Arbitrage Guidance for Tax-Exempt Bonds, 54606-54614 [07-4734]
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54606
Proposed Rules
Federal Register
Vol. 72, No. 186
Wednesday, September 26, 2007
This section of the FEDERAL REGISTER
contains notices to the public of the proposed
issuance of rules and regulations. The
purpose of these notices is to give interested
persons an opportunity to participate in the
rule making prior to the adoption of the final
rules.
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG–106143–07]
RIN 1545–BG41
Arbitrage Guidance for Tax-Exempt
Bonds
Internal Revenue Service (IRS),
Treasury.
ACTION: Notice of Proposed Rulemaking
and Notice of Public Hearing.
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AGENCY:
SUMMARY: This document contains
proposed regulations on the arbitrage
restrictions under section 148 of the
Internal Revenue Code applicable to taxexempt bonds issued by State and local
governments. These proposed
regulations are being issued in order to
update existing regulations to address
certain current market developments, to
simplify and correct certain provisions,
and to make existing regulations more
administrable. These proposed
regulations affect State and local
governmental issuers of tax-exempt
bonds. This document also provides
notice of a public hearing on these
proposed regulations.
DATES: Written or electronic comments
must be received by December 26, 2007.
Outlines of topics to be discussed at the
public hearing scheduled for January 30,
2008, at 10 a.m., must be received by
January 2, 2008.
ADDRESSES: Send submissions to:
CC:PA:LPD:PR (REG–106143–07),
Internal Revenue Service, PO Box 7604,
Ben Franklin Station, Washington, DC
20044. Submissions may be hand
delivered to: CC:PA:LPD:PR Monday
through Friday between the hours of 8
a.m. and 4 p.m. to CC:PA:LPD:PR (REG–
106143–07), Courier’s Desk, Internal
Revenue Service, 1111 Constitution
Avenue, NW., Washington, DC, or sent
electronically via the Federal
eRulemaking Portal at
www.regulations.gov (IRS REG–106143–
07). The public hearing will be held in
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the Main IRS Auditorium at the Internal
Revenue Building, 1111 Constitution
Avenue, NW., Washington, DC.
FOR FURTHER INFORMATION CONTACT:
Concerning the proposed regulations,
Carla Young, (202) 622–3980;
concerning submissions of comments
and the hearing,
Richard.A.Hurst@irscounsel.treas.gov,
or (202) 622–7180 (not toll-free
numbers).
SUPPLEMENTARY INFORMATION:
Background
This document contains proposed
amendments to the Income Tax
Regulations (26 CFR part 1) on the
arbitrage investment restrictions under
section 148 of the Internal Revenue
Code (Code). On June 18, 1993, the
Treasury Department and the Internal
Revenue Service (IRS) published
comprehensive final regulations in the
Federal Register (TD 8476, 58 FR
33510) on the arbitrage investment
restrictions and related provisions on
tax-exempt bonds under sections 103,
148, 149, and section 150 of the Code,
and, since that time, those final
regulations have been amended in
certain limited respects (the regulations
issued in 1993 and the amendments
thereto are collectively referred to as the
Existing Regulations). The Treasury
Department and the IRS have since
determined that certain provisions in
the Existing Regulations need to be
modified. This document contains
proposed discrete amendments to the
Existing Regulations (the Proposed
Regulations) to update the Existing
Regulations to address certain current
market developments, to simplify
certain provisions in the Existing
Regulations, to correct certain technical
issues in the Existing Regulations, and
to make the Existing Regulations more
administrable.
In addition, the Treasury Department
and the IRS are in the process of
reviewing the Existing Regulations for
future regulatory guidance on additional
discrete issues for the same purposes.
Explanation of Provisions
I. Existing Regulations
Section 103(a) of the Code generally
excludes from gross income interest on
a State or local bond. Under section
103(b), however, the interest exclusion
does not apply to an arbitrage bond, as
defined in section 148. Section 148
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provides two related, but independent
types of restrictions to determine
whether a bond is an arbitrage bond: A
yield restriction requirement and an
arbitrage rebate requirement. Generally,
these restrictions limit the ability of an
issuer to invest bond proceeds in
investments at a yield that materially
exceeds the yield on the bond issue and
require that certain excess earnings
above the yield on the bond issue be
rebated to the Federal government.
Investment earnings that exceed the
yield on the bond issue are commonly
referred to as arbitrage.
Under section 148(a) of the Code, the
yield restriction requirement generally
provides that a bond is an arbitrage
bond if an issuer reasonably expects to
earn arbitrage or if the issuer,
subsequent to the issuance of the bonds,
engages in a deliberate action to earn
arbitrage on bond proceeds. Exceptions
to the yield restriction requirement
permit an issuer to earn arbitrage in
limited circumstances, such as during
limited temporary periods for prompt
spending of bond proceeds and other
similar temporary periods.
Under section 148(f) of the Code, the
arbitrage rebate requirement provides
that a bond is an arbitrage bond if the
issuer fails to timely rebate to the
United States arbitrage otherwise
permitted to be earned on certain
investments acquired with bond
proceeds. Generally, arbitrage rebate is
paid every 5 years and upon the
redemption of the bond issue.
The Existing Regulations provide
detailed rules for applying the two types
of arbitrage restrictions, including rules
for determining yield on the bond issue
and yield on the investments, and rules
for computing and paying arbitrage
rebate. The Treasury Department and
the IRS believe that discrete changes
need to be made to the Existing
Regulations to simplify and clarify
certain provisions, to make certain
provisions more administrable, and to
update the regulations to reflect current
market practices.
II. Proposed Regulations
The Proposed Regulations make a
number of discrete changes to the
Existing Regulations. Highlighted in this
preamble are certain more substantive
changes which are discussed in further
detail. In addition, certain more minor
changes are addressed in summary
form.
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(1) Hedges based on taxable interest
rates. The Proposed Regulations make
revisions to accommodate certain
hedges in which floating payments
under the hedge are based on a taxable
interest rate and to clarify that bonds
covered by such a hedge are ineligible
for treatment as fixed yield bonds under
the special hedging rule in § 1.148–
4(h)(4).
(2) Joint Bond Yield Authority. The
Proposed Regulations remove the
provision in the Existing Regulations
that permits the IRS Commissioner to
authorize a single yield computation on
multiple bond issues.
(3) Electronic GIC Bidding. The
Proposed Regulations revise the bidding
safe harbor for establishing the fair
market value of guaranteed investment
contracts (GICs) to accommodate
electronic bidding.
(4) Refunds of Overpayments of
Rebate. The Proposed Regulations
clarify that the amount that an issuer is
entitled to receive under a rebate refund
claim is the excess of the total amount
actually paid over the rebate amount.
A. Changes To Accommodate Certain
Hedges
Section 1.148–4 of the Existing
Regulations sets forth rules for
determining the yield on an issue of
bonds for purposes of applying the
arbitrage rules. In general, § 1.148–4(h)
of the Existing Regulations permits
issuers to compute the yield on an issue
by taking into account payments under
‘‘qualified hedges.’’ The Existing
Regulations provide two ways in which
a qualified hedge can be taken into
account in computing yield on the
issue, known commonly as ‘‘simple
integration’’ and ‘‘super integration.’’
For both simple integration and super
integration, a hedge must be a ‘‘qualified
hedge,’’ which is a hedge that meets a
series of eligibility requirements.
Generally, in order to be a qualified
hedge, a hedge must be interest based,
the terms of the hedge must correspond
closely with the terms of the hedged
bonds, the issuer must duly identify the
hedge, and the hedge must contain no
significant investment element. For
super integration, the hedge must meet
additional eligibility requirements
which focus on assuring that the terms
of the hedge and the hedge bonds
sufficiently correspond so as to warrant
treating the hedged bonds as fixed-yield
bonds for arbitrage purposes.
In the case of simple integration,
generally all net payments on the hedge
and the hedged bonds are taken into
account in determining the yield on the
bond issue. For example, if an issuer
issues bonds paying interest at a
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variable rate and enters into a hedge
under which the issuer receives floating
interest rate payments from the hedge
provider and pays fixed interest
payments to the hedge provider (a
variable-to-fixed hedge), the variable
rate that the issuer pays to the
bondholders, the floating rate that the
issuer receives on the hedge, and the
fixed payments that the issuer pays on
the hedge are all taken into account on
a net basis in determining the yield on
the bond issue. In the case of simple
integration, the hedged bonds are
treated as variable yield bonds, which
means that the yield on the bond issue
is periodically recomputed and the
rebate the issuer must pay to the United
States is based on the issuer’s actual net
payments and receipts on the bond and
the hedge. Thus, for example, any ‘‘basis
risk’’ difference between the actual
interest rate that the issuer pays on its
variable-yield hedged bond and the
actual interest rate it receives on the
floating interest rate on the hedge (along
with the fixed payments on the hedge)
is taken into account in determining the
yield on the hedged bonds.
In the case of super integration where
the payments on the hedge and the
hedged bonds sufficiently correspond so
that the yield on the hedged bonds is
fixed and determinable with certain
assumptions, the hedged bonds are
treated as fixed-yield bonds for arbitrage
purposes. In the case of super
integration, any basis risk difference
between the floating-rate interest
payments on the hedge and the variablerate interest payments on the hedged
bonds is ignored in determining the
yield on the hedged bonds for arbitrage
purposes through an assumption that
treats those floating and variable rates as
the same.
One of the eligibility requirements for
a qualified hedge under the Existing
Regulations is that it be interest based.
For simple integration, one of the
subsidiary aspects used in determining
whether a variable-to-fixed interest rate
hedge is interest based focuses on
whether the variable interest rate on the
hedged bonds and the floating interest
rate on the hedge are ‘‘substantially the
same.’’ For super integration purposes,
such rates must be ‘‘reasonably expected
to be substantially the same throughout
the term of the hedge.’’ This aspect of
the interest-based contract standard has
raised technical issues in recent years in
connection with its application to
certain kinds of hedges, as discussed
further in this preamble.
In general, hedging plays an
increasingly important role in the taxexempt bond market. An issuer of bonds
may use hedges to protect itself against
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interest rate risks. For example, an
issuer that issues variable-rate bonds
may hedge or protect itself against
unfavorable interest rate changes in the
market by entering into a variable-tofixed interest rate swap. Historically,
issuers of tax-exempt bonds generally
used a type of swap under which the
hedge provider paid a floating interest
rate that was determined based on a
market index of tax-exempt interest
rates, such as the Securities Industry
and Financial Markets Association
(SIFMA) Municipal Swap Index.
A significant development in the taxexempt bond market since the
promulgation of the Existing
Regulations has been the trend toward
the use by issuers of variable-to-fixed
interest rate swaps as hedges in which
the floating interest rate that the swap
provider pays to the issuer is
determined based on a percentage of a
market index of taxable interest rates,
such as the London Interbank Offered
Rate (LIBOR) (a taxable-index hedge).
Issuers have indicated that these
taxable-index hedges offer more
liquidity, more transparency in pricing,
and lower costs than hedges based on a
tax-exempt interest index.
Issuers have raised interpretative
questions about how to apply the
qualified hedge provisions of the
Existing Regulations to taxable-index
hedges because interest rates on taxable
indices generally do not correspond as
closely as interest rates on tax-exempt
market indices to actual market interest
rates on tax-exempt, variable-rate bonds.
These interpretative questions are
particularly important for taxable-index
hedges used with advance refunding
bond issues because issuers generally
need to use the qualified hedge rules or
some other regime to determine with
certainty the yield on the tax-exempt
advance refunding bonds in order to
comply with the applicable arbitrage
yield restrictions on investments in
defeasance escrows.
The IRS and the Treasury Department
have determined that taxable-index
hedges based on widely-used taxable
indices, such as LIBOR based hedges,
sufficiently improve the efficiency of
the tax-exempt bond market to warrant
accommodation. The Proposed
Regulations accommodate these hedges
by modifying (1) the provisions for
‘‘yield reduction payments,’’ which
permit an issuer to reduce yield on an
investment by making payments to the
Federal government in certain permitted
circumstances to comply with yield
restriction rules and (2) the qualified
hedge provisions. The Proposed
Regulations make clear, however, that
while taxable-index hedges can be
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qualified hedges, and therefore eligible
for simple integration, they are not
eligible for super integration because
there is an insufficient correlation
between tax-exempt bond interest rates
and taxable market interest rate indices.
However, the IRS and the Treasury
Department understand that issuers
have recently issued variable-rate bonds
that bear interest equal to a percentage
of LIBOR, and seek public comments on
whether special accommodation under
the super integration rule is required for
those bond issues.
Yield reduction payments effectively
integrate the yield restriction
requirements with the arbitrage rebate
requirements. For certain limited
situations, § 1.148–5(c) of the Existing
Regulations permits yield reduction
payments to be paid to the United States
to satisfy yield restriction requirements
on certain investments. Yield reduction
payments are similar to, but not
identical to, rebate payments. In general,
the purpose of the yield reduction
payment rules is to simplify compliance
with the sometimes overlapping yield
restriction and arbitrage rebate
requirements by allowing issuers to
make payments similar to rebate
payments to the United States to satisfy
yield restriction and rebate in
appropriate circumstances. For
example, an issuer may effectively
reduce the yield on an investment to a
yield that will not violate the yield
restriction rules and also satisfy the
arbitrage rebate requirement through a
yield reduction payment.
The Proposed Regulations modify the
yield reduction payment rules to permit
issuers to make yield reduction
payments on certain variable-yield
advance refunding issues in which the
issuer has entered into a qualified hedge
in the form of a variable-to-fixed interest
rate swap to hedge its interest rate risk.
