Protected: Qualified Hedges and the 80/20 Rule (I.R.C. 148)

July 26, 2015

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Yield on an issue of bonds (1.148-4)

November 23, 2014

General Matters

The yield on a fixed yield issue is the discount rate that, when used in computing the present value as of the issue date of all unconditionally payable payments of principal, interest, and fees for qualified guarantees on the issue and amounts reasonably expected to be paid as fees for qualified guarantees on the issue, produces an amount equal to the present value, using the same discount rate, of the aggregate issue price of bonds of the issue as of the issue date. Further, payments include certain amounts properly allocable to a qualified hedge. Yield on a fixed yield issue is computed as of the issue date and is not affected by subsequent unexpected events, except to the extent provided in paragraphs (b)(4) and (h)(3) of this section.

For fixed yield bonds subject to mandatory sinking fund redemptions, the yield on the issue is computed using the value of those bonds on the redemption date (not their stated principal amount) plus accrued and unpaid interest.  This rule is written to require the valuation of heavily discounted term bonds at the lower, accreted value, not the par value.  It is okay to use the stated principal amount as long as the difference between the stated principal amount and the issue price of the bond is not more than the product of 0.25% per year (times) the stated redemption price at maturity (times) the number of years to the weighted average maturity of the expected mandatory sinking fund schedule.  Treas. Reg. 1.148-4(b)(2)(ii).  “Stated redemption price” for this purpose means the total redemption price of the bond – which includes any call premiums.

Certain bonds subject to optional early redemption must be treated as redeemed at their stated redemption prices on the optional redemption dates that would produce the lowest yield on the issue.  For example, this applies to premium bonds whe the premium is more than the product of 0.25% (times) the stated redemption price of the bonds at maturity (times) the number of complete years to the first optional redemption date for the bonds.  This also applies to stepped coupon bonds when the bonds bear interest at increasing interest rates.  Treas. Reg. 1.148-4(b)(3).

For purposes of computing yield on a variable yield issue, up-front and non-level payments for a qualified guarantee must be allocated to each computation period.  The 1993 final regulations have a safe harbor for the allocation of non-level payments if an equal amount is treated as paid as of the first day of each bond year over the term of the qualified guarantee.  If a guaranteed variable yield bonds is redeemed prior to maturity, qualified guarantee payments otherwise allocable to the period after redemption are to be allocated to remaining outstanding bonds of the issue or, if none remain outstanding, to the computation period before such redemption.  See Treas. Reg. 1.148-4(f)(6)(ii).

PLR 200403095 (Sept. 30, 2003):  Corporation may calculate a single yield on the Organization 1 Bonds and may calculate a single yield on the Organization 2 Bonds on behalf of Subsidiary 1 and Subsidiary 2, respectively.  Organization 1 and Organization 2 were each established as nonprofit corporations under 501(c)(3) and operated as a qualified scholarship funding corporation.  Treas. Reg. 1.148-4(a) provides that the Commissioner may permit issuers of qualified mortgage bonds and qualified student loan bonds to use a single yield for two or more issues.  Corporation, through a series of transactions, had acquired 100 percent of the stock of both Subsidiaries.

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

March 3, 2014

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.

Grants (Treas. Reg. 1.148-6(d))

January 29, 2014


Proceeds of a tax-exempt bond that are used to make a grant to an unrelated party are considered spent for yield restriction and arbitrage rebate purposes as soon as the grant is made.  Treas. Reg. 1.148-6(d)(4).  Bond counsel have interpreted the grant provision (and the September 2013 proposed regulations) to apply only for purposes of determining when the proceeds are spent.  The ability to treat the proceeds as spent does not relieve the issuer of tracking the use of grant moneys by the grantee for other purposes relating to tax-exemption of the bonds.  For example, the issuer must determine that the grant proceeds are used for proper capital expenditures or permitted working capital purposes.

