
sought guidance on appropriate parameters for such financings. The 
Proposed Regulations provide a new objective safe harbor against the 
creation of replacement proceeds for working capital financings that 
have terms longer than the proposed 13-month safe harbor. This new safe 
harbor requires an issuer to determine the first year in which it 
expects to have available amounts for working capital expenditures, 
monitor for actual available amounts in each year beginning with the 
year it first expects to have such amounts, and apply such available 
amounts in each year either to retire or to invest in tax-exempt bonds 
that are not investment property under section 148(b)(3) of the Code 
(that is, tax-exempt bonds that are not subject to the alternative 
minimum tax). Consistent with the purpose of the replacement proceeds 
rules, this new safe harbor aims to control the burden of unnecessary 
tax-exempt financings on the tax-exempt bond market by requiring 
issuers to redeem or purchase tax-exempt bonds.
    The Existing Regulations have a general arbitrage anti-abuse rule, 
which provides, in part, that specific factors (particularly bona fide 
cost under-runs and long-term financial distress) may justify a bond 
maturity that exceeds the maturity safe harbors against the creation of 
replacement proceeds. Separately, the Existing Regulations provide more 
favorable accounting rules for certain extraordinary, non-recurring 
working capital items, such as casualty losses. The Proposed 
Regulations add extraordinary working capital items to the factors that 
may justify a bond term beyond the maturity safe harbors against the 
creation of replacement proceeds.

II. Qualified Hedge Provisions (Sec.  1.148-4)

    To determine the yield on hedged bonds for purposes of the 
arbitrage investment restrictions, the Existing Regulations permit 
issuers to take into account and integrate the net payments on certain 
qualified hedges entered into to modify the risk of interest rate 
changes with the payments on the associated hedged tax-exempt bonds. In 
general, to be a qualified hedge, the terms of the hedge must 
correspond closely with those of the hedged bonds, the issuer must 
identify the hedge, and the hedge must contain no significant 
investment element.
    The Existing Regulations provide that a termination of a qualified 
hedge includes any sale or other disposition of the hedge by the issuer 
or the acquisition by the issuer of an offsetting hedge. The Existing 
Regulations further provide that a deemed termination of a qualified 
hedge occurs when certain material modifications or assignments of a 
hedge result in a realization event to the issuer under section 1001. 
Under the Existing Regulations, if a hedge is deemed terminated, the 
issuer is deemed to have made or received a termination payment and, if 
applicable (such as when there is a material modification of the 
hedge), a deemed acquisition payment for a ``new'' hedge. Because the 
hedge is integrated with the bond yield, the deemed payments, like 
actual termination payments, can affect the yield on the bonds.
    Issues have arisen in this area as a result of market conditions 
during the last several years. State and local governments have faced a 
number of circumstances that have put pressure on issuers to modify or 
terminate their existing qualified hedges. Treasury and the IRS have 
also received questions indicating that there is uncertainty about what 
constitutes an ``offsetting

[[Page 56846]]

hedge'' that terminates a qualified hedge.
    In the 2007 Proposed Regulations, Treasury and the IRS solicited 
public comments regarding the types of offsetting hedges that are 
necessary for valid business purposes and recommendations on how to 
clarify the rule in the Existing Regulations regarding offsetting 
hedges. The Proposed Regulations consider those comments and propose 
rules that provide greater certainty regarding hedge terminations and 
clarify and simplify the treatment of modifications and terminations of 
qualified hedges.
    A. Modifications of qualified hedges. The Proposed Regulations 
provide guidance on the treatment of modifications of qualified hedges 
while eliminating the concept of offsetting hedges. The Proposed 
Regulations provide that a modification, including an actual 
modification, an acquisition of another hedge, or an assignment, 
generally will result in a deemed termination of a hedge if the 
modification is material and results in a deemed disposition under 
section 1001.
    The Proposed Regulations provide, however, that a material 
modification of a qualified hedge that otherwise would result in a 
deemed termination will not result in such a termination if the 
modified hedge is a qualified hedge. For this purpose, the Proposed 
Regulations require testing the modified hedge for compliance with the 
requirements for qualified hedges at the time of the modification.
    These proposed changes generally produce results that are 
economically comparable to the Existing Regulations, but in a simpler 
manner. The Proposed Regulations reduce complexity associated with the 
approach under the Existing Regulations by eliminating the need to 
account for deemed hedge termination and acquisition payments, which 
deemed payments generally offset each other without substantive effect 
on the yield on the hedged bonds.
    B. Continuations of qualified hedges in refundings. The Existing 
Regulations generally treat a refunding of hedged bonds as a deemed 
termination of a qualified hedge and require accounting for the deemed 
termination payment in the yield on the refunding bonds over the 
remaining term of the original hedge in accordance with economic 
substance. The Proposed Regulations simplify the treatment of qualified 
hedges upon refunding hedged bonds when there is no actual termination 
of the associated hedge. If the affected hedge meets the requirements 
for a qualified hedge of the refunding bonds as of the issue date of 
the refunding bonds, with certain exceptions, the Proposed Regulations 
treat the affected hedge as continuing as a qualified hedge of the 
refunding bonds instead of being terminated. Similar to the proposed 
treatment of hedge modifications, the proposed treatment of these 
continuations of qualified hedges in refundings under the Proposed 
Regulations generally produces economically comparable results as the 
Existing Regulations in a simpler manner.
    C. Termination of hedges at fair market value. The 2007 Proposed 
Regulations clarify that the termination payment for a termination or a 
deemed termination of a qualified hedge is equal to the fair market 
value of the hedge on the termination date. In response to comments 
received on the clarification in the 2007 Proposed Regulation, these 
Proposed Regulations modify the 2007 proposed rule. For a deemed 
termination of a qualified hedge, the Proposed Regulations provide that 
the amount of the termination payment is equal to the fair market value 
of the qualified hedge on the termination date. For an actual 
termination of a qualified hedge, the Proposed Regulations provide that 
the amount of the hedge termination payment treated as made or received 
on the hedged bonds (i) may not exceed the fair market value of the 
qualified hedge if paid by the issuer, and (ii) may not be less than 
the fair market value of the qualified hedge if received by the issuer. 
Comments on the 2007 Proposed Regulations as well as comments received 
in response to these Proposed Regulations will be considered in 
connection with finalizing this rule.

