Trust Classification (I.R.C. 7701)

April 18, 2016

General Discussion:

Section 301.7701-4(c)(1) of the regulations (part of the “Sears Regulations”) provides that an investment trust that has multiple classes of ownership interests is ordinarily classified as a business entity under section 301.7701-2.  An investment trust that has multiple classes of ownership interest, however, is classified as a trust for tax purposes if (1) there is no power under the trust agreement to vary the investment of the certificate holders, and (2) the trust is formed to facilitate direct investment in the assets of the trust and the existence of multiple classes of ownership interest is incidental to that purpose.

See TAM 200512020, describing the use of a trust purportedly to accomplish the stripping of interest from underlying securities. The trust, through a side agreement, provided multiple classes of ownership interest.

Why are trust arrangements that are commonly used in connection with certificated municipal lease financings not classified as business entities under the Sears Regulations?  See Announcement 84-62 (Jan. 1, 1984).  Although a “grantor trust” is used in these financings, the grantor trust rules are not applicable.  The IRS announced in Ann. 84-62 that the multiple-class investment trusts do not apply to certain state and local government financing arrangements.  “The financing arrangements, which are an alternative to the direct issuance of serial and/or term obligations by state and local government obligors, are used to satisfy exceptions to debt limitations imposed under state law. […] The substance of these financing arrangements is the same as if a state or local government obligor directly issued a series of separate debt obligations.  Under such arrangements, the trustee serves in the same capacity as an indenture trustee in a typical secured bond issue by making payments from the state or local government obligor to the COPs owners.”  Darrell R. Larsen, American Bar Association, Secondary Market Tax-Exempt Asset Securitization for Sponsors, Investors, Other Market Participants and their Counsel.


Single Issue

February 7, 2012

General Rules:

The single issue determination addresses “substance over form” concerns.  The issue determination is primarily relevant for determining whether bonds can be included in a single-yield computation. Bonds treated as part of a single issue under the test below will be so treated for purposes of the arbitrage rules and for purposes of the limits on issue size for small issues of IDBs under Section 144.

Under Treas. Reg. 1.150-1(c), “issue” means two or more bonds that meet all of the following requirements:

  1. Sold at substantially the same time;
  2. Sold pursuant to the same plan of financing;
  3. Payable from the same source of funds.
Note that all of these requirements must be met in order to treat two or more bonds as the same issue.  This test applies for all purposes of the tax laws relating to tax-exempt bonds (i.e., also for purposes of the arbitrage rules and limits on issue size for small issues of IDBs under Section 144 of the Code).
TAM 200424003:  Whether Series A Bonds and Series B Bonds are a single issue under Treas. Reg. 1.150-1(c).  The Service concludes that the series must be treated as one issue to clearly reflect the economic substance of the transaction and prevent avoidance of Section 148 of the Code.

Sold at Substantially the Same Time:

Bonds are treated as sold at substantially the same time if they are sold less than 15 days apart.  The sale date is not the issue date.  Instead, it is the date on which there is a binding contract in writing for the sale or exchange of the bonds (e.g., signing of the bond purchase agreement).  See this report for a discussion of sale date and related matters for private placements: http://meetings.abanet.org/webupload/commupload/CL190016/sitesofinterest_files/Commitment.pdf

Sold Pursuant to Same Plan of Financing:

Factors material to the plan of financing include the purposes for the bonds and the structure of the financing.  The regulations provide the following examples:

  • Bonds to finance a single facility or related facilities are part of the same plan of financing;
  • Short-term bonds to finance working capital expenditures and long-term bonds to finance capital projects are not part of the same plan of financing;
  • Certificates of participation in a lease and general obligation bonds secured by tax revenues are not part of the same plan of financing.

Payable from the Same Source of Funds:

The bonds must be reasonably expected to be paid from substantially the same source of funds, determined without regard to guarantees from parties unrelated to the obligor.

Separate Issue Election:

Treas. Reg. 1.150-1(c)(3) contains a separate election provision under which a single issue under the general rule can be treated as separate issues for certain purposes.  This separate issue election does not apply for purposes of I.R.C. 141, 144(a) (Qualified small issue bond), 148 (Arbitrage), 149(d) (Advance refundings) and 149(g) (Treatment of hedge bonds).

Until the proposed regulations in Treas. Reg. 1.141-13 came out, there was a concern that Treas. Reg. 1.141-13(d) did not permit a multipurpose issue allocation of an issue consisting of PABs and governmental bonds.  The fourth sentence in Treas. Reg. 1.141-13(d)(1) states that (1) the issue to be allocated, and (2) each of the separate issues under the allocation, must consist of tax-exempt bonds.  While the second part of the sentence is “workable” since the intent of the allocation is to prove that each portion can be its own issue of tax-exempt bonds, the first part of the sentence does not seem to make sense.  The election is made precisely because the issue as a whole cannot be a tax-exempt bond issue.  The proposed regulations revise the sentence to read as follows, which clarifies the rule: “Each of the separate issues under the allocation must consist of one or more tax-exempt bonds.”

Tax-Advantaged Bonds:

Each type of tax-advantaged bond that has a different structure for delivery or the borrowing subsidy or different program eligibility requirements is treated as part of a different issue under Treas. Reg. 1.150-1(c).  See proposed regulations issued September 16, 2013, REG-148659-07.

Discussions of Frequently Asked Questions:

  • Taxable Bonds:  Are taxable bonds and tax-exempt bonds part of the same issue? Under paragraph (2) of the regulations, taxable bonds and tax-exempt bonds are not part of the same issue. The issuance of tax-exempt bonds in a transaction (or series of transactions) that includes taxable bonds, however, may constitute an abusive arbitrage device under Treas. Reg. 1.148-10(a) or a device to avoid other limitations, and as a result, the IRS could determine that a single issue exists despite the taxable and tax-exempt natures of the separate bonds.
  • Draw Down Bonds:  What are the special “issue” rules for draw down bonds? See Treas. Reg. 1.150-1(c)(4) and see the draw down bonds entry elsewhere in this blog.
  • Senior Lien vs. Junior Lien Bonds; Separate Purposes:  If a series of Senior Lien and a series of Junior Lien Bonds are issued within 15 days of one another, should these bonds be considered one issue for federal income tax purposes, considering the following: (1) both series of bonds are paid from a pledge of the same revenues; and (2) one series is intended as a current or advance refunding issue and the other series is intended as a new money project issue? It would be reasonable to conclude that these series would constitute a single issue.
  • BABs (direct pay), “traditional” taxables, tax-exempts:  Three issues or one, assuming same source of funds and plans of finance?  This was subject of a lengthy discussion in June 2009 among Section 103 tax attorneys.  See that discussion.
  • Refunding Bonds and New Money Bonds Sold on the Same Day:  [To come]

References:

See MtF “Single Issue” (20120625)