The bond community has been concerned that the grant provisions of the regulations still require the issuer to determine whether the bonds constitute reimbursement bonds.  Some bond counsel have determined that, given the lack of guidance by the Internal Revenue Service, the use of grant moneys must satisfy the official intent rules and other reimbursement requirements under Treas. Reg. 1.150-2.  In other words, if the grantee uses the grant proceeds to reimburse itself for prior capital expenditures, some type of official intent for reimbursement must be adopted – likely by the issuer itself.

NABL has requested guidance from the Treasury Department concerning the reimbursement matter, as well as with respect to other relevant matters.  See December 2013 comments here.

Yield and Valuation of Investments (Treas. Reg. § 1.148-5)

October 24, 2013


The term “arbitrage bond” for purposes of I.R.C. § 148 means any bond issued as part of an issue any portion of the proceeds of which are reasonably expected (at the time of issuance of the bond) to be used directly or indirectly (1) to acquire higher yielding investments, or (2) to replace funds which were used directly or indirectly to acquire higher yielding investments.  For purposes of I.R.C. § 148(a), a bond is treated as an arbitrage bond if the issuer intentionally uses any portion of the proceeds of the issue of which such bond is a part in a manner described in (1) or (2).

“Higher yielding investment” means any investment property which produces yield over the term of the issue which is materially higher than the yield on the issue.

“Investment property” includes (A) any security, (B) any obligation, (C) any annuity contract, (D) any investment-type property, or (E) in some cases residential rental property.  Tax-exempt bonds do not generally include any tax-exempt bond.

Computation of arbitrage yield and rebate due on investments requires a valuation of the investments at various points in time. Investments must be appropriately valued upon purchase or sale and on any date that the investment becomes allocable to the issue or ceases to be allocable to the issue by virtue of the universal cap or the transferred proceeds rules. Also, in order to properly compute rebate due on any date other than a final computation date, an appropriate interim valuation must be made.  These rules are contained in Treas. Reg. 1.148-5.

PLR 9142012 (Jul. 17, 1991) (aka “Alabama” ruling): This letter is in response to your request on behalf of the Taxpayer for rulings that (i) the Authority’s proposed Bonds, the proceeds of which are to be used to make a payment under the Purchase Contract, will not by reason of that payment be private activity bonds within the meaning of section 141(a) of the Internal Revenue Code, and (ii) the Purchase Contract will not be investment property as defined in section 148(b)(2) .  The Authority argues that the up-front payment for capacity charges should be treated as an advance payment rather than as a private loan or other arrangement that would lead to “private business use” of the bond proceeds.  The IRS agrees.  The PLR then describes the history of the definition of “investments” and “investment-type” property.  Prepayments contain a time value of money component which gives them a built-in investment return.  Because of this, Congress recognized that prepayments may be investment property when they are made to avoid arbitrage restrictions instead of for other reasons.  The Authority had motivations to make the prepayment that were other than arbitrage avoidance.

Value of Investments:

The value of an investment on a date is determined using one of the following valuation methods consistently for all purposes of I.R.C. 148 to that investment on that date:

1. Plan par investment:  A plain par investment is valued at its outstanding stated principal amount, plus any accrued unpaid interest on that date.

2. Fixed rate investment:  A fixed rate investment may be valued at its present value on that date.

3. Any investment:  Any investment may be valued at its fair market value on that date.

Any yield restricted investment must be valued at present value.  For example, a purpose investment or an investment allocable to gross proceeds in a refunding escrow after the expiration of the initial period must be valued at present value.

How do you value stocks or other types of equity that may be part of a reserve fund?  There is no guidance on how to value these types of investments.  Arguably, stock that doesn’t pay dividends doesn’t have an interest cash flow that might be viewed as a cash flow producing a yield.  How is appreciation of the stock captured in the calculation of yield?  One probably treats the appreciation on each valuation date as a cash flow giving rise to yield.  The valuation occurs on, among other dates, the date the investment becomes allocated to the issue, under Treas. Reg. 1.148-5(d)(3)(i), and on each rebate calculation date.  Many bond counsel advise clients not to transfer stock or other equity to a yield restricted fund because of the difficulty in valuing the stock and the lack of guidance.  Once concern is that significant appreciation could lead to endless excess arbitrage on the investment.