III. Other Technical Changes

    The Proposed Regulations make other technical changes to the 
Existing Regulations. This section describes the technical changes.
    A. Temporary period spending exception to yield restriction (Sec.  
1.148-2). The Existing Regulations provide certain short-term 
exceptions, called ``temporary period'' exceptions, which allow 
investment of proceeds of tax-exempt bonds for fairly short periods 
without yield restriction. These exceptions reduce administrative 
burdens and recognize that limited arbitrage potential exists for bond 
proceeds that are spent promptly.
    The Existing Regulations provide no express exceptions for proceeds 
used for certain types of working capital expenditures, such as certain 
extraordinary working capital items. The Proposed Regulations broaden 
the existing 13-month temporary period exception to yield restriction 
for restricted working capital expenditures to include all working 
capital expenditures.
    B. Certification of hedge provider (Sec.  1.148-4). Concerns have 
been raised about pricing of hedges involving tax-exempt bonds. 
Existing regulations require, among other items, that a hedge must be 
identified by the actual issuer on its books and records to be a 
qualified hedge. The identification must specify the hedge provider, 
the terms of the contract, and the hedged bonds. To promote greater 
accountability and transparency about pricing of these hedges, the 
Proposed Regulations require that the identification also include a 
certificate provided by the hedge provider specifying certain 
information regarding the hedge including a statement about the bona 
fide, arm's-length nature of the pricing and information about payments 
beyond those properly taken into account as payments to modify the risk 
of interest rate changes.
    C. Yield and valuation of investments (Sec.  1.148-5). The Existing 
Regulations provide guidance on how to value investments allocated to 
an issue. Absent a special rule, the Existing Regulations give issuers 
the option to choose a valuation method, provided that the chosen 
method is consistently applied for arbitrage purposes on a valuation 
date. The special rules in the Existing Regulations leave some 
ambiguity about when the present value and the fair market value 
methods of valuation are permitted or required.
    The Proposed Regulations clarify that the fair market value method 
of valuation generally is required for any investment (including a 
yield-restricted investment) on the date the investment is first 
allocated to an issue or first ceases to be allocated to an issue as a 
consequence of a deemed acquisition or a deemed disposition.
    The Existing Regulations include only one exception to this 
mandatory fair market value rule. The issuer has the option to value an 
investment at present value when proceeds are allocated from one bond 
issue to another bond issue as transferred proceeds in refundings or 
universal cap allocations, provided that both affected bond issues 
consist exclusively of tax-exempt bonds. This exception applies only to 
transfers between two tax-exempt bond issues to address a concern about 
allocating excessive value to obligations without arbitrage 
restrictions. This exception, however, creates a disincentive against 
retiring tax-exempt bonds with taxable bonds, such as when the fair 
market value of the investment would cause investment yield to exceed 
the tax-

[[Page 56847]]

exempt bond yield. Such a disincentive is inconsistent with the general 
policies behind the arbitrage rules as stated in Sec.  1.148-0. To 
provide more appropriate incentives, the Proposed Regulations change 
this rule to require only that the issue from which the investment is 
allocated (that is, the first issue in an allocation from one issue to 
another) consists exclusively of tax-exempt bonds.
    D. Authority of Commissioner under anti-abuse rule (Sec.  1.148-
10). The Existing Regulations provide the Commissioner with authority 
to exercise discretion with respect to any transaction entered into for 
the principal purpose of obtaining a material financial advantage based 
on the difference between tax-exempt and taxable interest rates in a 
manner that is inconsistent with the arbitrage rules. The Proposed 
Regulations revise the Existing Regulations to clarify that the 
Commissioner has the authority to depart from the arbitrage rules as 
necessary to prevent such material financial advantage.
    E. Transition provision for certain guarantee funds (Sec.  1.148-
11). Section 1.148-11(d)(1) provides a transition rule that allows 
certain State perpetual trust funds (for example, certain state 
permanent school funds) to pledge funds to guarantee tax-exempt bonds 
without resulting in arbitrage-restricted replacement proceeds. In 
Notice 2010-5 (2010-2 IRB 256) the Treasury Department and the IRS 
proposed to increase the amount of tax-exempt bonds that such funds 
could guarantee under this special rule and stated their intent to 
issue proposed regulations to implement this change. The Proposed 
Regulations include these changes. The Proposed Regulations also extend 
this rule to cover certain tax-exempt bonds issued to finance public 
charter schools in response to comments received on the Notice. See 26 
CFR 601.601(d)(2).
    F. Definitions and special rules (Sec.  1.150-1).
    1. Definition of tax-advantaged bonds. The Proposed Regulations 
provide a new definition of tax-advantaged bonds as tax-exempt bonds 
under section 103, taxable bonds that provide Federal tax credits to 
investors to subsidize the issuer's borrowing costs, and taxable bonds 
that provide refundable Federal tax credits payable directly to issuers 
under section 6431, or any future similar bonds that provide a Federal 
subsidy for any portion of an issuer's borrowing costs.
    2. Definition of issue. The Existing Regulations provide that tax-
exempt bonds and taxable bonds are not part of the same issue. 
Questions have arisen regarding the appropriate treatment of taxable 
tax-advantaged bonds for purposes of this composite issue provision. 
The Proposed Regulations clarify that taxable tax-advantaged bonds and 
other taxable bonds are treated as part of different issues. The 
Proposed Regulations also clarify that different types of tax-
advantaged bonds are treated as parts of different issues.
    3. Definition and treatment of grants. The Existing Regulations 
include a definition of a grant. The Existing Regulations also provide 
a special arbitrage spending rule that treats proceeds used by an 
issuer to make a grant to an unrelated party as spent for arbitrage 
investment tracking purposes when the grant is made. A longstanding 
question is whether an issuer may look at the grantee's use of the 
grant funds to determine whether the bond issue complies with other 
arbitrage and general program restrictions on tax-exempt bonds. For 
example, taking into account the grantee's use may impact whether the 
issue finances capital projects or working capital expenditures, and 
accordingly which arbitrage rules apply to that issue. The Proposed 
Regulations expand the application of the existing definition of grant 
for arbitrage purposes to apply that definition to other tax-exempt 
bond provisions. The Proposed Regulations clarify that the character 
and nature of a grantee's use of proceeds generally is taken into 
account in determining whether other applicable non-arbitrage 
requirements of the issue are met.