This modification to the yield reduction
rule applies for nonpurpose investments
allocable to gross proceeds of an
advance refunding issue deposited into
an advance refunding escrow when: (1)
The issuer has entered into a qualified
hedge in the form of a variable-to-fixed
interest rate swap on all of its variablerate bonds that are allocable to the yield
restricted defeasance escrow, (2) the
hedge covers a period from the issue
date of the bonds until the final
payment is made from the defeasance
escrow, and (3) the yield on the advance
refunding escrow is not reasonably
expected to exceed the yield on the
issue, determined by taking into account
the fixed payments that the issuer is
expected to make under the hedge and
by assuming that the corresponding
variable interest payments to be made
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by the issuer on the hedged bonds and
to be received by the issuer on the hedge
are equal and paid on the same date. In
effect, the Proposed Regulations allow
yield reduction payments in this context
only to be made to cover the basis risk
differences between the hedge and the
hedged bonds.
The Proposed Regulations also modify
the qualified hedge provisions to
provide that the floating rate on the
taxable-index hedge and the variable
rate on the hedged bonds will be treated
as substantially the same for purposes of
§ 1.148–4(h)(2)(v)(B) if: (1) The
difference between the two rates is not
greater than one-quarter of one percent
(.25 percent, or 25 basis points) on the
date the issuer enters into the hedge,
and (2) for a three-year period that ends
on the date the issuer enters into the
hedge, the average difference between
the issuer’s actual tax-exempt interest
rate on comparable variable-rate bonds
(or, if no such comparable bonds exist,
a reasonable tax-exempt interest rate
index, such as the SIFMA Municipal
Swap Index, for that same period) and
an interest rate determined in the same
manner as the floating interest rate on
the hedge does not exceed one-quarter
of one percent (.25 percent, or 25 basis
points). For example, if the floating rate
on the hedge is 67 percent of LIBOR,
then 67 percent of LIBOR, determined
on the same days as the issuer’s actual
interest rates (or tax-exempt index, if
applicable) are determined, is compared
to the issuer’s actual interest rates (or
the tax-exempt index, if applicable) for
the three-year period ending on the date
the hedge is entered into and the
differences are averaged to determine
whether the average difference exceeds
one-quarter of one percent. For this
purpose, a reasonable sample may be
used if the sample for the issuer’s actual
rates (or tax-exempt market index rates,
if applicable) and the sample of floating
rates used for the hedge are determined
as of the same dates.
The Proposed Regulations also make
certain other limited changes to the
hedging and yield reduction rules
which are discussed with other
miscellaneous changes in this preamble.
B. Joint Yield Authority
In general, for arbitrage purposes, the
yield on a bond issue is determined on
an issue-by-issue basis. Section 1.148–
4(a) of the Existing Regulations,
however, authorizes the IRS
Commissioner to permit issuers of
certain types of tax-exempt bonds,
specifically qualified mortgage bonds
and qualified student loan bonds, to
compute a single joint bond yield for
purposes of applying the arbitrage
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restrictions to two or more issues of
these types of tax-exempt bonds.
Since the promulgation of the Existing
Regulations, the IRS has received
numerous private letter ruling requests
for joint bond yield computations and
has ruled on one of these requests. The
Treasury Department and the IRS, based
on what the IRS has learned from these
ruling requests, are concerned about the
highly factual nature of the requests,
and the potential for arbitrage
manipulations with joint yield
computations that would not be
apparent from a private letter ruling
request and that could not reasonably be
discovered in the context of such a
request. For these reasons, the Proposed
Regulations eliminate the regulatory
provision that permits joint yield
computations. However, the Treasury
Department and the IRS are considering
whether generally applicable, objective
standards can be created under which
joint yield computations should be
allowed. Accordingly, the Proposed
Regulations solicit public comments on
when joint yield computations are
needed for sound business reasons and
whether objective standards can be
created that would allow these
computations in a manner that is
consistent with the purposes of section
148. In addition, comments are sought
on the following: The treatment of openended joint yield calculations that allow
future issues to be included in the joint
yield computation, the treatment of
qualified hedges or guarantees that
cover some but not all of the bonds, the
treatment of reserves, the application of
prepayment assumptions, the effect of
partial refundings, and other issues that
impact the administrability of joint
yield calculations. Pending final
resolution of this issue, the IRS will not
entertain any private letter ruling
requests for permission to use a joint
yield computation.
C. Modified Fair Market Value Safe
Harbor for Guaranteed Investment
Contracts
Under § 1.148–5(d)(3) of the Existing
Regulations, investments purchased
with bond proceeds must be valued at
fair market value. Section 1.148–
5(d)(6)(iii) of the Existing Regulations
provides a safe harbor for establishing
the fair market value of a guaranteed
investment contract (GIC) for arbitrage
purposes. That safe harbor generally
relies on a prescribed bidding procedure
and the receipt of at least three bids
from independent parties. The bidding
process requirements under the safe
harbor include a requirement that all
bidders be given an equal opportunity to
bid with no opportunity to review other
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bids (that is, the ‘‘no last look’’ rule) and
a requirement that the bid specifications
be provided to prospective bidders ‘‘in
writing.’’
In the past several years, the taxexempt bond market has seen the
advent of various electronic bidding
procedures and internet platforms for
bidding GICs. While the particular
features of specific GIC bidding
procedures may vary, characteristics of
these electronic GIC bidding procedures
generally include using the internet to
receive bid specifications and to make
bids. The electronic bidding process
permits providers, under prescribed
times and procedures, to continuously
bid and to continuously view the
current highest bids (without
identification of the bidders). The
electronic platforms also provide the
capability to print out the results of the
GIC bidding process. The electronic GIC
bidding procedures have raised certain
technical issues regarding whether they
can comply with the fair market value
safe harbor for GICs under the Existing
Regulations.
The Treasury Department and the IRS
believe that electronic GIC bidding
procedures generally offer the
constructive potential for increasing the
transparency of pricing of investments
purchased with proceeds of tax-exempt
bonds. Accordingly, the Proposed
Regulations amend the fair market value
safe harbor for GICs to accommodate
electronic bidding procedures by (1)
permitting bid specifications to be sent
electronically over the Internet or by fax
and (2) amending the no last look rule
to provide that there is not a prohibited
last look if all bidders have an equal
opportunity for a last look.
D. Recovery of Overpayment of Rebate
Generally, an issuer computes the
amount of arbitrage rebate that it owes
under a method that future values
payments and receipts on investments
using the yield on the bond issue. Under
this method, an arbitrage payment made
on one computation date is future
valued to the next computation date to
determine the amount of arbitrage rebate
owed on that subsequent computation
date. Section 1.148–3(i)(1) of the
Existing Regulations provides that an
issuer may recover an overpayment of
arbitrage rebate with respect to an issue
of tax-exempt bonds if the issuer
establishes to the satisfaction of the IRS
Commissioner that an overpayment
occurred. Section 1.148–3(i)(1) further
defines an overpayment as the excess of
‘‘the amount paid’’ (emphasis added) to
the United States for an issue under
section 148 over the sum of the rebate
amount for that issue as of the most
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recent computation date and all
amounts that are otherwise required to
be paid under section 148 as of the date
the recovery is requested. Thus, even if
the future value of the issuer’s arbitrage
rebate payment on a computation date,
computed under the method for
determining arbitrage rebate, is greater
than the issuer’s rebate amount on that
date, an issuer is only entitled to a
refund to the extent that the amount
actually paid exceeds that rebate
amount. The Existing Regulations limit
the amount of the refund in this manner
because the Treasury Department and
the IRS were concerned about whether
the IRS had statutory authority to pay
interest on arbitrage rebate payments.
To permit a refund in an amount
calculated in whole or in part based
upon a future value of the amount
actually paid would effectively result in
an interest payment on that payment.
Example 2(iii)(D) in § 1.148–3(j) of the
Existing Regulations has caused
confusion because it could be
interpreted to mean that an issuer can
receive a refund of a rebate payment
when the future value of such rebate
payment exceeds the rebate amount on
the next computation date, even though
the actual amount of the previous rebate
payment does not exceed the rebate
amount on that next computation date.
The Proposed Regulations make a
technical amendment to this example to
conform this example to the intended
purpose of § 1.148–3(i)(1). Because the
proposed change does not change the
regulatory rule, but merely makes an
existing example conform to that rule,
the Proposed Regulations provide that
the effective date for this provision is
the same as the effective date for the
regulatory rule. However, the IRS will
not reopen rebate refund claims that
have been processed before the date the
Proposed Regulations are published in
the Federal Register.
E. Other Miscellaneous Changes
1. Qualified Hedge Provisions
The Proposed Regulations make the
following additional changes to the
hedging rules in § 1.148–4(h) and
specifically seek the following
comments on the hedging rules.
a. Cost of Funds Hedges. The
Proposed Regulations clarify that for
purposes of applying the definition of
periodic payment under § 1.446–3(e)(1)
to determine whether a hedge has a
significant investment element under
§ 1.148–4(h)(2)(ii)(A), a ‘‘specified
index’’ under § 1.446–3(c)(2) (upon
which periodic payments are based) is
deemed to include payments under a
cost-of-funds swap, thereby eliminating
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any doubt that these hedges can be
qualified hedges.
b. Size and Scope of a Qualified
Hedge. The Proposed Regulations add
an express requirement under § 1.148–
4(h)(2)(v) that limits the size and scope
of a qualified hedge to a level that is
reasonably necessary to hedge the
issuer’s risk with respect to interest rate
changes on the hedged bonds. This
proposed limitation is comparable to a
former provision that was in the
arbitrage regulations from 1993 to 1997,
but was removed in connection with
1997 amendments to the Existing
Regulations. The Treasury Department
and the IRS believe that this principle
was implicitly carried forward in the
subsidiary standards under the interestbased contract requirement in the
Existing Regulations in 1997. The
Proposed Regulations, however, provide
an explicit separate requirement to
clarify the continued application of this
principle.
c. Correspondence of Payments for
Simple Integration. Commentators have
requested guidance on what time period
satisfies the rule under § 1.148–
4(h)(2)(vi) that requires payments on a
hedge to correspond closely in time to
the payments on the hedged bonds. The
Proposed Regulations add a rule for
simple integration that treats payments
as corresponding closely in time for this
purpose if the payments are made
within 60 calendar days of each other.
This proposed rule contrasts with the
rules for super integration, which
require that payments be made within
15 days of each other. The Proposed
Regulations provide a more flexible time
period for correspondence of payments
for simple integration purposes
consistent with the fact that simple
integration results in more accurate
accounting for all net payments.
d. Time for Identification of Qualified
Hedges. Commentators have indicated
that the three-day period for identifying
a hedge under § 1.148–4(h)(2)(viii) of
the Existing Regulations raises practical
difficulties, particularly with respect to
hedges that are not entered into
contemporaneously with the issuance of
the hedged bonds. The Proposed
Regulations extend the time in § 1.148–
4(h)(2)(viii) for when an issuer must
identify a qualified hedge from three
days to fifteen days and clarify that
these are calendar days. The Proposed
Regulations, however, retain the
requirement that the actual State or
local governmental issuer, rather than
the conduit borrower, identify the hedge
because the Treasury Department and
the IRS believe that it is important for
State and local governments to be
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responsible for qualified hedges on their
bonds.
e. Termination of Hedges at Fair
Market Value. The Proposed
Regulations clarify that under § 1.148–
4(h)(3)(iv)(B), the termination payment
for a termination or a deemed
termination is equal to the fair market
value of the hedge on the termination
date.
f. Solicitation of Comment on
Offsetting Hedges. The Treasury
Department and the IRS have received
requests for clarification of the scope of
the rule that treats offsetting hedges as
deemed terminations of qualified
hedges under § 1.148–4(h)(3)(iv)(A). The
Treasury Department and the IRS seek
express public comment regarding the
types of offsetting hedges that are
necessary for valid business purposes
and recommendations on how to clarify
the scope of this rule on offsetting
hedges.
2. Yield Reduction Payment Rules
The Proposed Regulations permit
issuers to make yield reduction
payments for nonpurpose investments
allocable to proceeds of an issue,
including an advance refunding issue,
that an issuer purchases on a date when
the issuer is unable to purchase State
and Local Government Series Securities
(SLGS) because the Department of
Treasury, Bureau of Public Debt, has
suspended sales of SLGS. This
provision incorporates and expands
Revenue Procedure 95–47, 1995–2 CB
417, which permits yield reduction
payments in more limited situations
than the Proposed Regulations when
SLGS are unavailable.
The Proposed Regulations also
reorganize the yield reduction rules to
make them easier to read.
to be called before maturity and before
amortization of the premium.
Section 1.148–4(b)(3)(i) of the Existing
Regulations treats a yield-to-call bond as
redeemed at the stated redemption price
on the optional redemption date that
would produce the lowest yield on the
issue (as contrasted with the lowest
yield on the particular premium bond).
This methodology, which considers the
lowest yield on the issue for these yieldto-call bonds, requires computations of
possible combinations of redemption
dates in circumstances in which the
variations of redemption dates may have
very limited impact on yield.
The Proposed Regulations simplify
the yield calculations for these yield-tocall bonds to focus on the redemption
date that results in the lowest yield on
the particular premium bond (rather
than the more complex existing focus on
the lowest yield on the issue). This
change corresponds to a former version
of this regulatory rule which was in
effect under applicable arbitrage
regulations from 1989 through 1992.
4. Arbitrage Rebate Computation Credit
Section 1.148–3(d)(1)(iv) of the
Existing Regulations provides that an
issuer may take certain credits against
payment of arbitrage rebate in the
amount of $1,000 for each rebate
computation date, subject to certain
limitations, to help offset the cost of
computing rebate. The Proposed
Regulations increase this rebate credit to
$1,400 for any bond year ending in the
year 2007 to reflect the change in the
Consumer Price Index since the $1,000
rebate credit was published. The
Proposed Regulations further adjust the
computation date credit for inflation for
bond years ending in each year
thereafter.
