Rebate Requirement (I.R.C. 148(f))

General Matters

Section 148(f) requires that issuers rebate certain excess earnings on proceeds of tax-exempt bonds to the federal government.

Rebate Calculation

Even if the issuer is permitted to earn a higher yield under the yield restriction rules and related exceptions, the arbitrage profit from investments must be paid, or “rebated,” to the Treasury Department.  The future value method is used to determine the amount that must be rebated, as follows:

  1. Identify dates and amounts of payments for and receipts from each investment of gross proceeds during the computation period ending on the computation date;
  2. Future value those amounts by assuming that interest is earned and compounded over the period to the computation date at a rate equal to the bond yield;
  3. If the future value of the actual receipts on the investments (earnings, sales, maturities) exceeds the future value of the payments (purchase prices) calculated in step 2 above, that excess is the rebate amount.

By “future valuing” at the bond yield, if the issuer’s actual rate of return is lower than the bond yield, the future value of the receipts will not be greater than the future value of the payments, so no rebate will be owed.  This is referred to as “negative arbitrage.”

Computation Date Credit:

Section 1.148-3(d)(1)(iv) of the Regulations provides a rebate credit of $1,000, adjusted annually after 2007.  The computation date credit for bond years ending 2013 is $1,590, according to Rev. Proc. 2012-41.  The credit for bond years ending 2014 is $1,620, according to Rev. Proc. 2013-35.

Proposed Regulations Modifying Arbitrage Regulations:

See Proposed Regulations Modify Arbitrage Regulations (by Jones Day) for a good summary of the proposed regulations.

Penalty in Lieu of Loss of Tax Exemption

A taxpayer cannot appeal TEB’s decision to not waive the penalty imposed under I.R.C. 148(f)(7) for failing to pay arbitrage rebate according to regulations.  See CCA 201539029 (Oct. 1, 2015)

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