Investment-Type Property:

Investment-type property is defined as any property held principally as a passive vehicle for the production of income.  For this purpose, production of income includes any benefit based on the time value of money, including the benefit from making a prepayment.

The definition of investment-type property was revised in the final regulations published August 4, 2003 and effective October 3, 2003 (T.D. 9085).  The regulations provide rules for determining whether a prepayment for property or services results in a private loan or investment-type property.  See also the comments by NABL of December 23, 1999 regarding matters relating to the definition of investment-type property.

A prepayment in exchange for a simultaneous transfer of an ownership interest in property (tangible or intangible) is not a prepayment.

The primary purpose of adding the categories of annuity contract and “investment-type property” was to reverse the conclusion of several pre-1986 private letter rulings that held that annuity contracts and similar arrangements were not “securities or obligations” within the meaning of pre-1986 law.

Private loan context:  A loan may be either a purpose investment or a nonpurpose investment.  A loan that is a nonpurpose investment does not cause the private loan financing test to be met.  For example, proceeds invested in loans, such as obligations of the United States, during a temporary period, as part of a reasonably required reserve or replacement fund, as part of a refunding escrow, or as part of a minor portion are generally not treated as loans under the private loan financing test.  Treas. Reg. § 1.141-5(c)(2).

Treatment of RECs as investment-type property (capital asset concern, but also investment-type property concern)?  Building developers often purchase renewable energy certificates (RECs) to qualify for points under the LEED certification program.  The more points the building qualifies for, the higher the LEED rating.  To receive a LEED point by purchasing RECs, the RECs must document that the development/developer has entered into a contract of at least two years under which the development/developer is deemed to receive renewable energy.  RECs could be treated as capital assets that are capitalizable, and hence might be financeable with tax-exempt bond proceeds.  There is case law by the Tax Court (136 T.C. No. 15, April 2011) concerning the characterization of Colorado income tax credits.  (May the seller of Colorado income tax credits treat the gain as capital gain?)  The court concludes that the income tax credit is not specifically excluded from the definition of capital asset in I.R.C. 1221 (i.e., suggesting capital asset treatment) and that the income tax credit is not an income replacement (status of an item as an income replacement suggests that one should not allow the taxpayer to avoid ordinary income tax treatment by claiming the item as a capital asset).  Therefore, the income tax credit is a capital asset that, if sold, would lead to a capital gain or loss.  If the asset has a life of more than one year, it would be capitalizable.  This reasoning could apply to RECs such that RECs are capitalizable and therefore financeable with tax-exempt bonds.  The concern, however, is that RECs might be viewed as investment-type property because there is an active market for RECs.  One would need to make sure there is no plan to sell the RECs.  On the other hand, RECs give the holder the ability to achieve LEED certification, which may suggest that the RECs are a cost of the building – another basis for possible capitalization.

PLR 200116004 (Dec. 2000): Whether prepayment for water rights is investment-type property and a good reimbursement expenditure under Treas. Reg. 1.150-2.

Pooled Financing Bonds (I.R.C. 149(f)(4)(A))

February 25, 2013

General Discussion:

An issuer may decide to issue tax-exempt bonds for the purpose of making loans to two or more conduit borrowers.  Borrowers may be governmental entities, section 501(c)(3) organizations or private businesses.  Borrowers are generally interested in these types of financings because the pooling of proceeds may reduce issuance costs and lower interest rates.

Special tax rules may apply when bonds are issued to make loans to two or more conduit borrowers.  The rules result from the concern that tax-exempt bonds not be issued substantially in advance of when the proceeds are actually needed by the borrowers.  Other rules reflect the belief that pooled bond issuers should not unduly benefit from their issuance of the bonds on behalf of the ultimate consumers (the borrowers) of the proceeds.