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3. Modification of Yield Computation
for Yield-to-Call Premium Bonds
5. External Commingled Investment
Funds
The Proposed Regulations simplify
the rules for computing yield on an
issue that has certain callable premium
bonds. Existing Regulations generally
provide that the yield on an issue is
based on the yield to maturity, taking
into account certain assumptions. The
Existing Regulations have a special rule
for certain callable bonds issued with
significant amounts of bond premium
(sometimes called yield-to-call bonds),
which requires a determination of yield
to a call date, based on certain assumed
optional redemptions. The general
purpose of this rule is to recognize that
a yield-to-maturity computation may
not be economically accurate in this
circumstance because these yield-to-call
bonds are more likely than other bonds
The Existing Regulations provide
certain preferential rules for the
treatment of administrative costs to
certain widely-held ‘‘external
commingled funds,’’ as defined in
§ 1.148–5(e)(2)(ii)(B). Under the Existing
Regulations, a fund is treated as widely
held if the fund, on average, has more
than 15 unrelated investors, each of
which maintains prescribed minimum
average investments in the fund. The
Proposed Regulations make a technical
change to allow additional smaller
investors to invest in an external
commingled fund without disqualifying
the fund so long as at least 16 unrelated
investors each maintain the required
minimum average investments in the
fund.
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6. Pooled Bonds
The Proposed Regulations make
conforming changes to § 1.148–8(d) to
reflect legislative changes made to
section 148(f)(4)(D) by section 508 of the
Tax Increase Prevention and
Reconciliation Act of 2005, Pub. L. No.
109–222, 120 Stat. 345 (TIPRA). Under
TIPRA, Congress eliminated the rule in
§ 148(f)(4)(D)(ii)(II) that permitted a pool
bond issuer to ignore its pool bond issue
in computing whether it had exceeded
its $5 million limit for purposes of the
small issuer rebate exception of section
148(f)(4)(D). Correspondingly, the
Proposed Regulations eliminate the
provisions in the Existing Regulations
that permit a pool bond issuer to ignore
the amount of its pool bond issue in
determining whether the issuer meets
the small issuer exception of section
148(f)(4)(D). The Proposed Regulations
retain the provision that permits a State
or local governmental conduit borrower
to ignore the amount of certain pool
bond issues in excess of the amount it
borrows from that pool. Consistent with
the statutory change, the Proposed
Regulations provide that the change for
pool bond issuers is effective for bonds
issued after May 17, 2006, the effective
date of the relevant provision of TIPRA.
III. Effective Dates
The Proposed Regulations are
proposed to apply to bonds sold on or
after a date that is 90 days after
publication of final regulations in the
Federal Register, but an issuer may
apply certain specified provisions of the
Proposed Regulations to bonds sold
before the date that is 90 days after
publication of the final regulations in
the Federal Register as provided in
proposed § 1.148–11(k). Except for the
changes to the qualified hedging rules
which must be applied in their entirety,
issuers that are permitted, but not
required, to apply the proposed changes
may apply some or all of the changes to
a bond issue.
The Proposed Regulations contain a
technical amendment to the example in
the general arbitrage rebate rules. This
change applies to bonds subject to
§ 1.148–3(i), the dates of applicability
for which are set forth in the Existing
Regulations.
The Proposed Regulations contain a
special effective date provision for the
regulatory change that conforms the
arbitrage regulations to the legislative
change made to the small issuer rebate
exception for pooled bond issuers. This
change applies to bonds issued after
May 17, 2006, the effective date of the
relevant provision of TIPRA.
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Federal Register / Vol. 72, No. 186 / Wednesday, September 26, 2007 / Proposed Rules
Effect on Other Documents
On the date of applicability of the
final regulations, Revenue Procedure
95–47, 1995–2 CB 417, will be
obsoleted.
Special Analyses
It has been determined that this notice
of proposed rulemaking is not a
significant regulatory action as defined
in EO 12866. Therefore, a regulatory
assessment is not required. It is hereby
certified that these proposed regulations
will not have a significant economic
impact on a substantial number of small
entities. Therefore, a Regulatory
Flexibility Analysis under the
Regulatory Flexibility Act (5 U.S.C.
chapter 6) is not required. Some of the
proposed changes clarify existing
regulatory provisions, conform the
regulations to a recent statutory change,
or otherwise involve simplifying or
clarifying changes that will not have a
significant economic impact on
governmental jurisdictions or other
entities of any size. Other proposed
changes involve the treatment of certain
hedging transactions, such as interest
rate swaps, for purposes of the arbitrage
investment restrictions on tax-exempt
bonds issued by State and local
governments. Although there is a lack of
available data regarding the extent of
usage of these hedging transactions by
small entities, the IRS and the Treasury
Department understand that these
hedging transactions are used primarily
by larger State and local governments
and other eligible larger entities. The
IRS and the Treasury Department
specifically solicit comment from any
party, particularly affected small
entities, on the accuracy of this
certification. Pursuant to section 7805(f)
of the Internal Revenue Code, this
regulation has been submitted to the
Small Business Administration for
comment on its impact on small
governmental jurisdictions.
rmajette on PROD1PC64 with PROPOSALS
Comments and Public Hearing
Before these Proposed Regulations are
adopted as final regulations,
consideration will be given to any
written (a signed original and eight (8)
copies) or electronic comments that are
submitted timely to the IRS. The
Treasury Department and IRS request
comments on the clarity of the proposed
rules and how they can be made easier
to understand. All comments will be
available for public inspection and
copying.
A public hearing has been scheduled
for January 30, 2008 at 10 a.m. in the
Main IRS Auditorium, Internal Revenue
Service Building, 1111 Constitution
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54611
Avenue, NW., Washington, DC. Due to
building security procedures, visitors
must enter at the Constitution Avenue
entrance. In addition, all visitors must
present photo identification to enter the
building. Because of access restrictions,
visitors will not be admitted beyond the
immediate entrance area more than 30
minutes before the hearing starts. For
information about having your name
placed on the building access list to
attend the hearing, see the FOR FURTHER
INFORMATION CONTACT section of this
preamble.
The rules of 26 CFR 601.601(a)(3)
apply to the hearing. Persons who wish
to present oral comments at the hearing
must submit written or electronic
comments and an outline of the topics
to be discussed and the time to be
devoted to each topic (a signed original
and eight (8) copies) by January 2, 2008.
A period of 10 minutes will be allotted
to each person for making comments.
An agenda showing the scheduling of
the speakers will be prepared after the
deadline for receiving outlines has
passed. Copies of the agenda will be
available free of charge at the hearing.
4. Add entries for new paragraphs (k),
(k)(1), (k)(2), (k)(3) and (k)(4) in the table
of contents for § 1.148–11.
The revised and added provisions
read as follows:
Drafting Information
*
The principal authors of these
regulations are Rebecca L. Harrigal and
Carla A. Young, Office of Associate
Chief Counsel (Financial Institutions
and Products), IRS. However, other
personnel from the IRS and Treasury
Department participated in their
development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and
recordkeeping requirements.
Proposed Amendments to the
Regulations
Accordingly, 26 CFR part 1 is
proposed to be amended as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation
for part 1 continues to read in part as
follows:
Authority: 26 U.S.C. 7805 * * *
Sections 1.148–0, 1.148–3, 1.148–4, 1.148–
5, 1.148–8 and 1.148–11 also issued under 26
U.S.C. 148(i).
Par. 2. Section 1.148–0(c) is amended
as follows:
1. Add entry for new paragraph (d)(4)
in the table of contents for § 1.148–3.
2. Revise entry for paragraph (d) in
the table of contents for § 1.148–8.
3. Remove entries for paragraph (d)(1)
and paragraph (d)(2) in the table of
contents for § 1.148–8.
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§ 1.148–0
Scope and Table of Contents.
*
*
*
*
*
§ 1.148–3
General arbitrage rebate rules.
*
*
*
*
*
(d) * * *
(4) Cost-of living adjustment.
*
*
*
*
*
§ 1.148–8 Small issuer exception to rebate
requirement.
*
*
*
*
*
(d) Pooled financings—treatment of
conduit borrowers.
*
*
*
*
*
§ 1.148–11
Effective dates.
*
*
*
*
*
(k) Certain arbitrage guidance updates.
(1) In general.
(2) Permissive earlier application.
(3) Rebate overpayment recovery.
(4) Small issuer exception to rebate
requirement for conduit borrowers of pooled
financings.
*
*
*
*
Par. 3. Section 1.148–3 is amended by
revising paragraph (d)(1)(iv) and adding
a new paragraph (d)(4) as follows:
§ 1.148–3
General arbitrage rebate rules.
*
*
*
*
*
(d) * * *
(1) * * *
(iv) On the last day of each bond year
during which there are amounts
allocated to gross proceeds of an issue
that are subject to the rebate
requirement, and on the final maturity
date, a computation credit of $1,400 for
any bond year ending in 2007 and, for
bond years ending after 2007, a
computation credit in the amount
determined under paragraph (d)(4) of
this section; and
*
*
*
*
*
(4) Cost-of-living adjustment. For any
calendar year after 2007, the $1,400
computation credit set forth in
paragraph (d)(1)(iv) shall be increased
by an amount equal to such dollar
amount multiplied by the cost-of-living
adjustment determined under section
1(f)(3) for such year as modified by this
paragraph (d)(4). In applying section
1(f)(3) to determine this cost-of-living
adjustment, the reference to ‘‘calendar
year 1992’’ in section 1(f)(3)(B) shall be
changed to ‘‘calendar year 2006.’’ If any
such increase determined under this
paragraph (d)(4) is not a multiple of $10,
such increase shall be rounded to the
nearest multiple thereof.
*
*
*
*
*
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Federal Register / Vol. 72, No. 186 / Wednesday, September 26, 2007 / Proposed Rules
Par. 4. Section 1.148–3(j) is amended
by revising Example 2(iii)(D) to read as
follows:
§ 1.148–3
*
General arbitrage rebate rules.
*
*
(j) * * *
*
*
Example 2. * * *
(iii) * * *
(D) If the yield during the second
computation period were, instead,
7.0000 percent, the rebate amount
computed as of July 1, 2004, would be
$1,320,891. The future value of the
payment made on July 1, 1999, would
be $1,471,007. Although the future
value of the payment made on July 1,
1999 ($1,471,007), exceeds the rebate
amount computed as of July 1, 2004
($1,320,891), § 1.148–3(i) limits the
amount recoverable as a defined
overpayment of rebate under section
148 to the excess of the total ‘‘amount
paid’’ over the sum of the amount
determined under the future value
method to be the ‘‘rebate amount’’ as of
the most recent computation date and
all other amounts that are otherwise
required to be paid under section 148 as
of the date the recovery is requested.
Because the total amount that the issuer
paid on July 1, 1999 ($1,042,824.60),
does not exceed the rebate amount as of
July 1, 2004 ($1,320,891), the issuer
would not be entitled to recover any
overpayment of rebate in this case.
*
*
*
*
*
Par. 5. Section 1.148–4(a) is revised to
read as follows:
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§ 1.148–4
Yield on an issue of bonds.
(a) In general. The yield on an issue
of bonds is used to apply investment
yield restrictions under section 148(a)
and to compute rebate liability under
section 148(f). Yield is computed under
the economic accrual method using any
consistently applied compounding
interval of not more than one year. A
short first compounding interval and a
short last compounding interval may be
used. Yield is expressed as an annual
percentage rate that is calculated to at
least four decimal places (for example,
5.2525 percent). Other reasonable,
standard financial conventions, such as
the 30 days per month/360 days per
year convention, may be used in
computing yield but must be
consistently applied. The yield on an
issue that would be a purpose
investment (absent section 148(b)(3)(A))
is equal to the yield on the conduit
financing issue that financed that
purpose investment.
*
*
*
*
*
Par. 6. Section 1.148–4 is amended
by:
1. Revising paragraph (b)(3)(i), and
adding a new sentence at the end of
paragraph (h)(2)(ii)(A).
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2. Revising the heading and
introductory text of paragraph (h)(2)(v).
3. Amending paragraph (h)(2)(v)(B) by
revising the last sentence.
4. Adding paragraphs (h)(2)(v)(B)(1),
(2) and (3).
5. Adding a new sentence at the end
of paragraph (h)(2)(vi).
6. Revising the heading and first
sentence of paragraph (h)(2)(viii).
7. Amending paragraph (h)(3)(iv)(B)
by adding a new sentence immediately
after the first sentence.
8. Adding a new sentence at the end
of paragraph (h)(4)(i)(C).
The revised and added provisions
read as follows:
§ 1.148–4
Yield on an issue of bonds.
*
*
*
*
*
(b) * * *
(3) Yield on certain fixed yield bonds
subject to optional early redemption—(i)
In general. If a fixed yield bond is
subject to optional early redemption and
is described in paragraph (b)(3)(ii) of
this section, the yield on the issue
containing the bond is computed by
treating the bond as redeemed at its
stated redemption price on the optional
redemption date that would produce the
lowest yield on that bond.
*
*
*
*
*
(h) * * *
(2) * * *
(ii) * * *
(A) * * * For purposes of applying
the definition of periodic payment
under § 1.446–3 to determine whether a
hedge has a significant investment
element under this paragraph
(h)(2)(ii)(A), the definition of ‘‘specified
index’’ under § 1.446–3 (upon which
periodic payments are required to be
based) is deemed also to include
payments an issuer receives under a
hedge that are computed to be equal to
the issuer’s cost of funds, such as the
issuer’s actual market-based tax-exempt
variable interest rate on its bonds.