IV. Effective/Applicability Dates

    The Proposed Regulations generally are proposed to apply 
prospectively to bonds that are sold on or after the date that is 90 
days after publication of final regulations in the Federal Register. 
Section 1.148-4(h)(2)(viii) is proposed to apply to qualified hedges 
that are entered into on or after the date that is 90 days after the 
date of publication of the final regulations in the Federal Register. 
Section 1.148-4(h)(3)(iv)(A) through (H) and (h)(4)(iv) are proposed to 
apply to hedges that are entered into on or after the date that is 90 
days after the date of publication of final regulations in the Federal 
Register, to qualified hedges that are modified on or after such date 
with respect to such modifications, and to qualified hedges on bonds 
that are refunded on or after such date with respect to such refunding.
    In addition, except as otherwise provided in the next paragraph, 
issuers may apply and rely upon the Proposed Regulations, in whole or 
in part, with respect to bonds that are sold on or after September 16, 
2013, and before the date that is 90 days after publication of final 
regulations in the Federal Register.
    Issuers may apply and rely upon Sec.  1.148-4(h)(3)(iv)(A) through 
(H) and (h)(4)(iv) of the Proposed Regulations in whole to hedges that 
are entered into on or after September 16, 2013, and before the date 
that is 90 days after publication of final regulations in the Federal 
Register; to qualified hedges that are modified on or after September 
16, 2013, and before the date that is 90 days after publication of 
final regulations in the Federal Register with respect to such 
modifications; and to qualified hedges on bonds that are refunded on or 
after September 16, 2013, and before the date that is 90 days after 
publication of final regulations in the Federal Register with respect 
to such refunding.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
12866, as supplemented by Executive Order 13563. 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 or 
simplify existing regulatory provisions, or otherwise involve 
simplifying or clarifying changes that will not have a significant 
economic impact on governmental jurisdictions or other entities of any 
size. These proposed regulations amend the issue price definition used 
for arbitrage purposes and provide a new objective safe harbor against 
the creation for replacement proceeds for long term working capital 
financings. These proposed changes are not expected to have a 
significant economic impact because they provide greater certainty to 
issuers and assist issuers in complying with the arbitrage restrictions 
on tax-exempt bonds.
    Other proposed changes involve the treatment of certain hedging 
transactions, including requiring a certificate from a hedge provider. 
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 large 
counterparties. The IRS and the Treasury Department specifically 
solicit comment from any party,

[[Page 56848]]

particularly small entities, on the accuracy of this certification. 
Pursuant to section 7805(f) of the Code, this regulation has been 
submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on its impact on small business.

Comments and Public Hearing

    Before these Proposed Regulations are adopted as final regulations, 
consideration will be given to any comments that are submitted timely 
to the IRS as prescribed in this preamble under the ADDRESSES heading. 
The IRS and the Treasury Department request comments on all aspects of 
the proposed rules. All comments that are submitted by the public will 
be available for public inspection and copying at www.regulations.gov 
or upon request.
    A public hearing has been scheduled for February 5, 2014, at 10:00 
a.m. in the IRS Auditorium, Internal Revenue Service, 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 15 minutes before the hearing 
starts. For more 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 by December 16, 2013. Submit a 
signed paper original and eight (8) copies or an electronic copy. 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 Johanna Som de 
Cerff, Office of Associate Chief Counsel (Financial Institutions and 
Products), IRS, and Vicky Tsilas, Office of Tax Policy. However, other 
personnel from the IRS and Treasury 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

0
Paragraph 1. The authority citation for part 1 is amended by removing 
the entry for Sec.  1.148-6 and revising the entry for Sec. Sec.  
1.148-0 through 1.148-11 to read in part as follows:

    Authority: 26 U.S.C. 7805 * * *
    Sections 1.148-0 through 1.148-11 also issued under 26 U.S.C. 
148(i). * * *

0
Par. 2. Section 1.141-0 is amended by revising the section heading for 
Sec.  1.141-15 and adding new entries for Sec.  1.141-15(l), (m), and 
(n) to read as follows:


Sec.  1.141-0  Table of contents.

* * * * *


Sec.  1.141-15  Effective/applicability dates.