There are special non-arbitrage limitations, arbitrage limitations, rebate rules and refunding rules for pooled financings.

Non-Arbitrage Limitations:

See I.R.C. 149(f), 149(g), 147(b)

Exceptions to Rebate:

There are certain special rules for pooled financings, including the rules described below.

With respect to the six-month spending exception to rebate, the six-month period for pooled financings begins on the issue date of the pool bonds (not on the date of the loan to the borrower).  Therefore, the gross proceeds are not treated as “spent” for purposes of the spending exception until the gross proceeds are spent for their ultimate purposes (rather than on the making of a loan).  Under Treas. Reg. § 1.148-7(b)(6), the pooled bond issuer may elect (on or before the issue date) to apply the spending requirements separately to each loan to a conduit borrower, as discussed in the next paragraph.  If the election is made and proceeds are loaned to the ultimate borrower, the six-month spending period begins for the loan on the earlier of (1) the date the loan is made or (2) the date 12 months from the issue date of the pooled bonds.

For purposes of the two-year construction spending exception to rebate, special rules provide that the Available Construction Proceeds (ACP) of pooled bonds that are construction issues automatically qualify for the two-year rule.  In other words, under I.R.C. § 148(c)(2), if pooled bonds are issued and part of the issue is used to make or finance loans for construction expenditures, that portion of the bonds is entitled to a two-year temporary period (two-year spending exception) rather than the six month spending exception.  The pooled bond issue may elect to apply the spending exceptions separately to each conduit loan.  If the election is made, then (1) the spending requirements for a loan begin on the earlier of the date the loan is made or the first day following the one-year period beginning on the issue date of the pooled financing issue, and (2) the rebate requirement (and none of the spending exceptions) applies to the gross proceeds on the issue before the date on which the spending requirements begin.  See Treas. Reg. 1.148-7(b)(6)(ii).  If the issuer makes this election, it may make all elections under the two-year rule separately for each loan, and may pay rebate with regard to some conduit loans and the 1.5% penalty for other conduit loans from the same pooled financing issue.  The 1.5% penalty is computed separately for each conduit loan.  If a borrower in the pool fails to meet the expenditure requirements, the issuer must pay rebate in accordance with the general rules of I.R.C. § 148(f)(2), unless it has elected to pay the 1.5% penalty in lieu of rebate.  This election must be made on or before the date the pooled bonds are issued and is irrevocable.  A pooled issue, however, may elect to terminate the 1.5% penalty for a loan rather than for the entire issue.

For purposes of the small issuer exception to rebate, in the context of a pooled financing in which the borrower otherwise meets the small issuer exception, the small issuer exception is available to the proceeds of the pooled issue in the hands of the small borrower.  The pooled financing may mix large and small issuers and treat each borrowing separately for purposes of available rebate exceptions.  A loan to a conduit borrower qualifies for the small issuer exception, however, only if (1) the bonds of the pooled financing are not PABs, (2) none of the loans to conduit borrowers are PABs and (3) the loan to the conduit borrower meets all requirements of the small issuer exception.  The issuer of the pooled financing issue is, however, subject to the rebate requirement for any unloaded gross proceeds.  Also, in determining the $5,000,000 size limitation of a pooled financing issuer, bonds of the pooled financing issue are not counted against the issuer for purposes of applying the small issuer exception to the issuer’s other issues, to the extent that the pooled financing issuer is not an ultimate borrower in the financing and the conduit borrowers are governmental units with general taxing powers and not subordinate to the issuer.  See I.R.C. 148(f)(4)(D)(ii)(II) and Treas. Reg. 1.148-8(d)(1).

Other Matters:

Private activity bond requirements:  I.R.C. § 147 – Maturity limitation

Other general bond requirements:  I.R.C. § 149

Current refundings versus advance refundings

PLR 200315012 regarding multipurpose issues and refundings

TEB enforcement of I.R.C. § 6700 penalties in pooled financing bond cases


Gannett and Jones, Pooled Financings, CPE Exempt Organizations Technical Instruction Program for FY 2000 Training.