*
*
*
*
*
(v) Interest-based contract and size
and scope of hedge. The contract is
primarily interest-based (for example, a
hedge based on a debt index rather than
an equity index). In addition, the size
and scope of the hedge under the
contract is limited to that which is
reasonably necessary to hedge the
issuer’s risk with respect to interest rate
changes on the hedged bonds. For
example, a contract is limited to
hedging an issuer’s risk with respect to
interest rate changes on the hedged
bonds if the hedge is based on the
issuer’s principal amount of bonds and
reasonably expected interest
requirements rather than based on a
greater notional amount or an interest
rate level greater than the expected
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interest requirements. A contract is not
primarily interest based unless—
*
*
*
*
*
(B) * * * For this purpose,
differences that would not prevent the
resulting bond from being substantially
similar to another type of bond or to
result in overhedging include:
(1) A difference between the interest
rate used to compute payments on the
hedged bond and the interest rate used
to compute payments on the hedge
where one interest rate is substantially
the same as, but not identical to, the
other. For this purpose, if an interest
rate swap under which the issuer pays
the hedge provider a fixed interest
payment and receives from the hedge
provider a floating interest rate that is
based on a taxable interest rate or a
taxable market interest rate index, the
floating rate on the hedge and the
variable rate on the hedged bonds will
be treated as being substantially the
same only if:
(i) The difference between the interest
rate on the issuer’s hedged bonds and
the floating interest rate on the hedge
does not exceed one quarter of one
percent (.25 percent, or 25 basis points)
on the date that the issuer enters into
the hedge; and
(ii) For a three-year period that ends
on the date the issuer enters into the
hedge, the average difference between
the issuer’s actual tax-exempt interest
rate on comparable variable-rate bonds
(or, if no such comparable bonds exist,
rates from a reasonable tax-exempt
interest rate index, such as the SIFMA
Municipal Swap Index, for that same
period) and interest rates determined in
the same manner as the floating interest
rate on the hedge and as of the same
dates as the issuer’s comparable
variable-rate bonds (or the tax-exempt
market index, if applicable) does not
exceed one-quarter of one percent (.25
percent, or 25 basis points). For
example, if the floating rate on the
hedge is 67 percent of LIBOR, then 67
percent of LIBOR, determined as of the
same dates as the issuer’s actual interest
rates (or tax-exempt market index, if
applicable) is compared to those actual
interest rates (or the tax-exempt market
index, if applicable) for the three-year
period ending on the date the hedge is
entered into and the differences are
averaged to determine whether the
average difference exceeds one-quarter
of one percent. For this purpose, a
reasonable sample may be used if the
sample for the issuer’s actual rates (or
tax-exempt market index rates, if
applicable) and the sample of floating
rates used for the hedge are determined
as of the same dates.
(2) A difference resulting from the
payment of a fixed premium for a cap
(for example, payments for a cap that
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are made in other than level
installments).
(3) A difference resulting from the
allocation of a termination payment if
the termination was unexpected as of
the date that the parties entered into the
hedge contract.
(vi) * * * For this purpose, such
payments will be treated as
corresponding closely in time under this
paragraph (h)(2)(vi) if they are made
within 60 calendar days of each other.
*
*
*
*
*
(viii) Reasonably contemporaneous
identification. The contract must be
identified by the actual issuer on its
books and records maintained for the
hedged bonds not later than 15 calendar
days after the date on which the issuer
and the hedge provider enter into the
hedge contract. * * *
(3) * * *
(iv) * * *
(B) * * * The amount of the
termination payment in a termination or
deemed termination is equal to the fair
market value of the qualified hedge on
the date of the termination. * * *
*
*
*
*
*
(4) * * *
(i) * * *
(C) * * * Except for an anticipatory
hedge that is terminated or otherwise
closed substantially contemporaneously
with the hedged bond in accordance
with paragraph (h)(5)(ii) or (h)(5)(iii) of
this section, a hedge based on a taxable
interest rate or taxable interest index
(for example, the London Interbank
Offered Rate or LIBOR) does not meet
the requirements of this paragraph (C).
*
*
*
*
*
Par. 7. Section 1.148–5(c) is amended
by:
1. Removing existing paragraph
(c)(3)(ii).
2. Adding introductory language to
paragraph (c)(3).
3. Removing the heading in paragraph
(c)(3)(i) and redesignating the existing
text in paragraph (c)(3)(i)(A) as the text
in paragraph (c)(3)(i).
4. Redesignate existing paragraphs
(c)(3)(i)(B), (c)(3)(i)(C), (c)(3)(i)(D),
(c)(3)(i)(E), (c)(3)(i)(F), and (c)(3)(i)(G) as
paragraphs (c)(3)(ii), (c)(3)(iii), (c)(3)(iv),
(c)(3)(v), (c)(3)(vi), and (c)(3)(vii),
respectively.
5. Redesignate existing paragraphs
(c)(3)(i)(C)(1) and (c)(3)(i)(C)(2) as
paragraphs (c)(3)(iii)(A) and
(c)(3)(iii)(B), respectively, in newly
redesignated paragraph (c)(3)(iii).
6. Redesignate existing paragraphs
(c)(3)(i)(E)(1) and (c)(3)(i)(E)(2) as
paragraphs (c)(3)(v)(A) and (c)(3)(v)(B),
respectively, in newly redesignated
paragraph (c)(3)(v).
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Jkt 211001
7. Amend newly redesignated
paragraph (c)(3)(i), (c)(3)(ii), (c)(3)(iii),
(c)(3)(iv), (c)(3)(v), (c)(3)(vi) and
(c)(3)(vii) by adding headings to each
paragraph.
8. Revise newly redesignated
paragraph (c)(3)(v).
9. Revise newly redesignated
paragraph (c)(3)(vi).
10. Amend newly redesignated
paragraph (c)(3)(vii) by removing the
period at the end of the paragraph and
replacing it with a semicolon.
11. Amending paragraph (c)(3) by
adding new paragraphs (c)(3)(viii) and
(c)(3)(ix).
The revised and added provisions
read as follows:
§ 1.148–5 Yield and valuation of
investments.
*
*
*
*
*
(c) * * *
(3) Applicability of special yield
reduction rule. Except as otherwise
expressly provided in paragraphs
(c)(3)(i) through (ix) of this section,
paragraph (c) applies only to
investments listed in paragraphs (c)(3)(i)
through (c)(3)(ix) of this section that are
allocated to proceeds of an issue other
than gross proceeds of an advance
refunding issue.
(i) Nonpurpose investments allocated
to proceeds of an issue that qualified for
certain temporary periods. * * *
(ii) Investments allocable to certain
variable yield issues. * * *
(iii) Nonpurpose investments
allocable to certain transferred
proceeds. * * *
(A) * * *
(B) * * *
(iv) Purpose investments allocable to
certain qualified student loans. * * *
(v) Nonpurpose investments allocable
to gross proceeds in certain reserve
funds. Nonpurpose investments
allocable to gross proceeds of an issue
in a reasonably required reserve or
replacement fund or a fund that, except
for its failure to satisfy the size
limitation in § 1.148–2(f)(2)(ii), would
qualify as a reasonably required reserve
or replacement fund, but only to the
extent the requirements in paragraphs
(c)(3)(v)(A) or (B) of this section are met.
This paragraph (c)(3)(v) includes
nonpurpose investments described in
this paragraph that are allocable to
transferred proceeds of an advance
refunding issue, but only to the extent
necessary to satisfy yield restriction
under section 148(a) on those proceeds
treating all investments allocable to
those proceeds as a separate class.
(A) * * *
(B) * * *
(vi) Nonpurpose investments
allocable to certain replacement
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54613
proceeds of refunded issues.
Nonpurpose investments allocated to
replacement proceeds of a refunded
issue, including a refunded issue that is
an advance refunding issue, as a result
of the application of the universal cap
to amounts in a refunding escrow;
(vii) Investments allocable to
replacement proceeds under a certain
transition rule. * * *
(viii) Nonpurpose investments
allocable to proceeds when SLGS are
unavailable. Nonpurpose investments
allocable to proceeds of an issue,
including an advance refunding issue,
that an issuer purchases on a date when
the issuer is unable to purchase State
and Local Government Series Securities
(SLGS) because the U.S. Department of
Treasury, Bureau of Public Debt, has
suspended sales of those securities; and
(ix) Nonpurpose investments
allocable to proceeds of certain variableyield advance refunding issues.
Nonpurpose investments allocable to
proceeds of a variable-yield advance
refunding issue (the hedged bond issue)
deposited in a yield restricted
defeasance escrow if—
(A) The issuer has entered into a
qualified hedge under § 1.148–4(h)(2)
with respect to all of the variable-yield
bonds of the issue allocable to the yield
restricted defeasance escrow and that
hedge is in the form of a variable-tofixed interest rate swap under which the
issuer pays the hedge provider a fixed
interest rate and receives from the hedge
provider a floating interest rate;
(B) Such qualified hedge covers a
period beginning on the issue date of
the hedged bond issue and ending on or
after the date on which the final
payment is to be made from the yield
restricted defeasance escrow; and
(C) The issuer restricts the yield on
the yield restricted defeasance escrow to
a yield that is not greater than the yield
on the hedged bond issue, determined
by taking into account the issuer’s fixed
payments to be made under the hedge
and by assuming that the issuer’s
variable yield payments to be paid on
the hedged bonds are equal to the
floating payments to be received by the
issuer under the qualified hedge and are
paid on the same dates (that is, such
yield reduction payments can only be
made to address basis risk differences
between the variable yield payments on
the hedged bonds and the floating
payments received on the hedge).
*
*
*
*
*
Par. 8. Section 1.148–5(d)(6) is
amended by revising paragraphs
(d)(6)(iii)(A)(1) and (d)(6)(iii)(A)(6) to
read as follows:
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§ 1.148–5 Yield and valuation of
investments.
*
*
*
*
*
(d) * * *
(6) * * *
(iii) * * *
(A) * * *
(1) The bid specifications are in
writing and are timely forwarded, or are
made available on an internet website or
other similar electronic media that is
regularly used to post bid specifications,
to potential bidders. For purposes of
this paragraph (d)(6)(iii)(A), a writing
includes a hard copy, a fax, or an
electronic e-mail copy.
*
*
*
*
*
(6) All potential providers have an
equal opportunity to bid. If the bidding
process affords any opportunity for a
potential provider to review other bids
before providing a bid, then providers
have an equal opportunity to bid only
if all potential providers have an equal
opportunity to review other bids. Thus,
no potential provider may be given an
opportunity to review other bids that is
not equally given to all potential
providers (that is, no exclusive ‘‘last
look’’).
*
*
*
*
*
Par. 9. Section 1.148–5(e)(2) is
amended by revising the second
sentence of paragraph (e)(2)(ii)(B) to
read as follows:
§ 1.148–5 Yield and valuation of
investments.
rmajette on PROD1PC64 with PROPOSALS
*
*
*
*
*
(e) * * *
(2) * * *
(ii) * * *
(B) External commingled funds. * * *
For purposes of this paragraph
(e)(2)(ii)(B), a fund is treated as widely
held only if, during the immediately
preceding fixed, semiannual period
chosen by the fund (for example,
semiannual periods ending June 30 and
December 31), the fund had a daily
average of more than 15 investors that
were not related parties, and at least 16
of the unrelated investors each
maintained a daily average amount
invested in the fund that was not less
than the lesser of $500,000 and one
percent (1%) of the daily average of the
total amount invested in the fund (with
it being understood that additional
smaller investors will not disqualify the
fund). * * *
*
*
*
*
*
Par. 10. Section 1.148–8(d) is revised
to read as follows:
§ 1.148–8 Small Issuer Exception to
Rebate Requirement.
*
*
*
VerDate Aug<31>2005
*
*
15:45 Sep 25, 2007
Jkt 211001
(d) Pooled financings—treatment of
conduit borrowers. A loan to a conduit
borrower in a pooled financing qualifies
for the small issuer exception,
regardless of the size of either the
pooled financing or of any loan to other
conduit borrowers, only if—
(1) The bonds of the pooled financing
are not private activity bonds;
(2) None of the loans to conduit
borrowers are private activity bonds;
and
(3) The loan to the conduit borrower
meets all the requirements of the small
issue exception.
*
*
*
*
*
Par. 11. Section 1.148–11 is revised
by adding new paragraph (k) as follows:
§ 1.148–11
Effective Dates.
*
*
*
*
*
(k) Certain arbitrage guidance
updates.
(1) In general. Sections 1.148–
3(d)(1)(iv); 1.148–3(d)(4); 1.148–4(a);
1.148–4(b)(3)(i); 1.148–4(h)(2)(ii)(A);
1.148–4(h)(2)(v); 1.148–4(h)(2)(vi);
1.148–4(h)(2)(viii); 1.148–4(h)(3)(iv)(B);
1.148–4(h)(4)(i)(C); 1.148–5(c)(3); 1.148–
5(d)(6)(iii)(A) and 1.148–5(e)(2)(ii)(B), as
in effect on the effective date of the final
regulations (the revised provisions),
apply to bonds sold on or after the date
that is 90 days after publication of the
final regulations in the Federal Register,
for bonds subject to such applicable
section of the regulations as in effect
before the effective date of the final
regulations.
(2) Permissive earlier application. To
the extent provided in paragraphs
(k)(2)(i) through (vi) of this section,
issuers may apply the proposed
regulations to bonds sold before the date
that is 90 days after publication of the
final regulations in the Federal Register.
(i) Section 1.148–3(d)(1)(iv) and
§ 1.148–3(d)(4) may be applied for bond
years ending on or after the date of
publication of the proposed regulations
in the Federal Register for bonds to
which 1.148–3(d)(1)(iv) applies.
(ii) Section 1.148–4(b)(3)(i) may be
applied for bonds sold on or after the
date of publication of the proposed
regulations in the Federal Register for
bonds to which that section applies.
(iii) Sections 1.148–4(h)(2)(ii)(A),
1.148–4(h)(2)(v), 1.148–4(h)(2)(vi),
1.148–4(h)(2)(viii), 1.148–4(h)(3)(iv)(B),
and 1.148–4(h)(4)(i)(C) may be applied,
in whole but not in part, for qualified
hedges entered into on or after the date
of publication of the proposed
regulations in the Federal Register for
bonds to which § 1.148–4(h) applies.
(iv) Section 1.148–5(c)(3) may be
applied for investments purchased on or
after the date of publication of the
PO 00000
Frm 00009
Fmt 4702
Sfmt 4702
proposed regulations in the Federal
Register for bonds to which that section
applies.
