Arbitrage Restrictions on Tax-Exempt Bonds

Federal RegisterMay 10, 1994

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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

[TD 8538]

RIN 1545-AS50

Arbitrage Restrictions on Tax-Exempt Bonds

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

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SUMMARY: This document contains final and temporary regulations on the

arbitrage and related restrictions applicable to tax-exempt bonds

issued by State and local governments. Changes to the applicable law

were made by the Tax Reform Act of 1986, the Technical and

Miscellaneous Revenue Act of 1988, the Revenue Reconciliation Act of

1989, and the Revenue Reconciliation Act of 1990. These regulations

affect issuers of tax-exempt bonds and provide guidance for complying

with the arbitrage and related restrictions. The text of the temporary

regulations also serves as the text of a portion of the proposed

regulations set forth in the notice of proposed rulemaking on this

subject in the Proposed Rules section of this issue of the Federal

DATES: These regulations are effective on June 9, 1994.

For dates of applicability of these regulations, see Sec. 1.148-

11T.

FOR FURTHER INFORMATION CONTACT: William P. Cejudo at 202-622-3980 (not

a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

These regulations are being issued without prior notice and public

procedure pursuant to the Administrative Procedure Act (5 U.S.C. 553).

For this reason, the collection of information contained in these

regulations has been reviewed and, pending receipt and evaluation of

public comments, approved by the Office of Management and Budget under

control number 1545-1347.

For further information concerning this collection of information,

and where to submit comments on the collection of information and the

accuracy of the estimated burden, and suggestions for reducing this

burden, please refer to the preamble to the cross-referencing notice of

proposed rulemaking published in the Proposed Rules section of this

issue of the Federal Register.

Background

Section 148 restricts the use of proceeds of tax-exempt State and

local bonds to acquire higher yielding investments. Proposed

regulations relating to the arbitrage and related rules were published

at Secs. 1.148-0 through 1.148-11, 1.149(d)-1, 1.149(g)-1, 1.150-1, and

1.150-2 in the Federal Register for November 6, 1992. Written comments

were received on the proposed regulations, and additional public

comments were received at a public hearing held on February 2, 1993.

After consideration of the comments, the proposed regulations were

modified and adopted in final form in the Federal Register for June 18,

1993 (the June 1993 regulations).

This document contains temporary and final regulations amending the

Income Tax Regulations (26 CFR part 1) under sections 103, 148, 149,

and 150 of the Internal Revenue Code to clarify and revise certain

provisions of the June 1993 regulations. The amended provisions of the

June 1993 regulations contain references to applicable provisions of

the temporary regulations, and the final regulations apply as if the

changes contained in the appropriate portion of the temporary

regulations were incorporated therein. For example, Sec. 1.148-

1(c)(4)(ii)(A) is amended to reference Sec. 1.148-1T(c)(4)(ii)(A),

which contains provisions that apply in lieu of those formerly

contained in Sec. 1.148-1(c)(4)(ii)(A).

Explanation of Provisions

A. Sec. 1.103-8T--Interest on Bonds To Finance Certain Exempt

Facilities

The June 1993 regulations amended the ``official action'' rules of

Sec. 1.103-8(a)(5) to better coordinate those rules and the

reimbursement bond rules of Sec. 1.150-2. The temporary regulations

clarify the application of these rules to situations in which the

financed facility is placed in service after the issuance of the bonds.

B. Sec. 1.148-1T--Definitions and Elections

The June 1993 regulations provide that replacement proceeds may

arise if a working capital reserve is financed but not to the extent

that the issuer maintained a working capital reserve. The temporary

regulations provide guidance to determine whether an issuer has

maintained a working capital reserve.

C. Sec. 1.148-4T--Yield on an Issue of Bonds

1. Certain Variable Yield Bonds Aggregated for Fixed Yield Treatment

The temporary regulations expand the types of bonds eligible for

fixed yield treatment to include certain variable yield bonds that, if

aggregated and treated as a single bond, would be a fixed yield bond.

2. Qualified Hedging Transactions

The June 1993 regulations permit certain qualified hedges to be

taken into account in determining the yield on an issue. The temporary

regulations revise and clarify these rules. Most significantly, the

temporary regulations amend the rules treating certain variable yield

bonds as fixed yield bonds to provide fixed yield treatment for bonds

that are hedged with certain other hedges, such as certain interest

rate caps. Municipal financing transactions with so-called embedded

derivative products raise significant policy issues under any

contingent interest regulations that may be promulgated under section

1275. For this reason, under the original issue discount regulations,

certain of these transactions do not qualify as ``variable rate debt

instruments'' and are subject to the contingent payment rules. The

modifications to the qualified hedging rules do not imply a conclusion

by the IRS and Treasury that the ``interest'' payments in these

financings are properly treated as tax-exempt. It is expected that

future regulations will deal specifically with these issues. In a

related change, the temporary regulations clarify that a hedge (other

than a qualified hedge) may constitute investment-type property. The

proposed amendments to the arbitrage regulations also provide special

rules for purposes of determining whether interest rate caps are

investment-type property.

D. Sec. 1.148-5T--Yield and Valuation of Investments

1. Permissive Single Investment Rule

The temporary regulations limit the rule that permits yield

restricted investments to be treated as a single investment for

arbitrage rebate purposes to nonpurpose investments in a refunding

escrow fund and in a sinking fund that is related to the refunding

escrow fund.

2. Fair Market Valuation

The temporary regulations limit the exception to the fair market

valuation rule for certain transferred proceeds allocations, universal

cap allocations, and investments in a commingled fund to those

involving exclusively tax-exempt bond issues.

