Treas. Reg. 1.150-1(d)(2)(iii) provides the following:
(A) Refunding of a conduit financing issue by a conduit loan refunding issue. Except as provided in paragraph (d)(2)(iii)(B) of this section, the use of the proceeds of an issue that is used to refund an obligation that is a purpose investment (a conduit refunding issue) by the actual issuer of the conduit financing issue determines whether the conduit refunding issue is a refunding of the conduit financing issue (in addition to a refunding of the obligation that is the purpose investment).
Assume on date X the governmental authority (the “Authority”) issues bonds (the “Authority Bonds”) and uses the proceeds thereof to fund a loan (the “Loan”) to a town (the “Town”). On the same date, the Town issues its “governmental agency bond” to the Authority to secure the Loan. Many years later, on date Y, the Town decides to pay off the Loan. To do so, it issues refunding bonds (the “Refunding Bonds”) and uses the proceeds to redeem the governmental agency bond.
Under Treas. Reg. 1.150-1(d)(2)(iii), when the Town uses proceeds of the Refunding Bonds to redeem the governmental agency bond, the Authority can either (1) use those proceeds to refund its own Authority Bonds or (2) “recycle” those proceeds to make future Loans if certain conditions are satisfied.
Now, assume the Authority Bonds aren’t callable within 90 days and the Authority can’t “recycle” the proceeds. In this case, the Authority will need to advance refund the Authority Bonds. This could be a problem if the Authority theretofore already advance refunded the Authority Bonds once. By permitting the Town to pay off the governmental agency bond with cash only (and not with a Refunding Bond issue), the Authority is protecting its ability to conduct advance refundings of the Authority Bonds.