(v) Section 1.148–5(d)(6)(iii)(A) may
be applied to guaranteed investment
contracts entered into on or after the
date of publication of the proposed
regulations in the Federal Register for
bonds to which § 1.148–5(d)(6)(iii)
applies.
(vi) Section 1.148–5(e)(2)(ii)(B) may
be applied with respect to investors
investing in the fund on or after the date
of publication of the proposed
regulations in the Federal Register for
bonds to which that section applies.
(3) Rebate overpayment recovery.
Section 1.148–3(j) applies to bonds
subject to § 1.148–3(i).
(4) Small issuer exception to rebate
requirement for conduit borrowers of
pooled financings. Section 1.148–8(d)
applies to bonds issued after May 17,
2006.
Linda E. Stiff,
Deputy Commissioner for Services and
Enforcement.
[FR Doc. 07–4734 Filed 9–24–07; 8:45 am]
BILLING CODE 4830–01–P
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG–148393–06]
RIN 1545–BG12
Medical and Accident Insurance
Benefits Under Qualified Plans;
Correction
Internal Revenue Service (IRS),
Treasury.
ACTION: Correction to notice of proposed
rulemaking.
AGENCY:
SUMMARY: This document contains
corrections to notice of proposed
rulemaking that was published in the
Federal Register on Monday, August 20,
2007 (72 FR 46421), regarding the tax
treatment of payments by qualified
plans for medical or accident insurance.
FOR FURTHER INFORMATION CONTACT:
Pamela Kinard at (202) 622–6060.
SUPPLEMENTARY INFORMATION:
Background
The notice of proposed rulemaking
(REG–148393–06) that is the subject of
these corrections is under section 402(a)
of the Internal Revenue Code.
Need for Correction
As published, the notice of proposed
rulemaking (REG–148393–06) contains
E:\FR\FM\26SEP1.SGM
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Agencies
[Federal Register Volume 72, Number 186 (Wednesday, September 26, 2007)]
[Proposed Rules]
[Pages 54606-54614]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 07-4734]
========================================================================
Proposed Rules
Federal Register
________________________________________________________________________
This section of the FEDERAL REGISTER contains notices to the public of
the proposed issuance of rules and regulations. The purpose of these
notices is to give interested persons an opportunity to participate in
the rule making prior to the adoption of the final rules.
========================================================================
Federal Register / Vol. 72, No. 186 / Wednesday, September 26, 2007 /
Proposed Rules
[[Page 54606]]
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG-106143-07]
RIN 1545-BG41
Arbitrage Guidance for Tax-Exempt Bonds
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of Proposed Rulemaking and Notice of Public Hearing.
-----------------------------------------------------------------------
SUMMARY: This document contains proposed regulations on the arbitrage
restrictions under section 148 of the Internal Revenue Code applicable
to tax-exempt bonds issued by State and local governments. These
proposed regulations are being issued in order to update existing
regulations to address certain current market developments, to simplify
and correct certain provisions, and to make existing regulations more
administrable. These proposed regulations affect State and local
governmental issuers of tax-exempt bonds. This document also provides
notice of a public hearing on these proposed regulations.
DATES: Written or electronic comments must be received by December 26,
2007. Outlines of topics to be discussed at the public hearing
scheduled for January 30, 2008, at 10 a.m., must be received by January
2, 2008.
ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-106143-07), Internal
Revenue Service, PO Box 7604, Ben Franklin Station, Washington, DC
20044. Submissions may be hand delivered to: CC:PA:LPD:PR Monday
through Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR
(REG-106143-07), Courier's Desk, Internal Revenue Service, 1111
Constitution Avenue, NW., Washington, DC, or sent electronically via
the Federal eRulemaking Portal at www.regulations.gov (IRS REG-106143-
07). The public hearing will be held in the Main IRS Auditorium at the
Internal Revenue Building, 1111 Constitution Avenue, NW., Washington,
DC.
FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations,
Carla Young, (202) 622-3980; concerning submissions of comments and the
hearing, Richard.A.Hurst@irscounsel.treas.gov, or (202) 622-7180 (not
toll-free numbers).
SUPPLEMENTARY INFORMATION:
Background
This document contains proposed amendments to the Income Tax
Regulations (26 CFR part 1) on the arbitrage investment restrictions
under section 148 of the Internal Revenue Code (Code). On June 18,
1993, the Treasury Department and the Internal Revenue Service (IRS)
published comprehensive final regulations in the Federal Register (TD
8476, 58 FR 33510) on the arbitrage investment restrictions and related
provisions on tax-exempt bonds under sections 103, 148, 149, and
section 150 of the Code, and, since that time, those final regulations
have been amended in certain limited respects (the regulations issued
in 1993 and the amendments thereto are collectively referred to as the
Existing Regulations). The Treasury Department and the IRS have since
determined that certain provisions in the Existing Regulations need to
be modified. This document contains proposed discrete amendments to the
Existing Regulations (the Proposed Regulations) to update the Existing
Regulations to address certain current market developments, to simplify
certain provisions in the Existing Regulations, to correct certain
technical issues in the Existing Regulations, and to make the Existing
Regulations more administrable.
In addition, the Treasury Department and the IRS are in the process
of reviewing the Existing Regulations for future regulatory guidance on
additional discrete issues for the same purposes.
Explanation of Provisions
I. Existing Regulations
Section 103(a) of the Code generally excludes from gross income
interest on a State or local bond. Under section 103(b), however, the
interest exclusion does not apply to an arbitrage bond, as defined in
section 148. Section 148 provides two related, but independent types of
restrictions to determine whether a bond is an arbitrage bond: A yield
restriction requirement and an arbitrage rebate requirement. Generally,
these restrictions limit the ability of an issuer to invest bond
proceeds in investments at a yield that materially exceeds the yield on
the bond issue and require that certain excess earnings above the yield
on the bond issue be rebated to the Federal government. Investment
earnings that exceed the yield on the bond issue are commonly referred
to as arbitrage.
Under section 148(a) of the Code, the yield restriction requirement
generally provides that a bond is an arbitrage bond if an issuer
reasonably expects to earn arbitrage or if the issuer, subsequent to
the issuance of the bonds, engages in a deliberate action to earn
arbitrage on bond proceeds. Exceptions to the yield restriction
requirement permit an issuer to earn arbitrage in limited
circumstances, such as during limited temporary periods for prompt
spending of bond proceeds and other similar temporary periods.
Under section 148(f) of the Code, the arbitrage rebate requirement
provides that a bond is an arbitrage bond if the issuer fails to timely
rebate to the United States arbitrage otherwise permitted to be earned
on certain investments acquired with bond proceeds. Generally,
arbitrage rebate is paid every 5 years and upon the redemption of the
bond issue.
The Existing Regulations provide detailed rules for applying the
two types of arbitrage restrictions, including rules for determining
yield on the bond issue and yield on the investments, and rules for
computing and paying arbitrage rebate. The Treasury Department and the
IRS believe that discrete changes need to be made to the Existing
Regulations to simplify and clarify certain provisions, to make certain
provisions more administrable, and to update the regulations to reflect
current market practices.
II. Proposed Regulations
The Proposed Regulations make a number of discrete changes to the
Existing Regulations. Highlighted in this preamble are certain more
substantive changes which are discussed in further detail. In addition,
certain more minor changes are addressed in summary form.
[[Page 54607]]
(1) Hedges based on taxable interest rates. The Proposed
Regulations make revisions to accommodate certain hedges in which
floating payments under the hedge are based on a taxable interest rate
and to clarify that bonds covered by such a hedge are ineligible for
treatment as fixed yield bonds under the special hedging rule in Sec.
1.148-4(h)(4).
(2) Joint Bond Yield Authority. The Proposed Regulations remove the
provision in the Existing Regulations that permits the IRS Commissioner
to authorize a single yield computation on multiple bond issues.
(3) Electronic GIC Bidding. The Proposed Regulations revise the
bidding safe harbor for establishing the fair market value of
guaranteed investment contracts (GICs) to accommodate electronic
bidding.
(4) Refunds of Overpayments of Rebate. The Proposed Regulations
clarify that the amount that an issuer is entitled to receive under a
rebate refund claim is the excess of the total amount actually paid
over the rebate amount.
A. Changes To Accommodate Certain Hedges
Section 1.148-4 of the Existing Regulations sets forth rules for
determining the yield on an issue of bonds for purposes of applying the
arbitrage rules. In general, Sec. 1.148-4(h) of the Existing
Regulations permits issuers to compute the yield on an issue by taking
into account payments under ``qualified hedges.'' The Existing
Regulations provide two ways in which a qualified hedge can be taken
into account in computing yield on the issue, known commonly as
``simple integration'' and ``super integration.''
For both simple integration and super integration, a hedge must be
a ``qualified hedge,'' which is a hedge that meets a series of
eligibility requirements. Generally, in order to be a qualified hedge,
a hedge must be interest based, the terms of the hedge must correspond
closely with the terms of the hedged bonds, the issuer must duly
identify the hedge, and the hedge must contain no significant
investment element. For super integration, the hedge must meet
additional eligibility requirements which focus on assuring that the
terms of the hedge and the hedge bonds sufficiently correspond so as to
warrant treating the hedged bonds as fixed-yield bonds for arbitrage
purposes.
In the case of simple integration, generally all net payments on
the hedge and the hedged bonds are taken into account in determining
the yield on the bond issue. For example, if an issuer issues bonds
paying interest at a variable rate and enters into a hedge under which
the issuer receives floating interest rate payments from the hedge
provider and pays fixed interest payments to the hedge provider (a
variable-to-fixed hedge), the variable rate that the issuer pays to the
bondholders, the floating rate that the issuer receives on the hedge,
and the fixed payments that the issuer pays on the hedge are all taken
into account on a net basis in determining the yield on the bond issue.
In the case of simple integration, the hedged bonds are treated as
variable yield bonds, which means that the yield on the bond issue is
periodically recomputed and the rebate the issuer must pay to the
United States is based on the issuer's actual net payments and receipts
on the bond and the hedge. Thus, for example, any ``basis risk''
difference between the actual interest rate that the issuer pays on its
variable-yield hedged bond and the actual interest rate it receives on
the floating interest rate on the hedge (along with the fixed payments
on the hedge) is taken into account in determining the yield on the
hedged bonds.
In the case of super integration where the payments on the hedge
and the hedged bonds sufficiently correspond so that the yield on the
hedged bonds is fixed and determinable with certain assumptions, the
hedged bonds are treated as fixed-yield bonds for arbitrage purposes.
In the case of super integration, any basis risk difference between the
floating-rate interest payments on the hedge and the variable-rate
interest payments on the hedged bonds is ignored in determining the
yield on the hedged bonds for arbitrage purposes through an assumption
that treats those floating and variable rates as the same.
One of the eligibility requirements for a qualified hedge under the
Existing Regulations is that it be interest based. For simple
integration, one of the subsidiary aspects used in determining whether
a variable-to-fixed interest rate hedge is interest based focuses on
whether the variable interest rate on the hedged bonds and the floating
interest rate on the hedge are ``substantially the same.'' For super
integration purposes, such rates must be ``reasonably expected to be
substantially the same throughout the term of the hedge.'' This aspect
of the interest-based contract standard has raised technical issues in
recent years in connection with its application to certain kinds of
hedges, as discussed further in this preamble.
In general, hedging plays an increasingly important role in the
tax-exempt bond market. An issuer of bonds may use hedges to protect
itself against interest rate risks. For example, an issuer that issues
variable-rate bonds may hedge or protect itself against unfavorable
interest rate changes in the market by entering into a variable-to-
fixed interest rate swap. Historically, issuers of tax-exempt bonds
generally used a type of swap under which the hedge provider paid a
floating interest rate that was determined based on a market index of
tax-exempt interest rates, such as the Securities Industry and
Financial Markets Association (SIFMA) Municipal Swap Index.
A significant development in the tax-exempt bond market since the
promulgation of the Existing Regulations has been the trend toward the
use by issuers of variable-to-fixed interest rate swaps as hedges in
which the floating interest rate that the swap provider pays to the
issuer is determined based on a percentage of a market index of taxable
interest rates, such as the London Interbank Offered Rate (LIBOR) (a
taxable-index hedge). Issuers have indicated that these taxable-index
hedges offer more liquidity, more transparency in pricing, and lower
costs than hedges based on a tax-exempt interest index.
Issuers have raised interpretative questions about how to apply the
qualified hedge provisions of the Existing Regulations to taxable-index
hedges because interest rates on taxable indices generally do not
correspond as closely as interest rates on tax-exempt market indices to
actual market interest rates on tax-exempt, variable-rate bonds. These
interpretative questions are particularly important for taxable-index
hedges used with advance refunding bond issues because issuers
generally need to use the qualified hedge rules or some other regime to
determine with certainty the yield on the tax-exempt advance refunding
bonds in order to comply with the applicable arbitrage yield
restrictions on investments in defeasance escrows.
The IRS and the Treasury Department have determined that taxable-
index hedges based on widely-used taxable indices, such as LIBOR based
hedges, sufficiently improve the efficiency of the tax-exempt bond
market to warrant accommodation. The Proposed Regulations accommodate
these hedges by modifying (1) the provisions for ``yield reduction
payments,'' which permit an issuer to reduce yield on an investment by
making payments to the Federal government in certain permitted
circumstances to comply with yield restriction rules and (2) the
qualified hedge provisions. The Proposed Regulations make clear,
however, that while taxable-index hedges can be
[[Page 54608]]
qualified hedges, and therefore eligible for simple integration, they
are not eligible for super integration because there is an insufficient
correlation between tax-exempt bond interest rates and taxable market
interest rate indices. However, the IRS and the Treasury Department
understand that issuers have recently issued variable-rate bonds that
bear interest equal to a percentage of LIBOR, and seek public comments
on whether special accommodation under the super integration rule is
required for those bond issues.