E. Sec. 1.148-9--Arbitrage Rules for Refunding Issues

Multipurpose Issue Allocations

The June 1993 regulations provide that allocations of multipurpose

issues must be reasonable. For multipurpose refunding issues, in

addition to the reasonableness requirement, the June 1993 regulations

provide additional limitations. Comments are requested on possible

changes to the allocation rule that generally focuses on matching the

debt service structure of the prior issue that would provide additional

flexibility for refundings involving extensions of maturity.

F. Sec. 1.148-11T--Effective Dates

Overpayment of Rebate

The temporary regulations allow for retroactive application of the

provisions of the June 1993 regulations relating to recovery of

overpayments.

G. Sec. 1.149(d)-1T--Limitations on Advance Refundings

Savings Test

The temporary regulations clarify the application of the

multipurpose issue rules to the section 149(d) requirement that the

refunded bonds in an advance refunding be retired at the first call

date if savings are produced.

H. Sec. 1.150-1T--Definitions

Definition of Issue

The June 1993 regulations define ``issue'' for purposes of the tax-

exempt bond restrictions. The temporary regulations clarify certain

aspects of this definition including whether bonds are expected to be

paid from the same source of funds.

I. Effective Dates

The temporary and final regulations apply to bonds sold after June

6, 1994. In addition, issuers may apply these regulations to other

bonds to which the June 1993 regulations apply.

Special Analyses

It has been determined that this Treasury decision is not a

significant regulatory action as defined in EO 12866. Therefore, a

regulatory assessment is not required. It also has been determined that

section 553(b) of the Administrative Procedures Act (5 U.S.C. chapter

5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply

to these regulations, and, therefore, a Regulatory Flexibility Analysis

is not required. Pursuant to section 7805(f) of the Internal Revenue

Code, these regulations will be submitted to the Chief Counsel for

Advocacy of the Small Business Administration for comment on their

impact on small business.

Drafting Information

The principal author of these regulations is William P. Cejudo,

Office of Assistant Chief Counsel (Financial Institutions and

Products), IRS. However, other personnel from the IRS and 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

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

PART 1--[AMENDED]

PART 602--[AMENDED]

Paragraph 1. The authority citation for part 1 is amended by adding

an entry in numerical order to read in part as follows:

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

Section 1.148-11T also issued under 26 U.S.C. 148(f), (g), and

(i). * * *

Par. 2. In Sec. 1.103-8, paragraph (a)(5) is revised to read as

follows:

Sec. 1.103-8 Interest on bonds to finance certain exempt facilities.

(a) * * *

* * * * *

(5) See Sec. 1.103-8T.

* * * * *

Par. 3. Section 1.103-8T is added to read as follows:

Sec. 1.103-8T Interest on bonds to finance certain exempt facilities

(temporary).

(a)(1) through (4) [Reserved]. For guidance see Sec. 1.103-8.

(5) Limitation. (i) A facility qualifies under Sec. 1.103-8 only to

the extent that there is a valid reimbursement allocation under

Sec. 1.150-2 with respect to expenditures that are incurred before the

issue date of the bonds to provide the facility and that are to be paid

with the proceeds of the issue. In addition, if the original use of the

facility begins before the issue date of the bonds, the facility does

not qualify under Sec. 1.103-8 if any person that was a substantial

user of the facility at any time during the 5-year period before the

issue date or any related person to that user receives (directly or

indirectly) 5 percent or more of the proceeds of the issue for the

user's interest in the facility, and is a substantial user of the

facility at any time during the 5-year period after the issue date,

unless--

(A) An official intent for the facility is adopted under

Sec. 1.150-2 within 60 days after the date on which acquisition,

construction, or reconstruction of that facility commenced; and

(B) For an acquisition, no person that is a substantial user or

related person after the acquisition date was also a substantial user

more than 60 days before the date on which the official intent was

adopted.

(ii) A facility the original use of which commences (or the

acquisition of which occurs) on or after the issue date of bonds to

provide that facility qualifies under Sec. 1.103-8 only to the extent

that an official intent for the facility is adopted under Sec. 1.150-2

by the issuer of the bonds within 60 days after the commencement of the

construction, reconstruction, or acquisition of that facility.

Temporary construction or other financing of a facility prior to the

issuance of the bonds to provide that facility will not cause that

facility to be one that does not qualify under this paragraph

(a)(5)(ii).

(iii) For purposes of paragraph (a)(5)(i) of this section,

substantial user has the meaning used in section 147(a)(1); related

person has the meaning used in section 144(a)(3); and a user that is a

governmental unit within the meaning of Sec. 1.103-1 is disregarded.

(iv) Except to the extent provided in Sec. 1.150-2(j) and

Sec. 1.148-11T(i), this paragraph (a)(5) applies to bonds issued after

June 30, 1993.

Par. 4. In Sec. 1.148-0, paragraph (c) is amended as follows:

1. The introductory text is revised.

2. The entry for Sec. 1.148-4, paragraph (b)(5) is redesignated

paragraph (b)(6).

3. A new entry for Sec. 1.148-4, paragraph (b)(5) is added.

4. An entry for Sec. 1.148-11, paragraph (i) is added.

Sec. 1.148-0 Scope and table of contents.

* * * * *

contents for Secs. 1.148-1, 1.148-2, 1.148-3, 1.148-4, 1.148-5, 1.148-

6, 1.148-7, 1.148-8, 1.148-9, 1.148-10 and 1.148-11.

* * * * *

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

* * * * *

(b) * * *

(5) Special aggregation rule treating certain bonds as a single

fixed yield bond.

