Tax and Revenue Anticipation Notes (I.R.C. 148)

This posting describes certain tax issues relating to tax and revenue anticipation notes.

General Discussion

Tax and revenue anticipation notes are issued by governmental units to finance operations while waiting to receive taxes or other revenues.

Yield Restriction and Arbitrage Rebate

The same general principles that apply to TRANs also apply to other tax-exempt financings:

  1. An issuer can arbitrage the proceeds while awaiting their expenditure, provided the issue qualifies for a temporary period; and
  2. Arbitrage will be subject to rebate unless the issue qualifies for either a spending exception or the small issuer exception.

The small issuer exception applies on the same basis to TRANs as to other financings. However, there are a number of special rules for TRANs. These special rules for TRANs are as follows:

  1. The temporary period is either 13 months or two years. (1.148-2(e)(3))
  2. TRANs are a financing for working capital, so the issuer must use the proceeds-spent-last accounting to determine whether it has spent the TRAN proceeds. An issuer cannot treat TRAN proceeds as spent until it has spent all other available amounts.
  3. A statutory safe harbor provides that an issue qualifies for the six-month spending exception from rebate if the cumulative cash flow deficit within six months after issuance of the TRANs equals at least 90% of the TRAN proceeds. This safe harbor reflects PSL accounting with a 10% cushion. (One can still use the normal 6-month expenditure exception – without the 10% safe harbor cushion – and take into account the 5% reserve.)

Temporary Period (Default: 13 Months; Extended: To Maturity)

The regulations permit TRANs to have a temporary period exception from yield restriction until the maturity of the TRAN issue, provided the issue meets the following two requirements:

  1. The TRANs must be reasonably expected to be paid from tax revenues from tax levies for a single fiscal year.
  2. The TRANs must mature by the earlier of two years after the issue date or 60 days after the last date for payment of the taxes without interest or penalty.

For TRAN issues that do not meet both of these requirements, the applicable temporary period is a general temporary period of 13 months for working capital expenditures. Treas. Reg. § 1.148-2(e)(3).

The two-year and 13-month temporary periods apply only to proceeds that the issuer reasonably expects to spend within the two-year or 13-month period. This expectation must be formed on the basis of proceeds-spent-last accounting. The result is that to invest its proceeds at an unrestricted yield, a TRAN issuer must have a reasonable expectation that it will, after spending all other available amounts, spend its TRAN proceeds within the applicable period.
An issue of TRANs will not be treated as outstanding longer than is reasonably necessary to accomplish the governmental purposes of the issue if the final maturity date of the issue is not later than the end of the applicable temporary period, generally 13 months. The IRS announced this rule as a safe harbor in August 2001 and confirmed it in a final revenue procedure dated May 13, 2002. Notice 2001-49; Rev. Proc. 2002-31.

TRAN Sizing

The maximum borrowing amount (issue price) is the greater of (a) maximum deficit within six months divided by 90%, and (b) maximum deficit within six months plus the lesser of (i) 5% of the fiscal year disbursements or (ii) that fiscal year’s average cash balance.

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