* * * * *
    (l) [Reserved]
    (m) [Reserved]
    (n) Effective/applicability dates for certain regulations relating 
to certain definitions.
* * * * *
0
Par. 3. Section 1.141-1 is amended by revising paragraph (a) to read as 
follows:


Sec.  1.141-1  Definitions and rules of general application.

    (a) In general. For purposes of Sec. Sec.  1.141-0 through 1.141-
16, the following definitions and rules apply: the definitions in this 
section, the definitions in Sec.  1.150-1, the definition of placed in 
service in Sec.  1.150-2(c), the definition of reasonably required 
reserve or replacement fund in Sec.  1.148-2(f), and the definitions in 
Sec.  1.148-1 of bond year, commingled fund, fixed yield issue, higher 
yielding investments, investment, investment proceeds, issue price, 
issuer, nonpurpose investment, purpose investment, qualified guarantee, 
qualified hedge, reasonable expectations or reasonableness, rebate 
amount, replacement proceeds, sale proceeds, variable yield issue and 
yield.
* * * * *
0
Par. 4. Section 1.141-15 is amended by revising the section heading and 
adding paragraphs (l), (m), and (n) to read as follows:


Sec.  1.141-15  Effective/applicability dates.

* * * * *
    (l) [Reserved]
    (m) [Reserved]
    (n) Effective/applicability dates for certain regulations relating 
to certain definitions. Revised Sec.  1.141-1(a) applies to bonds that 
are sold on or after the date that is 90 days after publication of 
final regulations in the Federal Register.
0
Par. 5. Section 1.148-0 is amended by adding new entries in paragraph 
(c) for Sec. Sec.  1.148-1(f) and 1.148-11(k) and (l); and revising the 
entries for Sec. Sec.  1.148-2(e)(3) and 1.148-10(e) and section 
heading for Sec.  1.148-11 to read as follows:


Sec.  1.148-0  Scope and table of contents.

* * * * *
    (c) Table of contents. * * *


Sec.  1.148-1  Definitions and elections.

* * * * *
    (f) Definition of issue price.
    (1) In general.
    (2) Tax-exempt bonds issued for money.
    (3) Definitions.
    (4) Special rules.


Sec.  1.148-2  General arbitrage yield restriction rules.

* * * * *
    (e) * * *
    (3) Temporary period for working capital expenditures.
* * * * *


Sec.  1.148-10  Anti-abuse rules and authority of Commissioner.

* * * * *
    (e) Authority of the Commissioner to prevent transactions that are 
inconsistent with the purpose of the arbitrage rules.
* * * * *


Sec.  1.148-11  Effective/applicability dates.

* * * * *
    (k) [Reserved]
    (l) Certain arbitrage guidance updates.
0
Par. 6. Section 1.148-1 is amended by:
0
1. Revising the definition of issue price in paragraph (b).
0
2. Revising paragraphs (c)(4)(i)(B)(1) and (c)(4)(ii).
0
3. Removing the ``or'' at the end of paragraph (c)(4)(i)(B)(2).
0
4. Removing the period at the end of paragraph (c)(4)(i)(B)(3) and 
adding in its place a semi-colon and the word ``or''.
0
5. Adding a new paragraphs (c)(4)(i)(B)(4) and (f).
    The additions and revisions read as follows:


Sec.  1.148-1  Definitions and elections.

* * * * *
    (b) * * *
    Issue price means issue price as defined in paragraph (f) of this 
section.
* * * * *

[[Page 56849]]