* * * * *

Sec. 1.148-11 Effective dates.

* * * * *

(i) Transition rule for certain amendments.

Par. 5. In Sec. 1.148-1, paragraph (c)(4)(ii)(A) is revised to read

as follows:

Sec. 1.148-1 Definitions and elections.

* * * * *

(4) * * *

(ii) * * *

(A) In general. See Sec. 1.148-1T(c)(4)(ii)(A).

* * * * *

Par. 6. Section 1.148-1T is added to read as follows:

Sec. 1.148-1T Definitions and elections (temporary).

(a) [Reserved]. For guidance see Sec. 1.148-1.

(b) Certain definitions.

Investment-type property. See Sec. 1.148-1(b). Investment-type

property also includes a contract that would be a hedge (within the

meaning of Sec. 1.148-4(h)) except that it contains a significant

investment element.

(c)(4)(ii) Bonds financing a working capital reserve--(A) In

general. Except as otherwise provided in Sec. 1.148-1(c)(4)(ii)(B),

replacement proceeds arise to the extent a working capital reserve is,

directly or indirectly, financed with the proceeds of the issue

(regardless of the expenditure of proceeds of the issue). Thus, for

example, if an issuer that does not maintain a working capital reserve

borrows to fund such a reserve, the issuer will have replacement

proceeds. To determine the amount of a working capital reserve

maintained, an issuer may use the average amount maintained as a

working capital reserve during annual periods of at least one year, the

last of which ends within a year before the issue date. For example,

the amount of a working capital reserve may be computed using the

average of the beginning or ending monthly balances of the amount

maintained as a reserve (net of unexpended gross proceeds) during the

one year period preceding the issue date.

Par. 7. In Sec. 1.148-2, paragraph (b)(2)(ii) is revised to read as

follows:

Sec. 1.148-2 General arbitrage yield restriction rules.

* * * * *

(b) * * *

(2) * * *

(ii) Exception to certification requirements. See Sec. 1.148-

2T(b)(2)(ii).

* * * * *

Par. 8. Section 1.148-2T is added to read as follows:

Sec. 1.148-2T General arbitrage yield restriction rules (temporary).

(a) through (b)(2)(i) [Reserved]. For guidance see Sec. 1.148-2.

(b)(2)(ii) Exceptions to certification requirement. An issuer is

not required to make a certification for an issue under Sec. 1.148-

2(b)(2)(i) if--

(A) The issuer reasonably expects as of the issue date that there

will be no unspent gross proceeds after the issue date, other than

gross proceeds in a bona fide debt service fund (e.g., equipment lease

financings in which the issuer purchases equipment in exchange for an

installment payment note); or

(B) The issue price of the issue does not exceed $1,000,000.

Par. 9. In Sec. 1.148-3, paragraph (h)(3) is amended by adding a

sentence after the last sentence to read as follows:

Sec. 1.148-3 General arbitrage rebate rules.

* * * * *

(h) * * *

(3) * * * See also Sec. 1.148-3T(h)(3).

* * * * *

Par. 10. Section 1.148-3T is added to read as follows:

Sec. 1.148-3T General arbitrage rebate rules (temporary).

(a) through (h)(2) [Reserved]. For guidance see Sec. 1.148-3.

(h)(3) Waivers of the penalty. For purposes of Sec. 1.148-3(h)(3),

willful neglect does not include a failure that is attributable solely

to the permissible retroactive selection of a short first bond year if

the rebate amount that the issuer failed to pay is paid within 60 days

of the selection of that bond year.

Par. 11. Section 1.148-4 is amended as follows:

1. Paragraph (b)(5) is redesignated as paragraph (b)(6).

2. New paragraph (b)(5) is added.

3. Paragraph (g) is revised.

4. Paragraph (h)(1) is revised.

5. Paragraph (h)(2)(vii) is revised.

6. Paragraph (h)(2)(ix) is revised.

7. Paragraphs (h)(3), (4), and (5) are revised.

8. The revised and added provisions read as follows:

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

* * * * *

(b) * * *

(5) Special aggregation rule treating certain bonds as a single

fixed yield bond. See Sec. 1.148-4T(b)(5).

* * * * *

(g) Yield on certain mortgage revenue and student loan bonds. See

Sec. 1.148-4T(g).

(h) * * *

(1) In general. See Sec. 1.148-4T(h)(1).

(2) * * *

* * * * *

(vii) Timing and duration. See Sec. 1.148-4T(h)(2)(vii).

* * * * *

(ix) Identification. See Sec. 1.148-4T(h)(2)(ix).

(3) Accounting for qualified hedges. See Sec. 1.148-4T(h)(3).

(4) Certain variable yield bonds treated as fixed yield bonds. See

Sec. 1.148-4T(h)(4).

(5) Authority of the Commissioner. See Sec. 1.148-4T(h)(6).

Par. 12. Section 1.148-4T is added to read as follows:

Sec. 1.148-4T Yield on an issue of bonds (temporary).

(a) through (b)(4) [Reserved]. For guidance see Sec. 1.148-4.

(b)(5) Special aggregation rule treating certain bonds as a single

fixed yield bond. Two variable yield bonds of an issue are treated in

the aggregate as a single fixed yield bond if--

(i) Aggregate treatment would result in the single bond being a

fixed yield bond; and

(ii) The terms of the bonds do not contain any features that could

distort the aggregate fixed yield from what the yield would be if a

single fixed yield bond were issued. For example, if an issue contains

a bond bearing interest at a floating rate and a related bond bearing

interest at a rate equal to a fixed rate minus that floating rate,

those two bonds are treated as a single fixed yield bond only if

neither bond may be redeemed unless the other bond is also redeemed at

the same time.