Temporary periods in refundings (Treas. Reg. 1.148-9(d)) and Permitted Waivers (Treas. Reg. 1.148-9(g))

January 6, 2013

Treas. Reg. 1.148-9 contains special arbitrage rules for refunding issues. These rules apply for all purposes of section 148 and govern allocations of proceeds, bonds, and investments to determine transferred proceeds, temporary periods, reasonably required reserve or replacement funds, minor portions, and separate issue treatment of certain multipurpose issues.

Treas. Reg. 1.148-9(d) provides the following:

(d) Temporary periods in refundings—(1) In general. Proceeds of a refunding issue may be invested in higher yielding investments under section 148(c) only during the temporary periods described in paragraph (d)(2) of this section.

(2) Types of temporary periods in refundings. The available temporary periods for proceeds of a refunding issue are as follows:

(i) General temporary period for refunding issues. Except as otherwise provided in this paragraph (d)(2), the temporary period for proceeds (other than transferred proceeds) of a refunding issue is the period ending 30 days after the issue date of the refunding issue.

(ii) Temporary periods for current refunding issues—(A) In general. Except as otherwise provided in paragraph (d)(2)(ii)(B) of this section, the temporary period for proceeds (other than transferred proceeds) of a current refunding issue is 90 days.

(B) Temporary period for short-term current refunding issues. The temporary period for proceeds (other than transferred proceeds) of a current refunding issue that has an original term to maturity of 270 days or less may not exceed 30 days. The aggregate temporary periods for proceeds (other than transferred proceeds) of all current refunding issues described in the preceding sentence that are part of the same series of refundings is 90 days. An issue is part of a series of refundings if it finances or refinances the same expenditures for a particular governmental purpose as another issue.

(iii) Temporary periods for transferred proceeds—(A) In general. Except as otherwise provided in paragraph (d)(2)(iii)(B) of this section, each available temporary period for transferred proceeds of a refunding issue begins on the date those amounts become transferred proceeds of the refunding issue and ends on the date that, without regard to the discharge of the prior issue, the available temporary period for those proceeds would have ended had those proceeds remained proceeds of the prior issue.

(B) Termination of initial temporary period for prior issue in an advance refunding. The initial temporary period under § 1.148-2(e) (2) and (3) for the proceeds of a prior issue that is refunded by an advance refunding issue (including transferred proceeds) terminates on the issue date of the advance refunding issue.

(iv) Certain short-term gross proceeds. Except for proceeds of a refunding issue held in a refunding escrow, proceeds otherwise reasonably expected to be used to pay principal or interest on the prior issue, replacement proceeds not held in a bona fide debt service fund, and transferred proceeds, the temporary period for gross proceeds of a refunding issue is the 13-month period beginning on the date of receipt.

Treas. Reg. 1.148-9(g) provides the following:

(g) Certain waivers permitted. On or before the issue date, an issuer may waive the right to invest in higher yielding investments during any temporary period or as part of a reasonably required reserve or replacement fund. At any time, an issuer may waive the right to invest in higher yielding investments as part of a minor portion.

Upon election of the waiver in Treas. Reg. 1.148-9(g), an issuer may blend the investments of the sale proceeds of the Refunding Bonds, the transferred proceeds and the resulting investment proceeds for purposes of computing the rebate and yield reduction payments under I.R.C. 148.  The waiver may be helpful in refundings that will give rise to transferred proceeds which are invested at rates higher than the Refunding Bond yield.  See PLR 201150026 (September 7, 2011, released December 16, 2011) in which an issuer is granted an extension of the deadline for making the waiver election where the issuer’s refunding bonds gave rise to transferred proceeds that were not discovered until the refunding bonds were issued.

(Note, see 1.148-2(h) for waivers not in connection with refundings.)