    (c) * * *
    (4) * * *
    (i) * * *
    (B) * * *
    (1) For the portion of an issue that is to be used to finance 
restricted working capital expenditures, if that portion is not 
outstanding longer than the temporary period under Sec.  1.148-2(e)(3) 
for which the proceeds qualify;
* * * * *
    (4) For the portion of an issue that is to be used to finance 
working capital expenditures and that is outstanding for a period 
longer than the temporary period under Sec.  1.148-2(e)(3), if that 
portion satisfies paragraph (c)(4)(ii) of this section.
    (ii) Safe harbor for longer-term working capital financings. A 
portion of an issue used to finance working capital expenditures 
satisfies this paragraph (c)(4)(ii) if the issuer meets the 
requirements of paragraphs (c)(4)(ii)(A) and (c)(4)(ii)(B) of this 
section.
    (A) Determine expected available amounts. An issuer meets the 
requirements of this paragraph (c)(4)(ii)(A) if--
    (1) On the issue date, the issuer determines the first fiscal year 
following the applicable temporary period (determined under Sec.  
1.148-2(e)) in which it reasonably expects to have available amounts 
for the financed working capital expenditures (first testing year), but 
in no event can the first testing year be later than five years after 
the issue date; and
    (2) Beginning with the first testing year and for each subsequent 
fiscal year for which the applicable portion of the issue remains 
outstanding, the issuer determines its available amounts for the 
financed working capital expenditures as of the first day of the fiscal 
year (yearly available amount).
    (B) Application of yearly available amount to reduce burden on tax-
exempt bond market. An issuer meets the requirements of this paragraph 
(c)(4)(ii)(B) if, within 90 days after the start of each year in which 
it determines a yearly available amount, the issuer applies an amount 
equal to the yearly available amount for such year to redeem or invest 
in tax-exempt bonds that are excluded from investment property under 
section 148(b)(3) (that is, tax-exempt bonds that are not subject to 
the alternative minimum tax)(eligible tax-exempt bonds). The maximum 
amount required to be applied in such manner shall equal the 
outstanding principal amount of the applicable portion of the issue 
subject to the safe harbor in this paragraph (c)(4)(ii), determined as 
of the date of such redemption or investment. Any amounts invested in 
eligible tax-exempt bonds shall be invested or reinvested continuously 
in such tax-exempt bonds, except during a permitted reinvestment period 
of no more than 30 days in a fiscal year, for as long as the applicable 
portion of the issue remains outstanding.
* * * * *
    (f) Definition of issue price--(1) In general. Except as otherwise 
provided in this paragraph (f), issue price is defined in sections 1273 
and 1274 and the regulations under those sections. In determining the 
issue price under section 1274 of a bond that is issued for property, 
the adjusted applicable Federal rate, as computed for purposes of 
section 1288, is used in lieu of the applicable Federal rate in 
determining the issue price.
    (2) Tax-exempt bonds issued for money--(i) In general. The issue 
price of tax-exempt bonds issued for money is the first price at which 
a substantial amount of the bonds is sold to the public (as defined in 
paragraph (f)(3)(i) of this section). See paragraph (f)(4)(ii) of this 
section for an issue including bonds with different payment and credit 
terms.
    (ii) Safe harbor for determining issue price of tax-exempt bonds 
issued for money. For purposes of paragraph (f)(2)(i) of this section, 
the issuer may treat the first price at which a minimum of 25 percent 
of the bonds is sold to the public as the issue price. However the 
preceding sentence applies only if all orders at this sale price 
received from the public within the offering period are filled to the 
extent the public orders at such price do not exceed the amount of 
bonds sold.
    (3) Definitions. For purposes of this paragraph (f), the following 
definitions apply:
    (i) Public. Public means any person (as defined in section 
7701(a)(1)) other than an underwriter.
    (ii) Underwriter--(A) In general. Except as otherwise provided in 
paragraph (f)(3)(ii)(C) of this section, the term underwriter means any 
person (as defined in section 7701(a)(1)) that purchases bonds from an 
issuer for the purpose of effecting the original distribution of the 
bonds or that otherwise participates directly or indirectly in such 
original distribution. An underwriter includes a lead underwriter and 
any member of a syndicate that contractually agrees to participate in 
the underwriting of the bonds for the issuer. A securities dealer 
(whether or not a member of an underwriting syndicate for the issuer) 
that purchases bonds (whether or not from the issuer) for the purpose 
of effecting the original distribution of the bonds is also treated as 
an underwriter for purposes of this section
    (B) Certain related parties included. Except as otherwise provided 
in paragraph (f)(3)(ii)(C) of this section, an underwriter includes any 
related party (as defined in Sec.  1.150-1(b)) to an underwriter.
    (C) Holding for investment. A person (as defined in section 
7701(a)(1)) that holds bonds for investment is treated as a member of 
the public with respect to those bonds.
    (iii) Securities dealer. Securities dealer means a dealer in 
securities, as defined in section 475(c)(1).
    (4) Special rules. For purposes of this paragraph (f), the 
following special rules apply:
    (i) Subsequent sale at a different price. The issue price as 
determined under paragraph (f)(1) or (2) of this section does not 
change if part of the issue is later sold at a different price.
    (ii) Separate determinations. The issue price of bonds in an issue 
that do not have the same credit and payment terms is determined 
separately.
0
Par. 7. Section 1.148-2 is amended by revising paragraph (e)(3)(i) to 
read as follows:


Sec.  1.148-2  General arbitrage yield restriction rules.

* * * * *
    (e) * * *
    (3) * * *
    (i) General rule. The proceeds of an issue that are reasonably 
expected to be allocated to working capital expenditures within 13 
months after the issue date qualify for a temporary period of 13 months 
beginning on the issue date. Paragraph (e)(2) of this section contains 
additional temporary period rules for certain working capital 
expenditures that are treated as part of a capital project.
* * * * *
0
Par. 8. Section 1.148-4 is amended by:
0
1. Revising paragraphs (h)(2)(viii) and (h)(3)(iv)(A).
0
2. Redesignating paragraph (h)(3)(iv)(B) as newly redesignated 
paragraph (h)(3)(iv)(E) and revising newly redesignated paragraph 
(h)(3)(iv)(E).
0
3. Redesignating paragraph (h)(3)(iv)(C) as newly redesignated 
paragraph (h)(3)(iv)(F) and revising the first sentence in newly 
redesignated paragraph (h)(3)(iv)(F).
0
4. Redesignating paragraph (h)(3)(iv)(D) as newly redesignated 
paragraph (h)(3)(iv)(G) and revising

[[Page 56850]]

newly redesignated paragraph (h)(3)(iv)(G).
0
5. Redesignating paragraph (h)(3)(iv)(E) as newly redesignated 
paragraph (h)(3)(iv)(H) and revising the first sentence in newly 
redesignated paragraph (h)(3)(iv)(H).
0
6. Adding new paragraphs (h)(3)(iv)(B), (h)(3)(iv)(C), (h)(3)(iv)(D) 
and (h)(4)(iv).
    The revisions and additions read as follows:


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

* * * * *
    (h) * * *
    (2) * * *
    (viii) Identification--(A) In general. 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. 
The identification must be maintained by the actual issuer and must 
specify the name of the hedge provider, the terms of the contract, the 
hedged bonds, and include a hedge provider's certification as described 
in paragraph (h)(2)(viii)(B) of this section. The identification must 
contain sufficient detail to establish that the requirements of this 
paragraph (h)(2) and, if applicable, paragraph (h)(4) of this section 
are satisfied. In addition, the existence of the hedge must be noted on 
the first form relating to the issue of which the hedged bonds are a 
part that is filed with the Internal Revenue Service on or after the 
date on which the contract is identified pursuant to this paragraph 
(h)(2)(viii).
    (B) Hedge provider's certification. The hedge provider's 
certification must provide that--
    (1) The terms of the hedge were agreed to between a willing buyer 
and willing seller in a bona fide, arm's-length transaction;
    (2) The rate payable by the issuer under the hedge is comparable to 
the rate that the hedge provider would have quoted on the trade date to 
enter into a reasonably comparable hedge with a counterparty that is 
similarly situated to the issuer and that involves a hedge on debt 
obligations other than tax-exempt bonds, taking into account all the 
terms of the hedge;
    (3) The hedge provider has not made, and does not expect to make, 
any payment to any third party in connection with the hedge, except for 
any such third-party payment that the hedge provider expressly 
identifies in documents for the hedge; and
    (4) The amounts paid or received pursuant to the hedge do not 
include any payments other than payments reasonably allocable to the 
modification of risk of interest rate changes and to the hedge 
provider's overhead that are properly taken into account under 
paragraph (h)(3)(i) of this section, unless the hedge provider 
separately identifies such payments.
    (3) * * *
    (iv) Accounting for modifications and terminations--(A) 
Modification defined. A modification of a qualified hedge includes, 
without limitation, a change in the terms of the hedge, an issuer's 
acquisition of another hedge with terms that have the effect of 
modifying an issuer's risks of interest rate changes or other terms of 
an existing qualified hedge, or an assignment of a hedge provider's 
remaining rights and obligations under the hedge to a third party. For 
example, if the issuer enters into a qualified hedge that is an 
interest rate swap under which it receives payments based on LIBOR, and 
subsequently enters a second hedge (with the same or different 
provider) that limits the issuer's exposure under the existing 
qualified hedge to variations in LIBOR, the new hedge modifies the 
qualified hedge.
    (B) Termination defined. A termination means either an actual or a 
deemed termination of a qualified hedge. Except as otherwise provided, 
an actual termination of a qualified hedge occurs to the extent that 
the issuer sells, disposes of, or otherwise actually terminates all or 
a portion of the hedge. A deemed termination of a qualified hedge 
occurs if the hedge ceases to meet the requirements for a qualified 
hedge of the hedged bonds; the issuer makes a modification (as defined 
in paragraph (h)(3)(iv)(A) of this section) that results in a deemed 
exchange of the hedge and a realization event to the issuer under 
section 1001; or the issuer redeems all or a portion of the hedged 
bonds.
    (C) Special rules for certain modifications when the hedge remains 
qualified. A modification of a qualified hedge that otherwise would 
result in a deemed termination under paragraph (h)(3)(iv)(B) of this 
section does not result in such a termination if the modified hedge 
meets the requirements for a qualified hedge, determined as of the date 
of the modification. For purposes of this paragraph (h)(3)(iv)(C), when 
determining whether the hedge is qualified, the fact that the existing 
qualified hedge is off-market as of the date of the modification is 
disregarded and the identification requirement in paragraph 
(h)(2)(viii) of this section applies by measuring the time period for 
identification from the date of the modification and without regard to 
the requirement for a hedge provider's certification.
    (D) Continuations of certain qualified hedges in refundings. If 
hedged bonds are redeemed using proceeds of a refunding issue, the 
qualified hedge is not actually terminated, and the hedge meets the 
requirements for a qualified hedge for the refunding bonds as of the 
issue date of the refunding bonds, then no termination of the hedge 
occurs and the hedge instead is treated as a qualified hedge for the 
refunding bonds. For purposes of this paragraph (h)(3)(iv)(D), when 
determining whether the hedge is a qualified hedge for the refunding 
bonds, the fact that the hedge is off-market with respect to the 
refunding bonds as of the issue date of the refunding bonds is 
disregarded and the identification requirement in paragraph 
(h)(2)(viii) of this section applies by measuring the time period for 
identification from the issue date of the refunding bonds and without 
regard to the requirement for a hedge provider's certification.
    (E) General allocation rules for hedge termination payments. Except 
as otherwise provided in paragraphs (h)(3)(iv)(F), (G), and (H) of this 
section, a payment made or received by an issuer to terminate a 
qualified hedge, or a payment deemed made or received for a deemed 
termination, is treated as a payment made or received, as appropriate, 
on the hedged bonds. Upon an actual termination of a qualified hedge, 
the amount of the payment that an issuer may treat as a termination 
payment made or received on the hedged bonds--
    (1) May not exceed the fair market value of the qualified hedge on 
such date if paid by the issuer; and
    (2) May not be less than the fair market value of the qualified 
hedge on such date if received by the issuer.
    Upon a deemed termination of a qualified hedge, the amount of the 
termination payment is equal to the fair market value of the qualified 
hedge on the termination date. Except as otherwise provided, a 
termination payment is reasonably allocated to the remaining periods 
originally covered by the terminated hedge in a manner that reflects 
the economic substance of the hedge.
    (F) Special rule for terminations when bonds are redeemed. Except 
as otherwise provided in this paragraph (h)(3)(iv)(F) and in paragraph 
(h)(3)(iv)(G) of this section, when a qualified hedge is deemed 
terminated because the hedged bonds are redeemed, the termination 
payment as determined under paragraph

[[Page 56851]]