(g) Yield on certain mortgage revenue and student loan bonds. For

purposes of section 148 and Sec. 1.148-4, section 143(g)(2)(C)(ii)

applies to the computation of yield on an issue of qualified mortgage

bonds or qualified veterans' mortgage bonds. For purposes of applying

sections 148 and 143(g) to a variable yield issue of qualified mortgage

bonds, qualified veterans' mortgage bonds, or qualified student loan

bonds, the yield on that issue is computed over the term of the issue,

and Sec. 1.148-4(d) does not apply to the issue. As of any date before

the final maturity date, the yield over the term of the issue is based

on the actual amounts paid or received to that date and the amounts

that are reasonably expected (as of that date) to be paid or received

over the remaining term of the issue.

(h) Qualified hedging transactions--(1) In general. Payments made

or received by an issuer under a qualified hedge (as defined in

Sec. 1.148-4(h)(2)) relating to bonds of an issue are taken into

account (as provided in paragraph (h)(3) of this section) to determine

the yield on the issue. Except as provided in paragraphs (h)(4) and

(h)(5)(ii)(C) of this section, the bonds to which a qualified hedge

relates are treated as variable yield bonds. These hedging rules apply

solely for purposes of sections 143(g), 148, and 149(d).

(2) (i) through (vi) [Reserved]. For guidance see Sec. 1.148-

4(h)(2).

(2)(vii) Timing and duration. For a contract to be a qualified

hedge under Sec. 1.148-4(h)(2), payments must not begin to accrue under

the contract on a date earlier than the issue date of the hedged bonds

and must not accrue longer than the hedged interest payments on the

hedged bonds.

(viii) [Reserved]. For guidance see Sec. 1.148-4(h).

(ix) Identification. For a contract to be a qualified hedge under

Sec. 1.148-4(h)(2), the contract must be identified by the actual

issuer on its books and records maintained for the hedged bonds not

later than three days after the date on which the parties enter into

the contract. The identification must specify the hedge provider, the

terms of the contract, and the hedged bonds. The identification must

contain sufficient detail to establish that the requirements of

Sec. 1.148-4(h)(2), and if applicable, paragraph (h)(4) of this section

are satisfied. The existence of the hedge must be noted on all forms

filed with the Internal Revenue Service for the issue on or after the

date on which the hedge is entered into.

(3) Accounting for qualified hedges--(i) In general. Except as

otherwise provided in paragraph (h)(4) of this section, payments made

or received by the issuer under a qualified hedge are treated as

payments made or received, as appropriate, on the hedged bonds that are

taken into account in determining the yield on those bonds. These

payments are reasonably allocated to the hedged bonds in the period to

which the payments relate, as determined under paragraph (h)(3)(iii) of

this section. Payments made or received by the issuer include payments

deemed made or received when a contract is terminated or deemed

terminated under this paragraph (h)(3). Payments reasonably allocable

to the reduction of risk of interest rate changes and to the hedge

provider's overhead under this paragraph (h) are included as payments

made or received under a qualified hedge.

(ii) Exclusions from hedge. Payments for services or other items

under the contract that are not expressly treated as payments under the

qualified hedge under paragraph (h)(3)(i) of this section are not

payments with respect to a qualified hedge.

(iii) Timing and allocation of payments. The period to which a

payment made by the issuer relates is determined under general Federal

income tax principles, including, without limitation, Sec. 1.446-3, and

adjusted as necessary to reflect the end of a computation period and

the start of a new computation period. Except as provided in paragraphs

(h)(3)(iv) and (h)(5)(ii) of this section, a payment received by the

issuer is taken into account in the period that the interest payment

that the payment hedges is required to be made.

(iv) Termination payments--(A) Termination defined. 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. A deemed termination occurs when the hedged bonds are redeemed

and when a hedge ceases to be a qualified hedge of the hedged bonds. In

the case of an assignment by a hedge provider of its remaining rights

and obligations on the hedge to a third party or a modification of the

hedging contract, the assignment or modification is treated as a

termination with respect to the issuer only if it results in a deemed

exchange of the hedge and a realization event under section 1001.

(B) General rule. A payment made or received by an issuer to

terminate a qualified hedge, including loss or gain realized or deemed

realized, is treated as a payment made or received on the hedged bonds,

as appropriate. The 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.

as otherwise provided in this paragraph (h)(3)(iv)(C) and in paragraph

(h)(3)(iv)(D) of this section, when a qualified hedge is deemed

terminated because the hedged bonds are redeemed, the fair market value

of the contract on the redemption date is treated as a termination

payment made or received on that date. When hedged bonds are redeemed,

any payment received by the issuer on termination of a hedge, including

a termination payment or a deemed termination payment, reduces, but not

below zero, the interest payments made by the issuer on the hedged

bonds in the computation period ending on the termination date. The

remainder of the payment, if any, is reasonably allocated over the bond

years in the immediately preceding computation period or periods to the

extent necessary to eliminate the excess.

(D) Special rules for refundings. 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)(B) 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, rather than the hedged bonds, has been redeemed, paragraph

(h)(3)(iv)(C) of this section applies to the termination payment by

treating it as a payment on the redeemed refunding issue.

(E) Safe harbor for certain non-level payments. A non-level payment

to terminate a hedge does not result in that hedge failing to satisfy

the applicable provisions of paragraph (h)(3)(iv)(B) of this section if

the payment is allocated to each bond year for which the hedge would

have been in effect in accordance with this paragraph (h)(3)(iv)(E).