Yield reduction payments effectively integrate the yield
restriction requirements with the arbitrage rebate requirements. For
certain limited situations, Sec. 1.148-5(c) of the Existing
Regulations permits yield reduction payments to be paid to the United
States to satisfy yield restriction requirements on certain
investments. Yield reduction payments are similar to, but not identical
to, rebate payments. In general, the purpose of the yield reduction
payment rules is to simplify compliance with the sometimes overlapping
yield restriction and arbitrage rebate requirements by allowing issuers
to make payments similar to rebate payments to the United States to
satisfy yield restriction and rebate in appropriate circumstances. For
example, an issuer may effectively reduce the yield on an investment to
a yield that will not violate the yield restriction rules and also
satisfy the arbitrage rebate requirement through a yield reduction
payment.
The Proposed Regulations modify the yield reduction payment rules
to permit issuers to make yield reduction payments on certain variable-
yield advance refunding issues in which the issuer has entered into a
qualified hedge in the form of a variable-to-fixed interest rate swap
to hedge its interest rate risk. This modification to the yield
reduction rule applies for nonpurpose investments allocable to gross
proceeds of an advance refunding issue deposited into an advance
refunding escrow when: (1) The issuer has entered into a qualified
hedge in the form of a variable-to-fixed interest rate swap on all of
its variable-rate bonds that are allocable to the yield restricted
defeasance escrow, (2) the hedge covers a period from the issue date of
the bonds until the final payment is made from the defeasance escrow,
and (3) the yield on the advance refunding escrow is not reasonably
expected to exceed the yield on the issue, determined by taking into
account the fixed payments that the issuer is expected to make under
the hedge and by assuming that the corresponding variable interest
payments to be made by the issuer on the hedged bonds and to be
received by the issuer on the hedge are equal and paid on the same
date. In effect, the Proposed Regulations allow yield reduction
payments in this context only to be made to cover the basis risk
differences between the hedge and the hedged bonds.
The Proposed Regulations also modify the qualified hedge provisions
to provide that the floating rate on the taxable-index hedge and the
variable rate on the hedged bonds will be treated as substantially the
same for purposes of Sec. 1.148-4(h)(2)(v)(B) if: (1) The difference
between the two rates is not greater than one-quarter of one percent
(.25 percent, or 25 basis points) on the date the issuer enters into
the hedge, and (2) for a three-year period that ends on the date the
issuer enters into the hedge, the average difference between the
issuer's actual tax-exempt interest rate on comparable variable-rate
bonds (or, if no such comparable bonds exist, a reasonable tax-exempt
interest rate index, such as the SIFMA Municipal Swap Index, for that
same period) and an interest rate determined in the same manner as the
floating interest rate on the hedge does not exceed one-quarter of one
percent (.25 percent, or 25 basis points). For example, if the floating
rate on the hedge is 67 percent of LIBOR, then 67 percent of LIBOR,
determined on the same days as the issuer's actual interest rates (or
tax-exempt index, if applicable) are determined, is compared to the
issuer's actual interest rates (or the tax-exempt index, if applicable)
for the three-year period ending on the date the hedge is entered into
and the differences are averaged to determine whether the average
difference exceeds one-quarter of one percent. For this purpose, a
reasonable sample may be used if the sample for the issuer's actual
rates (or tax-exempt market index rates, if applicable) and the sample
of floating rates used for the hedge are determined as of the same
dates.
The Proposed Regulations also make certain other limited changes to
the hedging and yield reduction rules which are discussed with other
miscellaneous changes in this preamble.
B. Joint Yield Authority
In general, for arbitrage purposes, the yield on a bond issue is
determined on an issue-by-issue basis. Section 1.148-4(a) of the
Existing Regulations, however, authorizes the IRS Commissioner to
permit issuers of certain types of tax-exempt bonds, specifically
qualified mortgage bonds and qualified student loan bonds, to compute a
single joint bond yield for purposes of applying the arbitrage
restrictions to two or more issues of these types of tax-exempt bonds.
Since the promulgation of the Existing Regulations, the IRS has
received numerous private letter ruling requests for joint bond yield
computations and has ruled on one of these requests. The Treasury
Department and the IRS, based on what the IRS has learned from these
ruling requests, are concerned about the highly factual nature of the
requests, and the potential for arbitrage manipulations with joint
yield computations that would not be apparent from a private letter
ruling request and that could not reasonably be discovered in the
context of such a request. For these reasons, the Proposed Regulations
eliminate the regulatory provision that permits joint yield
computations. However, the Treasury Department and the IRS are
considering whether generally applicable, objective standards can be
created under which joint yield computations should be allowed.
Accordingly, the Proposed Regulations solicit public comments on when
joint yield computations are needed for sound business reasons and
whether objective standards can be created that would allow these
computations in a manner that is consistent with the purposes of
section 148. In addition, comments are sought on the following: The
treatment of open-ended joint yield calculations that allow future
issues to be included in the joint yield computation, the treatment of
qualified hedges or guarantees that cover some but not all of the
bonds, the treatment of reserves, the application of prepayment
assumptions, the effect of partial refundings, and other issues that
impact the administrability of joint yield calculations. Pending final
resolution of this issue, the IRS will not entertain any private letter
ruling requests for permission to use a joint yield computation.
C. Modified Fair Market Value Safe Harbor for Guaranteed Investment
Contracts
Under Sec. 1.148-5(d)(3) of the Existing Regulations, investments
purchased with bond proceeds must be valued at fair market value.
Section 1.148-5(d)(6)(iii) of the Existing Regulations provides a safe
harbor for establishing the fair market value of a guaranteed
investment contract (GIC) for arbitrage purposes. That safe harbor
generally relies on a prescribed bidding procedure and the receipt of
at least three bids from independent parties. The bidding process
requirements under the safe harbor include a requirement that all
bidders be given an equal opportunity to bid with no opportunity to
review other
[[Page 54609]]
bids (that is, the ``no last look'' rule) and a requirement that the
bid specifications be provided to prospective bidders ``in writing.''
In the past several years, the tax-exempt bond market has seen the
advent of various electronic bidding procedures and internet platforms
for bidding GICs. While the particular features of specific GIC bidding
procedures may vary, characteristics of these electronic GIC bidding
procedures generally include using the internet to receive bid
specifications and to make bids. The electronic bidding process permits
providers, under prescribed times and procedures, to continuously bid
and to continuously view the current highest bids (without
identification of the bidders). The electronic platforms also provide
the capability to print out the results of the GIC bidding process. The
electronic GIC bidding procedures have raised certain technical issues
regarding whether they can comply with the fair market value safe
harbor for GICs under the Existing Regulations.
The Treasury Department and the IRS believe that electronic GIC
bidding procedures generally offer the constructive potential for
increasing the transparency of pricing of investments purchased with
proceeds of tax-exempt bonds. Accordingly, the Proposed Regulations
amend the fair market value safe harbor for GICs to accommodate
electronic bidding procedures by (1) permitting bid specifications to
be sent electronically over the Internet or by fax and (2) amending the
no last look rule to provide that there is not a prohibited last look
if all bidders have an equal opportunity for a last look.
D. Recovery of Overpayment of Rebate
Generally, an issuer computes the amount of arbitrage rebate that
it owes under a method that future values payments and receipts on
investments using the yield on the bond issue. Under this method, an
arbitrage payment made on one computation date is future valued to the
next computation date to determine the amount of arbitrage rebate owed
on that subsequent computation date. Section 1.148-3(i)(1) of the
Existing Regulations provides that an issuer may recover an overpayment
of arbitrage rebate with respect to an issue of tax-exempt bonds if the
issuer establishes to the satisfaction of the IRS Commissioner that an
overpayment occurred. Section 1.148-3(i)(1) further defines an
overpayment as the excess of ``the amount paid'' (emphasis added) to
the United States for an issue under section 148 over the sum of the
rebate amount for that issue as of the most recent computation date and
all amounts that are otherwise required to be paid under section 148 as
of the date the recovery is requested. Thus, even if the future value
of the issuer's arbitrage rebate payment on a computation date,
computed under the method for determining arbitrage rebate, is greater
than the issuer's rebate amount on that date, an issuer is only
entitled to a refund to the extent that the amount actually paid
exceeds that rebate amount. The Existing Regulations limit the amount
of the refund in this manner because the Treasury Department and the
IRS were concerned about whether the IRS had statutory authority to pay
interest on arbitrage rebate payments. To permit a refund in an amount
calculated in whole or in part based upon a future value of the amount
actually paid would effectively result in an interest payment on that
payment.
Example 2(iii)(D) in Sec. 1.148-3(j) of the Existing Regulations
has caused confusion because it could be interpreted to mean that an
issuer can receive a refund of a rebate payment when the future value
of such rebate payment exceeds the rebate amount on the next
computation date, even though the actual amount of the previous rebate
payment does not exceed the rebate amount on that next computation
date. The Proposed Regulations make a technical amendment to this
example to conform this example to the intended purpose of Sec. 1.148-
3(i)(1). Because the proposed change does not change the regulatory
rule, but merely makes an existing example conform to that rule, the
Proposed Regulations provide that the effective date for this provision
is the same as the effective date for the regulatory rule. However, the
IRS will not reopen rebate refund claims that have been processed
before the date the Proposed Regulations are published in the Federal
Register.
E. Other Miscellaneous Changes
1. Qualified Hedge Provisions
The Proposed Regulations make the following additional changes to
the hedging rules in Sec. 1.148-4(h) and specifically seek the
following comments on the hedging rules.
a. Cost of Funds Hedges. The Proposed Regulations clarify that for
purposes of applying the definition of periodic payment under Sec.
1.446-3(e)(1) to determine whether a hedge has a significant investment
element under Sec. 1.148-4(h)(2)(ii)(A), a ``specified index'' under
Sec. 1.446-3(c)(2) (upon which periodic payments are based) is deemed
to include payments under a cost-of-funds swap, thereby eliminating any
doubt that these hedges can be qualified hedges.
b. Size and Scope of a Qualified Hedge. The Proposed Regulations
add an express requirement under Sec. 1.148-4(h)(2)(v) that limits the
size and scope of a qualified hedge to a level that is reasonably
necessary to hedge the issuer's risk with respect to interest rate
changes on the hedged bonds. This proposed limitation is comparable to
a former provision that was in the arbitrage regulations from 1993 to
1997, but was removed in connection with 1997 amendments to the
Existing Regulations. The Treasury Department and the IRS believe that
this principle was implicitly carried forward in the subsidiary
standards under the interest-based contract requirement in the Existing
Regulations in 1997. The Proposed Regulations, however, provide an
explicit separate requirement to clarify the continued application of
this principle.
c. Correspondence of Payments for Simple Integration. Commentators
have requested guidance on what time period satisfies the rule under
Sec. 1.148-4(h)(2)(vi) that requires payments on a hedge to correspond
closely in time to the payments on the hedged bonds. The Proposed
Regulations add a rule for simple integration that treats payments as
corresponding closely in time for this purpose if the payments are made
within 60 calendar days of each other. This proposed rule contrasts
with the rules for super integration, which require that payments be
made within 15 days of each other. The Proposed Regulations provide a
more flexible time period for correspondence of payments for simple
integration purposes consistent with the fact that simple integration
results in more accurate accounting for all net payments.
d. Time for Identification of Qualified Hedges. Commentators have
indicated that the three-day period for identifying a hedge under Sec.
1.148-4(h)(2)(viii) of the Existing Regulations raises practical
difficulties, particularly with respect to hedges that are not entered
into contemporaneously with the issuance of the hedged bonds. The
Proposed Regulations extend the time in Sec. 1.148-4(h)(2)(viii) for
when an issuer must identify a qualified hedge from three days to
fifteen days and clarify that these are calendar days. The Proposed
Regulations, however, retain the requirement that the actual State or
local governmental issuer, rather than the conduit borrower, identify
the hedge because the Treasury Department and the IRS believe that it
is important for State and local governments to be
[[Page 54610]]
responsible for qualified hedges on their bonds.
e. Termination of Hedges at Fair Market Value. The Proposed
Regulations clarify that under Sec. 1.148-4(h)(3)(iv)(B), the
termination payment for a termination or a deemed termination is equal
to the fair market value of the hedge on the termination date.
f. Solicitation of Comment on Offsetting Hedges. The Treasury
Department and the IRS have received requests for clarification of the
scope of the rule that treats offsetting hedges as deemed terminations
of qualified hedges under Sec. 1.148-4(h)(3)(iv)(A). The Treasury
Department and the IRS seek express public comment regarding the types
of offsetting hedges that are necessary for valid business purposes and
recommendations on how to clarify the scope of this rule on offsetting
hedges.
2. Yield Reduction Payment Rules
The Proposed Regulations permit issuers to make yield reduction
payments for nonpurpose investments allocable to proceeds of an issue,
including an advance refunding issue, that an issuer purchases on a
date when the issuer is unable to purchase State and Local Government
Series Securities (SLGS) because the Department of Treasury, Bureau of
Public Debt, has suspended sales of SLGS. This provision incorporates
and expands Revenue Procedure 95-47, 1995-2 CB 417, which permits yield
reduction payments in more limited situations than the Proposed
Regulations when SLGS are unavailable.
The Proposed Regulations also reorganize the yield reduction rules
to make them easier to read.
3. Modification of Yield Computation for Yield-to-Call Premium Bonds
The Proposed Regulations simplify the rules for computing yield on
an issue that has certain callable premium bonds. Existing Regulations
generally provide that the yield on an issue is based on the yield to
maturity, taking into account certain assumptions. The Existing
Regulations have a special rule for certain callable bonds issued with
significant amounts of bond premium (sometimes called yield-to-call
bonds), which requires a determination of yield to a call date, based
on certain assumed optional redemptions. The general purpose of this
rule is to recognize that a yield-to-maturity computation may not be
economically accurate in this circumstance because these yield-to-call
bonds are more likely than other bonds to be called before maturity and
before amortization of the premium.