(h)(3)(iv)(E) of this section is treated as made or received on that 
date. * * *
    (G) Special rules for refundings. When there is a termination of a 
qualified hedge because there is a refunding of the hedged bonds, to 
the extent that the hedged bonds are redeemed using the proceeds of a 
refunding issue, the termination payment is accounted for under 
paragraph (h)(3)(iv)(E) of this section by treating it as a payment on 
the refunding issue, rather than the hedged bonds. In addition, to the 
extent that the refunding issue is redeemed during the period to which 
the termination payment has been allocated to that issue, paragraph 
(h)(3)(iv)(F) of this section applies to the termination payment by 
treating it as a payment on the redeemed refunding issue.
    (H) Safe harbor for allocation of certain termination payments. A 
payment to terminate a qualified hedge does not result in that hedge 
failing to satisfy the applicable provisions of paragraph (h)(3)(iv)(E) 
of this section if that payment is allocated in accordance with this 
paragraph (h)(3)(iv)(H). * * *
    (4) * * *
    (iv) Consequences of certain modifications. The special rules under 
paragraph (h)(4)(iii) of this section regarding the effects of 
terminations of qualified hedges of fixed yield hedged bonds also 
applies in the same manner to modifications of a qualified hedge under 
paragraph (h)(3)(iv)(C) of this section. Thus, for example, a 
modification may result in a prospective change in the yield on the 
hedged bonds for arbitrage rebate purposes under Sec.  1.148-3.
* * * * *
0
Par. 9. Section 1.148-5 is amended by:
0
1. Revising paragraphs (c)(3), (d)(2) and (d)(3).
0
2. Revising the last sentence in paragraph (d)(6)(i) and adding a 
sentence at the end of the paragraph.
    The revisions and additions read as follows:


Sec.  1.148-5  Yield and valuation of investments.

* * * * *
    (c) * * *
    (3) Applicability of special yield reduction rule--(i) through (ix) 
[Reserved].
    (x) Investments allocable to gross proceeds of an issue to the 
extent that the yield reduction payments made with respect to such 
investments under paragraph (c)(1) of this section relate to any 
difference between the amount of the actual issue price of the issue 
and the issuer's reasonable expectations regarding such issue price 
determined as of the sale date of the issue.
    (d) * * *
    (2) Mandatory valuation of certain yield restricted investments at 
present value. Except as otherwise provided in paragraphs (b)(3) and 
(d)(3) of this section, a yield restricted investment must be valued at 
present value.
    (3) Mandatory valuation of certain investments at fair market 
value--(i) In general. Except as otherwise provided in paragraphs 
(d)(3)(ii) and (d)(4) of this section, an investment must be valued at 
fair market value on the date that it is first allocated to an issue or 
first ceases to be allocated to an issue as a consequence of a deemed 
acquisition or deemed disposition. For example, if an issuer deposits 
existing nonpurpose investments into a sinking fund for an issue, those 
investments must be valued at fair market value as of the date first 
deposited into the fund.
    (ii) Exception to fair market value requirement for transferred 
proceeds allocations, universal cap allocations, and commingled funds. 
Paragraph (d)(3)(i) of this section does not apply if the investment is 
allocated from one issue to another as a result of the transferred 
proceeds allocation rule under Sec.  1.148-9(b) or the universal cap 
rule under Sec.  1.148-6(b)(2), provided that the issue from which the 
investment is allocated (that is, the first issue in an allocation from 
one issue to another) consists exclusively of tax-exempt bonds. In 
addition, paragraph (d)(3)(i) of this section does not apply to 
investments in a commingled fund (other than a bona fide debt service 
fund) unless it is an investment being initially deposited in or 
withdrawn from a commingled fund described in Sec.  1.148-6(e)(5)(ii).
* * * * *
    (6) * * * (i) * * * On the purchase date, the fair market value of 
a United States Treasury obligation that is purchased directly from the 
United States Treasury, including a State and Local Government Series 
(SLGS) security, is its purchase price. The fair market value of a SLGS 
security on any date other than the original purchase date is the 
redemption price for redemption on that date.
* * * * *


Sec.  1.148-6  [Amended]

0
Par. 10. In Sec.  1.148-6, paragraph (d)(4)(iii) is removed.
0
Par. 11. Section 1.148-10 is amended by revising the last sentence of 
paragraph (a)(4) and the heading and first sentence of paragraph (e) to 
read as follows:


Sec.  1.148-10  Anti-abuse rules and authority of Commissioner.

    (a) * * *
    (4) * * * These factors may be outweighed by other factors, such as 
bona fide cost underruns, an issuer's bona fide need to finance 
extraordinary working capital items, or an issuer's long-term financial 
distress.
* * * * *
    (e) Authority of the Commissioner to prevent transactions that are 
inconsistent with the purpose of the arbitrage rules. If an issuer 
enters into a transaction for a principal purpose of obtaining a 
material financial advantage based on the difference between tax-exempt 
and taxable interest rates in a manner that is inconsistent with the 
purposes of section 148, the Commissioner may exercise the 
Commissioner's discretion to depart from the rules of Sec. Sec.  1.148-
1 through 1.148-11 as necessary to prevent such financial advantage. * 
* *
0
Par. 12. Section 1.148-11 is amended by:
0
1. Revising the section heading.
0
2. Redesignating paragraph (d)(1) as newly redesignated paragraph 
(d)(1)(i).
0
3. Redesignating paragraphs (d)(1)(i), (d)(1)(ii), (d)(1)(iii), 
(d)(1)(iv), (d)(1)(v), and (d)(1)(vi) as newly redesignated paragraphs 
(d)(1)(i)(A), (d)(1)(i)(B), (d)(1)(i)(C), (d)(1)(i)(D), (d)(1)(i)(E), 
and (d)(1)(i)(F), respectively.
0
4. Revising newly redesignated paragraphs (d)(1)(i)(B), (d)(1)(i)(D), 
and (d)(1)(i)(F), and adding new paragraphs (d)(1)(ii), (k) and (l).
    The revisions and additions read as follows:


Sec.  1.148-11  Effective/applicability dates.