For a variable yield issue, an equal amount (or for any short bond

year, a proportionate amount of the equal amount) must be allocated to

each bond year such that the sum of the present values of the annual

amounts equals the present value of the non-level payment. Present

value is computed as of the day the hedge is terminated, using the

yield on the hedged bonds, determined without regard to the non-level

payment. The yield used for this purpose is computed for the period

beginning on the first date the hedge is in effect and ending on the

date the hedge is terminated. On the other hand, for a fixed yield

issue, the non-level payment is taken into account as a single payment

on the date it is paid.

(4) Certain variable yield bonds treated as fixed yield bonds--(i)

In general. Except as otherwise provided in this paragraph (h)(4), if

the issuer of variable yield bonds enters into a qualified hedge, the

hedged bonds are treated as fixed yield bonds paying a fixed interest

rate if:

(A) Start date. The date on which payments begin to accrue on the

hedge is not later than 15 days after the issue date of the hedged

bonds.

(B) Maturity. The term of the hedge is equal to the entire period

during which the hedged bonds bear interest at variable interest rates.

hedge correspond closely in time to the hedged portion of the payments

on the hedged bonds. Hedge payments received within 15 days of the

related payments on the hedged bonds generally so correspond.

(D) Aggregate payments fixed. Taking into account all payments made

and received under the hedge and all payments on the hedged bonds

(i.e., after netting all payments), the issuer's aggregate payments are

fixed and determinable as of a date not later than 15 days after the

issue date of the hedged bonds. Payments on bonds are treated as fixed

for purposes of this paragraph (h)(4)(i)(D) if payments on the bonds

are based, in whole or in part, on one interest rate, payments on the

hedge are based, in whole or in part, on a second interest rate that is

substantially the same as, but not identical to, the first interest

rate and payments on the bonds would be fixed if the two rates were

identical. Rates are treated as substantially the same if they are

reasonably expected to be substantially the same throughout the term of

the hedge. For example, an objective 30-day tax-exempt variable rate

index or other objective index (e.g., J.J. Kenny Index, PSA Municipal

swap index, a percentage of LIBOR) may be substantially the same as an

issuer's individual 30-day interest rate.

(ii) Accounting. Except as otherwise provided in this paragraph

(h)(4)(ii), in determining yield on the hedged bonds, all the issuer's

actual interest payments on the hedged bonds and all payments made and

received on a hedge described in paragraph (h)(4)(i) of this section

are taken into account. If payments on the bonds and payments on the

hedge are based, in whole or in part, on variable interest rates that

are substantially the same within the meaning of paragraph (h)(4)(i)(D)

of this section (but not identical), yield on the issue is determined

by treating the variable interest rates as identical. For example, if

variable rate bonds bearing interest at a weekly rate equal to the rate

necessary to remarket the bonds at par are hedged with an interest rate

swap under which the issuer receives payments based on a short-term

floating rate index that is substantially the same as, but not

identical to, the weekly rate on the bonds, the interest payments on

the bonds are treated as equal to the payments received by the issuer

under the swap for purposes of computing the yield on the bonds.

(iii) Effect of termination--(A) In general. Except as otherwise

provided in this paragraph (h)(4)(iii) and paragraph (h)(5) of this

section, the issue of which the hedged bonds are a part is treated as

if it were reissued as of the termination date of the qualified hedge

covered by paragraph (h)(4)(i) of this section in determining yield on

the hedged bonds for purposes of Sec. 1.148-3. The redemption price of

the retired issue and the issue price of the new issue equal the

aggregate values of all the bonds of the issue on the termination date.

In computing the yield on the new issue for this purpose, any

termination payment is accounted for under paragraph (h)(3)(iv) of this

section, applied by treating the termination payment as made or

received on the new issue under this paragraph (h)(4)(iii).

(B) Effect of early termination. Except as otherwise provided in

this paragraph (h)(4)(iii), the general rules of paragraph (h)(4)(i) of

this section do not apply in determining the yield on the hedged bonds

for purposes of Sec. 1.148-3 if the hedge is terminated or deemed

terminated within 5 years after the issue date of the issue of which

the hedged bonds are a part. Thus, the hedged bonds are treated as

variable yield bonds for purposes of Sec. 1.148-3 from the issue date.

does not apply to a termination if, based on the facts and

circumstances (e.g., taking into account both the termination and any

qualified hedge that immediately replaces the terminated hedge), there

is no change in the yield. In addition, this paragraph (h)(4)(iii) does

not apply to a termination caused by the bankruptcy or insolvency of

the hedge provider if the Commissioner determines that the termination

occurred without any action by the issuer (other than to protect its

rights under the hedge).

(5) Special rules for certain hedges--(i) Certain acquisition

payments. A payment to the issuer by the hedge provider (e.g., an up-

front payment for an off-market swap) in connection with the

acquisition of a hedge that, but for that payment, would be a qualified

hedge, does not cause the hedge to fail to be a qualified hedge

provided the payment to the issuer and the issuer's payments under the

hedge in excess of those that it would make if the hedge bore rates

equal to the on-market rates for the hedge are separately identified in

a certification of the hedge provider and not taken into account in

determining the yield on the issue of which the hedged bonds are a

part. The on-market rates are determined as of the date the parties

enter into the contract.

(ii) Anticipatory hedges--(A) In general. A contract does not fail

to be a hedge under Sec. 1.148-4(h)(2)(i)(A) solely because it is

entered into with respect to an anticipated issuance of tax-exempt

bonds. The identification required under Sec. 1.148-4T(h)(2)(ix) must

specify the reasonably expected governmental purpose, principal amount,

and issue date of the hedged bonds, and the manner in which interest is

reasonably expected to be computed.