Section 1.148-4(b)(3)(i) of the Existing Regulations treats a
yield-to-call bond as redeemed at the stated redemption price on the
optional redemption date that would produce the lowest yield on the
issue (as contrasted with the lowest yield on the particular premium
bond). This methodology, which considers the lowest yield on the issue
for these yield-to-call bonds, requires computations of possible
combinations of redemption dates in circumstances in which the
variations of redemption dates may have very limited impact on yield.
The Proposed Regulations simplify the yield calculations for these
yield-to-call bonds to focus on the redemption date that results in the
lowest yield on the particular premium bond (rather than the more
complex existing focus on the lowest yield on the issue). This change
corresponds to a former version of this regulatory rule which was in
effect under applicable arbitrage regulations from 1989 through 1992.
4. Arbitrage Rebate Computation Credit
Section 1.148-3(d)(1)(iv) of the Existing Regulations provides that
an issuer may take certain credits against payment of arbitrage rebate
in the amount of $1,000 for each rebate computation date, subject to
certain limitations, to help offset the cost of computing rebate. The
Proposed Regulations increase this rebate credit to $1,400 for any bond
year ending in the year 2007 to reflect the change in the Consumer
Price Index since the $1,000 rebate credit was published. The Proposed
Regulations further adjust the computation date credit for inflation
for bond years ending in each year thereafter.
5. External Commingled Investment Funds
The Existing Regulations provide certain preferential rules for the
treatment of administrative costs to certain widely-held ``external
commingled funds,'' as defined in Sec. 1.148-5(e)(2)(ii)(B). Under the
Existing Regulations, a fund is treated as widely held if the fund, on
average, has more than 15 unrelated investors, each of which maintains
prescribed minimum average investments in the fund. The Proposed
Regulations make a technical change to allow additional smaller
investors to invest in an external commingled fund without
disqualifying the fund so long as at least 16 unrelated investors each
maintain the required minimum average investments in the fund.
6. Pooled Bonds
The Proposed Regulations make conforming changes to Sec. 1.148-
8(d) to reflect legislative changes made to section 148(f)(4)(D) by
section 508 of the Tax Increase Prevention and Reconciliation Act of
2005, Pub. L. No. 109-222, 120 Stat. 345 (TIPRA). Under TIPRA, Congress
eliminated the rule in Sec. 148(f)(4)(D)(ii)(II) that permitted a pool
bond issuer to ignore its pool bond issue in computing whether it had
exceeded its $5 million limit for purposes of the small issuer rebate
exception of section 148(f)(4)(D). Correspondingly, the Proposed
Regulations eliminate the provisions in the Existing Regulations that
permit a pool bond issuer to ignore the amount of its pool bond issue
in determining whether the issuer meets the small issuer exception of
section 148(f)(4)(D). The Proposed Regulations retain the provision
that permits a State or local governmental conduit borrower to ignore
the amount of certain pool bond issues in excess of the amount it
borrows from that pool. Consistent with the statutory change, the
Proposed Regulations provide that the change for pool bond issuers is
effective for bonds issued after May 17, 2006, the effective date of
the relevant provision of TIPRA.
III. Effective Dates
The Proposed Regulations are proposed to apply to bonds sold on or
after a date that is 90 days after publication of final regulations in
the Federal Register, but an issuer may apply certain specified
provisions of the Proposed Regulations to bonds sold before the date
that is 90 days after publication of the final regulations in the
Federal Register as provided in proposed Sec. 1.148-11(k). Except for
the changes to the qualified hedging rules which must be applied in
their entirety, issuers that are permitted, but not required, to apply
the proposed changes may apply some or all of the changes to a bond
issue.
The Proposed Regulations contain a technical amendment to the
example in the general arbitrage rebate rules. This change applies to
bonds subject to Sec. 1.148-3(i), the dates of applicability for which
are set forth in the Existing Regulations.
The Proposed Regulations contain a special effective date provision
for the regulatory change that conforms the arbitrage regulations to
the legislative change made to the small issuer rebate exception for
pooled bond issuers. This change applies to bonds issued after May 17,
2006, the effective date of the relevant provision of TIPRA.
[[Page 54611]]
Effect on Other Documents
On the date of applicability of the final regulations, Revenue
Procedure 95-47, 1995-2 CB 417, will be obsoleted.
Special Analyses
It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in EO 12866. Therefore,
a regulatory assessment is not required. It is hereby certified that
these proposed regulations will not have a significant economic impact
on a substantial number of small entities. Therefore, a Regulatory
Flexibility Analysis under the Regulatory Flexibility Act (5 U.S.C.
chapter 6) is not required. Some of the proposed changes clarify
existing regulatory provisions, conform the regulations to a recent
statutory change, or otherwise involve simplifying or clarifying
changes that will not have a significant economic impact on
governmental jurisdictions or other entities of any size. Other
proposed changes involve the treatment of certain hedging transactions,
such as interest rate swaps, for purposes of the arbitrage investment
restrictions on tax-exempt bonds issued by State and local governments.
Although there is a lack of available data regarding the extent of
usage of these hedging transactions by small entities, the IRS and the
Treasury Department understand that these hedging transactions are used
primarily by larger State and local governments and other eligible
larger entities. The IRS and the Treasury Department specifically
solicit comment from any party, particularly affected small entities,
on the accuracy of this certification. Pursuant to section 7805(f) of
the Internal Revenue Code, this regulation has been submitted to the
Small Business Administration for comment on its impact on small
governmental jurisdictions.
Comments and Public Hearing
Before these Proposed Regulations are adopted as final regulations,
consideration will be given to any written (a signed original and eight
(8) copies) or electronic comments that are submitted timely to the
IRS. The Treasury Department and IRS request comments on the clarity of
the proposed rules and how they can be made easier to understand. All
comments will be available for public inspection and copying.
A public hearing has been scheduled for January 30, 2008 at 10 a.m.
in the Main IRS Auditorium, Internal Revenue Service Building, 1111
Constitution Avenue, NW., Washington, DC. Due to building security
procedures, visitors must enter at the Constitution Avenue entrance. In
addition, all visitors must present photo identification to enter the
building. Because of access restrictions, visitors will not be admitted
beyond the immediate entrance area more than 30 minutes before the
hearing starts. For information about having your name placed on the
building access list to attend the hearing, see the FOR FURTHER
INFORMATION CONTACT section of this preamble.
The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who
wish to present oral comments at the hearing must submit written or
electronic comments and an outline of the topics to be discussed and
the time to be devoted to each topic (a signed original and eight (8)
copies) by January 2, 2008. A period of 10 minutes will be allotted to
each person for making comments.
An agenda showing the scheduling of the speakers will be prepared
after the deadline for receiving outlines has passed. Copies of the
agenda will be available free of charge at the hearing.
Drafting Information
The principal authors of these regulations are Rebecca L. Harrigal
and Carla A. Young, Office of Associate Chief Counsel (Financial
Institutions and Products), IRS. However, other personnel from the IRS
and Treasury Department participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, 26 CFR part 1 is proposed to be amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
Sections 1.148-0, 1.148-3, 1.148-4, 1.148-5, 1.148-8 and 1.148-
11 also issued under 26 U.S.C. 148(i).
Par. 2. Section 1.148-0(c) is amended as follows:
1. Add entry for new paragraph (d)(4) in the table of contents for
Sec. 1.148-3.
2. Revise entry for paragraph (d) in the table of contents for
Sec. 1.148-8.
3. Remove entries for paragraph (d)(1) and paragraph (d)(2) in the
table of contents for Sec. 1.148-8.
4. Add entries for new paragraphs (k), (k)(1), (k)(2), (k)(3) and
(k)(4) in the table of contents for Sec. 1.148-11.
The revised and added provisions read as follows:
Sec. 1.148-0 Scope and Table of Contents.
* * * * *
Sec. 1.148-3 General arbitrage rebate rules.
* * * * *
(d) * * *
(4) Cost-of living adjustment.
* * * * *
Sec. 1.148-8 Small issuer exception to rebate requirement.
* * * * *
(d) Pooled financings--treatment of conduit borrowers.
* * * * *
Sec. 1.148-11 Effective dates.
* * * * *
(k) Certain arbitrage guidance updates.
(1) In general.
(2) Permissive earlier application.
(3) Rebate overpayment recovery.
(4) Small issuer exception to rebate requirement for conduit
borrowers of pooled financings.
* * * * *
Par. 3. Section 1.148-3 is amended by revising paragraph (d)(1)(iv)
and adding a new paragraph (d)(4) as follows:
Sec. 1.148-3 General arbitrage rebate rules.
* * * * *
(d) * * *
(1) * * *
(iv) On the last day of each bond year during which there are
amounts allocated to gross proceeds of an issue that are subject to the
rebate requirement, and on the final maturity date, a computation
credit of $1,400 for any bond year ending in 2007 and, for bond years
ending after 2007, a computation credit in the amount determined under
paragraph (d)(4) of this section; and
* * * * *
(4) Cost-of-living adjustment. For any calendar year after 2007,
the $1,400 computation credit set forth in paragraph (d)(1)(iv) shall
be increased by an amount equal to such dollar amount multiplied by the
cost-of-living adjustment determined under section 1(f)(3) for such
year as modified by this paragraph (d)(4). In applying section 1(f)(3)
to determine this cost-of-living adjustment, the reference to
``calendar year 1992'' in section 1(f)(3)(B) shall be changed to
``calendar year 2006.'' If any such increase determined under this
paragraph (d)(4) is not a multiple of $10, such increase shall be
rounded to the nearest multiple thereof.
* * * * *
[[Page 54612]]
Par. 4. Section 1.148-3(j) is amended by revising Example 2(iii)(D)
to read as follows:
Sec. 1.148-3 General arbitrage rebate rules.
* * * * *
(j) * * *
Example 2. * * *
(iii) * * *
(D) If the yield during the second computation period were,
instead, 7.0000 percent, the rebate amount computed as of July 1, 2004,
would be $1,320,891. The future value of the payment made on July 1,
1999, would be $1,471,007. Although the future value of the payment
made on July 1, 1999 ($1,471,007), exceeds the rebate amount computed
as of July 1, 2004 ($1,320,891), Sec. 1.148-3(i) limits the amount
recoverable as a defined overpayment of rebate under section 148 to the
excess of the total ``amount paid'' over the sum of the amount
determined under the future value method to be the ``rebate amount'' as
of the most recent computation date and all other amounts that are
otherwise required to be paid under section 148 as of the date the
recovery is requested. Because the total amount that the issuer paid on
July 1, 1999 ($1,042,824.60), does not exceed the rebate amount as of
July 1, 2004 ($1,320,891), the issuer would not be entitled to recover
any overpayment of rebate in this case.
* * * * *
Par. 5. Section 1.148-4(a) is revised to read as follows:
Sec. 1.148-4 Yield on an issue of bonds.
(a) In general. The yield on an issue of bonds is used to apply
investment yield restrictions under section 148(a) and to compute
rebate liability under section 148(f). Yield is computed under the
economic accrual method using any consistently applied compounding
interval of not more than one year. A short first compounding interval
and a short last compounding interval may be used. Yield is expressed
as an annual percentage rate that is calculated to at least four
decimal places (for example, 5.2525 percent). Other reasonable,
standard financial conventions, such as the 30 days per month/360 days
per year convention, may be used in computing yield but must be
consistently applied. The yield on an issue that would be a purpose
investment (absent section 148(b)(3)(A)) is equal to the yield on the
conduit financing issue that financed that purpose investment.
* * * * *
Par. 6. Section 1.148-4 is amended by:
1. Revising paragraph (b)(3)(i), and adding a new sentence at the
end of paragraph (h)(2)(ii)(A).
2. Revising the heading and introductory text of paragraph
(h)(2)(v).
3. Amending paragraph (h)(2)(v)(B) by revising the last sentence.
4. Adding paragraphs (h)(2)(v)(B)(1), (2) and (3).
5. Adding a new sentence at the end of paragraph (h)(2)(vi).
6. Revising the heading and first sentence of paragraph
(h)(2)(viii).
7. Amending paragraph (h)(3)(iv)(B) by adding a new sentence
immediately after the first sentence.
8. Adding a new sentence at the end of paragraph (h)(4)(i)(C).
The revised and added provisions read as follows:
Sec. 1.148-4 Yield on an issue of bonds.
* * * * *
(b) * * *
(3) Yield on certain fixed yield bonds subject to optional early
redemption--(i) In general. If a fixed yield bond is subject to
optional early redemption and is described in paragraph (b)(3)(ii) of
this section, the yield on the issue containing the bond is computed by
treating the bond as redeemed at its stated redemption price on the
optional redemption date that would produce the lowest yield on that
bond.
* * * * *
(h) * * *
(2) * * *
(ii) * * *
(A) * * * For purposes of applying the definition of periodic
payment under Sec. 1.446-3 to determine whether a hedge has a
significant investment element under this paragraph (h)(2)(ii)(A), the
definition of ``specified index'' under Sec. 1.446-3 (upon which
periodic payments are required to be based) is deemed also to include
payments an issuer receives under a hedge that are computed to be equal
to the issuer's cost of funds, such as the issuer's actual market-based
tax-exempt variable interest rate on its bonds.