* * * * *
    (d) * * *
    (1) * * *
    (i) * * *
    (B) The corpus of the guarantee fund may be invaded only to support 
specifically designated essential governmental functions (designated 
functions) carried on by political subdivisions with general taxing 
powers or public elementary and public secondary schools;
* * * * *
    (D) The issue guaranteed consists of obligations that are not 
private activity bonds (other than qualified 501(c)(3) bonds) 
substantially all of the proceeds of which are to be used for 
designated functions;
* * * * *
    (F) As of the sale date of the bonds to be guaranteed, the amount 
of the bonds to be guaranteed by the fund plus the then-outstanding 
amount of bonds

[[Page 56852]]

previously guaranteed by the fund does not exceed a total amount equal 
to 500 percent of the total costs of the assets held by the fund as of 
December 16, 2009.
    (ii) The Commissioner may, by published guidance, set forth 
additional circumstances under which guarantees by certain perpetual 
trust funds will not cause amounts in the fund to be treated as 
replacement proceeds.
* * * * *
    (k) [Reserved]
    (l) Additional arbitrage guidance updates--(1) In general. Sections 
1.148-1(b); 1.148-1(c)(4)(i)(B)(1); 1.148-1(c)(4)(i)(B)(4); 1.148-
1(c)(4)(ii); 1.148-1(f); 1.148-2(e)(3)(i); 1.148-5(c)(3); 1.148-
5(d)(2); 1.148-5(d)(3); 1.148-5(d)(6)(i); 1.148-6(d)(4); 1.148-
10(a)(4); 1.148-10(e); 1.148-11(d)(1)(i)(B); 1.148-11(d)(1)(i)(D); 
1.148-11(d)(1)(i)(F); and 1.148-11(d)(1)(ii) apply to bonds that are 
sold on or after the date that is 90 days after the date of publication 
of final regulations in the Federal Register.
    (2) Section 1.148-4(h)(2)(viii) applies to hedges that are entered 
into on or after the date that is 90 days after the date of publication 
of the final regulations in the Federal Register.
    (3) Section 1.148-4(h)(3)(iv)(A) through (H) and (h)(4)(iv) apply 
to--
    (i) Hedges that are entered into on or after the date that is 90 
days after the date of publication of the final regulations in the 
Federal Register;
    (ii) Qualified hedges that are modified on or after the date that 
is 90 days after the date of publication of the final regulations in 
the Federal Register with respect to modifications on or after such 
date; and
    (iii) Qualified hedges on bonds that are refunded on or after the 
date that is 90 days after the date of publication of the final 
regulations in the Federal Register with respect to the refunding on or 
after such date.
0
Par. 13. Section 1.150-1 is amended by:
0
1. Adding a new paragraph (a)(2)(iii).
0
2. Adding a definition for tax-advantaged bond in alphabetical order to 
paragraph (b).
0
3. Revising paragraph (c)(2).
0
4. Adding a new paragraph (f).
    The revisions and additions read as follows:


Sec.  1.150-1  Definitions.

    (a) * * *
    (2) * * *
    (iii) Special effective date for definitions of tax-advantaged 
bond, issue, and grant. The definition of tax-advantaged bond in 
paragraph (b) of this section, the revisions to the definition of issue 
in paragraph (c)(2) of this section, and the definition and rules 
regarding the treatment of grants in paragraph (f) of this section 
apply to bonds that are sold on or after the date that is 90 days after 
publication of final regulations in the Federal Register.
* * * * *
    (b) * * *
    Tax-advantaged bond means a tax-exempt bond, a taxable bond that 
provides a Federal tax credit to the investor with respect to the 
issuer's borrowing costs, a taxable bond that provides a refundable 
Federal tax credit payable directly to the issuer of the bond for its 
borrowing costs under section 6431, or any future similar bond that 
provides a Federal subsidy for any portion of the borrowing costs. 
Examples of tax-advantaged bonds include qualified tax credit bonds 
under section 54A(d)(1) and build America bonds under section 54AA.
* * * * *
    (c) * * *
    (2) Exceptions for different types of tax-advantaged bonds and 
taxable bonds. Each type of tax-advantaged bond that has a different 
structure for delivery of the borrowing subsidy or different program 
eligibility requirements is treated as part of a different issue under 
this paragraph (c). Further, tax-advantaged bonds and bonds that are 
not tax-advantaged bonds are treated as part of different issues under 
this paragraph (c). The issuance of tax-advantaged bonds in a 
transaction with other non tax-advantaged bonds must be tested under 
the arbitrage anti-abuse rules under Sec.  1.148-10(a) and other 
applicable anti-abuse rules (for example, limitations against window 
maturity structures or unreasonable allocations of bonds).
* * * * *
    (f) Definition and treatment of grants--(1) Definition. Grant means 
a transfer for a governmental purpose of money or property to a 
transferee that is not a related party to or an agent of the 
transferor. The transfer must not impose any obligation or condition to 
directly or indirectly repay any amount to the transferor or a related 
party. Obligations or conditions intended solely to assure expenditure 
of the transferred moneys in accordance with the governmental purpose 
of the transfer do not prevent a transfer from being a grant.
    (2) Treatment. Except as otherwise provided (for example, Sec.  
1.148-6(d)(4), which treats proceeds used for grants as spent for 
arbitrage purposes when the grant is made), the character and nature of 
a grantee's use of proceeds are taken into account in determining which 
rules are applicable to the bond issue and whether the applicable 
requirements for the bond issue are met.
    For example, a grantee's use of proceeds generally determines 
whether the proceeds are used for capital projects or working capital 
expenditures under section 148 and whether the qualified purposes for 
the specific type of bond issue are met.

Beth Tucker,
Deputy Commissioner for Operations Support.
[FR Doc. 2013-21880 Filed 9-13-13; 8:45 am]
BILLING CODE 4830-01-P