(B) Special rules. Payments made in connection with the issuance of

a bond to terminate or otherwise close (terminate) an anticipatory

hedge of that bond do not prevent the hedge from satisfying the

requirements of Sec. 1.148-4(h)(2)(vi) and paragraph (h)(2)(vii) of

this section. Amounts received or deemed to be received by the issuer

in connection with the issuance of the hedged bonds to terminate an

anticipatory hedge are treated as proceeds of the hedged bonds.

anticipatory hedge is a fixed yield bond if, taking into account

payments on the hedge that are made or fixed on or before the issue

date of the bond and the payments to be made on the bond, the bond

satisfies the definition of fixed yield bond. See also paragraph (h)(4)

of this section.

(6) Authority of the Commissioner--(i) In general. A contract is

not a qualified hedge if the Commissioner determines, based on all the

facts and circumstances, that treating the contract as a qualified

hedge would provide a material potential for arbitrage, or a principal

purpose for entering into the contract is that arbitrage potential. For

example, a contract that requires a substantial nonperiodic payment may

constitute, in whole or part, an embedded loan, investment-type

property, or other investment.

(ii) Other qualified hedges. The Commissioner, by publication of a

revenue ruling or revenue procedure, may specify contracts that do not

otherwise meet the requirements of Sec. 1.148-4(h)(2) as qualified

hedges and contracts that do not otherwise meet the requirements of

paragraph (h)(4) of this section as causing the hedged bonds to be

treated as fixed yield bonds.

(iii) Recomputation of yield. If an issuer enters into a hedge that

is not properly identified, fails to properly associate an anticipatory

hedge with the hedged bonds, or otherwise fails to meet the

requirements of this section, the Commissioner may recompute the yield

on the issue taking the hedge into account if the failure to take the

hedge into account distorts that yield or otherwise fails to clearly

reflect the economic substance of the transaction.

Par. 13. Section 1.148-5 is amended as follows:

1. Paragraph (b)(2)(iii) is revised.

2. Paragraph (c)(2)(i) is revised.

3. Paragraph (c)(3)(ii) is revised.

4. Paragraph (d)(3)(ii) is revised.

5. A sentence is added at the end of paragraph (e)(2)(ii)(B).

6. Paragraph (e)(2)(iii) is revised.

7. The revised provisions read as follows:

Sec. 1.148-5 Yield and valuation of investments.

* * * * *

(b) * * *

(2) * * *

(iii) Permissive application of single investment rules to certain

yield restricted investments for all purposes of section 148. See

Sec. 1.148-5T(b)(2)(iii).

* * * * *

(2) * * *

(i) In general. See Sec. 1.148-5T(c)(2)(i).

* * * * *

(3) * * *

(ii) Exception to yield reduction payments rule for advance

refunding issues. See Sec. 1.148-5T(c)(3)(ii).

(d) * * *

(3) * * *

(ii) Exception to fair market value requirement for transferred

proceeds allocations, universal cap allocations, and commingled funds.

See Sec. 1.148-5T(d)(3)(ii).

(e) * * *

(2) * * *

(ii) * * *

(B) * * * See also Sec. 1.148-5T(e)(2)(B).

(iii) Special rule for guaranteed investment contracts. See

Sec. 1.148-5T(e)(2)(iii).

* * * * *

Par. 14. Section 1.148-5T is added to read as follows:

Sec. 1.148-5T Yield and valuation of investments (temporary).

(a) through (b)(2)(ii) [Reserved]. For guidance see Sec. 1.148-5.

(b)(2)(iii) Permissive application of single investment rules to

certain yield restricted investments for all purposes of section 148.

For all purposes of section 148, an issuer may treat all of the yield

restricted nonpurpose investments in a refunding escrow and a sinking

fund that is reasonably expected as of the issue date to be maintained

to reduce the yield on the investments in the refunding escrow as a

single investment having a single yield, determined under

Sec. 1.148(b)(2).

(b) (2)(iv) through (c)(1) [Reserved]. For guidance see Sec. 1.148-

(c)(2) Manner of payment--(i) In general. Except as otherwise

provided in Sec. 1.148-5(c)(2)(ii), an amount is paid under Sec. 1.148-

5(c) if it is paid to the United States at the same time and in the

same manner as rebate amounts are required to be paid or at such other

time or in such manner as the Commissioner may prescribe. For example,

yield reduction payments must be made on or before the date of required

rebate installment payments as described in Sec. 1.148-3(f). The date a

payment is required to be paid is determined without regard to

Sec. 1.148-3(h). An amount that is paid untimely is not taken into

account under this paragraph (c) unless the Commissioner determines

that the failure to pay timely is not due to willful neglect. The

provisions of Sec. 1.148-3(i) apply to payments made under Sec. 1.148-

5(c).

(c)(2)(ii) through (c)(3)(i) [Reserved] For guidance see

Sec. 1.148-5.

(c)(3)(ii) Exception to yield reduction payments rule for advance

refunding issues. Section 1.148-5(c)(1) does not apply to investments

allocable to gross proceeds of an advance refunding issue, other than--

(A) Transferred proceeds to which Sec. 1.148-5(c)(3)(i)(C) applies;

(B) Replacement proceeds to which Sec. 1.148-5(c)(3)(i)(F) applies;

and

but only to the extent necessary to satisfy yield restriction under

section 148(a) on those proceeds treating all investments allocable to

those proceeds as a separate class.