* * * * *
(v) Interest-based contract and size and scope of hedge. The
contract is primarily interest-based (for example, a hedge based on a
debt index rather than an equity index). In addition, the size and
scope of the hedge under the contract is limited to that which is
reasonably necessary to hedge the issuer's risk with respect to
interest rate changes on the hedged bonds. For example, a contract is
limited to hedging an issuer's risk with respect to interest rate
changes on the hedged bonds if the hedge is based on the issuer's
principal amount of bonds and reasonably expected interest requirements
rather than based on a greater notional amount or an interest rate
level greater than the expected interest requirements. A contract is
not primarily interest based unless--
* * * * *
(B) * * * For this purpose, differences that would not prevent the
resulting bond from being substantially similar to another type of bond
or to result in overhedging include:
(1) A difference between the interest rate used to compute payments
on the hedged bond and the interest rate used to compute payments on
the hedge where one interest rate is substantially the same as, but not
identical to, the other. For this purpose, if an interest rate swap
under which the issuer pays the hedge provider a fixed interest payment
and receives from the hedge provider a floating interest rate that is
based on a taxable interest rate or a taxable market interest rate
index, the floating rate on the hedge and the variable rate on the
hedged bonds will be treated as being substantially the same only if:
(i) The difference between the interest rate on the issuer's hedged
bonds and the floating interest rate on the hedge does not exceed one
quarter of one percent (.25 percent, or 25 basis points) on the date
that the issuer enters into the hedge; and
(ii) For a three-year period that ends on the date the issuer
enters into the hedge, the average difference between the issuer's
actual tax-exempt interest rate on comparable variable-rate bonds (or,
if no such comparable bonds exist, rates from a reasonable tax-exempt
interest rate index, such as the SIFMA Municipal Swap Index, for that
same period) and interest rates determined in the same manner as the
floating interest rate on the hedge and as of the same dates as the
issuer's comparable variable-rate bonds (or the tax-exempt market
index, if applicable) does not exceed one-quarter of one percent (.25
percent, or 25 basis points). For example, if the floating rate on the
hedge is 67 percent of LIBOR, then 67 percent of LIBOR, determined as
of the same dates as the issuer's actual interest rates (or tax-exempt
market index, if applicable) is compared to those actual interest rates
(or the tax-exempt market index, if applicable) for the three-year
period ending on the date the hedge is entered into and the differences
are averaged to determine whether the average difference exceeds one-
quarter of one percent. For this purpose, a reasonable sample may be
used if the sample for the issuer's actual rates (or tax-exempt market
index rates, if applicable) and the sample of floating rates used for
the hedge are determined as of the same dates.
(2) A difference resulting from the payment of a fixed premium for
a cap (for example, payments for a cap that
[[Page 54613]]
are made in other than level installments).
(3) A difference resulting from the allocation of a termination
payment if the termination was unexpected as of the date that the
parties entered into the hedge contract.
(vi) * * * For this purpose, such payments will be treated as
corresponding closely in time under this paragraph (h)(2)(vi) if they
are made within 60 calendar days of each other.
* * * * *
(viii) Reasonably contemporaneous identification. The contract must
be identified by the actual issuer on its books and records maintained
for the hedged bonds not later than 15 calendar days after the date on
which the issuer and the hedge provider enter into the hedge contract.
* * *
(3) * * *
(iv) * * *
(B) * * * The amount of the termination payment in a termination or
deemed termination is equal to the fair market value of the qualified
hedge on the date of the termination. * * *
* * * * *
(4) * * *
(i) * * *
(C) * * * Except for an anticipatory hedge that is terminated or
otherwise closed substantially contemporaneously with the hedged bond
in accordance with paragraph (h)(5)(ii) or (h)(5)(iii) of this section,
a hedge based on a taxable interest rate or taxable interest index (for
example, the London Interbank Offered Rate or LIBOR) does not meet the
requirements of this paragraph (C).
* * * * *
Par. 7. Section 1.148-5(c) is amended by:
1. Removing existing paragraph (c)(3)(ii).
2. Adding introductory language to paragraph (c)(3).
3. Removing the heading in paragraph (c)(3)(i) and redesignating
the existing text in paragraph (c)(3)(i)(A) as the text in paragraph
(c)(3)(i).
4. Redesignate existing paragraphs (c)(3)(i)(B), (c)(3)(i)(C),
(c)(3)(i)(D), (c)(3)(i)(E), (c)(3)(i)(F), and (c)(3)(i)(G) as
paragraphs (c)(3)(ii), (c)(3)(iii), (c)(3)(iv), (c)(3)(v), (c)(3)(vi),
and (c)(3)(vii), respectively.
5. Redesignate existing paragraphs (c)(3)(i)(C)(1) and
(c)(3)(i)(C)(2) as paragraphs (c)(3)(iii)(A) and (c)(3)(iii)(B),
respectively, in newly redesignated paragraph (c)(3)(iii).
6. Redesignate existing paragraphs (c)(3)(i)(E)(1) and
(c)(3)(i)(E)(2) as paragraphs (c)(3)(v)(A) and (c)(3)(v)(B),
respectively, in newly redesignated paragraph (c)(3)(v).
7. Amend newly redesignated paragraph (c)(3)(i), (c)(3)(ii),
(c)(3)(iii), (c)(3)(iv), (c)(3)(v), (c)(3)(vi) and (c)(3)(vii) by
adding headings to each paragraph.
8. Revise newly redesignated paragraph (c)(3)(v).
9. Revise newly redesignated paragraph (c)(3)(vi).
10. Amend newly redesignated paragraph (c)(3)(vii) by removing the
period at the end of the paragraph and replacing it with a semicolon.
11. Amending paragraph (c)(3) by adding new paragraphs (c)(3)(viii)
and (c)(3)(ix).
The revised and added provisions read as follows:
Sec. 1.148-5 Yield and valuation of investments.
* * * * *
(c) * * *
(3) Applicability of special yield reduction rule. Except as
otherwise expressly provided in paragraphs (c)(3)(i) through (ix) of
this section, paragraph (c) applies only to investments listed in
paragraphs (c)(3)(i) through (c)(3)(ix) of this section that are
allocated to proceeds of an issue other than gross proceeds of an
advance refunding issue.
(i) Nonpurpose investments allocated to proceeds of an issue that
qualified for certain temporary periods. * * *
(ii) Investments allocable to certain variable yield issues. * * *
(iii) Nonpurpose investments allocable to certain transferred
proceeds. * * *
(A) * * *
(B) * * *
(iv) Purpose investments allocable to certain qualified student
loans. * * *
(v) Nonpurpose investments allocable to gross proceeds in certain
reserve funds. Nonpurpose investments allocable to gross proceeds of an
issue in a reasonably required reserve or replacement fund or a fund
that, except for its failure to satisfy the size limitation in Sec.
1.148-2(f)(2)(ii), would qualify as a reasonably required reserve or
replacement fund, but only to the extent the requirements in paragraphs
(c)(3)(v)(A) or (B) of this section are met. This paragraph (c)(3)(v)
includes nonpurpose investments described in this paragraph that are
allocable to transferred proceeds of an advance refunding issue, but
only to the extent necessary to satisfy yield restriction under section
148(a) on those proceeds treating all investments allocable to those
proceeds as a separate class.
(A) * * *
(B) * * *
(vi) Nonpurpose investments allocable to certain replacement
proceeds of refunded issues. Nonpurpose investments allocated to
replacement proceeds of a refunded issue, including a refunded issue
that is an advance refunding issue, as a result of the application of
the universal cap to amounts in a refunding escrow;
(vii) Investments allocable to replacement proceeds under a certain
transition rule. * * *
(viii) Nonpurpose investments allocable to proceeds when SLGS are
unavailable. Nonpurpose investments allocable to proceeds of an issue,
including an advance refunding issue, that an issuer purchases on a
date when the issuer is unable to purchase State and Local Government
Series Securities (SLGS) because the U.S. Department of Treasury,
Bureau of Public Debt, has suspended sales of those securities; and
(ix) Nonpurpose investments allocable to proceeds of certain
variable-yield advance refunding issues. Nonpurpose investments
allocable to proceeds of a variable-yield advance refunding issue (the
hedged bond issue) deposited in a yield restricted defeasance escrow
if--
(A) The issuer has entered into a qualified hedge under Sec.
1.148-4(h)(2) with respect to all of the variable-yield bonds of the
issue allocable to the yield restricted defeasance escrow and that
hedge is in the form of a variable-to-fixed interest rate swap under
which the issuer pays the hedge provider a fixed interest rate and
receives from the hedge provider a floating interest rate;
(B) Such qualified hedge covers a period beginning on the issue
date of the hedged bond issue and ending on or after the date on which
the final payment is to be made from the yield restricted defeasance
escrow; and
(C) The issuer restricts the yield on the yield restricted
defeasance escrow to a yield that is not greater than the yield on the
hedged bond issue, determined by taking into account the issuer's fixed
payments to be made under the hedge and by assuming that the issuer's
variable yield payments to be paid on the hedged bonds are equal to the
floating payments to be received by the issuer under the qualified
hedge and are paid on the same dates (that is, such yield reduction
payments can only be made to address basis risk differences between the
variable yield payments on the hedged bonds and the floating payments
received on the hedge).
* * * * *
Par. 8. Section 1.148-5(d)(6) is amended by revising paragraphs
(d)(6)(iii)(A)(1) and (d)(6)(iii)(A)(6) to read as follows:
[[Page 54614]]
Sec. 1.148-5 Yield and valuation of investments.
* * * * *
(d) * * *
(6) * * *
(iii) * * *
(A) * * *
(1) The bid specifications are in writing and are timely forwarded,
or are made available on an internet website or other similar
electronic media that is regularly used to post bid specifications, to
potential bidders. For purposes of this paragraph (d)(6)(iii)(A), a
writing includes a hard copy, a fax, or an electronic e-mail copy.
* * * * *
(6) All potential providers have an equal opportunity to bid. If
the bidding process affords any opportunity for a potential provider to
review other bids before providing a bid, then providers have an equal
opportunity to bid only if all potential providers have an equal
opportunity to review other bids. Thus, no potential provider may be
given an opportunity to review other bids that is not equally given to
all potential providers (that is, no exclusive ``last look'').
* * * * *
Par. 9. Section 1.148-5(e)(2) is amended by revising the second
sentence of paragraph (e)(2)(ii)(B) to read as follows:
Sec. 1.148-5 Yield and valuation of investments.
* * * * *
(e) * * *
(2) * * *
(ii) * * *
(B) External commingled funds. * * * For purposes of this paragraph
(e)(2)(ii)(B), a fund is treated as widely held only if, during the
immediately preceding fixed, semiannual period chosen by the fund (for
example, semiannual periods ending June 30 and December 31), the fund
had a daily average of more than 15 investors that were not related
parties, and at least 16 of the unrelated investors each maintained a
daily average amount invested in the fund that was not less than the
lesser of $500,000 and one percent (1%) of the daily average of the
total amount invested in the fund (with it being understood that
additional smaller investors will not disqualify the fund). * * *
* * * * *
Par. 10. Section 1.148-8(d) is revised to read as follows:
Sec. 1.148-8 Small Issuer Exception to Rebate Requirement.
* * * * *
(d) Pooled financings--treatment of conduit borrowers. A loan to a
conduit borrower in a pooled financing qualifies for the small issuer
exception, regardless of the size of either the pooled financing or of
any loan to other conduit borrowers, only if--
(1) The bonds of the pooled financing are not private activity
bonds;
(2) None of the loans to conduit borrowers are private activity
bonds; and
(3) The loan to the conduit borrower meets all the requirements of
the small issue exception.
* * * * *
Par. 11. Section 1.148-11 is revised by adding new paragraph (k) as
follows:
Sec. 1.148-11 Effective Dates.
* * * * *
(k) Certain arbitrage guidance updates.
(1) In general. Sections 1.148-3(d)(1)(iv); 1.148-3(d)(4); 1.148-
4(a); 1.148-4(b)(3)(i); 1.148-4(h)(2)(ii)(A); 1.148-4(h)(2)(v); 1.148-
4(h)(2)(vi); 1.148-4(h)(2)(viii); 1.148-4(h)(3)(iv)(B); 1.148-
4(h)(4)(i)(C); 1.148-5(c)(3); 1.148-5(d)(6)(iii)(A) and 1.148-
5(e)(2)(ii)(B), as in effect on the effective date of the final
regulations (the revised provisions), apply to bonds sold on or after
the date that is 90 days after publication of the final regulations in
the Federal Register, for bonds subject to such applicable section of
the regulations as in effect before the effective date of the final
regulations.
(2) Permissive earlier application. To the extent provided in
paragraphs (k)(2)(i) through (vi) of this section, issuers may apply
the proposed regulations to bonds sold before the date that is 90 days
after publication of the final regulations in the Federal Register.
(i) Section 1.148-3(d)(1)(iv) and Sec. 1.148-3(d)(4) may be
applied for bond years ending on or after the date of publication of
the proposed regulations in the Federal Register for bonds to which
1.148-3(d)(1)(iv) applies.
(ii) Section 1.148-4(b)(3)(i) may be applied for bonds sold on or
after the date of publication of the proposed regulations in the
Federal Register for bonds to which that section applies.
(iii) Sections 1.148-4(h)(2)(ii)(A), 1.148-4(h)(2)(v), 1.148-
4(h)(2)(vi), 1.148-4(h)(2)(viii), 1.148-4(h)(3)(iv)(B), and 1.148-
4(h)(4)(i)(C) may be applied, in whole but not in part, for qualified
hedges entered into on or after the date of publication of the proposed
regulations in the Federal Register for bonds to which Sec. 1.148-4(h)
applies.
(iv) Section 1.148-5(c)(3) may be applied for investments purchased
on or after the date of publication of the proposed regulations in the
Federal Register for bonds to which that section applies.
(v) Section 1.148-5(d)(6)(iii)(A) may be applied to guaranteed
investment contracts entered into on or after the date of publication
of the proposed regulations in the Federal Register for bonds to which
Sec. 1.148-5(d)(6)(iii) applies.
(vi) Section 1.148-5(e)(2)(ii)(B) may be applied with respect to
investors investing in the fund on or after the date of publication of
the proposed regulations in the Federal Register for bonds to which
that section applies.
(3) Rebate overpayment recovery. Section 1.148-3(j) applies to
bonds subject to Sec. 1.148-3(i).
(4) Small issuer exception to rebate requirement for conduit
borrowers of pooled financings. Section 1.148-8(d) applies to bonds
issued after May 17, 2006.
Linda E. Stiff,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 07-4734 Filed 9-24-07; 8:45 am]
BILLING CODE 4830-01-P