Issuers of governmental bonds often commingle gross proceeds of an issue with other funds in order to provide for more efficient investment. The 1993 regulations provide special rules to prevent avoidance of rebate. Nonetheless, commingling gross proceeds is not prohibited.
A commingled fund is defined as a fund or account that contains both the gross proceeds of an issue and amounts in excess of $25,000 that are not gross proceeds of that issue, if the amounts in the fund or account are invested and accounted for collectively, without regard to the source of funds. See Treas. Reg. 1.148-1(b).
Under Treas. Reg. 1.148-6(e)(1), an accounting method for gross proceeds of an issue in a commingled fund, other than a bona fide debt service fund, is reasonable only if it satisfies certain requirements set forth in the subsection and summarized below, in addition to the other requirements of the section:
- Investments held by a commingled fund: Generally, ratable allocations are required. Not less frequently than as of the close of each fiscal period, all payments and receipts (including deemed payments and receipts) or investments held by a commingled fund must be allocated among the different investors in the fund. The allocation must be based on a consistently applied, reasonable ratable allocation method. There are safe harbors for determining reasonable ratable allocations.
- Certain expenditures involving a commingled fund: […]
- Fiscal periods: […]
- Unrealized gains and losses on investments of a commingled fund: […] Note that the mark-to-market requirement does not apply to a commingled fund that operates exclusively as a reserve fund, sinking fund or replacement fund for two or more issues of the same issuer.
- Allocations of commingled funds serving as common reserve funds or sinking funds: See next heading.
Each different source of funds is an investor in the fund. For example, a city that invests gross proceeds of a bond issue and receipts from taxes in a commingled fund is treated as two different investors.
The definition of commingled fund in Treas. Reg. 1.148-1 applies for purposes of Treas. Reg. 1.141-0 through 1.141-16.
There is a reference to a commingled fund concept in Treas. Reg. 1.141-1, which relates to a matter not related to this topic. (But, on a related matter, are there any private business use issues when reserve fund moneys from a reserve fund, originally funded with tax-exempt bond proceeds, are used to pay debt service on a taxable bond? Probably not if the reserve purpose is a neutral cost?)
There are reference to payments and receipts in connection with commingled funds in Treas. Reg. 1.148-3(d)(1)(i), (2)(i) and (3).
Exception for Commingled Funds Serving as Common Reserve Funds or Sinking Funds:
Notwithstanding the annual reasonable ratable allocation method required by paragraph (e)(2) of the regulations section, if a commingled fund serves as a common reserve fund, replacement fund or sinking fund for two or more issues (a commingled reserve), after making reasonable adjustments to account for proceeds allocated under paragraphs (b)(1) (the one-issue rule and general ordering rules)and (b)(2) (the universal cap on value of nonpurpose investments allocated to an issue rule), investments held by that commingled fund must be allocated ratably among the issues served by the commingled fund in accordance with one of the following methods:
- the relative values of the bonds of those issues under Treas. Reg. 1.148-4(e) (plain par bonds are valued at outstanding stated principal amount, plus accrued unpaid interest; other bonds are valued at their present value on that date);
- the relative amounts of the remaining maximum annual debt service requirements on the outstanding principal amounts of those issues; or
- the relative original stated principal amounts of the outstanding issues.
While exempt from the mark-to-market requirements described under the prior heading, investments in the reserve fund must still be valued at fair market value the first time they are allocated to proceeds. Treas. Reg. 1.148-5(d)(3).
An issuer must make any allocations required by this paragraph as of a date at least every 3 years and as of each date that an issue first becomes secured by the commingled reserve. If relative original principal amounts are used to allocate, allocations must also be made on the retirement of any issue secured by the commingled reserve.
The exception for commingled reserve funds provides for the following test upon each new bond issue that is secured by the fund: (1) make sure not more than 10% of the sale proceeds of the new bonds are deposited to the reserve fund; (2) allocate the reserve fund and make sure that the portion allocable to the new bonds does not exceed the lesser of the three-prong reasonableness test for reserve funds. The additional bonds test and definition of reserve requirement should reflect this test.
Is the use of a parity reserve fund for the purposes of the fund a refunding of one issue with proceeds of another? No. In PLR 200441021, Congress’ intent is quoted as follows:
To rule that the use of a parity reserve under the specific conditions for which the reserve expressly was established is a refunding would place significant constraints on the function and utility of parity reserve funds, constraints that we do not believe Congress intended. In this case, however, Issuer’s proposed use of the amounts in the Reserve Fund is not under such conditions. Nevertheless, based on the facts and circumstances, we conclude that the proposed use is not a refunding.
Rulings Relating to Commingled Funds
PLR 200036033 (Jun. 7, 2000): Relates to Treas. Reg. 1.148-6(d)(6) – Expenditures of certain commingled investment proceeds of governmental issues.
FSA 001709 (Jan. 31, 2004): Municipal bonds; litigation hazards; investment yield; management fee; safe harbors; arbitrage bonds.