(d)(1) through (d)(3)(i) [Reserved]. For guidance see Sec. 1.148-5.

(d)(3)(ii) Exception to fair market value requirement for

transferred proceeds allocations, universal cap allocations, and

commingled funds. Section 1.148-5(d)(3)(i) does not apply if the

investment is allocated from one issue to another issue 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 both issues

consist exclusively of tax-exempt bonds. In addition, Sec. 1.148-

5(d)(3)(i) 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)(iii).

(e)(1) through (e)(2)(ii)(A) [Reserved]. For guidance see

Sec. 1.148-5.

(e)(2)(ii)(B) External commingled funds. For any semiannual period,

a commingled fund satisfies the 10 percent requirement of Sec. 1.148-

5(e)(2)(ii)(B) if--

(1) Based on average amounts on deposit, this requirement was

satisfied for the prior semiannual period; and

(2) The fund does not accept deposits that would cause it to fail

to meet this requirement.

(iii) Special rule for guaranteed investment contracts. For a

guaranteed investment contract, a broker's commission or similar fee

paid on behalf of either an issuer or the provider is treated as an

administrative cost and, except in the case of an issue that satisfies

section 148(f)(4)(D)(i), is not a qualified administrative cost to the

extent that the present value of the commission, as of the date the

contract is allocated to the issue, exceeds the present value of annual

payments equal to .05 percent of the weighted average amount reasonably

expected to be invested each year of the term of the contract. For this

purpose, present value is computed using the taxable discount rate used

by the parties to compute the commission or, if not readily

ascertainable, a reasonable taxable discount rate.

Par. 15. In Sec. 1.148-6, paragraph (d)(3)(iii)(C) is revised to

read as follows:

Sec. 1.148-6 General allocation and accounting rules.

* * * * *

(d) * * *

(3) * * *

(iii) * * *

Sec. 1.148-6T(d)(3)(iii)(C).

* * * * *

Par. 16. Section 1.148-6T is added to read as follows:

Sec. 1.148-6T General allocation and accounting rules (temporary).

(a) through (d)(3)(iii)(B) [Reserved]. For guidance see Sec. 1.148-

(d)(3)(iii)(C) Qualified endowment funds treated as unavailable.

For a 501(c)(3) organization, a qualified endowment fund is treated as

unavailable. A fund is a qualified endowment fund if--

(1) The fund is derived from gifts or bequests, or the income

thereon, that were neither made nor reasonably expected to be used to

pay working capital expenditures;

(2) Pursuant to reasonable, established practices of the

organization, the governing body of the 501(c)(3) organization

designates and consistently operates the fund as a permanent endowment

fund or quasi-endowment fund restricted as to use; and

(3) There is an independent verification (e.g., from an independent

certified public accountant) that the fund is reasonably necessary as

part of the organization's permanent capital.

Par. 17. Section 1.148-9 is amended as follows:

1. Paragraph (c)(2)(ii)(B) is revised.

2. Paragraph (h)(4)(vi) is added.

3. The revised and added provisions read as follows:

Sec. 1.148-9 Arbitrage rules for refunding issues.

* * * * *

(2) * * *

(ii) * * *

(B) Permissive allocation of non-proceeds to earliest expenditures.

See Sec. 1.148-9T(c)(2)(ii)(B).

* * * * *

(h) * * *

(4) * * *

(vi) See Sec. 1.148-9T(h)(4)(vi).

* * * * *

Par. 18. Section 1.148-9T is added to read as follows:

Sec. 1.148-9T Arbitrage rules for refunding issues (temporary).

(a) through (c)(2)(ii)(A) [Reserved]. For guidance see Sec. 1.148-

(c)(2)(ii)(B) Permissive allocation of non-proceeds to earliest

expenditures. Excluding amounts covered by Sec. 1.148-9(c)(2)(ii)(A)

and subject to any required earlier expenditure of those amounts, any

amounts in a mixed escrow that are not proceeds of a refunding issue

may be allocated to the earliest maturing investments in the mixed

escrow, provided that those investments mature and the proceeds thereof

are expended before the date of any expenditure from the mixed escrow

to pay any principal of the prior issue.

(d) through (h)(4)(v) [Reserved]. For guidance see Sec. 1.148-9.

(h)(4)(vi) Exception for refundings of interim notes. Section

1.148-9(h)(4)(v) need not be applied to refunding bonds issued to

provide permanent financing for one or more projects if the prior issue

had a term of less than 3 years and was sold in anticipation of

permanent financing, but only if the aggregate term of all prior issues

sold in anticipation of permanent financing was less than 3 years.

Par. 19. Section 1.148-10 is amended as follows:

1. Paragraph (b)(2) is revised.

2. A sentence is added at the end of paragraph (c)(2)(ix).

3. The added and revised provisions read as follows:

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

* * * * *

(b) * * *

(2) Application. See Sec. 1.148-10T(b)(2).

(2) * * *

(ix) * * * See also Sec. 1.148-10T(c)(2)(ix).

* * * * *

Par. 20. Section 1.148-10T is added to read as follows:

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

(temporary).

(a) through (b)(1) [Reserved]. For guidance see Sec. 1.148-10.

(b)(2) Application. The provisions of Sec. 1.148-10(b) only apply

to the portion of an issue that, as a result of actions taken (or

actions not taken) after the issue date, overburdens the market for

tax-exempt bonds, except that for an issue that is reasonably expected

as of the issue date to overburden the market, those provisions apply

to all of the gross proceeds of the issue.

10.

(c)(2)(ix) For purposes of Sec. 1.148-10(c)(2), excess gross

proceeds do not include gross proceeds allocable to fees for a

qualified hedge for the refunding issue.

Par. 21. Section 1.148-11 is amended by adding paragraph (i) to

read as follows:

Sec. 1.148-11 Effective dates.

* * * * *

(i) Transition rule for certain amendments. See Sec. 1.148-11T(i).

Par. 22. Section 1.148-11T is added to read as follows:

Sec. 1.148-11T Effective dates (temporary).

(a) through (c)(3) [Reserved]. For guidance see Sec. 1.148-11.

(c)(4) Retroactive application of overpayment recovery provisions.

An issuer may apply the provisions of Sec. 1.148-3(i) to any issue that

is subject to section 148(f) or to sections 103(c)(6) or 103A(i) of the

Internal Revenue Code of 1954.

(d) through (h) [Reserved]. For guidance see Sec. 1.148-11.

(i) Transition rule for certain amendments. Sections 1.103-8(a)(5),

1.148-1 through 1.148-11, 1.149(d)-1, and 1.150-1, as amended on June

6, 1994 (the effective date) to reflect amendments to Secs. 1.103-

8(a)(5), 1.148-1 through 1.148-11, 1.149(d)-1, and 1.150-1 (as

contained in 26 CFR Part 1 edition revised April 1, 1994), and sections

1.103-8T, 1.148-1T, 1.148-2T, 1.148-3T, 1.148-4T, 1.148-5T, 1.148-6T,

1.148-9T, 1.148-10T, 1.148-11T, 1.149(d)-1T, and 1.150-1T apply in

whole, but not in part,--

(1) To bonds sold after the effective date;

(2) To bonds issued prior to July 1, 1993, if the issuer, after the

effective date, first applies Secs. 1.148-1 through 1.148-11, to the

bonds under Sec. 1.148-11 (b) or (c); and

(3) At the option of the issuer, to bonds to which Secs. 1.148-1

through 1.148-11, as in effect before the effective date, apply.

Par. 23. In Sec. 1.149(d)-1, paragraph (f)(3) is revised to read as

follows:

Sec. 1.149(d)-1 Limitations on advance refundings.

* * * * *

(f) * * *

(3) Application of savings test to multipurpose issues. See

Sec. 1.149(d)-1T.

* * * * *

Par. 24. Section 1.149(d)-1T is added to read as follows:

Sec. 1.149(d)-1T Limitations on advance refundings (temporary).

(a) through (f)(2) [Reserved]. For guidance see Sec. 1.149(d)-1.

(f)(3) Application of savings test to multipurpose issues. Except

as otherwise provided in this paragraph (f)(3), the multipurpose issue

rules in Sec. 1.148-9(h) apply for purposes of the savings test. If any

separate issue in a multipurpose issue increases the aggregate present

value debt service savings on the entire multipurpose issue or reduces

the present value debt service losses on that entire multipurpose

issue, that separate issue satisfies the savings test.

Par. 25. Section 1.150-1 is amended as follows:

1. Paragraph (c)(1) is revised.

2. The paragraph heading for (c)(4) is revised.

3. Paragraph (c)(4)(iii) is added.

4. The revised and added provisions read as follows:

Sec. 1.150-1 Definitions.

* * * * *

(4) Special rules for certain financings--(i) * * *

* * * * *

(iii) See Sec. 1.150-1T(c)(4)(iii).

* * * * *

Par. 26. Section 1.150-1T is added to read as follows:

Sec. 1.150-1T Definitions (temporary).

(a) through (b) [Reserved]. For guidance see Sec. 1.150-1.

provided, the provisions of this paragraph (c) apply for all purposes

of sections 103 and 141 through 150. Except as otherwise provided in

this paragraph (c), two or more bonds are treated as part of the same

issue if all of the following factors are present:

(i) Sold at substantially the same time. The bonds are sold at

substantially the same time. Bonds are treated as sold at substantially

the same time if they are sold less than 15 days apart. For this

purpose only, a variable yield bond is treated as sold on its issue

date.

(ii) Sold pursuant to the same plan of financing. The bonds are

sold pursuant to the same plan of financing. Factors material to the

plan of financing include the purposes for the bonds and the structure

of the financing. For example, generally--

(A) Bonds to finance a single facility or related facilities are

part of the same plan of financing;

(B) Short-term bonds to finance working capital expenditures and

long-term bonds to finance capital projects are not part of the same

plan of financing; and

bonds secured by tax revenues are not part of the same plan of

financing.

(iii) Payable from same source of funds. The bonds are reasonably

expected to be paid from substantially the same source of funds,

determined without regard to guarantees from parties unrelated to the

obligor.

(2) through (4)(ii) [Reserved]. For guidance see Sec. 1.150-1

(c)(3) through (c)(4)(ii).

(c)(4)(iii) Certain general obligation bonds. Bonds are part of the

same issue if secured by a pledge of the issuer's full faith and credit

(or a substantially similar pledge) and sold and issued on the same

dates pursuant to a single offering document.

(5) [Reserved]. For guidance see Sec. 1.150-1(c)(5).

(6) Sale date. The sale date of a bond is the first day on which

there is a binding contract in writing for the sale or exchange of the

bond.

Dated: April 14, 1994.

Margaret Milner Richardson,

Commissioner of Internal Revenue.

Approved:

Leslie Samuels,

Assistant Secretary of the Treasury (Tax Policy).

[FR Doc. 94-11104 Filed 5-5-94; 2:17 pm]

BILLING CODE 4830-01-U

This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.